1

REPORTABLE

IN THE SUPREME COURT OF INDIA

CIVIL APPELLATE JURISDICTION

CIVIL APPEAL NOS. 104-109 OF 2015

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

VERSUS

COMMISSIONER OF INCOME TAX, NEW DELHI .....RESPONDENT(S)

WITH

CIVIL APPEAL NO. 1423 OF 2015

CIVIL APPEAL NO. 3267 OF 2013

CIVIL APPEAL NO. 130 OF 2015

CIVIL APPEAL NOS. 110-112 OF 2015

CIVIL APPEAL NO. 1500   OF 2018 (ARISING OUT OF SLP (CIVIL) NO. 19614 OF 2013)

CIVIL APPEAL NO.  1508   OF 2018 (ARISING OUT OF SLP (CIVIL) NO. 31417 OF 2016)

CIVIL APPEAL NO. 115 OF 2015

CIVIL APPEAL NO. 8596 OF 2014

2

CIVIL APPEAL NO.  1505   OF 2018 (ARISING OUT OF SLP (CIVIL) NO. 27054 OF 2016)

CIVIL APPEAL NOS. 10096 OF 2013

CIVIL APPEAL NO. 123 OF 2015

CIVIL APPEAL NO. 6590 OF 2015

CIVIL APPEAL NO. 1576   OF 2018 (@ SPECIAL LEAVE PETITION (CIVIL) NO.  4024  OF 2018

@   DIARY NO. 39820 OF 2017)

CIVIL APPEAL NO. 1579    OF 2018 (ARISING OUT OF SLP (CIVIL) NO. 20475 OF 2017)

CIVIL APPEAL NO. 1578    OF 2018 (ARISING OUT OF SLP (CIVIL) NO. 23123 OF 2017)

CIVIL APPEAL NO. 18019 OF 2017

CIVIL APPEAL NO.  1580   OF 2018 (ARISING OUT OF SLP (CIVIL) 32405 OF 2017)

CIVIL APPEAL NO. 1575    OF 2018 (@ SPECIAL LEAVE PETITION (CIVIL) NO.  4023  OF 2018

@ DIARY NO. 36413 OF 2017)

CIVIL APPEAL NO. 2802  OF 2018 (@ SPECIAL LEAVE PETITION (CIVIL) NO. 6746    OF 2018

@   DIARY NO. 1146 OF 2018)

CIVIL APPEAL NO. 2791  OF 2018

3

(@ SPECIAL LEAVE PETITION (CIVIL) NO. 6685   OF 2018 @   DIARY NO. 39823 OF 2017)

CIVIL APPEAL NO.  2792    OF 2018 (@ SPECIAL LEAVE PETITION (CIVIL) NO.  6686   OF 2018

@ DIARY NO. 41903 OF 2017)

CIVIL APPEAL NO.  1577    OF 2018 (@ SPECIAL LEAVE PETITION (CIVIL) NO. 4027   OF 2018

@   DIARY NO. 41890 OF 2017)

CIVIL APPEAL NO. 2793   OF 2018 (@ SPECIAL LEAVE PETITION (CIVIL) NO. 6687   OF 2018

@   DIARY NO. 41203 OF 2017) A N D

CIVIL APPEAL NO.  2794    OF 2018 (@ SPECIAL LEAVE PETITION (CIVIL) NO.   6688    OF 2018

@ DIARY NO. 41922 OF 2017)

J U D G M E N T

A.K. SIKRI, J.

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

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

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

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

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

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

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

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

4

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

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

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

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

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

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

following terms:

“Section 14A - For the purposes of computing the total income under this Chapter, no deduction shall be allowed in respect of expenditure incurred by the assessee in relation to income which does not form part of the total income under this Act.”

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

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

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

amendment vide Finance Act, 2002 which was to operate retrospectively

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

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

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

3) Though, it is clear from the plain language of the aforesaid provision that

no deduction is to be allowed in respect of expenditure incurred by the

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

income under  the Act,  the effect  whereof  is  that  if  certain  income is

earned which is not to be included while computing total income, any

5

expenditure  incurred  to  earn  that  income  is  also  not  allowed  as  a

deduction.  It is well known that tax is leviable on the net income.  Net

income is arrived at after deducting the expenditures incurred in earning

that income.  Therefore, from the gross income, expenditure incurred to

earn that income is allowed as a deduction and thereafter tax is levied

on the net income.  The purpose behind Section 14A of the Act, by not

permitting deduction of the expenditure incurred in relation to income,

which does not form part of total income, is to ensure that the assessee

does not get double benefit.  Once a particular income itself is not to be

included  in  the  total  income  and  is  exempted  from tax,  there  is  no

reasonable  basis  for  giving  benefit  of  deduction  of  the  expenditure

incurred in earning such an income.  For example, income in the form of

dividend earned on shares held in a company is not taxable.  If a person

takes  interest  bearing  loan  from  the  Bank  and  invests  that  loan  in

shares/stocks,  dividend  earned  therefrom  is  not  taxable.   Normally,

interest  paid  on  the  loan  would  be  expenditure  incurred  for  earning

dividend income.  Such an interest would not be allowed as deduction

as it is an expenditure incurred in relation to dividend income which itself

is spared from tax net.  There is no quarrel upto this extent.

