Where the Special Bench had to consider whether s. 14A applied with respect to dividend earned by an assessee trading in shares and holding shares as stock-in-trade, HELD:

By the Bench:

(i) S. 14A has an overriding effect and applies to all expenditure in relation to exempt income even though such expenditure would have been allowable under other provisions such as 36 (1) (iii);

(ii) Sub-sections (2) and (3) of s. 14A, though inserted by the F. A. 2006 w.e.f. 1.4.2007, read with Rule 8D, are procedural and clarificatory in nature and apply to pending matters;

By the Majority:

(iii) The words “in relation to” in s. 14A encompass not only the direct expense but also the indirect expense which has any relation to the exempt income. The argument that the words contemplate a “direct and immediate connection” between the expenditure and the exempt income cannot be accepted. Accordingly, the argument that s. 14A cannot apply to shares held as stock-in-trade cannot be accepted. The fact that the dividend income is “incidental” to the purchase of shares is also irrelevant. The question as to whether the onus is on the assessee or the AO for bringing an item of expenditure within s. 14A is also irrelevant in view of Rule 8D;

By the VP, dissenting:

(iv) The words “in relation to” in s. 14A mean a “dominant and immediate connection” between the expenditure and the exempt income. To determine whether there is such a connection, one has to see the object with which the expenditure is incurred. If the expenditure is incurred mainly to earn taxable income and the tax-free income is incidental, there is no such connection and s. 14A does not apply. The onus is on the AO to establish that there is a “dominant and immediate connection” between the expenditure and the exempt income;

(v) In the case of a dealer in shares, the dominant object of acquiring shares is not to earn dividend and consequently s. 14A does not apply.