Page 1

REPORTABLE IN THE SUPREME COURT OF INDIA CIVIL APPELLATE JURISDICTION CIVIL APPEAL NO. 7020 OF 2011

GODREJ & BOYCE MANUFACTURING COMPANY LIMITED              ...APPELLANT

VERSUS DY. COMMISSIONER OF INCOME-TAX & ANR.               ...RESPONDENTS

J U D G M E N T RANJAN GOGOI, J.

1. The appellant Company, incorporated in the year  1932,  is  engaged  in  the  business  of manufacture  of  steel  furniture,  security equipments, typewriters, electrical equipments and a host of other related products.  It is also a promoter of various other companies and invests its funds  in  such  companies  in  order  to  maintain control of such concerns as sister concerns. 2. The issue in the present appeal relates to

Page 2

the  admissibility  or  otherwise  of  deduction  of expenditure  incurred  in  earning  dividend  income which is not includible in the total income of the Assessee  by  virtue  of  the  provisions  of  Section 10(33)  of  the  Income  Tax  Act,  1961  (hereinafter referred to as “the Act”) as in force during the relevant Assessment Year i.e. 2002-2003. 3. For  the  Assessment  Year  2002-2003,  the appellant – Company filed its return declaring a total  loss  of  Rs.45,90,39,210/-.  In  the  said return, it had shown income by way of dividend from companies and income from units of mutual funds to the extent of Rs.34,34,78,686.  Dividend income to the  extent  of  98%  of  the  said  amount  was contributed by the Godrej group companies whereas only 0.05% thereof amounting to Rs.1,71,000/- came from  non-Godrej  group  companies.   A  sum  of Rs.66,79,000/-, constituting 1.95% of the aforesaid dividend  income,  came  from  mutual  funds. Admittedly, a substantial part of the appellant's

Page 3

investment in the group companies was in the form of bonus shares which did not involve any fresh capital investment or outlay. 4. The other relevant facts which may be taken notice of is that  on the first day of the previous year relevant to the Assessment Year 2002-2003 i.e. 1st April, 2001, the investment in shares and mutual funds of the appellant company stood at Rs.127.19 crore whereas at the end of the previous year i.e. as on 31st March, 2002 the investment was Rs.125.54 crore.  The above figures would go to show that there  were  no  fresh  investments  made  during  the previous  year  relevant  to  the  Assessment  Year 2002-2003.  In fact, the investments had come down to the extent noticed above.  5. Furthermore, as against the investment of Rs.125.54 crore as on 31st March, 2002, on the said date the appellant had a total of  Rs.280.64 crore by way of interest free funds in the form of share capital  (Rs.6.55  crore)  as  well  as  Reserves  and

Page 4

Surplus (Rs.274.09 crore). On the other hand, as against the investment of Rs.127.19 crore on the first day of the previous year i.e. 1st April, 2001, the appellant had a total of Rs.270.51 crore by way of interest free funds in the form of share capital (Rs.6.55 crore) and Reserves and Surplus (Rs.263.96 crore).  The  above  facts  would  show  that  the appellant  had  sufficient  interest  free  funds available for the purpose of making investments.  6. At this stage we may go back a little in time and start with the Assessment Year 1998-1999 wherein  the  appellant's  dividend  income  was Rs.11,41,34,093/-. The Assessing Officer notionally allocated  Rs.1,47,40,000/-  out  of  the  total interest  expenditure  of  Rs.34,64,89,000/-  as referable  to  the  earning  of  the  said  dividend income and had disallowed such interest expenditure and  consequently  reduced  the  exemption  available under  Section  10(33)  of  the  Act  to  the  net dividend. In appeal, the Commissioner of Income Tax

Page 5

(Appeals) allowed exemption of the entire dividend income on the ground that the Assessing Officer had failed to show any nexus between the investments in shares and units of mutual funds on the one hand and the borrowed funds on the other.  The learned Income Tax Appellate Tribunal (hereinafter referred to as “Tribunal”) which was moved by the Revenue confirmed the appellate order. The said order had attained finality. 7. For  the  Assessment  Years  1999-2000  and 2001-2002 the issue with regard to exemption under Section 10(33) of the Act was similarly held in favour  of  the  assessee  by  the  Commissioner  of Income Tax (Appeals) and the learned Tribunal, once again. Initially, the Assessing Officer, in both the  Assessment  Years,  had  disallowed  notionally computed interest expenditure as being relatable to the earning of dividend income.  The said appellate order(s)  had  also  attained  finality.  For  the intervening Assessment Year 2000-2001 there was no

Page 6

scrutiny  of  the  appellant's  return  of  income. Consequently, the dividend income was allowed in full without disallowing any expenditure incurred in relation to earning such income.  However, for the  Assessment  Year  2002-2003,  the  Assessing Officer did not allow interest expenditure to the extent of Rs.6,92,06,000/- holding the same to be attributable to earning the dividend income of Rs. 34,34,78,686/-   The  said  figure  of  interest expenditure  disallowed  was  worked  out  from  the total  interest  expenditure  for  the  year  on  a notional  basis in  the ratio  of the  cost of  the investments in shares and units of mutual funds to the  cost  of  the  total  assets  appearing  in  the balance sheet.  Though the aforesaid order of the Assessing Officer was reversed by the Commissioner of  Income  Tax  (Appeals)  following  the  earlier orders pertaining to the previous Assessment Years, as noticed above, the learned Tribunal, in appeal, took  a  different  view  by  its  order  dated  26th