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

circumstances where the shares/stocks were purchased of a company

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

6

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

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

dominant intention for purchasing the share was not to earn dividends

income but control of the business in the company in which shares were

invested or for the purpose of trading in the shares as a business activity

etc.  In this backdrop, the issue is as to whether the expenditure incurred

can be treated as expenditure ‘in relation to income’ i.e. dividend income

which does not form part of the total income.  To put it differently, is the

dominant  or  main  object  would  be  a  relevant  consideration  in

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

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

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

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

cases pertain  to  dividend income,  whether  it  was for  the purpose of

investment in order to retain controlling interest in a company or in group

of companies or the dominant purpose was to have it as stock-in-trade.   

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

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

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

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

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

7

account;  and,  (b)  as trading assets for  the purpose of  acquiring and

retaining control over investee group companies, particularly Max India

Ltd., a widely held quoted public limited company.  Any profit/loss arising

on sale of shares/securities held as ‘investment’ is returned as income

under  the  head ‘capital  gains’,  whereas  profit/loss  arising  on sale  of

shares/securities held as ‘trading assets’ (i.e. held,  inter alia,  with the

intention  of  acquiring,  exercising  and  retaining  control  over  investee

group companies) has been regularly offered and assessed to tax as

business  income  under  the  head  ‘profits  and  gains  of  business  or

profession’.  

Consistent  with  the  aforesaid  treatment  regularly  followed,  the

appellant filed return for the previous year relevant to the Assessment

Year  2002-03,  declaring  income  of  Rs.78,90,430/-.   No  part  of  the

interest  expenditure of  Rs.1,16,21,168/-  debited to the profit  and loss

account,  to the extent  relatable to investment in shares of  Max India

Limited, yielding tax free dividend income, was considered disallowable

under  Section 14A of  the Act  on the ground that  shares in  the said

company were acquired for the purposes of retaining controlling interest

and not with the motive of earning dividend.  According to the appellant,

the dominant purpose/intention of investment in shares of Max India Ltd.

was  acquiring/retaining  controlling  interest  therein  and  not  earning

dividend and, therefore, dividend of Rs.49,90,860/- earned on shares of

8

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

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

the  assessment  order  dated  August  27,  2004,  under  Section  143(3)

worked out disallowance under  

Section 14A of  the Act  at  Rs.67,74,175/-  by apportioning the interest

expenditure of Rs.1,16,21,168/- in the ratio of investment in shares of

Max India Ltd. (on which dividend was received) to the total amount of

unsecured loan.  The AO, however, restricted disallowance under that

Section to Rs.49,90,860/- being the amount of  dividend received and

claimed exempt.

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

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

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

Tribunal,  New Delhi  (for  short  the  ‘ITAT’).   In  view of  the  conflicting

decisions  of  various  Benches  by  the  ITAT  with  respect  to  the

interpretation of Section 14A of the Act, a Special Bench was constituted

in the matter of ITO v. Daga Capital Management (Private) Ltd.1  The

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

Special Bench.   

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

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

1  312 ITR (AT) 1

9

inter alia, held that investment in shares representing controlling interest

did  not  amount  to  carrying  on  of  business  and,  therefore,  interest

expenditure incurred for acquiring shares in group companies was hit by

the provisions of Section 14A of the Act.  The Special Bench further held

that holding of shares with the intention of acquiring/retaining controlling

interest would normally be on capital account, i.e. as investment and not

as ‘trading assets’.  For that reason too, the Special Bench held that

there existed dominant connection between interest paid on loan utilized

for  acquiring  the  aforesaid  shares  and  earning  of  dividend  income.

Consequently, the provisions of Section 14A of the Act were held to be

attracted on the facts of the case.

8) On  the  interpretation  of  the  expression  ‘in  relation  to’,  the  majority

opinion of the Special Bench was that the requirement of there being

direct and proximate connection between the expenditure incurred and

exempt income earned could not be read into the provision.  According

to the majority view, ‘what is relevant is to work out the expenditure in

relation  to  the  exempt  income  and  not  to  examine  whether  the

expenditure incurred by the assessee has resulted into exempt income

or taxable income’.  As per the minority view, however, the existence of

dominant and immediate connection between the expenditure incurred

and  dividend  income  was  a  condition  precedent  for  invoking  the

provisions of Section 14A of the Act.  It was accordingly held, as per the

10

minority, that mere receipt of dividend income, incidental to the holding

of shares, in the case of a dealer in shares, would not be sufficient for

invoking provisions of Section 14A of the Act.   

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

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

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

held that the expression ‘in relation to’ appearing in Section 14A of the

Act was synonymous with ‘in connection with’ or ‘pertaining to’, and, that

the provisions of that Section apply regardless of the intention/motive

behind  making  the  investment.   As  a  consequence,  proportionate

disallowance of the expenditure incurred by the assessee is maintained.

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

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

Commissioner of Income Tax  v. State Bank of Patiala2 has taken a

view which runs contrary to the aforesaid view taken by the Delhi High

Court.  The Punjab and Haryana High Court followed, with approval, the

judgment  of  the  High  Court  of  Karnataka  in  CCI  Ltd.  v.  Joint

Commissioner of Income Tax, Udupi Range3  The Revenue has filed

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

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

2  (2017) 391 ITR 218 (P&H) 3  (2012) 206 Taxman 563

11

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

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

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

the Revenue.   

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

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

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

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

entirety hereinbelow:

“Expenditure incurred in relation to income not includible in total income.

14A. (1)  For  the  purposes  of  computing  the  total  income under this Chapter, no deduction shall be allowed in respect of expenditure incurred by the assessee in relation to income which does not form part of the total income under this Act.

