2008 (10) TMI 383 - AT - Income Tax

Expenditure incurred in relation to income not includible in total income - scope of section 14A - dividend income earned by the assessee engaged in the business of dealing in shares and securities, on the shares held as stock-in-trade - Whether or not any disallowance of expenses is warranted u/s 14A, when the assessee is dealing in shares by way of purchase and sale and any dividend income, which is exempt u/s 10(33), is earned on the shares or other securities held by it as stock-in-trade - Judicial Member and Accountant Member are not consensus ad idem with Third Member - The case of the revenue is that the disallowance is necessary u/s 14A even when the shares are held as stock-in-trade. On the other hand, the view point of the assessee is that the main purpose of making investment in shares and securities is to hold them as stock-in-trade and earning profit on their trading, which income is otherwise taxable under the head ‘Profits and gains of business or profession’ (‘Business income’).

HELD THAT:- On perusal of the section 14A reveals that any expenditure incurred in relation to income not forming part of total income has to be disallowed. Thus, the scope of this section entirely depends upon the meaning of the expression ‘in relation to’ used by the Legislature in this section. Such expression has not been defined in the Act.

In the case of Ahmed G.H. Ariff v. CWT [1969 (8) TMI 4 - SUPREME COURT] held that: "It is well-settled that where the Legislature uses a legal term which has received judicial interpretation, the courts must assume that the term has been used in the sense in which it has been judicially interpreted."

In view of the above legal position, it is held that the expression ‘in relation to’ in section 14A of the Act must be understood in the same sense in which their Lordships of the Apex Court understood in the case of H.H. Maharajadhiraja Madhav Rao Jivaji Rao Scindia Bahadur of Gwalior [1970 (12) TMI 87 - SUPREME COURT].

Accordingly, the expression ‘in relation to’ would mean dominant and immediate connection. This means that disallowance of expenditure u/s 14A can be made only when there is dominant and immediate connection between the expenditure incurred and the income not forming part of the total income. As a necessary corollary, it would mean that disallowance cannot be made if the connection is not dominant and immediate but is merely incidental, ancillary or remote one. The contention of the revenue that the expression ‘in relation to’ would mean any and every relation except remote is, therefore, rejected.

The decision of the Hon’ble Supreme Court in the case of Doypack Systems (P.) Ltd. v. Union of India [1988 (2) TMI 61 - SUPREME COURT] has been relied on by the revenue for the proposition that the expression ‘in relation to’ would include direct as well as indirect connection. A perusal of this decision shows that it was rendered by Bench of two Judges without considering the decision of the Constitution Bench of Eleven Judges in the case of H.H. Maharajadhiraja Madhav Rao Jivaji Rao Scindia Bahadur of Gwalior (supra).

It is a settled rule of precedence that in case of any conflict of opinion between the views expressed by different Benches of a Court then the view taken by the Larger Bench would prevail since the Division Bench cannot enlarge the scope of the decision rendered by the Larger Bench. Therefore, in our opinion, the later decision cannot be applied to determine the scope of section 14A of the Act.

Nature of the connection between the expenditure incurred and the income earned by the assessee - If the expenditure is incurred with a view to earn the taxable income then it can be said that dominant and immediate connection exists between the expenditure incurred and the taxable income and consequently, no disallowance u/s 14A can be made even where some tax-free income is received incidentally. On the other hand, if the expenditure is incurred mainly with a view to earn the tax-free income then it can be said, that the dominant and immediate connection exists between the expenditure incurred and in the tax-free income and consequently disallowance u/s 14A can be made even though some taxable income may arise incidentally.

Disallowance can be made u/s 14A on proportionate basis in accordance with the provisions of sub-sections (2) and (3) of section 14A of the Act. At this stage, it may also be pointed out that section 14A was inserted with a view to overcome the effect of the decision of the Supreme Court in the case of Rajasthan State Warehousing Corpn.[2000 (2) TMI 5 - SUPREME COURT].

Disallowance u/s 14A, in the case of a dealer in shares - Generally, in our opinion, a dealer in shares does not acquire shares and securities to earn dividend income. The dominant and immediate object behind acquisition of shares is to earn profit on the sale of shares at the earliest point of time which is chargeable to tax under the Act. Sometimes, such person by chance may also get the dividend on the shares held by him as ‘stock-in-trade’. Since such dividend income is never intended at the time of purchase of shares, in our opinion, the connection between the expenditure incurred and the dividend income can be said to be incidental only since the dominant and immediate connection exists only between the expenditure incurred and profit on sale of shares.

