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TMI Blog2018 (3) TMI 805X X X X Extracts X X X X X X X X Extracts X X X X ..... stment Limited may have made the investment in order to gain control of the investee company. However, that does not appear to be a relevant factor in determining the issue at hand. Fact remains that such dividend income is non-taxable. In this scenario, if expenditure is incurred on earning the dividend income, that much of the expenditure which is attributable to the dividend income has to be disallowed and cannot be treated as business expenditure. Keeping this objective behind Section14A of the Act in mind, the said provision has to be interpreted, particularly, the word in relation to the income that does not form part of total income. Prior to introduction of Section 14A the law was that when an assessee had a composite and indivisible business which had elements of both taxable and non-taxable income, the entire expenditure in respect of said business was deductible and, in such a case, the principle of apportionment of the expenditure relating to the non-taxable income did not apply. The principle of apportionment was made available only where the business was divisible. It is to find a cure to the aforesaid problem that the Legislature has not only inserted Section 14A by ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ch a satisfaction, nature of loan taken by the assessee for purchasing the shares/making the investment in shares is to be examined by the AO. Rule 8D of the Rules is prospective in nature and could not have been made applicable in respect of the Assessment Years prior to 2007 when this Rule was inserted. X X X X Extracts X X X X X X X X Extracts X X X X ..... diture shall also not be allowed as deduction. Though, Section 14A was inserted by the Finance Act, 2001, but it was given retrospective effect from April 1, 1962. Original Section was in the following terms: "Section 14A - For the purposes of computing the total income under this Chapter, no deduction shall be allowed in respect of expenditure incurred by the assessee in relation to income which does not form part of the total income under this Act." 2) By the Finance Act, 2006, the aforesaid provision was amended whereby it was renumbered as sub-section (1) and sub-sections (2) and (3) were added thereto. Before that, a proviso was also added by amendment vide Finance Act, 2002 which was to operate retrospectively from May 11, 2001. In these batch of appeals, we are not concerned with sub-sections (2), (3) or the proviso and it is only interpretation that has to be given to sub-section (1), which arises for consideration. 3) Though, it is clear from the plain language of the aforesaid provision that no deduction is to be allowed in respect of expenditure incurred by the assessee in relation to income which does not form part of the total income under the Act, the effect wher ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... in Civil Appeal Nos. 104-109 of 2015, aforesaid is the scenario. Though, in some other cases, there may be little difference in fact situation. However, all these cases pertain to dividend income, whether it was for the purpose of investment in order to retain controlling interest in a company or in group of companies or the dominant purpose was to have it as stock-in-trade. 5) Before we proceed further, we may briefly note the facts of Civil Appeal Nos. 104-109 of 2015, for better understanding of the issue involved. The appellant company is engaged, inter alia, in the business of finance, investment and dealing in shares and securities. The appellant holds shares/securities in two portfolios, viz. (a) as investment on capital account; and, (b) as trading assets for the purpose of acquiring and retaining control over investee group companies, particularly Max India Ltd., a widely held quoted public limited company. Any profit/loss arising on sale of shares/securities held as 'investment' is returned as income under the head 'capital gains', whereas profit/loss arising on sale of shares/securities held as 'trading assets' (i.e. held, inter alia, with the intention of acquiring, ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... at investment in shares representing controlling interest did not amount to carrying on of business and, therefore, interest expenditure incurred for acquiring shares in group companies was hit by the provisions of Section 14A of the Act. The Special Bench further held that holding of shares with the intention of acquiring/retaining controlling interest would normally be on capital account, i.e. as investment and not as 'trading assets'. For that reason too, the Special Bench held that there existed dominant connection between interest paid on loan utilized for acquiring the aforesaid shares and earning of dividend income. Consequently, the provisions of Section 14A of the Act were held to be attracted on the facts of the case. 8) On the interpretation of the expression 'in relation to', the majority opinion of the Special Bench was that the requirement of there being direct and proximate connection between the expenditure incurred and exempt income earned could not be read into the provision. According to the majority view, 'what is relevant is to work out the expenditure in relation to the exempt income and not to examine whether the expenditure incurred by the assessee has res ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... uction shall be allowed in respect of expenditure incurred by the assessee in relation to income which does not form part of the total income under this Act. (2) The Assessing Officer shall determine the amount of expenditure incurred in