(2)  The  Assessing  Officer  shall  determine  the  amount  of expenditure incurred in relation to such income which does not form part of the total income under this Act in accordance with  such  method  as  may be  prescribed,  if  the  Assessing Officer, having regard to the accounts of the assessee, is not satisfied with the correctness of the claim of the assessee in respect of such expenditure in relation to income which does not form part of the total income under this Act.

(3)  The  provisions  of  sub-section  (2)  shall  also  apply  in relation  to  a  case  where  an  assessee  claims  that  no expenditure has been incurred by him in relation to income which does not form part of the total income under this Act :

Provided that nothing contained in this section shall empower  the  Assessing  Officer  either  to  reassess  under section 147 or pass an order enhancing the assessment or reducing a refund already made or otherwise increasing the liability  of  the  assessee  under  section  154,  for  any

12

assessment year beginning on or before the 1st day of April, 2001.”

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

empowers  the  AO  to  extricate  that  amount  of  expenditure  which  is

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

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

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

delegated legislation, in the form of Rule 8D of the Income Tax Rules,

1962 (for short ‘Rules’) which Rule was inserted w.e.f. March 24, 2008

vide Income Tax (Fifth Amendment) Rules, 20084.  We, thus, reproduce

Rule 8D hereunder:

“Method  for  determining  amount  of  expenditure  in relation to income not includible in total income.

8D.(1)  Where  the  Assessing  Officer,  having  regard  to  the accounts of the assessee of a previous year, is not satisfied with—

(a) the correctness of the claim of expenditure made by the assessee; or

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

in relation to income which does not  form part  of  the total income  under  the  Act  for  such  previous  year,  he  shall determine  the  amount  of  expenditure  in  relation  to  such income in accordance with the provisions of sub-rule (2).

(2) The expenditure in relation to income which does not form part of  the total  income shall  be the aggregate of following amounts, namely:—

4 In  Civil  Appeal  No.  2165 of  2012 (Commissioner  of  Income Tax, Mumbai  v. M/s. Essar Teleholdings Ltd. through its Manager pronounced on January 31, 2018, this Court has held that Rule 8D is prospective in nature.

13

(i) the amount of expenditure directly relating to income which does not form part of total income;

(ii) in a case where the assessee has incurred expenditure by way of interest during the previous year which is not directly attributable  to  any particular  income or  receipt,  an  amount computed in accordance with the following formula, namely:—

Where A = amount of  expenditure by way of  interest  other than  the  amount  of  interest  included  in  clause  (i)  incurred during the previous year;

B = the average of value of investment, income from which does  not  or  shall  not  form  part  of  the  total  income,  as appearing in the balance sheet of the assessee, on the first day and the last day of the previous year;

C = the average of total assets as appearing in the balance sheet of the assessee, on the first day and the last day of the previous year;

(iii) an amount equal to one-half per cent of the average of the value of investment, income from which does not or shall not form part  of  the total  income, as  appearing in  the balance sheet of the assessee, on the first day and the last day of the previous year.

(3) For the purposes of this rule, the “total assets” shall mean, total assets as appearing in the balance sheet excluding the increase on account of revaluation of assets but including the decrease on account of revaluation of assets.”

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

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

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

JUDGMENT OF DELHI HIGH COURT IN MAXOPP INVESTMENT LTD.

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

14

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

and formulation thereof by the High Court was as under:

“1.  Whether  expenditure  (including  interest  paid  on  funds borrowed)  in  respect  of  investment  in  shares  of  operating companies for  acquiring and retaining a controlling interest therein  is  hit  by  section  14A of  the  Income tax  Act,  1961 inasmuch as the dividend received on such shares does not form part of the total income?”

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

business  of  finance,  investment  and  was  dealing  in  shares  and

securities.  The  assessee  held  shares  and  securities,  partly  as

investments on the “capital account” and partly as “trading assets” for

the purpose of acquiring and retaining control over its group companies,

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

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

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

assessment  year  2002-03,  the  assessee  incurred  total  interest

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

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

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

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

that  although  borrowed  funds  were  partly  utilised  for  investment  in

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

intention  to  acquire  and  retain  a  controlling  interest  in  the  aforesaid

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

15

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

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

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

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

Section  14A in  the  Act,  the  law was  that  when  an  assessee  had  a

composite and indivisible business, which had elements of both taxable

and non-taxable income, the entire expenditure in respect of the said

business  was  deductible  and,  in  such  a  case,  the  principle  of

apportionment of the expenditure relating to the non-taxable income did

not apply. However, where the business was divisible, the principle of

apportionment of the expenditure was applicable and the expenditure

apportioned to the ‘exempt’ income or income not exigible to tax, was

not allowable as a deduction.   The High Court, then, took cognizance of

the legislative intent and objective behind the insertion of Section 14A by

referring to the Memorandum Explaining the Provisions of the Finance

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

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

keep in mind the objectives behind this provision, we reproduce that part

of the discussion hereunder:

“Objective behind insertion of section 14A

15. The object behind the insertion of section 14A in the said Act  is  apparent  from  the  Memorandum  explaining  the provisions of the Finance Bill 2001 which is to the following effect:-

16

“Certain  incomes  are  not  includable  while  computing the  total  income as  these  are  exempt  under  various provisions of  the Act.  There have been cases where deductions  have  been  claimed  in  respect  of  such exempt  income.  This  in  effect  means  that  the  tax incentive  given  by  way  of  exemptions  to  certain categories of income is being used to reduce also the tax payable on the non-exempt income by debiting the expenses incurred to earn the exempt income against taxable income. This is against the basic principles of taxation  whereby  only  the  net  income,  i.e.,  gross income minus the expenditure is taxed. On the same analogy, the  exemption  is  also  in  respect  of  the  net income. Expenses incurred can be allowed only to the extent  they  are  relatable  to  the  earning  of  taxable income.

