THE issues before the Bench are - Whether, even if assessee incures interest expenditure on borrowed funds utilised not to earn dividend income but to gain controlling stake in a company, the same is liable to disallowance u/s 14A; Whether Rule 8D is retrospective in nature and whether the disallowance is required to be made only if the expenditure is actually incurred in relation to earning dividends. And the verdict partly goes against the assessee.
Facts of the case
Assessee is in the business of finance, investment and of dealing in shares and securities. Assessee held shares and securities, partly as investments on the "capital account" and partly as "trading assets" for acquiring and retaining control over its group companies. Profit resulting on the sale of shares held as trading assets was offered to tax as business income. Assessee claimed interest as business expenditure u/s 36(1)(iii). Assessee contended that the expenditure claimed was not hit by section 14A 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 group company and the receipt of dividend was merely incidental.
AO invoked section 14A and apportioned the interest expenditure in the ratio of investment in shares of group company, on which dividend was received, to the principal amount of unsecured loans and made disallowance u/s 14A. CIT (A) confirmed the order of the AO. ITAT held by constituting a special bench in the case of Daga Capital Management, that the expenditure claimed was hit by the provisions of section 14A. Pursuant to the majority decision of the Special Bench of the Tribunal, the issue of quantum of expenditure to be disallowed was restored to the AO to be recomputed in terms of Rule 8D which was held to be retrospective.
Assessee contended that holding of shares for acquiring and retaining control of operating companies amounts to business and consequently dividend income on such shares was in the nature of business income. The intention behind acquiring such shares was not to earn dividend but to acquire and retain a controlling interest in the operating companies. The dividend was merely incidental. The word "incurred" used in section 14A must be taken literally in the sense that the expenditure must have actually taken place. The expression "in relation to" implies that there must be a direct and proximate connection with the subject matter. 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.
After hearing both the parties, the High Court held that,
++ prior to the introduction of section 14A in the said 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 object behind the insertion of section 14A 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. 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;
++ Sub-section (1) of section 14A clearly stipulates that for the purposes of computing total income under Chapter IV, 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 the said Act. A lot of emphasis was laid on the expressions "incurred" and "in relation to". It is the duty of the court to determine in what particular meaning and particular shade of meaning the word or expression was used by the Constitution makers and in discharging the duty the court will take into account the context in which it occurs The expression "relating to" would depend upon the context in which it occurs. The submission of the assessee that a narrow meaning ought to be ascribed to the expression "in relation to" appearing in section 14A is not acceptable. The provision was inserted by virtue of the Finance Act, 2001 with retrospective effect from 01/04/1962. It was the intention of Parliament that it should appear in the statute book, from its inception, that expenditure incurred in connection with income which does not form part of total income ought not to be allowed as a deduction. The factum of making the said provision retrospective makes it clear that Parliament wanted that it should be understood by all that from the very beginning, such expenditure was not allowable as a deduction. 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. 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. Thus, the expression "in relation to" appearing in Section 14 A of the said act cannot be ascribed a narrow or constricted meaning;
++ assessee contended that the words "expenditure incurred" as appearing in section 14A(1) clearly mean that there must be actual expenditure. The said point is not acceptable as the words "in relation to" could not be subscribed to the narrow interpretation. While it is agreed that the expression "expenditure incurred" refers to actual expenditure and not to some imagined expenditure, it is made clear that the `actual' expenditure that is in contemplation u/s 14A(1) of the said Act is the `actual' expenditure in relation to or in connection with or pertaining to exempt income. If no expenditure is incurred in relation to the exempt income, no disallowance can be made under section 14A of the said Act;
++ Sub-section (2) of Section 14A of the said Act provides the manner in which the AO is to determine the amount of expenditure incurred in relation to income which does not form part of the total income only if the AO, 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 the said Act. Therefore, the condition precedent for the AO entering upon a determination of the amount of the expenditure incurred in relation to exempt income is that the AO must record that he is not satisfied with the correctness of the claim of the assessee in respect of such expenditure. Sub-section (3) is nothing but an offshoot of sub-section (2) of Section 14A. Sub-section (3) applies to cases where the assessee claims that no expenditure has been incurred in relation to income which does not form part of the total income under the said Act. In other words, sub-section (2) deals with cases where the assessee specifies a positive amount of expenditure in relation to income which does not form part of the total income under the said Act and sub-section (3) applies to cases where the assessee asserts that no expenditure had been incurred in relation to exempt income. In both cases, AO, if satisfied with the correctness of the claim of the assessee in respect of such expenditure or no expenditure, cannot embark upon a determination of the amount of expenditure in accordance with any prescribed method. It is only if the AO is not satisfied with the correctness of the claim of the assessee, the AO gets jurisdiction to determine the amount of expenditure incurred in relation to such income which does not form part of the total income in accordance with the prescribed method. The prescribed method being the method stipulated in Rule 8D of the said Rules. While rejecting the claim of the assessee with regard to the expenditure or no expenditure, as the case may be, in relation to exempt income, the AO would have to indicate cogent reasons for the same;
