MAXOPP INVESTMENT LTD. versus COMMISSIONER OF INCOME TAX, NEW DELHI on 12 February 2018

MAXOPP INVESTMENT LTD.

v.

COMMISSIONER OF INCOME TAX, NEW DELHI

(Civil Appeal Nos. 104-109 of 2015)

FEBRUARY 12, 2018

[A. K. SIKRI AND ASHOK BHUSHAN, JJ.]

Income Tax Act, 1961:

s. 14A – Applicability of – To dividend income – In caseswhere dominant purpose of investment was to retain controllinginterest in a Company/group of companies or where dominantpurpose was to have stock-in-trade – Whether dominant purposetest or theory of apportionment to be applied for interpreting theprovision – Held: For interpreting s. 14A, dominant purpose forwhich investment into shares is made by an assessee, may not berelevant – Principle of appointment comes into play as that is theprinciple which is engrained in s. 14A – s. 14A is applicable to thedividend income irrespective of whether the shares are held to gaincontrol or as stock-in-trade – However, where shares are held asstock-in-trade, the expenditure incurred in acquiring those shareshave to be apportioned – Only that expenditure which is “in relationto” earning dividends can be disallowed u/s. 14A and s. 8D –Assessing Officer needs to record satisfaction having regard to thekind of assessee why the claim of assessee as to the quantum of suomotu 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 beenincurred by the assessee “in relation to income which does notform part of the total income under this Act”. Axiomatically, it isthat expenditure alone which has been incurred in relation to theincome which is includible in total income that has to bedisallowed. If an expenditure incurred has no causal connectionwith the exempted income, then such an expenditure wouldobviously be treated as not related to the income that is exempted

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Afrom tax, and such expenditure would be allowed as businessexpenditure. Such expenditure would then be considered asincurred in respect of other income which is to be treated as partof the total income. [Para 32][808-A-C]

2. For interpreting Section 14A of the Act, the dominantBpurpose for which the investment into shares is made by anassessee, may not be relevant. No doubt, the assessee may havemade the investment in order to gain control of the investeecompany. However, that does not appear to be a relevant factorin determining the issue at hand. Fact remains that such dividendincome is non-taxable. In this scenario, if expenditure is incurredCon earning the dividend income, that much of the expenditurewhich is attributable to the dividend income has to be disallowedand cannot be treated as business expenditure. Keeping thisobjective behind Section14A of the Act in mind, the said provisionhas to be interpreted, particularly, the word ‘in relation to theDincome’ that does not form part of total income. Considered inthis hue, the principle of apportionment of expenses comes intoplay as that is the principle which is engrained in Section 14A ofthe Act. [Para 34][808-F-H; 809-A-B]

3. Delhi High Court, therefore, correctly observed that priorEto introduction of Section 14A of the Act, the law was that whenan assessee had a composite and indivisible business which hadelements of both taxable and non-taxable income, the entireexpenditure in respect of said business was deductible and, insuch a case, the principle of apportionment of the expenditurerelating to the non-taxable income did not apply. The principle ofFapportionment was made available only where the business wasdivisible. It is to find a cure to the aforesaid problem that theLegislature has not only inserted Section 14A by the Finance(Amendment) Act, 2001 but also made it retrospective, i.e., 1962when the Income Tax Act itself came into force. The aforesaidGintent was expressed loudly and clearly in the Memorandumexplaining the provisions of the Finance Bill, 2001. The opinionof Punjab & Haryana High Court which went by dominant purposetheory, is not acceptable. The aforesaid reasoning would beapplicable in cases where shares are held as investment in the H

investee company, may be for the purpose of having controllinginterest 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 profitstherefrom. When the shares are held as ‘stock-in-trade’, certaindividend is also earned, though incidentally, which is also anincome. However, by virtue of Section 10 (34) of the Act, thisdividend income is not to be included in the total income and isexempt from tax. This triggers the applicability of Section 14A ofthe Act which is based on the theory of apportionment ofexpenditure between taxable and non-taxable income. Therefore,to that extent, depending upon the facts of each case, theexpenditure incurred in acquiring those shares will have to beapportioned. [Para 39][811-A-C]

5. The cases where shares are held as ‘stock-in-trade’, itbecomes a business activity of the assessee to deal in those sharesas a business proposition. Whether dividend is earned or notbecomes immaterial. In fact, it would be a quirk of fate that whenthe investee company declared dividend, those shares are heldby the assessee, though the assessee has to ultimately trade thoseshares by selling them to earn profits. [Para 40][811-F-G]

6. Having regard to the language of Section 14A(2) of theAct, read with Rule 8D of the Income Tax Rules, it is made clearthat before applying the theory of apportionment, the AO needsto record satisfaction that having regard to the kind of theassessee, suo moto disallowance under Section 14A was notcorrect. It will be in those cases where the assessee in his returnhas himself apportioned but the AO was not accepting the saidapportionment. In that eventuality, it will have to record itssatisfaction to this effect. Further, while recording such asatisfaction, nature of loan taken by the assessee for purchasingthe shares/making the investment in shares is to be examinedby the AO. [Para 41][812-C-D]

CIT v. Walfort Share and Stock Brokers P Ltd. (2010)326 ITR 1 (SC) – relied on.

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AITO v. Daga Capital Management (Private) Ltd.312 ITR (AT) 1 ; Principal Commissioner of IncomeTax 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 ; Commissionerof Income Tax, Mumbai v. M/s. Essar Teleholdings Ltd.Bthrough its Manager 2018 (1) SCALE 681 ; DoypackSystems Pvt. Ltd. v. Union of India (1988) 2 SCC 299 :[1988] 2 SCR 962 ; CIT v. Nawanshahar CentralCo-operative Bank Ltd. (2007) 289 ITR 6 (SC) ;Commissioner of Income Tax v. G.K.K. Capital MarketsC(P.) Ltd. (2017) 392 ITR 196 (Cal) ; Dhanuka and Sonsv. CIT (2011) 339 ITR 319 (Cal) – referred to.

Case Law Reference

From the Judgment and Order dated 18.11.2011 of the High Courtof Delhi at New Delhi in ITA No. 687, 853, 856, 1060 of 2009, 263 and416 of 2010

GWITH

Civil Appeal Nos.3267 and 10096 of 2013, Civil AppealNos. 8596 of 2014, Civil Appeal Nos.1423, 130, 110-112, 115, 123, 6590of 2015, Civil Appeal No.18019 of 2017, Civil Appeal Nos.1500, 1508,1505, 1576, 1579, 1578, 1580, 1575, 2802, 2791, 2792, 1577, 2793 and2794 of 2018.H

Jehangir D. Mistri, K. Radhakrishnan, Ajay Vohra, Sanjay KumarBansal, Sr. Advs., Ms. Vanita Bhargava, Ajay Bhargava, Rony O. John,Abhisaar Bairagi, M/S. Khaitan & Co., Arijit Prasad, Rupesh Kumar,D. L. Chidananda, Ms. Sadhna Sandhu, Ms. Gargi Khanna, ManishPushkarna, Ritin Rai, Mrs. Anil Katiyar, Satyen Sethi, Ms. Gargi S.,Rameshwar Prasad Goyal, Arta Trana Panda, Brajesh Kumar, RajivTyagi, D. Kumar, Dr. Rakesh Gupta, Ambhoj Kumar Sinha, Ms. MonikaGhai, Somil Agarwal, Ms. Kavita Jha, Udit Haresh, Ms. Kavita Jha,Amit Prasad, Aljo K. Joseph, Ashish Somvashi, Ms. Shelna K., MayankNagi, Tarun Singh, Shubham, Shekhar Prit Jha, Shrey Cathly, Nikhil Gupta,Apoorv Chandra Saxena, Sumit K. Batra, Pranjal Srivastava, Subodh S.Patil, Advs. for the appearing parties.

