1

REPORTABLE

IN THE SUPREME COURT OF INDIA

CIVIL APPELLATE JURISDICTION

CIVIL APPEAL NOS. 104-109 OF 2015

MAXOPP INVESTMENT LTD. .....APPELLANT(S)

VERSUS

COMMISSIONER OF INCOME TAX,

NEW DELHI .....RESPONDENT(S)

WITH

CIVIL APPEAL NO. 1423 OF 2015

CIVIL APPEAL NO. 3267 OF 2013

CIVIL APPEAL NO. 130 OF 2015

CIVIL APPEAL NOS. 110-112 OF 2015

CIVIL APPEAL NO. 1500 OF 2018

(ARISING OUT OF SLP (CIVIL) NO. 19614 OF 2013)

CIVIL APPEAL NO. 1508 OF 2018

(ARISING OUT OF SLP (CIVIL) NO. 31417 OF 2016)

CIVIL APPEAL NO. 115 OF 2015

CIVIL APPEAL NO. 8596 OF 2014

2

CIVIL APPEAL NO. 1505 OF 2018

(ARISING OUT OF SLP (CIVIL) NO. 27054 OF 2016)

CIVIL APPEAL NOS. 10096 OF 2013

CIVIL APPEAL NO. 123 OF 2015

CIVIL APPEAL NO. 6590 OF 2015

CIVIL APPEAL NO. 1576 OF 2018

(@ SPECIAL LEAVE PETITION (CIVIL) NO. 4024 OF 2018

@ DIARY NO. 39820 OF 2017)

CIVIL APPEAL NO. 1579 OF 2018

(ARISING OUT OF SLP (CIVIL) NO. 20475 OF 2017)

CIVIL APPEAL NO. 1578 OF 2018

(ARISING OUT OF SLP (CIVIL) NO. 23123 OF 2017)

CIVIL APPEAL NO. 18019 OF 2017

CIVIL APPEAL NO. 1580 OF 2018

(ARISING OUT OF SLP (CIVIL) 32405 OF 2017)

CIVIL APPEAL NO. 1575 OF 2018

(@ SPECIAL LEAVE PETITION (CIVIL) NO. 4023 OF 2018

@ DIARY NO. 36413 OF 2017)

CIVIL APPEAL NO. 2802 OF 2018

(@ SPECIAL LEAVE PETITION (CIVIL) NO. 6746 OF 2018

@ DIARY NO. 1146 OF 2018)

CIVIL APPEAL NO. 2791 OF 2018

3

(@ SPECIAL LEAVE PETITION (CIVIL) NO. 6685 OF 2018

@ DIARY NO. 39823 OF 2017)

CIVIL APPEAL NO. 2792 OF 2018

(@ SPECIAL LEAVE PETITION (CIVIL) NO. 6686 OF 2018

@ DIARY NO. 41903 OF 2017)

CIVIL APPEAL NO. 1577 OF 2018

(@ SPECIAL LEAVE PETITION (CIVIL) NO. 4027 OF 2018

@ DIARY NO. 41890 OF 2017)

CIVIL APPEAL NO. 2793 OF 2018

(@ SPECIAL LEAVE PETITION (CIVIL) NO. 6687 OF 2018

@ DIARY NO. 41203 OF 2017)

A N D

CIVIL APPEAL NO. 2794 OF 2018

(@ SPECIAL LEAVE PETITION (CIVIL) NO. 6688 OF 2018

@ DIARY NO. 41922 OF 2017)

J U D G M E N T

A.K. SIKRI, J.

Chapter IV of the Income Tax Act, 1961 (hereinafter referred to as

the ‘Act’) contains the provisions pertaining to ‘computation of total

income’. Section 14 which is the first provision under this Chapter

enumerates five heads of income within which all income are to be

classified. Under the scheme of the Act, certain types of income are

exempt from tax and, in this behalf, specific provisions are made

stipulating that such incomes would not form part of the total income

under the Act as fortiorari, they are not included under any of the heads

4

of income and, therefore, no taxes levied on such exempted incomes. It

is in this backdrop, Section 14A of the Act clarifies that if any expenditure

is incurred in earning that income which does not form part of the total

income, such expenditure shall also not be allowed as deduction.

Though, Section 14A was inserted by the Finance Act, 2001, but it was

given retrospective effect from April 1, 1962. Original Section was in the

following terms:

“Section 14A - 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.”

2)By the Finance Act, 2006, the aforesaid provision was amended

whereby it was renumbered as sub-section (1) and sub-sections (2) and

(3) were added thereto. Before that, a proviso was also added by

amendment vide Finance Act, 2002 which was to operate retrospectively

from May 11, 2001. In these batch of appeals, we are not concerned

with sub-sections (2), (3) or the proviso and it is only interpretation that

has to be given to sub-section (1), which arises for consideration.

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

5

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 expenditures 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.