Page 7

August,  2009.   The  learned  Tribunal  held  that sub-sections (2) and (3) of Section 14A of the Act (inserted by the Finance Act, 2006 with effect from 1st April, 2007) were retrospectively applicable to the Assessment Year 2002-2003 and, therefore, the matter should be remanded to the Assessing Officer for  recording  his  satisfaction/findings  in  the light of the said sub-sections of Section 14A of the Act.   This was notwithstanding the fact that the only disallowance made by the Assessing Officer which was reversed in appeal by the Commissioner of Income  Tax  (Appeals)  was  in  respect  of  interest expenditure  what  was  worked  out  on  a  notional basis.   8. The  High  Court  by  the  impugned  judgment dated  12th August,  2010,  inter  alia,  held  that Section 14A of the Act has to be construed on a plain grammatical construction thereof and the said provision  is  attracted  in  respect  of  dividend income referred to in Section 115-O as such income

Page 8

is  not  includible  in  the  total  income  of  the shareholder. Sub-sections (2) and (3) of Section 14A of the Act and rule 8D of the Income-tax Rules, 1962  (hereinafter  referred  to  as  “the  Rules”) would, however, not apply to the AY 2002-03 as the said provisions do not have retrospective effect. Notwithstanding the above the High Court upheld the remand as made by the Tribunal to the AO though for a  slightly  different  reason  as  will  be  noticed hereinafter.   We  may  also  notice  that  the  High Court in its impugned judgment also held that the tax  paid  under  section  115-O  of  the  Act  is  an additional tax on that component of the profits of the  dividend  distributing  company  which  is distributed by way of dividends and that the same is not a tax on dividend income of the assessee. 9. Aggrieved,  the  instant  appeal  has  been filed raising two questions in the main which have been summarized by the appellant, and we may say accurately, as follows :

Page 9

“(a)Irrespective  of  the  factual  position and  findings  in  the  case  of  the Appellant, whether the phrase “income which  does  not  form  part  of  total income  under  this  Act”  appearing  in Section 14A includes within its scope dividend income on shares in respect of which tax is payable under Section 115-O of the Act and income on units of  mutual  funds  on  which  tax  is payable under Section 115-R.

(b) Whatever  be  the  view  on  the  legal aspects, whether on the facts and in the circumstances of the Appellant's case and bearing in mind the unanimous findings of the lower authorities over a considerable period of time (which were  accepted  by  the  Revenue)  there could at all be any question of the provisions  of  Section  14A  in  the

Page 10

appellant's case.” 10. We  have  heard  Shri  Sohrab  E.  Dastur, learned Senior Counsel appearing for the appellant and Shri Ranjit Kumar, learned Solicitor General appearing for the Revenue. 11. At the very outset, the relevant provisions of the Act which will require a consideration are extracted below:

“2. In  this  Act,  unless  the  context otherwise requires,— (22) "dividend" includes— (a) any  distribution  by  a  company  of

accumulated  profits,  whether capitalised  or  not,  if  such distribution entails the release by the company to its shareholders of all or any part of the assets of the company;

(b)  xxx xxx xxx xxx xxx     

(c)  xxx xxx xxx xxx xxx   (d)  xxx xxx xxx xxx xxx   (e)  xxx xxx xxx xxx xxx   

but  "dividend"  does  not  include— ……………

xxx xxx xxx xxx xxx

Page 11

(24) "income" includes— (i) profits and gains ; (ii) dividend ; (iia) ………………”

xxx xxx xxx xxx xxx  10.   Incomes  not  included  in  total income.- In computing the total income of a previous year of any person, any income  falling  within  any  of  the following clauses shall not be included-

xxx xxx xxx xxx xxx  (33) any income by way of- (i)  dividends  referred  to  in section 115-O; or (ii) income received in respect of units from the Unit Trust of India  established  under  the Unit Trust of India Act, 1963 (52 of 1963); or (iii)  income  received  in respect  of  the  units  of  a mutual  fund  specified  under clause (23D) Provided that this clause shall not apply to any income arising from transfer of units of the Unit  Trust  of  India  or  of  a mutual  fund,  as  the  case  may be”

xxx xxx xxx xxx xxx

Page 12

14A. Expenditure incurred in relation to income not includible in total income.-  

(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

Page 13

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.

Rule 8D.- (introduced by CBDT Notifica- tion No.45/2002 dated 24.03.2008.

“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

Page 14

(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:-

        A x _B_               C

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

Page 15

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.”