The Judgment of the Court was delivered by

A. K. SIKRI, J. 1. Chapter IV of the Income Tax Act, 1961(hereinafter referred to as the ‘Act’) contains the provisions pertainingto ‘computation of total income’. Section 14 which is the first provisionunder this Chapter enumerates five heads of income within which allincome are to be classified. Under the scheme of the Act, certain typesof income are exempt from tax and, in this behalf, specific provisionsare made stipulating that such incomes would not form part of the totalincome under the Act as fortiorari, they are not included under any ofthe heads of income and, therefore, no taxes levied on such exemptedincomes. It is in this backdrop, Section 14A of the Act clarifies that ifany expenditure is incurred in earning that income which does not formpart of the total income, such expenditure shall also not be allowed asdeduction. Though, Section 14A was inserted by the Finance Act, 2001,but it was given retrospective effect from April 1, 1962. Original Sectionwas in the following terms:

“Section 14A - For the purposes of computing the total incomeunder this Chapter, no deduction shall be allowed in respect ofexpenditure incurred by the assessee in relation to income whichdoes not form part of the total income under this Act.”

2. By the Finance Act, 2006, the aforesaid provision was amendedwhereby it was renumbered as sub-section (1) and sub-sections (2) and(3) were added thereto. Before that, a proviso was also added byamendment vide Finance Act, 2002 which was to operate retrospectivelyfrom May 11, 2001. In these batch of appeals, we are not concerned AB

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Awith sub-sections (2), (3) or the proviso and it is only interpretation thathas to be given to sub-section (1), which arises for consideration.

3. Though, it is clear from the plain language of the aforesaidprovision that no deduction is to be allowed in respect of expenditureincurred by the assessee in relation to income which does not form partBof the total income under the Act, the effect whereof is that if certainincome is earned which is not to be included while computing total income,any expenditure incurred to earn that income is also not allowed as adeduction. It is well known that tax is leviable on the net income. Netincome is arrived at after deducting the expenditures incurred in earningthat income. Therefore, from the gross income, expenditure incurred toCearn that income is allowed as a deduction and thereafter tax is leviedon the net income. The purpose behind Section 14A of the Act, by notpermitting deduction of the expenditure incurred in relation to income,which does not form part of total income, is to ensure that the assesseedoes not get double benefit. Once a particular income itself is not to beDincluded in the total income and is exempted from tax, there is noreasonable basis for giving benefit of deduction of the expenditure incurredin earning such an income. For example, income in the form of dividendearned on shares held in a company is not taxable. If a person takesinterest bearing loan from the Bank and invests that loan in shares/stocks,dividend earned therefrom is not taxable. Normally, interest paid on theEloan would be expenditure incurred for earning dividend income. Suchan interest would not be allowed as deduction as it is an expenditureincurred in relation to dividend income which itself is spared from taxnet. There is no quarrel upto this extent.

4. However, in these appeals, the question has arisen under variedFcircumstances where the shares/stocks were purchased of a companyfor the purpose of gaining control over the said company or as ‘stock-in-trade’. However, incidentally income was also generated in the form ofdividends as well. On this basis, the assessees contend that the dominantintention for purchasing the share was not to earn dividends income butGcontrol of the business in the company in which shares were invested orfor the purpose of trading in the shares as a business activity etc. In thisbackdrop, the issue is as to whether the expenditure incurred can betreated as expenditure ‘in relation to income’ i.e. dividend income whichdoes not form part of the total income. To put it differently, is the dominantor main object would be a relevant consideration in determining as toH

whether expenditure incurred is ‘in relation to’ the dividend income. Inmost of the appeals, including in Civil Appeal Nos. 104-109 of 2015,aforesaid is the scenario. Though, in some other cases, there may belittle difference in fact situation. However, all these cases pertain todividend income, whether it was for the purpose of investment in orderto retain controlling interest in a company or in group of companies orthe dominant purpose was to have it as stock-in-trade.

5. Before we proceed further, we may briefly note the facts ofCivil Appeal Nos. 104-109 of 2015, for better understanding of the issueinvolved.

The appellant company is engaged, inter alia, in the business offinance, investment and dealing in shares and securities. The appellantholds shares/securities in two portfolios, viz. (a) as investment on capitalaccount; and, (b) as trading assets for the purpose of acquiring andretaining control over investee group companies, particularly Max IndiaLtd., a widely held quoted public limited company. Any profit/loss arisingon sale of shares/securities held as ‘investment’ is returned as incomeunder the head ‘capital gains’, whereas profit/loss arising on sale ofshares/securities held as ‘trading assets’ (i.e. held, inter alia, with theintention of acquiring, exercising and retaining control over investee groupcompanies) has been regularly offered and assessed to tax as businessincome under the head ‘profits and gains of business or profession’.

Consistent with the aforesaid treatment regularly followed, theappellant filed return for the previous year relevant to the AssessmentYear 2002-03, declaring income of Rs.78,90,430/-. No part of the interestexpenditure of Rs.1,16,21,168/- debited to the profit and loss account, tothe extent relatable to investment in shares of Max India Limited, yieldingtax free dividend income, was considered disallowable under Section14A of the Act on the ground that shares in the said company wereacquired for the purposes of retaining controlling interest and not withthe motive of earning dividend. According to the appellant, the dominantpurpose/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 IndiaLtd. during the relevant previous year was only incidental to the holdingof such shares. The Assessing Officer (AO), while passing theassessment order dated August 27, 2004, under Section 143(3) workedout disallowance under Section 14A of the Act at Rs.67,74,175/- by AB

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Aapportioning the interest expenditure of Rs.1,16,21,168/- in the ratio ofinvestment in shares of Max India Ltd. (on which dividend was received)to the total amount of unsecured loan. The AO, however, restricteddisallowance under that Section to Rs.49,90,860/- being the amount ofdividend received and claimed exempt.B 6. In appeal, the Commissioner of Income Tax (Appeals)

B 6. In appeal, the Commissioner of Income Tax (Appeals){CIT(A)} vide order dated January 12, 2005 upheld the order of theAO. The appellant herein carried the matter in further appeal to theIncome Tax Appellate Tribunal, New Delhi (for short the ‘ITAT’). Inview of the conflicting decisions of various Benches by the ITAT withrespect to the interpretation of Section 14A of the Act, a Special BenchCwas constituted in the matter of ITO v. Daga Capital Management(Private) Ltd.[1] The appeal of the appellant was also tagged and heardby the aforesaid Special Bench.

