TMI Blog2010 (11) TMI 183X X X X Extracts X X X X X X X X Extracts X X X X ..... on the shares purchase for investment. Disallowance of proportionate administrative expenses - There cannot be a parity or equal basis for apportionment of the administrative expenses between the delivery based transaction and non-delivery based transaction as well as trading and investment activities. Undisputedly the labour hours and other overhead expenses will be less in case of non-delivery based transaction of purchase and sale of shares & securities in comparison to the delivery based transaction. Similarly in case of collection of dividend through cheques or vouchers will costs more than direct credit in D-mat account. It is undisputable fact that the dividend was directly credited in the D-mat account. Secondly, the dividend income is on the shares held for trading purposes. - Matter remanded to the file of AO with direction. - IT Appeal No. 456 (Mum) of 2009 - - - Dated:- 10-11-2010 - R.K. Panda, Accountant Member J, And Vijay Pal Rao, Judicial Member J, S.C. Tiwari and Meghna Butala for the Appellant. S.K. Patwa for the Respondent. ORDER Per Vijay Pal Rao, Judicial Member : This appeal by the assessee is directed against the order dated 23.1 ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... litigant gets free licence to approach the court at it's will. In view of this legal and factual position, we condone the delay of 67 days in filing the appeal before the Tribunal and take up the matter for adjudication on merits. Disallowance u/s 14A of the IT Act. 8. The brief facts of the case are that the assessee company is engaged in the business of trading in shares and securities as well as in private projects and investment in shares and securities. During the previous year relevant to the assessment year under consideration the assessee earned dividend income of Rs. 2,98,92,569 ; and claimed exemption under section 10(33) of the IT Act. During the relevant period the total income credited by the assessee to the profit and loss account amounting to Rs. 39,03,43,325 which includes dividend income of Rs. 2,98,92,569. The assessee also debited an amount of Rs.10,68,26,946 to the profit and loss account which includes administrative and other expenses of Rs. 1,53,19,834 and financial expenses of Rs. 6,36,05,264. The details of financial expenses are as under : ( a ) interest paid to Bank Rs.63,33,224 Others Rs.5,38,55,863 Total ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... . On the basis of the decision of the jurisdictional High Court in the case of CIT v. Emraid Co. Ltd. (supra) it was submitted that the assessee is trading in shares, therefore, the question of applicability of section 14 does not arise as the monies have been borrowed only for the purposes of trading in shares. The assessee further submitted that in view of the decision of the jurisdictional High Court the client of the assessee is entitled to get the deduction of interest paid for doing the trading of the business in shares. 13. After going through the contents of the letter dated 31.10.2006, the AO was of the opinion that the assessee has quoted the observations of the decision of jurisdictional High Court in the case of CIT v. Emraild Co. Ltd. and stated that the provision of the section 14A does not apply to the assessee. The AO observed that the assessee did not produced details of utilization of borrowed amount with supporting evidence on which the interest is paid and debited to the profit and loss account. 14. During the course of assessment proceedings the assessee submitted that the assessee has reduced the loan by Rs. 1,28,58,678 i.e., the share holder ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... he interest bearing borrowed fund. As can be seen from the above that the borrowed funds ( Rs. 52,90,70,980 ) are more than the own funds ( Rs.27,94,34,833 ) of the assessee. In the absence on the part of the assessee of showing the nexus of investment with own capital funds. I therefore, proceed to hold that the investment in the ratio of borrowed funds to the total funds is made out of borrowed funds and interest attributable to such funds to the total funds is made out of borrowed funds and interest attributable to such funds is held as incurred for earning exempted income. Total funds Rs. 80,85,05,813 Borrowed funds Rs. 52,90,70,980 % of borrowed funds 64.44% Total investment Rs. 27,06,64,720 Investment our of borrowed funds (64.44% of 27,06,64,720) Rs. 17,71,22,993 Total interest paid Rs. 6,01,89,088 Therefore interest attributed to investment out of borrowed funds 6,01,89,088 x 17,71,22,993 52,90,70,980 = 2,01,50,172 In view of the above, interest expenses of Rs. 2,01,50,172 is held as attributable to the investment out of borrowed funds. The amoun ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... stablishes that the retroactivity of the provisions is not yet annulled. 