relation to such income which does not form part of the total income under this Act in accordance with such method as may be prescribed, if the Assessing Officer, having regard to the accounts of the assessee, is not satisfied with the correctness of the claim of the assessee in respect of such expenditure in relation to income which does not form part of the total income under this Act. (3) The provisions of sub-section (2) shall also apply in relation to a case where an assessee claims that no expenditure has been incurred by him in relation to income which does not form part of the total income under this Act : Provided that nothing contained in this section shall empower the Assessing Officer either to reassess under section 147 or pass an order enhancing the assessment or reducing a refund already made or otherwise increasing the liability of the assessee under section 154, for any assessment year beginning on or before the 1st day of Ap ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... previous year; (iii) an amount equal to one-half per cent of the average of the value of investment, income from which does not or shall not form part of the total income, as appearing in the balance sheet of the assessee, on the first day and the last day of the previous year. (3) For the purposes of this rule, the "total assets" shall mean, total assets as appearing in the balance sheet excluding the increase on account of revaluation of assets but including the decrease on account of revaluation of assets." 13) With the aforesaid statutory scheme in mind, we traverse through the judgments of the Delhi High Court in Maxopp Investment Ltd. and that of Punjab and Haryana High Court in State Bank of Patiala. JUDGMENT OF DELHI HIGH COURT IN MAXOPP INVESTMENT LTD. 14) Three questions fell for consideration before the High Court. For the purpose of these appeals, it is only question No. 1 which is relevant, and formulation thereof by the High Court was as under: "1. Whether expenditure (including interest paid on funds borrowed) in respect of investment in shares of operating companies for acquiring and retaining a controlling interest therein is hit by section 14A of the Inc ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... urt. Since, for the purpose of the present case, it is necessary to keep in mind the objectives behind this provision, we reproduce that part of the discussion hereunder: "Objective behind insertion of section 14A 15. The object behind the insertion of section 14A in the said Act is apparent from the Memorandum explaining the provisions of the Finance Bill 2001 which is to the following effect:- "Certain incomes are not includable while computing the total income as these are exempt under various provisions of the Act. There have been cases where deductions have been claimed in respect of such exempt income. This in effect means that the tax incentive given by way of exemptions to certain categories of income is being used to reduce also the tax payable on the non-exempt income by debiting the expenses incurred to earn the exempt income against taxable income. This is against the basic principles of taxation whereby only the net income, i.e., gross income minus the expenditure is taxed. On the same analogy, the exemption is also in respect of the net income. Expenses incurred can be allowed only to the extent they are relatable to the earning of taxable income. It is propos ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ke dividend income which does not form part of the total income, any expenditure/deduction relatable to such (exempt or non-taxable) income, even if it is of the nature specified in sections 15 to 59 of the said Act, cannot be allowed against any other income which is includable in the total income. The exact words used by the Supreme Court are as under:- "Further, section 14 specifies five heads of income which are chargeable to tax. In order to be chargeable, an income has to be brought under one of the five heads. Sections 15 to 59 lay down the rules for computing income for the purpose of chargeability to tax under those heads. Sections 15 to 59 quantify the total income chargeable to tax. The permissible deductions enumerated in sections 15 to 59 are now to be allowed only with reference to income which is brought under one of the above heads and is chargeable to tax. If an income like dividend income is not a part of the total income, the expenditure/deduction though of the nature specified in sections 15 to 59 but related to the income not forming part of the total income could not be allowed against other income includable in the total income for the purpose of chargeabil ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... gainst other taxable income. 17) Likewise, explaining the meaning of 'expenditure incurred', the High Court agreed that this expression would mean incurring of actual expenditure and not to some imagined expenditure. At the same time, observed the High Court, the 'actual' expenditure that is in contemplation under section 14A(1) of the said Act is the 'actual' expenditure in relation to or in connection with or pertaining to exempt income. The corollary to this is that if no expenditure is incurred in relation to the exempt income, no disallowance can be made under section 14A of the said Act. On the basis of the aforesaid discussion, the High Court answered the question formulated by it in the affirmative. JUDGMENT OF PUNJAB AND HARYANA HIGH COURT IN STATE BANK OF PATIALA 18) This case arose in the context where exempt income in the form of dividend was earned by the Bank from securities held by it as its stock in trade. The assessee filed its return declaring an income of about ₹ 670 crores which was selected for scrutiny. The return showed dividend income exempt under section 10(34) and (35) of about ₹ 11.07 crores and net interest income exempt under section 10(1 ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... T is right in law in deleting the addition made on account of disallowance under section 14A of the Income Tax Act, 1961?" 