Facts

There were certain batch of appeals which were before the Supreme Court. The Delhi High court in case of Maxopp Investment Ltd. was against the assessee hence Assessee had filed appeals before Supreme Court. However, Punjab and Haryana High Court in case of Pr. CIT v.  State Bank  of  Patiala  [2017] 391 ITR 218 (Punj. & Har.)(HC) had taken a view contrary to view taken by the Delhi High Court. The Punjab and Haryana High Court followed, with approval,  the judgment of the High Court of Karnataka in CCI Ltd. v.  Jt. CIT [2012]  206 Taxman 563 (Karn) (HC). The Revenue had filed appeals in such cases challenging the correctness of said decisions.

Facts of Delhi High Court decision Maxopp Investment Ltd.:

The company was engaged, inter alia, in the business of finance, investment and dealing in shares and securities. The Assessee held shares/ securities in two portfolios, viz. (a) as investment on capital account; and,

(b) as trading assets for the purpose of acquiring and retaining control  over investee group companies, particularly Max India Ltd., a widely held quoted public limited company. Any profit/loss arising on sale of shares/ securities held as ‘investment’ was returned as income under the head ‘capital gains’, whereas profit/loss arising on sale of shares/securities held  as ‘trading assets’ (i.e. held, inter alia, with the intention of acquiring, exercising and retaining control over investee groupcompanies) has been regularly offered and assessed to tax as business income under the head ‘profits and gains of business or profession’. Consistent with the aforesaid treatment regularly followed, the Assessee filed return for the previous year relevant to the Assessment Year  2002-03, declaring income  of Rs.78,90,430/-. No part of the interest expenditure of Rs.1,16,21,168/- debited to the profit and loss account, to the extent  relatable  to investment in shares of Max India Limited, yielding tax free dividend income, was considered disallowable under Section 14A of the Act on the ground that shares in the said company were acquired for the purposes of retaining controlling interest and not with the motive of earningdividend.

 

 

According to the Assessee, the dominant purpose/intention of investment  in shares of Max India Ltd. was acquiring/retaining controlling interest therein and not earning dividend and, therefore, dividend of Rs.49,90,860/- earned on shares of Max IndiaLtd. during the relevant previous year  was only incidental to the holding of such shares. The Assessing Officer (AO), while passing the assessment order, under Section 143(3) worked   out disallowance under Section 14A of the Act at Rs.67,74,175/- by apportioning the interest expenditure of Rs.1,16,21,168/- in the ratio of investment in shares of Max India Ltd. (on which dividend was received)  to the total amount of unsecured loan. The AO, however, restricted disallowance under that Section to Rs.49,90,860/- being the amount of dividend received and claimed exempt.

In appeal, the CIT(A) upheld the order of the AO. Assessee herein carried the matter in further appeal to the ITAT. In view of the conflicting decisions of various Benches by the ITAT  with respect to the interpretation  of Section 14A of the Act, a Special Bench was constituted in the matter    of ITO v. Daga Capital Management (P.) Ltd. [2009] 117 ITD 169 (SB) (Mum.)(Trib). The appeal of the Assessee company was also tagged and heard by the aforesaid Special Bench.

The Special Bench of the ITAT  in the case of Daga Capital Management   (P.) Ltd. (supra), dismissing the appeal of the Assessee, inter alia, held  that investment in shares representing controlling interest did not amount to carrying on of business and, therefore, interest expenditure  incurred for acquiring shares in group companies was hit by the provisions of Section 14A of the Act. The Special Bench further held that holding of shares with the intention of acquiring/retaining controlling interest would normally be on capital account, i.e. as investment and not as ‘trading assets’. For that reason too, the Special Bench held that there existed dominant connection between interest paid on loan utilized for acquiring the aforesaid shares and earning of dividend income. Consequently, the provisions of Section 14A of the Act were  held  to be attracted on the facts of the case.