It  is  proposed to  insert  a  new section  14A so  as  to clarify  the  intention  of  the  Legislature  since  the inception of the Income-tax Act, 1961, that no deduction shall be made in respect of any expenditure incurred by the assessee in relation to income which does not form part of the total income under the Income-tax Act.

The  proposed  amendment  will  take  effect retrospectively from April 1, 1962 and will accordingly, apply in relation to the assessment year 1962-63 and subsequent assessment years.”

16.  As  observed  by  the  Supreme  Court  in  the  case of CIT v. Walfort Share and Stock Brokers P Ltd: 326 ITR 1 (SC),  the insertion of  section 14 A with  retrospective effect reflects the serious attempt on the part of Parliament not to allow deduction in respect of any expenditure incurred by the assessee in relation to income, which does not form part of the  total  income  under  the  said  act  against  the  taxable income. The Supreme Court further observed as under:-

“.. In other words, section 14 A clarifies that expenses incurred can be allowed only to the extent that they are relatable  to  the  earning  of  taxable  income.  In  many cases the nature of expenses incurred by the assessee may be relatable partly to the exempt income and partly to the taxable income. In the absence of section 14A, the expenditure incurred in respect of exempt income was  being  claimed  against  taxable  income. The mandate of section 14A is clear. It desires to curb the practice  to  claim  deduction  of  expenses  incurred  in

17

relation to exempt income against taxable income and at the same time avail of the tax incentive by way of an exemption  of  exempt  income  without  making  any apportionment  of  expenses  incurred  in  relation  to exempt income…  ”

“..Expenses allowed can only be in respect of earning taxable income. This is the purport of section 14A. In section  14A,  the  first  phrase  is  “for  the  purposes  of computing the total income under this Chapter” which makes  it  clear  that  various  heads  of  income  as prescribed in the Chapter IV would fall  within section 14A. The next phrase is, “in relation to income which does not  form part  of  total  income under the Act”.  It means  that  if  an  income does not  form part  of  total income,  then  the  related  expenditure  is  outside  the ambit of the applicability of section 14A..

(Emphasis supplied)”

17. The Supreme Court also clearly held that in the case of an income like dividend income which does not form part of the total  income,  any  expenditure/deduction  relatable  to  such (exempt or  non-taxable)  income, even if  it  is  of  the nature specified  in  sections  15  to  59  of  the  said  Act,  cannot  be allowed against any other income which is includable in the total income. The exact words used by the Supreme Court are as under:-

“Further,  section  14  specifies  five  heads  of  income which are chargeable to tax. In order to be chargeable, an  income has  to  be  brought  under  one  of  the  five heads.  Sections  15  to  59  lay  down  the  rules  for computing income for  the purpose of  chargeability to tax under those heads. Sections 15 to 59 quantify the total  income  chargeable  to  tax. The  permissible deductions enumerated in sections 15 to 59 are now to be  allowed  only  with  reference  to  income  which  is brought  under  one  of  the  above  heads  and  is chargeable to tax. If an income like dividend income is not  a  part  of  the  total  income,  the expenditure/deduction though of the nature specified in sections 15 to 59 but related to the income not forming part of the total income could not be allowed against other  income  includable  in  the  total  income  for  the purpose  of  chargeability  to  tax. The  theory  of apportionment  of  expenditure  between  taxable  and non-taxable has, in principle, been now widened under

18

section 14 A.   (emphasis supplied)”

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

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

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

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

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

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

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

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

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

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

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

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

disallowed  under  section  14A of  the  Act.   If  the  dominant  and  main

objective of spending was not the earning of ‘exempt’ income then, the

expenditure  could  not  be  disallowed  under  section  14A  of  the  Act

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

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

propositions advanced by the learned counsel for the assessees which

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

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

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

19

High Court, instead, referred to the judgment in the case of  Doypack

Systems Pvt. Ltd.  v. Union of India5 wherein this Court has held that

expressions ‘pertaining to’, ‘in relation to’ and ‘arising out of’ used in the

deeming provisions, are used in an expansive sense.  It also referred to

the judgment of this Court in CIT v. Walfort Share and Stock Brokers

P Ltd.6 wherein this Court has held that the basic principle of taxation is

to tax the net income, i.e., gross income minus the expenditure and on

the same analogy the exemption is also in respect of net income. In

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

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

permitted to be debited against other taxable income.

17) Likewise,  explaining  the  meaning  of  ‘expenditure  incurred’,  the

High Court agreed that this expression would mean incurring of actual

expenditure and not to some imagined expenditure.  At the same time,

observed the High Court, the ‘actual’ expenditure that is in contemplation

under section 14A(1) of the said Act is the ‘actual’ expenditure in relation

to or in connection with or pertaining to exempt income. The corollary to

this is that if no expenditure is incurred in relation to the exempt income,

no disallowance can be made under section 14A of the said Act.  On the

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

formulated by it in the affirmative.

