1 South Indian Bank Ltd. vs. Commissioner of Income Tax [Appeal No. 9606 of 2011]
Civil Appeal No. 9606 of 2011; Civil Appeal No. 5610 of 2021 [Arising out of SLP (C) No. 32761 of 2018; Civil Appeal Nos. 9609, 9610, 9611, 9615, 9608, 9612, 9614, 9613, 9607 of 2011; and 3367 and 2963 of 2012
Date of order: 9th September, 2021
Disallowance of expenditure – Section 14A – Expenditure incurred in relation to incomes which are not includible in total income – Proportionate disallowance of interest is not warranted u/s 14A for investments made in tax-free bonds / securities (held as stock-in-trade) which yield tax-free dividend and interest to assessee banks in those situations where interest-free own funds available with the assessee exceeded their investments
1. The question of law that arose before the Supreme Court was on the interpretation of section 14A which reads as follows:
‘Whether proportionate disallowance of interest paid by the banks is called for under section 14A of Income-tax Act for investments made in tax-free bonds / securities which yield tax-free dividend and interest to assessee banks when the assessee had sufficient interest-free own funds which were more than the investments made?’
1.1 For convenience, the Supreme Court adverted to the facts from the Civil Appeal No. 9606 of 2011 (South Indian Bank Ltd. vs. CIT, Trichur) to decide the appeal.
The assessees were scheduled banks and in the course of their banking business they also engaged in the business of investments in bonds, securities and shares which earned them interests from such securities and bonds, as also dividend income on investments in shares of companies, and from units of UTI, etc., which were tax-free.
1.2 None of the assessee banks amongst the appellants maintained separate accounts for the investments made in bonds, securities and shares wherefrom the tax-free income is earned so that disallowances could be limited to the actual expenditure incurred by the assessee.
1.3 In the absence of separate accounts for investments which earned tax-free income, the A.O. made proportionate disallowance of interest attributable to the funds invested to earn tax-free income. The A.O. worked out proportionate disallowance by referring to the average cost of deposit for the relevant year. The CIT(A) had concurred with the A.O.’s view.
1.4 The ITAT in the assessee’s appeal against the CIT(A), considered the absence of separate identifiable funds utilised by the assessee for making investments in tax-free bonds and shares but found that the assessee bank was having indivisible business and considering their nature of business, the investments made in tax-free bonds and in shares would therefore be in the nature of stock-in-trade. The ITAT then noticed that the assessee bank was having surplus funds and reserves from which investments could be made. Accordingly, it accepted the assessee’s case that investments were not made out of interest- or cost-bearing funds alone. In consequence, it was held by the ITAT that disallowance u/s 14A was not warranted in the absence of the clear identity of the funds.
The decision of the ITAT was reversed by the Kerala High Court on acceptance of the contentions advanced by the Revenue in its appeal.
2. The appellants argued before the Supreme Court that the investments made in bonds and shares should be considered to have been made out of interest-free funds which were substantially more than the investment made and therefore the interest paid by the assessee on its deposits and other borrowings should not be considered to be expenditure incurred in relation to tax-free income on bonds and shares; and as a corollary, there should be no disallowance u/s 14A. On the other hand, the counsel for Revenue referred to the reasoning of the CIT(A) and of the High Court to project its case. The contention on behalf of the assessee was rejected by the CIT(A) as also by the High Court primarily on the ground that the assessee had not kept its interest-free funds in a separate account and as such had purchased the bonds / shares from a mixed account.
3. The Supreme Court noted that section 14A was introduced by the Finance Act, 2001 with retrospective effect from 1st April, 1962. The new section was inserted in the aftermath of the judgment of this Court in the case of Rajasthan State Warehousing Corporation vs. CIT [(2000) 242 ITR 450 (SC)]. The said section provided for disallowance of expenditure incurred by the assessee in relation to income which does not form part of its total income. As such, if the assessee incurs any expenditure for earning tax-free income such as interest paid for funds borrowed, for investment in any business which earns tax-free income, the assessee is disentitled to deduction of such interest or other expenditure. Although the provision was introduced retrospectively from 1st April, 1962, the retrospective effect was neutralised by a proviso introduced later by the Finance Act, 2002 with effect from 11th May, 2001 whereunder reassessment, rectification of assessment was prohibited for any assessment year up to the assessment year 2000-01 when the proviso was introduced, without making any disallowance u/s 14A. The earlier assessments were therefore permitted to attain finality. As such, the disallowance u/s 14A was intended to cover pending assessments and for the assessment years commencing from 2001-02.