Against the aforesaid order of the Special Bench, Assessee preferred appeal  to the High Court. The Delhi High Court held that the expression ‘in relation to’ appearing in Section 14A of the 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, proportionate disallowance of the expenditure incurred by the assessee was maintained.

Taking note of certain judgments, the  High  Court  observed that  prior to the insertion of Section 14A in the Act, thelaw was that when an

 

 

assessee had a composite and indivisible business, which had elements     of both taxable and non-taxable income, the entire expenditure in respect  of the said business was  deductible and, in such a  case, the  principle  of apportionment of the expenditure relating to the non-taxable income   did not apply. However, where the business was divisible, the principle     of apportionment of the expenditure was applicable and the expenditure apportioned to the ‘exempt’ income or income notexigible to  tax, was  not allowable as a deduction. The High Court, then, took cognizance of    the legislative intent and objective behind the insertion of Section 14A  and disagreed with the propositions advanced by the Assessee, that if the dominant and main objective of spending was not the earning of ‘exempt’ income then, the expenditure could not be disallowed under section 14A. Likewise, explaining the meaning of ‘expenditure incurred’, the High Court agreed that this expression would mean incurring of actual expenditure  and not to some imagined expenditure. At  the same time, observed  the High Court, the ‘actual’ expenditure that is in contemplation under section 14A(1) of the said Act  was the ‘actual’ expenditure  in relation to or  in connection with or pertaining to exempt income. The corollary to this    is that if no expenditure is incurred in relation to the exempt income, no disallowance can be made under section 14A of the said Act.

Facts of Punjab and Haryana High Court decision in case of State Bank of Patiala:

In this case exempt income in the form of dividend was earned by the Bank from securities held by it as its  stock in  trade. The  assessee filed its return declaring an income of about Rs.670 crores which was selected for scrutiny. The return showed dividend income exempt under section 10(34) and (35) of about Rs.11.07 crores and net interest income exempt under section 10(15)(iv) (h) of about Rs.1.12 crores. The total exempt income claimed in the return was, therefore, Rs.12,19,78,015/-.The assessee while claiming the exemption contended that the investment in shares, bonds, etc. constituted its stock-in-trade; that the investment had not been made only for earning tax free income; that the tax free income was only incidental to the assessee’s main business of sale and purchase    of securities and, therefore, no expenditure had been incurred for earning such exempt income; the expenditure would have remained the same even    if no dividend or interest income had been earned by the assessee from    the said securities and that no expenditure on proportionate basis could    be allocated against exempt income. The assessee also contended that in any event it had acquired the securities from its own funds and, therefore, section 14A was not applicable. The AO restricted the disallowance to the amount which was claimed as exempt income by applying the formula contained in Rule 8D holding that Section 14A would be applicable.

 

 

The CIT(A) issued notice of enhancement under Section 251 of the Act   and held that in view of Section 14A of the Act, the assessee was not to     be allowed any deduction in respect of income which is not chargeable      to tax. Therefore, he disallowed the entire expenditure claimed instead of restricting the disallowance to the amount which was claimed as exempt income as done by the AO.

The ITAT  set aside the order of the AO as well as CIT(A). It referred to        a CBDT Circular No.18/2015 dated 02.11.2015 which states that income arising from investment of a banking concern is attributable to the business of banking which falls under the head “Profits and gains of business and profession”. The circular states that shares and stock held     by the bank are ‘stock-in-trade’ and not ‘investment’. Referring to certain judgments and the earlier orders of the Tribunal, it was held that if shares are held as stock-in-trade and not as investment even the disallowance under rule 8D would be nil as rule 8D(2)(i) would be confined to direct expenses for earning the tax exempt income.