19) In its analysis, the High Court accepted the contention of the counsel for the assessee that the assessee is engaged in the purchase and sale of shares as a trader with the object of earning profit and not with a view to earn interest or dividend. The assessee does not have an investment portfolio. The securities constitute the assessee's stock-in-trade. The Department, in fact, rightly accepted, as a matter of fact, that the dividend and interest earned was from the securities that constituted the assessee's stock-in-trade. The same is, in any event, established. The assessee carried on the business of sale and purchase of securities. It was supported by Circular No.18, dated November 02, 2015, issued by the CBDT, which reads as under:- "Subject: Interest from Non-SLR securities of Banks - Reg. It has been brought to the notice of the Board that in the case of Banks, field officers are taking a view that, "expenses relatable to investment in non-SLR securities need to be disallowed u/s 57(i) of the Act as interest on non-SLR securities is income from ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... 6 (SC). Since, the shares, bonds, debentures purchased by the assessees constituted its stock-in-trade, the provisions of Section 14A were not applicable. Here, the Court noted distinction between stock-in-trade and investment and made the following observations: "17. Under section 14A, an expenditure can be disallowed only if it is incurred by the assessee in relation to income exempt from tax. The dividend or interest from the assessee's stock-in-trade i.e. the securities was exempt from tax in view of sections 10(15)(iv)(h),(34) and (35). This was incidental to its business of banking. The business income on account of the assessee trading in the securities is assessable under the head "Profits and gains of business and profession". The expenditure incurred in relation to stock-in-trade arising as a result of investment in shares and debentures is deductible under sections 28 to 37. There is a distinction between stock-in-trade and investment. The object of earning profit from trading in securities is different from the object of earning income, such as, dividend and interest arising therefrom. The object of trading in securities does not constitute the activity of investment ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... nd the income derived therefrom is offered to tax as business income. The remaining 37% of the shares are retained. It has remained unsold with the assessee. It is those unsold shares have yielded dividend, for which, the assessee has not incurred any expenditure at all. Though the dividend income is exempted from payment of tax, if any expenditure is incurred in earning the said income, the said expenditure also cannot be deducted. But in this case, when the assessee has not retained shares with the intention of earning dividend income and the dividend income is incidental to his business of sale of shares, which remained unsold by the assessee, it cannot be said that the expenditure incurred in acquiring the shares has to be apportioned to the extent of dividend income and that should be disallowed from deductions. In that view of the matter, the approach of the authorities is not in conformity with the statutory provisions contained under the Act. Therefore, the impugned orders are not sustainable and require to be set aside." 25) At this stage, it will also be useful to refer a judgment of Calcutta High Court in Commissioner of Income Tax v. G.K.K. Capital Markets (P.) Ltd. (2 ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... nal and has contended that the assessee itself having failed to produce material in support of its contention, the Assessing Officer rightly assessed the deductible income on proportionate basis. Mr. Sarkar submits that the same is in conformity with Rule 8D of the Income tax Rule and thus, we should not interfere with the order passed by the Tribunal. 7. After hearing the learned counsel appearing for the parties and after going through the materials on record and the decisions cited by Mr. Khaitan, we find that the Supreme Court in the cases of CIT v. Maharastra Sugar Mills Ltd. [1971] 82 ITR 452 and Rajasthan State Warehousing Corpn. v. CIT [2000] 242 ITR 450/109 Taxman 145 having held that where there is one indivisible business giving rise to taxable income as well as exempt income, the entire expenditure incurred in relation 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 of the Act was enacted to overcome those judicial pronouncements. The object of section 14A of the Act is to disallow the direct and indirect expenditure incurred in relation to income which does not form part of the total inco ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ounsel for the Revenue. A brief resume of their submissions would serve the purpose. 