3.1 The Supreme Court noted that in the present batch of appeals before it, it was concerned with disallowances made u/s 14A for the A.Ys. commencing from 2001-02 onwards or for pending assessments.
4. The Supreme Court noted several decisions wherein it was held that in a situation where the assessee has mixed funds (made up partly of interest-free funds and partly of interest-bearing funds) and payment is made out of such mixed fund, the investment must be considered to have been made out of the interest-free fund.
4.1 In Pr. CIT vs. Bombay Dyeing and Mfg. Co. Ltd. (ITA No. 1225 of 2015), the question whether the Tribunal was justified in deleting the disallowance u/s 80M on the presumption that when the funds available to the assessee were both interest-free and loans, the investments made would be out of the interest-free funds available with the assessee, provided the interest-free funds were sufficient to meet the investments, was answered in favour of the assessee. The resultant SLP of the Revenue challenging the Bombay High Court judgment was dismissed both on merit and on delay by this Court.
4.2 In Commissioner of Income Tax (Large Taxpayer Unit) vs. Reliance Industries Ltd. [(2019) 410 ITR 466 (SC)], a Division Bench of the Supreme Court held that where there is a finding of fact that interest-free funds available to assessee were sufficient to meet its investment, it will be presumed that investments were made from such interest-free funds.
4.3 In HDFC Bank Ltd. vs. Deputy Commissioner of Income Tax [(2016) 383 ITR 529 (Bom)], the assessee was a scheduled bank and the issue therein pertained to disallowance u/s 14A. In this case, the Bombay High Court, even while remanding the case back to the Tribunal for adjudicating afresh, observed (relying on its own previous judgment in the same assessee’s case for a different assessment year) that if the assessee possesses sufficient interest-free funds as against investment in tax-free securities, then there is a presumption that investment which has been made in tax-free securities has come out of interest-free funds available with the assessee. In such a situation, section 14A would not be applicable. Similar views were expressed by other High Courts in CIT vs. Suzlon Energy Ltd. [(2013) 354 ITR 630 (Guj)], CIT vs. Microlabs Ltd. [(2016) 383 ITR 490 (Karn)] and CIT vs. Max India Ltd. [(2016) 388 ITR 81 (P&H)].
4.4 On reading of these judgments, the Supreme Court was of the opinion that the High Courts had correctly interpreted the scope of section 14A in their decisions favouring the assessees.
4.4.1 According to the Supreme Court, applying the same logic, the disallowance would be legally impermissible for the investment made by the assessees in bonds / shares using interest-free funds u/s 14A. In other words, if investments in securities are made out of common funds and the assessee has available non-interest-bearing funds larger than the investments made in tax-free securities, then in such cases disallowance u/s 14A cannot be made.
4.4.2 The Supreme Court said that the decisions in S.A. Builders vs. CIT (2007) 1 SCC 781, where this Court ruled on the issue of disallowance in relation to funds lent to a sister concern out of mixed funds and which was pending consideration before the larger bench of this Court in SLP (C) No. 14729 of 2012 titled as Addl. CIT vs. Tulip Star Hotels Ltd., were distinguishable as the factual scenario was different and therefore the issue pending before the larger Bench had no bearing on the present matters. In that case, loans were extended to a sister concern, while here the assessee banks had invested in bonds / securities.
4.4.3 According to the Supreme Court, the High Court herein had endorsed the proportionate disallowance made by the A.O. u/s 14A to the extent of investments made in tax-free bonds / securities, primarily because a separate account was not maintained by the assessee. The Supreme Court in this context observed that there was no corresponding legal obligation upon the assessee to maintain separate accounts for different types of funds held by it. In the absence of any statutory provision which compels the assessee to maintain separate accounts for different types of funds, the Revenue’s contention could not be sustained.
