Expenditure with No Causal Connection to Exempted Income Treated as Business Expenditure, Rules Supreme Court.

Section 14A (of Income Tax Act, 1961) states that if an expenditure is incurred in earning income that is exempt from tax, such expenditure shall not be allowed as a deduction. The purpose behind this provision is to prevent taxpayers from obtaining double benefits. However, the Supreme Court has clarified that if an expenditure incurred has no causal connection with the exempted income, then such expenditure would be treated as not related to the income that is exempted from tax. In such cases, the expenditure would be allowed as a business expenditure. The court emphasized that the dominant intention or purpose of incurring the expenditure is relevant in determining whether it is related to the exempted income. The decision was made in a case where the expenditure was incurred for acquiring shares for the purpose of gaining control over a company or for trading purposes, and incidentally, dividend income was also generated. The court held that the expenditure in such cases cannot be considered as related to the dividend income, and therefore, it can be allowed as a deduction. The case involves the interpretation of Section 14A (of Income Tax Act, 1961), which deals with the disallowance of expenditure incurred in relation to income that is not includible in the total income. The Special Bench of the Income Tax Appellate Tribunal (ITAT) held that interest expenditure incurred for acquiring shares in group companies was hit by the provisions of Section 14A (of Income Tax Act, 1961). The majority opinion of the Special Bench was that there is no requirement of a direct and proximate connection between the expenditure and the exempt income. However, the minority view stated that there must be a dominant and immediate connection between the expenditure and the dividend income for Section 14A (of Income Tax Act, 1961) to be applicable. The case was appealed to the High Court of Delhi, which held that the expression "in relation to" in Section 14A (of Income Tax Act, 1961) is synonymous with "in connection with" or "pertaining to," and that the provisions of Section 14A (of Income Tax Act, 1961) apply regardless of the intention or motive behind making the investment. The court maintained the proportionate disallowance of the expenditure incurred by the assessee. It is worth noting that the Punjab and Haryana High Court has taken a different view in a recent judgment, following the High Court of Karnataka's decision. Due to the conflict of opinions among various High Courts, these appeals have been filed by the assessees who were unsuccessful before the High Court and by the Income Tax Department against judgments favorable to the assessee. The relevant statutory provisions, including Section 14A (of Income Tax Act, 1961) and Rule 8D (of Income Tax Rules, 1962), are discussed in detail. Rule 8D (of Income Tax Rules, 1962) provides the method for determining the amount of expenditure in relation to income not includible in the total income. The judgments of the Delhi High Court in Maxopp Investment Ltd. and the Punjab and Haryana High Court in State Bank of Patiala are examined in light of the statutory scheme. In the Maxopp Investment Ltd. case, the High Court of Delhi considered three questions, with the first question being relevant to the present appeals. The question was whether the expenditure, including interest paid on funds borrowed, in respect of investment in shares of operating companies for acquiring and retaining controlling interest is hit by Section 14A (of Income Tax Act, 1961). The court noted that the assessee company was engaged in finance, investment, and dealing in shares and securities. The assessee held shares and securities as investments on the capital account and as trading assets for acquiring and retaining control over its group companies, particularly Max India Ltd. The assessee claimed that the expenditure incurred was not hit by Section 14A (of Income Tax Act, 1961) because the investment in shares was made with the intention to acquire and retain controlling interest, and the receipt of dividend was incidental. The High Court discussed the legislative history of Section 14A (of Income Tax Act, 1961) and Rule 8D (of Income Tax Rules, 1962). It noted that prior to the insertion of Section 14A (of Income Tax Act, 1961), the law stated that when an assessee had a composite and indivisible business with elements of both taxable and non-taxable income, the entire expenditure in respect of the business was deductible. However, if the business was divisible, the principle of apportionment of expenditure was applicable, and the expenditure apportioned to the exempt income was not deductible. The court referred to the legislative intent behind the insertion of Section 14A (of Income Tax Act, 1961), as explained in the Memorandum Explaining the Provisions of the Finance Bill, 2001. The objective was to prevent the deduction of expenses incurred in relation to exempt income and to ensure that expenses are allowed only to the extent they are relatable to the earning of taxable income. The court cited the Supreme Court's observations in the case of CIT v. Walfort Share and Stock Brokers P Ltd., which clarified that expenses incurred can only be allowed to the extent they are relatable to the earning of taxable income and not exempt income. The High Court emphasized that Section 14A (of Income Tax Act, 1961) applies to expenses incurred in relation to income that does not form part of the total income. It clarified that if an income does not form part of the total income, then the related expenditure is outside the ambit of the applicability of Section 14A (of Income Tax Act, 1961). This summary focuses on the discussion and interpretation of Section 14A (of Income Tax Act, 1961) in the Maxopp Investment Ltd. case by the High Court of Delhi. In the Maxopp Investment Ltd. case, the High Court of Delhi discussed the interpretation of the expressions "in relation to" and "expenditure incurred" in Section 14A (of Income Tax Act, 1961). The court rejected the contention that the word "incurred" should be taken literally to mean actual expenditure and that there must be a direct and proximate connection with the exempt income. Instead, the court referred to previous judgments that emphasized the expansive meaning of the expressions "in relation to" and "pertaining to" used in deeming provisions. The court also highlighted the principle that expenses incurred can only be allowed to the extent they are relatable to the earning of taxable income, and the same principle applies to the exemption of income. Therefore, if income does not form part of the total income, the associated expenditure cannot be debited against taxable income. The High Court clarified that "expenditure incurred" refers to actual expenditure in relation to or in connection with exempt income. If no expenditure is incurred in relation to the exempt income, no disallowance can be made under Section 14A (of Income Tax Act, 1961). Based on this interpretation, the High Court answered the question in the affirmative, stating that the expenditure incurred by the assessees could be disallowed under Section 14A (of Income Tax Act, 1961). In the State Bank of Patiala case, which was considered by the Punjab and Haryana High Court, the issue was whether Section 14A (of Income Tax Act, 1961) applied to a bank earning exempt income in the form of dividend from securities held as stock in trade. The High Court accepted the contention that the bank was engaged in the purchase and sale of shares as a trader to earn profit, and the securities constituted its stock in trade. The court referred to a circular issued by the Central Board of Direct Taxes (CBDT), which stated that income arising from investments made by a banking concern is attributable to the business of banking and falls under the head "Profits and gains of business and profession." Based on this analysis, the High Court held that Section 14A (of Income Tax Act, 1961) was not applicable, and the disallowance made by the assessing officer was deleted. This summary focuses on the interpretations of Section 14A (of Income Tax Act, 1961) in the Maxopp Investment Ltd. case by the High Court of Delhi and in the State Bank of Patiala case by the Punjab and Haryana High Court. In the Maxopp Investment Ltd. case, the High Court recognized the distinction between stock-in-trade and investment. It referred to a circular issued by the CBDT, which stated that income arising from investments made by a banking concern is attributable to the business of banking and falls under the head "Profits and gains of business and profession." The court held that if shares and securities are treated as stock-in-trade, the income derived from them would be business income, and Section 14A (of Income Tax Act, 1961) would not be applicable. The court emphasized that the purpose of purchasing the securities was to earn profits from trading, and any expenditure incurred was for the purchase and sale of the stock-in-trade, not for earning dividend or interest income. Therefore, no expenditure could be disallowed under Section 14A (of Income Tax Act, 1961) in relation to the exempt income. The High Court also referred to the judgment in Walfort Share and Stock Brokers P Ltd., which held that payback does not constitute an "expenditure incurred" under Section 14A (of Income Tax Act, 1961). The court concluded that the entire expenditure, including administrative costs, was incurred for the purchase and sale of the stock-in-trade, irrespective of whether the securities yielded any income. The High Court concurred with the judgments of the Karnataka High Court and the Calcutta High Court, which held that if no expenditure is incurred in earning dividend income, no notional expenditure can be deducted. In the State Bank of Patiala case, the Punjab and Haryana High Court held that if a banking institution treats shares and securities as stock-in-trade, the provisions of Section 14A (of Income Tax Act, 1961) are not applicable. The court referred to Circular No.18 issued by the CBDT, which clarified that income arising from investments made by a banking concern is attributable to the business of banking and falls under the head "Profits and gains of business and profession." The court emphasized that the purpose of the purchase and sale of shares was to earn profit, not to earn interest or dividend income. The court concluded that no disallowance could be made under Section 14A (of Income Tax Act, 1961) as the expenditure was incurred for the purchase and sale of the stock-in-trade. In both cases, the courts emphasized the distinction between stock-in-trade and investment and held that if the securities were treated as stock-in-trade, the provisions of Section 14A (of Income Tax Act, 1961) would not apply. In the present case, the main issue is whether the dominant purpose test or the theory of apportionment should be applied while interpreting Section 14A (of Income Tax Act, 1961). The assessees argue that the dominant purpose for investing in shares, such as gaining control over the investee company, should determine the applicability of Section 14A (of Income Tax Act, 1961). However, the court opines that the dominant purpose may not be relevant in this context. The crucial factor is that the dividend income is non-taxable. If expenditure is incurred to earn the dividend income, the portion of expenditure attributable to the dividend income should be disallowed and cannot be treated as business expenditure. The court emphasizes that Section 14A (of Income Tax Act, 1961) is based on the principle of apportionment of expenses. The provision aims to exclude both the exempt income and the expenditure directly related to that income from the computation of assessable income, to prevent double benefit to the assessee. Therefore, the words "in relation to" in Section 14A (of Income Tax Act, 1961) should be interpreted to require a direct and proximate nexus between the incurred expenditure and the earning of exempt income. The court refers to the judgment in Walfort Share and Stock Brokers P Ltd., which supports the principle of apportionment. It states that if an income does not form part of the total income, the related expenditure is outside the ambit of Section 14A (of Income Tax Act, 1961). The theory of apportionment of expenditure between taxable and non-taxable income has been expanded under Section 14A (of Income Tax Act, 1961). Based on these considerations, the court concludes that the principle of apportionment should be applied in interpreting Section 14A (of Income Tax Act, 1961). If expenditure is incurred to earn dividend income that is non-taxable, the portion of expenditure attributable to the dividend income should be disallowed as it is not business expenditure. This interpretation aligns with the objective of Section 14A (of Income Tax Act, 1961) to prevent the double benefit of exempt income and deduction for related expenditure. Overall, the court rejects the dominant purpose test and emphasizes the principle of apportionment for determining the disallowance of expenditure under Section 14A (of Income Tax Act, 1961). In summary, the Supreme Court concludes that the dominant purpose test is not applicable in interpreting Section 14A (of Income Tax Act, 1961). The court upholds the principle of apportionment of expenditure between taxable and non-taxable income. In cases where shares are held as investment to gain control over the investee company, the dividend income is not considered the dominant purpose, and the expenditure incurred in acquiring those shares needs to be apportioned. On the other hand, when shares are held as stock-in-trade for trading purposes, the dividend income earned incidentally is exempt under Section 10(34) (of Income Tax Act, 1961). Therefore, the expenditure incurred in acquiring those shares must be apportioned under Section 14A (of Income Tax Act, 1961). The court affirms the judgment of the Delhi High Court, which holds that prior to the introduction of Section 14A (of Income Tax Act, 1961), the entire expenditure in respect of a composite and indivisible business was deductible, and the principle of apportionment did not apply. The court rejects the dominant purpose theory applied by the Punjab and Haryana High Court. The court also refers to a circular issued by the Central Board of Direct Taxes (CBDT), which distinguishes between stock-in-trade and investment and clarifies that if the motive behind the purchase and sale of shares is to earn a profit, it is treated as trading profit, and if the object is to derive income by way of dividend, it is treated as income from investment. The court emphasizes that the Assessing Officer (AO) must record satisfaction before applying the theory of apportionment, particularly when the assessee has already apportioned the expenditure in their return and the AO disagrees with the apportionment. The nature of the loan taken by the assessee for purchasing shares or making investments should also be examined by the AO. The court dismisses the appeals of the assessees, upholds the dismissal of certain appeals by the Punjab and Haryana High Court, and allows one appeal filed by the Revenue. It clarifies that Rule 8D (of Income Tax Rules, 1962) is prospective in nature and cannot be applied to assessment years prior to its introduction in 2007. Overall, the court provides clarity on the interpretation and application of Section 14A (of Income Tax Act, 1961), affirming the principle of apportionment of expenditure and rejecting the dominant purpose test.

