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TMI Blog2010 (8) TMI 77X X X X Extracts X X X X X X X X Extracts X X X X ..... tion 14A, more particularly sub section (2) and do not offend Article 14 of the Constitution - the Assessing Officer is duty bound to determine the expenditure which has been incurred in relation to income which does not form part of the total income under the Act. The Assessing Officer must adopt a reasonable basis or method consistent with all the relevant facts and circumstances after furnishing a reasonable opportunity to the assessee to place all germane material on the record; - ITA NO.626 OF 2010 and WP NO.758 OF 2010 - - - Dated:- 12-8-2010 - DR.D.Y.CHANDRACHUD AND J.P.DEVADHAR, JJ. Mr. S.E.Dastur, Sr. Advocate with Mr. P.J.Pardiwala, Sr. Advocate, Mr. Nitesh Joshi i/b. Mr. Atul K. Jasani for the Appellant in ITXA 626/10, and Petitioner in W.P.758/10. Mr. Porus F.Kaka, Sr. Advocate with Mr. Divyesh Chawla i/b. Mr. Atul K.Jasani for the Intervenor. Mr. Darius J.Khambata, ASG with Mr. Rohan J.Cama, Mr. J.S.Saluja, Mr. Suresh Kumar and Mr. P.S.Sahadevan for the Respondents in all matters. JUDGMENT (PER DR.D.Y.CHANDRACHUD, J.): A. The gist of the case: 1. Section 14A(1) of the Income Tax Act, 1961 stipulates that in computing the total income of an ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... held, following its decision in the case of Daga Capital Management Private Limited,{117 ITD 169 (Mum)}, that subsections (2) and (3) of Section 14A are procedural in nature and have retrospective effect. The Tribunal noted that the Assessing Officer had not examined the correctness of the claim of the assessee with reference to the accounts of the assessee, having regard to the provisions of Section 14A(2). The proceedings were remanded back to the Assessing Officer for a fresh examination on the basis of the provisions of Section 14A(2). 3. The assessee is in appeal against the decision of the Tribunal - and has raised the following substantial questions of law: "(A) Whether on the facts and in the circumstances of the case, the Tribunal ought to have held that as the limited issue raised by Respondent No.1 in the assessment order was as to the quantum of the exemption under Section 10(33) that was available and not to disallow any part of the expenditure claimed, hence it was not open to the Revenue to expand the scope of appeal by invoking the provisions of Section 14A of the Act to disallow the expenditure incurred; (B) Whether on the facts and in the circumstances of th ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... under Section 10(33). During the course of scrutiny proceedings, the assessee was called upon to explain why the net dividend income from tax free securities should not be exempted instead of the gross dividend receipts as claimed in the return. In its reply dated 25 November 2004, the assessee claimed that a major portion of its dividend amounting to Rs. 19.86 crores was received from group Companies and of the total shares, 95% consisted of Bonus Shares for which no cost had been incurred. The shares of Godrej Soaps Limited were stated to have been acquired several years earlier, the assessee being a promoter of that Company. The assessee contended that at no stage in the past, "except in a few recent Assessment Years, has the Income Tax Department attributed any interest or expenditure towards the earning of this dividend income". The assessee contended that it had reserves of Rs.274 crores and capital of Rs. 6.55 crores which would be more than adequate to cover the investments. The Assessing Officers were, according to the assessee, satisfied in the earlier years with its explanation and it was contended that there was consequently no allocation of interest to the earning of ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ga Capital Management Private Limited, the provisions of subsections (2) and (3) of Section 14A had been held to be procedural in nature and hence retrospective. The Tribunal observed that the Assessing Officer would determine the expenditure incurred in relation to income which does not form part of the total income under Subsection (2), only where he was not satisfied with the correctness of the claim of the assessee. The Assessing Officer had, as a matter of fact, not considered Section 14A(2) since it had not been enacted on the date when the order was passed. On the view which the Tribunal took, it directed the Assessing Officer to examine the issue afresh in the light of the specific provision contained in Section 14A(2). C. The Challenges considered: 9. At this stage now, it would be appropriate to consider the challenges taken up on behalf of the assessee and, as we deal with them, we consider the submissions of the assessee and the arguments in defence of the Additional Solicitor General for the Union of India. C1. Whether Section 14A is attracted in the case of dividend income received from shares and income from mutual funds: 10. The submission of the assesse ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... 14(3) of the Income Tax Act, 1922. Income of a Cooperative Society from its trading activity being exempt from tax, the income of the assessee from Government securities had to be apportioned between income earned from investment for trading purposes and for nontrading purposes. There was no statutory rule and no departmental instructions governing the apportionment of income from Government securities between business and nonbusiness sources of income. The Supreme Court held that nonetheless a rule of apportionment would have to be applied: "It was never urged, and it cannot be urged, that in the absence of a specific rule for apportionment, the entire income from Government securities should be brought to tax. Any attempt to bring the entire income from Government securities would infringe Section 14(3) of the Act. A rule of apportionment consistent with commercial accounting must be evolved for determining the income from Government securities attributable to business activity of the society." The Supreme Court held that a rule of apportionment which dismembers income in proportion to the business and nonbusiness components of the single source from which it arises would be ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ld that Parliament had not contemplated an enquiry on whether the expenditure had produced or will produce taxable income. 