What is the Disallowance under section 14A

What is the Disallowance under section 14A
Section 14A has been introduced by the Finance Act 2001 with retrospective effect from 1962. The provision was originally introduced to restrict the allowance of expenditure on income which does not form part of the total income. In other words,the provision disallows any expenditure incurred towards the earning of exempt income. Even after the introduction, the taxpayers preferred not to expressly provide for expenditure incurred towards such exempt income or show the minimal as it might get disallowed in the hands of the assessee.

Disallowance is the aggregate of the following items incurred towards income which does not form part of the total income.
  • Amount of interest expenditure incurred
  • Expenditure incurred by way of interest * Average of value of investment/Average of total assets
  • 0.5% of the average of the value of investment,
The Introduction of Rule 8D has had big blow on the taxpayers earning huge dividend income, or investments, assets, borrowed funds or interest expenditure.

Analysis of the provisions of Section 14A

Section 14A is divided in three parts as follows:
  • Section 14A is applicable only if assessee has incurred any expenditure to earn income which does not form part of total income. It means if assessee has incurred any expenditure for making investments or maintaining investments are not covered unde section 14A.
  • Section 14A is applicable if assessee claims that expenditure has been incurred and AO is not satisfied with the correctness of the claim of the assessee having regards to the accounts of the assessee.
  • Section 14A is applicable if assessee claims that no expenditure has been incurred.

Process of applying section 14A

Whether assessee has incurred any expenditure to earn income which does not form part of total income? If yes, section 14A is applicable and move on to sub-section 2 of section 14A, if not, section 14A is not applicable at all.

If section 14A is applicable as per point 1. Then sub-section 2 of section 14A is applicable where assessee claims the amount of expenditure incurred in relation to exempt income and subsection. 3 of section is applicable where assessee claims that no expenditure has been incurred in relation to exempt income.

Sub-section 2 of Section 14A

If assessee claims the amount of expenditure incurred by him in relation to exempt income then AO need to verify the correctness of the claim of the assessee having regards to the accounts of the assessee. It means AO should check the accounts of the assessee to verify the claim of the assessee.

If the AO is satisfied with the claim of the assessee the amount of expenditure as claimed by the assessee shall be disallowed by the AO u/s 14A.

If the AO is not satisfied with the claim of the assessee having regards to the accounts of the assessee then he should record his dissatisfaction before went on to apply the formula prescribed in rule 8D to determine the amount of expenditure to be disallowed u/s 14A.

Sub-section 3 of Section 14A

If assessee claims that no expenditure has been incurred then AO can directly apply formula prescribed in rule 8D to determine the amount of expenditure to be disallowed u/s 14A. The AO is not required to record the correctness of the claim of the assessee under sub-section 3 of Section 14A of the Income Tax Act