115-O. Tax  on  distributed  profits  of domestic companies.-

(1)  Notwithstanding  anything

Page 16

contained  in  any  other provision  of  this  Act  and subject  to  the  provisions  of this  section,  in  addition  to the  income-tax  chargeable  in respect of the total income of a  domestic  company  for  any assessment  year,  any  amount declared,  distributed  or  paid by  such  company  by  way  of dividends  (whether  interim  or otherwise) on or after the 1st day of April, 2003, whether out of  current  or  accumulated profits  shall  be  charged  to additional  income-tax (hereafter  referred  to  as  tax on distributed profits) at the rate of fifteen per cent. (1A) xxx xxx xxx xxx xxx (1B) xxx xxx xxx xxx xxx   (2)  Notwithstanding  that  no income-tax  is  payable  by  a domestic company on its total income  computed  in  accordance with  the  provisions  of  this Act,  the  tax  on  distributed profits  under  sub-section  (1) shall  be  payable  by  such company. (3)  The  principal  officer  of the  domestic  company  and  the company shall be liable to pay the tax on distributed profits to  the credit  of the  Central Government within fourteen days from the date of—

Page 17

(a) declaration  of  any dividend; or

(b)distribution  of  any dividend; or

(c) payment of any dividend, whichever is earliest. (4)  The  tax  on  distributed profits so paid by the company shall be treated as the final payment  of tax  in respect  of the  amount  declared, distributed  or  paid  as dividends and no further credit therefor  shall  be  claimed  by the  company  or  by  any  other person in respect of the amount of tax so paid. (5)  No  deduction  under  any other  provision  of  this  Act shall be allowed to the company or a shareholder in respect of the  amount  which  has  been charged  to  tax  under sub-section  (1)  or  the  tax thereon. (6) xxx xxx xxx xxx xxx (7) xxx xxx xxx xxx xxx (8) xxx xxx xxx xxx xxx”

xxx xxx xxx xxx xxx xxx “115R. Tax on distributed income to unit holders.-  (1)  Notwithstanding  anything contained  in  any  other  provisions  of this  Act  and  section  32  of  the  Unit Trust of India Act, 1963 (52 of 1963), any amount of income distributed on or

Page 18

before the 31st day of March, 2002 by the  Unit  Trust  of  India  to  its  unit holders shall be chargeable to tax and the Unit Trust of India shall be liable to  pay  additional  income-tax  on  such distributed income at the rate of ten per cent:

Provided that nothing contained in this  sub-section  shall  apply  in respect of any income distributed to a unit holder of open-ended equity oriented  funds  in  respect  of  any distribution made from such fund for a period of three years commencing from the 1st day of April, 1999.

(2)  Notwithstanding  anything  contained in any other provision of this Act, any amount  of  income  distributed  by  the specified company or a Mutual Fund to its unit holders shall be chargeable to tax and such specified company or Mutual Fund shall be liable to pay additional income-tax on such distributed income at the rate of—

(i) xxx xxx xxx xxx xxx (ii) xxx xxx xxx xxx xxx (iii) xxx xxx xxx xxx xxx

xxx xxx xxx xxx xxx xxx xxx   

12. Shri  Sohrab  E.  Dastur,  learned  Senior Counsel appearing for the appellant has argued that Section 14A of the Act pertains to disallowance of expenditure relatable to an item of income on which

Page 19

tax has not been paid. According to the learned counsel,  Section  14A  applies  only  in  situations where income is tax free; non-taxable and there is no incidence of tax per se.  Dividend on shares is subjected to tax under Section 115-O of the Act whereas  returns  of  units  or  mutual  funds  is subjected to tax under Section 115R.  The fact that the tax on such dividend is paid by the dividend paying  company  and  not  by  the  recipient  of  the dividends, according to the learned counsel, is of no consequence.  Proceeding further, Shri Dastur has argued that under Section 10(33) of the Act, income by way of dividend referred to in Section 115-O of the Act or income received in respect of units  from the  UTI or  of mutual  funds alone  is exempted.  It is only one specie of dividend income which is exempted under Section 10(33) of the Act whereas other species of such (dividend) income, say for example, dividend from foreign companies is still liable to tax.  As tax has already been paid

Page 20

on  such  dividend,  though  by  the  dividend  paying company,  Section  14A  will  not  apply  to  exclude expenditure incurred to earn such dividend income as the said income, really, is not tax-free.    13. Shri Dastur has further argued that there is a discernible correlation between Section 10(33) and Section 115-O of the Act inasmuch as both the Sections were inserted in the Act by the Finance Act, 1997. When the earlier status was restored by the  Finance  Act,  2002  shareholders  once  again became liable for tax on dividends which position continued until the provisions of Section 10(33) of the Act [engrafted as Section 10(34)] and Section 115-O were reintroduced by the Finance Act, 2003 with effect from 1st April, 2003.  It is, therefore, argued that both the Sections 10(33) and Section 115-O of the Act constitute a composite scheme for taxation of dividend income wherein the legislative policy is clear that dividend, though to be taxed in the hands of the company distributing the same,

