TMI Blog2011 (11) TMI 30X X X X Extracts X X X X X X X X Extracts X X X X ..... ions (2) and (3) of Section 14A would be workable only with effect from the date of introduction of Rule 8D. This is so because prior to that date, there was no prescribed method and sub-sections (2) and (3) of Section 14A remained unworkable. - Rule 8D would operate prospectively. Even for the pre-Rule 8D period, whenever the issue of section 14A arises before an Assessing Officer, he has, first of all, to ascertain the correctness of the claim of the assessee in respect of the expenditure incurred in relation to income which does not form part of the total income under the said Act. - In case, the assessing officer is not, on the basis of objective criteria and after giving the assessee a reasonable opportunity, satisfied with the correctness of the claim of the assessee, he shall have to reject the claim and state the reasons for doing so. Having done so, the assessing officer will have to determine the amount of expenditure incurred in relation to income which does not form part of the total income under the said Act. He is required to do so on the basis of a reasonable and acceptable method of apportionment. - ITA 687/09, 112/2010, 263/2010, 805/2009, 98/2009, 856/2009, 853 ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... 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 Income tax Act, 1961 inasmuch as the dividend received on such shares does not form part of the total income. 2. Whether the provisions of sub-section (2) and sub-section (3) of section 14A inserted by the Finance Act, 2006 with effect from 01/04/2007, would apply retrospectively to all pending proceedings. 3. Whether Rule 8D inserted by the Income -tax (Fifth Amendment) Rules, 2008 with effect from 24/03/2008 was procedural in nature and hence would apply retrospectively to all pending proceedings. 3. In order to provide some factual basis behind the above mentioned questions, we shall refer to the appeal in the case of Maxopp Investment Limited v. CIT [ ITA No.687/2009]. The assessee company is in the business of finance, investment and of dealing in shares and securities. The assessee held shares and securities, partly as investments on the "capital account" and partly as "trading assets" for the purpose of acquiring and retaining control over its group companies, primarily Max India Ltd. As per the assessee, a ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ntended on behalf of the assessees that holding of shares for acquiring and retaining control of operating companies amounts to business and, consequently, dividend income on such shares is in the nature of business income. It was further submitted that the intention behind acquiring such shares was not to earn dividend but to acquire and retain a controlling interest in the operating companies. Dividend was merely incidental. It was thus contended that the interest paid on the funds borrowed to acquire such shares was allowable as a business expenditure as it was not directed at earning dividend income, which was incidental. Legislative History of Section 14A and Rule 8D 6. Before we delve deeper into the questions at hand it would be appropriate to not only examine the provisions of section 14A of the said act but also to notice its legislative history. Section 14A was inserted into the said Act by the Finance Act, 2001 with retrospective effect from 01/04/1962. Expenditure incurred in relation to income not includible in total income . 14A. For the purposes of computing the total income under this Chapter, no deduction shall be allowed in respect of expendi ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... in relation to income not includible in total income . 14A. (1) 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) 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 alread ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... rage 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. The law prior to insertion of Section 14A 12. Prior to the introduction of section 14A in the said Act, the position in law was as laid down by the Supreme Court in CIT v. Maharashtra Sugar Mills Ltd: 82 ITR 452 (SC) and Rajasthan State Warehousing Corporation v. CIT: 242 ITR 450 (SC). In Maharashtra sugar Mills Ltd (supra) the assessee s business comprised of two parts, namely, (1) cultivation of sugar cane and (2) the manufacture of sugar. The revenue had contended that as the income from the cultivation of sugar cane, being the result of an agricultural operation, was not exigible to tax, therefore, any expenditure incurred in respect of that activity was not deductible. The Supreme Court repelled this contention in the followi ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... e from that head is deductible; and (iii) in computing "profits and gains of business or profession" when an assessee is carrying on business in various ventures and some among them yield taxable income and the others do not, the question of allowability of the expenditure under section 37 of the Act will depend on: (a) fulfilment of requirements of that provision noted above; and (b) on the facts whether all the ventures carried on by him constituted one indivisible business or not; if they do, the entire expenditure will be a permissible deduction but if they do not, the principle of apportionment of the expenditure will apply because there will be no nexus between the expenditure attributable to the venture not forming an integral part of the business and the expenditure sought to be deducted as the business expenditure of the assessee." 14. Thus, prior to the introduction of section 14A in the said 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 the said business was deductible and, in such a case, the principle of apportionment of the expe ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... 