3.3.2 In a subsequent decision, in the case of Union Bank of India v. ACIT in IT ANo.5347/Mum/2007 also, the hon. Members have held that only the expenditure, which has been proved to have been incurred in relation to the earning of tax free income can be disallowed and the section cannot be extended to disallow even expenditure, which is assumed to have been incurred for the purposes of earning the tax free income. If these judgments by the Hon. Judicial tribunals are harmoniously analyzed. It is clearly established that the retroactivity of provisions of section 14A is not yet annulled. Expenses which can be related to the exempt income earning, need to be apportioned in a reasonable way. In order to set to rest the reasonableness with respect to such estimate, the CBDT has issued Rule 8D, which has been made operative from AY 2007-08. However, in the absence of a clear cut provision for such estimate before this day, it will be most appropriate for the assessing authority to apply Rule 8D for earlier years as well. Once the retroactivity and the need for apportionment o f expenses are established, ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... at the activity of purchase and sale of shares is mainly on treading account. The assessee has not purchased shares with a view to earn dividend income. Profit arising to the assessee on sale of shares in the trading account is chargeable to tax under the head "profits and gains of business or profession" and have been offered and assessed likewise. On these facts the assessee humbly submits that no part of finance charges including interest paid by the assessee is disallowable u/s14A as expenditure incurred in relation to dividend received by the assessee. The assessee in this behalf strongly relied upon the judgment of Hon. Jurisdictional High Court in the case of CIT v. Emerald Co. Ltd. [2006] 284 ITR 586. 20. The assessee in this behalf relied upon the judgment of Hon. Calcutta High Court in the case of CIT v. Kanoria Investment P. Ltd. 232 ITR 7 (Cal.) to the effect that even if the borrowed money is applied in purchase of shares which yield dividend, the entire interest paid on borrowing should be allowed as deduction in computing business income and no part of interest should be apportioned and deducted from dividend. The Ld. A.R. has submitted that in the case o ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... es on which dividend is received. 23. On the other hand, the learned DR has heavily relied upon the orders of the lower authorities. He has submitted that even otherwise the apportionment of the expenditure incurred in relation to the exempt income on reasonable basis is inherent in the provisions of section 14A. The provisions of section 14A does not make a difference whether any amount is incurred and debited in the trading account for trading activities or the said expenditure is incurred towards the other purchases. The provisions of section 14A are applicable if the assessee has earned the income which is not forming the part of the total income of the assessee and certain expenses are incurred for earning the said income. He has relied upon the decision of the Hon. jurisdictional High Court in the case of Godrej and Boyce Mfg Co. Ltd. v. DCIT 234 CTR (Bom.). 24. We have considered the rival contentions and relevant record. The AO disallowed the interest expenditure on borrowed funds under the provisions of section 14A as well as the administrative expenditure by apportioning the same for earning the dividend income. The CIT(A) while passing the impugned order thou ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... il. Consequently, Rule 8D which has been notified on 24 March 2008 would apply with effect from Assessment Year 2008-09. The rule consequently cannot have application in respect of Assessment Year 2002-03 which is the year under consideration in this case." 26. Since the assessment year under consideration is assessment year 2004-05 therefore in view of the decision (supra) of the jurisdictional High Court, the provisions of Rule 8D cannot be applied. Disallowance of proportionate Interest 27. Now we take up the controversy of disallowance of proportionate interests incurred for earning the dividend income. The CIT(A) in paragraph 3.3.2 as reproduced above has not been disputed, the settled legal proposition that only the expenditure which has been proved to have been incurred in relation to earn the tax free income can be disallowed and the provisions of section 14A cannot be extended to disallowed even the expenditure which is assumed to have been incurred for the purposes of earning the tax free income. The business of the assessee predominantly is trading in shares, securities and derivatives though the assessee was also having the investment in the shares and secu ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ssee, thus, claimed the dividend received as exempt under section 10 ( 33 ) and also claimed set-off for the loss against its taxable income, thereby seeking to reduce its tax liability and gain tax advantage. The insertion of section 14A with retrospective effect is the serious attempt on the part of the Parliament not to allow deduction in respect of any expenditure incurred by the assessee in relation to income, which does not form part of the total income under the Act against the taxable income ( see Circular No. 14 of 2001, dated 22.11.2001 ) . In other words, section 14A clarifies that expenses incurred can be allowed only to the extent they are relatable to the earning of taxable income. In many cases the nature of expenses 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 exemptio ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... "expenditure incurred" in section 14A refers to expenditure on rent, taxes, salaries, interest, etc. in respect of which allowances are provided for ( see sections 30 to 37 ) . Every payout is not entitled to allowances for deduction. These allowances are admissible to qualified deductions. These deductions are for debits in the real sense. A pay-back does not constitute an "expenditure incurred" in terms of section 14A. Even applying the principles of accountancy, a pay-back in the strict sense does not constitute an "expenditure" as it does not impact the Profit Loss Account. Pay-back or return of investment will impact the balance-sheet whereas return on investment will impact the Profit Loss Account. Cost of acquisition of an asset impacts the