5. The Supreme Court then adverted to Maxopp Investment Ltd. vs. CIT [(2018) 402 ITR 640 (SC)] which also dealt with the issue of disallowance u/s 14A in cases where investments were held as stock-in-trade and referred to some of its following observations:
(i) The purpose behind section 14A in 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.
(ii) As per section 14A(1), deduction of that expenditure is not to be allowed which has been incurred by the assessee ‘in relation to income which does not form part of the total income under this Act’. Axiomatically, it is that expenditure alone which has been incurred in relation to the income which is includible in the total income that has to be disallowed. If an expenditure incurred has no causal connection with the exempted income, then such 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.
(iii) It is to be kept in mind that in those cases where shares are held as stock-in-trade, it becomes a business activity of the assessee to deal in those shares as a business proposition. Whether dividend is earned or not becomes immaterial. In fact, it would be a quirk of fate that when the investee company declared dividend, those shares are held by the assessee, though the assessee has to ultimately trade those shares by selling them to earn profits. The situation here is, therefore, different from the case like Maxopp Investment Ltd. [Maxopp Investment Ltd. vs. CIT (2012) 347 ITR 272 (Del)] where the assessee would continue to hold those shares as it wants to retain control over the investee company. In that case, whenever dividend is declared by the investee company, that would necessarily be earned by the assessee and the assessee alone. Therefore, even at the time of investing into those shares, the assessee knows that it may generate dividend income as well, and as and when such dividend income is generated, that would be earned by the assessee. In contrast, where the shares are held as stock-in-trade, this may not necessarily be the situation. The main purpose is to liquidate those shares whenever the share price goes up in order to earn profits.
(iv) It will be in those cases where the assessee in his return has himself apportioned but the A.O. is not accepting the said apportionment. In that eventuality, it will have to record its satisfaction to this effect.
6. The Supreme Court thereafter referred to another important judgment dealing with section 14A disallowance, viz., Godrej and Boyce Manufacturing Co. Ltd. vs. DCIT [(2017) 394 ITR 449(SC)]. Here, the assessee had access to adequate interest-free funds to make investments and the issue pertained to disallowance of expenditure incurred to earn dividend income, which was not forming part of the total income of the assessee. It was observed that for disallowance of expenditure incurred in earning an income it is a condition precedent that such income should not be includible in the total income of the assessee. The Supreme Court accordingly concluded that for attracting provisions of section 14A, the proof of fact regarding such expenditure being incurred for earning exempt income is necessary.
7. The Supreme Court proceeded further to examine yet another aspect of the matter. It noted that the Central Board of Direct Taxes (CBDT) had issued Circular No. 18 of 2015 dated 2nd November, 2015 which had analysed and explained that all shares and securities held by a bank which are not bought to maintain Statutory Liquidity Ratio (SLR) are its stock-in-trade and not investments, and income arising out of those is attributable to the business of banking. This Circular came to be issued in the aftermath of CIT vs. Nawanshahar Central Co-operative Bank Ltd. [(2007) 160 Taxman 48 (SC)], wherein the Supreme Court had held that investments made by a banking concern is part of its banking business. Hence, the income earned through such investments would fall under the head Profits & Gains of business. The Punjab & Haryana High Court in the case of Pr. CIT vs. State Bank of Patiala [(2017) 393 ITR 476 (P&H)] while adverting to the CBDT Circular, concluded (correctly, according to the Supreme Court) that shares and securities held by a bank are stock-in-trade and all income received on such shares and securities must be considered to be business income. That is why section 14A would not be attracted to such income.
7.1 Reverting back to the situation, the Supreme Court observed that the Revenue in the present case was not contending that the assessee banks had held the securities for maintaining the SLR as mentioned in the Circular. In view of this position, when there was no finding that the investments of the assessee were of the related category, tax implication would not arise against the appellants from the said Circular.
8. The Supreme Court concluded that the proportionate disallowance of interest was not warranted u/s 14A for investments made in tax-free bonds / securities which yielded tax-free dividend and interest to the assessee banks in those situations where interest-free own funds available with the assessee exceeded their investments. The Supreme Court agreed with the view taken by the ITAT favouring the assessees.
