|CORAM:||N. K. Choudhry (JM), Sanjay Arora (AM)|
|SECTION(S):||14A, Rule 8D|
|CATCH WORDS:||Disallowance u/s 14A & Rule 8D|
|DATE:||April 12, 2018 (Date of pronouncement)|
|DATE:||May 10, 2018 (Date of publication)|
|FILE:||Click here to download the file in pdf format|
Disallowance u/s 14A & Rule 8D has to be made even if the assessee has not earned any tax-free income on the investment. Cheminvest 378 ITR 33 (Del) is not binding on the AO as it is a non-jurisdictional High Court. CBDT's Circular 5/2014 is in accordance with Godrej & Boyce Mfg. Co. Ltd 394 ITR 449 (SC) & Maxopp Investment Ltd 402 ITR 640 (SC)
4.2 The second, equally relevant, aspect of the matter is if the provision could be invoked in the absence of any tax-exempt income. Toward this, while the ld. Pr.CIT relies on the Board Circular 5/2014, the ld. Authorized Representative (AR), the assessee’s counsel, was during hearing at pains to emphasize that the same stands since ‘torn apart’ by the Hon’ble High Courts (Cheminvest Ltd. in ITA No. 794/2014, dated 02/9/2015), so that it is bereft of any value. On being asked if the same had been set aside or stayed by any High Court, he would though admit of it being not the case. The question is not which of the two is correct (view) or more correct, but if same is binding on the A.O. as an assessing authority. The reason is simple. The A.O., despite an order by the revisionary authority directing him to do so, cannot pass an order consistent with the Board Circular where the same has been struck down by a competent court, unless, of course, the same stands, at the same time, upheld by the Hon’ble jurisdictional High Court. In fact, even a decision by the said Court (or by the Hon’ble Apex Court) contrary to the dictum of the said Circular, i.e., without it being stayed or struck down by any court, shall have same effect, so that the said Circular would in that case loose its binding force on the AO. Further, a decision by a non-jurisdictional High Court shall not have the same affect in-as-much as the same is not binding on the AO (refer: Suresh Desai & Ass. v. CIT  230 ITR 912 (Del); Geoffery Manners & Co. Ltd. v. CIT  221 ITR 695 (Bom); CIT v. Thane Electricity Supply Ltd.  206 ITR 797 (Bom); Patil Vijayakumar v. Union of India  151 ITR 48 (Kar)). No such decision by either the Hon’ble jurisdictional High Court or the Hon’ble Apex Court has been brought to our notice.
The moot question therefore is if the said Circular is in conformity with the law. Section 14A, immediately succeeds section 14 – the first section of Chapter IV of the Act, enumerating the heads of income under which all income, subject to the other provisions of the Act, is to be classified for the purpose of computation of total income, introduced by Finance Act, 2001 w.r.e.f. 01.04.1962 (since renumbered as 14A (1)), reads as under:
‘Expenditure incurred in relation to income not includible in total income
14A.(1) For the purposes of computing the total income under this Chapter, no deduction shall be allowed in respect of expenditure incurred by the assessee in relation to income which does not form part of the total income under this Act.’ [emphasis, supplied]_
The issue is if section 14A(1) would stand attracted even if such income, i.e., income not includible in the total income, is not actually earned, of course, subject to expenditure relatable to such income having been incurred. The Circular 5/2014, after explaining the rationale of the provision of section 14A (with reference to Circular 14 of 2001), i.e., to curb the practice of reducing the tax liability on taxable income (i.e., income forming part of the total income) by claiming expenditure incurred in earning tax-exempt income against taxable income, goes on to state that the legislative intent is that the expenditure relatable to earning such income shall have to be considered for disallowance. Surely, in that event i.e., expenditure relating to earning tax-exempt income having been incurred, it would become irrelevant if the exempt income has actually materialized or not, so that the disallowance of the said expenditure u/s. 14A would ensue. The same therefore is only a continuation of Circular 14 of 2001, taking the premise of section 14A to its logical conclusion. And which is to apply the basic principle of taxation, i.e., that it is only the net income – taxable or non-taxable, i.e., net of all expenditure incurred for earning the same, that could be subject to tax or, as the case may be, exempt from tax. The latter Circular, which is again in consonance with the Memorandum explaining the provisions of Finance Bill, 2001 (introducing section 14A) as well as the Notes to the Clauses presented along with the said Bill, has been noted with approval by the Hon’ble Apex Court in CIT v. Walfort Share & Stock Brokers P. Ltd.  326 ITR 1 (SC), holding as under: (pgs. 15-16)
‘The insertion of section 14A with retrospective effect is the serious attempt on the part of Parliament not to allow deduction in respect of any expenditure incurred by the assessee in relation to income, which does not form part of the total income under the Act against the taxable income (see Circular No. 14 of 2001 dated November 22, 2001). In other words, section 14A clarifies that expenses incurred can be allowed only to the extent 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 exemption of exempt income without making any apportionment of expenses incurred in relation to exempt income. The basic reason for insertion of section 14A is that certain incomes are not includible while computing total income as these are exempt under certain provisions of the Act.’