4)However, in these appeals, the question has arisen under varied

circumstances where the shares/stocks were purchased of a company

for the purpose of gaining control over the said company or as

6

‘stock-in-trade’. However, incidentally income was also generated in the

form of dividends as well. On this basis, the assessees contend 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 is 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, is the

dominant or main object would be a relevant consideration in

determining as to whether expenditure incurred is ‘in relation to’ the

dividend income. In most of the appeals, including in Civil Appeal Nos.

104-109 of 2015, aforesaid is the scenario. Though, in some other

cases, there may be little difference in fact situation. However, all these

cases pertain 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.

5)Before we proceed further, we may briefly note the facts of Civil Appeal

Nos. 104-109 of 2015, for better understanding of the issue involved.

The appellant company is engaged, inter alia, in the business of

finance, investment and dealing in shares and securities. The appellant

holds shares/securities in two portfolios, viz. (a) as investment on capital

7

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’ is 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

group companies) 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

appellant 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 earning dividend. According to the appellant,

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

8

Max India Ltd. during the relevant previous year was only incidental to

the holding of such shares. The Assessing Officer (AO), while passing

the assessment order dated August 27, 2004, 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.

6)In appeal, the Commissioner of Income Tax (Appeals) {CIT(A)} vide

order dated January 12, 2005 upheld the order of the AO. The appellant

herein carried the matter in further appeal to the Income Tax Appellate

Tribunal, New Delhi (for short 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 (Private) Ltd.

1

The

appeal of the appellant was also tagged and heard by the aforesaid

Special Bench.

7)The Special Bench of the ITAT in the case of Daga Capital

Management (Private) Ltd., dismissing the appeal of the appellant,

1 312 ITR (AT) 1

9

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.

8)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

10

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 14A of the Act.

9)Against the aforesaid order of the Special Bench, the appellant preferred

appeal under Section 260A of the Act to the High Court. The High

Court of Delhi has, vide impugned judgment dated November 18, 2011,

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 is maintained.

10) It would be pertinent to point out at this stage that Punjab and

Haryana High Court in a recent judgment in the case of Principal

Commissioner of Income Tax v. State Bank of Patiala

2

has taken a

view which runs contrary to the aforesaid 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. Joint

Commissioner of Income Tax, Udupi Range

3

The Revenue has filed

appeals challenging the correctness of the aforesaid decisions. Thus, in

view of conflict of opinions of various High Courts, these batch of

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

3 (2012) 206 Taxman 563

11

appeals are by those assessees who were lost before the High Court

and by the Income Tax Department against the judgments of the High

Court where the view taken is favourable to the assessee and against

the Revenue.

11) Before adverting to the discussions on these judgments, let us go

through the relevant statutory provisions, as that would enable us to

appreciate the ratio of these cases more appropriately. Since the focus

of discussion is Section 14A of the Act, we reproduce Section 14A in its

entirety hereinbelow:

“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.

(2) The Assessing Officer shall determine the amount of

expenditure incurred in relation to such income which does

not form part of the total income under this Act in accordance

with such method as may be prescribed, if the Assessing

Officer, having regard to the accounts of the assessee, is not

satisfied with the correctness of the claim of the assessee in

respect of such expenditure in relation to income which does

not form part of the total income under this Act.

(3) The provisions of sub-section (2) shall also apply in

relation to a case where an assessee claims that no

expenditure has been incurred by him in relation to income

which does not form part of the total income under this Act :

Provided that nothing contained in this section shall

empower the Assessing Officer either to reassess under

section 147 or pass an order enhancing the assessment or

reducing a refund already made or otherwise increasing the

liability of the assessee under section 154, for any

12

assessment year beginning on or before the 1st day of April,

2001.”

12) Sub-section (2) of Section 14A deals with the proportionality as it

empowers the AO to extricate that amount of expenditure which is

incurred in relation to such income which does not form part of the total

income under the Act. However, this is to be done ‘in accordance with

such method as may be prescribed.’ This prescription is provided by the

delegated 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, 2008

vide Income Tax (Fifth Amendment) Rules, 2008

4

. We, thus, reproduce

Rule 8D hereunder:

“Method for determining amount of expenditure in

relation to income not includible in total income.

8D.(1) Where the Assessing Officer, having regard to the

accounts of the assessee of a previous year, is not satisfied

with—

(a) the correctness of the claim of expenditure made by the

assessee; or

(b) the claim made by the assessee that no expenditure has

been incurred,

in relation to income which does not form part of the total

income under the Act for such previous year, he shall

determine the amount of expenditure in relation to such

income in accordance with the provisions of sub-rule (2).

(2) The expenditure in relation to income which does not form

part of the total income shall be the aggregate of following

amounts, namely:—

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,

this Court has held that Rule 8D is prospective in nature.

13

(i) the amount of expenditure directly relating to income which

does not form part of total income;

(ii) in a case where the assessee has incurred expenditure by

way of interest during the previous year which is not directly

attributable to any particular income or receipt, an amount

computed in accordance with the following formula, namely:—

Where A = amount of expenditure by way of interest other

than the amount of interest included in clause (i) incurred

during the previous year;

B = the average of value of investment, income from which

does not or shall not form part of the total income, as

appearing in the balance sheet of the assessee, on the first

day and the last day of the previous year;

C = the average of total assets as appearing in the balance

sheet of the assessee, on the first day and the last day of the

previous year;

(iii) an amount equal to one-half per cent of the average of the

value of investment, income from which does not or shall not

form part of the total income, as appearing in the balance

sheet of the assessee, on the first day and the last day of the

previous year.

