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TMI Blog2018 (3) TMI 805X X X X Extracts X X X X X X X X Extracts X X X X ..... IL APPEAL NO. 1580 OF 2018, (ARISING OUT OF SLP (CIVIL) 32405 OF 2017), CIVIL APPEAL NO. 1575 OF 2018, (@ SPECIAL LEAVE PETITION (CIVIL) NO. 4023 OF 2018, @ DIARY NO. 36413 OF 2017), CIVIL APPEAL NO. 2802 OF 2018, (@ SPECIAL LEAVE PETITION (CIVIL) NO. 6746 OF 2018, @ DIARY NO. 1146 OF 2018), CIVIL APPEAL NO. 2791 OF 2018, (@ SPECIAL LEAVE PETITION (CIVIL) NO. 6685 OF 2018, @ DIARY NO. 39823 OF 2017), CIVIL APPEAL NO. 2792 OF 2018, (@ SPECIAL LEAVE PETITION (CIVIL) NO. 6686 OF 2018, @ DIARY NO. 41903 OF 2017), CIVIL APPEAL NO. 1577 OF 2018, (@ SPECIAL LEAVE PETITION (CIVIL) NO. 4027 OF 2018, @ DIARY NO. 41890 OF 2017), CIVIL APPEAL NO. 2793 OF 2018, (@ SPECIAL LEAVE PETITION (CIVIL) NO. 6687 OF 2018, @ DIARY NO. 41203 OF 2017), AND CIVIL APPEAL NO. 2794 OF 2018, (@ SPECIAL LEAVE PETITION (CIVIL) NO. 6688 OF 2018, @ DIARY NO. 41922 OF 2017) For the Appellant(s) : Mr. Satyen Sethi, Adv., Mr. Arta Trana Panda, Adv., Mr. Rameshwar Prasad Goyal, AOR, Mr. K. Radha Krishnan, Sr. Adv., Mr. Arijit Prasad, Adv., Mr. Rupesh Kumar, Adv., Mr. D.L. Chidanand, Adv., Ms. Sadhna Sandhu, Adv., Mr. Manish Pushkarna, Adv., Ms. Gargi Khanna, Adv., Mrs. Anil Katiyar, AOR, Mr. Brajesh Kumar, AOR, Mr. Aja ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... the Act, the effect whereof is that if certain income is earned which is not to be included while computing total income, any expenditure incurred to earn that income is also not allowed as a deduction. It is well known that tax is leviable on the net income. Net income is arrived at after deducting the expenditures incurred in earning that income. Therefore, from the gross income, expenditure incurred to earn that income is allowed as a deduction and thereafter tax is levied on the net income. The purpose behind Section 14A of the Act, by not permitting deduction of the expenditure incurred in relation to income, which does not form part of total income, is to ensure that the assessee does not get double benefit. Once a particular income itself is not to be included in the total income and is exempted from tax, there is no reasonable basis for giving benefit of deduction of the expenditure incurred in earning such an income. For example, income in the form of dividend earned on shares held in a company is not taxable. If a person takes interest bearing loan from the Bank and invests that loan in shares/stocks, dividend earned therefrom is not taxable. Normally, interest paid on t ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... intention of acquiring, exercising and retaining control over investee group companies) has been regularly offered and assessed to tax as business income under the head 'profits and gains of business or profession'. Consistent with the aforesaid treatment regularly followed, the appellant filed return for the previous year relevant to the Assessment Year 2002-03, declaring income of Rs. 78,90,430/-. No part of the interest expenditure of Rs. 1,16,21,168/- debited to the profit and loss account, to the extent relatable to investment in shares of Max India Limited, yielding tax free dividend income, was considered disallowable under Section 14A of the Act on the ground that shares in the said company were acquired for the purposes of retaining controlling interest and not with the motive of earning dividend. According to the appellant, the dominant purpose/intention of investment in shares of Max India Ltd. was acquiring/retaining controlling interest therein and not earning dividend and, therefore, dividend of Rs. 49,90,860/- earned on shares of Max India Ltd. during the relevant previous year was only incidental to the holding of such shares. The Assessing Officer (AO), while pas ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... sulted into exempt income or taxable income'. As per the minority view, however, the existence of dominant and immediate connection between the expenditure incurred and dividend income was a condition precedent for invoking the provisions of Section 14A of the Act. It was accordingly held, as per the minority, that mere receipt of dividend income, incidental to the holding of shares, in the case of a dealer in shares, would not be sufficient for invoking provisions of Section 14A of the Act. 9) Against the aforesaid order of the Special Bench, the appellant preferred appeal under Section 260A of the Act to the High Court. The High Court of Delhi has, vide impugned judgment dated November 18, 2011, held that the expression 'in relation to' appearing in Section 14A of the Act was synonymous with 'in connection with' or 'pertaining to', and, that the provisions of that Section apply regardless of the intention/motive behind making the investment. As a consequence, proportionate disallowance of the expenditure incurred by the assessee is maintained. 10) It would be pertinent to point out at this stage that Punjab and Haryana High Court in a recent judgment in the case of Principal Co ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... pril, 2001." 