Chapter IV of the Income Tax Act deals with the computation of total income, and Section 14A (of Income Tax Act, 1961) clarifies that no deduction shall be allowed in respect of expenditure incurred in relation to income that does not form part of the total income. The purpose of this provision is to prevent double benefit for the taxpayer when certain income is exempted from tax.

Section 14A (of Income Tax Act, 1961) was inserted by the Finance Act, 2001, and it was given retrospective effect from April 1, 1962. The provision states that if any expenditure is incurred to earn income that is not included in the total income, such expenditure shall not be allowed as a deduction. This ensures that the taxpayer does not claim a deduction for the expenditure incurred in earning exempted income.

The issue in these appeals arises when shares are purchased for purposes other than earning dividend income, such as gaining control over a company or trading as stock-in-trade. However, incidental dividend income is also generated. The question is whether the expenditure incurred can be treated as expenditure "in relation to" the dividend income that does not form part of the total income. The dominant intention or main object behind the purchase of shares becomes relevant in determining the relationship between the expenditure and the dividend income.

In Civil Appeal Nos. 104-109 of 2015, the appellant company is engaged in finance, investment, and dealing in shares. The appellant holds shares in two portfolios: as an investment on capital account and as trading assets for acquiring and retaining control over investee group companies. The appellant treated the profit/loss from the sale of shares held as investment as capital gains and offered the profit/loss from the sale of shares held as trading assets as business income.

The appellant claimed that the shares held for acquiring and retaining control over investee companies were not purchased with the motive of earning dividends but to maintain controlling interest. Therefore, the dividend income earned on those shares was incidental. The Assessing Officer disallowed a portion of the interest expenditure under Section 14A (of Income Tax Act, 1961), but the disallowance was restricted to the amount of dividend received and claimed exempt.

Overall, the appeals raise the question of whether the expenditure incurred can be considered "in relation to" the dividend income when the dominant intention behind purchasing the shares is not to earn dividends. The court will consider the interpretation and application of Section 14A (of Income Tax Act, 1961) in these scenarios.

This portion of the case involves the appeals and decisions made by various courts regarding the interpretation of Section 14A (of Income Tax Act, 1961). After the Commissioner of Income Tax (Appeals) upheld the order of the Assessing Officer (AO) disallowing certain expenditures incurred by the appellant, the matter was taken to the Income Tax Appellate Tribunal (ITAT).

Due to conflicting decisions on the interpretation of Section 14A (of Income Tax Act, 1961), a Special Bench was constituted to hear the appeals, including the appellant's case. The Special Bench, in the case of Daga Capital Management (Private) Ltd., held that investment in shares representing controlling interest did not amount to carrying on a business and that interest expenditure incurred for acquiring such shares was hit by Section 14A (of Income Tax Act, 1961). The majority opinion of the Special Bench stated that there need not be a direct and proximate connection between the expenditure and the exempt income. The minority view held that a dominant and immediate connection was necessary to invoke Section 14A (of Income Tax Act, 1961).

The appellant appealed to the Delhi High Court against the order of the Special Bench. The High Court, in its judgment, held that the expression 'in relation to' in Section 14A (of Income Tax Act, 1961) was synonymous with 'in connection with' or 'pertaining to', and that the provisions of the section applied regardless of the intention or motive behind the investment. The High Court maintained the proportionate disallowance of the expenditure incurred by the assessee.

It is noted that the Punjab and Haryana High Court, in a recent judgment in the case of State Bank of Patiala, took a different view from the Delhi High Court. The Punjab and Haryana High Court followed the judgment of the High Court of Karnataka in CCI Ltd. v. Joint Commissioner of Income Tax, Udupi Range. Due to this conflict of opinions among the High Courts, these appeals were filed by both the assessees who were unsuccessful before the High Court and the Income Tax Department against the judgments favoring the assessees.

This portion provides an overview of the relevant statutory provisions, namely Section 14A (of Income Tax Act, 1961) and Rule 8D (of Income Tax Rules, 1962). Section 14A (of Income Tax Act, 1961) deals with the disallowance of expenditure incurred in relation to income that is not includible in the total income under the Act. Sub-section (2) of Section 14A (of Income Tax Act, 1961) empowers the Assessing Officer to determine the amount of expenditure in relation to such income, in accordance with the method prescribed in Rule 8D (of Income Tax Rules, 1962).

Rule 8D (of Income Tax Rules, 1962) provides the methodology for determining the amount of expenditure in relation to income not included in the total income. It specifies that such expenditure includes the amount directly relating to income that does not form part of the total income, as well as an amount computed based on the average value of investments and total assets.

The judgments of the Delhi High Court in Maxopp Investment Ltd. and the Punjab and Haryana High Court in State Bank of Patiala are discussed. The Delhi High Court considered the question of whether expenditure, including interest paid on borrowed funds, in relation to investments in shares for acquiring and retaining controlling interest is hit by Section 14A (of Income Tax Act, 1961). The court referred to the legislative intent behind Section 14A (of Income Tax Act, 1961) and the objective of preventing the deduction of expenses incurred to earn exempt income. It noted the principle of apportionment of expenditure in cases of composite and divisible businesses.

The High Court discussed the objectives behind the insertion of Section 14A (of Income Tax Act, 1961), as stated in the Memorandum explaining the provisions of the Finance Bill 2001. The objective was to prevent deductions in respect of exempt income and ensure that expenses are allowed only to the extent they are related to the earning of taxable income.

