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TMI Blog2011 (11) TMI 267X X X X Extracts X X X X X X X X Extracts X X X X ..... deemed to have been admitted for hearing and it was on this basis that arguments were addressed. All these appeals are concerned with section 14A of the Income Tax Act, 1961 and Rule 8D of the Income Tax Rules, 1962. In particular, we are called upon to examine as to whether interest paid on funds borrowed for investing in shares of operating companies for acquiring and retaining a controlling interest therein is allowable under section 36(1)(iii) and is not hit by section 14A of the Income tax Act, 1961? and, consequently, we are also required to examine the retrospective applicability of the sub-sections (2) and (3) of the said section 14A and of the said Rule 8D to the assessment years in question which range from 1998-99 to 2005-06. Questions 2. Since, across these appeals, there were some minor differences in language insofar as the admitted and/or proposed questions were concerned, it was agreed that the following substantial questions of law would, in general, cover all the cases before us:- 1. Whether expenditure (including interest paid on funds borrowed) in respect of investment in shares of operating companies for acquiring and retaining a control ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ssing officer, invoking section 14A of the said act, apportioned the said interest expenditure in the ratio of investment in shares of Max India Ltd, on which dividend was received, to the principal amount of unsecured loans, which worked out to Rs. 67,74,175/-. However, the assessing officer restricted the disallowance under section 14A of the said act to Rs.49,90,860/-, being the amount of dividend received. On appeal, the CIT (A), by the order dated 12/01/2005, upheld the order of the assessing officer. Thereafter, the case of the assessee was heard by a Special Bench constituted in the case of Daga Capital Management (P) Ltd. The Special Bench of the Tribunal held that the expenditure claimed was hit by the provisions of section 14A of the said Act. Pursuant to the majority decision of the Special Bench of the Tribunal, the issue of quantum of expenditure to be disallowed was restored to the assessing officer to be recomputed in terms of Rule 8D of the Income Tax Rules, 1961 (hereinafter referred to as "the said rules"), which was held to be retrospective. 5. As regards Question 1, it has been contended on behalf of the assessees that holding of shares for acquiring and ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ise increasing the liability of the assessee under section 154, for any assessment year beginning on or before the 1st day of April, 2001." 9. Then, by the Finance Act, 2006, Section 14A was numbered as sub-section (1) thereof and after sub-section (1) as so numbered, the following sub-sections were inserted, with effect from 01/04/2007:- "(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." 10. Consequent upon the Finance Act, 2006, section 14A as it now stands is as under:- "Expenditure incurred in relat ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ome under the Act for such previous year, he shall determine the amount of expenditure in relation to such income in accordance with the provisions of sub-rule (2). (2) The expenditure in relation to income which does not form part of the total income shall be the aggregate of following amounts, namely:- (i) the amount of expenditure directly relating to income which does not form part of total income; (ii) in a case where the assessee has incurred expenditure by way of interest during the previous year which is not directly attributable to any particular income or receipt, an amount computed in accordance with the following formula, namely:- Where A = amount of expenditure by way of interest other than the amount of interest included in clause (i) incurred during the previous year; B = the average of 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; C = the average of total assets as appearing in the balance sheet of the assessee, on the first day and the last day of the previous year; & ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... that any expenditure laid out or expended wholly an exclusively for the purpose of such business shall be deducted as an allowance. The mandate of section 10(2) (xv) is plain and unambiguous. Undoubtedly, the allowance claimed in this case was laid out or expended for the purpose of the business carried on by the assessee. The fact that the income arising from a part of that business is not exigible to tax under the act is not a relevant circumstance." (Emphasis supplied) 13. In Rajasthan State warehousing Corporation (supra), the Supreme Court after, inter alia, considering its earlier decisions in CIT v. Indian bank Ltd: 56 ITR 77 (SC) and Maharashtra Sugar Mills Ltd (supra) laid down the following principles:- "(i) if income of an assessee is derived from various heads of income, he is entitled to claim deduction admissible under the respective head whether or not computation under each head results in taxable income; (ii) if income of an assessee arises under any of the heads of income but from different items, e.g., different house properties or different securities, etc., and income from one or more items alone is taxable whereas income from the other ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... 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 proposed to insert a new section 14A so as to clarify the intention of the Legislature since the inception of the Income - tax Act, 1961, that no deduction shall be made in respect 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. The proposed amendment will take effect retrospectively from April 1, 1962 and will accordingly, apply in relation to the assessment year 1962-63 and subsequent assessment years." 