On further appeal by the Revenue, the High Court  accepted  the contention of the Assessee that the assessee was engaged in the purchase and sale       of  shares as  a  trader with the object of  earning profit and not with    a view to earn interest or dividend. The assessee does not have an investment portfolio. The securities constitute the assessee’s stock-in- trade. The Department, accepted as a matter of fact, that the dividend  and interest earned was from the securities that constituted the assessee’s stock-in-trade. The Court further observed that as a banking institution,  the assessee was also statutorily required to place a part of its funds in approved securities. The Court followed the judgment of the High Court    of Karnataka in CCILtd. v. Jt. CIT [2012] 206 Taxman 563 (Karn.) (HC).

 

Issue

The question arose under varied circumstances where the shares/stocks were purchased of a company for the purpose of gaining control  over  the said company or as ‘stock-in-trade’. However, incidentally income  was also generated  in the form of dividends as well. On this basis, the assessees contended that the dominant intention for purchasing the share was not to earn dividends income but control    of the business in the company in which shares were invested or for the purpose   of trading in the shares as a business activity etc. In this backdrop, the issue was  as to whether the expenditure incurred can be treated as expenditure ‘in relation   to income’ i.e. dividend income which does not  form part of  the  total income. To put it differently, was the dominant or main object would be a relevant consideration in determining as to whether expenditure incurred is ‘in relation     to’ the dividend income. Though in some other cases, there were little difference   in fact situation. However, all these cases pertained to dividend income, whether

 

 

it was for the purpose of investment in order to retain controlling interest in a company or in group of companies or the dominant purpose was to have it as stock-in-trade.

 

View

On the interpretation of the expression ‘in relation to’, the majority opinion of     the Special Bench was that the requirement of there being direct and proximate connection between the expenditure incurred and exempt income earned could  not be read into the provision. According  to the majority view,  ‘what is relevant  is to work out the expenditure in relation to the exempt income and not to examine whether the expenditure incurred by the assessee has resulted into exempt income   or taxable income’. As per the minority view, however, the existence of dominant and immediate connection between the expenditure incurred and dividend income was a condition precedent for invoking the provisions of Section 14A of the Act.    It was accordingly held, as per the minority, that mere receipt of dividend income, incidental to the holding of shares, in the case of a dealer in shares, would not      be sufficient for invoking provisions of Section 14Aof the Act.

The Supreme Court observed that 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 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. The Court then proceeded to state that there was no quarrel in assigning this meaning to section 14A of the Act. In fact, all the High Courts, whether Delhi High Court on  the one hand or Punjab and Haryana High Court on the other hand, had agreed     in providing this interpretation to section 14A of the Act. The entire dispute was, what interpretation is to be given to the words ‘in relation to’ in the given scenario, viz. where the dividend income on the shares is earned, though the dominant purpose for subscribing in those shares of the investee company was  not to earn dividend. The Court had two scenarios in these sets of appeals. In     one group of cases the main purpose for investing in shares was to gain control  over the investee company. Other cases were those where the shares of investee company were 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 be examined as     to whether the expenditure was incurred, in respective scenarios, in relation to    the dividend income or not.

Thus the first and foremost issue that falls for consideration was as to whether    the dominant purpose test, which was pressed intoservice by the assessees

 

 

would apply while interpreting Section 14A of the Act or have to go by the theory of apportionment. The Court was of the opinion that the dominant purpose for which the investment into shares is  made by  an  assessee may  not be relevant. Court observed that no doubt, the assessee like Maxopp Investment Limited may have made the investment in order to gain control of the investee company. However, that does not appear to be a relevant factor in determining    the issue at hand. Fact remains that such dividend income is non-taxable. In  this scenario, if expenditure is incurred on earning the dividend income, that much of the expenditure which is attributable to the dividend income has to be disallowed and cannot be treated as business expenditure. Keeping this objective behind Section14A of the Act in mind, the said provision has to be interpreted, particularly, the word ‘in relation to the income’ that does not form part of total income. Considered in this hue, the principle of apportionment of expenses comes into play as thatis the principle which is engrained in Section 14A of the Act.

