Income Tax Act, 1961:
s. 14A – Applicability of – To dividend income – In cases where dominant purpose of investment was to retain controlling interest in a Company/group of companies or where dominant purpose was to have stock-in-trade – Whether dominant purpose test or theory of apportionment to be applied for interpreting the provision – Held: For interpreting s. 14A, dominant purpose for which investment into shares is made by an assessee, may not be relevant – Principle of appointment comes into play as that is the principle which is engrained in s. 14A – s. 14A is applicable to the dividend income irrespective of whether the shares are held to gain control or as stock-in-trade – However, where shares are held as stock-in-trade, the expenditure incurred in acquiring those shares have to be apportioned – Only that expenditure which is “in relation to” earning dividends can be disallowed u/s. 14A and s. 8D – Assessing Officer needs to record satisfaction having regard to the kind of assessee why the claim of assessee as to the quantum of suo motu disallowance u/s. 14A was not correct – Income Tax Rules, 1962 – r. 8D.
Disposing of the appeals, the Court
HELD: 1. As per Section 14A(1) of the Income Tax Act, 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 total income that has to be disallowed. If an expenditure incurred has no causal connection 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. Such expenditure would then be considered as incurred in respect of other income which is to be treated as part of the total income. [Para 32][808-A-C]
2. For interpreting Section 14A of the Act, the dominant purpose for which the investment into shares is made by an assessee, may not be relevant. No doubt, the assessee may have made the investment in order to gain control of the investee company. However, that does not appear to be a relevant factor in determining the issue at hand. Fact remains that such dividend income is non-taxable. In this scenario, if expenditure is incurred on earning the dividend income, that much of the expenditure which is attributable to the dividend income has to be disallowed and cannot be treated as business expenditure. Keeping this objective behind Section14A of the Act in mind, the said provision has to be interpreted, particularly, the word ‘in relation to the income’ that does not form part of total income. Considered in this hue, the principle of apportionment of expenses comes into play as that is the principle which is engrained in Section 14A of the Act. [Para 34][808-F-H; 809-A-B]
3. Delhi High Court, therefore, correctly observed that prior to introduction of Section 14A of the Act, the law was that when an assessee had a composite and indivisible business which had elements of both taxable and non-taxable income, the entire expenditure in respect of said business was deductible 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. The opinion of Punjab & Haryana High Court which went by dominant purpose theory, is not acceptable. 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. [Para 35][809-E-H; 810-A]
4. In the cases, where shares are held as stock-in-trade, the main purpose is to trade in those shares and earn profits therefrom. 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. Therefore, to that extent, depending upon the facts of each case, the expenditure incurred in acquiring those shares will have to be apportioned. [Para 39][811-A-C]
5. The 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. [Para 40][811-F-G]
6. Having regard to the language of Section 14A(2) of the Act, read with Rule 8D of the Income Tax Rules, it is made clear that before applying the theory of apportionment, the AO needs to record satisfaction that having regard to the kind of the assessee, suo moto disallowance under Section 14A was not correct. It will be in those cases where the assessee in his return has himself apportioned but the AO was not accepting the said apportionment. In that eventuality, it will have 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. [Para 41][812-C-D]
CIT v. Walfort Share and Stock Brokers P Ltd. (2010)
326 ITR 1 (SC) – relied on.
ITO v. Daga Capital Management (Private) Ltd.
312 ITR (AT) 1 ; Principal Commissioner of Income Tax v. State Bank of Patiala (2017) 391 ITR 218 (P&H) ; CCI Ltd. v. Joint Commissioner of Income Tax, Udupi Range (2012) 206 Taxman 563 ; Commissioner of Income Tax, Mumbai v. M/s. Essar Teleholdings Ltd. through its Manager 2018 (1) SCALE 681 ; Doypack Systems Pvt. Ltd. v. Union of India (1988) 2 SCC 299 : [1988] 2 SCR 962 ; CIT v. Nawanshahar Central Co-operative Bank Ltd. (2007) 289 ITR 6 (SC) ; Commissioner of Income Tax v. G.K.K. Capital Markets (P.) Ltd. (2017) 392 ITR 196 (Cal) ; Dhanuka and Sons v. CIT (2011) 339 ITR 319 (Cal) – referred to.
As published in the Supreme Court Reports, Supreme Court of India. Text from the Indian Supreme Court Judgments open data set (Dattam Labs), CC BY 4.0.
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