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 of the tax incentive by way of an exemption of exempt income without making any apportionment of expenses incurred in relation to exempt income ..Expenses allowed can only be in respect of earning taxable income. This is the purport of section 14A. In section 14A, the first phrase is "for the purposes of computing the total income under this Chapter" which makes it clear that various heads of income as prescribed in the Chapter IV would fall within section 14A. 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 s ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... to Mr Vohra, only that actual expenditure which is made directly and for the object of earning exempt income (in the present appeals dividend income) could be disallowed under section 14A. He submitted that if the dominant and main objective of spending was not the earning of exempt income then, the expenditure could not be disallowed under section 14A provided it was otherwise allowable under sections 15 to 59 of the said Act. Mr Satyen Sethi and Dr Rakesh Gupta, who appeared for some of the assesses, also adopted the arguments of Mr Vohra and emphasized that the expenditure must be actual and cannot be computed on the basis of some formula as stipulated under Rule 8D read with sub-sections (2) (3) of section 14A. in relation to 19. Let us examine the expression in relation to . Mr Vohra had referred to the Supreme Court decision in Madhav Rao Scindia v. Union of India: AIR 1971 SC 530 where, in paragraph 134, it is observed as under:- ".. The expression "provisions of this Constitution relating to" in article 363 means provisions having a dominant and immediate connection with: it does not mean merely having a reference to." 20. According to Mr Vohra, th ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ded that the expression "provisions of this Constitution relating to" in Article 363 meant provisions having a dominant an immediate connection with and the said expression did not mean merely having a reference to. The Supreme Court clearly explained that a wide meaning of the expression might exclude disputes from the jurisdiction of the courts in respect of rights or obligations, however indirect or tenuous the connection between the constitutional provision and the covenant may be. It is therefore clear that the expression "relating to" would depend upon the context in which it occurs. 22. In Doypack Systems Pvt Ltd v. Union of India: AIR 1988 SC 782, the Supreme Court observed that the expressions "pertaining to", "in relation to" and "arising out of", used in the deeming provision, are used in the expansive sense. The Supreme Court further observed as under:- "49. The expression "in relation to" (so also "pertaining to"), is a very broad expression which presupposes another subject matter. These are words of comprehensiveness which might both have a direct significance as well as an indirect significance depending on the context " " In this connection reference may be ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ld appear in the statute book, from its inception, that expenditure incurred in connection with income which does not form part of total income ought not to be allowed as a deduction. The factum of making the said provision retrospective makes it clear that Parliament wanted that it should be understood by all that from the very beginning, such expenditure was not allowable as a deduction. Of course, by introducing the proviso it made it clear that there was no intention to reopen finalised assessments prior to the assessment year beginning on 01/04/2001. Furthermore, as observed by the Supreme Court in Walfort (supra), the basic principle of taxation is to tax the net income, i.e., gross income minus the expenditure and on the same analogy the exemption is also in respect of net income. In other words, where the gross income would not form part of total income, it's associated or related expenditure would also not be permitted to be debited against other taxable income. 25. We are of the view that the expression "in relation to" appearing in Section 14 A of the said act cannot be ascribed a narrow or constricted meaning. If we were to accept the submission made on behalf of the ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... e under Section 14A cannot stand. 28. It was contended that unless and until there was actual expenditure for earning the exempted income, there could not be any disallowance under section 14A. While we agree that the expression expenditure incurred refers to actual expenditure and not to some imagined expenditure we would like to make it clear that 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. Scope of sub-sections (2) and (3) of Section 14A 29. Sub-section (2) of Section 14 A of the said Act provides the manner in which the Assessing Officer is to determine the amount of expenditure incurred in relation to income which does not form part of the total income. However, if we examine the provision carefully, we would find that the Assessing Officer is required to determine the amount of such expenditure only if the Assessing Officer, having regard to the accounts of the assessee, ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... Rule 8D 30. As we have already noticed, sub-section (2) of Section 14A of the said Act refers to the method of determination of the amount of expenditure incurred in relation to exempt income. The expression used is such method as may be prescribed . We have already mentioned above that by virtue of Notification No.45/2008 dated 24/03/2008, the Central Board of Direct Taxes introduced Rule 8D in the said Rules. The said Rule 8D also makes it clear that 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 said Act for such previous year, the Assessing Officer shall determine the amount of the expenditure in relation to such income in accordance with the provisions of sub-rule (2) of Rule 8D. We may observe that Rule 8D(1) places the provisions of Section 14A(2) and (3) in the correct perspective. As we have already seen, while discussing the provisions of Sub-sections (2) and (3) of Sectio ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ect expenditure, where it is by way of interest, is computed through the principle of apportionment, as indicated above. And, in cases where the indirect expenditure is not by way of interest, a rule of thumb figure of one half percent of the average value of the investment, income from which does not or shall not form part of the total income, is taken. Do sub-sections (2) and (3) of Section 14A and Rule 8D apply retrospectively . 