5  (1988) 2 SCC 299 6  (2010) 326 ITR 1 (SC)

20

JUDGMENT OF PUNJAB AND HARYANA HIGH COURT IN STATE BANK OF PATIALA

18) This case arose in the context where exempt income in the form of

dividend was earned by the Bank from securities held by it as its stock in

trade.   The  assessee  filed  its  return  declaring  an  income  of  about

Rs.670  crores  which  was  selected  for  scrutiny.  The  return  showed

dividend  income  exempt  under  section  10(34)  and  (35)  of  about

Rs.11.07 crores and net interest income exempt under section 10(15)(iv)

(h)  of  about  Rs.1.12 crores.  The total  exempt income claimed in the

return was, therefore, Rs.12,19,78,015/-. The assessee while claiming

the  exemption  contended  that  the  investment  in  shares,  bonds,  etc.

constituted its stock-in-trade; that  the investment had not been made

only  for  earning  tax  free  income;  that  the  tax  free  income was  only

incidental  to  the  assessee’s  main  business  of  sale  and  purchase  of

securities and, therefore, no expenditure had been incurred for earning

such exempt income; the expenditure would have remained the same

even if no dividend or interest income had been earned by the assessee

from the said securities and that no expenditure on proportionate basis

could  be  allocated  against  exempt  income.  The  assessee  also

contended that in any event it had acquired the securities from its own

funds and, therefore, section 14A was not applicable.  The AO restricted

the disallowance to the amount which was claimed as exempt income by

21

applying  the  formula  contained  in  Rule  8D holding  that  Section  14A

would be applicable.  The CIT(A) issued notice of enhancement under

Section 251 of the Act and held that in view of Section 14A of the Act,

the assessee was not to be allowed any deduction in respect of income

which  is  not  chargeable  to  tax.   Therefore,  he  disallowed  the  entire

expenditure  claimed  instead  of  restricting  the  disallowance  to  the

amount which was claimed as exempt income as done by the AO.  The

ITAT set aside the order of the AO as well as CIT(A).  It referred to a

CBDT Circular No.18/2015 dated 02.11.2015 which states that income

arising  from  investment  of  a  banking  concern  is  attributable  to  the

business of  banking which falls under the head “Profits and gains of

business and profession”. The circular states that shares and stock held

by the bank are ‘stock-in-trade’ and not ‘investment’. Referring to certain

judgments  (which we will  also  refer  to)  and the earlier  orders  of  the

Tribunal, it was held that if shares are held as stock-in-trade and not as

investment even the disallowance under rule 8D would be nil as rule

8D(2)(i) would be confined to direct expenses for earning the tax exempt

income.   In  the  aforesaid  factual  backdrop,  in  appeal  filed  by  the

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

arose for consideration:

“Whether  in  the  facts  and  circumstances  of  the  case,  the Hon’ble ITAT is right in law in deleting the addition made on account of disallowance under section 14A of the Income Tax Act, 1961?”

22

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

counsel for the assessee that the assessee is engaged in the purchase

and sale of shares as a trader with the object of earning profit and not

with a view to earn interest or dividend. The assessee does not have an

investment  portfolio.  The  securities  constitute  the  assessee’s

stock-in-trade. The Department, in fact, rightly accepted, as a matter of

fact, that the dividend and interest earned was from the securities that

constituted the assessee’s stock-in-trade. The same is,  in  any event,

established. The assessee carried on the business of sale and purchase

of securities. It was supported by Circular No.18, dated November 02,

2015, issued by the CBDT, which reads as under:-  

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

It has been brought to the notice of the Board that in the case of  Banks,  field  officers  are  taking  a  view  that,  “expenses relatable  to  investment  in  non-SLR  securities  need  to  be disallowed  u/s  57(i)  of  the  Act  as  interest  on  non-SLR securities is income from other sources.”  

2.  Clause  (id)  of  sub-section  (1)  of  Section  56  of  the  Act provides that income by way of interest on securities shall be chargeable to income-tax under the head “Income from Other Sources”,  if,  the  income  is  not  chargeable  to  income-tax under  the  head  “Profits  and  Gains  of  Business  and Profession”.  

3.  The  matter  has  been  examined  in  light  of  the  judicial decisions on this issue. In the case of CIT Vs Nawanshahar Central  Cooperative Bank Ltd.  [2007]  160TAXMAN 48(SC), the Apex Court held that the investments made by a banking concern are part of the business of banking. Therefore, the income arising from such investments  is  attributable to  the business of banking falling under the head “Profits and Gains of Business and Profession”.

23

3.2  Even  though  the  abovementioned  decision  was  in  the context  of  co-operative  societies/Banks  claiming  deduction under section 80P(2)(a)(i) of the Act, the principle is equally applicable to all banks/commercial banks, to which Banking Regulation Act, 1949 applies.  

4. In the light of the Supreme Court’s decision in the matter, the issue is well settled. Accordingly, the Board has decided that no appeals may henceforth be filed on this ground by the officers of the Department and appeals already filed, if any, on this  ground  before  Courts/Tribunals  may  be  withdrawn/not pressed  upon.  This  may  be  brought  to  the  notice  of  all concerned.

(emphasis supplied)”  

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

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

the motive behind purchase and sale of shares is to earn profit then the

same would be treated as trading profit  and if  the object is to derive

income by way of dividend then the profit would be said to have accrued

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

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

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

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

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

capital assets and in the latter as trading assets.  