15. In a subsequent decision in C.I.T. vs. Maharashtra Sugar Mills Limited,{(1971) 3 SCC 543}, the Supreme Court decided whether a portion of managing agency commission paid by the assessee could be disallowed while computing income from business. The finding of the Tribunal was that the cultivation of sugarcane and the manufacture of sugar constituted one indivisible business. According to the Revenue, the business consisted of two parts, namely, cultivation of sugarcane and the manufacture of sugar. The former being agricultural, the resultant income was not assessable to tax and according to the Revenue the expenditure incurred on that activity was not deductible. The Supreme Court held that the contention proceeded on the basis that only expenditure incurred in respect of a business activity giving rise to income, profits or gains taxable under the Act was allowable as a deduction and not otherwise. The Supreme Court noted that it was not disputed that cultivation of sugarcane and manufacture of sugar constituted one indivisible business. Hence, the profi ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... f the business and the expenditure sought to be deducted as the business expenditure of the assessee" In that case, the business of the assessee being one and indivisible, the Supreme Court held that it was not open to the Revenue to disallow a portion of the expenditure. 18. The principle of law which emerged from these cases was that in the case of a composite and individual business which earned both taxable and non-taxable income, expenditure incurred towards non-taxable income could not be isolated by apportionment and a disallowance could not be made. However, apportionment of expenditure was permissible when the non-taxable income arose from a separate business or under a different head of income. Enactment of Section 14A: 19. By the Finance Act of 2001, Parliament enacted Section 14A with retrospective effect from 1 April 1962 to amend the law by taking away the basis of the judgments of the Supreme Court in Indian Bank, Maharashtra Sugar and Rajasthan State Warehousing Corporation. As it was initially enacted, Section 14A postulated that for the purpose of computing the total income under the Chapter, no deduction shall be allowed in respect of expenditure incurr ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... lation to that business would have to be allowed even if a part of the income earned from the business is exempt from tax. Section 14A has been enacted to overcome these judicial pronouncements. 21. The insertion of Section 14A was curative and declaratory of the intent of the Parliament. The basic principle of taxation is that only net income, namely, gross income minus expenditure that is taxable. Expenses incurred can be allowed only to the extent that they are relatable to the earning of taxable income. However, assesses had claimed deductions in respect of income which was exempt under various provisions of the Act as a result of which the tax incentive given in respect of certain categories of income which were exempt was being utilized to reduce the tax payable on nonexempt income. This being contrary to legislative intent, Section 14A was inserted in order to restore the legal position consistent with Parliamentary intent. Declaratory or curative amendments are construed to be retrospective because they authoritatively set forth the original legislative intent. Parliament placed the matter beyond doubt by legislating upon Section 14A with retrospective effect from 1 April ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... nses incurred by the assessee may be relatable partly to the exempt income and partly to the taxable income. In the absence of Section 14A, the expenditure incurred in respect of exempt income was being claimed against taxable income. The mandate of Section 14A is clear. It desires to curb the practice to claim deduction of expenses incurred in relation to exempt income against taxable income and at the same time avail the tax incentive by way of exemption of exempt income without making any apportionment of expenses incurred in relation to exempt income. The basic reason for insertion of Section 14A is that certain incomes are not includible while computing total income as these are exempt under certain provisions of the Act. In the past, there have been cases in which deduction has been sought in respect of such incomes which in effect would mean that tax incentives to certain incomes was being used to reduce the tax payable on the nonexempt income by debiting the expenses, incurred to earn the exempt income, against taxable income. The basic principle of taxation is to tax the net income, i.e., gross income minus the expenditure. On the same analogy the exemption is also in resp ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... le to be disallowed. The test which has been enunciated in Walfort for attracting the provisions of Section 14A is that "there has to be a proximate cause for disallowance which is its relationship with the tax exempt income". Once the test of proximate cause, based on the relationship of the expenditure with tax exempt income is established, a disallowance would have to be effected under Section 14A. 24. The following principles would emerge from Section 14A and the decision in Walfort: (a) The mandate of Section 14A is to prevent claims for deduction of expenditure in relation to income which does not form part of the total income of the assessee; (b) Section 14A(1) is enacted to ensure that only expenses incurred in respect of earning taxable income are allowed; (c) The principle of apportionment of expenses is widened by Section 14A to include even the apportionment of expenditure between taxable and non-taxable income of an indivisible business; (d) The basic principle of taxation is to tax net income. This principle applies even for the purposes of Section 14A and expenses towards non-taxable income must be excluded; (e) Once