2010 (7) TMI 15 - SC - Income Tax

Dividend Stripping Transaction - Loss arising in the course of Dividend Stripping Transaction - Business Transaction - Setoff - AO disallowed the loss of ₹ 2,09,44,793 claimed by the assessee inter alia on the ground that a dividend stripping transaction was not a business transaction and since such a transaction was primarily for the purpose of tax avoidance, the loss so called was an artificial loss created by a pre-designed set of transaction - ITAT and HC allowed the loss to be deducted - Held that - Section 14A deals with disallowance of expenditure per se and not with a disallowance of a loss which arises at a point of time subsequent to the purchase of units and the receipt of exempt income and occurring only when there is a sale of the purchased units. - Under Section 94(7) the dividend goes to reduce the loss. It applies to cases where the loss is more than the dividend - Section 14A comes in when there is claim for deduction of an expenditure whereas Section 94(7) comes in when there is claim for allowance for the business loss. We may reiterate that one must keep in mind the conceptual difference between loss, expenditure, cost of acquisition, etc. while interpreting the scheme of the Act. - Para 12 of Accounting Standard AS-13 has no application to the facts of the present cases where units are bought at the ruling NAV with a right to receive dividend as and when declared in future and did not carry any vested right to claim dividends which had already accrued prior to the purchase. - Decided in favor of assessee - revenue appeal dismissed

Summary

Issues Involved:
1. Whether the loss arising in the course of dividend stripping transactions prior to 1.4.2002 was disallowable on the ground that such loss was artificial and not a business transaction.
2. Whether "return of investment" or "cost recovery" would fall within the expression "expenditure incurred" in Section 14A.
3. Impact of Section 94(7) w.e.f. 1.4.2002 on the impugned transactions.
4. Reconciliation of Section 14A with Section 94(7) of the Act.

Detailed Analysis:

1. Whether the loss arising in the course of dividend stripping transactions prior to 1.4.2002 was disallowable on the ground that such loss was artificial and not a business transaction:

The assessee, a member of the Bombay Stock Exchange, purchased units of Chola Freedom Technology Mutual Fund before the record date and earned a dividend. The NAV of the mutual fund fell post-dividend payout, and the assessee sold the units at a reduced NAV, claiming a loss. The AO disallowed the loss, considering it an artificial loss created by a pre-designed transaction for tax avoidance. The CIT(A) and the Tribunal had differing views, with the Tribunal allowing the set-off of the loss. The High Court affirmed the Tribunal's view, leading to the Department's appeal.

2. Whether "return of investment" or "cost recovery" would fall within the expression "expenditure incurred" in Section 14A:

The Department argued that the differential amount between the purchase and sale price of the units constituted "expenditure incurred" for earning tax-free income, thus disallowable under Section 14A. However, the Court held that "return of investment" does not constitute "expenditure incurred" as per Section 14A. The Court clarified that expenditure, return on investment, return of investment, and cost of acquisition are distinct concepts. The words "expenditure incurred" in Section 14A refer to actual disbursements like rent, taxes, salaries, etc., and not to pay-backs or returns of investment, which impact the balance sheet rather than the Profit & Loss Account.

3. Impact of Section 94(7) w.e.f. 1.4.2002 on the impugned transactions:

For assessment years prior to 1.4.2002, the Court held that losses from dividend stripping transactions could not be disallowed. The transactions were genuine, and the dividend received was tax-free as recognized under Section 10(33) of the Act. Post 1.4.2002, Section 94(7) curbs short-term losses by ignoring losses to the extent of the dividend received. The Court emphasized that Parliament did not treat the entire loss as fictitious, and losses over and above the dividend received would still be allowed post 1.4.2002.

4. Reconciliation of Section 14A with Section 94(7) of the Act:

The Court noted that Sections 14A and 94(7) operate in different fields. Section 14A deals with disallowance of expenditure incurred in earning tax-free income, whereas Section 94(7) deals with the disallowance of loss on the acquisition of an asset. Section 14A applies to cases where there is no acquisition of an asset, while Section 94(7) applies where there is an acquisition and subsequent sale of an asset. The Court emphasized the conceptual difference between loss, expenditure, and cost of acquisition, stating that Section 14A does not apply to cases covered by Section 94(7).

Conclusion:

The Supreme Court dismissed the Civil Appeals filed by the Department, finding no infirmity in the High Court's judgment. The Court concluded that:
- The loss from dividend stripping transactions prior to 1.4.2002 could not be disallowed.
- "Return of investment" does not fall within the expression "expenditure incurred" under Section 14A.
- Section 94(7) curbs short-term losses post 1.4.2002, allowing losses over and above the dividend received.
- Sections 14A and 94(7) operate in different fields and address different situations.