7. The Special Bench of the ITAT in the case of Daga CapitalManagement (Private) Ltd., dismissing the appeal of the appellant,Dinter alia, held that investment in shares representing controlling interestdid not amount to carrying on of business and, therefore, interestexpenditure incurred for acquiring shares in group companies was hit bythe provisions of Section 14A of the Act. The Special Bench furtherheld that holding of shares with the intention of acquiring/retainingEcontrolling interest would normally be on capital account, i.e. as investmentand not as ‘trading assets’. For that reason too, the Special Bench heldthat there existed dominant connection between interest paid on loanutilized for acquiring the aforesaid shares and earning of dividend income.Consequently, the provisions of Section 14A of the Act were held to beattracted on the facts of the case.F

8. On the interpretation of the expression ‘in relation to’, themajority opinion of the Special Bench was that the requirement of therebeing direct and proximate connection between the expenditure incurredand exempt income earned could not be read into the provision.According to the majority view, ‘what is relevant is to work out theGexpenditure in relation to the exempt income and not to examine whetherthe expenditure incurred by the assessee has resulted into exempt incomeor taxable income’. As per the minority view, however, the existence ofdominant and immediate connection between the expenditure incurredand 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 invokingprovisions of Section 14A of the Act.

9. Against the aforesaid order of the Special Bench, the appellantpreferred appeal under Section 260A of the Act to the High Court. TheHigh Court of Delhi has, vide impugned judgment dated November 18,2011, held that the expression ‘in relation to’ appearing in Section 14A ofthe 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, proportionatedisallowance of the expenditure incurred by the assessee is maintained.

10. It would be pertinent to point out at this stage that Punjab andHaryana High Court in a recent judgment in the case of PrincipalCommissioner of Income Tax v. State Bank of Patiala[2] has taken aview which runs contrary to the aforesaid view taken by the Delhi HighCourt. The Punjab and Haryana High Court followed, with approval,the judgment of the High Court of Karnataka in CCI Ltd. v. JointCommissioner of Income Tax, Udupi Range[3] The Revenue has filedappeals challenging the correctness of the aforesaid decisions. Thus, inview of conflict of opinions of various High Courts, these batch of appealsare by those assessees who were lost before the High Court and by theIncome Tax Department against the judgments of the High Court wherethe view taken is favourable to the assessee and against the Revenue.

11. Before adverting to the discussions on these judgments, let usgo through the relevant statutory provisions, as that would enable us toappreciate the ratio of these cases more appropriately. Since the focusof discussion is Section 14A of the Act, we reproduce Section 14A in itsentirety hereinbelow:

“Expenditure incurred in relation to income not includible in totalincome.

14A. (1) For the purposes of computing the total income underthis Chapter, no deduction shall be allowed in respect of expenditureincurred by the assessee in relation to income which does notform part of the total income under this Act.

2 (2017) 391 ITR 218 (P&H)

3(2012) 206 Taxman 563

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A(2) The Assessing Officer shall determine the amount ofexpenditure incurred in relation to such income which does notform part of the total income under this Act in accordance withsuch method as may be prescribed, if the Assessing Officer, havingregard to the accounts of the assessee, is not satisfied with thecorrectness of the claim of the assessee in respect of suchBexpenditure in relation to income which does not form part of thetotal income under this Act.

(3) The provisions of sub-section (2) shall also apply in relation toa case where an assessee claims that no expenditure has beenincurred by him in relation to income which does not form part ofthe total income under this Act :

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Provided that nothing contained in this section shall empowerthe Assessing Officer either to reassess under section 147 or passan order enhancing the assessment or reducing a refund alreadymade or otherwise increasing the liability of the assessee undersection 154, for any assessment year beginning on or before the1st day of April, 2001.”

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12. Sub-section (2) of Section 14A deals with the proportionalityas it empowers the AO to extricate that amount of expenditure which isincurred in relation to such income which does not form part of the totalEincome under the Act. However, this is to be done ‘in accordance withsuch method as may be prescribed.’ This prescription is provided by thedelegated 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, 2008vide Income Tax (Fifth Amendment) Rules, 2008[4]. We, thus, reproduceRule 8D hereunder:F

“Method for determining amount of expenditure in relationto income not includible in total income.

8D.(1) Where the Assessing Officer, having regard to the accountsof the assessee of a previous year, is not satisfied with—

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(a) the correctness of the claim of expenditure made by theassessee; or 4 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, thisHCourt has held that Rule 8D is prospective in nature.

(b) the claim made by the assessee that no expenditure has beenincurred, in relation to income which does not form part of the total incomeunder the Act for such previous year, he shall determine the amountof expenditure in relation to such income in accordance with theprovisions of sub-rule (2).

(2) The expenditure in relation to income which does not formpart of the total income shall be the aggregate of followingamounts, namely:—

(i) the amount of expenditure directly relating to income whichdoes not form part of total income;

(ii) in a case where the assessee has incurred expenditure byway of interest during the previous year which is not directlyattributable to any particular income or receipt, an amountcomputed in accordance with the following formula, namely:—

Where A = amount of expenditure by way of interest other thanthe amount of interest included in clause (i) incurred during theprevious year; B = the average of value of investment, income from which doesnot or shall not form part of the total income, as appearing in thebalance sheet of the assessee, on the first day and the last day ofthe previous year; C = the average of total assets as appearing in the balance sheetof the assessee, on the first day and the last day of the previousyear;

(iii) an amount equal to one-half per cent of the average of thevalue of investment, income from which does not or shall notform part of the total income, as appearing in the balance sheet ofthe assessee, on the first day and the last day of the previousyear.

(3) For the purposes of this rule, the “total assets” shall mean,total assets as appearing in the balance sheet excluding the increase A

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Aon account of revaluation of assets but including the decrease onaccount of revaluation of assets.”

13. With the aforesaid statutory scheme in mind, we traversethrough the judgments of the Delhi High Court in Maxopp InvestmentLtd. and that of Punjab and Haryana High Court in State Bank ofBPatiala.JUDGMENT OF DELHI HIGH COURT IN MAXOPPINVESTMENT LTD.

14. Three questions fell for consideration before the High Court.For the purpose of these appeals, it is only question No. 1 which isCrelevant, and formulation thereof by the High Court was as under:

“1. Whether expenditure (including interest paid on funds borrowed)in respect of investment in shares of operating companies foracquiring and retaining a controlling interest therein is hit by section14A of the Income tax Act, 1961 inasmuch as the dividend receivedDon such shares does not form part of the total income?”