a proximate cause for disallowance is ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... part of the total income, in accordance with the prescribed method, arises if the Assessing Officer is not satisfied with the correctness of the claim of the assessee in respect of the expenditure which the assessee claims to have incurred in relation to income which does not part of the total income. Moreover, the satisfaction of the Assessing Officer has to be arrived at, having regard to the accounts of the assessee. Hence, Sub section (2) does not ipso facto enable the Assessing Officer to apply the method prescribed by the rules straightaway without considering whether the claim made by the assessee in respect of the expenditure incurred in relation to income which does not form part of the total income is correct. The Assessing Officer must, in the first instance, determine whether the claim of the assessee in that regard is correct and the determination must be made having regard to the accounts of the assessee. The satisfaction of the Assessing Officer must be arrived at on an objective basis. It is only when the Assessing Officer is not satisfied with the claim of the assessee, that the legislature directs him to follow the method that may be prescribed. In a situation whe ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... form part of the total income under this Act" can have no application to dividend income from shares or to income from mutual funds for the reason that such income is not exempt from income tax, but is subject to tax under Section 115O and Section 115R. 28. Now, Subsection (1) of Section 115O prior to its substitution by the Finance Act of 2003 with effect from 1 April 2003, provided as follows: "(1) Notwithstanding anything contained in any other provision of this Act and subject to the provisions of this section, in addition to the income-tax chargeable in respect of the total income of a domestic company for any assessment year, any amount declared, distributed or paid by such company by way of dividends (whether interim or otherwise) on or after the 1st day of June, 1997 but on or before the 31st day of March, 2002, whether out of current or accumulated profits shall be charged to additional income tax (hereinafter referred to as tax on distributed profits) at the rate of ten per cent." Subsection (2) of Section 115O stipulates that the tax on distributed profits under subsection (1) shall be payable by the company notwithstanding that no income tax is payable by a domes ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ear). Plainly dividend income and income from mutual funds are incomes which by virtue of the provisions of Section 10, do not form part of the total income under the Act. Expenditure incurred in relation to the earning of such income has to be disallowed under Section 14A. 30. The submission which has been urged on behalf of the assessee is that the expression "income which does not form part of the total income" under the Act should be interpreted to mean income which is exempt from tax, On this hypothesis, it has been urged that Section 14A will not apply to dividend income because the Revenue has already received its share of tax. 31. The submission cannot be accepted. The expression "income which does not form part of the total income" under the Act must receive its plain and grammatical construction. Such income is income which is not includible in computing the total income of the assessee under the provisions of the Act for a previous year. Now it is trite law that under the Act, "it is income that is taxed but it is not taxed in vacuo. It is taxed in the hands of a person."{CIT vs. Indian Bank Limited, AIR 1965 SC 1473 at paragraph19 page 1476}. Section 2(45) defines t ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... dend. 33. Section 115O provides that a domestic company which declares, distributes or pays dividend out of current or accumulated profits, shall, apart from paying tax on its total income, pay additional income-tax on the amount of profits declared, distributed or paid as dividend or after 1 April 2003. 34. To illustrate, if Rs.1,000/is the total income of a domestic company and out of the total income of Rs.1,000/, Rs. 300/ is declared, distributed or paid as dividend, then that domestic company is liable to pay income tax on the total income of Rs.1,000/at the rate specified under the relevant Finance Act and is further liable to pay additional income-tax at the rate prescribed under Section 115O on the amount of profits declared, distributed or paid as dividend. 35. Section 115O has been enacted with a view to exempt dividend income. Prior to the insertion of Section 115O, domestic companies were liable to pay tax on the total income (including profits distributed as dividends) and shareholders were liable to pay tax on dividend income received. Domestic companies distributing profits as dividends were liable to deduct tax at source and shareholders receiving the dividen ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ection 14A, it is evident that the tax on distributed profits is a charge on the Company. The Company is chargeable to tax on its profits as a distinct taxable entity. It does not do so on behalf of the shareholder. The Company does not act as an agent of the shareholder in paying the tax under Section 115O. In the hands of the recipient shareholder dividend does not form part of the total income. On the contrary, Section 10(33) clearly evinces parliamentary intent that incomes from dividend (and from mutual funds) are not includible in the total income. 