(3) For the purposes of this rule, the “total assets” shall mean,

total assets as appearing in the balance sheet excluding the

increase on account of revaluation of assets but including the

decrease on account of revaluation of assets.”

13) With the aforesaid statutory scheme in mind, we traverse through

the judgments of the Delhi High Court in Maxopp Investment Ltd. and

that of Punjab and Haryana High Court in State Bank of Patiala.

JUDGMENT OF DELHI HIGH COURT IN MAXOPP INVESTMENT LTD.

14) Three questions fell for consideration before the High Court. For

14

the purpose of these appeals, it is only question No. 1 which is relevant,

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 for acquiring and retaining a controlling interest

therein is hit by section 14A of the Income tax Act, 1961

inasmuch as the dividend received on such shares does not

form part of the total income?”

15) On facts, it was noted that the assessee company is in the

business 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 of acquiring and retaining control over its group companies,

primarily Max India Ltd. As per the assessee, any profit resulting on the

sale of shares held as trading assets was duly offered to tax as business

income of the assessee. During the previous year relevant to the

assessment year 2002-03, the assessee incurred total interest

expenditure of Rs. 1,61,21,168/-, which was claimed as business

expenditure under section 36(1)(iii) of the Income Tax Act, 1961

(hereinafter referred to as “the said act”). According to the assessee, the

expenditure claimed was not hit by section 14A of the Act, on the ground

that although borrowed funds were partly utilised for investment in

shares held as trading assets, such investment was made with the

intention to acquire and retain a controlling interest in the aforesaid

company and that the receipt of dividend thereon was merely incidental.

15

The High Court then took note of legislative history of Section 14A of the

Act and Rule 8D of the Rules. Thereafter, the Court went on to discuss

the law which stood prior to insertion of Section 14A. Taking note of

certain judgments, the High Court observed that prior to the insertion of

Section 14A in 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 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 not exigible 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 by

referring to the Memorandum Explaining the Provisions of the Finance

Bill, 2001. It also reproduced passages from few judgments of this

Court. Since, for the purpose of the present case, it is necessary to

keep in mind the objectives behind this 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

Act is apparent from the Memorandum explaining the

provisions of the Finance Bill 2001 which is to the following

effect:-

16

“Certain incomes are not includable while computing

the total income as these are exempt under various

provisions of the Act. There have been cases where

deductions have been claimed in respect of such

exempt income. This in effect means that the tax

incentive given by way of exemptions to certain

categories of income is being used to reduce also the

tax payable on the non-exempt income by debiting the

expenses incurred to earn the exempt income against

taxable income. This is against the basic principles of

taxation whereby only the net income, i.e., gross

income minus the expenditure is taxed. On the same

analogy, the exemption is also in respect of the net

income. Expenses incurred can be allowed only to the

extent they are relatable to the earning of taxable

income.

It is proposed to insert a new section 14A so as to

clarify the intention of the Legislature since the

inception of the Income-tax Act, 1961, that no deduction

shall be made in respect of any expenditure incurred by

the assessee in relation to income which does not form

part of the total income under the Income-tax Act.

The proposed amendment will take effect

retrospectively from April 1, 1962 and will accordingly,

apply in relation to the assessment 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), the insertion of section 14 A with retrospective effect

reflects 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 said act against the taxable

income. The Supreme Court further observed as under:-

“.. In other words, section 14 A clarifies that expenses

incurred can be allowed only to the extent that 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

17

relation to exempt income against taxable income and

at the same time avail of the tax incentive by way of an

exemption of exempt income without making any

apportionment of expenses incurred in relation to

exempt income… ”

“..Expenses allowed can only be in respect of earning

taxable income. This is the purport of section 14A. In

section 14A, the first phrase is “for the purposes of

computing the total income under this Chapter” which

makes it clear that various heads of income as

prescribed in the Chapter IV would fall within section

14A. The next phrase is, “in relation to income which

does not form part of total income under the Act”. It

means that if an income does not form part of total

income, then the related expenditure is outside the

ambit of the applicability of section 14A..

(Emphasis supplied)”

17. The Supreme Court also clearly held that in the case of an

income like dividend income which does not form part of the

total income, any expenditure/deduction relatable to such

(exempt or non-taxable) income, even if it is of the nature

specified in sections 15 to 59 of the said Act, cannot be

allowed against any other income which is includable in the

total income. The exact words used by the Supreme Court

are as under:-

“Further, section 14 specifies five heads of income

which are chargeable to tax. In order to be chargeable,

an income has to be brought under one of the five

heads. Sections 15 to 59 lay down the rules for

computing income for the purpose of chargeability to

tax under those heads. Sections 15 to 59 quantify the

total income chargeable to tax. The permissible

deductions enumerated in sections 15 to 59 are now to

be allowed only with reference to income which is

brought under one of the above heads and is

chargeable to tax. If an income like dividend income is

not a part of the total income, the

expenditure/deduction though of the nature specified in

sections 15 to 59 but related to the income not forming

part of the total income could not be allowed against

other income includable in the total income for the

purpose of chargeability to tax. The theory of

apportionment of expenditure between taxable and

non-taxable has, in principle, been now widened under

18

section 14 A.

