Exempt income disallowance under tax law applies only when exempt income is actually earned, not on notional income.

Section 14A disallowance under Rule 8D applies only to expenditure incurred in relation to exempt income actually earned in the relevant previous year. Where no exempt income arises in that year, the assessment must remain year-specific and based on real income, so disallowance on a notional or anticipated exempt income cannot be sustained. The matching concept also requires the expenditure to be considered in the year in which the corresponding exempt income is actually received.

---

---

Issues: Whether disallowance of expenditure under Section 14A of the Income-tax Act, 1961 read with Rule 8D of the Income-tax Rules, 1962 can be made in a year in which no exempt income has been earned.

Analysis: Section 14A is directed to expenditure incurred in relation to actual exempt income of the relevant previous year. The assessment under the Act is year-specific and proceeds on real income. Reading the expression "includable" in a manner that permits disallowance in the absence of exempt income would amount to assessing notional income and applying an artificial computation to an income stream that did not arise in the relevant year. The matching concept also requires that expenditure relating to exempt income be considered in the year in which such income is actually earned.

Conclusion: Disallowance under Section 14A read with Rule 8D cannot be sustained where no exempt income was earned in the relevant previous year, and the issue is answered in favour of the assessee.

Ratio Decidendi: Section 14A and Rule 8D apply only where exempt income is actually earned in the relevant previous year, and they cannot be invoked to disallow expenditure on a notional or anticipated exempt income.

---