The Hindu Business Line : Intricacies of indivisible business

Section 14A of the Income-Tax Act, 1961 stipulates that for computing the income of an assessee, no deduction shall be allowed in respect of expenditure incurred by him in relation to income which does not form part of his total income under the Act.

Sub-section (2) of Section 14A, inserted in the statute book with effect from April 1, 2007, further stipulates that the assessing officer (AO) shall determine the amount of expenditure incurred by the assessee in relation to such income in accordance with the prescribed method, if having regard to the assessee’s accounts, he is not satisfied with the correctness of his claim. This would also hold good where the assessee claims that no expenditure has been incurred in relation to such income.

Generating controversy

A cursory look at this small and seemingly simple section would hardly reveal the extent of controversies this section has created and, needless to add, that each judgment on this issue seems to fuel the existing confusion.

One such issue revolves around the applicability of this section if the business carried on by the assessee constitutes one indivisible business.

In such cases question arises as to whether the entire expenditure would be a permissible deduction and apportionment of the expenditure under Section 14A is at all called for.

Another controversy prevails in the arena, that is, whether this section can be used as a tool to disallow expenses in case of incidental income which is exempt. One can cite the example of a dealer in shares. Dividend on ‘trading asset’ in such cases could be construed as incidental income, as shares are purchased for trading and the intention is to earn profit from share trading. Would this section be triggered in such cases?

Scope of the Section

Further, there are different views on whether Section 14A is applicable just in respect of exempt incomes or whether it can be stretched to cover incomes which are excluded from total income by virtue of Chapter VI-A.

At this juncture, one may note that the legislature has used the words ‘total income’ in contrast to ‘gross total income’ in Section 14A. Not to mention that it has been held that donations do not constitute expenditure and as Section 14A is invoked only in case of expenditure, a donation made out of exempt income is not hit.

Implications of this section in case of an investment company are all the more baffling and have far-reaching implications. According to one view, in case in a year there is no dividend income, Section 14A is not triggered and there cannot be any related disallowance.

However, this would also imply that in the year there is even a small dividend income, Section 14A would be invoked. Another view is that the actual receipt/accrual of dividend should not matter in the case of such companies.

On the quantification aspect, taking the example of dividend income again, there are different views as to whether expenditure relating to collection of dividend is the only expenditure incurred in relation to such income or does indirect expenditure also fall within its ambit.

One can argue that investment decisions are complex and require substantial market research, trend analysis and decisions regarding acquisition, retention and disposal at the right time. This in any case, cannot be achieved by incurring no or nominal expenditure, hence administrative and other management expenses also need to be considered. Further, can a percentage of the total expenditure worked out on the basis of proportion of dividend income to the total income meet the desired goal? One may note that on all these issues conflicting views prevail.

A fresh look needed

Controversies also revolve around the aspect as to whether till the point of time rules are framed under sub-section (2) of this section, the AO is incapacitated. In addition, can this section be adjudged to be a procedural section and hence it may be concluded that the inability of the AO to make any adjustment under this section would apply to all pending matters or would it be applicable only from assessment year 2007-2008 onwards.

It is recommended that a fresh look be taken at this section before it creates a huge maze of issues, difficult for the taxpayers to wade through.

(The author is principal consultant, PricewaterhouseCoopers.)

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