32. While examining the legislative history of Section 14A and Rule 8D, we have already noted that Section 14A, as introduced by virtue of the Finance Act, 2001, was with retrospective effect from 01.04.1962. The proviso was inserted by virtue of the Finance Act, 2002 and it was made clear that nothing in Section 14A empowered the Assessing Officer to either re-assess under Section 147 or pass an order enhancing the assessment or reducing the refund already made or otherwise increasing the liability of the assessee under Section 154, for any assessment year beginning on or before the first day of April, 2001. Thus, in respect of all the assessment years prior to the assessment year beginning on or before the 1st day of April, 2001, concluded asse ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... 8D of the said Rules were only machinery provisions and ought to be read retrospectively so as to give meaning to Section 14A(1). 35. We are of the view that Rule 8D would operate prospectively. We agree with the submissions made by Dr Rakesh Gupta that if the said Rule were to have retrospective effect, nothing prevented the Central Board of Direct Taxes from saying so, particularly, in view of the fact that it had the power to make a rule retrospective by virtue of Section 295(4) of the said Act. Instead of making Rule 8D retrospective, clause 1(2) of the Income-tax (Fifth Amendment) Rules, 2008 made it clear that the rules would come into force from the date of their publication in the Official Gazette. It is, therefore, clear that Rule 8D, which was introduced by virtue of the Notification No.45/2008 dated 24.03.2008, was prospective in operation and cannot be regarded as being retrospective. We may also point out that we have had the benefit of the decision of the Bombay High Court in Godrej and Boyce Mfg. Co. Ltd v DCIT: (2010) 328 ITR 81 (Bom), wherein it has, inter alia, been held that the provisions of Rule 8D of the said Rules has prospective effect and shall apply with ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... 41. Sub-section (2) of section 14A, as we have seen, stipulates that the Assessing Officer shall determine the amount of expenditure incurred in relation to income which does not form part of the total income in accordance with such method as may be prescribed . Of course, this determination can only be undertaken if the Assessing Officer is not satisfied with the correctness of the claim of the assessee in respect of such expenditure. This part of section 14A(2) which explicitly requires the fulfillment of a condition precedent is also implicit in section 14A(1) [as it now stands] as also in its initial avatar as section 14A. It is only the prescription with regard to the method of determining such expenditure which is new and which will operate prospectively. In other words, section 14A, even prior to the introduction of sub-sections (2) (3) would require the assessing officer to first reject the claim of the assessee with regard to the extent of such expenditure and such rejection must be for disclosed cogent reasons. It is then that the question of determination of such expenditure by the assessing officer would arise. The requirement of adopting a specific method of deter ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... the amount of expenditure incurred in relation to income which does not form part of the total income under the said Act. He is required to do so on the basis of a reasonable and acceptable method of apportionment. 43. At this juncture, we must make it clear that Dr Rakesh Gupta s arguments that Rule 8D of the said Rules exceeds the mandate of section 14A, have not been considered by us because the appeals before us are in respect of assessment years prior to the introduction of Rule 8D. We therefore refrain from expressing any opinion on the issue as to whether Rule 8D (and, to what extent, if at all) is ultra vires section 14A of the said Act. Answers to the questions 44. In view of the foregoing, Question 1 is answered in the affirmative and Questions 2 3, in the negative. Assessees appeals 45. The appeals on behalf of the assessees are:- ITA No. Cause Title Assessment year 853/2009 Cheminvest Ltd v. CIT 2001-02 1060/2009 Maxpak Investment Ltd v. CIT 2001-02 687/2009 Maxopp Investment Ltd v. CIT 2002-03 856/2009 Cheminvest Ltd v. CIT 2002-03 ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... of the Assessing Officer to re-compute the disallowance under section 14A and directed the Assessing Officer to identify if any expenditure had been incurred for earning exempt income and to disallow only such expenditure. In view of the discussion above, the assessing officer shall now have to follow the steps outlined in paragraph 42 above. ITA No.98/2009 [CIT v. Escorts Finance Ltd](2001-02) The Tribunal confirmed the deletion by the CIT(A) of the disallowance made by the Assessing Officer on account of administrative expenses and interest on loan by invoking section 14A of the said Act. The Tribunal s judgment and order, to the extent it deleted the disallowance under section 14A, is set aside and the matter is restored to the file of the assessing officer who is to follow the steps outlined in paragraph 42 above. ITA No.683/2008 [CIT v. ICRA Ltd](AY 2001-02) ITA No.702/2008 [CIT v. ICRA Ltd](AY 2003-04) The Tribunal deleted the addition made by the Assessing Officer who had disallowed proportionate expenditure under section 14A of the said Act by apportioning the administrative expenses in respect of exempt income. In both cases, the Tribunal s judgment ..... X X X X Extracts X X X X X X X X Extracts X X X X
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