++ Rule 8D makes it clear that where the AO, 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 said Act for such previous year, the AO shall determine the amount of the expenditure in relation to such income in accordance with the provisions of sub-rule (2) of Rule 8D. Determination of the amount of expenditure in relation to exempt income under Rule 8D would only come into play when the AO rejects the claim of the assessee in this regard. As per sub-rule (2) of Rule 8D, the method for determining the expenditure in relation to exempt income has three components. The first component is the amount of expenditure directly relating to income which does not form part of the total income. The second component is computed on the basis of the formula given therein in a case where the assessee incurs expenditure by way of interest which is not directly attributable to any particular income or receipt. The formula essentially apportions the amount of expenditure by way of interest [other than the amount of interest included in clause (i)] incurred during the previous year in the ratio of the average value of investment, income from which does not or shall not form part of the total income, to the average of the total assets of the assessee. The third component is an artificial figure – one half percent of the average value of the investment, income from which does not or shall not form part of the total income, as appearing in the balance sheets of the assessee, on the first day and the last day of the previous year. It is the aggregate of these three components which would constitute the expenditure in relation to exempt income and it is this amount of expenditure which would be disallowed under Section 14A of the said Act. It is, therefore, clear that in terms of the said Rule, the amount of expenditure in relation to exempt income has two aspects – (a) direct and (b) indirect. The direct expenditure is straightaway taken into account by virtue of clause (i) of sub-rule (2) of Rule 8D. The indirect expenditure, where it is by way of interest, is computed through the principle of apportionment. And, in cases where the indirect expenditure is not by way of interest, a rule of thumb figure of one half percent of the average value of the investment, income from which does not or shall not form part of the total income, is taken;
++ section 14A, as introduced by virtue of the Finance Act, 2001, was with retrospective effect from 01.04.1962. A proviso was inserted by virtue of the Finance Act, 2002 that nothing in Section 14A empowered the AO to either re-assess u/s 147 or pass an order enhancing the assessment or reducing the refund already made or otherwise increasing the liability of the assessee u/s 154, for any assessment year beginning on or before the first day of April, 2001. Thus, the assessment years prior to the assessment year beginning on or before the 1st day of April, 2001, concluded assessments could not be disturbed despite the fact that Section 14A is retrospective with effect from 01.04.1962. Although sub-sections (2) and (3) had been introduced with effect from 01.04.2007, they remained empty shells inasmuch as the expression "such method as may be prescribed" got meaning only by the introduction of Rule 8D by virtue of the Income-tax (Fifth Amendment) Rules, 2008. If the said Rule were to have retrospective effect, nothing prevented the CBDT from saying so, particularly, in view of the fact that it had the power to make a rule retrospective by virtue of Section 295(4) of the said Act. Instead of making Rule 8D retrospective, clause 1(2) of the Income-tax (Fifth Amendment) Rules, 2008 made it clear that the rules would come into force from the date of their publication in the Official Gazette;
++ section 14A(2) explicitly requires the fulfillment of a condition precedent is also implicit in section 14A(1) as also in its initial avatar as section 14A. It is only the prescription with regard to the method of determining such expenditure which is new and which will operate prospectively. Section 14A, even prior to the introduction of sub-sections (2) & (3) would require the AO to first reject the claim of the assessee with regard to the extent of such expenditure and such rejection must be for disclosed cogent reasons. It is then that the question of determination of such expenditure by the assessing officer would arise. Prior to the specific method of determining such expenditure has been introduced by virtue of sub-section (2) of section 14A, the AO was free to adopt any reasonable and acceptable method;
++ the ITAT had, after upholding the disallowance u/s 14A, restored the matters to the AO with the direction to re-compute the disallowance in accordance with Rule 8D of the said Rules. In some cases, the ITAT deleted the disallowance holding that the earning of dividend was merely incidental to holding of shares and AO had also failed to pinpoint the expenditure actually incurred in respect of the dividend income. However, since Rule 8D would be inapplicable to the assessment years prior to 2008-2009, the AO would have to to satisfy himself with the correctness of the claim of the assessee with regard to such expenditure. If he is satisfied that the assessee has correctly reflected the amount of such expenditure, he has to do nothing further. On the other hand, if he is satisfied on an objective analysis and for cogent reasons that the amount of such expenditure as claimed by the assessee is not correct, he is required to determine the amount of such expenditure on the basis of a reasonable and acceptable method of apportionment.