Given the conflicting views of the Delhi High Court and the Punjab and Haryana High Court, these appeals were filed to resolve the differences in interpretation and determine the applicability of Section 14A (of Income Tax Act, 1961) in cases where expenditure is incurred in relation to income not includible in the total income.

In this portion, the judgments of the Supreme Court in CIT v. Walfort Share and Stock Brokers P Ltd and the judgments of the Delhi High Court in Maxopp Investment Ltd and the Punjab and Haryana High Court in State Bank of Patiala are discussed.

The Supreme Court in CIT v. Walfort Share and Stock Brokers P Ltd observed that the insertion of Section 14A (of Income Tax Act, 1961) reflects the intention of Parliament not to allow the deduction of any expenditure incurred in relation to income that does not form part of the total income. It clarified that expenses can only be allowed to the extent that they are related to the earning of taxable income. The court emphasized that if an income does not form part of the total income, the expenditure/deduction, even if of a nature specified in sections 15 to 59 of the Act, cannot be allowed against other income included in the total income.

The Delhi High Court in Maxopp Investment Ltd analyzed the provisions of Section 14A (of Income Tax Act, 1961) and interpreted the expressions 'in relation to' and 'expenditure incurred' occurring in the section. It disagreed with the contention that the word 'incurred' should be taken literally to mean actual expenditure, stating that the 'actual' expenditure contemplated under Section 14A (of Income Tax Act, 1961) is the expenditure in relation to or in connection with exempt income. The court concluded that if no expenditure is incurred in relation to the exempt income, no disallowance can be made under Section 14A (of Income Tax Act, 1961).

The Punjab and Haryana High Court in State Bank of Patiala considered a case where a bank earned exempt income in the form of dividend from securities held as stock-in-trade. The court accepted the bank's contention that it was engaged in the purchase and sale of shares as a trader with the objective of earning a profit. It held that the disallowance under Rule 8D (of Income Tax Rules, 1962) would be nil if shares are held as stock-in-trade and not as investment, as Rule 8D(2)(i) (of Income Tax Rules, 1962) would be confined to direct expenses for earning tax-exempt income.

The circular issued by the CBDT was also referred to, which clarified that income arising from investments made by a banking concern is attributable to the business of banking and falls under the head "Profits and Gains of Business and Profession."

These judgments provide insights into the interpretation and application of Section 14A (of Income Tax Act, 1961) in determining the disallowance of expenditure incurred in relation to income that does not form part of the total income.

In this portion, the High Court discusses the distinction between stock-in-trade and investment and the application of Section 14A (of Income Tax Act, 1961) in relation to dividend and interest income earned from securities held as stock-in-trade.

The High Court refers to a circular issued by the CBDT, which states that if the motive behind the purchase and sale of shares is to earn a profit, it would be treated as trading profit, and if the objective is to derive income through dividends, it would be considered income from investment. The High Court observes that if the shares and securities are treated as stock-in-trade, the income arising from them would be business income, and any expenditure incurred in relation to the stock-in-trade would be deductible under sections 28 (of Income Tax Act, 1961) to 37 of the Act.

The court further discusses the judgment in CIT v. Nawanshahar Central Co-operative Bank Ltd., which held that banking institutions are required to place a part of their funds in approved securities. Since the securities purchased by the assessees constituted their stock-in-trade, the provisions of Section 14A (of Income Tax Act, 1961) were not applicable.

The High Court then analyzes the judgment in CIT v. Walfort Share and Stock Brokers P Ltd., which dealt with dividend stripping. It notes that the expenditure to be disallowed under Section 14A (of Income Tax Act, 1961) is the expenditure incurred to "earn" exempt income. The court concludes that if the purpose of purchasing the securities was not to earn dividend and interest income but to earn profits from trading, the entire expenditure, including administrative costs, was incurred for the purchase and sale of the stock-in-trade and not in relation to the exempt income.

The High Court refers to the judgments of the Karnataka High Court in CCI Ltd. and the Calcutta High Court in Commissioner of Income Tax v. G.K.K. Capital Markets(P.) Ltd., both of which agreed with the view that if no expenditure is incurred in earning dividend income and the dividend income is incidental to the business, the expenditure cannot be disallowed under Section 14A (of Income Tax Act, 1961).

These judgments emphasize that the disallowance under Section 14A (of Income Tax Act, 1961) applies only to expenditure incurred in relation to income exempt from tax, and if the shares and securities are treated as stock-in-trade, the expenditure incurred for trading purposes cannot be disallowed.

In this portion, the High Court discusses the arguments presented by the assessees and the Revenue.

The assessees argue that when shares are acquired for the purpose of acquiring controlling interest in a company, the objective is to maintain control over the management and not specifically to earn dividends. Therefore, they contend that no expenditure was incurred in relation to the dividend income, and Section 14A (of Income Tax Act, 1961) should not be applicable. They argue that Section 14A (of Income Tax Act, 1961) should be interpreted to require a direct and proximate nexus between the expenditure incurred and the earning of exempt income. They also highlight that the legislative intention behind Section 14A (of Income Tax Act, 1961) was to exclude both exempt income and related expenditure from the computation of assessable income.

On the other hand, the Revenue argues in favor of the view taken by the Delhi High Court. They emphasize that the objective of Section 14A (of Income Tax Act, 1961) is to disallow expenditure incurred in relation to income exempt from tax. They contend that interpreting the provision expansively aligns with this objective and prevents double benefits for the assessee.

The Revenue points out that the Supreme Court's judgment in Walfort Share and Stock Brokers P Ltd. supports the disallowance of expenditure related to exempt income. They argue that the expression "in relation to" in Section 14A (of Income Tax Act, 1961) should be given a broad meaning to serve the purpose of the provision.

Both sides present their respective interpretations of Section 14A (of Income Tax Act, 1961) and its objective, with the assessees advocating for a limited interpretation and the Revenue supporting a broader interpretation that disallows expenditure related to exempt income.

In this section, the court addresses the arguments presented by both sides and provides its analysis.

The court clarifies that Section 14A (of Income Tax Act, 1961) disallows the deduction of expenditure incurred "in relation to income which does not form part of the total income." It emphasizes that only expenditure with a causal connection to the exempted income should be disallowed, while expenditure unrelated to the exempted income can be allowed as a business expenditure.

The court notes that all High Courts, including the Delhi High Court and the Punjab and Haryana High Court, have agreed on this interpretation of Section 14A (of Income Tax Act, 1961). The court explains that the objective of Section 14A (of Income Tax Act, 1961) is to apportion expenses between taxable and non-taxable income. It quotes the Walfort Share and Stock Brokers P Ltd. case, which highlights the principle of apportionment of expenditure under Section 14A (of Income Tax Act, 1961).

The court disagrees with the dominant purpose test proposed by the assessees and adopts the principle of apportionment. It states that Section 14A (of Income Tax Act, 1961) was introduced to address the issue of composite and indivisible businesses with both taxable and non-taxable income. The court supports the Delhi High Court's view that the principle of apportionment applies even when the dominant purpose of investing in shares is to gain control over the investee company.

Regarding shares held as stock-in-trade, the court mentions Circular No. 18/2015 issued by the CBDT. The circular cites the Nawanshahar case and clarifies that income from investments made by banking institutions falls under the head "profits and gains of business and profession." The circular states that no appeals should be filed on this ground, and if any appeals are already filed, they should be withdrawn. The court highlights that this circular applies not only to co-operative societies/banks but also to all banks and commercial banks regulated by the Banking Regulation Act, 1949.

Based on this analysis, the court concludes that the dominant purpose test is not applicable, and the principle of apportionment should be followed. The appeals related to shares held for controlling interest purposes are dismissed. The court also acknowledges the CBDT circular regarding shares held as stock-in-trade by banking institutions.

In this section, the court discusses the treatment of shares held as stock-in-trade and the apportionment of expenditure.

The court agrees with the Punjab and Haryana High Court's observation that there is a distinction between stock-in-trade and investment. If the shares are held as stock-in-trade, the main purpose is to trade and earn profits, but any incidental dividend income earned is exempt from tax. Therefore, Section 14A (of Income Tax Act, 1961), which is based on the theory of apportionment, applies, and the expenditure incurred in acquiring those shares needs to be apportioned based on the facts of each case.

The court notes that in cases where shares are held as stock-in-trade, the focus is on liquidating the shares to earn profits, and whether dividend income is earned becomes immaterial. The court distinguishes this situation from cases where the assessee holds shares to retain control over the investee company and expects to earn dividend income. The court explains that the apportionment of expenditure applies when shares are held as stock-in-trade, as per the principle established in the Walfort Share and Stock Brokers P Ltd. case.

The court acknowledges that the Assessing Officer (AO) should record satisfaction before applying the theory of apportionment, especially when the assessee has already apportioned the expenditure but the AO does not accept it. The nature of the loan taken by the assessee for purchasing the shares/investment in shares should also be examined by the AO.