8.1 The Supreme Court clarified that the above conclusion was arrived at because a nexus had not been established between expenditure disallowed and earning of exempt income. The respondents had failed to refer to any statutory provision which obligated the assessee to maintain separate accounts which might justify proportionate disallowance.
9. Finally, referring to the general expectations from tax policies / systems, the Supreme Court quoted the following words of Adam Smith in his seminal work, The Wealth of Nations:
‘The tax which each individual is bound to pay ought to be certain and not arbitrary. The time of payment, the manner of payment, the quantity to be paid ought all to be clear and plain to the contributor and to every other person.’
9.1 In the above context, the Supreme Court observed as under:
‘Echoing what was said by the 18th century economist, it needs to be observed here that in taxation regime, there is no room for presumption and nothing can be taken to be implied. The tax an individual or a corporate is required to pay is a matter of planning for a taxpayer and the Government should endeavour to keep it convenient and simple to achieve maximisation of compliance. Just as the Government does not wish for avoidance of tax, equally it is the responsibility of the regime to design a tax system for which a subject can budget and plan. If proper balance is achieved between these, unnecessary litigation can be avoided without compromising on generation of revenue.’
10. In view of the foregoing discussion, the Supreme Court answered the issue framed in these appeals against the Revenue and in favour of the assessees. The appeals by the assessees were accordingly allowed with no order on costs.
Notes:
(i) The judgment of the Apex Court in the case of Maxopp Investments Ltd. (the Maxopps case) considered in the above case [referred to in para 5 above] was analysed in the BCAJ in the column Closements in the months of January and February, 2018.
(i-a) After the judgment in the Maxopps case, a debate had started as to whether in case of securities held as stock-in-trade yielding exempt income, section 14A should apply or, in view of a specific para in the Maxopps case [reproduced in our above Closements at para 7.1.1], section 14A should not apply. This para is also largely referred in the above case at para 5(iii). Post Maxopps case, the trend in the decisions largely relied on the said para to take a view that in such cases section 14A should not be invoked for making proportionate disallowance of the interest, etc. The issue generally in these cases was the interpretation / implications of the said para in such cases. The said para is now considered as the key observation in the above case [i.e., the South Indian Bank Ltd. case] in adjudicating the issue of expenditure on securities held as stock-in-trade. This issue now gets finally settled with the above judgment in the South Indian Bank Ltd. case. Of course, in case of direct expenses incurred for exempt income, different consideration may apply.
(ii) In the above case, a common question has been decided in a set of appeals involving a few banks. The Kerala High Court had decided this issue against the assessee and the Apex Court considered the South Indian Bank Ltd. case [unreported] as a lead case and considered the facts of that case to decide the common issue. As such, the facts of the case are taken as available in the judgment of the Apex Court. Some of the other cases in appeal are also unreported. It seems that the above cases related to A.Y. 2001-02 up to A.Y. 2007-08 and in these cases the provisions of section 14A(2) [read with Rule 8D] and section 14A(3) [introduced and becoming effectively applicable from A.Y. 2008-09] were effectively not applicable either because of the prior assessment years involved or due to non-recording of a requisite satisfaction as envisaged in section 14A(2).
(ii-a) In the above case, a common question [referred to in para 1 above] considered by the Apex Court was whether proportionate disallowance of interest paid by the banks is permissible u/s 14A for investments made in securities (held as stock-in-trade) yielding exempt dividend / interest income where the assessees had sufficient interest-free own funds available which were more than such investments.
(ii-b) In the appeals before the Apex Court, it was an admitted fact that the assessees did not maintain separate accounts for interest-free own funds and other funds [mixed funds] for making such investments and the investments were made from the mixed funds. However, in all cases the interest-free funds available with the assessee were more than such investments. In such cases, the real issue was whether a presumption can be made that such investments under such circumstances are to be considered as made out of own interest-free funds available with the assessee (Presumption Theory). A majority of the High Courts had decided the issue in favour of the assessees by accepting the Presumption Theory. However, the Kerala High Court was of a different view and hence the above cases came up before the Apex Court in the cases of certain banks.