12) Sub-section (2) of Section 14A deals with the proportionality as it empowers the AO to extricate that amount of expenditure which is incurred in relation to such income which does not form part of the total income under the Act. However, this is to be done 'in accordance with such method as may be prescribed.' This prescription is provided by the delegated legislation, in the form of Rule 8D of the Income Tax Rules, 1962 (for short 'Rules') which Rule was inserted w.e.f. March 24, 2008 vide Income Tax (Fifth Amendment) Rules, 2008 (In Civil Appeal No. 2165 of 2012 (Commissioner of Income Tax, Mumbai v. M/s. Essar Teleholdings Ltd. through its Manager pronounced on January 31, 2018, this Court has held that Rule 8D is prospective in nature.). We, thus, reproduce Rule 8D hereunder: "Method for determining amount of expenditure in relation to income not includible in total income. 8D.(1) 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 relati ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... come tax Act, 1961 inasmuch as the dividend received on such shares does not form part of the total income?" 15) On facts, it was noted that the assessee company is in the business of finance, investment and was 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, any profit resulting on the sale of shares held as trading assets was duly offered to tax as business income of the assessee. During the previous year relevant to the assessment year 2002-03, the assessee incurred total interest expenditure of Rs. 1,61,21,168/-, which was claimed as business expenditure under section 36(1)(iii) of the Income Tax Act, 1961 (hereinafter referred to as "the said act"). According to the assessee, the expenditure claimed was not hit by section 14A of the Act, on the ground that although borrowed funds were partly utilised for investment in shares held as trading assets, such investment was made with the intention to acquire and retain a controlling interest in the aforesaid ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... 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 under:- ".. In other words, section 14 A clarifies that expenses incurred can be allowed only to the extent that they are relatable to the earning of taxable income. In many cases the nature of expenses incurred by the assessee may be relatable partly ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ax. The theory of apportionment of expenditure between taxable and non-taxable has, in principle, been now widened under section 14 A. (emphasis supplied)" 16) The High Court then undertook the exercise of analysing the provisions of Section 14A of the Act and, in the process, examined the contours and scope of the expressions 'in relation to' and 'expenditure incurred' occurring therein. The High Court pointed out that contention of the assessees, in this behalf, was 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. Further, the expression "in relation to" implies that there must be a direct and proximate connection with the subject matter. In other words, 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 of the Act. 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 of the Act ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... out Rs. 1.12 crores. The total exempt income claimed in the return was, therefore, Rs. 12,19,78,015/-. The assessee while claiming the exemption contended that the investment in shares, bonds, etc. constituted its stock-in-trade; that the investment had not been made only for earning tax free income; that the tax free income was only incidental to the assessee's main business of sale and purchase of securities and, therefore, no expenditure had been incurred for earning such exempt income; the expenditure would have remained the same even if no dividend or interest income had been earned by the assessee from the said securities and that no expenditure on proportionate basis could be allocated against exempt income. The assessee also contended that in any event it had acquired the securities from its own funds and, therefore, section 14A was not applicable. The AO restricted the disallowance to the amount which was claimed as exempt income by applying the formula contained in Rule 8D holding that Section 14A would be applicable. The CIT(A) issued notice of enhancement under Section 251 of the Act and held that in view of Section 14A of the Act, the assessee was not to be allowed any ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... use (id) of sub-section (1) of Section 56 of the Act provides that income by way of interest on securities shall be chargeable to income-tax under the head "Income from Other Sources", if, the income is not chargeable to income-tax under the head "Profits and Gains of Business and Profession". 3. The matter has been examined in light of the judicial decisions on this issue. In the case of CIT Vs Nawanshahar Central Cooperative Bank Ltd. [2007] 160TAXMAN 48(SC), the Apex Court held that the investments made by a banking concern are part of the business of banking. Therefore, the income arising from such investments is attributable to the business of banking falling under the head "Profits and Gains of Business and Profession". 