Many times entrepreneurs invest the retained earnings or idle company funds in Shares of different Companies and even in listed Companies/Mutual funds, through stock exchange. Most of the times this is done in anticipation of better returns on idle funds and at times this is done as the entrepreneur ignores the difference between the Company funds and Personal funds.
Wise investments in shares and mutual funds have given wonderful returns. Over and above this, dividend earned from shares and units of mutual funds are exempt from income tax u/s 10 (34) of the Income Tax Act. Still further, long term capital gains on sale of STT paid shares/mutual funds are exempt from Capital gains taxes.
Think again if you invest your Company funds in Shares and Mutual Funds ignoring section 14A of the Income Tax Act, 1961.
As per section 14A:
- While computing taxable income of a person/company, deduction of expenses incurred in relation to earning an ‘Exempt’ income shall not be allowed;
- The assessing officer needs to be satisfied about of quantum of such expenses incurred;
- If the assessing officer is not satisfied about the quantum of such expense or if the person claims that he has incurred no expense in relation to such investments which yield ‘exempt’ income, “the assessing officer shall determine such expenditure as per the method prescribed under Rule 8 D of the Income Tax Rules”
- As per Rule 8D – The aggregate of amount incurred directly in relation to such investments and 1% of the annual average of the monthly averages of such investment value, shall be deemed to be the expenses incurred in relation to earning such exempt income.
- To make things more complicated, the upper limit of disallowance under this section is the total expenditure (Including expenses incurred in normal course of business in relation to taxable income) claimed in the books of accounts of the entity and not the amount of exempt income earned. Which means, irrespective of the quantum of dividend/exempt capital gains income, huge amount of expenses claimed in the books of accounts of the Company can be disallowed (Added to total profit/income and can be taxed), if the books of accounts have good quantum of such Investments.
This is a heavily litigated matter; hence, the entrepreneurs should avoid getting into such a situation. It is always recommended that personal savings and investments should always be kept separate from your business/company funds. Such investments should be made in personal capacity as far as possible.
Even if investments are made from the Company, for better utilization of idle company funds, the cost of disallowance u/s 14A, as discussed above, should be factored in while computing the expected returns on such investments.