(emphasis supplied)”

16) The High Court then undertook the exercise of analysing the

provisions of Section 14A of the Act and, in the process, examined the

contours and scope of the expressions ‘in relation to’ and ‘expenditure

incurred’ occurring therein. The High Court pointed out that contention

of the assessees, in this behalf, was that the word ‘incurred’ must be

taken literally in the sense that the expenditure must have actually taken

place. Moreover, the expenditure must also have taken place in relation

to income which does not form part of total income. Further, the

expression “in relation to” implies that there must be a direct and

proximate connection with the subject matter. In other words, only that

actual expenditure which is made directly and for the object of earning

exempt income (in the present appeals - dividend income) could be

disallowed under section 14A of the Act. 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 of the Act

provided it was otherwise allowable under sections 15 to 59 of the said

Act. The High Court, however, did not agree with the aforesaid

propositions advanced by the learned counsel for the assessees which

according to it was mired by several difficulties. Distinguishing the case

law cited by the assessees where the expression ‘in relation to’ was

interpreted by this Court, as not applicable in the present context, the

19

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 ‘pertaining to’, ‘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 this Court in CIT v. Walfort Share and Stock Brokers

P Ltd.

6

wherein this Court 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 the exemption is also in respect of net income. In

other words, where the gross income would not form part of total

income, it's associated or related expenditure would also not be

permitted to be debited against other taxable income.

17) 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 is 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. On the

basis of the aforesaid discussion, the High Court answered the question

formulated by it in the affirmative.

5 (1988) 2 SCC 299

6 (2010) 326 ITR 1 (SC)

20

JUDGMENT OF PUNJAB AND HARYANA HIGH COURT IN STATE BANK

OF PATIALA

18) This case arose in the context where 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

21

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 (which we will also refer to) 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. In the aforesaid factual backdrop, in appeal filed by the

Revenue, the High Court noted that following substantial question of law

arose for consideration:

“Whether in the facts and circumstances of the case, the

Hon’ble ITAT is right in law in deleting the addition made on

account of disallowance under section 14A of the Income Tax

Act, 1961?”

22

19) In its analysis, the High Court accepted the contention of the

counsel for the assessee that the assessee is 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, in fact, rightly 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 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, issued by the CBDT, which reads as under:-

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

It has been brought to the notice of the Board that in the case

of Banks, field officers are taking a view that, “expenses

relatable to investment in non-SLR securities need to be

disallowed u/s 57(i) of the Act as interest on non-SLR

securities is income from other sources.”

2. Clause (id) of sub-section (1) of Section 56 of the Act

provides that income by way of interest on securities shall be

chargeable to income-tax under the head “Income from Other

Sources”, if, the income is not chargeable to income-tax

under the head “Profits and Gains of Business and

Profession”.

3. The matter has been examined in light of the judicial

decisions on this issue. In the case of CIT Vs Nawanshahar

Central Cooperative Bank Ltd. [2007] 160TAXMAN 48(SC),

the Apex Court held that the investments made by a banking

concern are part of the business of banking. Therefore, the

income arising from such investments is attributable to the

business of banking falling under the head “Profits and Gains

of Business and Profession”.

23

3.2 Even though the abovementioned decision was in the

context of co-operative societies/Banks claiming deduction

under section 80P(2)(a)(i) of the Act, the principle is equally

applicable to all banks/commercial banks, to which Banking

Regulation Act, 1949 applies.

4. In the light of the Supreme Court’s decision in the matter,

the issue is well settled. Accordingly, the Board has decided

that no appeals may henceforth be filed on this ground by the

officers of the Department and appeals already filed, if any, on

this ground before Courts/Tribunals may be withdrawn/not

pressed upon. This may be brought to the notice of all

concerned.

(emphasis supplied)”

20) The High Court pointed out that the Circular carves out a

distinction between stock-in-trade and investment and provides that if

the 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 the investment. If the assessee is found to have treated the shares

and securities as stock-in-trade, the income arising therefrom would be

business income. A loss would be a business loss. Thus, an assessee

may have two portfolios, namely, investment portfolio and a trading

portfolio. In the case of the former, the securities are to be treated as

capital assets and in the latter as trading assets.

21) Further, as a banking institution, the assessee was also statutorily

required to place a part of its funds in approved securities, as held in

24

CIT v. Nawanshahar Central Co-operative Bank Ltd.