balance sheet. Return of investment brings down the cost. It will not increase the expenditure. Hence, expenditure, return on investment, return of investment and cost of acquisition are distinct concepts. Therefore, one needs to read the words "expenditure incurred" in section 14A in the context of the scheme of the Act and, if so read, it is clear that it disallows certain expenditures incurred to earn exempt income from being ded ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... units and the payment of tax-free dividend, hence, disallowance of the loss. In the lead case, we are concerned with the assessment years prior to insertion of section 94 ( 7 ) vide Finance Act, 2001 w.e.f. 1.4.2002. We are of the view that the AO had erred in disallowing the loss. In the case of Vijaya Bank v. Additional Commissioner of Income-tax [1991] 187 ITR 541, it was held by this Court that where the assessee buys securities at a price determined with reference to their actual value as well as interest accrued thereon till the date of purchase the entire price paid would be in the nature of capital outlay and no part of it can be set off as expenditure against income accruing on those securities. The real objection of the Department appears to be that the assessee is getting tax-free dividend; that at the same time it is claiming loss on the sale of the units; that the assessee had purposely and in a planned manner entered into a pre-meditated transaction of buying and selling units yielding exempted dividends with full knowledge about the fall in the NAV after the record date and the payment of tax-free dividend and, therefore, loss on sale was not genuine. We find no ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... bject of section 94 ( 7 ) which is inserted to curb tax avoidance by certain types of transactions in securities. There is one more way of answering this point. Sections 14A and 94 ( 7 ) were simultaneously inserted by the same Finance Act, 2001. As stated above, section 14A was inserted w.e.f. 1.4.1962 whereas section 94 ( 7 ) was inserted w.e.f. 1.4.2002. The reason is obvious. Parliament realized that several public sector undertakings and public sector enterprises had invested huge amounts over last couple of years in the impugned dividend stripping transactions so also declaration of dividends by mutual fund are being vetted and regulated by SEBI for last couple of years. If section 94 ( 7 ) would have been brought into effect from 1.4.1962, as in the case of section 14A, it would have resulted in reversal of large number of transactions. This could be one reason why the Parliament intended to give effect to section 94 ( 7 ) only w.e.f. 1.4.2002. It is important to clarify that this last reasoning has nothing to do with the interpretations given by us to sections 14A and 94 ( 7 ) . However, it is the duty of the court to examine the circumstances and reasons why section 1 ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... AV with a right to receive dividend as and when declared in future and did not carry any vested right to claim dividends which had already accrued prior to the purchase. For the above reasons, we find no infirmity in the impugned judgment of the High Court and, accordingly, these Civil Appeals filed by the Department are dismissed with no order as to costs." ( emphasis supplied ) 28. As observed by the Hon. Apex Court the basic principle of taxation is to tax the net income and on the same analogy the exemption is also allowed in respect of the net exempted income. Therefore, if there is an expenditure directly or indirectly incurred in relation to the exempt income the same cannot be claimed against the income which is taxable. The Hon. Supreme Court has laid down the principle for attracting the provisions of section 14A that here should be proximate cause for disallowance which has relationship with the tax exempt income. The Hon'ble. Jurisdictional High Court in the case of Godrej and Boyce Mfg Co. Ltd. v. Dy CIT (supra) has also taken note of the decision of the hon ble Supreme Court in the case of CIT v. Wallfort Share and Stock Brokers Pvt. Ltd. (supra) in par ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... owed as a deduction as against the taxable income. As a result of the enactment of section 14A, no expenditure can be allowed as a deduction in relation to income which does not form part of the total income under the Act. Hence, even in the case of a composite and indivisible business, which results in the earning of taxable and nontaxable 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 nontaxable 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 ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... rred in relation to the income which form the part of the total income should be allowed. The expenditure incurred in relation to the income which does not form the part of the total income has to be disallowed. The Hon'ble High Court further observed that section 14A has implicit within it a notion of apportionment. Even prior to the amendment whereby the sub-section 2 of section 14A was brought into the statute, the AO would have to apportion the expenditure and disallow the expenditure incurred by the assessee in relation to the income which does not form part of the total income. The Hon. jurisdictional High Court held that the AO has to follow a reasonable method of apportioning the expenditure consistent with what the circumference of the case would warrant and having regard to all relevant facts and circumstances. There must be a proximate relationship between the expenditure and the income which does not form part of the total income. Once such a proximate