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

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

24

CIT  v.  Nawanshahar  Central  Co-operative  Bank  Ltd.7.   Since,  the

shares, bonds, debentures purchased by the assessees constituted its

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

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

made the following observations:

“17.  Under section 14A, an expenditure can be disallowed only if  it  is  incurred by the assessee in  relation to  income exempt from tax. The dividend or interest from the assessee’s stock-in-trade i.e. the securities was exempt from tax in view of sections 10(15)(iv)(h),(34) and (35). This was incidental to its business of banking. The business income on account of the assessee trading in the securities is assessable under the head  “Profits  and  gains  of  business  and  profession”.  The expenditure incurred in relation to stock-in-trade arising as a result of investment in shares and debentures is deductible under  sections  28  to  37.  There  is  a  distinction  between stock-in-trade  and  investment.  The  object  of  earning  profit from trading in securities is different from the object of earning income, such as, dividend and interest arising therefrom. The object of trading in securities does not constitute the activity of investment where the object is to earn dividend or interest.”

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

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

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

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

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

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

in fact, is a payout.   

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

7  (2007) 289 ITR 6 (SC)

25

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

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

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

“Now,  the  dividend  and  interest  are  income.  The  question then is whether the assessee can be said to have incurred any expenditure at all or any part of the said expenditure in respect of the exempt income viz. dividend and interest that arose  out  of  the  securities  that  constituted  the  assessee’s stock-in-trade.  The  answer  must  be  in  the  negative.  The purpose of the purchase of the said securities was not to earn income arising therefrom, namely, dividend and interest, but to earn profits from trading in i.e. purchasing and selling the same. It  is  axiomatic,  therefore,  that  the entire expenditure including administrative costs was incurred for the purchase and sale of the stock-in-trade and, therefore, towards earning the business income from the trading activity of purchasing and  selling  the  securities.  Irrespective  of  whether  the securities  yielded  any  income  arising  therefrom,  such  as, dividend or interest, no expenditure was incurred in relation to the same.”

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

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

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

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

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

under:

“5.   When  no  expenditure  is  incurred  by  the  assessee  in earning the dividend income, no notional expenditure could be deducted  from  the  said  income.   It  is  not  the  case  of  the assessee retaining any shares so as to have the benefit  of dividend.  63% of the shares, which were purchased, are sold and the income derived therefrom is offered to tax as business income.  The remaining 37% of the shares are retained.  It has remained unsold with the assessee.  It is those unsold shares have  yielded  dividend,  for  which,  the  assessee  has  not incurred any expenditure at all.  Though the dividend income is

26

exempted from payment of tax, if any expenditure is incurred in earning the said income, the said expenditure also cannot be deducted.   But  in  this  case,  when  the  assessee  has  not retained shares with the intention of earning dividend income and the dividend income is incidental to his business of sale of shares, which remained unsold by the assessee, it cannot be said that the expenditure incurred in acquiring the shares has to be apportioned to the extent of dividend income and that should  be  disallowed  from  deductions.   In  that  view of  the matter, the approach of the authorities is not in conformity with the statutory provisions contained under the Act.   Therefore, the impugned orders are not sustainable and require to be set aside.”

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

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

(P.) Ltd.8 which has also agreed with the view taken by the Karnataka

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

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

long-term capital  gains  as  exempt  income  and  declared  expenditure

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

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

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

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

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

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

questions whether the Appellate Tribunal  was justified in deleting the

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

8  (2017) 392 ITR 196 (Cal)

27

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

held  that  the  AO  had  accepted  the  correctness  of  the  disallowable

expenditure  offered  by  the  assessee  on  its  claim  of  the  amount  as

long-term capital gains.  He had not allowed the claim itself treating the

amount  as  business  income  to  thereafter  disallow  the  offered

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

recorded by the AO regarding the exempt income claimed being treated

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

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

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

application.   

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

High Court in the case of Dhanuka and Sons v. CIT9 was cited by the

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

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

assessee from its business was from dividend whereas the assessee

was  unable  to  produce  any  material  before  the  authorities  below

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

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

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

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

9  (2011) 339 ITR 319 (Cal)

28

Sons read as under:

“6.  Mr. Sarkar, the learned advocate appearing on behalf of the revenue, has, on the other hand, supported the order passed by the  Tribunal  and has  contended that  the  assessee itself having failed to produce material in support of its contention, the Assessing Officer rightly assessed the deductible income on proportionate basis. Mr. Sarkar submits that the same is in conformity with Rule 8D of the Income tax Rule and thus, we should not interfere with the order passed by the Tribunal.

7.  After hearing the learned counsel appearing for the parties and  after  going  through  the  materials  on  record  and  the decisions cited by Mr. Khaitan, we find that the Supreme Court in  the  cases  of CIT v. Maharastra  Sugar  Mills  Ltd. [1971]  82 ITR  452  and Rajasthan  State  Warehousing Corpn. v. CIT [2000] 242 ITR 450/109 Taxman 145 having held that  where  there  is  one  indivisible  business  giving  rise  to taxable  income  as  well  as  exempt  income,  the  entire expenditure incurred in relation to that business would have to be  allowed  even  if  a  part  of  the  income  earned  from  the business  is  exempt  from  tax,  section  14A  of  the  Act  was enacted  to  overcome  those  judicial  pronouncements.  The object of section 14A of the Act is to disallow the direct and indirect expenditure incurred in relation to income which does not form part of the total income.

8.  In the case before us, there is no dispute that part of the income of  the  assessee  from  its  business  is  from dividend which is exempt from tax whereas the assessee was unable to produce any material before the authorities below showing the source  from which  such  shares  were  acquired.  Mr.  Khaitan strenuously contended before us that  for  the last  few years before  the  relevant  previous  year,  no  new share  has  been acquired and thus, the loan that was taken and for which the interest is payable by the assessee was not for acquisition of those old shares and, therefore, the authorities below erred in law in giving benefit of proportionate deduction.