15. On facts, it was noted that the assessee company is in thebusiness 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 ofEacquiring and retaining control over its group companies, primarily MaxIndia Ltd. As per the assessee, any profit resulting on the sale of sharesheld as trading assets was duly offered to tax as business income of theassessee. During the previous year relevant to the assessment year2002-03, the assessee incurred total interest expenditure ofRs. 1,61,21,168/-, which was claimed as business expenditure underFsection 36(1)(iii) of the Income Tax Act, 1961 (hereinafter referred toas “the said act”). According to the assessee, the expenditure claimedwas not hit by section 14A of the Act, on the ground that althoughborrowed funds were partly utilised for investment in shares held astrading assets, such investment was made with the intention to acquireGand retain a controlling interest in the aforesaid company and that thereceipt of dividend thereon was merely incidental. The High Court thentook note of legislative history of Section 14A of the Act and Rule 8D ofthe Rules. Thereafter, the Court went on to discuss the law which stoodprior to insertion of Section 14A. Taking note of certain judgments, theHigh Court observed that prior to the insertion of Section 14A in the Act,H

the law was that when an assessee had a composite and indivisiblebusiness, which had elements of both taxable and non-taxable income,the entire expenditure in respect of the said business was deductibleand, in such a case, the principle of apportionment of the expenditurerelating to the non-taxable income did not apply. However, where thebusiness was divisible, the principle of apportionment of the expenditurewas applicable and the expenditure apportioned to the ‘exempt’ incomeor income not exigible to tax, was not allowable as a deduction. TheHigh Court, then, took cognizance of the legislative intent and objectivebehind the insertion of Section 14A by referring to the MemorandumExplaining the Provisions of the Finance Bill, 2001. It also reproducedpassages from few judgments of this Court. Since, for the purpose ofthe present case, it is necessary to keep in mind the objectives behindthis provision, we reproduce that part of the discussion hereunder:

“Objective behind insertion of section 14A

15. The object behind the insertion of section 14A in the said Actis apparent from the Memorandum explaining the provisions ofthe Finance Bill 2001 which is to the following effect:- “Certain incomes are not includable while computing the totalincome as these are exempt under various provisions of theAct. There have been cases where deductions have beenclaimed in respect of such exempt income. This in effect meansthat the tax incentive given by way of exemptions to certaincategories of income is being used to reduce also the tax payableon the non-exempt income by debiting the expenses incurredto earn the exempt income against taxable income. This isagainst the basic principles of taxation whereby only the netincome, i.e., gross income minus the expenditure is taxed. Onthe same analogy, the exemption is also in respect of the netincome. Expenses incurred can be allowed only to the extentthey are relatable to the earning of taxable income.

It is proposed to insert a new section 14A so as to clarify theintention of the Legislature since the inception of the Income-tax Act, 1961, that no deduction shall be made in respect ofany expenditure incurred by the assessee in relation to incomewhich does not form part of the total income under the Income-tax Act.

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The proposed amendment will take effect retrospectively fromApril 1, 1962 and will accordingly, apply in relation to theassessment 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), theinsertion of section 14 A with retrospective effect reflects theserious attempt on the part of Parliament not to allow deduction inrespect of any expenditure incurred by the assessee in relation toincome, which does not form part of the total income under thesaid act against the taxable income. The Supreme Court furtherobserved as under:- “.. In other words, section 14 A clarifies that expenses incurredcan be allowed only to the extent that they are relatable to theearning of taxable income. In many cases the nature ofexpenses incurred by the assessee may be relatable partly tothe exempt income and partly to the taxable income. In theabsence of section 14A, the expenditure incurred in respect ofexempt income was being claimed against taxable income.Themandate of section 14A is clear. It desires to curb thepractice to claim deduction of expenses incurred in relationto exempt income against taxable income and at the sametime avail of the tax incentive by way of an exemption ofexempt income without making any apportionment ofexpenses incurred in relation to exempt income…”

“..Expenses allowed can only be in respect of earning taxableincome. This is the purport of section 14A. In section 14A, thefirst phrase is “for the purposes of computing the total incomeunder this Chapter” which makes it clear that various heads ofincome as prescribed in the Chapter IV would fall within section14A. The next phrase is, “in relation to income which doesnot form part of total income under the Act”. It means thatif an income does not form part of total income, then therelated expenditure is outside the ambit of the applicabilityof section 14A..

(Emphasis supplied)”17. The Supreme Court also clearly held that in the case of anincome like dividend income which does not form part of the total income, any expenditure/deduction relatable to such (exempt ornon-taxable) income, even if it is of the nature specified in sections15 to 59 of the said Act, cannot be allowed against any otherincome which is includable in the total income. The exact wordsused by the Supreme Court are as under:- “Further, section 14 specifies five heads of income which arechargeable to tax. In order to be chargeable, an income has tobe brought under one of the five heads. Sections 15 to 59 laydown the rules for computing income for the purpose ofchargeability to tax under those heads. Sections 15 to 59quantify the total income chargeable to tax. The permissibledeductions enumerated in sections 15 to 59 are now to beallowed only with reference to income which is broughtunder one of the above heads and is chargeable to tax.Ifan income like dividend income is not a part of the total income,the expenditure/deduction though of the nature specified insections 15 to 59 but related to the income not forming part ofthe total income could not be allowed against other incomeincludable in the total income for the purpose of chargeabilityto tax. The theory of apportionment of expenditure betweentaxable and non-taxable has, in principle, been nowwidened under section 14 A.

16. The High Court then undertook the exercise of analysing theprovisions of Section 14A of the Act and, in the process, examined thecontours and scope of the expressions ‘in relation to’ and ‘expenditureincurred’ occurring therein. The High Court pointed out that contentionof the assessees, in this behalf, was that the word ‘incurred’ must betaken literally in the sense that the expenditure must have actually takenplace. Moreover, the expenditure must also have taken place in relationto income which does not form part of total income. Further, theexpression “in relation to” implies that there must be a direct andproximate connection with the subject matter. In other words, only thatactual expenditure which is made directly and for the object of earningexempt income (in the present appeals - dividend income) could bedisallowed under section 14A of the Act. If the dominant and mainobjective of spending was not the earning of ‘exempt’ income then, the A

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Aexpenditure could not be disallowed under section 14A of the Act providedit was otherwise allowable under sections 15 to 59 of the said Act. TheHigh Court, however, did not agree with the aforesaid propositionsadvanced by the learned counsel for the assessees which according to itwas mired by several difficulties. Distinguishing the case law cited bythe assessees where the expression ‘in relation to’ was interpreted byBthis Court, as not applicable in the present context, the High Court, instead,referred to the judgment in the case of Doypack Systems Pvt. Ltd. v.Union of India[5] wherein this Court has held that expressions ‘pertainingto’, ‘in relation to’ and ‘arising out of’ used in the deeming provisions,are used in an expansive sense. It also referred to the judgment of thisCCourt in CIT v. Walfort Share and Stock Brokers P Ltd.[6] wherein thisCourt has held that the basic principle of taxation is to tax the net income,i.e., gross income minus the expenditure and on the same analogy theexemption is also in respect of net income. In other words, where thegross income would not form part of total income, it’s associated orrelated expenditure would also not be permitted to be debited againstDother taxable income.

17. Likewise, explaining the meaning of ‘expenditure incurred’,the High Court agreed that this expression would mean incurring ofactual expenditure and not to some imagined expenditure. At the sametime, observed the High Court, the ‘actual’ expenditure that is inEcontemplation under section 14A(1) of the said Act is the ‘actual’expenditure in relation to or in connection with or pertaining to exemptincome. The corollary to this is that if no expenditure is incurred in relationto the exempt income, no disallowance can be made under section 14Aof the said Act. On the basis of the aforesaid discussion, the High CourtFanswered the question formulated by it in the affirmative.