The court upholds the decision of the Punjab and Haryana High Court in the State Bank of Patiala cases, where the AO had already restricted the disallowance based on the exempt income claimed by the assessee. The court states that the CIT(A) was incorrect in disallowing the entire deduction of expenditure and agrees with the ITAT's decision to set aside the disallowance.

The court clarifies that Rule 8D (of Income Tax Rules, 1962) is prospective in nature and cannot be applied to assessment years prior to 2007. This view has already been upheld by the court in previous cases.

Based on these considerations, the court dismisses the appeals filed by the assessees, as well as the appeals filed by the Revenue, except for one appeal where the Revenue's case is allowed.

Overall, the court provides clarity on the treatment of shares held as stock-in-trade and emphasizes the application of the theory of apportionment in determining the disallowance of expenditure under Section 14A (of Income Tax Act, 1961).

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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 (of Income Tax Act, 1961) 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 of income and, therefore, no taxes levied on such exempted incomes. It is in this backdrop, Section 14A (of Income Tax Act, 1961) 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 (of Income Tax Act, 1961) 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 (of Income Tax Act, 1961) - 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 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 Income Tax Act, 1961), 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 ‘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.

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 Income Tax Act, 1961) 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 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) (of Income Tax Act, 1961) worked out disallowance under Section 14A (of Income Tax Act, 1961) 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 Income Tax Act, 1961), 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, 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 Income Tax Act, 1961). 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 Income Tax Act, 1961) 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 Income Tax Act, 1961). It was accordingly held, as per the minority, that mere receipt of dividend income, incidental to the holding of shares, in the case of a dealer in shares, would not be sufficient for invoking provisions of Section 14A (of Income Tax Act, 1961).

9) Against the aforesaid order of the Special Bench, the appellant preferred appeal under Section 260A (of Income Tax Act, 1961) 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 Income Tax Act, 1961) was synonymous with ‘in connection with’ or ‘pertaining to’, and, that the provisions of that Section apply regardless of the intention/motivebehind 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 Patiala2 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 Range3 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 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 Income Tax Act, 1961), we reproduce Section 14A (of Income Tax Act, 1961) 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 (of Income Tax Act, 1961) or pass an order enhancing the assessment or reducing a refund already made or otherwise increasing the liability of the assessee under section 154 (of Income Tax Act, 1961), for any assessment year beginning on or before the 1st day of April, 2001.”

12) Sub-section (2) of Section 14A (of Income Tax Act, 1961) 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 Income Tax Rules, 1962) (for short ‘Rules’) which Rule was inserted w.e.f. March 24, 2008 vide Income Tax (Fifth Amendment) Rules, 20084. We, thus, reproduce Rule 8D (of Income Tax Rules, 1962) hereunder:

(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 (of Income Tax Rules, 1962) is prospective in nature.

(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 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 Income Tax Act, 1961) inasmuch as the dividend received on such shares does not form part of the total income?”

The High Court then took note of legislative history of Section 14A (of Income Tax Act, 1961) and Rule 8D (of Income Tax Rules, 1962). Thereafter, the Court went on to discuss the law which stood prior to insertion of Section 14A (of Income Tax Act, 1961). Taking note of certain judgments, the High Court observed that prior to the insertion of Section 14A (of Income Tax Act, 1961) 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 (of Income Tax Act, 1961) 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 (of Income Tax Act, 1961) 15. The object behind the insertion of section 14A (of Income Tax Act, 1961) in the said Act is apparent from the Memorandum explaining the provisions of the Finance Bill 2001 which is to the following effect:-

It is proposed to insert a new section 14A (of Income Tax Act, 1961) 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 (of Income Tax Act, 1961) 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 (of Income Tax Act, 1961) 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 (of Income Tax Act, 1961), the expenditure incurred in respect of exempt income was being claimed against taxable income. The mandate of section 14A (of Income Tax Act, 1961) is clear. It desires to curb the practice to claim deduction of expenses incurred in relation to exempt income against taxable income and at the same time avail of the tax incentive by way of 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 (of Income Tax Act, 1961). In section 14A (of Income Tax Act, 1961), 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 (of Income Tax Act, 1961). 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 (of Income Tax Act, 1961).. (Emphasis supplied)”

“Further, section 14 (of Income Tax Act, 1961) 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 section 14 (of Income Tax Act, 1961) A. (emphasis supplied)”

16) The High Court then undertook the exercise of analysing the provisions of Section 14A (of Income Tax Act, 1961) 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 Income Tax Act, 1961). 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 Income Tax Act, 1961) provided it was otherwise allowable under sections 15 (of Income Tax Act, 1961) 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 High Court, instead, referred to the judgment in the case of Doypack Systems Pvt. Ltd. v. Union of India5 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. 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 Income Tax Act, 1961) 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 Income Tax Act, 1961) of the said Act. On the basis of the aforesaid discussion, the High Court answered the question formulated by it in the affirmative.

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) (of Income Tax Act, 1961) and (35) of about Rs.11.07 crores and net interest income exempt under section 10(15)(iv)(h) (of Income Tax Act, 1961) 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 (of Income Tax Act, 1961) was not applicable. The AO restricted the disallowance to the amount which was claimed as exempt income by applying the formula contained in Rule 8D (of Income Tax Rules, 1962) holding that Section 14A (of Income Tax Act, 1961) would be applicable. The CIT(A) issued notice of enhancement under Section 251 (of Income Tax Act, 1961) and held that in view of Section 14A (of Income Tax Act, 1961), 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 (of Income Tax Rules, 1962) would be nil as rule 8D(2)(i) (of Income Tax Rules, 1962) 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 Income Tax Act, 1961)?”

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:-

2. Clause (id) of sub-section (1) of Section 56 (of Income Tax Act, 1961) 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”.

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 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 (of Income Tax Act, 1961) were not applicable. Here, the Court noted distinction between stock-in-trade and investment and made the following observations:

“17. Under section 14A (of Income Tax Act, 1961), 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 (of Income Tax Act, 1961) 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 Income Tax Act, 1961) (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 (of Income Tax Act, 1961) 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) expenditure incurred to “earn” exempt income. The words ‘in relation to’ in Section 14A (of Income Tax Act, 1961) 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.”

“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 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 Income Tax Act, 1961). 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 Income Tax Rules, 1962) would not apply. On the questions whether the Appellate Tribunal was justified in deleting the disallowance under Section 14A (of Income Tax Act, 1961) computed in accordance with Rule 8D (of Income Tax Rules, 1962) 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 Income Tax Act, 1961) and that provision had no application.

“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 Income Tax Rules, 1962) 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 Income Tax Act, 1961) was enacted to overcome those judicial pronouncements. The object of section 14A (of Income Tax Act, 1961) 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 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 head “income from other sources”, in view of the mandatory prescription in Section 56 (of Income Tax Act, 1961), 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 Income Tax Act, 1961), 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 Income Tax Act, 1961) (prior to introduction of Section 14A (of Income Tax Act, 1961)).

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 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 (of Income Tax Act, 1961) would not be attracted. In this hue, it was submitted that Section 14A (of Income Tax Act, 1961) 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 (of Income Tax Act, 1961) 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 insertion of Section 14A (of Income Tax Act, 1961) 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 Income Tax Act, 1961) pointed towards that and that was equally the purpose behind the insertion of Section 14A (of Income Tax Act, 1961) 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 Income Tax Act, 1961), deduction of that expenditure is not to be allowed which has been incurred by the assessee “in relation to income which does not form part of the total income under this Act”. Axiomatically, it is that expenditure alone which has been incurred in relation to the income which is includible in total income that has to be disallowed. If an expenditure incurred has no causal connection with the exempted income, then such an expenditure would obviously be treated as not related to the income that is exempted from tax, and such expenditure would be allowed as business expenditure. 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 Income Tax Act, 1961). 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 Income Tax Act, 1961). 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) 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 Income Tax Act, 1961) 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 Income Tax Act, 1961) 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 Income Tax Act, 1961). 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.

The theory of apportionment of expenditure between taxable and non-taxable has, in principle, been now widened under section 14 (of Income Tax Act, 1961) A.”

35) The Delhi High Court, therefore, correctly observed that prior to introduction of Section 14A (of Income Tax Act, 1961), 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 (of Income Tax Act, 1961) 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 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 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 Income Tax Act, 1961) 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 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 Income Tax Act, 1961), 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 Income Tax Act, 1961) 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 Income Tax Rules, 1962) and holding that section 14A (of Income Tax Act, 1961) 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 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 hereinabove.

41) Having regard to the language of Section 14A(2) (of Income Tax Act, 1961), read with Rule 8D (of Income Tax Rules, 1962), 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 (of Income Tax Act, 1961) 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 Income Tax Act, 1961) read with Rule 8D (of Income Tax Rules, 1962) 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 Income Tax Rules, 1962) 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...”

Taking note of the aforesaid finding of fact, the High Court has dismissed the appeal of the assessee observing as under:

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.

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.

(A.K. SIKRI)

(ASHOK BHUSHAN)

NEW DELHI;

FEBRUARY 12, 2018.