Page 21

is not to be included in the total income of the recipient Assessee.  The mere fact that the amount is not to be included in the total income of the recipient  Assessee,  would  not  attract  the provisions of Section 14A of the Act, inasmuch as the cardinal test is whether the dividend income is tax-free  or  not.   The  person  paying  the  tax, according to the learned counsel, is not relevant for the aforesaid purpose. 14. Shri Dastur has also urged that the above position has been accepted by the Revenue in its counter affidavit wherein it has been admitted that the  exemption  granted  under  Section  10(33)  is consequent  upon  collection  of  tax  on  dividend income from the dividend distributing company under Section 115-O of the Act.  It is, therefore, argued by  Shri  Dastur  that  a  literal  interpretation  of Section  14A  must  be  avoided.  Reference  in  this regard is made to the case of  K.P. Varghese vs. Income-Tax  Officer,  Ernakulam  and  Anr.1.   It  is (1981) 131 ITR 597 (SC)

Page 22

specifically contended by Shri Dastur that tax on the dividend paid is not a tax on profits out of which  dividend  is  distributed  inasmuch  as  under Section   115-O of the Act dividend can be paid either from accumulated profits or current profits. In fact, Section 205 of the  Companies Act permits payment of dividend out of accumulated profits in the  year  though  the  company  may  have  incurred losses.   Furthermore,  it  is  contended  that  the dividend  paying  company  would  be  charged  to  tax under Section 115-O of the Act  even in a case where  no  tax  is  payable  under  the  regular provisions of the Act because its entire income, say, is otherwise eligible for deductions. In other words,  tax  under  Section  115-O  of  the  Act  is payable by the dividend paying company even when no tax is payable on the income of such company under the regular provisions of the Act.  

15. On the other hand, the learned Solicitor General of India, who has argued the case on behalf

Page 23

of  the  Revenue  has  laid  before  the  Court  the position of law prior to insertion of Section 14A of the Act by the Finance Act of 2001. According to the learned Solicitor General,  the insertion of Section  14A  in  the  Act  was  to  offset  several judicial pronouncements holding that in case of an assessee earning income which is both includible and non-includible in the total income, the entire expenses  would  be  permissible  as  deduction, including,  expenses  pertaining  to  income  not includible  in  the  total  income.  The  learned Solicitor General has drawn the attention of the Court to the Memorandum explaining the provisions of the Finance Bill, 2001 which is to the following effect.

“Certain  incomes  which  are  not includible 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

Page 24

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, that is, 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. Therefore, 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.”

16. The position is made clear by Circular No. 14  issued  by  the  C.B.D.T.  explaining  the  said purpose of the Finance Act, 2001. The said Circular has  also  been  placed  before  the  Court  by  the learned Solicitor General.  

17. The  learned  Solicitor  General  has  also

Page 25

traced the history of the Amendments to Section 14A of the Act and, in particular, to the insertion of sub-sections (2) and (3) thereof by the Finance Act of 2006. The purpose of insertion of sub-sections (2)  and  (3),  as  explained  in  the  Memorandum explaining the provisions of the Finance Bill 2006, has also been relied upon by the learned Solicitor General, who contends that from the said Memorandum it is clear that sub-sections (2) and (3) had been introduced as the existing provisions of Section 14A did not provide any method of computation of expenditure incurred to earn an income which does not  form  a  part  of  the  total  income.  It  is, therefore, urged by the learned Solicitor General that  the  legislative  intent  behind  enactment  of Section 14A and sub-sections (2) and (3) thereof was to combat situations where tax incentives given by way of non-inclusion of different categories of income under the head “Income which do not form part  of  the  total  Income”  was  actually  used  to

Page 26

reduce the tax payable on the total income.  

18. The Scheme of the Income Tax Act, 1961 has been  sought  to  be  explained  by  the  learned Solicitor General to contend that Section 14 of the Act provides for five heads of income i.e. ‘Income from  Salaries’;  ‘Income  from  House  Property’; ‘Income  from  Profits  &  Gains  of  Business  or Profession’;  ‘Income  from  Capital  Gains’;  and ‘Income from Other Sources’. It  is  contended  that even though Income from dividend falls under the head  “Income  from  Other  Sources”  specifically provided for under Section 56 of the Act, dividend income referred to in Section 115-O of the Act is excluded  from  the  provisions  of  deductions contained  in  Section  57  inasmuch  as  such  income does not form a part of the total income in view of Section 10(33) of the Act. The learned Solicitor General has argued that Section 14A reiterates a fundamental  principle  enshrined  by  the  Act  that expenses are allowable only to the extent that they

Page 27

have a nexus to the earning of taxable income or income which forms a part of the total income.

19. Reliance in this regard is placed on the decision of this Court in C.I.T.  vs. Walfort Share & Stock Brokers P. Ltd.2 which decision, according to the learned Solicitor General, virtually decides the issues arising in the present case.  