7

. Since, the

shares, bonds, debentures purchased by the assessees constituted its

stock-in-trade, the provisions of Section 14A were not applicable. Here,

the Court noted distinction between stock-in-trade and investment and

made the following observations:

“17. Under section 14A, an expenditure can be disallowed

only if it is incurred by the assessee in relation to income

exempt from tax. The dividend or interest from the assessee’s

stock-in-trade i.e. the securities was exempt from tax in view

of sections 10(15)(iv)(h),(34) and (35). This was incidental to

its business of banking. The business income on account of

the assessee trading in the securities is assessable under the

head “Profits and gains of business and profession”. The

expenditure incurred in relation to stock-in-trade arising as a

result of investment in shares and debentures is deductible

under sections 28 to 37. There is a distinction between

stock-in-trade and investment. The object of earning profit

from trading in securities is different from the object of earning

income, such as, dividend and interest arising therefrom. The

object of trading in securities does not constitute the activity of

investment where the object is to earn dividend or interest.”

22) The High Court then discussed in detail the judgment in Walfort

Share and Stock Brokers P Ltd. which related to dividend stripping.

After explaining the objective behind Section 14A of the Act (which is

already noted above), this Court in the facts of that case, had held that a

payback does not constitute an ‘expenditure incurred’ in terms of Section

14A as it does not impact the profit and loss account. This expenditure,

in fact, is a payout.

23) According to the High Court, what is to be disallowed is the

7 (2007) 289 ITR 6 (SC)

25

expenditure incurred to “earn” exempt income. The words ‘in relation to’

in Section 14A must be construed accordingly. Applying that principle to

the facts at hand, the High Court concluded as under:

“Now, the dividend and interest are income. The question

then is whether the assessee can be said to have incurred

any expenditure at all or any part of the said expenditure in

respect of the exempt income viz. dividend and interest that

arose out of the securities that constituted the assessee’s

stock-in-trade. The answer must be in the negative. The

purpose of the purchase of the said securities 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, that the entire expenditure

including administrative costs was incurred for the purchase

and sale of the stock-in-trade and, therefore, towards earning

the business income from the trading activity of purchasing

and selling the securities. Irrespective of whether the

securities yielded any income arising therefrom, such as,

dividend or interest, no expenditure was incurred in relation to

the same.”

24) We may also note here that the High Court referred to the

judgment of the Karnataka High Court in CCI Ltd. case and concurred

therewith. This judgment in CCI Ltd. is, however, a very short judgment

which records the submission of counsel for the parties very briefly and

thereafter the entire discussion is contained in para 5 that reads as

under:

“5. When no expenditure is incurred by the assessee in

earning the dividend income, no notional expenditure could be

deducted from the said income. It is not the case of the

assessee retaining any shares so as to have the benefit of

dividend. 63% of the shares, which were purchased, are sold

and the income derived therefrom is offered to tax as business

income. The remaining 37% of the shares are retained. It has

remained unsold with the assessee. It is those unsold shares

have yielded dividend, for which, the assessee has not

incurred any expenditure at all. Though the dividend income is

26

exempted from payment of tax, if any expenditure is incurred in

earning the said income, the said expenditure also cannot be

deducted. But in this case, when the assessee has not

retained shares with the intention of earning dividend income

and the dividend income is incidental to his business of sale of

shares, which remained unsold by the assessee, it cannot be

said that the expenditure incurred in acquiring the shares has

to be apportioned to the extent of dividend income and that

should be disallowed from deductions. In that view of the

matter, the approach of the authorities is not in conformity with

the statutory provisions contained under the Act. Therefore,

the impugned orders are not sustainable and require to be set

aside.”

25) At this stage, it will also be useful to refer a judgment of Calcutta

High Court in Commissioner of Income Tax v. G.K.K. Capital Markets

(P.) Ltd.

8

which has also agreed with the view taken by the Karnataka

High Court. In that case, the assessee was engaged in the business of

share trading. In the computation of income, the assessee claimed

long-term capital gains as exempt income and declared expenditure

disallowable against it under Section 14A of the Act. The AO treated the

long-term capital gains as business income. The Appellate Tribunal

found that the assessee did not have any investment and all the shares

were held as stock-in-trade as was evident from the orders of the lower

authorities. On those facts it held that once the assessee had kept the

shares as stock-in-trade, Rule 8D of the Rules would not apply. On the

questions whether the Appellate Tribunal was justified in deleting the

disallowance under Section 14A computed in accordance with Rule 8D

8 (2017) 392 ITR 196 (Cal)

27

and in holding the investments as shares stock-in-trade, the High Court

held that the AO had accepted the correctness of the disallowable

expenditure 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 as business income to thereafter disallow the offered

expenditure. According to the High Court, since the finding of fact was

recorded by the AO regarding the exempt income claimed being treated

as business income and the shares held by the assessee having been

treated as stock-in-trade, there could not have been disallowance of

expenditure under Section 14A of the Act and that provision had no

application.

