The Bombay High Court will shortly be hearing an interesting question of law in relation to Section 14A of the Income Tax Act – does disallowance under Section 14A arise when exempt income has not actually been earned? If certain expenditures have been incurred for the purpose of earning exempt dividend (for example), but if for some reason dividend is not actually earned, can that expenditure be disallowed under Section 14A?
The position of Section 14A after the decision in Godrej & Boyce is that for 14A disallowance there has to be a nexus between the exempt income and the expenditure. Can there be a nexus between two things when one of those does not actually exist?
A Special Bench of the Tribunal in Cheminvest had previously held that Section 14A disallowance would arise even when there is no exempt income actually earned. The Tribunal had noticed the decision of the Supreme Court in Rajendra Prasad Mody’s case, 115 ITR 522, where in the context of Section 57(iii) of the Act, the Court had held that for expenditure to be allowed, it was not necessary for any income to have actually been earned. The Tribunal applied the converse of this to hold that accordingly, for expenditure to be disallowed, it need not be necessary for any exempt income to have actually been earned. However, the relevant part of Section 57 uses the words “for the purposes of making or earning” – there, the language supports the conclusion that the only requirement is that the objective should be for making or earning income. Whether that objective is in fact successful or not is irrelevant. However, Section 14A uses the words “expenditure in relation to income which does not form part of total income”. The language in the two sections is thus different.
On the other hand, the weakness of the purely textual pro-assessee argument is magnified when one considers this. If the assessee’s argument is correct, even if a nominal sum is earned as exempt income, the entire expenditure will be disallowed. Thus, if dividend of Rs. 100 is earned, the whole expenditure incurred for earning that income is admittedly to be disallowed. What is the rational basis for saying that when that sum of Rs. 100 is not earned there should not be any disallowance whatsoever? Further, there is mild obiter in Godrej Boyce as well, saying that what matters is that the expenditure should be incurred ‘for earning’ exempt income.
This is an interesting, and close, issue; and the decision of the Bombay High Court in the next few weeks will be of interest.