relationship exists, the disallowance has to be effected. All expenditure incurred in the earning of income which does not form part of the total income has to be disallowed subject to compliance with the test adopted by ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... come. The word "incurred" clearly implies that it must be shown as a fact that some expenditure was in fact incurred by he assessee to produce exempted income. It was open to the legislature to confer power upon he AO to assume that a part of the expenditure must have necessarily been incurred to produce exempted income which the AO can estimate and disallow and accordingly, use suitable expressions in the section conferring such power upon the AO. One such instances is section 38 ( 2 ) "to a fair proportionate part thereof which the AO may determine having regard to the use of such building, machinery, plant or furniture for the purposes of the business or profession Another such instances of S.40A ( 2 )( a ) which gives power to the AO to determine, based on his own opinion , as to how much expenditure incurred by the assessee in respect of which payments made to closely related persons or concern, is excessive or unreasonable having regard to the fair market value of goods, services or facilities for which the payment is made or the legitimate needs of the business or the benefit derived by the assessee from the expenditure. But, when section 14A has not given such specific po ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ny doubt. The section confers power or authority upon the AO to disallow such expenditure as satisfies the requirements of the section. What the AO could not do earlier, in view of three binding judgments of the Supreme Court on the question, he can now do under section 14A. The power is, however, subject to the rider that he must show that the assessee in fact incurred expenditure which is related to the exempted income. It, therefore, appears to us clear that the section only removes the disability on the part of the AO to disallow such expenditure, a disability to which he was subjected by the three judgments of the Supreme Court cited supra. The mere removal of the disability statutorily, however does not ipso fact authorize him to assume that a part of the expenditure has been incurred by he assessee in relation to the exempted income and to proceed to disallow the same on estimate. The section does not, in our opinion, relieve the AO of the burden of proving, on the basis of evidence or material on record that the assessee has in fact incurred expenditure which has relation to the exempted income. Even in regard to section 80M, the Calcutta and Madhya Pradesh High Courts ha ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... hat in the case before the Calcutta High Court in Enemour Investments. Ltd. ( supra ) and the Madhya Prdesh High Court in State Bank of Indore ( supra ) even the revenue has not relied on the judgment of the Supreme Court in CIT v. United General Trust Ltd. ( supra ) thereby suggesting that in its understanding also that judgment cannot be understood as authority for permitting an estimated or notional expenditure to be disallowed in order to reduce the income eligible for the deduction. 21. Having held as above, we now proceed to examine whether there is any evidence or material on record in the present case authorizing the AO to invoke section 14A for the purpose of disallowing the expenditure of Rs. 5 lakhs. There is no dispute that the entire dividend of Rs. 83,02,635 which is exempt under section 10 ( 33 ) was received from M/s Eicher Motors Ltd. by a single dividend warrant and no effort or expenses were necessary or were incurred to earn such income. There is also no material brought before us to show that the assessee's contention that no part of the interest can be attributed to the earning of the dividend income since the shares were acquired from the ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... s on the revenue to prove that interest paid by the assessee on borrowed funds related to acquisition of shares yielding tax free income. Obviously, the revenue would be in a position to discharge the burden only on the basis of material on record to show that interest ( or any other expenditure ) was paid by the assessee on funds borrowed for acquiring the shares. It seems to us with respect, that it is possible to understand the order of the Tribunal in Maruti Udyog Ltd. ( supra ) as also laying done that only actual expenditure incurred by the assessee to earn exempted income can be disallowed by the AO u/s 14A". 32. From the decisions as discussed above it is settled that in order to disallow the expenditure u/s 14A of the Act there should be some expenditure actually incurred for earning the exempt income. Thus, the primary condition for disallowance is factual incurrence of expenditure in relation to the income not forming the part of the total income. 33. As it is clear from the memorandum of explanation the purpose of introduction of the section as well as from the various decisions (supra) that exemption is allowable only to the net income which does not form ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... l borrowed for the purposes of business or profession. The dividend earned on such shares is assessed under the head "other sources". Any expenditure incurred wholly or exclusively for the purposes of earning the dividend income is to be deduced under section 57 ( iii ) . Section 57 ( iii ) reads as follows: Deductions 57. The income chargeable under the head "Income from other sources" shall be computed after making the following deductions, namely : ( i ) ** ** ** ( ii ) ** ** ** ( iii ) any other expenditure ( not being in the nature of capital expenditure ) laid out or expended wholly and exclusively for the purpose of making or earning such income. 