INTRODUCTION
1.1 The Finance Act, 2001 introduced the
provisions of section 14A in Chapter IV of the Income Tax Act,1961[the Act]
with retrospective effect from 1/4/1962 to provide restriction on deduction,
while computing the Total Income under the Act, of any expenditure incurred in
relation to income which does not form part of the Total Income [such
income is hereinafter referred to as Exempt Income]. Effectively, the section
provides for disallowance of expenditure incurred in relation to Exempt Income.
1.1.1 For the purpose of determining the quantum of
disallowance u/s. 14A, the Finance Act, 2006 introduced section 14A (2)/(3)
with effect from 1/4/2007. Section 14A (2) provides that the Assessing Officer
[AO] shall determine the amount of expenditure incurred in relation to Exempt
Income in accordance with the prescribed method, if the AO, having regards to
the accounts of the assessee, is not satisfied with the correctness of the
claim of the assessee in respect of such expenditure. section 14A (3) further
provides that the provisions of section 14A (2) shall also apply in cases where
the assessee has claimed that no such expenditure is incurred [i.e. such
expenditure is NIL]. The method of determining such expenditure is prescribed
under Rule 8D which was introduced with effect from 24/3/2008 and the same was
subsequently amended with effect from 2/6/2016
1.2 In the context of the provisions of section
14A, large number of issues have come-up for debate such as: applicability of
section 14A in cases where the shares [having potential of yielding Exempt
Income] are acquired /retained not for the purpose of earning dividend income
but for acquiring/retaining controlling interest; such shares are for trading
purpose and held as ‘stock-in trade’ where the dividend is incidentally earned;
whether section 14A can apply to cases where no Exempt Income [dividend] is
earned during the relevant previous year; etc. The issues have also come-up
with regard to quantification of amount of disallowance u/s. 14A under
different circumstances; whether the amount of disallowance should be limited
to the amount of Exempt Income earned during the year and also, whether for
this purpose, the application of Rule 8D is mandatory in all cases irrespective
of the fact that the assessee himself has determined the proper amount of such
disallowance while furnishing the Return of Income or has made a claim that no
such expenditure is incurred; etc. Large scale litigation is continued on
number of such issues in the context of the implications of section 14A.
1.3 Recently, the Apex Court, in MaxOpp
Investments Ltd and other cases, had an occasion to consider the major/main
issue of applicability of the provisions of section 14A under the circumstances
where the shares were purchased of a company for the purpose of gaining control
over the said company or were purchased as ‘stock-in-trade’. Since this
judgment settles this major issue and in the process,deals with some other
issues in the context of these provisions, it is thought fit to consider the
same in this column.
MAXOPP INVESTMENTS LTD Vs. CIT (2018) 402 ITR
640 (SC)
Background
2.1 In the above
case, various appeals [preferred by the assessees as well as the Revenue] had
come-up before the Apex Court involving the implications of section 14A.
Initially, the Court noted that, in these appeals, the question has arisen
under varied circumstances where the shares/stocks were purchased of a company
for the purpose of gaining control over the said company or as
‘stock-in-trade’. However, incidentally income was also generated in the form
of dividends as well which was exempt. On this basis, the Assessees contend
that the dominant intention for purchasing the share was not to earn dividends
income but control of the business in the company in whose shares investment
was made or for the purpose of trading in the shares as a business activity and
the shares are held as stock-in-trade. In this backdrop, the issue is as to
whether the expenditure incurred can be treated as expenditure ‘in relation to
income’ i.e. dividend income which does not form part of the total income. To
put it differently, is the dominant or main object would be a relevant
consideration in determining as to whether expenditure incurred is ‘in relation
to’ the dividend income. In most of the appeals, including in Civil Appeal Nos.
104-109 of 2015 [MaxOpp Investment Ltd], aforesaid is the scenario. Though, in
some other cases, there may be little difference in fact situation. However,
all these cases pertain to dividend income, where the investment was made in
order to retain controlling interest in a company or in group of companies or
the dominant purpose was to have it as stock-in-trade.
2.2 In the above context, the Court noted that
the Delhi High Court in MaxOpp Investments Ltd had taken a view that the
provisions of section 14A would apply regardless of the purpose behind making
the investment and consequently, proportionate disallowance of the expenditure
incurred by the assessee will be justified if the expenditure is incurred in
relation to Exempt Income. In this case, after deciding this major common
issues, the Delhi High Court also separately decided some other appeals on
their individual facts with which we are not concerned in this write-up. On the
other hand, the Court noted that the Punjab & Haryana High Court in State
Bank of Patiala has taken a view which runs contrary to the view taken by the
Delhi High Court.