26) It would be pertinent to mention that earlier judgment of the same

High Court in the case of Dhanuka and Sons v. CIT

9

was cited by the

Revenue. However, this judgment was distinguished on the ground that,

in that case, there was no dispute that part of the income of the

assessee from its business was from dividend whereas the assessee

was unable to produce any material before the authorities below

showing the source from which such shares were acquired. For better

understanding, it would be necessary to note the discussion in the case

of Dhanuka and Sons, which was reproduced by the High Court in

G.K.K. Capital Markets (P.) Ltd. Para 6 to para 9 of Dhanuka and

9 (2011) 339 ITR 319 (Cal)

28

Sons read as under:

“6. Mr. Sarkar, the learned advocate appearing on behalf of the

revenue, has, on the other hand, supported the order passed

by the Tribunal and has contended that the assessee itself

having failed to produce material in support of its contention,

the Assessing Officer rightly assessed the deductible income

on proportionate basis. Mr. Sarkar submits that the same is in

conformity with Rule 8D of the Income tax Rule and thus, we

should not interfere with the order passed by the Tribunal.

7. After hearing the learned counsel appearing for the parties

and after going through the materials on record and the

decisions cited by Mr. Khaitan, we find that the Supreme Court

in the cases of CIT v. Maharastra Sugar Mills Ltd. [1971] 82

ITR 452 and Rajasthan State Warehousing

Corpn. v. CIT [2000] 242 ITR 450/109 Taxman 145 having held

that where there is one indivisible business giving rise to

taxable income as well as exempt income, the entire

expenditure incurred in relation to that business would have to

be allowed even if a part of the income earned from the

business is exempt from tax, section 14A of the Act was

enacted to overcome those judicial pronouncements. The

object of section 14A of the Act is to disallow the direct and

indirect expenditure incurred in relation to income which does

not form part of the total income.

8. In the case before us, there is no dispute that part of the

income of the assessee from its business is from dividend

which is exempt from tax whereas the assessee was unable to

produce any material before the authorities below showing the

source from which such shares were acquired. Mr. Khaitan

strenuously contended before us that for the last few years

before the relevant previous year, no new share has been

acquired and thus, the loan that was taken and for which the

interest is payable by the assessee was not for acquisition of

those old shares and, therefore, the authorities below erred in

law in giving benefit of proportionate deduction.

9. In our opinion, the mere fact that those shares were old

ones and not acquired recently is immaterial. It is for the

assessee to show the source of acquisition of those shares by

production of materials that those were acquired from the

funds available in the hands of the assessee at the relevant

point of time without taking benefit of any loan. If those shares

were purchased from the amount taken in loan, even for

instance, five or ten years ago, it is for the assessee to show

by the production of documentary evidence that such loaned

29

amount had already been paid back and for the relevant

assessment year, no interest is payable by the assessee for

acquiring those old shares. In the absence of any such

materials placed by the assessee, in our opinion, the

authorities below rightly held that proportionate amount should

be disallowed having regard to the total income and the

income from the exempt source. In the absence of any material

disclosing the source of acquisition of shares which is within

the special knowledge of the assessee, the assessing authority

took a most reasonable approach in assessment.”

27) We have already stated as to how the two divergent opinions have

emerged from different High Courts and the respective reasons in

support of these conflicting outcome. Obviously, assessees are banking

upon the reasons which prevailed with the High Courts that have taken

the view which are favourable to the assessees and the Revenue is

relying upon the reasoning given by Delhi High Court as well as Calcutta

High Court in Dhanuka and Sons case. Therefore, it may not be

necessary to give a detailed narrative of the arguments which were

advanced by various counsel appearing for the assessees as well as

counsel for the Revenue. A brief resume of their submissions would

serve the purpose.

28) Insofar as assessees are concerned, their arguments are

recapitulated in brief hereinbelow:

(i)The holding of investment in group companies representing

controlling interest, amounts to carrying on business, as held in the

various cases.

(ii)Notwithstanding that dividend income is assessable under the

30

head “income from other sources”, in view of the mandatory

prescription in Section 56 of the Act, the nature of dividend income

has to be ascertained on the facts of the case. Where dividend is

earned on shares held as stock-in-trade/shares purchased for

acquiring/retaining controlling interest, dividend income is in the

nature of business income.

(iii)Interest paid on loans borrowed for acquiring shares representing

controlling interest in the investee company is allowable business

expenditure in terms of Section 36(1)(iii) of the Act, since acquiring

controlling interest in companies and managing, administering,

financing and rehabilitating such companies are for business

and/or professional purposes and not for earned dividend.

(iv)Conversely, interest paid on funds borrowed for investment in

shares representing controlling interest does not represent

expenditure incurred for earning dividend income and is not

allowable under Section 57(iii) of the Act (prior to introduction of

Section 14A).