16. As observed by the Supreme Court in the case of CIT v. Walfort Share and Stock Brokers P Ltd: 326 ITR 1 (SC), the insertion of section 14 A with retrospective effect reflects the serious attempt on the part of 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 said act against the taxable income. The Supreme Court further observed as u ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... 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 chargeability to tax. The theory of apportionment of expenditure between taxable and nontaxable has, in principle, been now widened under section 14 A." (emphasis supplied) Analysis of section 14A 18. Sub-section (1) of section 14A clearly stipulates that for the purposes of computing total income under Chapter IV (Computation of Total Income), 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 the said Act. A lot of emphasis was laid on the expressions "incurred" and "in relation to". It was contended by Mr Ajay Vohra, who appeared on behalf of most of the assesses, that the word "incurred" must be taken literally in the sense that the expenditure must have actually taken place. Moreover, the expenditure must also have taken place in relation to income which does not form part of total income. Mr Vohra contend ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... isions of the Constitution relating to a treaty, agreement, covenant, engagement, sanad or other similar instrument which was entered into or executed before the commencement of the Constitution by any Ruler of an Indian State and to which the Government of the Dominion of India or any of its predecessor governments was a party and which is or has been continued in operation after such commencement. In the present appeals we are not concerned with a provision of the Constitution and that too dealing with the jurisdiction of a court. Secondly, what needs to be emphasised is that in the very same paragraph 134, the Supreme Court observed that the meaning of a word or expression used in the Constitution often is coloured by the context in which it occurs and that the simpler and more common the word or expression, the more meanings and shades of meaning it has. The Supreme Court further held that it is the duty of the court to determine in what particular meaning and particular shade of meaning the word or expression was used by the Constitution makers and in discharging the duty the court will take into account the context in which it occurs, the object to serve which it was used, it ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... elation to the rate of customs duty for the purposes of assessment, that appeal must be heard by a Special Bench. It further held that, similarly, where the appeal involved the determination of any question which had a relation to the value of goods for the purposes of assessment, that appeal must also be heard by a Special Bench. In this context the Supreme Court observed as under:- "The phrase "relation to" is, ordinarily, of wide import but, in the context of its use in the said expression in section 129C, it must be read as meaning a direct and proximate relationship to the rate of duty and to the value of goods for the purposes of assessment." This decision also makes it clear that the expression "in relation to" is, ordinarily, of wide import. In the normal course, the said expression would have an expansive meaning unless, of course, the context would otherwise suggest. 24. We do not agree with the submission of the learned counsel appearing on behalf of the assessees that a narrow meaning ought to be ascribed to the expression "in relation to" appearing in section 14A of the said act. The context does not suggest that a narrow meaning ought to be giv ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... e Supreme Court further clarified that if an income like dividend income is not part of the total income, the expenditure/deduction related to such income, though of the nature specified in sections 15 to 59, cannot be allowed against other income which is includable in the total income for the purpose of chargeability to tax. "expenditure incurred" 26. It was contended by the learned counsel for the assessees that the words "expenditure incurred" as appearing in section 14A(1) clearly mean that there must be actual expenditure. of course, the actual expenditure must be for earning the exempt income. We have already pointed out above, that we do not subscribe to the narrow interpretation sought to given to the words "in relation to" which the learned counsel for the assessees are espousing. Thus, we will have to consider the argument of the asssessees in respect of the expression "expenditure incurred" in the context of the expenditure being in connection with or pertaining to income which does not form part of the total income under the said Act. 27. A reference was made to the decision of the Punjab and Haryana High Court in the case of CIT-II v. Hero Cycl ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... plies to cases where the assessee claims that no expenditure has been incurred in relation to income which does not form part of the total income under the said Act. In other words, sub-section (2) deals with cases where the assessee specifies a positive amount of expenditure in relation to income which does not form part of the total income under the said Act and sub-section (3) applies to cases where the assessee asserts that no expenditure had been incurred in relation to exempt income. In both cases, the Assessing Officer, if satisfied with the correctness of the claim of the assessee in respect of such expenditure or no expenditure, as the case may be, cannot embark upon a determination of the amount of expenditure in accordance with any prescribed method, as mentioned in sub-section (2) of Section 14A of the said Act. It is only if the Assessing Officer is not satisfied with the correctness of the claim of the assessee, in both cases, that the Assessing Officer gets jurisdiction to determine the amount of expenditure incurred in relation to such income which does not form part of