The issue, thus, considered in perspective, is not if the income not forming the part of the total income (the tax-exempt income) is earned or not, but if expenditure relatable to such income has been incurred. If such expenditure stands incurred, section 14A(1) becomes applicable. With regard to the scope of the relatable expenditure, the Apex Court clarified the same with reference to any expenditure enumerated in sections 15 to 59 (para 17, pgs. 16-17 of the Reports). The question is simple. If taxable income (i.e., income forming part of the total income) is to be added at net of relatable expenditure, how could it be otherwise for the tax-exempt income? Rather, if not so considered, not only would it violate the basic principle of taxation, it would defeat the very purpose of section 14A, as expenditure relatable to tax-exempt income, where not earned, would get charged against taxable income. The actual earning of income – taxable or not taxable, as is apparent, and as we shall presently see, is irrelevant for the admissibility of such expenditure against the relevant income.
The afore-referred decision by the Apex Court stands followed and explained at length in_Godrej & Boyce Mfg. Co. Ltd. v. Dy. CIT  328 ITR 81 (Bom), culling out the principles laid down therein, as under: (para 31, pgs. 98-99)_
‘31. The following principles would emerge from s. 14A and the decision in Walfort (supra):
(a) The mandate of s. 14A is to prevent claims for deduction of expenditure in relation to income which does not form part of the total income of the assessee;
(b) Sec. 14A(1) is enacted to ensure that only expenses incurred in respect of earning taxable income are allowed;
(c) The principle of apportionment of expenses is widened by s. 14A to include even the apportionment of expenditure between taxable and non-taxable income of an indivisible business;
(d) The basic principle of taxation is to tax net income. This principle applies even for the purposes of s. 14A and expenses towards non-taxable income must be excluded;
(e) Once a proximate cause for disallowance is established – which is the relationship of the expenditure with income which does not form part of the total income – a disallowance has to be effected. All expenditure incurred in relation to income which does not form part of the total income under the provisions of the Act has to be disallowed under s. 14A. Income which does not form part of the total income is broadly adverted to as exempt income as an abbreviated appellation.’ (emphasis, ours)
Continuing further, with specific reference to the apportionment of expenditure in relation to the income not forming part of the total income, it would be relevant to reproduce from the extracted part of the decision in Walfort Share & Stock Brokers P. Ltd. (supra), as under, to which decision abundant reference stands made by the Hon’ble Court: (para 51, pgs. 106-107)
‘51. We have also been fortified in the conclusion which we have drawn, by the judgment of the Supreme Court in Walfort (supra). The Supreme Court has in the following observation expressly held that since dividend income does not form part of the total income, the expenditure that is incurred in the earning of such income cannot be allowed even though it is of a nature specified in ss. 15 to 59 :
"If an income like dividend income is not a part of the total income, the expenditure/deduction though of the nature specified in ss. 15 to 59 but related to the income not forming part of the total income could not be allowed against other income includible in the total income for the purpose of chargeability to tax."
Having observed thus, the Supreme Court held that the theory apportioning expenditure between taxable and non-taxable income has now, in principle, been widened under s. 14A. Hence, for the reasons that we have indicated earlier, we hold that income from dividend on shares is, in the hands of the recipient shareholder, income which does not form part of the total income. Hence, s. 14A would apply and the expenditure incurred in earning such income would have to be disallowed. Income from mutual fund stands on the same footing.’ (emphasis, ours)
Continuing our discussion, how, one may ask, could the expenditure incurred in earning tax-exempt income stand altered, either in nature or in quantum, depending on the quantum of the tax-exempt income, which could therefore be nil. The expenditure is incurred to produce or generate or in anticipation of, income, whether taxable or non-taxable. In fact, the classification as to tax status (i.e., taxable or non-taxable) has nothing to do with the income generating process; an income being, as a matter of fiscal incentive, being granted tax-exempt status, viz. agricultural income, under the Act, for the time being.