The Court affirmed the observation of Delhi High Court that prior to introduction   of Section 14A of the Act, the law was that when an assessee had a composite     and indivisible business which had elements of both taxable and non-taxable income, the entire expenditure in respect of said business was deductible and, in such a case, the principle of apportionment of the expenditure relating to the non- taxable income did not apply. The principle of apportionment was made available only where the business was divisible. It is to find a cure to the aforesaid problem that the Legislature has not only inserted Section 14A by the Finance (Amendment) Act, 2001 but also made it retrospective, i.e., 1962 when the Income Tax Act itself came into force. The aforesaid intent was expressed loudly and clearly in the Memorandum explaining the provisions of the Finance Bill, 2001. The Court, thus, agreed with the view taken by the Delhi High Court, and was    not inclined to accept the opinion of Punjab & Haryana High Court which went     by dominant purposetheory.

Post dominance purpose test, the other question that arose before the Court was what happens when the shares are held as ‘stock-in-trade’and not as ‘investment’, particularly, by the banks? On this specific aspect, CBDT had issued circular No. 18/2015 dated November 02,2015. This Circular took note of the judgment in CIT

1. Nawanshahar Central Co-operative Bank Ltd. [2007] 289 ITR 6 (SC) wherein it was held that investments made by a banking concern are part of the business or banking. Therefore, the  income arises from such investments is  attributable to business of banking falling under the head ‘profits and gains of business and profession’. Plain reading of the circular would make it clear that the issue was as    to whether income by way of interest on securities shall be chargeable to income tax under the head ‘income from other sources’ or it is to fall under the head ‘profits and gains of business and profession’. The Board, going by the decision      in Nawanshahar case, clarified that it has to be treated as income falling under    the head ‘profits and gains of business and profession’.The Board also 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. Punjab and Haryana High Court pointed out that this circular carves  out a distinction between ‘stock-in-trade’ and ‘investment’ and  provides that ifthe motive behind purchase and sale of shares is to earn profit, then the same would be treated as trading profit and if the object is to derive income by way       of dividend then the profit would be said to have accrued from investment. The Court to this extent, confirmed High Court’s view. However at the same time, Court did not agree with the test of dominant intention applied by the Punjab  and Haryana High Court. In that event, the question was as to on what basis  those cases are to be decided where the shares of other companies are purchased  by the assessees as ‘stock-in-trade’ and not as ‘investment’. The Supreme Court observed that where shares are held as stock-in-trade, the main purpose is to trade in those shares and earn profits therefrom. Those profits which would naturally be treated as ‘income’ under the head ‘profits and gains from business  and profession’. What happens is that, in the process, when the shares are held     as ‘stock-in-trade’, certain dividend is also earned, though incidentally, which is also an income. However, by virtue of Section 10 (34) of the Act, this dividend income is not to be included in the total income and is exempt from tax. As per   the Supreme Court this triggers the applicability of Section 14A of the Act  which  is based on the theory of apportionment of expenditure between taxable and non- taxable income as held in CIT v. Walfort Share and Stock Brokers (P) Ltd (2010)  326 ITR 1 (SC). Therefore, to that extent, depending upon the facts of each case,  the expenditure incurred in acquiring those shares will have to beapportioned.

The Court further noted from the facts in the State Bank of Patiala cases that the AO,  while passing the assessment order, had already restricted the disallowance   to the amount which was claimed as exempt income by applying the formula contained in Rule 8D of the Rules and holding that section 14A of the Act  would  be applicable. In spite of this exercise of apportionment of expenditure carried out   by the AO, CIT(A) disallowed the entire deduction of expenditure. Confirming the AO’s action of restricting the disallowance to exempt income the Court held that the view of the CIT(A) was clearly untenable and rightly set aside by the ITAT.

