Even if there is no exempt income, spending must be disallowed under Rule 8D of Income Tax: Budget 2022

No deduction shall be permitted in respect of expenditure in relation to tax-exempt income, according to Section 14A of the Income-tax Act of 1961. Over the years, there have been disagreements about whether an assessee can be disallowed under section 14A of the Act if no exempt income has accrued, arisen, or been received during the financial year. The Central Board of Direct Taxes (CBDT) released Circular No. 5/2014 on February 11, 2014, clarifying that Rule 8D, coupled with section 14A of the Act, allows for disallowance of expenditure even if the taxpayer has not generated any exempt income in that year. However, some courts have held that no disallowance can be made if there is no exempt income throughout the year.

Budget Proposal

The Budget proposes to clarify that Section 14A shall apply and shall be deemed to have always applied in cases where exempt income has not accrued, arisen, or been received during the financial year and expenditure has been incurred in relation to such exempt income in order to make the legislative intent clear and to avoid any misinterpretation. From FY 2021-22 onwards, the amendment would be in effect.

Individuals/ HUFs will not be able to claim this deduction when completing their income tax returns for FY 2021-22 (the deadline is July 31 for individuals/ HUFs without company income, unless the government extends the deadline).

Illustration

For Example, if during a previous year, an assessee incurs an expense of Rs. 1 lakh to earn a non-exempt income of Rs. 1.5 lakh and also incurs an expense of Rs. 20,000/- to earn exempt income which may or may not have accrued/received during the year. By holding that provisions of section 14A of the Act do not apply in this year as the exempt income was not accrued/received during the year, it amounts to holding that Rs. 20,000/- would be allowed as a deduction against non-exempt income of Rs. 1.5 Lakh even though this expense was not incurred wholly and exclusively for the purpose of earning non-exempt income. Such an interpretation defeats the legislative intent of both Section 14A as well as section 37 of the Act.

In order to make the intention of the legislation clear and to make it free from any misinterpretation, it is proposed to insert an Explanation to section 14A of the Income Tax Act to clarify that notwithstanding anything to the contrary contained in this Act, the provisions of this section shall apply and shall be deemed to have always applied in a case where exempt income has not accrued or arisen or has not been received during the previous year relevant to an assessment year and the expenditure has been incurred during the said previous year in relation to such exempt income.