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The case involves the interpretation of Section 14A (of Income Tax Act, 1961), which deals with the disallowance of expenditure incurred in relation to income that is not includible in the total income. The Special Bench of the Income Tax Appellate Tribunal (ITAT) held that interest expenditure incurred for acquiring shares in group companies was hit by the provisions of Section 14A (of Income Tax Act, 1961). The majority opinion of the Special Bench was that there is no requirement of a direct and proximate connection between the expenditure and the exempt income. However, the minority view stated that there must be a dominant and immediate connection between the expenditure and the dividend income for Section 14A (of Income Tax Act, 1961) to be applicable.

The case was appealed to the High Court of Delhi, which held that the expression "in relation to" in Section 14A (of Income Tax Act, 1961) is synonymous with "in connection with" or "pertaining to," and that the provisions of Section 14A (of Income Tax Act, 1961) apply regardless of the intention or motive behind making the investment. The court maintained the proportionate disallowance of the expenditure incurred by the assessee.

It is worth noting that the Punjab and Haryana High Court has taken a different view in a recent judgment, following the High Court of Karnataka's decision. Due to the conflict of opinions among various High Courts, these appeals have been filed by the assessees who were unsuccessful before the High Court and by the Income Tax Department against judgments favorable to the assessee.

The relevant statutory provisions, including Section 14A (of Income Tax Act, 1961) and Rule 8D (of Income Tax Rules, 1962), are discussed in detail. Rule 8D (of Income Tax Rules, 1962) provides the method for determining the amount of expenditure in relation to income not includible in the total income.

The judgments of the Delhi High Court in Maxopp Investment Ltd. and the Punjab and Haryana High Court in State Bank of Patiala are examined in light of the statutory scheme.

In the Maxopp Investment Ltd. case, the High Court of Delhi considered three questions, with the first question being relevant to the present appeals. The question was whether the expenditure, including interest paid on funds borrowed, in respect of investment in shares of operating companies for acquiring and retaining controlling interest is hit by Section 14A (of Income Tax Act, 1961). The court noted that the assessee company was engaged in finance, investment, and dealing in shares and securities. The assessee held shares and securities as investments on the capital account and as trading assets for acquiring and retaining control over its group companies, particularly Max India Ltd. The assessee claimed that the expenditure incurred was not hit by Section 14A (of Income Tax Act, 1961) because the investment in shares was made with the intention to acquire and retain controlling interest, and the receipt of dividend was incidental.

The High Court discussed the legislative history of Section 14A (of Income Tax Act, 1961) and Rule 8D (of Income Tax Rules, 1962). It noted that prior to the insertion of Section 14A (of Income Tax Act, 1961), the law stated that when an assessee had a composite and indivisible business with elements of both taxable and non-taxable income, the entire expenditure in respect of the business was deductible. However, if the business was divisible, the principle of apportionment of expenditure was applicable, and the expenditure apportioned to the exempt income was not deductible. The court referred to the legislative intent behind the insertion of Section 14A (of Income Tax Act, 1961), as explained in the Memorandum Explaining the Provisions of the Finance Bill, 2001. The objective was to prevent the deduction of expenses incurred in relation to exempt income and to ensure that expenses are allowed only to the extent they are relatable to the earning of taxable income. The court cited the Supreme Court's observations in the case of CIT v. Walfort Share and Stock Brokers P Ltd., which clarified that expenses incurred can only be allowed to the extent they are relatable to the earning of taxable income and not exempt income.

The High Court emphasized that Section 14A (of Income Tax Act, 1961) applies to expenses incurred in relation to income that does not form part of the total income. It clarified that if an income does not form part of the total income, then the related expenditure is outside the ambit of the applicability of Section 14A (of Income Tax Act, 1961).

This summary focuses on the discussion and interpretation of Section 14A (of Income Tax Act, 1961) in the Maxopp Investment Ltd. case by the High Court of Delhi.

In the Maxopp Investment Ltd. case, the High Court of Delhi discussed the interpretation of the expressions "in relation to" and "expenditure incurred" in Section 14A (of Income Tax Act, 1961). The court rejected the contention that the word "incurred" should be taken literally to mean actual expenditure and that there must be a direct and proximate connection with the exempt income. Instead, the court referred to previous judgments that emphasized the expansive meaning of the expressions "in relation to" and "pertaining to" used in deeming provisions. The court also highlighted the principle that expenses incurred can only be allowed to the extent they are relatable to the earning of taxable income, and the same principle applies to the exemption of income. Therefore, if income does not form part of the total income, the associated expenditure cannot be debited against taxable income.

The High Court clarified that "expenditure incurred" refers to actual expenditure in relation to or in connection with exempt income. If no expenditure is incurred in relation to the exempt income, no disallowance can be made under Section 14A (of Income Tax Act, 1961). Based on this interpretation, the High Court answered the question in the affirmative, stating that the expenditure incurred by the assessees could be disallowed under Section 14A (of Income Tax Act, 1961).

In the State Bank of Patiala case, which was considered by the Punjab and Haryana High Court, the issue was whether Section 14A (of Income Tax Act, 1961) applied to a bank earning exempt income in the form of dividend from securities held as stock in trade. The High Court accepted the contention that the bank was engaged in the purchase and sale of shares as a trader to earn profit, and the securities constituted its stock in trade. The court referred to a circular issued by the Central Board of Direct Taxes (CBDT), which stated that income arising from investments made by a banking concern is attributable to the business of banking and falls under the head "Profits and gains of business and profession." Based on this analysis, the High Court held that Section 14A (of Income Tax Act, 1961) was not applicable, and the disallowance made by the assessing officer was deleted.

This summary focuses on the interpretations of Section 14A (of Income Tax Act, 1961) in the Maxopp Investment Ltd. case by the High Court of Delhi and in the State Bank of Patiala case by the Punjab and Haryana High Court.

In the Maxopp Investment Ltd. case, the High Court recognized the distinction between stock-in-trade and investment. It referred to a circular issued by the CBDT, which stated that income arising from investments made by a banking concern is attributable to the business of banking and falls under the head "Profits and gains of business and profession." The court held that if shares and securities are treated as stock-in-trade, the income derived from them would be business income, and Section 14A (of Income Tax Act, 1961) would not be applicable. The court emphasized that the purpose of purchasing the securities was to earn profits from trading, and any expenditure incurred was for the purchase and sale of the stock-in-trade, not for earning dividend or interest income. Therefore, no expenditure could be disallowed under Section 14A (of Income Tax Act, 1961) in relation to the exempt income.

The High Court also referred to the judgment in Walfort Share and Stock Brokers P Ltd., which held that payback does not constitute an "expenditure incurred" under Section 14A (of Income Tax Act, 1961). The court concluded that the entire expenditure, including administrative costs, was incurred for the purchase and sale of the stock-in-trade, irrespective of whether the securities yielded any income. The High Court concurred with the judgments of the Karnataka High Court and the Calcutta High Court, which held that if no expenditure is incurred in earning dividend income, no notional expenditure can be deducted.

In the State Bank of Patiala case, the Punjab and Haryana High Court held that if a banking institution treats shares and securities as stock-in-trade, the provisions of Section 14A (of Income Tax Act, 1961) are not applicable. The court referred to Circular No.18 issued by the CBDT, which clarified that income arising from investments made by a banking concern is attributable to the business of banking and falls under the head "Profits and gains of business and profession." The court emphasized that the purpose of the purchase and sale of shares was to earn profit, not to earn interest or dividend income. The court concluded that no disallowance could be made under Section 14A (of Income Tax Act, 1961) as the expenditure was incurred for the purchase and sale of the stock-in-trade.

In both cases, the courts emphasized the distinction between stock-in-trade and investment and held that if the securities were treated as stock-in-trade, the provisions of Section 14A (of Income Tax Act, 1961) would not apply.

In the present case, the main issue is whether the dominant purpose test or the theory of apportionment should be applied while interpreting Section 14A (of Income Tax Act, 1961). The assessees argue that the dominant purpose for investing in shares, such as gaining control over the investee company, should determine the applicability of Section 14A (of Income Tax Act, 1961). However, the court opines that the dominant purpose may not be relevant in this context. The crucial factor is that the dividend income is non-taxable. If expenditure is incurred to earn the dividend income, the portion of expenditure attributable to the dividend income should be disallowed and cannot be treated as business expenditure.

The court emphasizes that Section 14A (of Income Tax Act, 1961) is based on the principle of apportionment of expenses. The provision aims to exclude both the exempt income and the expenditure directly related to that income from the computation of assessable income, to prevent double benefit to the assessee. Therefore, the words "in relation to" in Section 14A (of Income Tax Act, 1961) should be interpreted to require a direct and proximate nexus between the incurred expenditure and the earning of exempt income.

The court refers to the judgment in Walfort Share and Stock Brokers P Ltd., which supports the principle of apportionment. It states that if an income does not form part of the total income, the related expenditure is outside the ambit of Section 14A (of Income Tax Act, 1961). The theory of apportionment of expenditure between taxable and non-taxable income has been expanded under Section 14A (of Income Tax Act, 1961).