Having regard to the language of  Section 14A(2) of  the Act, read with Rule  8D of the Rules, the Court made it clear that before applying the theory of apportionment, the AO needs to record satisfaction that having regard to the kind of the assessee, suo moto disallowance under Section 14A was not correct.      It will be in those cases where the assessee in his return has himself apportioned but the AO  was not accepting the said apportionment. In that eventuality, it  will have to record its satisfaction to this effect. Further, while recording such a satisfaction, nature of loan taken by the assessee for purchasing the shares/making the investmentin shares is to be examined by the AO.

 

 

Held

Court held that; The argument that S. 14A & Rule 8D will not apply if the “dominant intention” of the assessee was not to earn  dividends  but to gain control of the company or to hold as stock-in-trade is not acceptable. S. 14A applies irrespective of whether the shares are held to gain control or not. However, where the shares are held as stock-in-trade, the expenditure incurred for earning business profits will have to be apportioned and allowed as a deduction. Only    that expenditure which is “in relation to” earning dividends can be disallowed     u/s 14A & Rule 8D. Further disallowance cannot be more that exempt income.     In case where the Assessee has made suo moto disallowance, the AO has to record proper satisfaction on why the claim of the assessee as to the quantum of  suo moto disallowance is not correct. (AY. 2002-03, 2008-09, 2009-10) (CA Nos. 104-109 of 2015 dt. 12-2-2018)

Editorial: Maxopp Investment Ltd. v. CIT (2012) 347 ITR 272 (Delhi) (HC) is affirmed. Decision of special Bench in ITO v. Daga Capital Management (2009) 312 ITR (AT) 1 (Mum.) (SB) is referred. In Godrej & Boyce Manufacturing Co    Ltd v. DCIT(2017) 394 ITR 449/247 Taxman 361/151 DTR 89/295 CTR 121 (SC)

the Court held that disallowance cannot be made in the absence of proof that expenditure has actually been incurred in earning dividend income. If the  AO  has accepted in earlier years he cannot take a contrary stand if the facts and circumstances have not changed. In PCIT v. Oil Industries Development Board (2019) 262 Taxman 102 (SC), the Court held that In the absence of any exempt income, no disallowance is permissible (CIT v. Essar Teleholdings Ltd (2018) 401 ITR 445 (SC) followed, Cheminvest Ltd v. CIT (2015) 378 ITR 33 (Delhi)(HC) approved). (SLP No. 2755/2019, dt. 16.02.2018)

After considering the aforesaid Supreme Court decision in case of Maxopp Investment and Punjab and Haryana High Court decision in case of State Bank      of Patiala, the Hon’ble Delhi Tribunal in case of Nice Bombay Transport (P.)   Ltd. [2019] 103 taxmann.com 338 (Delhi-Trib.) held that disallowance under Section 14A does not apply to Stock in trade and has heldthe following:

• Though the Hon’ble Apex Court has rejected the dominant purpose theory relied upon by the Hon’ble Punjab and Haryana High  Court in the aforesaid decision but has clearly made distinction between dividend earned in respect of shares acquired to  retain the controlling interest  in the investee company and the shares purchased for the purpose of liquidation or for trading, whenever the price goes up in order to earn

 

 

• Further it held that in Maxopp’s case the assessee continued to hold shares as it wanted to retain control over the investee company and whenever dividend income is declared by the investee company that would necessarily be earned by assessee and assessee alone and even at the time of investing into those shares the assessee knows that it will earn dividend income on the
• Therefore, even in the present case of the taxpayer, the shares are held as stock in trade thus, the main purpose is to liquidate the shares whenever price goes up, in order to earn profits. The Tribunal has thus held that the shares held as stock in trade stood on a different pedestal than the shares that were acquired with an intention to acquire and retain controlling interest in the investee company and thereby no disallowance could be made u/s. 14A of the Act and the addition made by the AO was not

• “Never apologize for being correct, or for being years ahead of your time. If you’re right and you know it, speak your mind.”

  – Mahatma Gandhi