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Investment which has not resulted in any income cannot be considered for 
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 In the return of income, the taxpayer had disallowed 
certain expenditure out of the fund management fees 
claimed under...
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Investment which has not resulted in any income cannot be considered for disallowance under Section 14A read with Rule 8D(2)(i) of the Rules

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Recently, the Hyderabad Bench of the Income-tax Appellate Tribunal in the case of Bellwether Microfinance Fund Pvt. Ltd. held that investment which has not resulted in any income during the year cannot be considered for disallowance under Section 14A of the Income-tax Act, 1961 read with Rule 8D(2)(i) of the Income-tax Rules, 1962. However, while computing disallowance under Rule 8D(2)(iii), the average of the total investment of the taxpayer as appearing in the balance sheet (irrespective of whether it has yielded income or not) on the first day and last day of the year can be considered for the purpose of disallowance.

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Investment which has not resulted in any income cannot be considered for disallowance under Section 14A read with Rule 8D(2)(i) of the Rules

  1. 1. KPMG FLASH NEWS KPMG IN INDIA Investment which has not resulted in any income cannot be considered for disallowance under Section 14A read with Rule 8D(2)(i) of the Rules 26 August 2014 Background Recently, the Hyderabad Bench of the Income-tax Appellate Tribunal (the Tribunal) in the case of Bellwether Microfinance Fund Pvt. Ltd.1 (the taxpayer) held that investment which has not resulted in any income during the year cannot be considered for disallowance under Section 14A of the Income-tax Act, 1961 (the Act) read with Rule 8D(2)(i) of the Income-tax Rules, 1962 (the Rules). However, while computing disallowance under Rule 8D(2)(iii), the average of the total investment of the taxpayer as appearing in the balance sheet (irrespective of whether it has yielded income or not) on the first day and last day of the year can be considered for the purpose of disallowance. The Tribunal while distinguishing Rule 8D(2)(i) from Rule 8D(2)(iii) observed that the use of the words ‘does not or shall not’ in Rule 8D(2)(iii) connotes that income not only does not form part of the total income during the year but it also shall not form part of the total income at any time. Had it been the intention of the Rule framing authorities to disallow under Rule 8D(2)(i) expenditure relating to total value of investment or income which is not earned during the relevant previous year, then, they would have used _______________ 1Bellwether Microfinance Fund Pvt. Ltd. v. ITO (ITA No. 1743/Hyd/2013) – Taxsutra.com the expression ‘does not or shall not form part of total income’ as appearing in Rule 8D(2)(iii) instead of words ‘does not form part of total income’. Facts of the case  The taxpayer is a non-banking financing company engaged in the business of investing in microfinance companies in India.  Subsequently, the taxpayer changed its business model by making investments in equity, mutual fund, and also advanced loans to microfinance institutions.  During the year under consideration, the taxpayer entered into a fund management agreement with Caspian Advisors Pvt. Ltd. (CAPL), as per which the said company would render consultation services to the taxpayer in the matter of investment etc. as fund manager. In lieu of the services rendered, the fund manager was to be paid remuneration to the fund based services by the taxpayer. © 2014 KPMG, an Indian Registered Partnership and a member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative (“KPMG International”), a Swiss entity. All rights reserved.
  2. 2.  In the return of income, the taxpayer had disallowed certain expenditure out of the fund management fees claimed under Section 14A of the Act read with Rule 8D of the Rules. However, the Assessing Officer (AO) did not agree with the disallowance worked out by the taxpayer. Accordingly, the AO quantified the expenditure pertaining to exempt/taxable income for the purpose of disallowance under Section 14A of the Act. Tribunal’s ruling  On perusal of Rule 8D of the Rules, it indicates that expenditure in relation to exempt income would be disallowed under Section 14A of the Act. However, the AO while working out disallowance under Rule 8D(2)(i) of the Rules had taken into consideration the total investment irrespective of the fact whether they have yielded income or not.  The term total income has not been defined either under Section 14A or under Rule 8D of the Rules. Therefore, reference can be made to the definition of ‘total income’ as provided in Section 2(45) of the Act.  Section 2(45) of the Act refers to Section 5 of the Act which envisages ‘scope of total income’. Perusal of Section 5 of the Act, it indicates that ‘total income’ includes income from whatever source derived which is received or deemed to be received in India in the previous year by or on behalf of such person, or accrues or arises or is deemed to accrue or arises to him in India during such year, or accrues or arise to him outside India during such year.  The expression of ‘total income’ referred to in Rule 8D(2)(i) cannot be in abstract. It must relate to a previous year income of which is sought to be assessed. Therefore, only expenditure directly relating to income which is earned either on receipt basis or on accrual basis, and which does not form part of total income of a particular assessment year, can be disallowed under Rule 8D(2)(i) of the Rules.  