Delhi High Court
Maxpak Investment Ltd vs Commissioner Of Income Tax, New … on 18 November, 2011
Author: Badar Durrez Ahmed
* IN THE HIGH COURT OF DELHI AT NEW DELHI
% Judgment delivered on: 18.11.2011
+ ITA 687/2009
MAXOPP INVESTMENT LTD ... Appellant
- versus -
COMMISSIONER OF INCOME-TAX, NEW DELHI ... Respondent
Advocates who appeared in this case:
For the Appellant : Mr Ajay Vohra with Ms Kavita Jha, Ms Akanksha Aggarwal and
Mr Amit Sachdeva
For the Respondent/Revenue : Mr Sanjeev Sabharwal with Ms P. L. Bansal and Ms Sonia Mathur
AND
+ ITA 112/2010
M/S EICHER GOODEARTH LTD … Appellant
– versus –
COMMISSIONER OF INCOME TAX NEW DELHI … Respondent
Advocates who appeared in this case:
For the Appellant : Mr Ajay Vohra with Ms Kavita Jha, Ms Akanksha Aggarwal and
Mr Amit Sachdeva
For the Respondent/Revenue : Mr Sanjeev Sabharwal with Mr Utpal Saha
AND
+ ITA 263/2010
MOHAIR INVESTMENT & TRADING CO. (P) LTD … Appellant
– versus –
COMMISSIONER OF INCOME TAX, NEW DELHI … Respondent
ITA 687/09 & Ors Page 1 of 38
Advocates who appeared in this case:
For the Appellant : Mr Ajay Vohra with Ms Kavita Jha, Ms Akanksha Aggarwal and
Mr Amit Sachdeva
For the Respondent/Revenue : Mr Sanjeev Sabharwal with Mr Utpal Saha
AND
+ ITA 805/2009
EICHER LTD … Appellant
– versus –
COMMISSIONER OF INCOME TAX, NEW DELHI … Respondent
Advocates who appeared in this case:
For the Appellant : Mr Ajay Vohra with Ms Kavita Jha, Ms Akanksha Aggarwal and
Mr Amit Sachdeva
For the Respondent/Revenue : Mr Sanjeev Sabharwal with Mr Utpal Saha
AND
+ ITA 98/2009
COMMISSIONER OF INCOME TAX DELHI-IV … Appellant
– versus –
ESCORTS FINANCE LTD … Respondent
Advocates who appeared in this case:
For the Appellant/Revenue : Mr Sanjeev Sabharwal with Mr Utpal Saha
For the Respondent : Mr R. M. Mehta
AND
+ ITA 853/2009
CHEMINVEST LTD … Appellant
– versus –
COMMISSIONER OF INCOME TAX, NEW DELHI … Respondent
Advocates who appeared in this case:
For the Appellant : Mr Ajay Vohra with Ms Kavita Jha, Ms Akanksha Aggarwal and
ITA 687/09 & Ors Page 2 of 38
Mr Amit Sachdeva
For the Respondent/Revenue : Mr Sanjeev Sabharwal with Mr Utpal Saha
AND
+ ITA 856/2009
CHEMINVEST LTD … Appellant
– versus –
COMMISSIONER OF INCOME TAX, NEW DELHI … Respondent
Advocates who appeared in this case:
For the Appellant : Mr Ajay Vohra with Ms Kavita Jha, Ms Akanksha Aggarwal and
Mr Amit Sachdeva
For the Respondent/Revenue : Mr Sanjeev Sabharwal with Mr Utpal Saha
AND
+ ITA 932/2009
THE COMMISSIONER OF INCOME TAX, DELHI-V … Appellant
– versus –
M/S NALWA INVESTMENTS LTD ... Respondent
Advocates who appeared in this case:
For the Appellant/Revenue : Ms Sonia Mathur
For the Respondent : Mr Ajay Vohra with Ms Kavita Jha, Ms Akanksha Aggarwal and
Mr Amit Sachdeva
AND
+ ITA 958/2009
MINDA INDUSTRIES LTD ... Appellant
- versus -
COMMISSIONER OF INCOME TAX, NEW DELHI ... Respondent
Advocates who appeared in this case:
For the Appellant : Mr Ajay Vohra with Ms Kavita Jha, Ms Akanksha Aggarwal and
Mr Amit Sachdeva
ITA 687/09 & Ors Page 3 of 38
For the Respondent/Revenue : Mr Sanjeev Sabharwal with Mr Utpal Saha
AND
+ ITA 1060/2009
MAXPAK INVESTMENT LTD … Appellant
– versus –
COMMISSIONER OF INCOME TAX, NEW DELHI … Respondent
Advocates who appeared in this case:
For the Appellant : Mr Ajay Vohra with Ms Kavita Jha, Ms Akanksha Aggarwal and
Mr Amit Sachdeva
For the Respondent/Revenue : Mr Sanjeev Sabharwal with Mr Utpal Saha
AND
+ ITA 1096/2009
JAGATJIT INDUSTRIES LTD … Appellant
– versus –
COMMISSIONER OF INCOME TAX & ANR ... Respondents
Advocates who appeared in this case:
For the Appellant : Mr Satyen Sethi with Mr Arta Trana Panda
For the Respondent/Revenue : Ms P. L. Bansal
AND
+ ITA 1114/2009
COMMISSIONER OF INCOME TAX, LTU ... Appellant
- versus -
SHARDA MOTORS INDUSTRIES LTD ... Respondent
Advocates who appeared in this case:
For the Appellant/Revenue : Mr Sanjeev Sabharwal with Mr Utpal Saha
For the Respondent : Mr Satyen Sethi with Mr Arta Trana Panda
ITA 687/09 & Ors Page 4 of 38
AND
+ ITA 936/2009
EICHER LTD ... Appellant
- versus -
COMMISSIONER OF INCOME TAX, NEW DELHI ... Respondent
Advocates who appeared in this case:
For the Appellant : Mr Ajay Vohra with Ms Kavita Jha, Ms Akanksha Aggarwal and
Mr Amit Sachdeva
For the Respondent/Revenue : Mr Sanjeev Sabharwal with Mr Utpal Saha
AND
+ ITA 416/2010
MEDICARE INVESTMENTS LTD … Appellant
– versus –
COMMISSIONER OF INCOME TAX, NEW DELHI … Respondent
Advocates who appeared in this case:
For the Appellant : Mr Ajay Vohra with Ms Kavita Jha, Ms Akanksha Aggarwal and
Mr Amit Sachdeva
For the Respondent/Revenue : Mr Sanjeev Sabharwal with Mr Utpal Saha
AND
+ ITA 57/2008
COMMISSIONER OF INCOME TAX, DELHI-VI … Appellant
– versus –
VOU INVESTMENT PVT LTD ... Respondent
Advocates who appeared in this case:
For the Appellant : Ms P. L. Bansal
For the Respondent/Revenue : Mr Ajay Vohra with Ms Kavita Jha, Ms Akanksha Aggarwal and
Mr Amit Sachdeva
ITA 687/09 & Ors Page 5 of 38
AND
+ ITA 139/2009
THE COMMISSIONER OF INCOME TAX, DELHI-V … Appellant
– versus –
M/S HCL PEROT SYSTEMS LTD ... Respondent
Advocates who appeared in this case:
For the Appellant : Ms P. L. Bansal and Ms Sonia Mathur
For the Respondent/Revenue : Mr Ajay Vohra with Ms Kavita Jha, Ms Akanksha Aggarwal and
Mr Amit Sachdeva
AND
+ ITA 77/2009
THE COMMISSIONER OF INCOME TAX, DELHI-V … Appellant
– versus –
M/S HCL PEROT SYSTEMS LTD ... Respondent
Advocates who appeared in this case:
For the Appellant : Ms P. L. Bansal and Ms Sonia Mathur
For the Respondent/Revenue : Mr Ajay Vohra with Ms Kavita Jha, Ms Akanksha Aggarwal and
Mr Amit Sachdeva
AND
+ ITA 683/2008
COMMISSIONER OF INCOME TAX, DELHI-IV … Appellant
– versus –
ICRA LTD … Respondent