JUDGMENT OF PUNJAB AND HARYANA HIGH COURT INSTATE BANK OF PATIALA

18. This case arose in the context where exempt income in theform of dividend was earned by the Bank from securities held by it as itsGstock in trade. The assessee filed its return declaring an income ofabout Rs.670 crores which was selected for scrutiny. The return showeddividend income exempt under section 10(34) and (35) of about Rs.11.07crores and net interest income exempt under section 10(15)(iv)(h) of 5(1988) 2 SCC 299H6 (2010) 326 ITR 1 (SC)

about Rs.1.12 crores. The total exempt income claimed in the returnwas, therefore, Rs.12,19,78,015/-. The assessee while claiming theexemption contended that the investment in shares, bonds, etc. constitutedits stock-in-trade; that the investment had not been made only for earningtax free income; that the tax free income was only incidental to theassessee’s main business of sale and purchase of securities and, therefore,no expenditure had been incurred for earning such exempt income; theexpenditure would have remained the same even if no dividend or interestincome had been earned by the assessee from the said securities andthat no expenditure on proportionate basis could be allocated againstexempt income. The assessee also contended that in any event it hadacquired the securities from its own funds and, therefore, section 14Awas not applicable. The AO restricted the disallowance to the amountwhich was claimed as exempt income by applying the formula containedin Rule 8D holding that Section 14A would be applicable. The CIT(A)issued notice of enhancement under Section 251 of the Act and held thatin view of Section 14A of the Act, the assessee was not to be allowedany deduction in respect of income which is not chargeable to tax.Therefore, he disallowed the entire expenditure claimed instead ofrestricting the disallowance to the amount which was claimed as exemptincome as done by the AO. The ITAT set aside the order of the AO aswell as CIT(A). It referred to a CBDT Circular No.18/2015 dated02.11.2015 which states that income arising from investment of a bankingconcern is attributable to the business of banking which falls under thehead “Profits and gains of business and profession”. The circular statesthat shares and stock held by the bank are ‘stock-in-trade’ and not‘investment’. Referring to certain judgments (which we will also referto) and the earlier orders of the Tribunal, it was held that if shares areheld as stock-in-trade and not as investment even the disallowance underrule 8D would be nil as rule 8D(2)(i) would be confined to direct expensesfor earning the tax exempt income. In the aforesaid factual backdrop, inappeal filed by the Revenue, the High Court noted that followingsubstantial question of law arose for consideration:

“Whether in the facts and circumstances of the case, the Hon’bleITAT is right in law in deleting the addition made on account ofdisallowance under section 14A of the Income Tax Act, 1961?”

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A19. In its analysis, the High Court accepted the contention of thecounsel for the assessee that the assessee is engaged in the purchaseand sale of shares as a trader with the object of earning profit and notwith a view to earn interest or dividend. The assessee does not have aninvestment portfolio. The securities constitute the assessee’s stock-in-trade. The Department, in fact, rightly accepted, as a matter of fact, thatBthe dividend and interest earned was from the securities that constitutedthe 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 02, 2015, issuedby the CBDT, which reads as under:- C

“Subject: Interest from Non-SLR securities of Banks – Reg.

It has been brought to the notice of the Board that in the case ofBanks, field officers are taking a view that, “expenses relatableto investment in non-SLR securities need to be disallowed u/s57(i) of the Act as interest on non-SLR securities is income fromDother sources.”

2. Clause (id) of sub-section (1) of Section 56 of the Act providesthat income by way of interest on securities shall be chargeableto income-tax under the head “Income from Other Sources”, if,the income is not chargeable to income-tax under the head “ProfitsEand Gains of Business and Profession”.

3. The matter has been examined in light of the judicial decisionson this issue. In the case of CIT Vs Nawanshahar CentralCooperative Bank Ltd. [2007] 160TAXMAN 48(SC), the ApexCourt held that the investments made by a banking concern arepart of the business of banking. Therefore, the income arisingfrom such investments is attributable to the business of bankingfalling under the head “Profits and Gains of Business andProfession”.

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3.2 Even though the abovementioned decision was in the contextof co-operative societies/Banks claiming deduction under section80P(2)(a)(i) of the Act, the principle is equally applicable to allbanks/commercial banks, to which Banking Regulation Act, 1949applies.

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4. In the light of the Supreme Court’s decision in the matter, theissue is well settled. Accordingly, the Board has decided that noappeals may henceforth be filed on this ground by the officers ofthe Department and appeals already filed, if any, on this groundbefore Courts/Tribunals may be withdrawn/not pressed upon. Thismay be brought to the notice of all concerned.

20. The High Court pointed out that the Circular carves out adistinction between stock-in-trade and investment and provides that ifthe motive behind purchase and sale of shares is to earn profit then thesame would be treated as trading profit and if the object is to deriveincome by way of dividend then the profit would be said to have accruedfrom the investment. If the assessee is found to have treated the sharesand securities as stock-in-trade, the income arising therefrom would bebusiness income. A loss would be a business loss. Thus, an assesseemay have two portfolios, namely, investment portfolio and a tradingportfolio. In the case of the former, the securities are to be treated ascapital assets and in the latter as trading assets.

21. Further, as a banking institution, the assessee was alsostatutorily required to place a part of its funds in approved securities, asheld in CIT v. Nawanshahar Central Co-operative Bank Ltd.[7]. Since,the shares, bonds, debentures purchased by the assessees constitutedits stock-in-trade, the provisions of Section 14A were not applicable.Here, the Court noted distinction between stock-in-trade and investmentand made the following observations:

“17. Under section 14A, an expenditure can be disallowed only ifit is incurred by the assessee in relation to income exempt fromtax. The dividend or interest from the assessee’s stock-in-tradei.e. the securities was exempt from tax in view of sections10(15)(iv)(h),(34) and (35). This was incidental to its business ofbanking. The business income on account of the assessee tradingin the securities is assessable under the head “Profits and gains ofbusiness and profession”. The expenditure incurred in relation tostock-in-trade arising as a result of investment in shares anddebentures is deductible under sections 28 to 37. There is adistinction between stock-in-trade and investment. The object of 7(2007) 289 ITR 6 (SC)

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Aearning profit from trading in securities is different from the objectof earning income, such as, dividend and interest arising therefrom.The object of trading in securities does not constitute the activityof investment where the object is to earn dividend or interest.”

22. The High Court then discussed in detail the judgment in WalfortBShare and Stock Brokers P Ltd. which related to dividend stripping.After explaining the objective behind Section 14A of the Act (which isalready noted above), this Court in the facts of that case, had held that apayback does not constitute an ‘expenditure incurred’ in terms of Section14A as it does not impact the profit and loss account. This expenditure,in fact, is a payout.C23. According to the High Court, what is to be disallowed is theexpenditure incurred to “earn” exempt income. The words ‘in relationto’ in Section 14A must be construed accordingly. Applying that principleto the facts at hand, the High Court concluded as under:

D“Now, the dividend and interest are income. The question then iswhether the assessee can be said to have incurred any expenditureat all or any part of the said expenditure in respect of the exemptincome viz. dividend and interest that arose out of the securitiesthat constituted the assessee’s stock-in-trade. The answer mustbe in the negative. The purpose of the purchase of the saidEsecurities 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, thatthe entire expenditure including administrative costs was incurredfor the purchase and sale of the stock-in-trade and, therefore,Ftowards earning the business income from the trading activity ofpurchasing and selling the securities. Irrespective of whether thesecurities yielded any income arising therefrom, such as, dividendor interest, no expenditure was incurred in relation to the same.”