9.  In our opinion, the mere fact that those shares were old ones  and  not  acquired  recently  is  immaterial.  It  is  for  the assessee to show the source of acquisition of those shares by production  of  materials  that  those  were  acquired  from  the funds available in the hands of the assessee at the relevant point of time without taking benefit of any loan. If those shares were  purchased  from  the  amount  taken  in  loan,  even  for instance, five or ten years ago, it is for the assessee to show by the production of documentary evidence that such loaned

29

amount  had  already  been  paid  back  and  for  the  relevant assessment year, no interest is payable by the assessee for acquiring  those  old  shares.  In  the  absence  of  any  such materials  placed  by  the  assessee,  in  our  opinion,  the authorities below rightly held that proportionate amount should be  disallowed  having  regard  to  the  total  income  and  the income from the exempt source. In the absence of any material disclosing the source of acquisition of shares which is within the special knowledge of the assessee, the assessing authority took a most reasonable approach in assessment.”

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

emerged  from  different  High  Courts  and  the  respective  reasons  in

support of these conflicting outcome.  Obviously, assessees are banking

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

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

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

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

necessary  to  give  a  detailed  narrative  of  the  arguments  which  were

advanced by various counsel appearing for the assessees as well as

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

serve the purpose.

28) Insofar  as  assessees  are  concerned,  their  arguments  are

recapitulated in brief hereinbelow:

(i) The  holding  of  investment  in  group  companies  representing

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

various cases.

(ii) Notwithstanding  that  dividend  income  is  assessable  under  the

30

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

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

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

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

acquiring/retaining controlling interest,  dividend income is  in  the

nature of business income.

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

controlling interest in the investee company is allowable business

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

controlling  interest  in  companies  and  managing,  administering,

financing  and  rehabilitating  such  companies  are  for  business

and/or professional purposes and not for earned dividend.

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

shares  representing  controlling  interest  does  not  represent

expenditure  incurred  for  earning  dividend  income  and  is  not

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

Section 14A).

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

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

purpose of acquiring controlling interest in the company, the dominant

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

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

31

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

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

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

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

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

interpretation  meaning  thereby mandating  and  requiring  a  direct  and

proximate nexus/link between the expenditure actually incurred and the

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

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

direct and proximate connection between the expenditure incurred and

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

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

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

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

relation  thereto’  from  entering  into  the  computation  of  assessable

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

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

deduction  in  respect  of  expenditure  actually  incurred  which  directly

resulted in the earning of exempt income by the assessee.  

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

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

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

32

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

expenditure incurred in respect of income earned, which is exempted

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

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

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

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

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

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

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

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

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

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

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

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

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

taken note of above.

32) In the first instance, it needs to be recognised that as per section

14A(1) of  the Act,  deduction of  that  expenditure is not  to be allowed

which has been incurred by the assessee “in relation to income which

does not form part of the total income under this Act”.  Axiomatically, it is

that expenditure alone which has been incurred in relation to the income

33

which  is  includible  in  total  income that  has  to  be  disallowed.   If  an

expenditure  incurred  has  no  causal  connection  with  the  exempted

income, then such an expenditure would obviously be treated as not

related to the income that is exempted from tax, and such expenditure

would be allowed as business expenditure.  To put it  differently, such

expenditure would then be considered as incurred in respect of other

income which is to be treated as part of the total income.

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

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

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

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

The entire dispute is as to what interpretation is to be given to the words

‘in relation to’ in the given scenario, viz. where the dividend income on

the shares is earned, though the dominant purpose for subscribing in

those shares of the investee company was not to earn dividend.  We

have two scenarios in these sets of appeals.  In one group of cases the

main  purpose  for  investing  in  shares  was  to  gain  control  over  the

investee company.  Other cases are those where the shares of investee

company  were  held  by  the  assessees  as  stock-in-trade  (i.e.  as  a

business  activity)  and  not  as  investment  to  earn  dividends.   In  this

context, it is to be examined as to whether the expenditure was incurred,

in respective scenarios, in relation to the dividend income or not.

34

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

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

which  is  pressed  into  service  by  the  assessees  would  apply  while

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

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

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

relevant.  No doubt, the assessee like Maxopp Investment Limited may

have  made  the  investment  in  order  to  gain  control  of  the  investee

company.  However, that  does not  appear  to  be a relevant  factor  in

determining the issue at hand.  Fact remains that such dividend income

is non-taxable. In this scenario, if expenditure is incurred on earning the

dividend income, that much of the expenditure which is attributable to

the dividend income has to  be disallowed and cannot  be treated as

business expenditure.  Keeping this objective behind Section14A of the

Act in mind, the said provision has to be interpreted,  particularly, the

word ‘in relation to the income’ that does not form part of total income.

Considered  in  this  hue,  the  principle  of  apportionment  of  expenses

comes into play as that is the principle which is engrained in Section 14A

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

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

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

therefrom.

35

“  The next phrase is, “in relation to income which does not form part of total income under the Act”. It means that if  an income does not form part of total income, then the related expenditure is outside the ambit of the applicability of section 14A..

xxx xxx xxx

The theory  of  apportionment  of  expenditure between taxable  and  non-taxable  has,  in  principle,  been  now widened under section 14 A.”