ITA 687/09 & Ors Page 6 of 38
Advocates who appeared in this case:
For the Appellant : Ms Prem Lata Bansal
For the Respondent : Dr Rakesh Gupta with Ms Poonam Ahuja and Mr Johnson Bara
AND
+ ITA 702/2008
COMMISSIONER OF INCOME TAX, DEHI-IV … Appellant
– versus –
ICRA LTD … Respondent
Advocates who appeared in this case:
For the Appellant : Ms Prem Lata Bansal
For the Respondent : Dr Rakesh Gupta with Ms Poonam Ahuja and Mr Johnson Bara
AND
+ ITA 217/2009
COMMISSIONER OF INCOME TAX, DELHI-I … Appellant
– versus –
GLAD INVESTMENTS PVT LTD
(Now merged with AKM SYSTEMS PVT LTD … Respondent
Advocates who appeared in this case:
For the Appellant/Revenue : Ms P. L. Bansal with Ms Anshul Sharma
For the Respondent : Mr Ajay Nair with Mr Rajat Joneja
AND
+ ITA 389/2010
THE COMMISSIONER OF INCOME TAX (LTU) ... Appellant
- versus -
SHARDA MOTORS INDUSTRIES LTD ... Respondent
Advocates who appeared in this case:
For the Appellant/Revenue : Mr Sanjeev Sabharwal with Mr Utpal Saha
For the Respondent : Mr Satyen Sethi with Mr Arta Trana Panda
ITA 687/09 & Ors Page 7 of 38
CORAM:
HON'BLE MR JUSTICE BADAR DURREZ AHMED
HON'BLE MR JUSTICE SIDDHARTH MRIDUL
1. Whether Reporters of local papers may be allowed to
see the judgment? YES
2. To be referred to the Reporter or not? YES
3. Whether the judgment should be reported in Digest? YES
BADAR DURREZ AHMED, J
1. This is a batch of twenty one (21) appeals under section 260A of the Income
Tax Act, 1961. Eleven (11) of these have been filed by assessees and ten (10) by the
revenue. Eight of these appeals – four by assessees and four by the revenue — have
been admitted and questions have been framed in them. The other appeals were
tagged along therewith. It was, however, clearly understood by all the counsel
appearing on both sides that the appeals which had not been formally admitted would
be deemed to have been admitted for hearing and it was on this basis that arguments
were addressed. All these appeals are concerned with section 14A of the Income Tax
Act, 1961 and Rule 8D of the Income Tax Rules, 1962. In particular, we are called
upon to examine as to whether interest paid on funds borrowed for investing in shares
of operating companies for acquiring and retaining a controlling interest therein is
allowable under section 36(1)(iii) and is not hit by section 14A of the Income tax Act,
1961? And, consequently, we are also required to examine the retrospective
applicability of the sub-sections (2) & (3) of the said section 14A and of the said Rule
8D to the assessment years in question which range from 1998-99 to 2005-06.
Questions
2. Since, across these appeals, there were some minor differences in language
insofar as the admitted and/or proposed questions were concerned, it was agreed that
ITA 687/09 & Ors Page 8 of 38
the following substantial questions of law would, in general, cover all the cases before
us:-
1. Whether expenditure (including interest paid on funds borrowed) in
respect of investment in shares of operating companies for acquiring
and retaining a controlling interest therein is hit by section 14A of
the Income tax Act, 1961 inasmuch as the dividend received on such
shares does not form part of the total income?
2. Whether the provisions of sub-section (2) and sub-section (3) of
section 14A inserted by the Finance Act, 2006 with effect from
01/04/2007, would apply retrospectively to all pending proceedings?
3. Whether Rule 8D inserted by the Income -tax (Fifth Amendment)
Rules, 2008 with effect from 24/03/2008 was procedural in nature
and hence would apply retrospectively to all pending proceedings?
3. In order to provide some factual basis behind the above mentioned questions,
we shall refer to the appeal in the case of Maxopp Investment Limited v. CIT [ ITA
No.687/2009]. The assessee company is in the business of finance, investment and of
dealing in shares and securities. The assessee held shares and securities, partly as
investments on the “capital account” and partly as “trading assets” for the purpose of
acquiring and retaining control over its group companies, primarily Max India Ltd.
As per the assessee, any profit resulting on the sale of shares held as trading assets
was duly offered to tax as business income of the assessee. During the previous year
relevant to the assessment year 2002-03, the assessee incurred total interest
expenditure of Rs. 1,61,21,168/-, which was claimed as business expenditure under
section 36 (1) (iii) of the Income Tax Act, 1961 (hereinafter referred to as “the said
act”). According to the assessee, the expenditure claimed was not hit by section 14A
of the said act, on the ground that although borrowed funds were partly utilised for
investment in shares held as trading assets, such investment was made with the
intention to acquire and retain a controlling interest in the aforesaid company and that
the receipt of dividend thereon was merely incidental.
ITA 687/09 & Ors Page 9 of 38
4. In respect of the said assessment year 2002-03, the assessee had filed a return
of income declaring an income of Rs.78,90,430/-. The assessee had received the
following incomes: –
1. Interest on loans advanced Rs. 1,94,70,181
2. Dividend received Rs. 49,90,860
3. Profit on sale of shares Rs. 1,49,285
The aforesaid dividend of Rs. 49,90,860/- was received on the shares of Max India
Ltd, held by the assessee as “trading assets”. By an order dated 27/08/2004, the
assessing officer, invoking section 14A of the said act, apportioned the said interest
expenditure in the ratio of investment in shares of Max India Ltd, on which dividend
was received, to the principal amount of unsecured loans, which worked out to Rs.