20. Referring to Section 115-O of the Act, the learned Solicitor General had submitted that the said section levies an additional income tax on the profits of a company which has been declared and distributed  to  its  shareholders  in  the  form  of dividend. No credit of such additional income tax paid  by  the  company  is  available  either  to  the company  or  the  shareholders  [Section  115-O(4)]. Such additional income tax paid by the company does not also enure to the benefit of the shareholders receiving  the  amount  of  dividend  distributed  by

(2010) 326 ITR 1 (SC)

Page 28

such company. The amount of such dividend does not form part of tax paid dividend in the hands of the shareholders. In fact, pointing to the provisions of Section 115-O(5) it is argued that under the said  provisions  a  shareholder  cannot  claim deduction in respect of the dividend received by it/him from a dividend paying company on which tax has been paid by the said company under Section 115-O(1) of the Act. This, according to the learned Solicitor General, makes the intent of Section 14 crystal  clear.  The  liability  to  pay  tax  under Section 115-O in respect of the dividend is on the dividend  paying  company  and  the shareholder/assessee  has  no  connection  with  the same. Such an assessee is not required to include the dividend amount in his/its total income for the purposes of charge to tax. In such a situation, the expenditure incurred for earning the said income cannot be allowed.

21. There is a supplemental argument made by

Page 29

the  learned  Solicitor  General  based  on  the provisions  of  Sections  194,  195,  196C  and  199 contained in Chapter XVII of the Act which deals with “Collection and Recovery of Tax” including tax on dividend income received by a shareholder. It may  be  convenient,  to  appreciate  what  has  been argued, to notice what the aforesaid provisions of the Act actually say.

194.  Dividends.  The  principal  officer of an Indian company or a company which has  made  the  prescribed  arrangements for  the  declaration  and  payment  of dividends  (including  dividends  on preference shares) within India, shall, before  making  any  payment  in  cash  or before issuing any cheque or warrant in respect  of  any  dividend  or  before making any distribution or payment to a shareholder, who is resident in India, of any dividend within the meaning of sub-clause  (a)  or  sub-clause  (b)  or sub-clause  (c)  or  sub-clause  (d)  or sub-clause  (e)  of  clause  (22)  of section  2,  deduct  from  the  amount  of such dividend, income-tax at the rates in  force :

Provided that no such deduction shall be made in the case of a shareholder,  being  an individual, if— (a) xxx xxx xxx xxx xxx

Page 32

sub-section (1A) of section 192 and paid to the Central Government shall be treated as the tax paid on behalf of the person in respect of whose income such payment of tax has been made. (3) The Board may, for the purposes of giving credit in respect of tax deducted or tax paid in terms of the provisions  of  this  Chapter,  make such  rules  as  may  be  necessary, including the rules for the purposes of giving credit to a person other than  those  referred  to  in sub-section (1) and sub-section (2) and  also  the  assessment  year  for which such credit may be given.

22.     All  the  said  provisions,  noticeably, exclude dividend received under Section 115-O. As the provisions of the aforesaid Sections of the Act contemplate  deduction  of  tax  payable  by  the shareholder on the dividend income, however, to the exception of dividend income under Section 115-O, it is submitted by the learned Solicitor General that it is crystal clear that the additional income tax paid under Section 115-O by the dividend paying company cannot assume the character of tax paid on

Page 33

dividend income by the assessee shareholder. The position,  according  to  the  learned  Solicitor General, is further fortified by the provisions of Section 115-O(4), reference to which has already been made earlier. Specific reference is made to Section 199 of the Act which provides for credit to be given for the tax deducted at source on dividend paid. If the tax paid on dividend under Section 115-O  is  on  income  earned  by  the  shareholder, Section 199 would have also provided for deduction of tax at source in respect of the dividends paid under Section 115-O of the Act to the assessee, it is contended.

23. Insofar as the second issue arising in the case is concerned, namely, the appellate orders of the  learned  Tribunal  for  the  Assessment  Years 1998-1999,  1999-2000  and  2001-2002  granting  the benefit of full deduction on interest expenditure, it is submitted by the learned Solicitor General that  each  assessment  year  has  to  be  reckoned

Page 34

separately; there is no estoppel and, furthermore, sub-sections (2) and (3) of Section 14A having been introduced by the Finance Act of 2006, the Tribunal and the High Court was fully justified in remanding the matter to the Assessing Officer for a de novo consideration  in  the  light  of  the  provisions contained in sub-sections (2) and (3) of Section 14A of the Act.

24. The  object  behind  the  introduction  of Section 14A of the Act by the Finance Act of 2001 is clear and unambiguous. The legislature intended to  check  the  claim  of  allowance  of  expenditure incurred  towards  earning  exempted  income  in  a situation where an assessee has both exempted and non-exempted income or includible or non-includible income. While there can be no scintilla of doubt that  if  the  income  in  question  is  taxable  and, therefore,  includible  in  the  total  income,  the deduction of expenses incurred in relation to such an income must be allowed, such deduction would not

Page 35

be permissible merely on the ground that the tax on the dividend received by the assessee has been paid by  the  dividend  paying  company  and  not  by  the recipient   assessee,   when   under   Section 10(33) of the Act such income by way of dividend is not a part of the total income of the recipient assessee. A plain reading of Section 14A would go to show that the income must not be includible in the total income of the assessee. Once the said condition is satisfied, the expenditure incurred in earning the said income cannot be allowed to be deducted.  The  section  does  not  contemplate  a situation where even though the income is taxable in the hands of the dividend paying company the same to be treated as not includible in the total income  of  the  recipient  assessee,  yet,  the expenditure incurred to earn that income must be allowed on the basis that no tax on such income has been  paid  by  the  assessee.  Such  a  meaning,  if ascribed to Section 14A, would be plainly beyond

Page 36

what the language of Section 14A can be understood to reasonably convey.  