the total income under the said Act in accordance with the prescribed method. The prescribed meth ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... has three components. The first component being the amount of expenditure directly relating to income which does not form part of the total income. The second component being computed on the basis of the formula given therein in a case where the assessee incurs expenditure by way of interest which is not directly attributable to any particular income or receipt. The formula essentially apportions the amount of expenditure by way of interest [other than the amount of interest included in clause (i)] incurred during the previous year in the ratio of the average value of investment, income from which does not or shall not form part of the total income, to the average of the total assets of the assessee. The third component is an artificial figure - one half percent of the average value of the investment, income from which does not or shall not form part of the total income, as appearing in the balance sheets of the assessee, on the first day and the last day of the previous year. It is the aggregate of these three components which would constitute the expenditure in relation to exempt income and it is this amount of expenditure which would be disallowed under Section 14A of the said ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ome of the assessees, submitted that Section 295 of the said Act empowered the Central Board of Direct Taxes to make rules for the whole or any part of India for carrying out the purpose of the said Act. He referred to sub-section (4) of Section 295 and submitted that the power to make rules conferred on the Central Board of Direct Taxes included the power to give retrospective effect, from a date not earlier than the date of the commencement of the said Act, to the rules or any of them and, unless the contrary was permitted (whether expressly or by necessary implication), no retrospective effect was to be given to any rule so as to prejudicially affect the interests of the assessees. He further submitted that Rule 8D was inserted in the said rules, but the Central Board of Direct Taxes did not make it retrospective. He submitted that whenever the CBDT felt it necessary to introduce a rule with retrospective effect, it did so by making the rule expressly retrospective. As an example, he referred to Rule 11EA which was inserted by the Income-tax (Ninth Amendment) Rules, 1997 with retrospective effect, from 01/10/1994. 34. On the other hand, it was contended on behalf of the ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... to Section 14A of the said Act that:- "This amendment will take effect from 1st April, 2007 and will, accordingly, apply in relation to the assessment year 2007-08 and subsequent years." 38. We may also refer to the CBDT Circular No.14/2006 dated 28.12.2006 and to paragraphs 11 to 11.3 thereof. Paragraph 11 dealt with the method for allocating expenditure in relation to exempt income and paragraphs 11.1 and 11.2 explained the basis and logic behind the introduction of sub-section (2) of Section 14A of the said Act. Paragraph 11.3 specifically provided for applicability of the provisions of subsection (2) and it clearly indicated that it would be applicable "from the assessment year 2007-08 onwards". 39. It is, therefore, clear that sub-sections (2) and (3) of Section 14A were introduced with prospective effect from the assessment year 2007-08 onwards. However, sub-section (2) of Section 14A remained an empty shell until the introduction of Rule 8D on 24.03.2008 which gave content to the expression "such method as may be prescribed" appearing in Section 14A(2) of the said Act. 40. From the above discussion, it is clear that, in effect, the provisions ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ble and acceptable method of apportionment. It would be appropriate to recall the words of the Supreme Court in Walfort (supra) to the following effect:- "The theory of apportionment of expenditure between taxable and non-taxable has, in principle, been now widened under section 14 A." So, even for the pre-Rule8D 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. Even where the assessee claims that no expenditure has been incuured in relation to income which does not form part of total income, the assessing officer will have to verify the correcteness of such claim. In case, the assessing officer is satisfied with the claim of the assessee with regard to the expenditure or no expenditure, as the case may be, the assessing officer is to accept the claim of the assessee insofar as the quantum of disallowance under section 14A is concerned. In such eventuality, the assessing officer cannot embark upon a determination of the amount of expend ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... disposed of as below:- ITA No. 77/2009 [CIT v. HCL Perot Systems Ltd](AY 2000-01) ITA No. 139/2009 [CIT v. HCL Perot Systems Ltd](AY 2001-02) The Tribunal did not sustain the disallowance made by the Assessing Officer under Section 14 A and directed the Assessing Officer to re-compute the disallowance in terms of the method of working given by the assessee. The revenue is aggrieved inasmuch as the Tribunal did not direct the Assessing Officer to re-compute the disallowance in terms of Rule 8D read with sub-sections (2) and (3) of section 14A. While Rule 8D would be inapplicable, the assessing officer would now have to follow the steps outlined in paragraph 42 above. ITA No.57/2008 [CIT v. Vou Investment Pvt Ltd](AY 1998-99) The Tribunal deleted the disallowance under section 14A by holding that the earning of dividend was merely incidental to holding of shares and that the Assessing Officer had also failed to pinpoint the expenditure actually incurred in respect of the dividend income. 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 asses ..... X X X X Extracts X X X X X X X X Extracts X X X X
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