67,74,175/-. However, the assessing officer restricted the disallowance under section
14A of the said act to Rs. 49,90,860/-, being the amount of dividend received. On
appeal, the CIT (A), by the order dated 12/01/2005, upheld the order of the assessing
officer. Thereafter, the case of the assessee was heard by a Special Bench constituted
in the case of Daga Capital Management (P) Ltd. The Special Bench of the Tribunal
held that the expenditure claimed was hit by the provisions of section 14A of the said
Act. Pursuant to the majority decision of the Special Bench of the Tribunal, the issue
of quantum of expenditure to be disallowed was restored to the assessing officer to be
recomputed in terms of Rule 8D of the Income Tax Rules, 1961 (hereinafter referred
to as “the said rules”), which was held to be retrospective.
5. As regards Question 1, it has been contended on behalf of the assessees that
holding of shares for acquiring and retaining control of operating companies amounts
to business and, consequently, dividend income on such shares is in the nature of
business income. It was further submitted that the intention behind acquiring such
shares was not to earn dividend but to acquire and retain a controlling interest in the
ITA 687/09 & Ors Page 10 of 38
operating companies. Dividend was merely incidental. It was thus contended that the
interest paid on the funds borrowed to acquire such shares was allowable as a business
expenditure as it was not directed at earning dividend income, which was incidental.
Legislative History of Section 14A and Rule 8D
6. Before we delve deeper into the questions at hand it would be appropriate to
not only examine the provisions of section 14A of the said act but also to notice its
legislative history. Section 14A was inserted into the said Act by the Finance Act,
2001 with retrospective effect from 01/04/1962.
“Expenditure incurred in relation to income not includible in
total income .
14A. For the purposes of computing the total income under this
Chapter, no deduction shall be allowed in respect of expenditure
incurred by the assessee in relation to income which does not
form part of the total income under this Act.”
7. By virtue of the Finance Act, 2002, the following proviso was inserted in
section 14A and was deemed to have been inserted with effect from 11/05/2001:-
“Provided that nothing contained in this section shall empower
the Assessing Officer either to reassess under section 147 or pass
an order enhancing the assessment or reducing a refund already
made or otherwise increasing the liability of the assessee under
section 154, for any assessment year beginning on or before the
1st day of April, 2001.”
8. As a result of the insertion of the said proviso, Section 14A was as follows:-
“Expenditure incurred in relation to income not includible in
total income.
14A. For the purposes of computing the total income under this
Chapter, no deduction shall be allowed in respect of expenditure
incurred by the assessee in relation to income which does not
form part of the total income under this Act.
ITA 687/09 & Ors Page 11 of 38
Provided that nothing contained in this section shall empower
the Assessing Officer either to reassess under section 147 or pass
an order enhancing the assessment or reducing a refund already
made or otherwise increasing the liability of the assessee under
section 154, for any assessment year beginning on or before the
1st day of April, 2001.”
9. Then, by the Finance Act, 2006, Section 14A was numbered as sub-section (1)
thereof and after sub-section (1) as so numbered, the following sub-sections were
inserted, with effect from 01/04/2007:-
“(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.”
10. Consequent upon the Finance Act, 2006, section 14A as it now stands is as
under:-
“Expenditure incurred in relation to income not includible in
total income .
14A. (1) For the purposes of computing the total income under
this Chapter, no deduction shall be allowed in respect of
expenditure incurred by the assessee in relation to income which
does not form part of the total income under this Act.
(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
ITA 687/09 & Ors Page 12 of 38
the correctness of the claim of the assessee in respect of such
expenditure in relation to income which does not form part of the
total income under this Act.
(3) The provisions of sub-section (2) shall also apply in relation
to a case where an assessee claims that no expenditure has been
incurred by him in relation to income which does not form part of
the total income under this Act.
Provided that nothing contained in this section shall empower
the Assessing Officer either to reassess under section 147 or pass
an order enhancing the assessment or reducing a refund already
made or otherwise increasing the liability of the assessee under
section 154, for any assessment year beginning on or before the
1st day of April, 2001.”
11. By Notification No.45/2008 dated 24/03/2008, the Central Board of Direct
Taxes (CBDT), in exercise of its powers under section 295 of the said Act read with
sub-section (2) of section 14A of the said Act, made the “Income-tax (Fifth
Amendment) Rules, 2008” to further amend the said Rules (i.e., the Income-tax Rules,
1962) by introducing Rule 8D therein. Clause 1(2) of the Income-tax (Fifth
Amendment) Rules, 2008 clearly stipulated that the rules would come into force from
the date of publication in the Official Gazette. The said Rule 8D is as under:-
“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).
ITA 687/09 & Ors Page 13 of 38
(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.”
ITA 687/09 & Ors Page 14 of 38
The law prior to insertion of Section 14A
12. Prior to the introduction of section 14A in the said Act, the position in law was
as laid down by the Supreme Court in CIT v. Maharashtra Sugar Mills Ltd: 82 ITR
452 (SC) and Rajasthan State Warehousing Corporation v. CIT: 242 ITR 450 (SC).
In Maharashtra sugar Mills Ltd (supra) the assessee’s business comprised of two
parts, namely, (1) cultivation of sugar cane and (2) the manufacture of sugar. The
revenue had contended that as the income from the cultivation of sugar cane, being the
result of an agricultural operation, was not exigible to tax, therefore, any expenditure
incurred in respect of that activity was not deductible. The Supreme Court repelled
this contention in the following manner:-
“This contention proceeds on the basis that only expenditure
incurred in respect of a business activity giving rise to income,
profit or gains taxable under the Act can be given deduction to
and not otherwise. We see no basis for this contention. To find
out whether the deduction claimed is permissible under the Act or
not, all that we have to do is to examine the relevant provisions of
the Act. Equitable considerations are wholly out of place in
construing the provisions of a taxing statute. We have to take the
provisions of the statute as they stand. If the amount claimed is
permissible under the Act then the same has to be deducted from
the gross profit. If it is not permissible under the Act, it has to be
rejected. As mentioned earlier, it is not disputed that the
cultivation of sugar-cane and the manufacture of sugar
constituted one single and indivisible business. Section 10(2)
says that profits under section 10(1) in respect of a business
should be computed after deducting the allowances mentioned
therein. One of the allowances allowed is that mentioned in
section 10(2)(xv) which says that any expenditure laid out or
expended wholly an exclusively for the purpose of such business
shall be deducted as an allowance. The mandate of section 10(2)
(xv) is plain and unambiguous. Undoubtedly, the allowance
claimed in this case was laid out or expended for the purpose of
the business carried on by the assessee. The fact that the income
arising from a part of that business is not exigible to tax under
the act is not a relevant circumstance.”
