Section 14A Judicial Pronouncements Chirag Ramesh Jobanputra
Issues for discussion Claim for exemption Investment vs. Stock-in-trade 14A vs. 115JB Significance of claim in books of account Own funds vs. Borrowed funds Share of profit in partnership firm 2
Claim for Exemption - scenarios In AY 2013-14 - Mr. A earned dividend income of Rs. 20,000/- which was claimed as exempt u/s 10(34) of the Income-tax Act, 1961. Mr. B earned dividend income of Rs. 20,000/- which was not claimed as exempt but was voluntarily offered to tax. Mr. C has not earned any dividend income during the year although Mr. C is holding securities capable of generating exempt income. 3
Claim for Exemption - issue The Bombay High Court in Godrej and Boyce has held that Once a proximate cause for disallowance is established which is the relationship of the expenditure with income which does not form part of the total income a disallowance u/s 14A has to be effected Whether disallowance can be made under section 14A of the Income-tax Act, 1961 read with Rule 8D of the Income-tax Rules, 1962 in computing total taxable income of Mr. A, B and C? 4
Claim for Exemption 14A Section 14A(1) reads as under 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 5
Claim for Exemption Mr. A Since Mr. A has earned income which is not included in the total income the provisions of section 14A are applicable. The expenditure incurred in relation to earning of income not included in total income shall be disallowed. If Mr. A s claim for incurring of expenditure is not accepted by the AO then the disallowance shall be made as per the method prescribed in Rule 8D. 6
Claim for Exemption Mr. B Mr. B has earned dividend income which is exempt under the Act but offered the same to tax thereby making an attempt to convert the exempt income into taxable income which is not in accordance with the Income-tax Act, 1961. The Mumbai Tribunal in Binayak Tex Processors Ltd. [2014] 44 taxmann.com 179 has held that even if the exempt income is offered to tax the provisions of 14A are applicable and disallowance is to be made as per Rule 8D. 7
Claim for Exemption Mr. C Mr. C has not earned any income which is exempt under the Act but holds securities capable of generating exempt income. Judicial Pronouncements CIT vs. Corrtech Energy Pvt Ltd. Appeal no. 239 of 2014 (Guj HC) dated 24.3.2014 Since the Assessee did not make any claim for exemption of any income from payment of tax the disallowance under section 14A could not be made. CIT vs. Lakhani Marketing Incl. ITA No. 970 of 2008 (P & H) dated 2.4.2014 The H ble High Court upheld the order of Tribunal wherein it has been held: 8
Claim for Exemption Mr. C That there must be income taxable under the Act; That this income must not form part of total income under the Act; That there must be an expenditure incurred by the Assessee; and That the expenditure must have a relation to the income which does not form part of the total income under the Act. Therefore unless and until there is receipt of exempted income for the concerned AY, section 14A of the Act cannot be invoked. 9
Claim for Exemption CBDT Circular CIRCULAR NO. 5/2014 [F.No. 225/182/2013 - ITA. II], DATED 11-2-2014: The legislative intent is to allow only that expenditure which is relatable to earning of income and it therefore follows that the expenses which are relatable to earning of exempt income have to be considered for disallowance, irrespective of the fact whether any such income has been earned during the financial year or not. 10
Claim for Exemption CBDT Circular The above position is further clarified by the usage of term 'includible' in the Heading to section 14A of the Act and also the Heading to Rule-8D of I.T. Rules, 1962 which indicates that it is not necessary that exempt income should necessarily be included in a particular year's income, for disallowance to be triggered. Also, section 14A of the Act does not use the word "income of the year" but "income under the Act". This also indicates that for invoking disallowance under section 14A, it is not material that assessee should have earned such exempt income during the financial year under consideration. 11
Claim for Exemption CBDT Circular Thus, in light of above, Central Board of Direct Taxes, in exercise of its powers under section 119 of the Act hereby clarifies that Rule 8D read with section 14A of the Act provides for disallowance of the expenditure even where taxpayer in a particular year has not earned any exempt income. Whether the Circular is applicable only if Rule 8D is applied? Whether the Circular has retrospective effect, if yes, then from AY 2008-09 onwards only? 12