24. We may also note here that the High Court referred to theGjudgment of the Karnataka High Court in CCI Ltd. case and concurredtherewith. This judgment in CCI Ltd. is, however, a very short judgmentwhich records the submission of counsel for the parties very briefly andthereafter the entire discussion is contained in para 5 that reads as under:

“5. When no expenditure is incurred by the assessee in earningthe dividend income, no notional expenditure could be deductedH

from the said income. It is not the case of the assessee retainingany shares so as to have the benefit of dividend. 63% of theshares, which were purchased, are sold and the income derivedtherefrom is offered to tax as business income. The remaining37% of the shares are retained. It has remained unsold with theassessee. It is those unsold shares have yielded dividend, forwhich, the assessee has not incurred any expenditure at all.Though the dividend income is exempted from payment of tax, ifany expenditure is incurred in earning the said income, the saidexpenditure also cannot be deducted. But in this case, when theassessee has not retained shares with the intention of earningdividend income and the dividend income is incidental to his businessof sale of shares, which remained unsold by the assessee, it cannotbe said that the expenditure incurred in acquiring the shares hasto be apportioned to the extent of dividend income and that shouldbe disallowed from deductions. In that view of the matter, theapproach of the authorities is not in conformity with the statutoryprovisions contained under the Act. Therefore, the impugnedorders are not sustainable and require to be set aside.”

25. At this stage, it will also be useful to refer a judgment ofCalcutta High Court in Commissioner of Income Tax v. G.K.K. CapitalMarkets (P.) Ltd.[8] which has also agreed with the view taken by theKarnataka High Court. In that case, the assessee was engaged in thebusiness of share trading. In the computation of income, the assesseeclaimed long-term capital gains as exempt income and declaredexpenditure disallowable against it under Section 14A of the Act. TheAO treated the long-term capital gains as business income. The AppellateTribunal found that the assessee did not have any investment and all theshares were held as stock-in-trade as was evident from the orders ofthe lower authorities. On those facts it held that once the assessee hadkept the shares as stock-in-trade, Rule 8D of the Rules would not apply.On the questions whether the Appellate Tribunal was justified in deletingthe disallowance under Section 14A computed in accordance with Rule8D and in holding the investments as shares stock-in-trade, the HighCourt held that the AO had accepted the correctness of the disallowableexpenditure 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 AB

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Aas business income to thereafter disallow the offered expenditure.According to the High Court, since the finding of fact was recorded bythe AO regarding the exempt income claimed being treated as businessincome and the shares held by the assessee having been treated asstock-in-trade, there could not have been disallowance of expenditureunder Section 14A of the Act and that provision had no application.B

26. It would be pertinent to mention that earlier judgment of thesame High Court in the case of Dhanuka and Sons v. CIT[9] was citedby the Revenue. However, this judgment was distinguished on the groundthat, in that case, there was no dispute that part of the income of theassessee from its business was from dividend whereas the assesseeCwas unable to produce any material before the authorities below showingthe source from which such shares were acquired. For betterunderstanding, it would be necessary to note the discussion in the caseof Dhanuka and Sons, which was reproduced by the High Court inG.K.K. Capital Markets (P.) Ltd. Para 6 to para 9 of Dhanuka andDSons read as under:

“6. Mr. Sarkar, the learned advocate appearing on behalf of therevenue, has, on the other hand, supported the order passed bythe Tribunal and has contended that the assessee itself havingfailed to produce material in support of its contention, the AssessingEOfficer rightly assessed the deductible income on proportionatebasis. Mr. Sarkar submits that the same is in conformity withRule 8D of the Income tax Rule and thus, we should not interferewith the order passed by the Tribunal.

7. After hearing the learned counsel appearing for the partiesFand after going through the materials on record and the decisionscited by Mr. Khaitan, we find that the Supreme Court in the casesof CIT v. Maharastra Sugar Mills Ltd. [1971] 82 ITR 452 andRajasthan State Warehousing Corpn. v. CIT [2000] 242 ITR 450/109 Taxman 145 having held that where there is one indivisiblebusiness giving rise to taxable income as well as exempt income,Gthe entire expenditure incurred in relation to that business wouldhave to be allowed even if a part of the income earned from thebusiness is exempt from tax, section 14A of the Act was enactedto overcome those judicial pronouncements. The object of section14A of the Act is to disallow the direct and indirect expenditure incurred in relation to income which does not form part of thetotal income.

incurred in relation to income which does not form part of thetotal income.

8. In the case before us, there is no dispute that part of theincome of the assessee from its business is from dividend whichis exempt from tax whereas the assessee was unable to produceany material before the authorities below showing the source fromwhich such shares were acquired. Mr. Khaitan strenuouslycontended before us that for the last few years before the relevantprevious year, no new share has been acquired and thus, the loanthat was taken and for which the interest is payable by the assesseewas not for acquisition of those old shares and, therefore, theauthorities below erred in law in giving benefit of proportionatededuction.

9. In our opinion, the mere fact that those shares were old onesand not acquired recently is immaterial. It is for the assessee toshow the source of acquisition of those shares by production ofmaterials that those were acquired from the funds available in thehands of the assessee at the relevant point of time without takingbenefit of any loan. If those shares were purchased from theamount taken in loan, even for instance, five or ten years ago, it isfor the assessee to show by the production of documentaryevidence that such loaned amount had already been paid backand for the relevant assessment year, no interest is payable by theassessee for acquiring those old shares. In the absence of anysuch materials placed by the assessee, in our opinion, the authoritiesbelow rightly held that proportionate amount should be disallowedhaving regard to the total income and the income from the exemptsource. In the absence of any material disclosing the source ofacquisition of shares which is within the special knowledge of theassessee, the assessing authority took a most reasonable approachin assessment.”

27. We have already stated as to how the two divergent opinionshave emerged from different High Courts and the respective reasons insupport of these conflicting outcome. Obviously, assessees are bankingupon the reasons which prevailed with the High Courts that have takenthe view which are favourable to the assessees and the Revenue isrelying upon the reasoning given by Delhi High Court as well as Calcutta AB

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AHigh Court in Dhanuka and Sons case. Therefore, it may not benecessary to give a detailed narrative of the arguments which wereadvanced by various counsel appearing for the assessees as well ascounsel for the Revenue. A brief resume of their submissions wouldserve the purpose.

B28. Insofar as assessees are concerned, their arguments arerecapitulated in brief hereinbelow:

(i) The holding of investment in group companies representingcontrolling interest, amounts to carrying on business, as held inthe various cases.

C(ii) Notwithstanding that dividend income is assessable under thehead “income from other sources”, in view of the mandatoryprescription in Section 56 of the Act, the nature of dividend incomehas to be ascertained on the facts of the case. Where dividendis earned on shares held as stock-in-trade/shares purchased forDacquiring/retaining controlling interest, dividend income is in thenature of business income.

(iii) Interest paid on loans borrowed for acquiring shares representingcontrolling interest in the investee company is allowable businessexpenditure in terms of Section 36(1)(iii) of the Act, sinceEacquiring controlling interest in companies and managing,administering, financing and rehabilitating such companies arefor business and/or professional purposes and not for earneddividend.