(Emphasis supplied)
ITA 687/09 & Ors Page 15 of 38
13. In Rajasthan State warehousing Corporation (supra), the Supreme Court
after, inter alia, considering its earlier decisions in CIT v. Indian bank Ltd: 56 ITR
77 (SC) and Maharashtra Sugar Mills Ltd (supra) laid down the following
principles:-
“(i) if income of an assessee is derived from various heads of
income, he is entitled to claim deduction admissible under
the respective head whether or not computation under each
head results in taxable income;
(ii) if income of an assessee arises under any of the heads of
income but from different items, e.g., different house
properties or different securities, etc., and income from
one or more items alone is taxable whereas income from
the other item is exempt under the Act, the entire
permissible expenditure in earning the income from that
head is deductible; and
(iii) in computing “profits and gains of business or profession”
when an assessee is carrying on business in various
ventures and some among them yield taxable income and
the others do not, the question of allowability of the
expenditure under section 37 of the Act will depend on:
(a) fulfilment of requirements of that provision noted
above; and
(b) on the facts whether all the ventures carried on by
him constituted one indivisible business or not; if
they do, the entire expenditure will be a permissible
deduction but if they do not, the principle of
apportionment of the expenditure will apply
because there will be no nexus between the
expenditure attributable to the venture not forming
an integral part of the business and the expenditure
sought to be deducted as the business expenditure
of the assessee.”
14. Thus, prior to the introduction of section 14A in the said Act, the law was that
when an assessee had a composite and indivisible business which had elements of
ITA 687/09 & Ors Page 16 of 38
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.
Objective behind insertion of section 14A
15. The object behind the insertion of section 14A in the said Act is apparent from
the Memorandum explaining the provisions of the Finance Bill 2001 which is to the
following effect:-
“Certain incomes are not includable while computing the total
income as these are exempt under various provisions of the Act.
There have been cases where deductions have been claimed in
respect of such exempt income. This in effect means that the tax
incentive given by way of exemptions to certain categories of
income is being used to reduce also the tax payable on the non-
exempt income by debiting the expenses incurred to earn the
exempt income against taxable income. This is against the basic
principles of taxation whereby only the net income, i.e., gross
income minus the expenditure is taxed. On the same analogy, the
exemption is also in respect of the net income. Expenses
incurred can be allowed only to the extent they are relatable to
the earning of taxable income.
It is proposed to insert a new section 14A so as to clarify the
intention of the Legislature since the inception of the Income –
tax Act, 1961, that no deduction shall be made in respect of any
expenditure incurred by the assessee in relation to income which
does not form part of the total income under the Income-tax Act.
The proposed amendment will take effect retrospectively from
April 1, 1962 and will accordingly, apply in relation to the
assessment year 1962-63 and subsequent assessment years.”
ITA 687/09 & Ors Page 17 of 38
16. As observed by the Supreme Court in the case of CIT v. Walfort Share and
Stock Brokers P Ltd: 326 ITR 1 (SC), the insertion of section 14 A with retrospective
effect reflects the serious attempt on the part of Parliament not to allow deduction in
respect of any expenditure incurred by the assessee in relation to income, which does
not form part of the total income under the said act against the taxable income. The
Supreme Court further observed as under:-
“.. In other words, section 14 A clarifies that expenses incurred
can be allowed only to the extent that they are relatable to the
earning of taxable income. In many cases the nature of expenses
incurred by the assessee may be relatable partly to the exempt
income and partly to the taxable income. In the absence of
section 14A, the expenditure incurred in respect of exempt
income was being claimed against taxable income. The mandate
of section 14A is clear. It desires to curb the practice to claim
deduction of expenses incurred in relation to exempt income
against taxable income and at the same time avail of the tax
incentive by way of an exemption of exempt income without
making any apportionment of expenses incurred in relation to
exempt income…”
“..Expenses allowed can only be in respect of earning taxable
income. This is the purport of section 14A. In section 14A, the
first phrase is “for the purposes of computing the total income
under this Chapter” which makes it clear that various heads of
income as prescribed in the Chapter IV would fall within section
14A. The next phrase is, “in relation to income which does not
form part of total income under the Act”. It means that if an
income does not form part of total income, then the related
expenditure is outside the ambit of the applicability of section
14A..”
(Emphasis supplied)
17. The Supreme Court also clearly held that in the case of an income like dividend
income which does not form part of the total income, any expenditure/deduction
relatable to such (exempt or non-taxable) income, even if it is of the nature specified
in sections 15 to 59 of the said Act, cannot be allowed against any other income which
ITA 687/09 & Ors Page 18 of 38
is includable in the total income. The exact words used by the Supreme Court are as
under:-
“Further, section 14 specifies five heads of income which are
chargeable to tax. In order to be chargeable, an income has to be
brought under one of the five heads. Sections 15 to 59 lay down
the rules for computing income for the purpose of chargeability
to tax under those heads. Sections 15 to 59 quantify the total
income chargeable to tax. The permissible deductions
enumerated in sections 15 to 59 are now to be allowed only with
reference to income which is brought under one of the above
heads and is chargeable to tax. If an income like dividend
income is not a part of the total income, the
expenditure/deduction though of the nature specified in sections
15 to 59 but related to the income not forming part of the total
income could not be allowed against other income includable in
the total income for the purpose of chargeability to tax. The
theory of apportionment of expenditure between taxable and non-
taxable has, in principle, been now widened under section 14 A.”
(emphasis supplied)
Analysis of section 14A
18. Sub-section (1) of section 14A clearly stipulates that for the purposes of
computing total income under Chapter IV (Computation of Total Income), no
deduction shall be allowed in respect of expenditure “incurred” by the assessee “in
relation to” income which does not form part of the total income under the said Act.
A lot of emphasis was laid on the expressions “incurred” and “in relation to”. It was
contended by Mr Ajay Vohra, who appeared on behalf of most of the assesses, 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. Mr Vohra contended that the
expression “in relation to” implies that there must be a direct and proximate
connection with the subject matter. In other words, according to Mr Vohra, 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.
ITA 687/09 & Ors Page 19 of 38
He submitted that if the dominant and main objective of spending was not the earning
of ‘exempt’ income then, the expenditure could not be disallowed under section 14A
provided it was otherwise allowable under sections 15 to 59 of the said Act.
Mr Satyen Sethi and Dr Rakesh Gupta, who appeared for some of the assesses, also
adopted the arguments of Mr Vohra and emphasized that the expenditure must be
actual and cannot be computed on the basis of some formula as stipulated under Rule
8D read with sub-sections (2) & (3) of section 14A.
“in relation to”
19. Let us examine the expression “in relation to”. Mr Vohra had referred to the
Supreme Court decision in Madhav Rao Scindia v. Union of India: AIR 1971 SC
530 where, in paragraph 134, it is observed as under:-
“.. The expression “provisions of this Constitution relating to” in
article 363 means provisions having a dominant and immediate
connection with: it does not mean merely having a reference to.”
20. According to Mr Vohra, the expression “in relation to” appearing in section
14A of the said Act has to be considered in similar light. He submitted that the
expenditure incurred must have a dominant and immediate connection with the
exempt income. Thus, according to him, since the shares were acquired for the
purpose of acquiring and retaining control of the operating company, the expenditure
in respect of such acquisition of shares would not have a dominant and immediate
connection with the dividend income, which was merely incidental. As such,
Mr Vohra submitted, the expenditure could not be disallowed under section 14 A of
the said act.