38. Counsel appearing on behalf of the Assessee sought to place reliance on a circular issued by the CBDT on 18 February 1998, explaining the provisions of the Finance Act of 1997, which introduced the provisions of Section 115O. The circular notes that according to the existing provisions of the Act, corporate dividends were taxed in the hands of shareholders under the head of income from other sources. Companies while paying dividend deducted tax at source at the rate in force and issued certificates of tax deduction to their shareholders. The shareholders, in turn, showed dividend income in their returns of income and claimed ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ting. 41. Another submission which has been urged on behalf of the assessees by Mr.Kaka, intervening Counsel is that Section 10 deals with three categories: (i) The first category is where the emphasis is on income which is exempt in the hands of any person. This category deals with the character of income such as agricultural income and not of the recipient of the income; (ii) The second category exemplified by subsections (2) and (2A) of Section 10 (where the recipient is a member of HUF or a partner) is where the same income is not to be charged to tax twice in the hands of two persons; (iii) The third category is where the character of the recipient is important and not the character of the income, e.g., a local authority. The submission is that Section 10(33) is not an exemption provision, but has been made to prevent the State from taxing the same income twice over. The object of Section 10(33), it was urged, is to prevent double taxation and Section 14A cannot apply to such a situation. In other words, it has been urged that it was only to disallow expenditure covered by the first category of Section 10 where the income is fully exempt from taxation in the hands of any per ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... e of a composite and indivisible business, which results in the earning of taxable and non-taxable income, it would be necessary to apportion the expenditure incurred by the assessee. Only that part of the expenditure which is incurred in relation to income which forms part of the total income can be allowed. The expenditure incurred in relation to income which does not form part of the total income has to be disallowed; (iii) From this it would follow that Section 14A has implicit within it a notion of apportionment. The principle of apportionment which prior to the amendment of Section14A would not have applied to expenditure incurred in a composite and indivisible business which results in taxable and non-taxable income, must after the enactment of the provisions apply even to such a situation; (iv) The expression "expenditure incurred" in Section 14A refers to expenditure on rent, taxes, salaries, interest etc. in respect of which allowances are provided for; (v) Subsections (2) and (3) of Section 14A are intended to enforce and implement the provisions of Subsection (1). The object of subsection (2) is to provide a uniformity of method where the Assessing Officer is, on ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... income tax chargeable on the total income of a domestic Company, additional income tax is charged on profits declared, distributed or paid. This tax which is referred to as a tax on distributed profits is what it means, namely, a tax on the profits of the Company. This is not a tax on dividend income. Under Section 115O, the charge is on a component of the profits of the Company; that component representing profits declared, distributed or paid. The tax under Section 115O is not a tax which is paid by the Company on behalf of the shareholder, nor does the Company act as an agent of the shareholder in paying the tax. This legal position is fortified by the circumstance that the shareholder is not entitled to any deduction in respect of the amount which has been charged to tax under subsection (1) or the tax thereon; (xi) Additional income-tax liability on the profits declared, distributed or paid as dividend by a domestic company, cannot be considered as tax on dividend, because, (a) Provisions contained in Chapter XIID are special provisions relating to tax on the distributed profits of domestic companies. Even Section 115O in Chapter XIID clearly states that the additional inc ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ular tax, payable on the profits of a domestic Company. Thus, the regular tax as well as the additional tax are taxes on the profits of the domestic companies. (e) Incomes enumerated in Section 10 are not includible in the total income, because the legislature exempts such income from tax. Dividends referred to in Section 115O are covered under Section 10(33) and hence exempt from tax. As noted earlier, the additional tax under Section 115O is a tax on the profits distributed as dividend and not a tax on dividend. In the absence of Section 10(33), tax would have been payable on the dividends referred in Section 115O. Therefore, it is clearly evident from Section 10(33) that dividends referred to in Section 115O are exempt from tax. (f) It is contended that dividends taxed in the hands of a domestic company under Section 115O if held taxable again in the hands of a shareholder, would amount to double taxation. There is no merit in this contention because, additional tax is a tax on the profits of the Company which is distributed as dividend, whereas, tax in the hands of a shareholder is a tax on dividend income. (g) This is also supported by Circular No.763 dated 18 February 1 ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... often strangers" yet "attempts should be made that these do not remain always so and if a construction results in equity rather than injustice, then such construction should be preferred to the literal construction". The same principle was adopted by the Supreme Court in an earlier decision in K.P.Verghese vs. Income Tax officer.{(1981) 131 ITR 597}. On similar lines is the decision of the Karnataka High Court in CIT vs. H.S.Shivarudrappa.{200 ITR 1}. 