Denial Under Proposed Section 14A Even Without Exempt Income: Tax Net Tightened in Budget 2022?

introduction

The Finance Bill 2022 introduced certain amendments with the aim of raising revenue and one of these amendments is inserted into Section 14A of the Income Tax Act 1961 (‘Act‘). Section 14A of the Act was introduced in 2001 with retroactive effect from the year 1962 to state that no deduction will be allowed for an expense incurred in connection with income which is not part of the total income. The method of identifying expenses incurred is prescribed by Rule 8D of the Income Tax Rules 1962 (‘Rules’). Since its inception, the applicability of this provision has always been the subject of dispute and one such point that has been often debated concerns the disallowance of expenses in the absence of exempt income.

In the year 2009, a special court in Delhi held that when an expense is incurred in relation to exempt income, regardless of whether exempt income was earned by the assessee or not, the dismissal must be challenged by the assessee. To go further, a circular was published by the CBDT in 2014 reiterating the point of view of the Special Chamber. However, even after the circular issued by CBDT, rulings still emerged that where there is no exempt income, denial under Section 14A is unjustified under a simple rule that where there is no there is no exempt income, there is no need to disallow the expense.

In this context, the Finance Bill 2022 proposed to insert an explanation to section 14A to clarify that, without exempt income earned in a year, refusal under section 14A will still be attracted . The bill further proposes to apply the amendment retroactively, thereby altering positions established by the courts in favor of taxpayers to date.

In light of this proposal, it is now imperative to identify the problems that may arise during its application.

1. Does the amendment only cover scenarios where exempt income is NIL in a given year?

2. In such a case, will the proposition established by the courts that disallowed expenses should not exceed the amount of exempt income still hold?

3. Does the obligation to register the satisfaction of the AO as provided for in the second part of article 14A of the law always have to be respected?

Should the denial be limited to exempt income even after the amendment?

Among many other issues that arose during the introduction of Section 14A, the issue of disallowing expenses being greater than exempt income has been the subject of litigation in various forums and has been decided in favor taxpayers who believe that the denial under Section 14A cannot exceed the exempt amount. earned income. That said, a question may now arise in the minds of taxpayers as to whether the proposed amendment will only apply in a situation where the exempt income is NIL. If the answer to this question is affirmative, the next question would be whether the position established by the courts as mentioned above would he continue to exercise his authority?

Based on a simple reading of the proposed explanation, it appears to the naked eye that denial would only be incurred where the exempt income is not accrued or incurred at all during a given year. That said, a taxpayer can still argue that a position that disallowed expenses cannot exceed the amount of exempt income would continue to apply outside of the proposed amendment.

Can the refusal be challenged when no exempt income is received from an investment?

Another issue that needs to be analyzed is whether a assessee can object to denial under Section 14A where no exempt income is received in a year against an investment that has the potential to provide exempt income.

Drawing:

Suppose a person rated “X” has made investments in stocks for which he is eligible for dividend income. This income was previously exempt in the hands of X. However, X had not received any dividends for 3 consecutive years. Pursuant to the proposed amendment, X was subject to denial of Article 14A for the expenses incurred. X then sells the shares and pays the necessary tax on them. Can X now go to the authority and seek to reverse the denials made because no exempt income was received by him for any of the years in which he suffered a denial?

The key question is: Is the mere possibility of earning exempt income enough to negate the deduction in cases where a assessee did not in fact earn any exempt income during the time they held an investment?

In the author’s view, X can argue in court that the exempt income to be received cannot be predicted if it is not accrued at all in a year and to comply with the proposed change the department for the purpose of the calculation must establish all exempt income received over the years and make the denial under Section 14A limiting to only that amount of exempt income.

It would be interesting to see how the courts weigh these arguments in light of the proposed amendment.

Is the registration of satisfaction still mandatory?

In addition, it is questionable whether the legal positions established by the courts that an AO must first register its satisfaction with the accuracy of the Assessée’s request for expenses incurred in relation to income exempt before invoking Rule 8D to disallow expenses under Section 14A must still be met or not after the proposed change.

The author is of the opinion that this AO requirement to register satisfaction will not be removed by the proposed change. Even under the proposed change, if the AO proposes to disallow the expense in a year in which no exempt income is earned applying Rule 8D, it must still record its satisfaction with reasons. well-founded and convincing explanation of why they believe an assessee incurred expenses related to exempt income. The AO must be able to determine, with an acceptable degree of accuracy, that the expense incurred relates to income that is not subject to tax.

Whether the provisions of Article 14A will have retroactive application?

Another problem that can arise is the retroactive application of the provision. Although the bill indicates that the amendment will not be effective until AY 2022-23, the inserted explanation describes a different understanding. Generally, when a change is made to a law, it is considered prospective, unless expressly stated otherwise. The proposed amendment to the article reads as follows:

“Section 14A shall apply and shall be deemed to have always applied where exempt income has not accrued or arisen or has not been received during the financial year and expenses have been incurred in relation to such exempt income.”

The proposed provision also appears to apply to past transactions. It is an accepted and known principle of law that an amendment cannot apply retroactively if it would engage the liability of an Assessée in the absence of any legal requirement existing at that time. Given that the proposed amendment seeks to tax assessors for past years also where the refusal has not been made, would this mean that the amendment is contrary to the well-established position of the law? Or because said modification is made in nature to provide clarity, can it be assumed that the responsibility to undergo the disallowance has always existed since its creation?

Conclusion

Budget 2022 introduced such an amendment to Section 14A with an apparent intent to clarify the controversies surrounding Section 14A. But whether he really ended the storm is something to wait and watch.