2.3 For the purpose of deciding above referred
major issue, the Court preferred to deal with the findings given by the Delhi
High Court in the case of MaxOpp Investment ltd vs. CIT (2012) -347 ITR 272
[MaxOpp Investment Ltd’s case] and by the Punjab & Haryana High Court
in the case of Principal CIT vs.
State Bank of Patiala (2017) – 391 ITR 218 [State Bank of Patiala’s case]
in the context of facts of these cases.
MAXOPP INVESTMENT LTD’S CASE
3.1 In the background given in para 2 above, the
Court decided to briefly note the facts in the above case of Delhi High Court
(arising from Civil Nos104-109 of 2015) for better understanding of the issues
involved and relevant findings given by the High Court in that case.
3.2 In the above case, the Appellant company
[MaxOpp Investment Ltd- one of the appellants in set of appeals before Apex
Court] was engaged, inter alia, in the business of finance, investments
and dealing in shares and securities. The Appellant holds shares/securities in
two portfolios, viz. (a) as investment on capital account and (b) as trading
assets for the purpose of acquiring and retaining control over investee group
companies, particularly Max India Ltd., a widely held quoted public limited
company. Any profit/loss arising on sale of shares/securities held as
‘investment’ is returned as income under the head ‘capital gains’, whereas
profit/loss arising on sale of shares/securities held as ‘trading assets’ (i.e.
held, inter alia, with the 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’ [Business Income].
3.2.1 Consistent
with the aforesaid treatment regularly followed, the Appellant filed return of
income 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 u/s. 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 AO, while passing the assessment order dated August 27th,
2004 u/s 143(3), worked out disallowance u/s. 14A at Rs. 67,74,175/- by
apportioning the interest expenditure of Rs. 1,16,21,168/- in the ratio of
investment in shares of Max India Ltd. (on which dividend was received) to the
total amount of unsecured loan. The AO, however, restricted disallowance under
that section to Rs. 49,90,860/-, being the amount of dividend received and
claimed exempt.
3.2.2 In appeal, the Commissioner of Income Tax
(Appeals) [CIT (A)] vide order dated January 12th, 2005 upheld the
order of the AO. The Appellant herein carried the matter in further appeal to
the Income Tax Appellate Tribunal, New Delhi (ITAT). In view of the conflicting
decisions of various Benches by the ITAT with respect to the interpretation of
section 14A of the Act, a Special Bench was constituted in the matter of ITO
vs. Daga Capital Management (Private) Ltd. 312 ITR (AT) 1 [Daga Capital’s case].
The appeal of the Appellant was also tagged and heard by the aforesaid Special
Bench.
3.2.3 The Special
Bench of the ITAT in Daga Capital’s case, dismissing the appeal of the
Appellant, inter alia, held that investment in shares representing
controlling interest did not amount to carrying on of business and, therefore,
interest expenditure incurred for acquiring shares in group companies was hit
by the provisions of section14A of the Act. The Special Bench further held that
holding of shares with the intention of acquiring/retaining controlling
interest would normally be on capital account, i.e. as investment and not as
‘trading assets’. For that reason too, the Special Bench held that there
existed dominant connection between interest paid on loan utilized for
acquiring the aforesaid shares and earning of dividend income. Consequently,
the provisions of section 14A of the Act were held to be attracted on the facts
of the case.
3.2.4 On the
interpretation of the expression ‘in relation to’, the majority opinion of the
Special Bench was that the requirement of there being direct and proximate
connection between the expenditure incurred and Exempt Income earned could not
be read into the provision. According to the majority view, ‘what is relevant
is to work out the expenditure in relation to the Exempt Income and not to
examine whether the expenditure incurred by the Assessee has resulted 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.
3.2.5 Against the
aforesaid order of the Special Bench, the Appellant preferred appeal u/s. 260A
of the Act to the High Court. The High Court of Delhi has, vide impugned
judgment dated November 18th, 2011, held that the expression ‘in
relation to’ appearing in section 14A 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.
3.2.6 While coming to the above conclusion, the
High Court also took into the account the law prevailing prior to insertion of
section 14A (Prior Law) and the object of insertion of section 14A. The Prior
Law was that when an assessee has a composite and indivisible business which
has elements of both taxable and non-taxable income, the entire business
expenditure was deductible and in such a case the principle of apportionment of
such expenditure relating to non-taxable income did not apply. However, where
the business was divisible, such principle of apportionment was applicable and
the expenditure apportioned to the Exempt Income was not eligible for deduction
[ref CIT vs. Indian Bank Ltd (1965)56 ITR 77 (SC), CIT vs. Maharashtra Sugar
Mills Ltd (1971)82 ITR 452(SC) and Rajasthan State Warehousing Cooperation vs.