45. The Court will not lightly reject the plain and grammatical construction of a statute. The subject must be within the letter of the law and the Court will not abandon the words used by the legislature in preference to a diffuse if even ephemeral object of deciphering purpose. Legislative purpose in fiscal enactments must lie within the folds of the words used. Before the Court rejects the plain and grammatical construction of a statute, it must be satisfied that such a construction would lead to a result unintended by the Legislature or result in an absurdity. For one thing, individual cases of hardship, set up on the basis of hypothetical examples tendered at the Bar do not establish absurdity of the law. Moreover, it has been ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... et income and expenses allowed can only be in relation to the earning of taxable income. We do not, therefore, accept the submission of the assessee that an absurdity would result on the application of the literal interpretation of Section 14A. C. 3 Constitutional validity of Subsections (2) and (3) of Section 14A and of Rule 8D: 46. Rule 8D provides as follows: "8D. (1) Where the Assessing Officer, having regard to the accounts of the assessee of a previous year, is not satisfied with (a) the correctness of the claim of expenditure made 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 the Act for such previous year, he shall determine the amount of expenditure in relation to such income in accordance with the provisions of subrule (2). (2) The expenditure in relation to income which does not form part of the total income shall be the aggregate of following amounts, namely: (i) the amount of expenditure directly relating to income which does not form part of total income; (ii) in a case where the assessee has incurred expenditure by way of intere ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... lue of investments is taken without reducing it by (a) Investments directly relatable to own funds as there can be no question of apportioning any part of the interest to investment which has given out of own funds and (b) Investments which are directly relatable to borrowed funds as otherwise apart from the direct interest disallowed under Rule 8D(2)(i), there would be a double disallowance of interest by way of a higher allocation of indirect interest expending under Rule 8D(2)(ii); and (iii) The determination of disallowance under Rule 8D(2)(ii)C adopting half percent of average value taken has nothing to do with the amount of the actual expenditure. In fact, the amount arrived at under the Rule can even exceed the total expenditure incurred by an assessee; (iv) The form prescribed in Rule 8D goes beyond Subsection (2) of Section 14A and at the least does not prescribe an accepted or a well settled method for determining expenditure. 49. On the other hand, it has been submitted on behalf of the Union of India that (i) Judicial review of the measure or manner in which a tax is computed is limited and it is only if there is perversity or capriciousness in the method adopted ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ortioned - the amount of expenditure by way of interest that will be taken (as 'A') will exclude any expenditure by way of interest which is directly attributable to any particular income or receipt (e.g. any aspect of the assessee's business such as plant/machinery etc.); (viii) As regards Rule 8D(2)(iii) since investments and the income that they realize will not usually require direct administrative or management expenses, and since these are usually accounted for in common with all the other businesses of the assessee, logic requires that some mechanism or formula be adopted for attributing part of the administrative/managerial expenses to the tax exempt investment income. It is common knowledge that under the Portfolio Management Scheme portfolio managers charge about 2 to 2.5% of the portfolio value as a fee. The profit element of such fee usually does not exceed 1% of the portfolio value. As set out in detail in the affidavit in reply adopting 0.50% of the average of the value of investments (income from which is tax exempt) is not unreasonable and results in identification of expenditure which has a direct and immediate connection with the tax exempt income; (ix) If a prora ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... wer to frame new policies and adjust existing ones in accordance with the felt needs of the time. While dealing with challenges to fiscal legislation, these principles must apply a fortiorari. The Court recognizes the existence of a healthy discretion in the Legislature in determining the subject of tax, the grant of exemptions and the creation of a machinery that would effectively enforce charging provisions. 51. In Khandige Sham Bhat v. Agricultural Income Tax Officer{AIR 1963 SC 591}, a Constitution Bench of the Supreme Court observed thus: "Courts, in view of the inherent complexity of fiscal adjustment of diverse elements, permit a larger discretion to the Legislature in the matter of classification, so long it adheres to the fundamental principles underlying the said doctrine. The power of the Legislature to classify is of "wide range and flexibility" so that it can adjust its system of taxation in all proper and reasonable ways." 52. Again, the Supreme Court emphasized that though the method suggested may be better than the method actually adopted by the legislature, the hardship in individual cases cannot in any event be avoided. Unless the method which has been a ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ties inasmuch as such legislations are designed to take care of complex situations and complex problems which do not admit of solutions through any doctrinaire approach or straitjacket formulae". Mr. Justice R.C.Lahoti (as the Learned Chief Justice then was) speaking for the Bench observed as follows: "The legislature gaining wisdom from historical facts, existing situations, matters of common knowledge and practical problems and guided by considerations of policy must be given a free hand to devise classes - whom to tax or not to tax, whom to exempt or not to exempt and whom to give incentives and lay down the rates of taxation, benefits or concessions. In the field of taxation if the test of Article 14 is satisfied by generality of provisions the courts would not substitute judicial wisdom for legislative wisdom." 