21. There are several difficulties with the argument advanced by Mr Vohra. The
first of them is that in Madhavrao Scindia (supra) the Supreme Court was concerned
ITA 687/09 & Ors Page 20 of 38
with the interpretation of a constitutional provision dealing with the jurisdiction of
courts, inter alia, concerning any dispute in respect of any right accruing under or any
liability or obligation arising out of any of the provisions of the Constitution relating
to a treaty, agreement, covenant, engagement, sanad or other similar instrument which
was entered into or executed before the commencement of the Constitution by any
Ruler of an Indian State and to which the Government of the Dominion of India or any
of its predecessor governments was a party and which is or has been continued in
operation after such commencement. In the present appeals we are not concerned
with a provision of the Constitution and that too dealing with the jurisdiction of a
court. Secondly, what needs to be emphasised is that in the very same paragraph 134,
the Supreme Court observed that the meaning of a word or expression used in the
Constitution often is coloured by the context in which it occurs and that the simpler
and more common the word or expression, the more meanings and shades of meaning
it has. The Supreme Court further held that it is the duty of the court to determine in
what particular meaning and particular shade of meaning the word or expression was
used by the Constitution makers and in discharging the duty the court will take into
account the context in which it occurs, the object to serve which it was used, it’s
collocation, the general congruity with the concept or object it was intended to
articulate and a host of other considerations. It is in this backdrop that the Supreme
Court concluded that the expression “provisions of this Constitution relating to” in
Article 363 meant provisions having a dominant an immediate connection with and
the said expression did not mean merely having a reference to. The Supreme Court
clearly explained that a wide meaning of the expression might exclude disputes from
the jurisdiction of the courts in respect of rights or obligations, however indirect or
tenuous the connection between the constitutional provision and the covenant may be.
It is therefore clear that the expression “relating to” would depend upon the context in
which it occurs.
ITA 687/09 & Ors Page 21 of 38
22. In Doypack Systems Pvt Ltd v. Union of India: AIR 1988 SC 782, the
Supreme Court observed that the expressions “pertaining to”, “in relation to” and
“arising out of”, used in the deeming provision, are used in the expansive sense. The
Supreme Court further observed as under:-
“49. The expression “in relation to” (so also “pertaining to”), is
a very broad expression which presupposes another subject
matter. These are words of comprehensiveness which might both
have a direct significance as well as an indirect significance
depending on the context…”
“… In this connection reference may be made to 76 Corpus Juris
Secundum at pages 620 and 621 where it is stated that the term
“relate” is also defined as meaning to bring into association or
connection with. It has been clearly mentioned that ” relating to”
has been held to be equivalent to or synonymous with as to
“concerning with” and “pertaining to”. The expression
“pertaining to” is an expression of expansion and not of
contraction.”
(emphasis supplied)
23. Mr Vohra also placed reliance on Navin Chemicals Manufacturing and
Trading Co Ltd v. Collector of Customs: 1993 (68) the LT 3 (SC). In the said
decision the controversy was with regard to the meaning to be given to the expression
“determination of any question having a relation to the rate of duty of customs or to
the value of goods for the purposes of assessment”. The Supreme Court was of the
view that the key was to be found in the words “for purposes of assessment”. It held
that where the appeal involved the determination of any question which had a relation
to the rate of customs duty for the purposes of assessment, that appeal must be heard
by a Special Bench. It further held that, similarly, where the appeal involved the
determination of any question which had a relation to the value of goods for the
purposes of assessment, that appeal must also be heard by a Special Bench. In this
context the Supreme Court observed as under: –
ITA 687/09 & Ors Page 22 of 38
“The phrase “relation to” is, ordinarily, of wide import but, in the
context of its use in the said expression in section 129C, it must
be read as meaning a direct and proximate relationship to the rate
of duty and to the value of goods for the purposes of assessment.”
This decision also makes it clear that the expression “in relation to” is, ordinarily, of
wide import. In the normal course, the said expression would have an expansive
meaning unless, of course, the context would otherwise suggest.
24. We do not agree with the submission of the learned counsel appearing on
behalf of the assessees that a narrow meaning ought to be ascribed to the expression
“in relation to” appearing in section 14A of the said act. The context does not suggest
that a narrow meaning ought to be given to the said expression. It is pertinent to note
that the provision was inserted by virtue of the Finance Act, 2001 with retrospective
effect from 01/04/1962. In other words, it was the intention of Parliament that it
should appear in the statute book, from its inception, that expenditure incurred in
connection with income which does not form part of total income ought not to be
allowed as a deduction. The factum of making the said provision retrospective makes
it clear that Parliament wanted that it should be understood by all that from the very
beginning, such expenditure was not allowable as a deduction. Of course, by
introducing the proviso it made it clear that there was no intention to reopen finalised
assessments prior to the assessment year beginning on 01/04/2001. Furthermore, as
observed by the Supreme Court in Walfort (supra), 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.
25. We are of the view that the expression “in relation to” appearing in Section
14 A of the said act cannot be ascribed a narrow or constricted meaning. If we were
ITA 687/09 & Ors Page 23 of 38
to accept the submission made on behalf of the assessees then sub-section (1) would
have to be read as follows:-
“For the purposes of computing the total income under this
Chapter, no deduction shall be allowed in respect of expenditure
incurred by the assessee with the main object of earning
income which does not form part of the total income under this
Act.”
That is certainly not the purport of the said provision. The expression “in relation to”
does not have any embedded object. It simply means “in connection with” or
“pertaining to”. If the expenditure in question has a relation or connection with or
pertains to exempt income, it cannot be allowed as a deduction even if it otherwise
qualifies under the other provisions of the said Act. In Walfort (supra), the Supreme
Court made it very clear that 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 heads of income and is chargeable to tax. The Supreme Court further clarified that
if an income like dividend income is not part of the total income, the
expenditure/deduction related to such income, though of the nature specified in
sections 15 to 59, cannot be allowed against other income which is includable in the
total income for the purpose of chargeability to tax.
“expenditure incurred”
26. It was contended by the learned counsel for the assessees that the words
“expenditure incurred” as appearing in section 14A(1) clearly mean that there must be
actual expenditure. Of course, the actual expenditure must be for earning the exempt
income. We have already pointed out above, that we do not subscribe to the narrow
interpretation sought to given to the words “in relation to” which the learned counsel
for the assessees are espousing. Thus, we will have to consider the argument of the
asssessees in respect of the expression “expenditure incurred” in the context of the
ITA 687/09 & Ors Page 24 of 38
expenditure being in connection with or pertaining to income which does not form
part of the total income under the said Act.
27. A reference was made to the decision of the Punjab & Haryana High Court in
the case of CIT-II v. Hero Cycles Ltd [ITA No. 331/2009 (O&M): decided on
4/11/2009] wherein it was observed that:-
“Disallowance under Section 14A requires finding of incurring
expenditure where it is found that for earning exempted income
no expenditure has been incurred, disallowance under Section
14A cannot stand.”
28. It was contended that unless and until there was actual expenditure for earning
the exempted income, there could not be any disallowance under section 14A. While
we agree that the expression “expenditure incurred” refers to actual expenditure and
not to some imagined expenditure we would like to make it clear that the ‘actual’
expenditure that is in contemplation under section 14A(1) of the said Act is the
‘actual’ expenditure in relation to or in connection with or pertaining to exempt
income. The corollary to this is that if no expenditure is incurred in relation to the
exempt income, no disallowance can be made under section 14A of the said Act.