29) Basing their case on the aforesaid principles, it was argued that

when the shares were acquired, as part of promoter holding, for the

purpose of acquiring controlling interest in the company, the dominant

object is to keep control over the management of the company and not

to earn the dividend from investment in shares. Whether dividend is

31

declared/earned or not is immaterial and, in either case, the assessee

would not liquidate the shares in investee companies. Therefore, no

expenditure was made ‘in relation to’ the income i.e. the dividend income

and, therefore, Section 14A would not be attracted. In this hue, it was

submitted that Section 14A was to be accorded plain and grammatical

interpretation meaning thereby mandating and requiring a direct and

proximate nexus/link between the expenditure actually incurred and the

earning of the exempt income. It was also argued that even if

contextual/purposive interpretation is to be given, that also called for

direct and proximate connection between the expenditure incurred and

earning of dividend. According to the learned counsel appearing for the

assessees, the legislative intention behind inserting Section 14A in this

statute was to exclude both, viz. the receipts which are exempt under

the provisions of the Act as well as expenditure actually incurred ‘in

relation thereto’ from entering into the computation of assessable

income, so as to remove the double benefit to the assessee (i) in the

form of exempt income, on which no tax is leviable; and (ii) providing

deduction in respect of expenditure actually incurred which directly

resulted in the earning of exempt income by the assessee.

30) Mr. K. Radhakrishnan, learned senior counsel appearing for the

Revenue, on the other hand, made a fervent plea to accept the view

taken by the Delhi High Court. He submitted that the objective behind

32

insertion of Section 14A of the Act manifestly pointed out that

expenditure incurred in respect of income earned, which is exempted

from tax, has to be disallowed. He also pointed out that this message

was eloquently brought out by this Court in Walfort Share and Stock

Brokers P Ltd. case. Otherwise, argued the learned senior counsel, the

assessee will get double benefit, one, in the form of exemption from

income tax insofar as dividend income is concerned and other by getting

deduction on account of expenditure as well. He, thus, submitted that

expression ‘in relation to’ had to be given expansive meaning in order to

sub-serve the purpose of the said provision. He also emphasised that

literal meaning of Section 14A of the Act pointed towards that and that

was equally the purpose behind the insertion of Section 14A as well.

31) We have given our thoughtful consideration to the argument of

counsel for the parties on both sides, in the light of various judgments

which have been cited before us, some of which have already been

taken note of above.

32) In the first instance, it needs to be recognised 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

33

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. 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.

33) There is no quarrel in assigning this meaning to section 14A of the

Act. In fact, all the High Courts, whether it is the Delhi High Court on the

one hand or the Punjab and Haryana High Court on the other hand,

have agreed in providing this interpretation to section 14A of the Act.

The entire dispute is as to 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. We

have 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 are 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.

34

34) Having clarified the aforesaid position, the first and foremost issue

that falls for consideration is as to whether the dominant purpose test,

which is pressed into service by the assessees would apply while

interpreting Section 14A of the Act or we have to go by the theory of

apportionment. We are of the opinion that the dominant purpose for

which the investment into shares is made by an assessee may not be

relevant. 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 that is the principle which is engrained in Section 14A

of the Act. This is so held in Walfort Share and Stock Brokers P Ltd.,

relevant passage whereof is already reproduced above, for the sake of

continuity of discussion, we would like to quote the following few lines

therefrom.

35

“ The next phrase is, “in relation to income which does

not form part of total income under the Act”. It means

that if an income does not form part of total income,

then the related expenditure is outside the ambit of the

applicability of section 14A..

xxx xxx xxx

The theory of apportionment of expenditure between

taxable and non-taxable has, in principle, been now

widened under section 14 A.”

35) The Delhi High Court, therefore, correctly observed that prior to

introduction of Section 14A of the Act, the law was that when an

assessee had a composite and indivisible business which had elements

of both taxable and non-taxable income, the entire expenditure in

respect of said business was deductible and, in such a case, the

principle of apportionment of the expenditure relating to the non-taxable

income did not apply. The principle of apportionment was made

available only where the business was divisible. It is to find a cure to the

aforesaid problem that the Legislature has not only inserted Section 14A

by the Finance (Amendment) Act, 2001 but also made it retrospective,

i.e., 1962 when the Income Tax Act itself came into force. The aforesaid

intent was expressed loudly and clearly in the Memorandum explaining

the provisions of the Finance Bill, 2001. We, thus, agree with the view

taken by the Delhi High Court, and are not inclined to accept the opinion

of Punjab & Haryana High Court which went by dominant purpose

theory. The aforesaid reasoning would be applicable in cases where

36

shares are held as investment in the investee company, may be for the

purpose of having controlling interest therein. On that reasoning,

appeals of Maxopp Investment Limited as well as similar cases where

shares were purchased by the assessees to have controlling interest in

the investee companies have 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 as

‘investment’, particularly, by the banks? On this specific aspect, CBDT

has 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 Nawanshahar case

wherein it is 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’. On that basis, the

Circular contains the decision of the Board that no appeal would be filed

on this ground by the officers of the Department and if the appeals are

already filed, they should be withdrawn. A reading of this 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

37

business and profession’. The Board, going by the decision of this Court

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.

38) From this, Punjab and Haryana High Court pointed out that this

circular carves out a distinction between ‘stock-in-trade’ and ‘investment’

and provides that if the 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. To this extent, the High Court

may be correct. At the same time, we do not agree with the test of

dominant intention applied by the Punjab and Haryana High Court,

which we have already discarded. In that event, the question is 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’. We proceed to discuss this aspect hereinafter.