25. The  reliance  placed  by  the  Assessee  on K.P. Varghese (supra) may now be considered.  In K.P.  Varghese (supra)  the  interpretation  of sub-section (2) of Section 52 of the Income Tax Act, 1961 (as it then in force), which is in the following terms, came up for consideration before this  Court.

“Consideration for transfer in cases of under-statement.  

52 (1) Where the person who acquires a capital asset from an assessee is directly  or  indirectly  connected with the assessee and the Income-tax Officer has reason to believe that the transfer was effected with the object of avoidance or reduction of the liability of the assessee under Section 45, the full value of the consideration  for  the  transfer shall, with the previous approval of the  Inspecting  Assistant Commissioner,  be  taken  to  be  the fair  market  value  of  the  capital asset on the date of the transfer.

Page 37

(2)  without  prejudice  to  the provisions of Sub-section (1), if in the  opinion  of  the  Income-tax Officer the fair market value of a capital  asset  transferred  by  an assessee  as  on  the  date  of  the transfer exceeds the full value of the  consideration  declared  by  the assessee in respect of the transfer of such capital assets by an amount of not less than fifteen per cent of the value declared, the full value of  the  consideration  for  such capital  asset  shall,  with  the previous approval of the Inspecting Assistant Commissioner, be taken to be its fair market value on the date of its transfer.

Provided that.....”

26. On behalf of the Assessee, it was contended that a literal construction of Section 52(2) of the Act, as quoted above, could lead to a manifestly unreasonable  and  absurd  consequence.   Such consequence  as  urged  by  the  Assessee  was appreciated by the Court by taking the illustration of  the  price  in  a  sale  agreement  of  immovable property as on the date of the agreement and the market price thereof as on the date of the sale

Page 38

which could be at a later point of time. If Section 52(2)  were  to  be  interpreted  literally,  the Assessee would be required to pay tax on capital gains  which  had  not  occurred  to  him.   It  was, therefore, held:

“It is difficult to conceive of any rational reason why the Legislature should have thought it fit to impose liability to tax on an assessee who is bound by law to carry out his contractual obligation to sell the property  at  the  agreed  price  and honestly  carries  out  such contractual  obligation.  It  would indeed be strange if obedience to the law should attract the levy of tax  on  income  which  has  neither arisen to the assessee nor has been received by him.”

Accordingly, it was held that:  “where  the  plain  literal interpretation  of  a  statutory provision  produces  a  manifestly absurd and unjust result which could never  have  been  intended  by  the Legislature,  the  court  may  modify the language used by the Legislature or even “do some violence” to it, so as to achieve the obvious intention of  the  Legislature  and  produce  a rational construction: Vide Luke v. IRC  [1963]  AC  557;  [1964]  54  ITR

Page 39

692.

27. We do not see how the aforesaid principle of  law  in  K.P.  Varghese (supra)  can  assist  the Assessee in the present case.  The literal meaning of  Section  14A,  far  from  giving  rise  to  any absurdity, appears to be wholly consistent with the scheme of the Act and the object/purpose of levy of tax  on  income.   Therefore,  the  well  entrenched principle of interpretation that where the words of the  statute  are  clear  and  unambiguous  recourse cannot be had to principles of interpretation other than the literal view will apply. In this regard, the view expressed by this Court in Commissioner of Income  Tax-III vs.  Calcutta  Knitwears,  Ludhiana3

may be usefully noticed below:   “the language of a taxing statute should  ordinarily  be  read  and understood in the sense in which it is harmonious with the object of the statute  to  effectuate  the legislative  animation.  A  taxing statute  should  be  strictly

(2014) 6 SCC 444 (para 31)

Page 40

construed;  common  sense  approach, equity, logic, ethics and morality have no role to play. Nothing is to be  read  in,  nothing  is  to  be implied; one can only look fairly at the language used and nothing more and nothing less.   

28.  A  similar  view  is  to  be  found  in Commissioner  of  Income-Tax vs.  Tara  Agencies4

wherein this Court had concluded that: “Therefore, the legal position seems to be clear and consistent that it is the bounden duty and obligation of  the  court  to  interpret  the statute as it is. It is contrary to all rules of construction to read words  into  a  statute  which  the legislature  in  its  wisdom  has deliberately  not  incorporated.” (para 69)

29. The off-quoted observations of Rowlatt,J. in the case of Cape Brandy Syndicate vs. IRC5  may also be noticed at this juncture.  On the question arising the learned Judge had observed (page 71) that:  

 (2007) 292 ITR 444(SC) [At Page 464]  [1921] 1 KB 64

Page 41

"...in a taxing statute one has to look at what is clearly said. There is no room for any intendment. There is no equity about a tax. There is no presumption as to a tax. Nothing is to be read in, nothing is to be implied. One can only look fairly on the language used."