Based on these considerations, the court concludes that the principle of apportionment should be applied in interpreting Section 14A (of Income Tax Act, 1961). If expenditure is incurred to earn dividend income that is non-taxable, the portion of expenditure attributable to the dividend income should be disallowed as it is not business expenditure. This interpretation aligns with the objective of Section 14A (of Income Tax Act, 1961) to prevent the double benefit of exempt income and deduction for related expenditure.

Overall, the court rejects the dominant purpose test and emphasizes the principle of apportionment for determining the disallowance of expenditure under Section 14A (of Income Tax Act, 1961).

In summary, the Supreme Court concludes that the dominant purpose test is not applicable in interpreting Section 14A (of Income Tax Act, 1961). The court upholds the principle of apportionment of expenditure between taxable and non-taxable income. In cases where shares are held as investment to gain control over the investee company, the dividend income is not considered the dominant purpose, and the expenditure incurred in acquiring those shares needs to be apportioned. On the other hand, when shares are held as stock-in-trade for trading purposes, the dividend income earned incidentally is exempt under Section 10(34) (of Income Tax Act, 1961). Therefore, the expenditure incurred in acquiring those shares must be apportioned under Section 14A (of Income Tax Act, 1961).

The court affirms the judgment of the Delhi High Court, which holds that prior to the introduction of Section 14A (of Income Tax Act, 1961), the entire expenditure in respect of a composite and indivisible business was deductible, and the principle of apportionment did not apply. The court rejects the dominant purpose theory applied by the Punjab and Haryana High Court.

The court also refers to a circular issued by the Central Board of Direct Taxes (CBDT), which distinguishes between stock-in-trade and investment and clarifies that if the motive behind the purchase and sale of shares is to earn a profit, it is treated as trading profit, and if the object is to derive income by way of dividend, it is treated as income from investment.

The court emphasizes that the Assessing Officer (AO) must record satisfaction before applying the theory of apportionment, particularly when the assessee has already apportioned the expenditure in their return and the AO disagrees with the apportionment. The nature of the loan taken by the assessee for purchasing shares or making investments should also be examined by the AO.

The court dismisses the appeals of the assessees, upholds the dismissal of certain appeals by the Punjab and Haryana High Court, and allows one appeal filed by the Revenue. It clarifies that Rule 8D (of Income Tax Rules, 1962) is prospective in nature and cannot be applied to assessment years prior to its introduction in 2007.

Overall, the court provides clarity on the interpretation and application of Section 14A (of Income Tax Act, 1961), affirming the principle of apportionment of expenditure and rejecting the dominant purpose test.