55. In Gujarat Ambuja Cements Limited v. Union of India {2005 AIR (SC) 3020} . Mrs. Justice Ruma Pal, speaking for a Bench of two Learned Judges followed the observations of the Constitution Bench in Ganga Sugar (supra) and observed thus: "Because of the inherent complexity of fiscal adjustments of diverse elements in the field of tax, the legisl ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... pportioning the expenditure incurred by the assessee between what is incurred in relation to the earning of taxable income and that which is incurred in relation to the earning of non-taxable income. As a matter of fact, the memorandum explaining the provisions of the Finance Bill 2006 and the CBDT circular dated 28 December 2006 state that since the existing provisions of Section 14A did not provide a method of computing the expenditure incurred in relation to income which did not form part of the total income, there was a considerable dispute between tax payers and the department on the method of determining such expenditure. It was in this background that sub section (2) was inserted so as to provide a uniform method applicable where the Assessing Officer is not satisfied with the correctness of the claim of the assessee. Sub section (3) clarifies that the application of the method would be attracted even to a situation where the assessee has claimed that no expenditure at all was incurred in relation to the earning of non-taxable income. 58. Parliament has provided an adequate safeguard to the invocation of the power to determine the expenditure incurred in relation to the ea ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... method which has been selected is capricious, fanciful or arbitrary, the Court will defer to the wisdom of the legislature and to its delegate who is subject to its legislative control. Burdens and disadvantages are not ground enough to strike down the constitutional validity of legislation or subordinate legislation. Cases of individual hardship are similarly not a valid ground for striking down constitutional validity. So long as the measure which has been put into place has nexus with the object sought to be achieved, is passes constitutional muster. Secondly, sub section (2) of Section 14A makes it abundantly clear that the power to apply the prescribed method arises only where the Assessing Officer is not satisfied with the correctness of the claim of the assessee having regard to the accounts of the assessee. It is because the assessee is unable to establish the correctness of the claim in respect of the expenditure incurred in earning income which does not form part of the taxable income that the Assessing Officer is compelled to make a determination. The Learned Additional Solicitor General has placed before the Court material that would indicate that if a simplistic prora ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... nt of exempt income. Under Portfolio Management Schemes (PMS) the fee charged ranges between 2 and 2.5% of the portfolio value which would be inclusive of a profit element for the portfolio manager. While the fixed administrative expenses were excluded, on the ground that in the case of a large corporate tax payer they would be spread over a large number of voluminous activities, the variable expenses were computed at onehalf percent of the value of the investment. The justification that has been offered in support of the rationale for Rule 8D cannot be regarded as being capricious, perverse or arbitrary. Applying the tests formulated by the Supreme Court it is not possible for this Court to hold that there is writ on the statute or on the subordinate legislation perversity, caprice or irrationality. There is certainly no 'madness in the method'. C.4 Retrospectivity 61. On behalf of the assessee it has been urged that sub sections (2) and (3) of Section 14A and Rule 8D cannot have retrospective effect. Counsel submitted that procedural laws are those which merely prescribe the manner in which rights and responsibilities may be exercised and enforced in a Court. Rule 8D which ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... was. Section 14A(1) merely sought to correct an erroneous judicial interpretation in relation to the apportionment of expenses; (iv) Rule 8D in the present case is clarificatory of how the primary legislation is to be implemented since (i) it only clarifies the method which could have been followed by the Assessing Officer in any case for determining how much of the deduction claimed had proximate relation with the exempt income and (ii) it would render workable in a uniform manner the parliamentary intent under Section 14A(1); and (v) The date which has been stated in the Amending Act from which the amendment is to have effect is irrelevant and the Court has to analyze the nature of the provision to determine whether it should be applied retrospectively. These submissions now fall for determination. 63. The fundamental principle of law is that Parliament has plenary power to legislate, on matters falling within its legislative competence and that power extends to the enactment of legislation with prospective and retrospective effect. Legislative competence of Parliament to enact the law is not in dispute. Law raises a presumption that an amendment which affects substantive righ ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... nguage employed in the statutory provision which may in express terms or by necessary implication empower the authority concerned to make a rule or regulation with retrospective effect. But where no such language is to be found it has been held by the courts that the person or authority exercising subordinate legislative functions cannot make a rule, regulation or byelaw which can operate with retrospective effect (see Subba Rao J. in Dr. Indramani Pyarelal Gupta v. W.R. Natu{(1963) 1 S.C.R. 721: AIR 1963 SC 274} the majority not having expressed any different opinion on the point ; Modi Food Products Ltd. v. Commissioner of Sales Tax{(1955) 6 S.T.C. 287: AIR 1956 All 35}; India Sugars Refineries Ltd. v. State of Mysore{AIR 1960 Mys. 326}, and General S. Shivdev Singh v. State of Punjab{(1959) P.L.R. 514 (F.B.)}" (ii) In Allied Motors (P) Ltd. v. Commissioner of Income Tax{(1997) 91 Taxman 205 (SC), the Supreme Court considered the provisions of Section 43B of the Income Tax Act, 1961 which were aimed at curbing activities of those tax payers who did not discharge their statutory liability towards payment of excise duty, employer's contribution to provident fund etc. for long per ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ply an obvious omission or to clear up doubts as to the meaning of the word "owner" in Section 22 and was therefore declaratory or clarificatory. (iv) In Commissioner of Income Tax v. Alom Extrusions Ltd.