An income exempt as per the extant law may not be so earlier or in fact even in future; the law witnessing a variation in this respect from time to time. The quantum of income that may arise is however, largely, uncertain, and which may be higher or lower (including nil) than the volume of the expenditure incurred. It is the latter case which results in the phenomenon of ‘loss’, which could thus be across both the categories of income, i.e., tax-exempt and taxable. The fact of the having incurred expenditure for earning income – tax-exempt (or non-exempt), which is largely a question of fact, would thus remain, and not undergo any change, irrespective of whether it has resulted in any income (of either genre), or in a sum lower than the expenditure incurred toward the same. The principle is well-settled, representing a fundamental concept of taxation, i.e., the allowability (or otherwise) of an expenditure would not depend upon whether it has in fact resulted in an income, i.e., positive income, which is in any case a matter subsequent, and that the mere fact that expenditure stands incurred for the purpose is sufficient for its admissibility, explained by the Apex Court in CIT v. Rajendra Prasad Mody  115 ITR 519 (SC). The Apex Court was in that case examining the true interpretation of section 57(iii), which employed the words_ ‘any expenditure (not being in the nature of capital expenditure) laid out or expended for the purpose of making or earning such income’, the question of law raised before it reading as under:
“Whether, on the facts and in the circumstances of the case, interest on money borrowed for investment in shares which had not yielded any dividend is admissible under s. 57(iii)?”
The Revenue’s contention was that the words of s. 57(iii) being narrower, contrasting them with the language of section 37(1), which allowed any expenditure laid out or expended wholly and exclusively for the purpose of business or profession in computing business income, the making or earning of income was a sine qua non to the admissibility of the expenditure u/s. 57(iii). And, therefore, where no income resulted, no expenditure would be deductible. The Apex Court, after a review of the judicial precedents, which it cited with abundance, also reproducing there-from, rejected the Revenue’s contention, stating that the plain and natural construction of the language of s. 57(iii) irresistibly leads to the conclusion that to bring a case within the section, it is not necessary that any income should in fact have been earned as a result of the expenditure (pg. 522 of the Reports).
Any other interpretation, to our mind, would not meet the test of equity and be liable to be regarded as arbitrary. The Apex Court in fact pointed out to the oddity of the situation arising out of the Revenue’s argument, giving an example (at page 522-523 of the Reports) where an expenditure of Rs.1,000/- (say) would not be deductible if no income was earned, while would get allowed even if Re. 1 was earned, resulting in a loss of Rs.999 under the head “Income from other sources”. This is also – inasmuch as the expenditure has not resulted in any dividend income, the assessee’s argument or claim in the instant case and, thus, liable to be ousted with equal force, even as the words employed in section 57(iii) – which in any case had to be heeded to, were indeed narrower than the scope of the words employed in section 14A, and which have been interpreted by the Hon’ble Courts as implying any expenditure, direct or indirect, which has a proximate nexus with or is attributable to the income under reference. Going by the example of the present case, if interest expenditure is incurred for acquiring and holding the shares, it would be so – a matter of fact, and it would matter little whether dividend income, or in whatever sum, stands earned. If it stands incurred, it is so, even if and irrespective that no dividend thereon has been declared and, thus, earned. This may be despite the relevant company having earned adequate profits to be able to declare dividend, being essentially a matter of business policy and prerogative of the Management. Expenditure by way of interest has, in either case, i.e., the dividend being declared or not, been incurred in earning that income, that is, in relation to that income and, therefore, would require being determined and excluded, being in relation to income not forming a part of the total income.
As afore-noted, this aspect stands amply explained in Rajendra Prasad Mody (supra), pointing to the oddity that arises when expenditure is recognized only when it produces a positive gross income. One may pause here to note that interest shall fall either u/s. 36(1)(iii) or u/s. 57(iii), i.e., fall within sections 15 to 59, where the income under reference (viz. dividend income) was to be considered as otherwise assessable as either ‘business income’ or as ‘income from other sources’.