Facts of the case
Assessee is in the business of finance, investment and of dealing in shares and securities. Assessee held shares and securities, partly as investments on the "capital account" and partly as "trading assets" for acquiring and retaining control over its group companies. Profit resulting on the sale of shares held as trading assets was offered to tax as business income. Assessee claimed interest as business expenditure u/s 36(1)(iii). Assessee contended that the expenditure claimed was not hit by section 14A 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 group company and the receipt of dividend was merely incidental.
AO invoked section 14A and apportioned the interest expenditure in the ratio of investment in shares of group company, on which dividend was received, to the principal amount of unsecured loans and made disallowance u/s 14A. CIT (A) confirmed the order of the AO. ITAT held by constituting a special bench in the case of Daga Capital Management, that the expenditure claimed was hit by the provisions of section 14A. Pursuant to the majority decision of the Special Bench of the Tribunal, the issue of quantum of expenditure to be disallowed was restored to the AO to be recomputed in terms of Rule 8D which was held to be retrospective.
Assessee contended that holding of shares for acquiring and retaining control of operating companies amounts to business and consequently dividend income on such shares was in the nature of business income. The intention behind acquiring such shares was not to earn dividend but to acquire and retain a controlling interest in the operating companies. The dividend was merely incidental. The word "incurred" used in section 14A must be taken literally in the sense that the expenditure must have actually taken place. The expression "in relation to" implies that there must be a direct and proximate connection with the subject matter. 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.
After hearing both the parties, the High Court held that,
++ prior to the introduction of section 14A in the said 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 object behind the insertion of section 14A 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. 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;
++ Sub-section (1) of section 14A clearly stipulates that for the purposes of computing total income under Chapter IV, 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 the said Act. A lot of emphasis was laid on the expressions "incurred" and "in relation to". It is the duty of the court to determine in what particular meaning and particular shade of meaning the word or expression was used by the Constitution makers and in discharging the duty the court will take into account the context in which it occurs The expression "relating to" would depend upon the context in which it occurs. The submission of the assessee that a narrow meaning ought to be ascribed to the expression "in relation to" appearing in section 14A is not acceptable. The provision was inserted by virtue of the Finance Act, 2001 with retrospective effect from 01/04/1962. It was the intention of Parliament that it should appear in the statute book, from its inception, that expenditure incurred in connection with income which does not form part of total income ought not to be allowed as a deduction. The factum of making the said provision retrospective makes it clear that Parliament wanted that it should be understood by all that from the very beginning, such expenditure was not allowable as a deduction. 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. 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. Thus, the expression "in relation to" appearing in Section 14 A of the said act cannot be ascribed a narrow or constricted meaning;
++ assessee contended that the words "expenditure incurred" as appearing in section 14A(1) clearly mean that there must be actual expenditure. The said point is not acceptable as the words "in relation to" could not be subscribed to the narrow interpretation. While it is agreed that the expression "expenditure incurred" refers to actual expenditure and not to some imagined expenditure, it is made clear that the `actual' expenditure that is in contemplation u/s 14A(1) of the said Act is the `actual' expenditure in relation to or in connection with or pertaining to exempt income. If no expenditure is incurred in relation to the exempt income, no disallowance can be made under section 14A of the said Act;
++ Sub-section (2) of Section 14A of the said Act provides the manner in which the AO is to determine the amount of expenditure incurred in relation to income which does not form part of the total income only if the AO, 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 the said Act. Therefore, the condition precedent for the AO entering upon a determination of the amount of the expenditure incurred in relation to exempt income is that the AO must record that he is not satisfied with the correctness of the claim of the assessee in respect of such expenditure. Sub-section (3) is nothing but an offshoot of sub-section (2) of Section 14A. Sub-section (3) applies to cases where the assessee claims that no expenditure has been incurred in relation to income which does not form part of the total income under the said Act. In other words, sub-section (2) deals with cases where the assessee specifies a positive amount of expenditure in relation to income which does not form part of the total income under the said Act and sub-section (3) applies to cases where the assessee asserts that no expenditure had been incurred in relation to exempt income. In both cases, AO, if satisfied with the correctness of the claim of the assessee in respect of such expenditure or no expenditure, cannot embark upon a determination of the amount of expenditure in accordance with any prescribed method. It is only if the AO is not satisfied with the correctness of the claim of the assessee, the AO gets jurisdiction to determine the amount of expenditure incurred in relation to such income which does not form part of the total income in accordance with the prescribed method. The prescribed method being the method stipulated in Rule 8D of the said Rules. While rejecting the claim of the assessee with regard to the expenditure or no expenditure, as the case may be, in relation to exempt income, the AO would have to indicate cogent reasons for the same;