{319 ITR 206 (SC)} , the Supreme Court considered the provisions of Section 43B of the Income Tax Act 1961. By way of the first proviso an incentive / relaxation was given in respect of tax, duty, cess or fee by stating that if this was paid before the date of filing of the return under the Income Tax Act, the assessee would be entitled to a deduction. This relaxation, however, did not apply to contributions to labour welfare funds. By the Finance Act of 2003 uniformity was brought about by equating the payment of tax, duty, cess and fee with contributions to welfare funds. The Finance Act of 2003 was made applicable only with effect from 1 April 2004. Hon'ble Mr. Justice S.H. Kapadia (as the Learned Chief Justice then was) speaking for the Supreme Court held that it was curative in nature and would apply retrospectively with effect from 1 April 1988; (v) In Commissioner of Wealth Tax v. Sharvan Kumar Swarup and Sons{(1994) 210 ITR 886} , Rule 1BB of the Wealth Tax Rules ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ction must bear interpretation in accordance with the ordinary rules of construction which is that it must be construed in accordance with the clear intent of the legislature to make the charge levied effective. (vii) Sedco Forex International Drill Inc. v. Commissioner of Income Tax{(2005) 279 ITR 310 (SC)} was a case where the Supreme Court considered whether the salary of an employee payable for field breaks outside India would be subjected to tax under Section 9(1)(ii) read with the explanation thereto in the Income Tax Act 1961. Under Section 5(2) the scope of total income as regards a nonresident was defined with reference to the receipt or accrual in India, whether deemed or actual. Section 9 defines income deemed to accrue or arise in India. By Clause (ii) of sub section (1) of Section 9, income which falls under the head 'salaries', if it is earned in India is included in such income. The Gujarat High Court had held that the words "earned in India" had to be interpreted as "arising or accruing in India" and not "from service rendered in India". Hence, as long as the liability to pay an amount under the head 'salaries' arose in India, Clause (ii) could be invoked. To ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... provisions of a proviso inserted into Section 36(1)(iii) of the Income Tax Act, 1961 by the Finance Act of 2003 with effect from 1 April 2004. The Supreme Court held that the proviso would not apply to Assessment Years 199293 to 199798. (ix) In Commissioner of Income Tax v. Gold Coin Health ( P) Ltd.,{304 ITR 308 (SC)} , the question which arose before a larger Bench of the Supreme Court was whether a penalty under Section 271(1)( c) of the Income Tax Act, 1961 could be levied if the returned income was a loss. This question had to be considered in the background of the amendment made by the Finance Act of 2002 with effect from 1 April 2003 in Explanation 4 to Section 271(1)(c)(iii). In its earlier decision in the case of Virtual Soft Systems Ltd. v. Commissioner of Income Tax,{(2007) 9 SCC 665}, the Supreme Court had rejected the contention of the Revenue that the amendment was clarificatory and retrospective holding that the amendment was stated to take effect from 1 April 2003. In Gold Coin the larger Bench held that the Court has to analyze the nature of the amendment to come to a conclusion whether it is in reality a clarificatory or declaratory provision. Hence, the dat ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... a statutory provision workable, the amendment may be construed to relate back to the provision in respect of which it supplies a remedial effect; (v) Where an amendment essentially provides a rule of evidence such as a method for the valuation of the property by adopting one among a set of well known and well accepted methods of valuation with a view to achieve uniformity in valuation and avoiding disparate valuations resulting from the application of different methods in respect of properties of a similar nature and character, the Court would place a construction on the statutory provision, giving the retrospective effect. 66. These principles would have now to be construed in the context of the provisions of Section 14A. The first point to be noted about the provisions of Section 14A and Rule 8D is that different dates have been provided in these provisions for their enforcement: (i) Sub section (1) of Section 14A was inserted by the Finance Act of 2001 with retrospective effect from 1 April 1962; (ii) Sub sections (2) and (3) were inserted in Section 14A by the Finance Act of 2006 with effect from 1 April 2007; (iii) The proviso was inserted by the Finance Act of 2002 ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... from 1 April 2007 and will, accordingly apply in relation to the Assessment Year 2007-08 and subsequent years". A circular was issued by the CBDT on 28 December 2006 once again clarifying the position that the amendment would be applicable "from the Assessment Year 2007-08 onwards". At any rate this construction which has been placed on the amendment both in the memorandum explaining the provisions of the Finance Bill of 2006 and in the circular of the CBDT dated 28 December 2006 can be regarded as a reasonable interpretation of the provision as explained by the Supreme Court in its judgment in Sedco (supra). The fourth aspect of the matter which would merit emphasis, is the principle of law which has been laid down by the Supreme Court in Shravan Kumar's case (supra). The test which has been formulated by the Supreme Court is as to whether the rule which is prescribed by subordinate legislation "merely provides a choice amongst well known and well settled modes" - in that case of valuation. In the case before the Supreme Court, the rule under the Wealth Tax Rules had adopted the method of capitalizing income on a number of years' purchase value. The Supreme Court emphasized that ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... prospectively. Finally, Subsection (4) of Section 295 of the Act provides as follows: "(4) The power to make rules conferred by this section shall include the power to give retrospective effect, from a date not earlier than the date of commencement of this Act, to the rules or any of them and, unless the contrary is permitted (whether expressly or by necessary implication), no retrospective effect shall be given to any rule so as to prejudicially affect the interests of assessees." Subsection (4) empowers the rule making authority to give retrospective effect to subordinate legislation. However, unless expressly or by necessary indication, a contrary provision is made, no retrospective effect is to be given to any rule so as to prejudicially affect the interests of the assessee. 