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

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

assessee had a composite and indivisible business which had elements

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

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

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

income  did  not  apply.   The  principle  of  apportionment  was  made

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

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

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

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

intent was expressed loudly and clearly in the Memorandum explaining

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

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

of  Punjab  &  Haryana  High  Court  which  went  by  dominant  purpose

theory.  The aforesaid reasoning would be applicable in cases where

36

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

purpose  of  having  controlling  interest  therein.   On  that  reasoning,

appeals of Maxopp Investment Limited as well as similar cases where

shares were purchased by the assessees to have controlling interest in

the investee companies have to fail and are, therefore, dismissed.

36) There is yet  another aspect which still  needs to be looked into.

What happens when the shares are held as ‘stock-in-trade’ and not as

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

has issued circular No. 18/2015 dated November 02, 2015.

37) This Circular has already been reproduced in Para 19 above.  This

Circular takes note of the judgment of this Court in Nawanshahar case

wherein it is held that investments made by a banking concern are part

of  the business or  banking.   Therefore,  the income arises from such

investments is attributable to business of banking falling under the head

‘profits  and  gains  of  business  and  profession’.   On  that  basis,  the

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

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

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

make it clear that the issue was as to whether income by way of interest

on securities shall be chargeable to income tax under the head ‘income

from other sources’ or it is to fall under the head ‘profits and gains of

37

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

in  Nawanshahar  case,  clarified  that  it  has  to  be  treated  as  income

falling under the head ‘profits and gains of business and profession’. The

Board also went to the extent of saying that this would not be limited

only to co-operative societies/Banks claiming deduction under Section

80P(2)(a)(i)  of  the  Act  but  would  also  be  applicable  to  all

banks/commercial  banks,  to  which  Banking  Regulation  Act,  1949

applies.   

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

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

and provides that if the motive behind purchase and sale of shares is to

earn profit, then the same would be treated as trading profit and if the

object is to derive income by way of dividend then the profit would be

said to have accrued from investment.  To this extent, the High Court

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

dominant  intention  applied  by  the  Punjab  and  Haryana  High  Court,

which we have already discarded.  In that event, the question is as to on

what basis those cases are to be decided where the shares of other

companies are purchased by the assessees as ‘stock-in-trade’ and not

as ‘investment’.  We proceed to discuss this aspect hereinafter.

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

38

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

we are not concerned with those profits which would naturally be treated

as  ‘income’  under  the  head  ‘profits  and  gains  from  business  and

profession’.  What happens is that, in the process, when the shares are

held  as  ‘stock-in-trade’,  certain  dividend  is  also  earned,  though

incidentally, which is also an income.  However, by virtue of Section 10

(34) of the Act, this dividend income is not to be included in the total

income and is exempt from tax.  This triggers the applicability of Section

14A  of  the  Act  which  is  based  on  the  theory  of  apportionment  of

expenditure between taxable and non-taxable income as held in Walfort

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

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

acquiring those shares will have to be apportioned.

40) We note from the facts in the State Bank of Patiala cases that the

AO,  while  passing  the  assessment  order,  had  already  restricted  the

disallowance to the amount which was claimed as exempt income by

applying the formula contained in Rule 8D of the Rules and holding that

section 14A of the Act would be applicable.  In spite of this exercise of

apportionment of expenditure carried out by the AO, CIT(A) disallowed

the entire deduction of expenditure.  That view of the CIT(A) was clearly

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

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

39

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

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

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

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

a business proposition.   Whether dividend is earned or not  becomes

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

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

though the  assessee has  to  ultimately  trade those  shares by selling

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

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

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

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

company that  would necessarily be earned by the assessee and the

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

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

well and as and when such dividend income is generated that would be

earned by the assessee.   In  contrast,  where the shares are held as

stock-in-trade,  this  may  not  be  necessarily  a  situation.   The  main

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

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

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

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

40

hereinabove.

41) Having regard to the language of Section 14A(2) of the Act, read

with Rule 8D of the Rules, we also make it clear that before applying the

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

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

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

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

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

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

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

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

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

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

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

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

following words:

“...Admittedly the assessee had paid total interest of Rs.2.92 crores  out  of  which  interest  paid  on  term  loan  raised  for specific purpose totals to Rs.1.70 crores and balance interest paid by the assessee is Rs.1.21 crores.  The funds utilized by the assessee being mixed funds and in view of the provisions of Rule 8D(2)(ii) of the Income Tax Rules the disallowance is confirmed at Rs.10,49,851/-, we find no merit in the ad hoc disallowance  made  by  the  CIT  (Appeals)  at  Rs.5,00,000/-. Consequently, ground  of  appeal  raised  by  the  Revenue  is partly  allowed  and  ground  raised  by  the  assessee  in cross-objection is allowed...”

41

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

dismissed the appeal of the assessee observing as under:

“In the present case, after examining the balance-sheet of the assessee, a finding of fact has been recorded that the funds utilized  by the  assessee being  mixed funds,  therefore,  the interest  paid  by  the  assessee  is  also  an  interest  on  the investments made.  Such being a finding of fact, we do not find  that  any  substantial  question  of  law  arises  for consideration of this Court.”

After  going  through  the  records  and  applying  the  principle  of

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

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

dismissed.

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

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

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

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

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

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

by  this  Court  in  Civil  Appeal  No.  2165  of  2012  (Commissioner  of

Income Tax,  Mumbai  v.  M/s.  Essar Teleholdings Ltd.  through its

Manager),  pronounced  on  January  31,  2018,  that  the  said  Rule  is

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

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

42

44) To sum up:

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

130, 1423 of 2015, are dismissed.

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

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

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

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

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

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

41203 of 2017, is allowed.

.............................................J. (A.K. SIKRI)

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

NEW DELHI; FEBRUARY 12, 2018.