CIT (2000) 242 ITR 452 (SC)]
3.3 The Apex Court considered the above
judgment and, inter alia, noted the following observations and findings
of the High Court:
a. The object behind the insertion of section 14A
in the said Act is apparent from the Memorandum explaining the provisions of
the Finance Bill, 2001 which is to the following effect:
‘Certain incomes
are not includable while computing the total income as these are exempt under
various provisions of the Act. There have been cases where deductions have been
claimed in respect of such Exempt Income. This in effect means that the tax
incentive given by way of exemptions to certain categories of income is being
used to reduce also the tax payable on the non-exempt income by debiting the
expenses incurred to earn the Exempt Income against taxable income. This is
against the basic principles of taxation whereby only the net income, i.e.,
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.’
b. As observed by the Apex Court in the case of CIT
vs. Walfort Share and Stock Brokers P. Ltd. (2010) 326 ITR 1 (SC) [Walfort’s
case], the insertion of section 14A 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 Exempt Income against the
taxable income. The Apex Court in Walfort’s case further observed as under:
“…In other words,
Section 14A 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 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 Section 14….”
The Apex Court in
Walfort’s case also clearly held that in the case of an income like dividend
income which does not form part of the total income, any expenditure/deduction
relatable to such (exempt or non-taxable) income, even if it is of the nature
specified in sections 15 to 59 of the Act, cannot be allowed against any other
income which is includable in the Total Income. The exact words used by the
Apex Court in that case are as under:
“Further, Section
14 specifies five heads of income which are chargeable to tax. In order to be
chargeable, an income has to be brought under one of the five heads. Sections
15 to 59 lay down the Rules for computing income for the purpose of
chargeability to tax under those heads. Sections 15 to 59 quantify the total
income chargeable to tax. The permissible deductions enumerated in Sections 15 to
59 are now to be allowed only with reference to income which is brought under
one of the above heads and is chargeable to tax. If an income like dividend
income is not a part 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 non-taxable has, in principle,
been now widened Under Section 14A.”
c. Likewise, explaining the meaning of
‘expenditure incurred’, the High Court agreed that this expression would mean
incurring of actual expenditure and not to some imagined expenditure. At the
same time, observed the High Court, the ‘actual’ expenditure that is in
contemplation u/s. 14A (1) 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 u/s. 14A.
STATE BANK OF PATIALA’S CASE.
4.1 In the above case, the Punjab and Haryana
High Court has taken a view which runs contrary to the aforesaid view taken by
the Delhi High Court. The Punjab and Haryana High Court followed the judgment
of the High Court of Karnataka in CCI Ltd. vs. Joint Commissioner of Income
Tax, (2012) 206 Taxman 563 [CCI Ltd’s case]. The Revenue has filed appeals
challenging the correctness of the said decision.
4.2 The Apex Court noted the brief facts of
this case and further noted that this case arose in the context where Exempt
Income was earned by the Bank from
securities held by it as its stock in trade. The Assessee filed its return
declaring an income of about Rs. 670 crores which was selected for scrutiny.
The return for the assessment year 2008-09 showed dividend income exempt u/s.
10(34) and (35) and net interest income exempt u/s. 10(15)(iv) (h). The total
Exempt Income claimed in the return of income was, Rs. 12,20 crore. 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 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 of Rs. 12.20 crore which was claimed
as Exempt Income as against the expenditure of Rs. 40.72 crore allocated
towards Exempt Income by applying the formula contained in Rule 8D holding that
section 14A would be applicable. The CIT(A) issued notice of enhancement u/s.
251 of the Act and held that in view of section 14A, the Assessee was not to be
allowed any deduction in respect of expenditure incurred in relation to Exempt
Income. Therefore, he disallowed the entire expenditure of Rs. 40.72 crore
instead of restricting the disallowance to the amount which was claimed as
Exempt Income as done by the AO. The ITAT set aside the order of the AO as well
as CIT (A). It referred to a CBDT Circular No. 18/2015 dated 02.11.2015 which
states that income arising from such investment of a banking concern is
attributable to the business of banking which falls under the head
“Profits and gains of business and profession”. The circular states
that shares and stock held by the bank are ‘stock-in-trade’ and not
‘investment’. Referring to certain judgments and the earlier orders of the
Tribunal, it was held that if shares are held as stock-in-trade and not as
investment even the disallowance under Rule 8D would be nil as Rule 8D(2)(i)
would be confined to direct expenses for earning the tax Exempt Income. In this
factual backdrop, in appeal filed by the Revenue, the High Court noted that
following substantial question of law arose for consideration:
“Whether in the
facts and circumstances of the case, the Hon’ble ITAT is right in law in
deleting the addition made on account of disallowance Under Section 14A of the
Income Tax Act, 1961?”