67. Even in the absence of sub sections (2) and (3) of Section 14A and of Rule 8D, the Assessing Officer was not precluded from making apportionment. Such an apportionment would have to be made in order to give effect to the substantive provisions of sub section (1) of Section 14A which provide that no deduction would be allowed in respect of expenditure incurred in relation to income which does not ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... we have noted earlier, we have come to the conclusion that the provisions of Rule 8D shall have no application to Assessment Year 2002-03 which is the year under consideration in this case. At the same time, as we have noted, Section 14A(1) would have to be given effect to. The principle underlying Section 14A(1) is that no deduction can be claimed in respect of the expenditure incurred in relation to income which does not form part of the total income under the Act. The dividend income earned by the assessee for Assessment Year 2002-03 does not form part of the total income in view of the provisions of Section 10(33) as they then stood. Hence, the expenditure which has been incurred in relation to the earning of that income would have to be apportioned and disallowed. Even if Rule 8D has no application to Assessment Year 2002-03 the Assessing Officer would be duty bound to compute the extent of the disallowance by the application of a reasonable method having regard to all the facts and circumstances of the case. In order to facilitate this exercise, an order of remand to the Assessing Officer would be necessary. 70. However, it has been urged on behalf of the assessee that ther ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... decisions, the Tribunal held that no nexus had been established between borrowed funds and investments by the assessee in dividend yielding shares / income yielding mutual funds. Now assuming that this is so, the only conclusion which emerges is that the assessee had utilized its own funds for the purpose of making the investments. The fact that the assessee has utilized its own funds in making the investments would not be dispositive of the question as to whether the assessee had incurred expenditure in relation to the earning of such income. Even if the assessee has utilized its own funds for making investments which have resulted in income which does not form part of the total income under the Act, the expenditure which is incurred in the earning of that income would have to be disallowed. That is exactly a matter which the Assessing Officer has to determine. Whether or not any expenditure was incurred by the assessee in relation to the earning of non-taxable income falls within the domain of the Assessing Officer. The basis on which the Tribunal had come to its decision for Assessment Years 1998-99, 1999-00 and 2001-02 would not conclude that question. 72. The precedents on w ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... assets could be fixed or non liquid assets and hence not investible. The real enquiry is whether there are interest free funds available on the assets side and in the absence of sufficient proof of available interest free funds, no such presumption can be drawn. Moreover, it has been urged that after the introduction of Section 14A(1), no such presumption can in any event be drawn, since Parliament expressly requires apportionment. We recapitulate our conclusions on this point thus: a) The ITAT had recorded a finding in the earlier assessments that the investments in shares and mutual funds have been made out of own funds and not out of borrowed funds and that there is no nexus between the investments and the borrowings. However, in none of those decisions was the disallowability of expenses incurred in relation to exempt income earned out of investments made out of own funds considered. Moreover, under Section 14A, expenditure incurred in relation to exempt income can be disallowed only if the assessing officer is not satisfied with the correctness of the expenditure claimed by the assessee. In the present case, no such exercise has been carried out and, therefore, the Tribunal ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ue of the provisions of Section 14A(1); ii) The payment by a domestic company under Section 115O(1) of additional income tax on profits declared, distributed or paid is a charge on a component of the profits of the company. The company is chargeable to tax on its profits as a distinct taxable entity and it pays tax in discharge of its own liability and not on behalf of or as an agent for its shareholders. In the hands of the shareholder as the recipient of dividend, income by way of dividend does not form part of the total income by virtue of the provisions of Section 10(33). Income from mutual funds stands on the same basis; iii)The provisions of sub sections (2) and (3) of Section 14A of the Income Tax Act 1961 are constitutionally valid; iv)The provisions of Rule 8D of the Income Tax Rules as inserted by the Income Tax (Fifth Amendment) Rules 2008 are not ultra vires the provisions of Section 14A, more particularly sub section (2) and do not offend Article 14 of the Constitution; v) The provisions of Rule 8D of the Income Tax Rules which have been notified with effect from 24 March 2008 shall apply with effect from Assessment Year 2008-09; vi)Even prior to Assessment Y ..... X X X X Extracts X X X X X X X X Extracts X X X X
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