In our considered opinion, the disallowance u/s 14A can be made in such cases in respect of expenditure incurred. However, onus would be heavy on the revenue to establish such connection because the settled legal proposition is that onus of proof lies on the person who invokes a particular provision or alleges that a fact exists. If AO wants to invoke the provisions of section 14A then onus would be on him to establish that there exists dominant and immediate connection between the expenditure incurred and the income not forming part of total income. On the other hand, where the assessee claims deduction u/s 36(1)(iii) or section 37, the onus would be on the assessee to prove that expenditure was for the purpose of the business. Once this onus is discharged, it would shift to the AO to establish that there exists dominant and immediate connection between expenditure incurred and income exempt from tax if section 14A is to be invoked by him. We hold accordingly.

Scope of sub-sections (2) and (3) of section 14A - We find that these are the procedural provisions for determining the disallowance of the expenditure in relation to income not forming part of the total income. These sub-sections provide the procedure for making disallowance u/s 14A.

Therefore, If the AO finds that there is dominant and immediate connection between the expenditure incurred and the income not forming part of the total income then only the provisions of sub-sections (2) and (3) would come into play and not otherwise. We hold accordingly.

Hence, it is held that in case of dealer in shares no disallowance u/s 14A of the Act can be made merely because some dividend is received incidentally unless it is established that there was dominant and immediate connection between the acquisition of shares and the earning of dividend income.

In the case of Daga Capital Management Pvt. Ltd., we find that assessee was engaged in the business of purchase and sale of shares and securities which is also apparent from the fact that AO himself has accepted the loss incurred in dealing of shares and securities. There is nothing on record to suggest that there was any dominant and immediate connection between the borrowed funds for acquisition of funds and the dividend earned by the assessee. The onus which lies on the AO to prove such connection has not been discharged and consequently, we do not find any infirmity in the order of the ld CIT(A) deleting the disallowance made by the AO.

In Case of Cheminvest Limited and Maxopp Investments Limited - In the case of investment companies, the main purpose of investment is to earn the maximum dividend income. There is no other motive or intention in case of investment companies. Therefore, we are of the view that there did not exist any dominant and immediate connection between the interest paid and the taxable income. In fact, such connection existed between interest paid and the dividend income since the only motive/object was to earn the dividend income as is apparent from the amount of dividend received. Therefore, in our view, the disallowance under section 14A was justified. The orders of the ld CIT(A) in both the cases are therefore upheld.

In the result, the appeal of the revenue in the case of M/s. Daga Capital Management (P.) Ltd. and the appeals of M/s. Maxopp Investments Ltd. and M/s. Cheminvest Ltd. are dismissed.

Two Members Decision - Ld AM and Ld JM - We observe that the disallowance is contemplated in respect of expenditure incurred by the assessee in relation to the income which does not form part of the total income under this Act. When the language of section is clear and does not admit of any doubt whatsoever, we are bound to interpret it literally.

It is trite law that so long as there is no ambiguity in the statutory language, resort to in interpretive process to unfold the Legislative intent becomes impermissible. Taxing statute has to be strictly construed and nothing can be read in it as has been held by the Hon’ble Supreme Court in several cases including Federation of Andhra Pradesh Chambers of Commerce & Industry v. State of Andhra Pradesh [2000 (8) TMI 78 - SUPREME COURT]. In Padmasundara Rao v. State of Tamil Nadu [2002 (3) TMI 44 - SUPREME COURT] also it was held that ‘while interpreting a statute legislative intention must be found in the words used by the Legislature itself; legislative casus omissus cannot be supplied interpretative process except in case of clear necessity and when reason for it is found in the four corners of the statute itself’.

We note that sub-section (1) of section 14A provides in unequivocal terms for not allowing deduction in respect of expenditure incurred by the assessee in relation to exempt income and sub-section (2) lays down the mechanism for determining such amount of expenditure incurred in relation to the exempt income in accordance with the method as prescribed under rule 8D. There is hardly anything to infer, that the Legislature intended to immune the expenditure in relation to incidental exempt income from the operation of section 14A. There is no exception for not considering any income which is exempt from tax, be it the main or incidental. We, therefore, jettison this argument.

We hold that the provisions of section 14A of the Act are applicable with respect of dividend income earned by the assessee engaged in the business of dealing with shares and securities, on the shares held as stock-in-trade when earning of such dividend income is incidental to the trading in shares. We, therefore, answer the question posed to us in affirmative. As we have held that sub-sections (2) and (3) of section 14A are retrospective in nature and the resultant rule 8D would also fall on the same line, then the disallowance u/s 14A is required to be computed with reference to the mandate of these provisions. We, therefore, set aside the impugned orders in all the cases before us and remit the matter to the file of the AO's for computing the disallowance in terms of section 14A r/w rule 8D.

In the result, all the appeals are allowed for statistical purposes, by majority view.