The principle informing the legislation of section 14A, or its insertion on the statute-book, which the Circulars by the Board have sought to explain and impress upon, stands upheld by the Hon’ble Apex Court as well as by the Hon’ble Courts, explaining and following its’ decision, also upholding the constitutionality of r. 8D, prescribing the method and procedure for apportionment of expenses. The principle, i.e., of only the net income being liable to tax and, therefore, the income which is not liable to tax – is well-settled, and in fact basic to the taxing statutes for the taxing of income, and does not admit of two views. This also explains it being made applicable w.r.e.f. 01/4/1962, i.e., from the date the Act itself comes into effect. Section 14A, as may now be clear, is toward providing the legislative framework for operationalizing the said principle by way of apportionment of the relevant expenditure, i.e., between taxable or non-taxable income/s, which assumes particular significance where incurred for an undivisible business. Why, direct expenditure in relation to tax-exempt income, as agriculture income (say), would get excluded for being allowed as deduction in computing taxable income even in the absence of section 14A, i.e., on the basis of principle of net income, i.e., net of expenditure incurred in relation to such income, as liable to tax (or to be excluded in computing the taxable income), as explained by the Tribunal in per its decision in ITO v. Daga Capital Management Pvt. Ltd.  312 ITR (AT) 1 (Mum) (SB); Damani Estates & Finance (P.) Ltd.  25 ITR (Trib) 683 (Mum); D. H. Securities (P.) Ltd. v. Dy. CIT  31 ITR (Trib) 381 (Mum), to cite some.
How could, one may ask, the agriculture expenditure incurred for agricultural activity, be claimed or allowed against taxable (as, say, business) income. This is as there is no question of apportionment of such expenditure, which arises only in the case of indirect expenditure, which could be either interest or any other, viz. administrative expenditure.
Reference in this regard may finally be made to the recent decision by the Hon’ble Apex Court in Maxopp Investment Ltd. & Ors. v. CIT (in CA Nos. 104- 109 of 2015, dated February 12, 2018 / copy on record). For our purposes, para 3 of the Judgment is of prime relevance, and which we reproduce as under:
‘3. Though, it is clear from the plain language of the aforesaid provision that no deduction is to be allowed in respect of expenditure incurred by the assessee in relation to income which does not form part of the total income under the Act, the effect whereof is that if certain income is earned which is not to be included while computing total income, any expenditure incurred to earn that income is also not allowed as a deduction. It is well known that tax is leviable on the net income. Net income is arrived at after deducting the expenditure incurred in earning that income. Therefore, from the gross income, expenditure incurred to earn that income is allowed as a deduction and thereafter tax is levied on the net income.
The purpose behind Section 14A of the Act, by not permitting deduction of the expenditure incurred in relation to income, which does not form part of total income, is to ensure that the assessee does not get double benefit. Once a particular income itself is not to be included in the total income and is exempted from tax, there is no reasonable basis for giving benefit of deduction of the expenditure incurred in earning such an income. For example, income in the form of dividend earned on shares held in a company is not taxable. If a person takes interest bearing loan from the Bank and invests that loan in shares/stocks, dividend earned therefrom is not taxable. Normally, interest paid on the loan would be expenditure incurred for earning dividend income. Such an interest would not be allowed as deduction as it is an expenditure incurred in relation to dividend income which itself is spared from tax net. There is no quarrel upto this extent.’ (emphasis, ours)
The principle behind section 14A and its applicability, and toward which the Hon’ble Court cites an example – which is the same as that obtains in the present case, is so well established that the Apex Court itself finds the same as settled and not disputed. The applicability of sec. 14A does not hinge on the actual earning of the tax-exempt income. Reference for the purpose may be made to the majority of view in Daga Capital Management Pvt. Ltd. (supra) (at para 8 of the Judgment), noted with the approval by Hon’ble Apex Court, as well as the arguments made before the Hon’ble High Court, pleading that the actual earning of dividend income was immaterial in-as-much as the relatable expenditure would remain the same (at para 30 of the Judgment), and which the Hon’ble Court found as so, noting that it would be earned by a quirk of fate where shares are held as ‘stock-in-trade’, while would stand to be earned whenever dividend is declared on shares held as investment – as in the present case, as in either case, section 14A gets attracted (para 40). The dispute in that case was with regard to the scope of the words ‘in relation thereto’ occurring in section 14A(1) as well as the relevance of the object for which the investment yielding (or liable to yield) tax-exempt income is made, on which there was variance between different High Courts. The words ‘in relation thereto’ were clarified to be accorded an expansive meaning so as to sub-serve the legislative intent behind sec. 14A, and the theory of predominant object had no place in the scheme of s. 14A.