Rule 8D(2)(i) does not refer to the investment made by the taxpayer. Therefore, the Tribunal referred Rule 8D(2)(iii) and observed that conjoint reading of clause (i) and clause (iii) of Rule 8D(2), indicates that there is a clear difference between them. Rule 8D(2)(i) provides for disallowance of expenditure directly relating to income which does not form part of the total income. However, Rule 8D(2)(iii) provides for disallowance of expenditure of the average value of investment, income from which does not or shall not form part of the total income, as appearing in the balance sheet of the taxpayer on the first day and last day of the previous year.  On perusal of Rule 8D(2)(i) of the Rules, it indicates that the disallowance of expenditure must relate to the income which does not form part of the total income of that year. Therefore, investment, which has not resulted in any income cannot be considered for the purpose of disallowance under Rule 8D(2)(i). However, while computing disallowance under Rule 8D(2)(iii), the average of the total investment of the taxpayer as appearing in the balance sheet on the first day and last day of the year irrespective of whether it has yielded income or not can be considered for the purpose of disallowance.  The use of the words ‘does not or shall not’ in Rule 8D(2)(iii) connote that income not only does not form part of the total income during the year, but it also shall not form part of the total income at any time. Had it been the intention of the Rule framing authorities to disallow under Rule 8D(2)(i) expenditure relating to total value of investment or income which is not earned during the relevant previous year, then, they would have used the expression ‘does not or shall not form part of total income’ as appearing in Rule 8D(2)(iii) instead of the words ‘does not form part of total income’.  If that being the case, the AO cannot disallow expenditure relating to investment which has not yielded any exempt income under Rule 8D(2)(i) of the Rules. Accordingly, the Tribunal directed the AO to disallow the expenditure relating to investments resulting in income earned/accrued which does not form part of the total income of the impugned assessment year. However, so far as AO’s computation of expenditure to be disallowed under Rule 8D(2)(iii) is concerned, the same was in conformity with Rule 8D(2)(iii), hence, do not call for any interference. Our comments Disallowance under Section 14A of the Act has been a subject matter of dispute before the Courts and the Tribunal. The Hyderabad Tribunal in the present case distinguished Rule 8D(2)(i) from Rule 8D(2)(iii) of the Rules and held that investment which has not resulted in any income during the year cannot be considered for disallowance under Rule 8D(2)(i) of the Rules. This is a welcome decision which provides clarity for computing disallowance under Section 14A of the Act by applying Rule 8D(2)(i) of the Rules. © 2014 KPMG, an Indian Registered Partnership and a member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative (“KPMG International”), a Swiss entity. All rights reserved.
  3. 3. www.kpmg.com/in Ahmedabad Commerce House V, 9th Floor, 902 & 903,Near Vodafone House,Corporate Road, Prahlad Nagar, Ahmedabad – 380 051 Tel: +91 79 4040 2200 Fax: +91 79 4040 2244 Bangalore Maruthi Info-Tech Centre 11-12/1, Inner Ring Road Koramangala, Bangalore 560 071 Tel: +91 80 3980 6000 Fax: +91 80 3980 6999 Chandigarh SCO 22-23 (Ist Floor) Sector 8C, Madhya Marg Chandigarh 160 009 Tel: +91 172 393 5777/781 Fax: +91 172 393 5780 Chennai No.10, Mahatma Gandhi Road Nungambakkam Chennai 600 034 Tel: +91 44 3914 5000 Fax: +91 44 3914 5999 Delhi Building No.10, 8th Floor DLF Cyber City, Phase II Gurgaon, Haryana 122 002 Tel: +91 124 307 4000 Fax: +91 124 254 9101 Hyderabad 8-2-618/2 Reliance Humsafar, 4th Floor Road No.11, Banjara Hills Hyderabad 500 034 Tel: +91 40 3046 5000 Fax: +91 40 3046 5299 Kochi Syama Business Center 3rd Floor, NH By Pass Road, Vytilla, Kochi – 682019 Tel: +91 484 302 7000 Fax: +91 484 302 7001 Kolkata Unit No. 603 – 604, 6th Floor, Tower – 1, Godrej Waterside, Sector – V, Salt Lake, Kolkata 700 091 Tel: +91 33 44034000 Fax: +91 33 44034199 Mumbai Lodha Excelus, Apollo Mills N. M. Joshi Marg Mahalaxmi, Mumbai 400 011 Tel: +91 22 3989 6000 Fax: +91 22 3983 6000 Pune 703, Godrej Castlemaine Bund Garden Pune 411 001 Tel: +91 20 3050 4000 Fax: +91 20 3050 4010 The information contained herein is of a general nature and is not intended to address the circumstances of any particular individual or entity. Although we endeavour to provide accurate and timely information, there can be no guarantee that such information is accurate as of the date it is received or that it will continue to be accurate in the future. No one should act on such information without appropriate professional advice after a thorough examination of the particular situation. © 2014 KPMG, an Indian Registered Partnership and a member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative (“KPMG International”), a Swiss entity. All rights reserved. The KPMG name, logo and “cutting through complexity“ are registered trademarks of KPMG International Cooperative (“KPMG International”), a Swiss entity. © 2014 KPMG, an Indian Registered Partnership and a member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative (“KPMG International”), a Swiss entity. All rights reserved.

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