39) In those cases, where shares are held as stock-in-trade, the main

38

purpose is to trade in those shares and earn profits therefrom. However,

we are not concerned with 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. 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 Walfort

Share and Stock Brokers P Ltd. case. Therefore, to that extent,

depending upon the facts of each case, the expenditure incurred in

acquiring those shares will have to be apportioned.

40) We note 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. That view of the CIT(A) was clearly

untenable and rightly set aside by the ITAT. Therefore, on facts, the

Punjab and Haryana High Court has arrived at a correct conclusion by

39

affirming the view of the ITAT, though we are not subscribing to the

theory of dominant intention applied by the High Court. It is to be kept in

mind that in those cases where shares are held as ‘stock-in-trade’, it

becomes a business activity of the assessee to deal in those shares as

a business proposition. Whether dividend is earned or not becomes

immaterial. In fact, it would be a quirk of fate that when the investee

company declared dividend, those shares are held by the assessee,

though the assessee has to ultimately trade those shares by selling

them to earn profits. The situation here is, therefore, different from the

case like Maxopp Investment Ltd. where the assessee would continue to

hold those shares as it wants to retain control over the investee

company. In that case, whenever dividend is declared by the investee

company that would necessarily be earned by the assessee and the

assessee alone. Therefore, even at the time of investing into those

shares, the assessee knows that it may generate dividend income as

well and as and when such 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 be necessarily a situation. The main

purpose is to liquidate those shares whenever the share price goes up in

order to earn profits. In the result, the appeals filed by the Revenue

challenging the judgment of the Punjab and Haryana High Court in State

Bank of Patiala also fail, though law in this respect has been clarified

40

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 applying the

theory of apportionment, the AO needs to record satisfaction that having

regard to the kind of the assessee, suo moto disallowance under

Section 14A was not correct. It will be in those cases where the

assessee in his return has himself apportioned but the AO was not

accepting the said apportionment. In that eventuality, it will have to

record its satisfaction to this effect. Further, while recording such a

satisfaction, nature of loan taken by the assessee for purchasing the

shares/making the investment in shares is to be examined by the AO.

42) Civil Appeal No. 1423 of 2015 is filed by M/s. Avon Cycles Limited,

Ludhiana, wherein the AO had invoked section 14A of the Act read with

Rule 8D of the Rules and apportioned the expenditure. The CIT(A) had

set aside the disallowance, which view was upturned by the ITAT in the

following words:

“...Admittedly the assessee had paid total interest of Rs.2.92

crores out of which interest paid on term loan raised for

specific purpose totals to Rs.1.70 crores and balance interest

paid by the assessee is Rs.1.21 crores. The funds utilized by

the assessee being mixed funds and in view of the provisions

of Rule 8D(2)(ii) of the Income Tax Rules the disallowance is

confirmed at Rs.10,49,851/-, we find no merit in the ad hoc

disallowance made by the CIT (Appeals) at Rs.5,00,000/-.

Consequently, ground of appeal raised by the Revenue is

partly allowed and ground raised by the assessee in

cross-objection is allowed...”

41

Taking note of the aforesaid finding of fact, the High Court has

dismissed the appeal of the assessee observing as under:

“In the present case, after examining the balance-sheet of the

assessee, a finding of fact has been recorded that the funds

utilized by the assessee being mixed funds, therefore, the

interest paid by the assessee is also an interest on the

investments made. Such being a finding of fact, we do not

find that any substantial question of law arises for

consideration of this Court.”

After going through the records and applying the principle of

apportionment, which is held to be applicable in such cases, we do not

find any merit in Civil Appeal No. 1423 of 2015, which is accordingly

dismissed.

43) Few appeals are filed by the Revenue against the assessees

which pertained to the period prior to the introduction of Rule 8D of the

Rules. Here, the case is decided in favour of the assessees also on the

ground that Rule 8D of the Rules is prospective in nature and could not

have been made applicable in respect of the Assessment Years prior to

2007 when this Rule was inserted. This view has already been upheld

by this Court 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, that the said Rule is

prospective in nature. On this ground alone, these appeals of the

Revenue fail as it is not necessary to go into the other issues.

42

44) To sum up:

(a)Appeals of the assessees, i.e. Civil Appeal Nos. 104-109, 110-112,

130, 1423 of 2015, are dismissed.

(b)Appeals of the Revenue, i.e. Civil Appeal Nos. 3267, 19614, 10096

of 2013, 8596 of 2014, 18019 of 2017, 115, 123, 6590 of 2015, Civil

Appeals arising out of SLP (C) Nos. 27054, 31417 of 2016, 20475,

23123, 32405 of 2017, Diary Nos. 36413, 39820, 39823, 41890,

41903, 41922 of 2017 and 1146 of 2018 are dismissed.

(c)Appeal of the Revenue, i.e. Civil Appeal arising out of Diary No.

41203 of 2017, is allowed.

.............................................J.

(A.K. SIKRI)

.............................................J.

(ASHOK BHUSHAN)

NEW DELHI;

FEBRUARY 12, 2018.