Claim for Exemption Representation The ICAI in its Pre-Budget Memorandum 2014 has pointed out the issues relating to Rule 8D and also suggested the remedies for the same as under Issue/ Justification - Rule 8D has created genuine hardships for tax payers, as the calculation basis under rule 8D is arbitrary. In many cases, the disallowance calculated as per rule 8D method exceeds the amount of total exempted income earned during the year. This is because of the following reasons: 13
Claim for Exemption Representation Firstly, the interest expense, which does not form part of exempted income, is disallowed. Secondly, while working out half percent of the average investments, all the investments in shares/mutual funds are considered. Thirdly, this method does not demarcate between investments that have generated or not generated income during the year. Lastly, no distinction has been made for companies earning dividend income due to holding strategic investments in group companies and very little expenditure is attributable to earn such dividend income. 14
Claim for Exemption Representation It is suggested that Only those expenses which are directly related to earning of exempt income shall be disallowed. Further, the overall maximum limit of expense to be disallowed should not exceed the tax payable on exempted income earned. Overall maximum limit of expense to be disallowed in case of dividend income earned from holding strategic investment in group companies shall be capped. 15
Investment vs. Stock in Trade Rule 8D provides for the method for determining amount of expenditure in relation to income not includible in total income. As per Rule 8D(2)(ii) and (iii) the disallowance is based on the average value of investments the income from which does not or shall not form part of the total income. Interpretation of the word investment leads to different opinions and views for entities transacting in shares and having investment and trading portfolio or only trading portfolio. 16
Investment vs. Stock in Trade Decisions in favour CCI Ltd. v. Jt. CIT [2012] 206 Taxman 563/20 taxmann.com 196 (Kar. HC) Dy. CIT v. India Advantage Securities Ltd., [IT Appeal No.6711 (Mum.) of 2011 dated 14/09/2012.] Ambit Securities Broking (P.) Ltd., v. Addl. CIT [IT Appeal No. 7856(Mum) of 2011, dated 6-07- 2013] 17
Investment vs. Stock in Trade Decisions Against Dy. CIT v. Gulshan Investment Co. Ltd. [2013] 142 ITD 89/31 taxmann.com 113 (Kol.) Jt. CIT v. American Express Bank Ltd. [2012] 138 ITD 288/24 taxmann.com 50 (Mum.) Dy. CIT v. Damani Estates and Finance (P.) Ltd. [IT Appeal No. 3029 (Mum.) of 2012, dated 17.1.2013] D.H. Securities P Ltd. Vs Dy. CIT [2014] 41 taxmann.com 352 (Mum) (TM) dated 27.11.2013 18
Investment vs. Stock in Trade Gulshan Investment Co. Ltd. Facts of the case The Assessee was engaged in the business of share trading having no investments. During the assessment year under scrutiny the Assessee had earned dividend income on shares held as stock in trade. The Assessee did not make any disallowance under section 14A read with Rule 8D. The AO computed the disallowance as per Rule 8D and considered the value of stock in trade as investment for the purpose of Rule 8D. 19
Investment vs. Stock in Trade Gulshan Investment Co. Ltd. Decision of Tribunal (after considering Bombay HC decision in Godrej and Boyce) Rule 8D(2)(ii) and (iii) of 1962 Rules can be applied in the situations in which shares are held as investments, and that this rule will not have any application when the shares are held as stock-intrade. It is so for the elementary reason that the one of the variables on the basis of which disallowance under rules 8D(2)(ii) and (iii) is to be computed is the value of 'investments, income from which does not or shall not form part of total income, and, when there are no such investments, the rule cannot have any application. 20
Investment vs. Stock in Trade Gulshan Investment Co. Ltd. However, that does not exclude the application of rule 8D(2)(i) which refers to the 'amount of expenditure directly relating to income which does not form part of total income'. So far as disallowance under section 14A in a situation in which the exempt income yielding asset, such as shares is held as stock-in-trade, and not as investment, the disallowance will be of related direct and indirect expenditure, whereas disallowance under rule 8D will be restricted to disallowance of only direct expenses. 21
Investment vs. Stock in Trade Gulshan Investment Co. Ltd. It is also clarified that the provisions of section 14A are indeed attracted whether or not the shares are held as stock-in-trade or as investments, even though the provisions of rule 8D(2)(ii) and (iii) cannot be invoked in such a case, and even though the provisions of rule 8D(2)(i) are much narrower in scope than the scope ofsection 14A simplicitor. 22