++ Rule 8D makes it clear that where the AO, 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 said Act for such previous year, the AO shall determine the amount of the expenditure in relation to such income in accordance with the provisions of sub-rule (2) of Rule 8D. Determination of the amount of expenditure in relation to exempt income under Rule 8D would only come into play when the AO rejects the claim of the assessee in this regard. As per sub-rule (2) of Rule 8D, the method for determining the expenditure in relation to exempt income has three components. The first component is the amount of expenditure directly relating to income which does not form part of the total income. The second component is computed on the basis of the formula given therein in a case where the assessee incurs expenditure by way of interest which is not directly attributable to any particular income or receipt. The formula essentially apportions the amount of expenditure by way of interest [other than the amount of interest included in clause (i)] incurred during the previous year in the ratio of the average value of investment, income from which does not or shall not form part of the total income, to the average of the total assets of the assessee. The third component is an artificial figure – one half percent of the average value of the investment, income from which does not or shall not form part of the total income, as appearing in the balance sheets of the assessee, on the first day and the last day of the previous year. It is the aggregate of these three components which would constitute the expenditure in relation to exempt income and it is this amount of expenditure which would be disallowed under Section 14A of the said Act. It is, therefore, clear that in terms of the said Rule, the amount of expenditure in relation to exempt income has two aspects – (a) direct and (b) indirect. The direct expenditure is straightaway taken into account by virtue of clause (i) of sub-rule (2) of Rule 8D. The indirect expenditure, where it is by way of interest, is computed through the principle of apportionment. And, in cases where the indirect expenditure is not by way of interest, a rule of thumb figure of one half percent of the average value of the investment, income from which does not or shall not form part of the total income, is taken;
++ section 14A, as introduced by virtue of the Finance Act, 2001, was with retrospective effect from 01.04.1962. A proviso was inserted by virtue of the Finance Act, 2002 that nothing in Section 14A empowered the AO to either re-assess u/s 147 or pass an order enhancing the assessment or reducing the refund already made or otherwise increasing the liability of the assessee u/s 154, for any assessment year beginning on or before the first day of April, 2001. Thus, the assessment years prior to the assessment year beginning on or before the 1st day of April, 2001, concluded assessments could not be disturbed despite the fact that Section 14A is retrospective with effect from 01.04.1962. Although sub-sections (2) and (3) had been introduced with effect from 01.04.2007, they remained empty shells inasmuch as the expression "such method as may be prescribed" got meaning only by the introduction of Rule 8D by virtue of the Income-tax (Fifth Amendment) Rules, 2008. If the said Rule were to have retrospective effect, nothing prevented the CBDT from saying so, particularly, in view of the fact that it had the power to make a rule retrospective by virtue of Section 295(4) of the said Act. Instead of making Rule 8D retrospective, clause 1(2) of the Income-tax (Fifth Amendment) Rules, 2008 made it clear that the rules would come into force from the date of their publication in the Official Gazette;
++ section 14A(2) explicitly requires the fulfillment of a condition precedent is also implicit in section 14A(1) as also in its initial avatar as section 14A. It is only the prescription with regard to the method of determining such expenditure which is new and which will operate prospectively. Section 14A, even prior to the introduction of sub-sections (2) & (3) would require the AO to first reject the claim of the assessee with regard to the extent of such expenditure and such rejection must be for disclosed cogent reasons. It is then that the question of determination of such expenditure by the assessing officer would arise. Prior to the specific method of determining such expenditure has been introduced by virtue of sub-section (2) of section 14A, the AO was free to adopt any reasonable and acceptable method;
++ the ITAT had, after upholding the disallowance u/s 14A, restored the matters to the AO with the direction to re-compute the disallowance in accordance with Rule 8D of the said Rules. In some cases, the ITAT deleted the disallowance holding that the earning of dividend was merely incidental to holding of shares and AO had also failed to pinpoint the expenditure actually incurred in respect of the dividend income. However, since Rule 8D would be inapplicable to the assessment years prior to 2008-2009, the AO would have to to satisfy himself with the correctness of the claim of the assessee with regard to such expenditure. If he is satisfied that the assessee has correctly reflected the amount of such expenditure, he has to do nothing further. On the other hand, if he is satisfied on an objective analysis and for cogent reasons that the amount of such expenditure as claimed by the assessee is not correct, he is required to determine the amount of such expenditure on the basis of a reasonable and acceptable method of apportionment.
No comments:
Post a Comment