11. In the case of an investor, the interest paid on borrowed funds used for purchase of shares would be deduced out of the dividend income. Since the dividend income included in the gross total income would be the net dividend ( gross dividend minus interest ) , deduction under section 80M would be allowed thereof. 12. In the present case, since the assessee is a trader, though dividend is separately assessable under section 56, it does not ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... the dividend income for the limited purposes of computing the deduction under section 80M of the Act. There is no statutory provisions requiring the AO to deduct the same expenses under two different heads of income. Since the income by way of dividend included in the gross total income is Rs. 1,34,984, the deduction under section 80M has to be granted with reference to the said amount of Rs. 1,34,984. 19. in the light of above discussion, we uphold the decision of the tribunal and answer the question in the affirmative, in favour of the assessee and against the revenue " 35. Thus, undisputedly, when the real purpose and intent to use the borrowed funds was for trading activity and if incidentally resulted some dividend income on the shares purchased for trading then the same would no change the purpose, nature or character of the expenditure. Thus, when the said expenditure (interest) incurred for trading activity then the same cannot be said to have been incurred for earning the dividend income. As per the basic principle of taxation only the net income i.e. gross income minus expenditure incurred is taxed. Accordingly, the expenditure which was incurred for earning t ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ncurred for earning any income which is not taxable under the Act, is not an allowable expenditure. Dividend income is exempt under section 10 ( 33 ) of the Income Tax Act and so much so, dividend earned by the assessee on the shares acquired by her with borrowed funds does not constitute total income in the hands of the assessee. So much so, in our view, disallowance was rightly made by the Assessing Officer. In fact, the Tribunal itself has estimated disallowance of Rs. 2 lakhs by applying section 14A. We do not know how the Tribunal can restrict the disallowance to Rs. 2 lakhs and allow balance above Rs. 15 lakhs when the whole borrowed funds were utilised by the assessee for purchase of shares in the company. In our view, the reasoning given by the Tribunal for disallowance of Rs.2 lakhs i.e. by applying section 14A, squarely applies for the interest paid on borrowed funds because it is on record that the entire funds borrowed were utilised for acquisition of shares by the assessee in the company. In fact, in our view, assessee would be entitled to deduction of interest under section 36 ( 1 )( iii ) of the Act on borrowed funds utilised for the acquisition of shares only if ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... mposite/indivisible business which receives taxable and non-taxable income. However, the principle of apportionment is applicable only in the cases where it is not possible to determine the actual expenditure incurred "in relation to" the income not forming the part of the total income. But when it is possible to determine the actual expenditure "in relation to" the exempt income or no expenditure has been incurred "in relation to" the exempt income then the principle of apportionment embedded in section 14A has not application. 37. Even otherwise, the AO has disallowed the interest expenditure on the borrowed funds treating as proportionately used for the investment purposes and not for the reason as used in trading purposes. As evident from the assessment order that the very basis of disallowances is borrowed funds used for investment purposes and estimated by the AO in proportion of borrowed fund to the total fund available. Whereas the dividend income is claimed on the shares purchased for trading purposes and held as stock-in-trade then the very basis of disallowance by the AO is incorrect, highly improper and inconsistent to the uncontraverted factual claim. It is pertine ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... r apportionment of the administrative expenses between the delivery based transaction and non-delivery based transaction as well as trading and investment activities. Undisputedly the labour hours and other overhead expenses will be less in case of non-delivery based transaction of purchase and sale of shares securities in comparison to the delivery based transaction. Similarly in case of collection of dividend through cheques or vouchers will costs more than direct credit in D-mat account. It is undisputable fact that the dividend was directly credited in the D-mat account. Secondly, the dividend income is on the shares held for trading purposes. Moreover, the AO has not given any finding that a particular expenditure is "in relation to" the dividend income. In the case of CIT v. General Insurance Corp. reported in 254 ITR 203. The Hon. Jurisdictional High Court has held that the expenditure incurred on account for salary paid to staff, stamp duty, transfer fee and safe custody charges are not directly relatable to the earning of the dividend and could not be deduced from the dividend income for the purpose of allowing deduction u/s 80M. Accordingly, in view of the decision ..... X X X X Extracts X X X X X X X X Extracts X X X X
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