Income Tax 2025

Appearance

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

14(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.

14(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 prescribed.

14(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.

Explanation

1. Section Summary ​

This section clarifies that no deductions are allowed for expenses incurred in relation to income that is exempt from taxation (i.e., income that does not form part of the total income). It also grants the Assessing Officer (AO) the authority to determine the amount of such expenses if they are not satisfied with the taxpayer’s claim. Additionally, the section applies even if the exempt income has not yet been received or accrued during the tax year.

2. Key Changes ​

  • Explicit Disallowance of Expenses: The new law explicitly states that expenses related to exempt income cannot be deducted, reinforcing a principle that existed but was not always clearly applied.
  • Assessing Officer’s Authority: The AO now has the power to determine the amount of expenditure related to exempt income if they find the taxpayer’s claim unsatisfactory. This is a procedural change that strengthens the AO’s oversight.
  • Timing of Expenditure: The section clarifies that the disallowance applies even if the exempt income has not yet been received or accrued in the tax year, which is a new clarification.

3. Practical Implications ​

  • For Taxpayers: Taxpayers must ensure that they do not claim deductions for expenses related to exempt income. This could affect individuals or businesses with mixed income streams (e.g., taxable business income and exempt dividend income).
  • For Businesses: Companies with significant exempt income (e.g., from tax-free bonds or dividends) must carefully segregate expenses related to taxable and exempt income to avoid disallowance.
  • For Compliance: Taxpayers must maintain detailed records to justify their claims regarding expenses and be prepared for potential scrutiny by the AO.

4. Critical Concepts ​

  • Exempt Income: Income that is not included in the total taxable income (e.g., agricultural income, dividends under Section 10(34), or interest on tax-free bonds).
  • Expenditure Incurred in Relation to Exempt Income: Costs directly or indirectly linked to earning exempt income (e.g., administrative expenses, interest on loans used to invest in tax-free bonds).
  • Assessing Officer’s Discretion: The AO can use any prescribed method to determine the amount of disallowed expenses if they are not satisfied with the taxpayer’s claim.

5. Compliance Steps ​

  • Segregate Expenses: Maintain clear records to distinguish between expenses related to taxable and exempt income.
  • Document Justification: Be prepared to provide evidence supporting the allocation of expenses.
  • Review Claims: Ensure no deductions are claimed for expenses related to exempt income.
  • Respond to AO Queries: If the AO questions the allocation of expenses, provide detailed explanations and supporting documents.

6. Examples ​

  • Scenario 1: A company earns ₹10 lakh from taxable business operations and ₹2 lakh as tax-free dividends. It incurs ₹1 lakh in administrative expenses. Under this section, the company cannot claim a portion of the ₹1 lakh as a deduction if it relates to earning the ₹2 lakh exempt dividend.
  • Scenario 2: An individual invests in tax-free bonds and incurs interest expenses on a loan taken to purchase these bonds. The interest expense cannot be claimed as a deduction since it relates to exempt income.

7. Effective Date/Transition Rules ​

  • The section applies to expenses incurred during the tax year, regardless of when the exempt income is received or accrued.
  • Taxpayers should review their expense allocations for the current and future tax years to ensure compliance.

This section aims to prevent taxpayers from reducing their taxable income by claiming deductions for expenses linked to exempt income, ensuring a fairer tax base.