(iv) Conversely, interest paid on funds borrowed for investment inshares representing controlling interest does not representFexpenditure incurred for earning dividend income and is notallowable under Section 57(iii) of the Act (prior to introductionof Section 14A).

29. Basing their case on the aforesaid principles, it was arguedthat when the shares were acquired, as part of promoter holding, for theGpurpose of acquiring controlling interest in the company, the dominantobject is to keep control over the management of the company and notto earn the dividend from investment in shares. Whether dividend isdeclared/earned or not is immaterial and, in either case, the assesseewould not liquidate the shares in investee companies. Therefore, no H

expenditure was made ‘in relation to’ the income i.e. the dividend incomeand, therefore, Section 14A would not be attracted. In this hue, it wassubmitted that Section 14A was to be accorded plain and grammaticalinterpretation meaning thereby mandating and requiring a direct andproximate nexus/link between the expenditure actually incurred and theearning of the exempt income. It was also argued that even if contextual/purposive interpretation is to be given, that also called for direct andproximate connection between the expenditure incurred and earning ofdividend. According to the learned counsel appearing for the assessees,the legislative intention behind inserting Section 14A in this statute wasto exclude both, viz. the receipts which are exempt under the provisionsof the Act as well as expenditure actually incurred ‘in relation thereto’from entering into the computation of assessable income, so as to removethe double benefit to the assessee (i) in the form of exempt income, onwhich no tax is leviable; and (ii) providing deduction in respect ofexpenditure actually incurred which directly resulted in the earning ofexempt income by the assessee.

30. Mr. K. Radhakrishnan, learned senior counsel appearing forthe Revenue, on the other hand, made a fervent plea to accept the viewtaken by the Delhi High Court. He submitted that the objective behindinsertion of Section 14A of the Act manifestly pointed out that expenditureincurred in respect of income earned, which is exempted from tax, hasto be disallowed. He also pointed out that this message was eloquentlybrought out by this Court in Walfort Share and Stock Brokers P Ltd.case. Otherwise, argued the learned senior counsel, the assessee willget double benefit, one, in the form of exemption from income tax insofaras dividend income is concerned and other by getting deduction onaccount of expenditure as well. He, thus, submitted that expression ‘inrelation to’ had to be given expansive meaning in order to sub-serve thepurpose of the said provision. He also emphasised that literal meaningof Section 14A of the Act pointed towards that and that was equally thepurpose behind the insertion of Section 14A as well.

31. We have given our thoughtful consideration to the argumentof counsel for the parties on both sides, in the light of various judgmentswhich have been cited before us, some of which have already beentaken note of above.

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A32. In the first instance, it needs to be recognised that as persection 14A(1) of the Act, deduction of that expenditure is not to beallowed which has been incurred by the assessee “in relation to incomewhich does not form part of the total income under this Act”.Axiomatically, it is that expenditure alone which has been incurred inrelation to the income which is includible in total income that has to beBdisallowed. If an expenditure incurred has no causal connection withthe exempted income, then such an expenditure would obviously betreated as not related to the income that is exempted from tax, and suchexpenditure would be allowed as business expenditure. To put itdifferently, such expenditure would then be considered as incurred inCrespect 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 ofthe Act. In fact, all the High Courts, whether it is the Delhi High Courton the one hand or the Punjab and Haryana High Court on the otherhand, have agreed in providing this interpretation to section 14A of theDAct. The entire dispute is as to what interpretation is to be given to thewords ‘in relation to’ in the given scenario, viz. where the dividend incomeon the shares is earned, though the dominant purpose for subscribing inthose shares of the investee company was not to earn dividend. Wehave two scenarios in these sets of appeals. In one group of cases themain purpose for investing in shares was to gain control over the investeeEcompany. Other cases are those where the shares of investee companywere held by the assessees as stock-in-trade (i.e. as a business activity)and not as investment to earn dividends. In this context, it is to beexamined as to whether the expenditure was incurred, in respectivescenarios, in relation to the dividend income or not.

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34. Having clarified the aforesaid position, the first and foremostissue that falls for consideration is as to whether the dominant purposetest, which is pressed into service by the assessees would apply whileinterpreting Section 14A of the Act or we have to go by the theory ofapportionment. We are of the opinion that the dominant purpose forGwhich the investment into shares is made by an assessee may not berelevant. No doubt, the assessee like Maxopp Investment Limited mayhave made the investment in order to gain control of the investee company.However, that does not appear to be a relevant factor in determining theissue at hand. Fact remains that such dividend income is non-taxable. Inthis scenario, if expenditure is incurred on earning the dividend income, H

that much of the expenditure which is attributable to the dividend incomehas to be disallowed and cannot be treated as business expenditure.Keeping this objective behind Section14A of the Act in mind, the saidprovision has to be interpreted, particularly, the word ‘in relation to theincome’ that does not form part of total income. Considered in this hue,the principle of apportionment of expenses comes into play as that is theprinciple which is engrained in Section 14A of the Act. This is so held inWalfort Share and Stock Brokers P Ltd., relevant passage whereof isalready reproduced above, for the sake of continuity of discussion, wewould like to quote the following few lines therefrom.

“The next phrase is, “in relation to income which does notform part of total income under the Act”. It means that if anincome does not form part of total income, then the relatedexpenditure is outside the ambit of the applicability of section14A..

xxxxxxxxxThe theory of apportionment of expenditure between taxableand non-taxable has, in principle, been now widened undersection 14 A.”

35. The Delhi High Court, therefore, correctly observed that priorto introduction of Section 14A of the Act, the law was that when anassessee had a composite and indivisible business which had elementsof both taxable and non-taxable income, the entire expenditure in respectof said business was deductible and, in such a case, the principle ofapportionment of the expenditure relating to the non-taxable income didnot apply. The principle of apportionment was made available only wherethe business was divisible. It is to find a cure to the aforesaid problemthat the Legislature has not only inserted Section 14A by the Finance(Amendment) Act, 2001 but also made it retrospective, i.e., 1962 whenthe Income Tax Act itself came into force. The aforesaid intent wasexpressed loudly and clearly in the Memorandum explaining the provisionsof the Finance Bill, 2001. We, thus, agree with the view taken by theDelhi High Court, and are not inclined to accept the opinion of Punjab &Haryana High Court which went by dominant purpose theory. Theaforesaid reasoning would be applicable in cases where shares are heldas investment in the investee company, may be for the purpose of havingcontrolling interest therein. On that reasoning, appeals of Maxopp AB

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AInvestment Limited as well as similar cases where shares were purchasedby the assessees to have controlling interest in the investee companieshave to fail and are, therefore, dismissed.

36. There is yet another aspect which still needs to be looked into.What happens when the shares are held as ‘stock-in-trade’ and not asB‘investment’, particularly, by the banks? On this specific aspect, CBDThas issued circular No. 18/2015 dated November 02, 2015.

