2021 (9) TMI 566 - SC - Income Tax

Disallowance u/s 14A - Exempted Income - proportionate disallowance of interest paid by the banks for investments made in tax free bonds/ securities which yield tax free dividend and interest to assessee Banks - whether assessee had sufficient interest free own funds which were more than the investments made? - whether Section 14A, enables the Department to make disallowance on expenditure incurred for earning tax free income in cases where assessee like the present appellant, do not maintain separate accounts for the investments and other expenditures incurred for earning the tax-free income? - HELD THAT - Revenue does not contend that the Assessee Banks had held the securities for maintaining the Statutory Liquidity Ratio (SLR), as mentioned in the circular - when there is no finding that the investments of the Assessee are of the related category, tax implication would not arise against the appellants, from the said circular. The aforesaid discussion and the cited judgments advise this Court to conclude that the proportionate disallowance of interest is not warranted, under Section 14A of Income Tax Act for investments made in tax free bonds/ securities which yield tax free dividend and interest to Assessee Banks in those situations where, interest free own funds available with the Assessee, exceeded their investments. With this conclusion, we unhesitatingly agree with the view taken by the learned ITAT favouring the assessees. The above conclusion is reached because nexus has not been established between expenditure disallowed and earning of exempt income. The respondents as earlier noted, have failed to substantiate their argument that assessee was required to maintain separate accounts. Their reliance on Honda Siel 2011 (7) TMI 275 - SC ORDER to project such an obligation on the assessee, is already negated. The learned counsel for the revenue has failed to refer to any statutory provision which obligate the assessee to maintain separate accounts which might justify proportionate disallowance - Decided in favour of the assessee.

Issues Involved:
1. Interpretation of Section 14A of the Income Tax Act.
2. Proportionate disallowance of interest paid by banks for investments in tax-free bonds/securities.
3. Obligation of maintaining separate accounts for investments and expenditures.

Detailed Analysis:

Interpretation of Section 14A of the Income Tax Act:
The core issue revolves around whether Section 14A allows for the disallowance of expenditure incurred for earning tax-free income in cases where the assessees do not maintain separate accounts for investments and related expenditures. Section 14A was introduced by the Finance Act, 2001, to ensure that expenditure incurred in generating tax-exempt income is not allowed as a deduction while calculating total income. The provision was made retrospective from 01.04.1962, but the retrospective effect was neutralized by a proviso introduced by the Finance Act, 2002, prohibiting reassessment or rectification for any assessment year up to 2000-2001 without making any disallowance under Section 14A.

Proportionate Disallowance of Interest Paid by Banks:
The assessees, being scheduled banks, did not maintain separate accounts for investments in tax-free bonds and shares. The Assessing Officer made proportionate disallowance of interest attributable to the funds invested to earn tax-free income, as the actual expenditure figures were not available. The CIT (A) concurred with the Assessing Officer, but the ITAT held that disallowance under Section 14A was not warranted in the absence of clear identity of funds. The High Court reversed ITAT's decision, leading to the appeal before the Supreme Court.

The Supreme Court examined whether investments made in bonds and shares should be considered to have been made out of interest-free funds, which were substantially more than the investments made. It was argued that the interest paid on deposits and other borrowings should not be considered as expenditure incurred in relation to tax-free income. The Court referred to various judgments, including Pr. CIT v. Bombay Dyeing and Mfg. Co. Ltd and Commissioner of Income Tax (Large Tax Payer Unit) Vs. Reliance Industries Ltd, which held that if interest-free funds are sufficient to meet the investments, it will be presumed that investments were made from such interest-free funds.

Obligation of Maintaining Separate Accounts:
The Revenue's contention that the assessee must maintain separate accounts for interest-free funds and interest-bearing funds was not supported by any statutory provision. The Court observed that there is no legal obligation on the assessee to maintain separate accounts for different types of funds. The Court referred to Maxopp Investment Ltd. v. CIT and Godrej and Boyce Manufacturing Company Ltd. V. DCIT, emphasizing that for attracting provisions of Section 14A, proof of expenditure incurred for earning exempt income is necessary.

The Court also considered the CBDT Circular no. 18 of 2015, which clarified that shares and securities held by a bank, not bought to maintain Statutory Liquidity Ratio (SLR), are its stock-in-trade and not investments. Hence, income arising out of those is attributable to the business of banking, and Section 14A would not be applicable.

Conclusion:
The Supreme Court concluded that proportionate disallowance of interest is not warranted under Section 14A for investments made in tax-free bonds/securities when interest-free own funds available with the assessee exceed their investments. The Court agreed with the ITAT's view favoring the assessees, as the nexus between expenditure disallowed and earning of exempt income was not established. The appeals by the assessees were allowed, and the issue was answered against the Revenue.

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