<img class="image-in" id="1" src="https://thakurani.sgp1.digitaloceanspaces.com/media/logos/Synopsis.JPG"/> Chapter IV of the Income Tax Act deals with the computation of total income, and Section 14A (of Income Tax Act, 1961) clarifies that no deduction shall be allowed in respect of expenditure incurred in relation to income that does not form part of the total income. The purpose of this provision is to prevent double benefit for the taxpayer when certain income is exempted from tax. 
Section 14A (of Income Tax Act, 1961) was inserted by the Finance Act, 2001, and it was given retrospective effect from April 1, 1962. The provision states that if any expenditure is incurred to earn income that is not included in the total income, such expenditure shall not be allowed as a deduction. This ensures that the taxpayer does not claim a deduction for the expenditure incurred in earning exempted income. 
The issue in these appeals arises when shares are purchased for purposes other than earning dividend income, such as gaining control over a company or trading as stock-in-trade. However, incidental dividend income is also generated. The question is whether the expenditure incurred can be treated as expenditure "in relation to" the dividend income that does not form part of the total income. The dominant intention or main object behind the purchase of shares becomes relevant in determining the relationship between the expenditure and the dividend income. 
In Civil Appeal Nos. 104-109 of 2015, the appellant company is engaged in finance, investment, and dealing in shares. The appellant holds shares in two portfolios: as an investment on capital account and as trading assets for acquiring and retaining control over investee group companies. The appellant treated the profit/loss from the sale of shares held as investment as capital gains and offered the profit/loss from the sale of shares held as trading assets as business income. 
The appellant claimed that the shares held for acquiring and retaining control over investee companies were not purchased with the motive of earning dividends but to maintain controlling interest. Therefore, the dividend income earned on those shares was incidental. The Assessing Officer disallowed a portion of the interest expenditure under Section 14A (of Income Tax Act, 1961), but the disallowance was restricted to the amount of dividend received and claimed exempt. 
Overall, the appeals raise the question of whether the expenditure incurred can be considered "in relation to" the dividend income when the dominant intention behind purchasing the shares is not to earn dividends. The court will consider the interpretation and application of Section 14A (of Income Tax Act, 1961) in these scenarios. 
This portion of the case involves the appeals and decisions made by various courts regarding the interpretation of Section 14A (of Income Tax Act, 1961). After the Commissioner of Income Tax (Appeals) upheld the order of the Assessing Officer (AO) disallowing certain expenditures incurred by the appellant, the matter was taken to the Income Tax Appellate Tribunal (ITAT). 
Due to conflicting decisions on the interpretation of Section 14A (of Income Tax Act, 1961), a Special Bench was constituted to hear the appeals, including the appellant's case. The Special Bench, in the case of Daga Capital Management (Private) Ltd., held that investment in shares representing controlling interest did not amount to carrying on a business and that interest expenditure incurred for acquiring such shares was hit by Section 14A (of Income Tax Act, 1961). The majority opinion of the Special Bench stated that there need not be a direct and proximate connection between the expenditure and the exempt income. The minority view held that a dominant and immediate connection was necessary to invoke Section 14A (of Income Tax Act, 1961). 
The appellant appealed to the Delhi High Court against the order of the Special Bench. The High Court, in its judgment, held that the expression 'in relation to' in Section 14A (of Income Tax Act, 1961) was synonymous with 'in connection with' or 'pertaining to', and that the provisions of the section applied regardless of the intention or motive behind the investment. The High Court maintained the proportionate disallowance of the expenditure incurred by the assessee. 
It is noted that the Punjab and Haryana High Court, in a recent judgment in the case of State Bank of Patiala, took a different view from the Delhi High Court. The Punjab and Haryana High Court followed the judgment of the High Court of Karnataka in CCI Ltd. v. Joint Commissioner of Income Tax, Udupi Range. Due to this conflict of opinions among the High Courts, these appeals were filed by both the assessees who were unsuccessful before the High Court and the Income Tax Department against the judgments favoring the assessees. 
This portion provides an overview of the relevant statutory provisions, namely Section 14A (of Income Tax Act, 1961) and Rule 8D (of Income Tax Rules, 1962). Section 14A (of Income Tax Act, 1961) deals with the disallowance of expenditure incurred in relation to income that is not includible in the total income under the Act. Sub-section (2) of Section 14A (of Income Tax Act, 1961) empowers the Assessing Officer to determine the amount of expenditure in relation to such income, in accordance with the method prescribed in Rule 8D (of Income Tax Rules, 1962). 
Rule 8D (of Income Tax Rules, 1962) provides the methodology for determining the amount of expenditure in relation to income not included in the total income. It specifies that such expenditure includes the amount directly relating to income that does not form part of the total income, as well as an amount computed based on the average value of investments and total assets. 
The judgments of the Delhi High Court in Maxopp Investment Ltd. and the Punjab and Haryana High Court in State Bank of Patiala are discussed. The Delhi High Court considered the question of whether expenditure, including interest paid on borrowed funds, in relation to investments in shares for acquiring and retaining controlling interest is hit by Section 14A (of Income Tax Act, 1961). The court referred to the legislative intent behind Section 14A (of Income Tax Act, 1961) and the objective of preventing the deduction of expenses incurred to earn exempt income. It noted the principle of apportionment of expenditure in cases of composite and divisible businesses. 
The High Court discussed the objectives behind the insertion of Section 14A (of Income Tax Act, 1961), as stated in the Memorandum explaining the provisions of the Finance Bill 2001. The objective was to prevent deductions in respect of exempt income and ensure that expenses are allowed only to the extent they are related to the earning of taxable income. 
Given the conflicting views of the Delhi High Court and the Punjab and Haryana High Court, these appeals were filed to resolve the differences in interpretation and determine the applicability of Section 14A (of Income Tax Act, 1961) in cases where expenditure is incurred in relation to income not includible in the total income. 
In this portion, the judgments of the Supreme Court in CIT v. Walfort Share and Stock Brokers P Ltd and the judgments of the Delhi High Court in Maxopp Investment Ltd and the Punjab and Haryana High Court in State Bank of Patiala are discussed. 
The Supreme Court in CIT v. Walfort Share and Stock Brokers P Ltd observed that the insertion of Section 14A (of Income Tax Act, 1961) reflects the intention of Parliament not to allow the deduction of any expenditure incurred in relation to income that does not form part of the total income. It clarified that expenses can only be allowed to the extent that they are related to the earning of taxable income. The court emphasized that if an income does not form part of the total income, the expenditure/deduction, even if of a nature specified in sections 15 to 59 of the Act, cannot be allowed against other income included in the total income. 
The Delhi High Court in Maxopp Investment Ltd analyzed the provisions of Section 14A (of Income Tax Act, 1961) and interpreted the expressions 'in relation to' and 'expenditure incurred' occurring in the section. It disagreed with the contention that the word 'incurred' should be taken literally to mean actual expenditure, stating that the 'actual' expenditure contemplated under Section 14A (of Income Tax Act, 1961) is the expenditure in relation to or in connection with exempt income. The court concluded that if no expenditure is incurred in relation to the exempt income, no disallowance can be made under Section 14A (of Income Tax Act, 1961). 
The Punjab and Haryana High Court in State Bank of Patiala considered a case where a bank earned exempt income in the form of dividend from securities held as stock-in-trade. The court accepted the bank's contention that it was engaged in the purchase and sale of shares as a trader with the objective of earning a profit. It held that the disallowance under Rule 8D (of Income Tax Rules, 1962) would be nil if shares are held as stock-in-trade and not as investment, as Rule 8D(2)(i) (of Income Tax Rules, 1962) would be confined to direct expenses for earning tax-exempt income. 
The circular issued by the CBDT was also referred to, which clarified that income arising from investments made by a banking concern is attributable to the business of banking and falls under the head "Profits and Gains of Business and Profession." 
These judgments provide insights into the interpretation and application of Section 14A (of Income Tax Act, 1961) in determining the disallowance of expenditure incurred in relation to income that does not form part of the total income. 
In this portion, the High Court discusses the distinction between stock-in-trade and investment and the application of Section 14A (of Income Tax Act, 1961) in relation to dividend and interest income earned from securities held as stock-in-trade. 
The High Court refers to a circular issued by the CBDT, which states that if the motive behind the purchase and sale of shares is to earn a profit, it would be treated as trading profit, and if the objective is to derive income through dividends, it would be considered income from investment. The High Court observes that if the shares and securities are treated as stock-in-trade, the income arising from them would be business income, and any expenditure incurred in relation to the stock-in-trade would be deductible under sections 28 (of Income Tax Act, 1961) to 37 of the Act. 
The court further discusses the judgment in CIT v. Nawanshahar Central Co-operative Bank Ltd., which held that banking institutions are required to place a part of their funds in approved securities. Since the securities purchased by the assessees constituted their stock-in-trade, the provisions of Section 14A (of Income Tax Act, 1961) were not applicable. 
The High Court then analyzes the judgment in CIT v. Walfort Share and Stock Brokers P Ltd., which dealt with dividend stripping. It notes that the expenditure to be disallowed under Section 14A (of Income Tax Act, 1961) is the expenditure incurred to "earn" exempt income. The court concludes that if the purpose of purchasing the securities was not to earn dividend and interest income but to earn profits from trading, the entire expenditure, including administrative costs, was incurred for the purchase and sale of the stock-in-trade and not in relation to the exempt income. 
The High Court refers to the judgments of the Karnataka High Court in CCI Ltd. and the Calcutta High Court in Commissioner of Income Tax v. G.K.K. Capital Markets(P.) Ltd., both of which agreed with the view that if no expenditure is incurred in earning dividend income and the dividend income is incidental to the business, the expenditure cannot be disallowed under Section 14A (of Income Tax Act, 1961). 
These judgments emphasize that the disallowance under Section 14A (of Income Tax Act, 1961) applies only to expenditure incurred in relation to income exempt from tax, and if the shares and securities are treated as stock-in-trade, the expenditure incurred for trading purposes cannot be disallowed. 
In this portion, the High Court discusses the arguments presented by the assessees and the Revenue. 
The assessees argue that when shares are acquired for the purpose of acquiring controlling interest in a company, the objective is to maintain control over the management and not specifically to earn dividends. Therefore, they contend that no expenditure was incurred in relation to the dividend income, and Section 14A (of Income Tax Act, 1961) should not be applicable. They argue that Section 14A (of Income Tax Act, 1961) should be interpreted to require a direct and proximate nexus between the expenditure incurred and the earning of exempt income. They also highlight that the legislative intention behind Section 14A (of Income Tax Act, 1961) was to exclude both exempt income and related expenditure from the computation of assessable income. 
On the other hand, the Revenue argues in favor of the view taken by the Delhi High Court. They emphasize that the objective of Section 14A (of Income Tax Act, 1961) is to disallow expenditure incurred in relation to income exempt from tax. They contend that interpreting the provision expansively aligns with this objective and prevents double benefits for the assessee. 
The Revenue points out that the Supreme Court's judgment in Walfort Share and Stock Brokers P Ltd. supports the disallowance of expenditure related to exempt income. They argue that the expression "in relation to" in Section 14A (of Income Tax Act, 1961) should be given a broad meaning to serve the purpose of the provision. 
Both sides present their respective interpretations of Section 14A (of Income Tax Act, 1961) and its objective, with the assessees advocating for a limited interpretation and the Revenue supporting a broader interpretation that disallows expenditure related to exempt income. 
In this section, the court addresses the arguments presented by both sides and provides its analysis. 
The court clarifies that Section 14A (of Income Tax Act, 1961) disallows the deduction of expenditure incurred "in relation to income which does not form part of the total income." It emphasizes that only expenditure with a causal connection to the exempted income should be disallowed, while expenditure unrelated to the exempted income can be allowed as a business expenditure. 
The court notes that all High Courts, including the Delhi High Court and the Punjab and Haryana High Court, have agreed on this interpretation of Section 14A (of Income Tax Act, 1961). The court explains that the objective of Section 14A (of Income Tax Act, 1961) is to apportion expenses between taxable and non-taxable income. It quotes the Walfort Share and Stock Brokers P Ltd. case, which highlights the principle of apportionment of expenditure under Section 14A (of Income Tax Act, 1961). 
The court disagrees with the dominant purpose test proposed by the assessees and adopts the principle of apportionment. It states that Section 14A (of Income Tax Act, 1961) was introduced to address the issue of composite and indivisible businesses with both taxable and non-taxable income. The court supports the Delhi High Court's view that the principle of apportionment applies even when the dominant purpose of investing in shares is to gain control over the investee company. 
Regarding shares held as stock-in-trade, the court mentions Circular No. 18/2015 issued by the CBDT. The circular cites the Nawanshahar case and clarifies that income from investments made by banking institutions falls under the head "profits and gains of business and profession." The circular states that no appeals should be filed on this ground, and if any appeals are already filed, they should be withdrawn. The court highlights that this circular applies not only to co-operative societies/banks but also to all banks and commercial banks regulated by the Banking Regulation Act, 1949. 
Based on this analysis, the court concludes that the dominant purpose test is not applicable, and the principle of apportionment should be followed. The appeals related to shares held for controlling interest purposes are dismissed. The court also acknowledges the CBDT circular regarding shares held as stock-in-trade by banking institutions. 
In this section, the court discusses the treatment of shares held as stock-in-trade and the apportionment of expenditure. 
The court agrees with the Punjab and Haryana High Court's observation that there is a distinction between stock-in-trade and investment. If the shares are held as stock-in-trade, the main purpose is to trade and earn profits, but any incidental dividend income earned is exempt from tax. Therefore, Section 14A (of Income Tax Act, 1961), which is based on the theory of apportionment, applies, and the expenditure incurred in acquiring those shares needs to be apportioned based on the facts of each case. 
The court notes that in cases where shares are held as stock-in-trade, the focus is on liquidating the shares to earn profits, and whether dividend income is earned becomes immaterial. The court distinguishes this situation from cases where the assessee holds shares to retain control over the investee company and expects to earn dividend income. The court explains that the apportionment of expenditure applies when shares are held as stock-in-trade, as per the principle established in the Walfort Share and Stock Brokers P Ltd. case. 
The court acknowledges that the Assessing Officer (AO) should record satisfaction before applying the theory of apportionment, especially when the assessee has already apportioned the expenditure but the AO does not accept it. The nature of the loan taken by the assessee for purchasing the shares/investment in shares should also be examined by the AO. 
The court upholds the decision of the Punjab and Haryana High Court in the State Bank of Patiala cases, where the AO had already restricted the disallowance based on the exempt income claimed by the assessee. The court states that the CIT(A) was incorrect in disallowing the entire deduction of expenditure and agrees with the ITAT's decision to set aside the disallowance. 
The court clarifies that Rule 8D (of Income Tax Rules, 1962) is prospective in nature and cannot be applied to assessment years prior to 2007. This view has already been upheld by the court in previous cases. 
Based on these considerations, the court dismisses the appeals filed by the assessees, as well as the appeals filed by the Revenue, except for one appeal where the Revenue's case is allowed. 
Overall, the court provides clarity on the treatment of shares held as stock-in-trade and emphasizes the application of the theory of apportionment in determining the disallowance of expenditure under Section 14A (of Income Tax Act, 1961). <img class="image-in" id="2" src="https://thakurani.sgp1.digitaloceanspaces.com/media/logos/SC-Images.JPG"/><ul class="image-icons" style="opacity: 1; margin-top: -65px;"><li class="align_left">Left</li><li class="align_middle">Middle</li><li class="full_width">Fit</li><li class="bleeed_size">Full</li><li class="align_right">Right</li></ul> 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 (of Income Tax Act, 1961) 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 of income and, therefore, no taxes levied on such exempted incomes. It is in this backdrop, Section 14A (of Income Tax Act, 1961) 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 (of Income Tax Act, 1961) 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 (of Income Tax Act, 1961) - 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.