Scope of sub-sections (2) and (3) of Section 14A
29. Sub-section (2) of Section 14 A of the said Act provides the manner in which
the Assessing Officer is to determine the amount of expenditure incurred in relation to
income which does not form part of the total income. However, if we examine the
provision carefully, we would find that the Assessing Officer is required to determine
the amount of such expenditure only 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 the said Act. In other words, the requirement of the
Assessing Officer embarking upon a determination of the amount of expenditure
incurred in relation to exempt income would be triggered only if the Assessing Officer
ITA 687/09 & Ors Page 25 of 38
returns a finding that he is not satisfied with the correctness of the claim of the
assessee in respect of such expenditure. Therefore, the condition precedent for the
Assessing Officer entering upon a determination of the amount of the expenditure
incurred in relation to exempt income is that the Assessing Officer must record that he
is not satisfied with the correctness of the claim of the assessee in respect of such
expenditure. Sub-section (3) is nothing but an offshoot of sub-section (2) of Section
14A. Sub-section (3) applies to cases where the assessee claims that no expenditure
has been incurred in relation to income which does not form part of the total income
under the said Act. In other words, sub-section (2) deals with cases where the
assessee specifies a positive amount of expenditure in relation to income which does
not form part of the total income under the said Act and sub-section (3) applies to
cases where the assessee asserts that no expenditure had been incurred in relation to
exempt income. In both cases, the Assessing Officer, if satisfied with the correctness
of the claim of the assessee in respect of such expenditure or no expenditure, as the
case may be, cannot embark upon a determination of the amount of expenditure in
accordance with any prescribed method, as mentioned in sub-section (2) of Section
14A of the said Act. It is only if the Assessing Officer is not satisfied with the
correctness of the claim of the assessee, in both cases, that the Assessing Officer gets
jurisdiction to determine the amount of expenditure incurred in relation to such
income which does not form part of the total income under the said Act in accordance
with the prescribed method. The prescribed method being the method stipulated in
Rule 8D of the said Rules. While rejecting the claim of the assessee with regard to the
expenditure or no expenditure, as the case may be, in relation to exempt income, the
Assessing Officer would have to indicate cogent reasons for the same.
Rule 8D
30. As we have already noticed, sub-section (2) of Section 14A of the said Act
refers to the method of determination of the amount of expenditure incurred in relation
ITA 687/09 & Ors Page 26 of 38
to exempt income. The expression used is – “such method as may be prescribed”.
We have already mentioned above that by virtue of Notification No.45/2008 dated
24/03/2008, the Central Board of Direct Taxes introduced Rule 8D in the said Rules.
The said Rule 8D also makes it clear that 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 said Act for such previous year, the
Assessing Officer shall determine the amount of the expenditure in relation to such
income in accordance with the provisions of sub-rule (2) of Rule 8D. We may
observe that Rule 8D(1) places the provisions of Section 14A(2) and (3) in the correct
perspective. As we have already seen, while discussing the provisions of Sub-sections
(2) and (3) of Section 14A, the condition precedent for the Assessing Officer to
himself determine the amount of expenditure is that he must record his dissatisfaction
with the correctness of the claim of expenditure made by the assessee or with the
correctness of the claim made by the assessee that no expenditure has been incurred.
It is only when this condition precedent is satisfied that the Assessing Officer is
required to determine the amount of expenditure in relation to income not includable
in total income in the manner indicated in sub-rule (2) of Rule 8D of the said Rules.
31. It is, therefore, clear that determination of the amount of expenditure in relation
to exempt income under Rule 8D would only come into play when the Assessing
Officer rejects the claim of the assessee in this regard. If one examines sub-rule (2) of
Rule 8D, we find that the method for determining the expenditure in relation to
exempt income has three components. The first component being the amount of
expenditure directly relating to income which does not form part of the total income.
The second component being computed on the basis of the formula given therein in a
case where the assessee incurs expenditure by way of interest which is not directly
ITA 687/09 & Ors Page 27 of 38
attributable to any particular income or receipt. The formula essentially apportions
the amount of expenditure by way of interest [other than the amount of interest
included in clause (i)] incurred during the previous year in the ratio of the average
value of investment, income from which does not or shall not form part of the total
income, to the average of the total assets of the assessee. The third component is an
artificial figure – one half percent of the average value of the investment, income from
which does not or shall not form part of the total income, as appearing in the balance
sheets of the assessee, on the first day and the last day of the previous year. It is the
aggregate of these three components which would constitute the expenditure in
relation to exempt income and it is this amount of expenditure which would be
disallowed under Section 14A of the said Act. It is, therefore, clear that in terms of
the said Rule, the amount of expenditure in relation to exempt income has two aspects
– (a) direct and (b) indirect. The direct expenditure is straightaway taken into account
by virtue of clause (i) of sub-rule (2) of Rule 8D. The indirect expenditure, where it is
by way of interest, is computed through the principle of apportionment, as indicated
above. And, in cases where the indirect expenditure is not by way of interest, a rule of
thumb figure of one half percent of the average value of the investment, income from
which does not or shall not form part of the total income, is taken.
Do sub-sections (2) and (3) of Section 14A and Rule 8D apply retrospectively ?
32. While examining the legislative history of Section 14A and Rule 8D, we have
already noted that Section 14A, as introduced by virtue of the Finance Act, 2001, was
with retrospective effect from 01.04.1962. The proviso was inserted by virtue of the
Finance Act, 2002 and it was made clear that nothing in Section 14A empowered the
Assessing Officer to either re-assess under Section 147 or pass an order enhancing the
assessment or reducing the refund already made or otherwise increasing the liability of
the assessee under Section 154, for any assessment year beginning on or before the
ITA 687/09 & Ors Page 28 of 38
first day of April, 2001. Thus, in respect of all the assessment years prior to the
assessment year beginning on or before the 1st day of April, 2001, concluded
assessments could not be disturbed despite the fact that Section 14A had been
expressly made retrospective with effect from 01.04.1962. The provisions of Section
14A, which were retrospective with effect from 01.04.1962 are now encapsulated in
sub-section (1) of Section 14A. It is also clear that sub-sections (2) and (3) of Section
14A were introduced subsequently by virtue of the Finance Act, 2006 and were
introduced with effect from 01.04.2007. However, although sub-sections (2) and (3)
had been introduced with effect from 01.04.2007, they remained empty shells
inasmuch as the expression “such method as may be prescribed” got meaning only by
the introduction of Rule 8D by virtue of the Income-tax (Fifth Amendment) Rules,
2008 which was notified by the Central Board of Direct Taxes by its notification
No.45/2008 dated 24/03/2008.