Investment vs. Stock in Trade D.H. Securities Pvt. Ltd. Facts of the case The Assessee is a private limited company and earned dividend income during the impugned assessment year. The dividend income was earned on shares held asstock in trade and not asinvestment. The Assessee disallowed certain expenditure under section 14A but not as per Rule 8D. The AO disallowed expenditure for earning exempt income as per Rule 8D considering stock in trade as investment. 23
Investment vs. Stock in Trade D.H. Securities Pvt. Ltd. Decision of Tribunal (TM) 1. Whether decision of Karnataka High Court in case of CCI Ltd. be followed? The issue under appeal is squarely covered by the principles laid down by the Hon'ble jurisdictional High Court in Godrej & Boyce Mfg. Co. Ltd. The assessee has mainly relied upon the decision of the Hon'ble Karnataka High Court in the case of CCI Ltd. (supra) and other Tribunal decisions including three decisions in which CCI Ltd.'s decision has been followed. 24
Investment vs. Stock in Trade D.H. Securities Pvt. Ltd. There is nothing in the said judgment of the Hon'ble Karnataka High Court to show that the judgment of the Hon'ble jurisdictional High Court in Godrej & Boyce Mfg. Co. Ltd. (supra) was brought to its notice or considered by it. On the other hand, the said judgment of the Hon'ble jurisdictional High Court has been, as rightly observed by the ld. AM, duly considered by the Hon'ble Calcutta High Court, which has subsequently been followed by the Division Benches of this Tribunal in American Express Bank Ltd. (supra) and Damani Estates & Finance (supra). 25
Investment vs. Stock in Trade D.H. Securities Pvt. Ltd. 2. Whether Section 14A is applicable to shares held as stock in trade? We do not think that the purpose for which the shares are purchased and held would in any manner impact the applicability of section 14A, which gets attracted on incurring the expenditure in relation to the tax exempt income. The hon'ble court in the case of Godrej & Boyce Mfg. Co. Ltd. (supra), after examining the genesis of the provision of section 14A, held that the same hasbeen enacted to overcome the incidence of non-disallowance of expenditure - in view of the judicial precedents by the apex court - 26
Investment vs. Stock in Trade D.H. Securities Pvt. Ltd. - where there is a one indivisible business giving rise to taxable as well as exempt incomes. That is, as in the instant case, where the share trading business yields both taxable income in the form of share trading profit and tax-exempt income by way of dividend income. Therefore, to say that section 14A would not apply as shares are held as stock-in-trade would again not hold. In view of the foregoing, it is held that disallowance under section 14A can be made in conformity with law even in cases where dividend income has been earned on the shares held as stock-in-trade. 27
Investment vs. Stock in Trade D.H. Securities Pvt. Ltd. 3. Whether Rule 8D is to be applied summarily and entire stock in trade is to be included in the value of investments? The rule is self- explanatory. There could be no quarrel with regard to the allocation of direct expenditure, which in fact states the obvious, and would in any case warrant a disallowance, i.e., even in the absence of the rule. - 8D(2)(i) Similarly, the part of the rule prescribing the ratio in respect of indirect expenditure (rule 8D(2)(iii)) cannot be altered on account of (say) hardship. 28
Investment vs. Stock in Trade D.H. Securities Pvt. Ltd. It is the interest exp. in Rule 8D(2)(ii) which presents a problem. In the instant case the shares, which yield the tax exempt dividend income, interest qua which is to be disallowed, being held as stock-in-trade, also yield share trading income, which is taxable. Therefore, to say that the entire interest relatable to the average share holding is to be attributed to the tax exempt dividend income would be patently incorrect on facts. However, considering that the dominant objective of the share holding, which in our view should be dispositive of the matter, is the share trading income, we propose a ratio of 20% toward the tax exempt dividend income. 29
14A and 115JB - issue Section 14A provides for disallowance of expenditure incurred in relation to exempt income. Section 115JB(2)(f) provides for addition of expenditure related to any income which is income exempt under section 10 except section 10(38), 11 or 12. There is no direct reference to provisions of section 14A in section 115JB. In the above scenario can the amount disallowable as per 14A be directly disallowed in section 115JB also? 30