5. In sum The principle that it is the net income, i.e., net of expenditure relatable thereto, which is subject to tax and, correspondingly, not liable to tax, i.e., where it does not form part of the total income, is well established. Equally well settled is the principle that once an income is liable (or not liable) to tax, all expenditure relatable thereto is to be reckoned, and it matters little that the said expenditure has indeed resulted in a positive income, or in whatever sum. It is in fact this, i.e., the expenditure being higher than the gross income, which could be nil, that leads to the phenomenon of loss, which could therefore be across both the categories income, i.e., taxable or non-taxable, being essentially a matter of fact.
The interpretation of the words ‘for earning such income’ stands already settled by the Apex Court in Rajendra Prasad Mody (supra). To therefore recognize relatable expenditure where it fructifies in a positive income is misconceived. It is, it may be appreciated, the quality of the expenditure that determines its deductibility and not its quantum or effect, i.e., where it stands incurred for the stated purpose. Given the premise of section 14A, i.e., to exclude income not forming part of the total income in computing the ‘total income’, with a view to determine the latter correctly, and the two principles afore-referred, the proposition under reference, i.e., to exclude all expenditure relatable to the earning of income not forming part of the total income, irrespective of its quantum, becomes axiomatic, even as noted by the Hon’ble Apex Court in Maxopp Investment Ltd. (supra). Para 32 thereof reads as under:
‘32. In the first instance, it needs to be recognized that as per section 14A(1) of the 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 (not) 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. To put it differently, such expenditure would then be considered as incurred in respect of other income which is to be treated as part of the total income.’
Where, one wonders, then, is the scope for two views. Relying extensively on its decision in Walfort Share & Stock Brokers P. Ltd. (supra), the Apex Court upheld the theory of apportionment, discountenancing the theory of predominant object.
The uncertainty of earning the dividend income, or of it being earned incidentally, was also noted by it, though to no moment. It was immaterial if dividend income was actually earned or not, which, rather, may be a consideration where the shares, as in the present case, are held to retain control over the investee company, i.e., for strategic reasons, as was the case with regard to the investment by Maxopp Investment Ltd. – one of the assessees in that case. The related expenditure has to be reckoned on an expansive basis, i.e., as attributable thereto. The constitutionality of r.8D, providing for rules of apportionment of both direct and indirect expenditure, stands already upheld by the Hon’ble High Court in Godrej & Boyce Mfg. Co. Ltd. (supra). Earlier, in Godrej & Boyce Mfg. Co. Ltd. v. Dy. CIT  394 ITR 449 (SC), with reference to the language of section 14A, the title of which is itself clarificatory, the Apex Court clarified that income must not be includible in the total income, so that once this condition is satisfied, the expenditure incurred in earning the same cannot be allowed to be deducted. The AO in the present case has clearly failed to apply the law in the matter, which gets reiterated time and again by the Hon’ble Apex Court.
6. In view of the foregoing, we find no merit in the assessee’s case. We, accordingly, uphold the impugned order, both on the aspect of lack of inquiry by the assessing authority, as well as his non-observance of the Board Circular 5/2014, which we have found to be in consonance with the law as explained by the Apex Court. The impugned order being after the date of amendment (by way of Explanation 2) to section 263, i.e., 01.06.2015, the same is an equally valid ground for the exercise of revisionary power u/s. 263. It is this power, i.e., to deem an order as erroneous in-so-for as it is prejudicial to the interests of the Revenue, that stands conferred w.e.f. 01.06.2015. That is, the law, w.e.f. 01.06.2015, deems an order as so, where any of the circumstances specified is, in the opinion of the competent authority, satisfied. It has nothing to do with the date of the passing of the order deemed erroneous, or the year to which it pertains. Being a part of the procedural law, the provision shall have effect from 01/06/2015 (also refer CWT v. Sharvan Kumar Swarup & Sons  210 ITR 886 (SC)). Rather, as we find on a perusal of the cited decisions by the Apex Court settling the law in the matter, the assessment does not represent a correct application of the law, furnishing one more ground, albeit pari materia, for the assessment being liable for revision u/s. 263. We decide accordingly.