33. Dr Rakesh Gupta, the learned counsel, who had appeared for some of the
assessees, submitted that Section 295 of the said Act empowered the Central Board of
Direct Taxes to make rules for the whole or any part of India for carrying out the
purpose of the said Act. He referred to sub-section (4) of Section 295 and submitted
that the power to make rules conferred on the Central Board of Direct Taxes included
the power to give retrospective effect, from a date not earlier than the date of the
commencement of the said Act, to the rules or any of them and, unless the contrary
was permitted (whether expressly or by necessary implication), no retrospective effect
was to be given to any rule so as to prejudicially affect the interests of the assessees.
He further submitted that Rule 8D was inserted in the said rules, but the Central Board
of Direct Taxes did not make it retrospective. He submitted that whenever the CBDT
felt it necessary to introduce a rule with retrospective effect, it did so by making the
rule expressly retrospective. As an example, he referred to Rule 11EA which was
ITA 687/09 & Ors Page 29 of 38
inserted by the Income-tax (Ninth Amendment) Rules, 1997 with retrospective effect,
from 01/10/1994.
34. On the other hand, it was contended on behalf of the revenue and, particularly,
by Mr Sanjeev Sabharwal that since Section 14A was introduced with retrospective
effect from 01.04.1962, the principles of Section 14A would have to be considered as
having always been a part of the said Act and, therefore, sub-sections (2) and (3) of
Section 14 A and Rule 8D of the said Rules were only machinery provisions and
ought to be read retrospectively so as to give meaning to Section 14A(1).
35. We are of the view that Rule 8D would operate prospectively. We agree with
the submissions made by Dr Rakesh Gupta that if the said Rule were to have
retrospective effect, nothing prevented the Central Board of Direct Taxes from saying
so, particularly, in view of the fact that it had the power to make a rule retrospective
by virtue of Section 295(4) of the said Act. Instead of making Rule 8D retrospective,
clause 1(2) of the Income-tax (Fifth Amendment) Rules, 2008 made it clear that the
rules would come into force from the date of their publication in the Official Gazette.
It is, therefore, clear that Rule 8D, which was introduced by virtue of the Notification
No.45/2008 dated 24.03.2008, was prospective in operation and cannot be regarded as
being retrospective. We may also point out that we have had the benefit of the
decision of the Bombay High Court in Godrej and Boyce Mfg. Co. Ltd v DCIT:
(2010) 328 ITR 81 (Bom), wherein it has, inter alia, been held that the provisions of
Rule 8D of the said Rules has prospective effect and shall apply with effect from
assessment year 2008-09 onwards.
36. Insofar as sub-sections (2) and (3) of Section 14A are concerned, they have
also been introduced by virtue of the Finance Act, 2006 with effect from 01.04.2007.
ITA 687/09 & Ors Page 30 of 38
This is apparent, first of all, from the Notes on Clauses of the Finance Bill, 2006
[Reported in 281 ITR (ST) at pages 139-140]. The said Notes on Clauses refers to
clause 7 of the Bill which had sought to amend Section 14A of the said Act. It is
specifically mentioned in the said Notes on Clauses that:-
“This amendment will take effect from 1st April, 2007 and will,
accordingly, apply in relation to the assessment year 2007-08 and
subsequent years.”
37. Furthermore, in the Memorandum explaining the provisions in the Finance Bill,
2006 [281 ITR (ST) at pages 281-281], it is once again stated with reference to clause
7 which pertains to the amendment to Section 14A of the said Act that:-
“This amendment will take effect from 1st April, 2007 and will,
accordingly, apply in relation to the assessment year 2007-08 and
subsequent years.”
38. We may also refer to the CBDT Circular No.14/2006 dated 28.12.2006 and to
paragraphs 11 to 11.3 thereof. Paragraph 11 dealt with the method for allocating
expenditure in relation to exempt income and paragraphs 11.1 and 11.2 explained the
basis and logic behind the introduction of sub-section (2) of Section 14A of the said
Act. Paragraph 11.3 specifically provided for applicability of the provisions of sub-
section (2) and it clearly indicated that it would be applicable “from the assessment
year 2007-08 onwards”.
39. It is, therefore, clear that sub-sections (2) and (3) of Section 14A were
introduced with prospective effect from the assessment year 2007-08 onwards.
However, sub-section (2) of Section 14A remained an empty shell until the
introduction of Rule 8D on 24.03.2008 which gave content to the expression “such
method as may be prescribed” appearing in Section 14A(2) of the said Act.
ITA 687/09 & Ors Page 31 of 38
40. From the above discussion, it is clear that, in effect, the provisions of sub-
sections (2) and (3) of Section 14A would be workable only with effect from the date
of introduction of Rule 8D. This is so because prior to that date, there was no
prescribed method and sub-sections (2) and (3) of Section 14A remained unworkable.
How is Section 14A to be worked for the period prior to the introduction of Rule
8D?
41. Sub-section (2) of section 14A, as we have seen, stipulates that the Assessing
Officer shall determine the amount of expenditure incurred in relation to income
which does not form part of the total income “in accordance with such method as may
be prescribed”. Of course, this determination can only be undertaken if the Assessing
Officer is not satisfied with the correctness of the claim of the assessee in respect of
such expenditure. This part of section 14A(2) which explicitly requires the fulfillment
of a condition precedent is also implicit in section 14A(1) [as it now stands] as also in
its initial avatar as section 14A. It is only the prescription with regard to the method
of determining such expenditure which is new and which will operate prospectively.
In other words, section 14A, even prior to the introduction of sub-sections (2) & (3)
would require the assessing officer to first reject the claim of the assessee with regard
to the extent of such expenditure and such rejection must be for disclosed cogent
reasons. It is then that the question of determination of such expenditure by the
assessing officer would arise. The requirement of adopting a specific method of
determining such expenditure has been introduced by virtue of sub-section (2) of
section 14A. Prior to that, the assessing was free to adopt any reasonable and
acceptable method.
ITA 687/09 & Ors Page 32 of 38
42. Thus, the fact that we have held that sub-sections (2) & (3) of section 14A and
Rule 8D would operate prospectively (and, not retrospectively) does not mean that the
assessing officer is not to satisfy himself with the correctness of the claim of the
assessee with regard to such expenditure. If he is satisfied that the assessee has
correctly reflected the amount of such expenditure, he has to do nothing further. On
the other hand, if he is satisfied on an objective analysis and for cogent reasons that
the amount of such expenditure as claimed by the assessee is not correct, he is
required to determine the amount of such expenditure on the basis of a reasonable and
acceptable method of apportionment. It would be appropriate to recall the words of
the Supreme Court in Walfort (supra) to the following effect:-
“The theory of apportionment of expenditure between taxable and
non-taxable has, in principle, been now widened under section 14
A.”
So, even for the pre-Rule8D period, whenever the issue of section 14A arises before
an Assessing Officer, he has, first of all, to ascertain the correctness of the claim of
the assessee in respect of the expenditure incurred in relation to income which does
not form part of the total income under the said Act. Even where the assessee claims
that no expenditure has been incuured in relation to income which does not form part
of total income, the assessing officer will have to verify the correcteness of such
claim. In case, the assessing officer is satisfied with the claim of the assessee with
regard to the expenditure or no expenditure, as the case may be, the assessing officer
is to accept the claim of the assessee insofar as the quantum of disallowance under
section 14A is concerned. In such eventuality, the assessing officer cannot embark
upon a determination of the amount of expenditure for the purposes of section14A(1).
