TMI Blog2007 (2) TMI 363X X X X Extracts X X X X X X X X Extracts X X X X ..... not made the investment in shares out of borrowed funds for the purpose of earning the dividend." 2. Briefly stated, the facts of the case are that the assessee was engaged in the business of trading in iron and steel parts during the previous year relevant to the assessment year under appeal. The assessee acquired 7,45,000 shares at the rate of Rs. 10 per share of M/s. Spectra Industries Ltd., a sister concern of the assessee. The Assessing Officer noticed that the assessee had made the aforesaid investment in shares in order to earn dividend which was exempt from tax under section 10( 33 ) of the Income-tax Act. The Assessing Officer further observed that the assessee had debited interest payments of Rs. 10,43,491 to the P L Account. He also found that the assessee had borrowed huge money and paid substantial interest to others and that it had given substantial amount of Rs. 74,50,000 for purchasing the shares and earning the dividend thereon. He therefore proceeded to examined the issue in terms of provisions of section14A of the Income-tax Act and accordingly issued a notice to the assessee. In reply, the assessee submitted that it had made investment in shares of the sis ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... business of the assessee to make investment in shares. Therefore, dividend earned on shares is liable to be assessed as income from other sources under section 56 of the Income-tax Act. Ld. CIT(A) has recorded a categorical finding that the assessee has failed to discharge his onus that interest paid on borrowings was used exclusively for the purposes of its business. He has also recorded a finding that interest bearing funds have been diverted for making investment in shares of the sister concern. 4. Deductions otherwise admissible under section 36(1)( iii ) and section 57( iii ) are now subject to the provisions of section 14A. Therefore, the applicability of the provisions of section 14A has to be examined first. If the expenses are not hit by section 14A(1), their deductibility has then to be considered under section 36(1)( iii ) or 57( iii ). 5. We shall therefore turn to section 14A, which prohibits deduction of any expenditure incurred by the assessee in relation to income, which does not form part of the total income under the Income-tax Act. Sub-sections (2) and (3) have been inserted in section 14A of the Income-tax Act by the Finance Act, 2006. Sub-section (2) p ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... cover all forms of expenses provided they have some connection with the exempt income. This is based on the principle that expenses must be allocated to that income to which they are connected to avoid distortions in the computation of both taxable as well as exempt income. This is also achieved by the matching principle of accountancy. In Taparia Tools Ltd. v. Joint CIT [2003] 260 ITR 102 1 (Bom.), the Hon ble jurisdictional High Court has explained the matching principle as under : "The mercantile system of accounting is based on accrual. Basically, it is a double entry system of accounting. Under the mercantile system of accounting, profits arising or accruing at the date of the transaction are liable to be taxed notwithstanding the fact that they are not actually received or deemed to be received under the Act. Under the mercantile system of accounting, therefore, book profits are liable to be taxed. The profits earned and credited in the books of account constitute the basis of computation of income. The system postulates the existence of tax in so far as monies due and payable by the parties to whom they are debited. Therefore, under the mercantile system of accounting ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... exempt under section 10(33), the interest on capital borrowed for acquisition of relevant shares yielding such dividend cannot be allowed deduction by operation of section 14A. In Dy. CIT v. SG Investments Industries Ltd. [2004] 89 ITD 44 (Cal.), the Calcutta Bench of this Tribunal has laid down two propositions: one, in view of section 14A inserted in the Income-tax Act with retrospective effect from 1-4-1962, pro rata expenses on account of interest relatable to investment in shares for earning exempt income from dividend are to be disallowed against taxable income and only the net dividend income is to be allowed exemption after deducting the expenses; and two, the expression "expenditure incurred by the assessee in relation to income which does not form part of the total income" in section 14A has to be given a wider meaning and would include both direct and indirect relationship between expenditure and exempt income. Following the decision of the Hon ble Supreme Court in CIT v. United General Trust Ltd. [1993] 200 ITR 488, the Calcutta Bench of the Tribunal has also held that the interest paid by the assessee being attributable to the money borrowed for the purpos ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... gment of Sargant L.J.: "The liability is imposed by the charging section, namely, section 38, the words of which are clear. The subsequent provisions as to assessment and so on are machinery only. They enable the liability to be quantified, and when quantified to be enforced against the subject, but the liability is definitely and finally created by the charging section and all the materials for ascertaining it are available immediately." In Halsubury s Law of England (Fourth edition, Vol. 23, paragraph 29), referring to the machinery provisions, it is stated : "It is important to distinguish between charging provisions, which impose the charge to tax, and machinery provisions, which provide the machinery for the quantification of the charge and the levying and collection of the tax in respect of the charge so imposed. Machinery provisions do not impose a charge or extend or restrict a charge elsewhere clearly imposed." In Kesoram Industries Cotton Mills Ltd. v. CWT [1966] 59 ITR 767 (SC), Hon ble Mr. Justice Shah observed: "Section 7(2) merely provides machinery in certain special cases for valuation of assets, and it is from the aggregate valuation of assets that the net ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... g a substantive right the institution of a suit carries with it the implication that all successive appeals available under the law then in force would be preserved to the parties to the suit throughout the rest of the career of the suit. There are two exceptions to the application of this rule, viz. , (1) when by competent enactment such right of appeal is taken away expressly or impliedly with retrospective effect; and (2) when the court to which appeal lay at the commencement of the suit stands abolished [ See Garikapatti Veeraya v. N. Subbiah Choudhry [1957] SCR 488; AIR 1957 SC 540, and Colonial Sugar Refinning Co. Ltd. v. Irving [1905] AC 369 (PC)]." Halsbury s Laws of England (Fourth edition, Vol. 44, paragraph 925) states: "The presumption against retrospection does not apply to legislation concerned merely with matters of procedure or of evidence; on the contrary, provisions of that nature are to be construed as retrospective unless there is a clear indication that such was not the intention of Parliament." All the aforesaid observations have been cited, with approval, by the Hon ble Supreme Court in CWT v. Sharvan Kumar Swarup Sons [1994] 210 ITR 886 . ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... purpose of its own business, i.e., construction business not only in the initial year of borrowing but also continued to be utilized in the succeeding years in which deduction is claimed. In K. Somasundaram Bros. v. CIT [1999] 238 ITR 939 (Mad.), it has been held that it is not the object of section 36(1)( iii ) to enable an assessee to make a large borrowing and create a liability for payment of interest thereon not only in the year in which the borrowing is made, but in the subsequent years as well, keep the loan outstanding and thereafter divert the amount initially borrowed by taking it out of the business by giving it interest-free to the relatives of partners and thereby continue to pay interest out of the income of the business and claim the amount of interest paid as a business expenditure. The payment of interest on the amount not used for earning the business income under section 28 cannot be regarded as business expenditure as the business does not derive any benefit by the outgoing by way of interest on an amount, which is no longer in the business, but had been diverted from the business for other purposes. The Hon ble High Court has further observed that this ..... 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