3.2 Even though the abovementioned decision was in the context of co-operative societies/Banks claiming deduction under section 80P(2)(a)(i) of the Act, the principle is equally applicable to all banks/commercial banks, to which Banking Regulation Act, 1949 applies. 4. In the light of the Supreme Court's decision in the matter, the issue is well settled. Accordingly, the Board has decided that no appeals may henceforth be filed on this ground by the offi ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... arn dividend or interest." 22) The High Court then discussed in detail the judgment in Walfort Share and Stock Brokers P Ltd. which related to dividend stripping. After explaining the objective behind Section 14A of the Act (which is already noted above), this Court in the facts of that case, had held that a payback does not constitute an 'expenditure incurred' in terms of Section 14A as it does not impact the profit and loss account. This expenditure, in fact, is a payout. 23) According to the High Court, what is to be disallowed is the expenditure incurred to "earn" exempt income. The words 'in relation to' in Section 14A must be construed accordingly. Applying that principle to the facts at hand, the High Court concluded as under: "Now, the dividend and interest are income. The question then is whether the assessee can be said to have incurred any expenditure at all or any part of the said expenditure in respect of the exempt income viz. dividend and interest that arose out of the securities that constituted the assessee's stock-in-trade. The answer must be in the negative. The purpose of the purchase of the said securities was not to earn income arising therefrom, namely, ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... hich has also agreed with the view taken by the Karnataka High Court. In that case, the assessee was engaged in the business of share trading. In the computation of income, the assessee claimed long-term capital gains as exempt income and declared expenditure disallowable against it under Section 14A of the Act. The AO treated the long-term capital gains as business income. The Appellate Tribunal found that the assessee did not have any investment and all the shares were held as stock-in-trade as was evident from the orders of the lower authorities. On those facts it held that once the assessee had kept the shares as stock-in-trade, Rule 8D of the Rules would not apply. On the questions whether the Appellate Tribunal was justified in deleting the disallowance under Section 14A computed in accordance with Rule 8D and in holding the investments as shares stock-in-trade, the High Court held that the AO had accepted the correctness of the disallowable expenditure offered by the assessee on its claim of the amount as long-term capital gains. He had not allowed the claim itself treating the amount as business income to thereafter disallow the offered expenditure. According to the High Co ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ore us, there is no dispute that part of the income of the assessee from its business is from dividend which is exempt from tax whereas the assessee was unable to produce any material before the authorities below showing the source from which such shares were acquired. Mr. Khaitan strenuously contended before us that for the last few years before the relevant previous year, no new share has been acquired and thus, the loan that was taken and for which the interest is payable by the assessee was not for acquisition of those old shares and, therefore, the authorities below erred in law in giving benefit of proportionate deduction. 9. In our opinion, the mere fact that those shares were old ones and not acquired recently is immaterial. It is for the assessee to show the source of acquisition of those shares by production of materials that those were acquired from the funds available in the hands of the assessee at the relevant point of time without taking benefit of any loan. If those shares were purchased from the amount taken in loan, even for instance, five or ten years ago, it is for the assessee to show by the production of documentary evidence that such loaned amount had alrea ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... senting controlling interest does not represent expenditure incurred for earning dividend income and is not allowable under Section 57(iii) of the Act (prior to introduction of Section 14A). 29) Basing their case on the aforesaid principles, it was argued that when the shares were acquired, as part of promoter holding, for the purpose of acquiring controlling interest in the company, the dominant object is to keep control over the management of the company and not to earn the dividend from investment in shares. Whether dividend is declared/earned or not is immaterial and, in either case, the assessee would not liquidate the shares in investee companies. Therefore, no expenditure was made 'in relation to' the income i.e. the dividend income and, therefore, Section 14A would not be attracted. In this hue, it was submitted that Section 14A was to be accorded plain and grammatical interpretation meaning thereby mandating and requiring a direct and proximate nexus/link between the expenditure actually incurred and the earning of the exempt income. It was also argued that even if contextual/purposive interpretation is to be given, that also called for direct and proximate connection bet ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... with the exempted income, then such an expenditure would obviously be treated as not related to the income that is exempted from tax, and such expenditure would be allowed as business expenditure. To put it differently, such expenditure would then be considered as incurred in respect of other income which is to be treated as part of the total income. 