4.3 The Apex Court then considered the above
judgment and, inter-alia, noted the following observations and findings
of the High Court:
(a) In its analysis, the High Court accepted the
contention of the counsel for the Assessee that the Assessee is engaged in the
purchase and sale of shares as a trader with the object of earning profit and
not with a view to earn interest or dividend. The Assessee does not have an
investment portfolio. The securities constitute the Assessee’s stock-in-trade.
The Department, in fact, rightly accepted, as a matter of fact, that the
dividend and interest earned was from the securities that constituted the
Assessee’s stock-in-trade. The same is, in any event, established. The Assessee
carried on the business of sale and purchase of securities. It was supported by
Circular No. 18, dated November 2th, 2015, issued by the CBDT, which
reads as under:
“Subject: Interest
from Non-SLR securities of Banks – Reg.
It has been brought
to the notice of the Board that in the case of Banks, field officers are taking
a view that, “expenses relatable to investment in non-SLR securities need
to be disallowed Under Section 57(i) of the Act as interest on non-SLR
securities is income from other sources.
2. Clause (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] 160 TAXMAN 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 u/s. 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 officers of the Department and appeals already filed, if
any, on this ground before Courts/Tribunals may be withdrawn/not pressed upon.
This may be brought to the notice of all concerned.”
(b) The High Court pointed out that the Circular
carves out a distinction between stock-in-trade and investment and provides
that if the motive behind purchase and sale of shares is to earn profit then
the same would be treated as trading profit and if the object is to derive
income by way of dividend then the profit would be said to have accrued from
the investment. If the Assessee is found to have treated the shares and
securities as stock-in-trade, the income arising therefrom would be business
income. A loss would be a business loss. Thus, an Assessee may have two
portfolios, namely, investment portfolio and a trading portfolio. In the case
of the former, the securities are to be treated as capital assets and in the
latter as trading assets.
(c) Further, as a banking institution, the Assessee
was also statutorily required to place a part of its funds in approved
securities, as held in CIT vs. Nawanshahar Central Co-operative Bank Ltd.
MANU/SC/2707/2005 : (2007) 289 ITR 6 (SC) [Nawan shahar’s case]. Since, the
shares, bonds, debentures purchased by the Assessee constituted its
stock-in-trade, the provisions of section 14A were not applicable. Here, the
High Court noted distinction between stock-in-trade and investment and stated
that the object of earning profit from trading in securities is different from
the object of earning income, such as, dividend and interest arising therefrom.
The object of trading in securities does not constitute the activity of
investment where the object is to earn dividend or interest.
(d) The High Court then discussed in detail the
judgment of the Apex Court in Walfort’s case (supra) which related to
dividend stripping. After explaining the objective behind section 14A, the Apex
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.
(e) 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, dividend and interest, but to earn
profits from trading in i.e. purchasing and selling the same. It is axiomatic,
therefore, that the entire expenditure including administrative costs was
incurred for the purchase and sale of the stock-in-trade and, therefore,
towards earning the business income from the trading activity of purchasing and
selling the securities. Irrespective of whether the securities yielded any
income arising therefrom, such as, dividend or interest, no expenditure was
incurred in relation to the same.”
4.4 The Court also noted that the Punjab and
Haryana High Court in the above case referred and concurred with the judgment
of Karnataka High Court in CCI Ltd’s case and considered the same. Apart from
this, the Court also felt it useful to refer and consider the judgment of
Calcutta High Court in the case of G.K. K. Capital Markets (P) Ltd [ (2017)
373 ITR 196 ] [G.K.K. Capital’s case] which had also agreed with the view
of the Karnataka High Court in CCI Ltd’s case. In this context, the Court also
mentioned that the earlier judgment of the Calcutta High Court in the case of Danuka
& Sons vs. CIT [(2011) 339 ITR 319} [Danuka & Sons’ case] was cited
by the Revenue in G.K.K. Capital’s case but that judgment was distinguished on
the ground that, in that case, there was no dispute that part of the income of
the assessee from its business was from dividend and the assessee was unable to
produce any material before the authorities below showing the source from which
the relevant shares were acquired.
[ to be
concluded]
Note: The judgment of the Apex Court in the
case of Rajasthan State Warehousing Corporation referred to in para 3.2.6
above dealing with the Prior Law was analysed in this column in the April, 2000
issue of this journal.
