No proportionate disallowance u/s 14A of ITA’61 or u/s 14 of ITA’25 when assessees own funds exceed investments; Disallowance on only investments that yield exempt income and not on total investments

When the assessee's own funds exceed the investments, a presumption can be drawn that the investments were made out of the assessee's own funds and no proportionate disallowance is warranted under Section 14A of Income Tax Act 1961 (ITA’61). Disallowance of expense under Section 14A of Income Tax Act 1961 (ITA’61) read with Rule 8D of Income Tax Rules 1962 (ITR’62) is not justified, when the assessee has ample own funds to make the investments was held in the case of Supreme Court in the case of South Indian Bank Limited.

Further disallowance under Section 14A read with Rule 8D should not be done based on the total investments but only the investments that yield exempt income during the year. Relying on the judgment of the Delhi High Court in the case of Cargo Motors Pvt. Ltd. Versus Dy Commissioner Of Income Tax - 2022 (10) TMI 571 - DELHI HIGH COURT the same was held in the case of Gujarat State Petronet Limited Versus Deputy Commissioner of Income Tax, Gandhinagar Circle, Gujarat - 2025 (10) TMI 653 - ITAT AHMEDABAD.
Section 14 of Income Tax Act 1925 (ITA’25) corresponds to Section 14A of Income Tax Act 1961 (ITA’61) and squarely holds the same position.
Section 14 of ITA’25 provides –

14. Income not forming part of total income and expenditure in relation to such income.

(1) Irrespective of anything to the contrary contained in this Act, for the purposes of computing the total income under this Chapter, no deduction shall be allowed in respect of expenditure incurred by the assessee in relation to income which does not form part of the total income.

(2) Where the Assessing Officer, having regard to the accounts of the assessee, is not satisfied with—

(a) the correctness of the claim of expenditure incurred by the assessee; or

(b) the claim made by the assessee that no expenditure has been incurred,
in relation to income which does not form part of the total income under this Act, he shall determine such amount of expenditure in accordance with any method, as may be prescribed.

(3) Irrespective of anything to the contrary contained in this Act, the provisions of this section shall apply in a case where any expenditure has been incurred during any tax year in relation to income which does not form part of the total income under this Act, but such income has not accrued or arisen or has not been received during that tax year.

Section 14A of ITA’61 provides –

1[Expenditure incurred in relation to income not includible in total income.

14A.2[(1)] 5[Notwithstanding anything to the contrary contained in this Act, for the purposes of] computing the total income under this Chapter, no deduction shall be allowed in respect of expenditure incurred by the assessee in relation to income which does not form part of the total income under this Act.]

3[(2) The Assessing Officer shall determine the amount of expenditure incurred in relation to such income which does not form part of the total income under this Act in accordance with such method as may be prescribed, if the Assessing Officer, having regard to the accounts of the assessee, is not satisfied with the correctness of the claim of the assessee in respect of such expenditure in relation to income which does not form part of the total income under this Act.

(3) The provisions of sub-section (2) shall also apply in relation to a case where an assessee claims that no expenditure has been incurred by him in relation to income which does not form part of the total income under this Act :]

4[Provided that nothing contained in this section shall empower the Assessing Officer either to reassess under section 147 or pass an order enhancing the assessment or reducing a refund

already made or otherwise increasing the liability of the assessee under section 154, for any assessment year beginning on or before the 1st day of April, 2001.]

6[Explanation.-For the removal of doubts, it is hereby clarified that notwithstanding anything to the contrary contained in this Act, the provisions of this section shall apply and shall be deemed to have always applied in a case where the income, not forming part of the total income under this Act, has not accrued or arisen or has not been received during the previous year relevant to an assessment year and the expenditure has been incurred during the said previous year in relation to such income not forming part of the total income.]
Rule 8D of ITR’25 provides –

1Method for determining amount of expenditure in relation to income not includible in total income.

8D(1) Where the Assessing Officer, having regard to the accounts of the assessee of a previous year, is not satisfied with-

(a) the correctness of the claim of expenditure made by the assessee; or

(b) the claim made by the assessee that no expenditure has been incurred,

in relation to income which does not form part of the total income under the Act for such previous year, he shall determine the amount of expenditure in relation to such income in accordance with the provisions of sub-rule (2).

2[(2) The expenditure in relation to income which does not form part of the total income shall be the aggregate of following amounts, namely:-

(i) the amount of expenditure directly relating to income which does not form part of total income; and

(ii) an amount equal to one per cent of the annual average of the monthly averages of the opening and closing balances of the value of investment, income from which does not or shall not form part of total income:

Provided that the amount referred to in clause (i) and clause (ii) shall not exceed the total expenditure claimed by the assessee.]