In case, the assessing officer is not, on the basis of objective criteria and after giving
the assessee a reasonable opportunity, satisfied with the correctness of the claim of the
assessee, he shall have to reject the claim and state the reasons for doing so. Having
done so, the assessing officer will have to determine the amount of expenditure
incurred in relation to income which does not form part of the total income under the
ITA 687/09 & Ors Page 33 of 38
said Act. He is required to do so on the basis of a reasonable and acceptable method
of apportionment.
43. At this juncture, we must make it clear that Dr Rakesh Gupta’s arguments that
Rule 8D of the said Rules exceeds the mandate of section 14A, have not been
considered by us because the appeals before us are in respect of assessment years prior
to the introduction of Rule 8D. We therefore refrain from expressing any opinion on
the issue as to whether Rule 8D (and, to what extent, if at all) is ultra vires section
14A of the said Act.
Answers to the questions
44. In view of the foregoing, Question 1 is answered in the affirmative and
Questions 2 & 3, in the negative.
Assessees’ appeals
45. The appeals on behalf of the assessees are:-
ITA No. Cause Title Assessment year
853/2009 Cheminvest Ltd v. CIT 2001-02
1060/2009 Maxpak Investment Ltd v. CIT 2001-02
687/2009 Maxopp Investment Ltd v. CIT 2002-03
856/2009 Cheminvest Ltd v. CIT 2002-03
805/2009 Eicher Ltd v. CIT 2002-03
936/2009 Eicher Ltd v. CIT 2001-02
112/2009 Eicher Goodearth Ltd v. CIT 2004-05
ITA 687/09 & Ors Page 34 of 38
263/2010 Mohair Investments Ltd v. CIT 2002-03
416/2010 Medicare Investments Ltd v. CIT 2002-03
958/2009 Minda Industries Ltd v. CIT 2002-03
1096/2009 Jagatjit Industries Ltd v. CIT 2004-05
In all these appeals, the Income Tax Appellate Tribunal had, after upholding the
disallowance under section 14A of the said Act, restored the matters to the respective
files of the concerned Assessing Officers with the direction to re-compute the said
disallowance in accordance with Rule 8D of the said Rules. However, since we have
held that Rule 8D would be inapplicable to the assessment years prior to 2008-2009,
the assessing officers would now have to follow the steps outlined in paragraph 42
above.
Revenue’s appeals
46. The appeals filed by the revenue are disposed of as below:-
ITA No. 77/2009 [CIT v. HCL Perot Systems Ltd](AY 2000-01)
ITA No. 139/2009 [CIT v. HCL Perot Systems Ltd](AY 2001-02)
The Tribunal did not sustain the disallowance made by the Assessing Officer under
Section 14 A and directed the Assessing Officer to re-compute the disallowance in
terms of the method of working given by the assessee. The revenue is aggrieved
inasmuch as the Tribunal did not direct the Assessing Officer to re-compute the
disallowance in terms of Rule 8D read with sub-sections (2) & (3) of section 14A.
ITA 687/09 & Ors Page 35 of 38
While Rule 8D would be inapplicable, the assessing officer would now have to follow
the steps outlined in paragraph 42 above.
ITA No.57/2008 [CIT v. Vou Investment Pvt Ltd](AY 1998-99)
The Tribunal deleted the disallowance under section 14A by holding that the earning
of dividend was merely incidental to holding of shares and that the Assessing Officer
had also failed to pinpoint the expenditure actually incurred in respect of the dividend
income. The Tribunal’s judgment and order to the extent it deleted the disallowance
under section 14A is set aside and the matter is restored to the file of the assessing
officer who is to follow the steps outlined in paragraph 42 above.
ITA No.932/2009 [CIT v. Nalwa Investments Ltd](AY 2004-05)
The Tribunal restored the matter to the file of the Assessing Officer to re-compute the
disallowance under section 14A and directed the Assessing Officer to identify if any
expenditure had been incurred for earning exempt income and to disallow only such
expenditure. In view of the discussion above, the assessing officer shall now have to
follow the steps outlined in paragraph 42 above.
ITA No.98/2009 [CIT v. Escorts Finance Ltd](2001-02)
The Tribunal confirmed the deletion by the CIT(A) of the disallowance made by the
Assessing Officer on account of administrative expenses and interest on loan by
invoking section 14A of the said Act. The Tribunal’s judgment and order, to the
extent it deleted the disallowance under section 14A, is set aside and the matter is
restored to the file of the assessing officer who is to follow the steps outlined in
paragraph 42 above.
ITA 687/09 & Ors Page 36 of 38
ITA No.683/2008 [CIT v. ICRA Ltd](AY 2001-02)
ITA No.702/2008 [CIT v. ICRA Ltd](AY 2003-04)
The Tribunal deleted the addition made by the Assessing Officer who had disallowed
proportionate expenditure under section 14A of the said Act by apportioning the
administrative expenses in respect of exempt income. In both cases, the Tribunal’s
judgment and order, to the extent it deleted the disallowance under section 14A, is set
aside and the matter is restored to the file of the assessing officer who is to follow the
steps outlined in paragraph 42 above.
ITA No.389/2009 [CIT v. Sharda Motors Industries Ltd](AY 2004-05)
ITA No.1114/2009 [CIT v. Sharda Motors Industries Ltd](AY 2005-06)
The Tribunal had, inter alia, deleted the disallowance made by the Assessing Officer
under section 14A of the said Act being the proportionate expenditure incurred in
relation to earning dividend income. In both cases, the Tribunal’s judgment and order,
to the extent it deleted the disallowance under section 14A, is set aside and the matter
is restored to the file of the assessing officer who is to follow the steps outlined in
paragraph 42 above.
ITA No.217/2009 [CIT v. AKM Systems Pvt Ltd](AY 2001-02)
The assessee company received dividend of Rs 81,87,432/- in respect of the
assessment year 2001-02. The Assessing Officer invoked the provisions of section
14A of the said Act and disallowed the entire office and administrative expenses of Rs
25,35,482/-. The Tribunal estimated the expenditure in relation to dividend income at
10% of the dividend income and sustained the addition of Rs 8,18,743/- only. The
revenue is aggrieved by the fact that the entire expenditure of Rs 25,35,482/- was not
disallowed and that the Tribunal estimated the disallowable expenditure by adopting a
formula of 10% of the dividend income. The Tribunal’s judgment and order, to the
ITA 687/09 & Ors Page 37 of 38
extent it partially deleted the disallowance under section 14A, is set aside and the
matter is restored to the file of the assessing officer who is to follow the steps outlined
in paragraph 42 above.
The appeals stand disposed of as above.
BADAR DURREZ AHMED, J
SIDDHARTH MRIDUL, J
NOVEMBER 18, 2011
HJ
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