(iii) The issue of applicability of Presumption Theory in such cases was largely settled in the context of the provisions of 36(i)(iii) [Ref: Reliance Industries Ltd. (410 ITR 466) and Hero Cycles Pvt. Ltd. (379 ITR 347-SC)]. However, in the context of section 14A this was considered, more so by the Revenue, as pending for final view. This may be due to the fact that in the Reliance Industries case before the Apex Court, the issue relating to section 14A disallowance was not raised, although it was decided by the High Court. In the context of section 36(i)(iii), it is also worth noting that now in the above case, the Apex Court has approved the view taken by the Bombay High Court in the case of the HDFC Bank Ltd. case [referred to in para 4.3 above]. In this case, the Bombay High Court followed its earlier decision in the case of the same assessee [(2014) 366 ITR 505 (Bom)] wherein the High Court had applied its earlier decision in the case of Reliance Utilities and Power Ltd. [(2009) 313 ITR 340 (Bom)] in which the Presumption Theory was applied in the context of disallowance u/s 36(1)(iii). As such, the judgment of the Bombay High Court in the Reliance Utilities case should be also treated as impliedly approved on this Theory in the above case.
(iii-a) In view of the above judgment, now the applicability of Presumption Theory in such cases in favour of the assessees gets settled in the context of disallowance u/s 14A. The Court has specifically held that in the absence of any statutory provisions requiring the assessee to maintain separate accounts for different types of funds, this Presumption Theory is applicable. Effectively, the Court has accepted the assessee’s proposition that in respect of payment made out of the mixed fund, it is the assessee who has such right of appropriation and also the right to assert from what part of the fund a
particular investment is made, and it may not be permissible for the Revenue to make an estimation of a proportionate figure.
(iv) In the above case, the Apex Court was dealing with a specific issue referred to in para 1 above [and mentioned in above Note (ii-a)] and the Court has responded favourably to decide that disallowance of interest u/s 14A under such circumstances is unwarranted. The Court has also approved the interpretation of section 14A in the decisions of various High Courts taking similar view [as mentioned in paras 4.3 and 4.4 above] and disagreed with the view taken by the Kerala High Court on this issue. In the process, the Court has also made certain observations in the judgment. It is worth noting that it is settled principle of law that the judgment of the Court should be read as a whole and observations made therein should be considered in the light of the questions before the Court. The decision is binding authority only for what it actually decides and not from what may come to flow from some observations made therein [Ref: Sun Engineering Works (P) Ltd. (198 ITR 297 – SC); CIT vs. Sudhir J. Mulji (214 ITR 154 – Bombay High Court), etc.].
(v) In the above case, after concluding the question before the Court, the Court has also made certain significant general observations [referred to in paras 9 and 9.1 above] with regard to the tax system in the country and pointed out that it is the responsibility of the regime to design a system for which a subject can budget and plan to avoid unnecessary litigation. Even earlier, the Apex Court has made significant observations in such context in other cases (e.g., CIT vs. Arvind Narottam 173 ITR 479.) We only hope that one day the authority [which has the power to take remedial action] will appreciate such a desire coming from the highest court of the land and make the life of genuine taxpayers easy in this context. At the same time, to achieve this goal genuine efforts are also required by all other shareholders without which the common goal of certainty and substantial reduction in litigation does not seem to be feasible. Let us hope that this will happen in the near future with the joint efforts of all stakeholders.
(vi) Currently, the earlier available exemption in respect of long-term capital gain on transfer of shares as well as dividend income is done away with and major litigation for disallowance u/s 14A was due to these exemptions. In this scenario, the efficacy and impact of section 14A is substantially reduced and as such the above judgment would be of more use only in pending litigation for earlier years except for the entities like banks which continue to make such investments in tax-free securities yielding exempt interest income [and hold them as stock-in-trade] for certain reasons. As such, the practical utility of the above judgment will now be limited for the general taxpayers. Therefore, the instant euphoria created in some quarters on the implications of the judgment appears to be misplaced. In fact, this is the reason why it was thought fit by us to cover this judgment in this column instead of with a detailed analysis [like in the Maxopps case] in the column Closements.
