IMPORTANT POINTS
Expenditure on shares, even for having controlling interest, but earning dividend are hit by section 14A(1).
Dividend income derived from shares as stock in trade not taxable u/s 10(34) making section 14A applicable.

Headnote:(a) Income Tax act, 1961 – Section 14A(1) – Dominant purpose test – Not relevant – rather, principle of apportionment of expenses applies – Held, expenditure on shares, even for having controlling interest, hit by section 14A(1). (Para 34, 35, 37)
       (2010) 326 ITR 1 (SC) – Relied upon
       (2017) 391 ITR 218 (P&H); (2012) 206 Taxman 563; 312 ITR (AT) 1; (1988) 2 SCC 299 – Referred
       (b) Income Tax act, 1961 – Section 14A(1) and 10(34) r/w Rule 8D, Income Tax Rules, 1962 – Stock in trade – Investments made by a banking concern – Part of the business or banking – Has to be treated as income falling under the head ‘profits and gains of business and profession’ – Dividend income derived from shares as stock in trade not taxable u/s 10(34) making section 14A applicable – Theory of apportionment – Rule 8D is prospective – a (Para 39, 43)
       (2010) 326 ITR 1 (SC); Civil Appeal No. 2165 of 2012 – Relied upon
       (2017) 391 ITR 218 (P&H) – Referred
       Facts of the case:
       The question involved in this case is whether the expenditure incurred for purchasing shares of a company with a view to gain control over it but which earns dividend which is exempt from income will be deductible u/s 14A(1)of the Income Tax act, 1961?
       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.
       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.
       In appeal, the Commissioner of Income Tax (Appeals) {CIT(A)} upheld the order of the AO.
       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.
       The Special Bench of the ITAT dismissing the appeal of the appellant 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 proportionate disallowance of the expenditure incurred by the assessee is maintained by High Court of Delhi.
       The Punjab and Haryana High Court in a recent judgment 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. The Revenue has filed appeals challenging the correctness of the aforesaid decisions.
       Thus, in view of conflict of opinions of various High Courts, these batch of appeals are by those assessees who were lost before the High Court and by the Income Tax Department against the judgments of the High Court where the view taken is favourable to the assessee and against the Revenue.
       Finding of the Court:
       Expenditure on shares, even for having controlling interest, but earning dividend are hit by section 14A(1).
       Dividend income derived from shares as stock in trade not taxable u/s 10(34) making section 14A applicable.
       Result: Civil Appeal arising out of Diary No. 41203 of 2017 allowed.
       Civil Appeal Nos. 104-109, 110-112, 130, 1423 of 2015; 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 dismissed.

JUDGMENT :

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 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 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 ‘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

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2018 Supreme(SC) 294

IMPORTANT POINTSExpenditure on shares, even for having controlling interest, but earning dividend are hit by section 14A(1).Dividend income derived from shares as stock in trade not taxable u/s 10(34) making section 14A applicable.

Cases Referred (3)

IMPORTANT POINTS
Expenditure on shares, even for having controlling interest, but earning dividend are hit by section 14A(1).
Dividend income derived from shares as stock in trade not taxable u/s 10(34) making section 14A applicable.