30. While  it  is  correct  that  Section  10(33) exempts only dividend income under Section 115-O of the Act and there are other species of dividend income on which tax is levied under the Act, we do not see how the said position in law would assist the  assessee  in  understanding  the  provisions  of Section  14A  in  the  manner  indicated.  What  is required  to  be  construed  is  the  provisions  of Section 10(33) read in the light of Section 115-O of  the  Act.  So  far  as  the  species  of  dividend income on which tax is payable under Section 115-O of the Act is concerned, the earning of the said dividend is tax free in the hands of the assessee and not includible in the total income of the said assessee. If that is so, we do not see how the

Page 42

operation  of  Section  14A  of  the  Act  to  such dividend income can be foreclosed.  The fact that Section 10(33) and Section 115-O of the Act were brought in together; deleted and reintroduced later in a composite manner, also, does not assist the assessee.  Rather,  the  aforesaid  facts  would countenance  a  situation  that  so  long  as  the dividend  income  is  taxable  in  the  hands  of  the dividend paying company, the same is not includible in the total income of the recipient assessee. At such  point  of  time  when  the  said  position  was reversed (by the Finance Act of 2002; reintroduced again  by  the  Finance  Act,  2003),  it  was  the assessee who was liable to pay tax on such dividend income.  In  such  a  situation  the  assessee  was entitled under Section 57 of the Act to claim the benefit  of  exemption  of  expenditure  incurred  to earn such income. Once Section 10(33) and 115-O was reintroduced the position was reversed.  The above, actually fortifies the situation that Section 14A

Page 43

of the Act would operate to disallow deduction of all expenditure incurred in earning the dividend income under Section 115-O which is not includible in the total income of the assessee.

31. So far as the provisions of Section 115-O of the Act are concerned, even if it is assumed that the additional income tax under the aforesaid provision  is  on  the  dividend  and  not  on  the distributed profits of the dividend paying company, no  material  difference  to  the  applicability  of Section 14A would arise. Sub-sections (4) and (5) of Section 115-O of the Act makes it very clear that the further benefit of such payments cannot be claimed either by the dividend paying company or by the recipient assessee. The provisions of Sections 194, 195, 196C and 199 of the Act, quoted above, would further fortify the fact that the dividend income under Section 115-O of the Act is a special category  of  income  which  has  been  treated differently  by  the  Act  making  the  same

Page 44

non-includible in the total income of the recipient assessee as tax thereon had already been paid by the  dividend  distributing  company.  The  other species of dividend income which attracts levy of income tax at the hands of the recipient assessee has been treated differently and made liable to tax under the aforesaid provisions of the Act. In fact, if the argument is that tax paid by the dividend paying  company  under  Section  115-O  is  to  be understood  to  be  on  behalf  of  the  recipient assessee,  the  provisions  of  Section  57  should enable  the  assessee  to  claim  deduction  of expenditure incurred to earn the income on which such tax is paid.  Such a position in law would be wholly incongruous in view of Section 10(33) of the Act.   

32. A brief reference to the decision of this Court  in  Commissioner  of  Income-Tax vs.  Walfort Share and Stock Brokers P. Ltd. (supra) may now be made, if only, to make the discussion complete.  In

Page 45

Walfort Share and Stock Brokers P. Ltd.(supra) the issue  involved  was:  “whether  in  a  dividend stripping  transaction  the  loss  on  sale  of  units

could be considered as expenditure in relation to

earning  of  dividend  income  exempt  under  Section

10(33), disallowable under Section 14A of the Act?”

33. While  answering  the  said  question  this Court considered the object of insertion of Section 14A in the Income Tax Act by Finance Act, 2001, details  of  which  have  already  been  noticed. Noticing  the  objects  and  reasons  behind introduction of Section 14A of the Act this Court held that:

“Expenses  allowed  can  only  be  in respect  of  earning  of  taxable income.”

In paragraph 17, this Court went on to observe that:

“Therefore, one needs to read the words  “expenditure  incurred”  in section 14A in the context of the

Page 46

scheme of the Act and, if so read, it  is  clear  that  it  disallows certain expenditure incurred to earn exempt  income  from  being  deducted from  other  income  which  is includible in the “total income” for the  purpose  of  chargeability  to tax.”

The views expressed in Walfort Share and Stock Brokers P. Ltd. (supra), in our considered opinion, yet again militate against the plea urged on behalf of the Assessee.

34. For  the  aforesaid  reasons,  the  first question  formulated  in  the  appeal  has  to  be answered against the appellant-assessee by holding that Section 14A of the Act would apply to dividend income on which tax is payable under Section 115-O of the Act.

