For example, a person makes payment of single insurance policy of LIC amounting to Rs. 4 lath. For making this payment he has taken a loan of ` 3Lakh from bank for which he has to pay yearly interest of ` 36,000. Now in view of the provisions contained in Section 14A of the Income Tax Act, 1961 this interest amount of Rs. 36,000 will not be allowed as a deduction while computing total income of the assessee because the amount to be received later on from the LIC is exempted under Section 10 of the Income Tax Act, 1961.
Let us take another illustration. If the same person takes loan for making investment in shares and mutual funds, then the interest payment for purchasing the shares and mutual fund units would not be allowed as a deduction because for the AY 2006-07 the income from dividend as also the income from mutual fund units is completely exempt from income tax under Section 10(33) of the Income Tax Act, 1961.