37. This Circular has already been reproduced in Para 19 above.This Circular takes note of the judgment of this Court in Nawanshaharcase wherein it is held that investments made by a banking concern areCpart of the business or banking. Therefore, the income arises from suchinvestments is attributable to business of banking falling under the head‘profits and gains of business and profession’. On that basis, the Circularcontains the decision of the Board that no appeal would be filed on thisground by the officers of the Department and if the appeals are alreadyfiled, they should be withdrawn. A reading of this circular would makeDit clear that the issue was as to whether income by way of interest onsecurities shall be chargeable to income tax under the head ‘incomefrom other sources’ or it is to fall under the head ‘profits and gains ofbusiness and profession’. The Board, going by the decision of this Courtin Nawanshahar case, clarified that it has to be treated as income fallingEunder the head ‘profits and gains of business and profession’. The Boardalso went to the extent of saying that this would not be limited only to co-operative societies/Banks claiming deduction under Section 80P(2)(a)(i)of the Act but would also be applicable to all banks/commercial banks,to which Banking Regulation Act, 1949 applies.

F38. From this, Punjab and Haryana High Court pointed out thatthis circular carves out a distinction between ‘stock-in-trade’ and‘investment’ and provides that if the motive behind purchase and sale ofshares is to earn profit, then the same would be treated as trading profitand if the object is to derive income by way of dividend then the profitwould be said to have accrued from investment. To this extent, the HighGCourt may be correct. At the same time, we do not agree with the testof dominant intention applied by the Punjab and Haryana High Court,which we have already discarded. In that event, the question is as to onwhat basis those cases are to be decided where the shares of othercompanies are purchased by the assessees as ‘stock-in-trade’ and notHas ‘investment’. We proceed to discuss this aspect hereinafter.

39. In those cases, where shares are held as stock-in-trade, themain purpose is to trade in those shares and earn profits therefrom.However, we are not concerned with those profits which would naturallybe treated as ‘income’ under the head ‘profits and gains from businessand profession’. What happens is that, in the process, when the sharesare held as ‘stock-in-trade’, certain dividend is also earned, thoughincidentally, 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 totalincome and is exempt from tax. This triggers the applicability of Section14A of the Act which is based on the theory of apportionment ofexpenditure between taxable and non-taxable income as held in WalfortShare and Stock Brokers P Ltd. case. Therefore, to that extent,depending upon the facts of each case, the expenditure incurred inacquiring those shares will have to be apportioned.

40. We note from the facts in the State Bank of Patiala cases thatthe AO, while passing the assessment order, had already restricted thedisallowance to the amount which was claimed as exempt income byapplying the formula contained in Rule 8D of the Rules and holding thatsection 14A of the Act would be applicable. In spite of this exercise ofapportionment of expenditure carried out by the AO, CIT(A) disallowedthe entire deduction of expenditure. That view of the CIT(A) was clearlyuntenable and rightly set aside by the ITAT. Therefore, on facts, thePunjab and Haryana High Court has arrived at a correct conclusion byaffirming the view of the ITAT, though we are not subscribing to thetheory of dominant intention applied by the High Court. It is to be keptin mind that in those cases where shares are held as ‘stock-in-trade’, itbecomes a business activity of the assessee to deal in those shares as abusiness proposition. Whether dividend is earned or not becomesimmaterial. In fact, it would be a quirk of fate that when the investeecompany declared dividend, those shares are held by the assessee, thoughthe assessee has to ultimately trade those shares by selling them to earnprofits. The situation here is, therefore, different from the case likeMaxopp Investment Ltd. where the assessee would continue to holdthose shares as it wants to retain control over the investee company. Inthat case, whenever dividend is declared by the investee company thatwould necessarily be earned by the assessee and the assessee alone.Therefore, even at the time of investing into those shares, the assesseeknows that it may generate dividend income as well and as and when AB

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Asuch 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 benecessarily a situation. The main purpose is to liquidate those shareswhenever the share price goes up in order to earn profits. In the result,the appeals filed by the Revenue challenging the judgment of the Punjaband Haryana High Court in State Bank of Patiala also fail, though law inBthis respect has been clarified hereinabove.

41. Having regard to the language of Section 14A(2) of the Act,read with Rule 8D of the Rules, we also make it clear that before applyingthe theory of apportionment, the AO needs to record satisfaction thathaving regard to the kind of the assessee, suo moto disallowance underCSection 14A was not correct. It will be in those cases where the assesseein his return has himself apportioned but the AO was not accepting thesaid apportionment. In that eventuality, it will have to record its satisfactionto this effect. Further, while recording such a satisfaction, nature ofloan taken by the assessee for purchasing the shares/making theDinvestment in shares is to be examined by the AO.

42. Civil Appeal No. 1423 of 2015 is filed by M/s. Avon CyclesLimited, Ludhiana, wherein the AO had invoked section 14A of the Actread with Rule 8D of the Rules and apportioned the expenditure. TheCIT(A) had set aside the disallowance, which view was upturned by theEITAT in the following words:

“...Admittedly the assessee had paid total interest of Rs.2.92 croresout of which interest paid on term loan raised for specific purposetotals to Rs.1.70 crores and balance interest paid by the assesseeis Rs.1.21 crores. The funds utilized by the assessee being mixedFfunds and in view of the provisions of Rule 8D(2)(ii) of the IncomeTax Rules the disallowance is confirmed at Rs.10,49,851/-, wefind no merit in the ad hoc disallowance made by the CIT (Appeals)at Rs.5,00,000/-. Consequently, ground of appeal raised by theRevenue is partly allowed and ground raised by the assessee incross-objection is allowed...”

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Taking note of the aforesaid finding of fact, the High Court hasdismissed the appeal of the assessee observing as under:

“In the present case, after examining the balance-sheet of theassessee, a finding of fact has been recorded that the funds utilized H

by the assessee being mixed funds, therefore, the interest paid bythe assessee is also an interest on the investments made. Suchbeing a finding of fact, we do not find that any substantial questionof law arises for consideration of this Court.”

A

After going through the records and applying the principle ofapportionment, which is held to be applicable in such cases, we do notfind any merit in Civil Appeal No. 1423 of 2015, which is accordinglydismissed.

B

43. Few appeals are filed by the Revenue against the assesseeswhich pertained to the period prior to the introduction of Rule 8D of theRules. Here, the case is decided in favour of the assessees also on theground that Rule 8D of the Rules is prospective in nature and could nothave been made applicable in respect of the Assessment Years prior to2007 when this Rule was inserted. This view has already been upheldby this Court in Civil Appeal No. 2165 of 2012 (Commissioner of IncomeTax, Mumbai v. M/s. Essar Teleholdings Ltd. through its Manager),pronounced on January 31, 2018, that the said Rule is prospective innature. On this ground alone, these appeals of the Revenue fail as it isnot necessary to go into the other issues.

C

D

44. To sum up:

(a) Appeals of the assessees, i.e. Civil Appeal Nos. 104-109, 110-112, 130, 1423 of 2015, are dismissed.

E

(b) Appeals of the Revenue, i.e. Civil Appeal Nos. 3267, 19614,10096 of 2013, 8596 of 2014, 18019 of 2017, 115, 123, 6590 of2015, Civil Appeals arising out of SLP (C) Nos. 27054, 31417of 2016, 20475, 23123, 32405 of 2017, Diary Nos. 36413, 39820,F39823, 41890, 41903, 41922 of 2017 and 1146 of 2018 aredismissed.

(c) Appeal of the Revenue, i.e. Civil Appeal arising out of DiaryNo. 41203 of 2017, is allowed.

G

Kalpana K. Tripathy

Appeals disposed of.

H