33) There is no quarrel in assigning this meaning to section 14A of the Act. In fact, all the High Courts, whether it is the Delhi High Court on the one hand or the Punjab and Haryana High Court on the other hand, have agreed in providing this interpretation to section 14A of the Act. The entire dispute is as to what interpretation is to be given to the words 'in relation to' in the given scenario, viz. where the dividend income on the shares is earned, though the dominant purpose for subscribing in those shares of the investee company was not to earn dividend. We have two scenarios in these sets of appeals. In one group of cases the main purpose for investing in shares was to gain control over the investee company. Other cases are those where the shares of investee company were held by the assessees as stock-in-trade (i.e. as a bus ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... tible and, in such a case, the principle of apportionment of the expenditure relating to the non-taxable income did not apply. The principle of apportionment was made available only where the business was divisible. It is to find a cure to the aforesaid problem that the Legislature has not only inserted Section 14A by the Finance (Amendment) Act, 2001 but also made it retrospective, i.e., 1962 when the Income Tax Act itself came into force. The aforesaid intent was expressed loudly and clearly in the Memorandum explaining the provisions of the Finance Bill, 2001. We, thus, agree with the view taken by the Delhi High Court, and are not inclined to accept the opinion of Punjab & Haryana High Court which went by dominant purpose theory. The aforesaid reasoning would be applicable in cases where shares are held as investment in the investee company, may be for the purpose of having controlling interest therein. On that reasoning, appeals of Maxopp Investment Limited as well as similar cases where shares were purchased by the assessees to have controlling interest in the investee companies have to fail and are, therefore, dismissed. 36) There is yet another aspect which still needs to ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... n those cases, where shares are held as stock-in-trade, the main purpose is to trade in those shares and earn profits therefrom. However, we are not concerned with those profits which would naturally be treated as 'income' under the head 'profits and gains from business and profession'. What happens is that, in the process, when the shares are held as 'stock-in-trade', certain dividend is also earned, though incidentally, which is also an income. However, by virtue of Section 10 (34) of the Act, this dividend income is not to be included in the total income and is exempt from tax. This triggers the applicability of Section 14A of the Act which is based on the theory of apportionment of expenditure between taxable and non-taxable income as held in Walfort Share and Stock Brokers P Ltd. case. Therefore, to that extent, depending upon the facts of each case, the expenditure incurred in acquiring those shares will have to be apportioned. 40) We note from the facts in the State Bank of Patiala cases that the AO, while passing the assessment order, had already restricted the disallowance to the amount which was claimed as exempt income by applying the formula contained in Rule 8D of the ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... to record its satisfaction to this effect. Further, while recording such a satisfaction, nature of loan taken by the assessee for purchasing the shares/making the investment in shares is to be examined by the AO. 42) Civil Appeal No. 1423 of 2015 is filed by M/s. Avon Cycles Limited, Ludhiana, wherein the AO had invoked section 14A of the Act read with Rule 8D of the Rules and apportioned the expenditure. The CIT(A) had set aside the disallowance, which view was upturned by the ITAT in the following words: "...Admittedly the assessee had paid total interest of Rs. 2.92 crores out of which interest paid on term loan raised for specific purpose totals to Rs. 1.70 crores and balance interest paid by the assessee is Rs. 1.21 crores. The funds utilized by the assessee being mixed funds and in view of the provisions of Rule 8D(2)(ii) of the Income Tax Rules the disallowance is confirmed at Rs. 10,49,851/-, we find no merit in the ad hoc disallowance made by the CIT (Appeals) at Rs. 5,00,000/-. Consequently, ground of appeal raised by the Revenue is partly allowed and ground raised by the assessee in cross-objection is allowed..." Taking note of the aforesaid finding of fact, the Hi ..... X X X X Extracts X X X X X X X X Extracts X X X X
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