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
‘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 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 Income Tax Act, 1961) 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
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) (of Income Tax Act, 1961)
worked out disallowance under Section 14A (of Income Tax Act, 1961) 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 Income Tax Act, 1961), 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,
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 Income Tax Act, 1961). 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 Income Tax Act, 1961) 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 Income Tax Act, 1961). It was accordingly held, as per the minority, that mere receipt of dividend income, incidental to the holding of shares, in the case of a dealer in shares, would not be sufficient for invoking provisions of Section 14A (of Income Tax Act, 1961).

9) Against the aforesaid order of the Special Bench, the appellant preferred appeal under Section 260A (of Income Tax Act, 1961) 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 Income Tax Act, 1961) was synonymous with ‘in connection with’ or ‘pertaining to’, and, that the provisions of that Section apply regardless of the intention/motivebehind 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 Patiala2 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 Range3 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
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 Income Tax Act, 1961), we reproduce Section 14A (of Income Tax Act, 1961) 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 (of Income Tax Act, 1961) or pass an order enhancing the assessment or
reducing a refund already made or otherwise increasing the
liability of the assessee under section 154 (of Income Tax Act, 1961), for any
assessment year beginning on or before the 1st day of April,
2001.”

12) Sub-section (2) of Section 14A (of Income Tax Act, 1961) 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 Income Tax Rules, 1962) (for short ‘Rules’) which Rule was inserted w.e.f. March 24, 2008 vide Income Tax (Fifth Amendment) Rules, 20084. We, thus, reproduce
Rule 8D (of Income Tax Rules, 1962) 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:—

(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
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 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 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 Income Tax Act, 1961), 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. 
The High Court then took note of legislative history of Section 14A (of Income Tax Act, 1961) and Rule 8D (of Income Tax Rules, 1962). Thereafter, the Court went on to discuss the law which stood prior to insertion of Section 14A (of Income Tax Act, 1961). Taking note of certain judgments, the High Court observed that prior to the insertion of Section 14A (of Income Tax Act, 1961) 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 (of Income Tax Act, 1961) 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 (of Income Tax Act, 1961)
15. The object behind the insertion of section 14A (of Income Tax Act, 1961) in the said
Act is apparent from the Memorandum explaining the
provisions of the Finance Bill 2001 which is to the following
effect:-

“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 (of Income Tax Act, 1961) 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 (of Income Tax Act, 1961) 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 (of Income Tax Act, 1961) 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 (of Income Tax Act, 1961),
the expenditure incurred in respect of exempt income
was being claimed against taxable income. The
mandate of section 14A (of Income Tax Act, 1961) is clear. It desires to curb the
practice to claim deduction of expenses incurred in
relation to exempt income against taxable income and
at the same time avail of the tax incentive by way of 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 (of Income Tax Act, 1961). In
section 14A (of Income Tax Act, 1961), 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 (of Income Tax Act, 1961). 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 (of Income Tax Act, 1961)..

(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 (of Income Tax Act, 1961) 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
section 14 (of Income Tax Act, 1961) A.

(emphasis supplied)”

16) The High Court then undertook the exercise of analysing the
provisions of Section 14A (of Income Tax Act, 1961) 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 Income Tax Act, 1961). 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 Income Tax Act, 1961)
provided it was otherwise allowable under sections 15 (of Income Tax Act, 1961) 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 High Court, instead, referred to the judgment in the case of Doypack
Systems Pvt. Ltd. v. Union of India5 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.
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 Income Tax Act, 1961) 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 Income Tax Act, 1961) of the said Act. On the basis of the aforesaid discussion, the High Court answered the question formulated by it in the affirmative.

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) (of Income Tax Act, 1961) and (35) of about
Rs.11.07 crores and net interest income exempt under section 10(15)(iv)(h) (of Income Tax Act, 1961) 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 (of Income Tax Act, 1961) was not applicable. The AO restricted
the disallowance to the amount which was claimed as exempt income by
applying the formula contained in Rule 8D (of Income Tax Rules, 1962) holding that Section 14A (of Income Tax Act, 1961)
would be applicable. The CIT(A) issued notice of enhancement under
Section 251 (of Income Tax Act, 1961) and held that in view of Section 14A (of Income Tax Act, 1961),
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 (of Income Tax Rules, 1962) would be nil as rule 8D(2)(i) (of Income Tax Rules, 1962) 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 Income Tax Act, 1961)?”

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 Income Tax Act, 1961) as interest on non-SLR
securities is income from other sources.” 
2. Clause (id) of sub-section (1) of Section 56 (of Income Tax Act, 1961)
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”.

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 Income Tax Act, 1961), 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
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 (of Income Tax Act, 1961) were not applicable. Here,
the Court noted distinction between stock-in-trade and investment and
made the following observations:

“17. Under section 14A (of Income Tax Act, 1961), 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 (of Income Tax Act, 1961) 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 Income Tax Act, 1961) (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 (of Income Tax Act, 1961) 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) expenditure incurred to “earn” exempt income. The words ‘in relation to’ in Section 14A (of Income Tax Act, 1961) 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
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 Income Tax Act, 1961). 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 Income Tax Rules, 1962) would not apply. On the
questions whether the Appellate Tribunal was justified in deleting the
disallowance under Section 14A (of Income Tax Act, 1961) computed in accordance with Rule 8D (of Income Tax Rules, 1962)
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 Income Tax Act, 1961) 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. CIT9 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
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 Income Tax Rules, 1962) 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 Income Tax Act, 1961) was
enacted to overcome those judicial pronouncements. The
object of section 14A (of Income Tax Act, 1961) 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
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
head “income from other sources”, in view of the mandatory
prescription in Section 56 (of Income Tax Act, 1961), 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 Income Tax Act, 1961), 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 Income Tax Act, 1961) (prior to introduction of
Section 14A (of Income Tax Act, 1961)).

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
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 (of Income Tax Act, 1961) would not be attracted. In this hue, it was submitted that Section 14A (of Income Tax Act, 1961) 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 (of Income Tax Act, 1961) 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
insertion of Section 14A (of Income Tax Act, 1961) 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 Income Tax Act, 1961) pointed towards that and that
was equally the purpose behind the insertion of Section 14A (of Income Tax Act, 1961) 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 Income Tax Act, 1961), deduction of that expenditure is not to be allowed
which has been incurred by the assessee “in relation to income which
does not form part of the total income under this Act”. Axiomatically, it is that expenditure alone which has been incurred in relation to the income which is includible in total income that has to be disallowed. If an expenditure incurred has no causal connection with the exempted
income, then such an expenditure would obviously be treated as not
related to the income that is exempted from tax, and such expenditure
would be allowed as business expenditure. 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 Income Tax Act, 1961). 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 Income Tax Act, 1961).
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) 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 Income Tax Act, 1961) 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 Income Tax Act, 1961) 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 Income Tax Act, 1961). 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.

“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 (of Income Tax Act, 1961).. 
The theory of apportionment of expenditure between
taxable and non-taxable has, in principle, been now
widened under section 14 (of Income Tax Act, 1961) A.”

35) The Delhi High Court, therefore, correctly observed that prior to
introduction of Section 14A (of Income Tax Act, 1961), 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 (of Income Tax Act, 1961) 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 &amp; Haryana High Court which went by dominant purpose
theory. The aforesaid reasoning would be applicable in cases where
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 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 Income Tax Act, 1961) 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
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 Income Tax Act, 1961), 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 Income Tax Act, 1961) 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 Income Tax Rules, 1962) and holding that
section 14A (of Income Tax Act, 1961) 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
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
hereinabove.

41) Having regard to the language of Section 14A(2) (of Income Tax Act, 1961), read
with Rule 8D (of Income Tax Rules, 1962), 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 (of Income Tax Act, 1961) 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 Income Tax Act, 1961) read with
Rule 8D (of Income Tax Rules, 1962) 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 Income Tax Rules, 1962) 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...”

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 Income Tax Rules, 1962). Here, the case is decided in favour of the assessees also on the ground that Rule 8D (of Income Tax Rules, 1962) 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. 
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. 
(A.K. SIKRI)
 
(ASHOK BHUSHAN)

NEW DELHI;
FEBRUARY 12, 2018.