28) Insofar as assessees are concerned, their arguments are recapitulated in brief hereinbelow: (i) The holding of investment in group companies representing controlling interest, amounts to carrying on business, as held in the various cases. (ii) Notwithstanding that dividend income is assessable under the head "income from other sources", in view of the mandatory prescription in Section 56 of the Act, the nature of dividend income has to be ascertained on the facts of the case. Where dividend is earned on shares held as stock-in-trade/shares purchased for acquiring/retaining controlling interest, dividend income is in the nature of business income. (iii) Interest paid on loans borrowed for acquiring shares representing controlling interest in the investee company is allowable business expenditure in terms of Section 36(1)(iii) of the Act, since acquiring controlling interest in companies and managing, administering, financing and rehabilitating such companies are for business and/or professional purposes and not for earned dividend. (iv) Conversely, interest paid on funds borrowed for in ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... arned senior counsel, the assessee will get double benefit, one, in the form of exemption from income tax insofar as dividend income is concerned and other by getting deduction on account of expenditure as well. He, thus, submitted that expression 'in relation to' had to be given expansive meaning in order to sub-serve the purpose of the said provision. He also emphasised that literal meaning of Section 14A of the Act pointed towards that and that was equally the purpose behind the insertion of Section 14A as well. 31) We have given our thoughtful consideration to the argument of counsel for the parties on both sides, in the light of various judgments which have been cited before us, some of which have already been taken note of above. 32) In the first instance, it needs to be recognised that as per section 14A(1) of the Act, deduction of that expenditure is not to be allowed which has been incurred by the assessee "in relation to income which does not form part of the total income under this Act". Axiomatically, it is that expenditure alone which has been incurred in relation to the income which is includible in total income that has to be disallowed. If an expenditure incurred ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... Act in mind, the said provision has to be interpreted, particularly, the word 'in relation to the income' that does not form part of total income. Considered in this hue, the principle of apportionment of expenses comes into play as that is the principle which is engrained in Section 14A of the Act. This is so held in Walfort Share and Stock Brokers P Ltd., relevant passage whereof is already reproduced above, for the sake of continuity of discussion, we would like to quote the following few lines therefrom. " The next phrase is, "in relation to income which does not form part of total income under the Act". It means that if an income does not form part of total income, then the related expenditure is outside the ambit of the applicability of section 14A.. xxx xxx xxx The theory of apportionment of expenditure between taxable and non-taxable has, in principle, been now widened under section 14 A." 35) The Delhi High Court, therefore, correctly observed that prior to introduction of Section 14A of the Act, the law was that when an assessee had a composite and indivisible business which had elements of both taxable and non-taxable income, the entire expenditure in respect of ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... that it has to be treated as income falling under the head 'profits and gains of business and profession'. The Board also went to the extent of saying that this would not be limited only to co-operative societies/Banks claiming deduction under Section 80P(2)(a)(i) of the Act but would also be applicable to all banks/commercial banks, to which Banking Regulation Act, 1949 applies. 38) From this, Punjab and Haryana High Court pointed out that this circular carves out a distinction between 'stock-in-trade' and 'investment' and provides that if the motive behind purchase and sale of shares is to earn profit, then the same would be treated as trading profit and if the object is to derive income by way of dividend then the profit would be said to have accrued from investment. To this extent, the High Court may be correct. At the same time, we do not agree with the test of dominant intention applied by the Punjab and Haryana High Court, which we have already discarded. In that event, the question is as to on what basis those cases are to be decided where the shares of other companies are purchased by the assessees as 'stock-in-trade' and not as 'investment'. We proceed to discuss this as ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ever dividend is declared by the investee company that would necessarily be earned by the assessee and the assessee alone. Therefore, even at the time of investing into those shares, the assessee knows that it may generate dividend income as well and as and when such dividend income is generated that would be earned by the assessee. In contrast, where the shares are held as stock-in-trade, this may not be necessarily a situation. The main purpose is to liquidate those shares whenever the share price goes up in order to earn profits. In the result, the appeals filed by the Revenue challenging the judgment of the Punjab and Haryana High Court in State Bank of Patiala also fail, though law in this respect has been clarified hereinabove. 41) Having regard to the language of Section 14A(2) of the Act, read with Rule 8D of the Rules, we also make it clear that before applying the theory of apportionment, the AO needs to record satisfaction that having regard to the kind of the assessee, suo moto disallowance under Section 14A was not correct. It will be in those cases where the assessee in his return has himself apportioned but the AO was not accepting the said apportionment. In that ev ..... X X X X Extracts X X X X X X X X Extracts X X X X
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