35. We may now deal with the second question arising in the case.

36. Section 14A as originally enacted by the Finance Act of 2001 with effect from 1.4.1962 is in

Page 47

the same form and language as currently appearing in  sub-section  (1)  of  Section  14A  of  the  Act. Sections 14A (2) and (3) of the Act were introduced by  the  Finance  Act  of  2006  with  effect  from 1.4.2007. The finding of the Bombay High Court in the impugned order that sub-sections (2) and (3) of Section 14A is retrospective has been challenged by the Revenue in another appeal which is presently pending  before  this  Court.  The  said  question, therefore,  need  not  and  cannot  be  gone  into. Nevertheless,  irrespective  of  the  aforesaid question,  what  cannot  be  denied  is  that  the requirement  for  attracting  the  provisions  of Section 14A(1) of the Act is proof of the fact that the  expenditure  sought  to  be  disallowed/deducted had actually been incurred in earning the dividend income.  Insofar  as  the  appellant-assessee  is concerned, the issues stand concluded in its favour in  respect  of  the  Assessment  Years  1998-1999, 1999-2000  and  2001-2002.  Earlier  to  the

Page 48

introduction of sub-sections (2) and (3) of Section 14A of the Act, such a determination was required to be made by the Assessing Officer in his best judgment.  In  all  the  aforesaid  assessment  years referred to above it was held that the Revenue had failed  to  establish  any  nexus  between  the expenditure  disallowed  and  the  earning  of  the dividend income in question. In the appeals arising out  of  the  assessments  made  for  some  of  the assessment  years  the  aforesaid  question  was specifically looked into from the standpoint of the requirements of the provisions of sub-sections (2) and (3) of Section 14A of the Act which had by then been  brought  into  force.   It  is  on  such consideration that findings have been recorded that the expenditure in question bore no relation to the earning  of  the  dividend  income  and  hence  the assessee  was  entitled  to  the  benefit  of  full exemption claimed on account of dividend income.

37. We do not see how in the aforesaid fact

Page 49

situation a different view could have been taken for the Assessment Year 2002-2003. Sub-sections (2) and (3) of Section 14A of the Act read with Rule 8D of  the  Rules  merely  prescribe  a  formula  for determination of expenditure incurred in relation to income which does not form part of the total income  under  the  Act  in  a  situation  where  the Assessing Officer is not satisfied with the claim of the assessee. Whether such determination is to be made on application of the formula prescribed under  Rule  8D  or  in  the  best  judgment  of  the Assessing Officer, what the law postulates is the requirement  of  a  satisfaction  in  the  Assessing Officer that having regard to the accounts of the assessee, as placed before him, it is not possible to generate the requisite satisfaction with regard to the correctness of the claim of the assessee. It is only thereafter that the provisions of Section 14A(2) and (3) read with Rule 8D of the Rules or a best judgment determination, as earlier prevailing,

Page 50

would become applicable.

38. In the present case, we do not find any mention of the reasons which had prevailed upon the Assessing  Officer,  while  dealing  with  the Assessment Year 2002-2003, to hold that the claims of the Assessee that no expenditure was incurred to earn the dividend income cannot be accepted and why the  orders  of  the  Tribunal  for  the  earlier Assessment  Years  were  not  acceptable  to  the Assessing Officer, particularly, in the absence of any new fact or change of circumstances. Neither any  basis  has  been  disclosed  establishing  a reasonable nexus between the expenditure disallowed and the dividend income received.  That any part of the borrowings of the assessee had been diverted to earn tax free income despite the availability of surplus  or  interest  free  funds  available  (Rs. 270.51 crores as on 1.4.2001 and Rs. 280.64 crores as on 31.3.2002) remains unproved by any material whatsoever.  While it is true that the principle of

Page 51

res  judicata would  not  apply  to  assessment proceedings under the Act, the need for consistency and  certainty  and  existence  of  strong  and compelling reasons for a departure from a settled position has to be spelt out which conspicuously is absent in the present case.  In this regard we may remind ourselves of what has been observed by this Court  in  Radhasoami  Satsang vs.  Commissioner  of Income-Tax6.

“We  are  aware  of  the  fact  that strictly speaking res judicata does not apply to income tax proceedings. Again, each assessment year being a unit, what is decided in one year may not apply in the following year but  where  a  fundamental  aspect permeating  through  the  different assessment years has been found as a fact  one  way  or  the  other  and parties have allowed that position to be sustained by not challenging the order, it would not be at all appropriate to allow the position to be changed in a subsequent year.”

39. In the above circumstances, we are of the view that the second question formulated must go in

(1992) 193 ITR (SC) 321 [At Page 329]

Page 52

favour of the assessee and it must be held that for the Assessment Year in question i.e. 2002-2003, the assessee is entitled to the full benefit of the claim of dividend income without any deductions.   

40. Consequently, the appeal is allowed and the order of the High Court is set aside subject to our conclusions,  as  above,  on  the  applicability  of Section 14A with regard to dividend income on which tax is paid under Section 115-O of the Act.

....................,J.            (RANJAN GOGOI)

....................,J.     (ASHOK BHUSHAN)

NEW DELHI MAY 8, 2017