14A and 115JB Case law ITO vs. RBK Sharebroking P Ltd. [2013] 37 taxmann.com 128 (Mum) The Assessee earned dividend income and claimed it exempt under the Act. The Assessee paid taxes on books profit under section 115JB of the Act. The Tribunal held that the amount disallowable u/s 14A is covered under clause (f) of Explanation (1) to section 115JB(2). No apportionment formula if exempt income is in the nature of LTCG exempt u/s 10(38)??? 31
Claim in the books of account case law Whether the AO has to record its satisfaction regarding incorrectness of the claim of Assessee? Sitsons India P Ltd vs. ACIT [2014] 44 taxmann.com 340 (Mum) A careful reading of the provisions of 14A(2) would show that the assessing officer is required to determine the amount of expenditure incurred in relation to exempted income, if he is not satisfied with the correctness of the claim made by the assessee, having regard to the accounts of the assessee. 32
Claim in the books of account case law The said section no where states that the satisfaction needs to be recorded in writing. The very fact that the assessing officer has proceeded to invoke the provisions of sec. 14A(2) shows that the assessing officer was not satisfied with the correctness of the claim made by the assessee. In the instant case, the assessee has claimed that it did not incur any expenditure in relation to earning of the dividend income. According to sec. 14A(3), the provisions of sec. 14A(2) shall have automatic application when such a claim is made. 33
Claim in the books of account case law In that kind of situation, in our view, the question of examining about satisfaction of the assessing officer with regard to the claim of the assessee does not arise, due to legal fiction embodied in sub-section (3) of the Act. 34
Claim in the books of account case law Harendra Thanawala vs. ACIT [2013] 38 taxmann.com 111 (Mum) - The A.O. may record his reasons for dissatisfaction, which would in fact enable the appellate authority in review proceedings to examine the same. At the same time, there being no express requirement in law for recording the reasons, his dissatisfaction may be implicit. In the instant case, the assessee has segregated the expenditure, debiting the same, where relating to his business, as claimed, to the profit and loss account, and where not so, to his capital account. 35
Claim in the books of account case law So, however, it cannot be denied that the assessee, by bifurcating or allocating the expenditure has made out a prima facie case of no expenditure in relation to the tax-free income having been claimed per the return of income. The Revenue's stand for application of rule 8D, i.e., that the assessee has not affected any suo motu disallowance, is untenable and cannot hold; the assessee having ostensibly debited such expenditure to the capital account. 36
Claim in the books of account case law The A.O. shall, we may though add, restrict his examination only to the profit and loss account of the assessee's business, as it is only in case the same bears any (indirect) expenditure qua income that does not form part of the total income, that disallowance u/r.8d could bemade by him. 37
Claim in the books of account case law DCIT vs. Ashish Jhunjunwala I.T.A No. 1809/Kol/2012 We find from the facts of the above case that the AO hasnot examined the accounts of the assessee and there is no satisfaction recorded by the AO about the correctness of the claim of the assessee and without the same he invoked Rule 8D of the Rules. While rejecting the claim of the assessee with regard to expenditure or no expenditure, as the case may be, in relation to exempted income, the AO has to indicate cogent reasons for the same. 38
Claim in the books of account case law Godrej & Boyce Mfg Co Ltd vs. DCIT [2010] 194 TAXMAN 203 (BOM.) Sub-section (2) of section 14A does not enable the Assessing Officer to apply the method prescribed by rule 8D without determining in the first instance the correctness of the claim of the assessee, having regard to the accounts of the assessee. Sub-section (2) of section 14A mandates that it is only when having regard to the accounts of the assessee, the Assessing Officer is not satisfied with the correctness of the claim of the assessee in respect of expenditure incurred in relation to income which does not form part of the total income under the Act, that he can proceed to make a determination under the Rules. 39
Claim in the books of account case law The satisfaction envisaged by sub-section (2) of section 14A is an objective satisfaction that has to be arrived at by the Assessing Officer having regard to the accounts of the assessee. The safeguard introduced by sub-section (2) of section 14A for a fair and reasonable exercise of power by the Assessing Officer, conditioned as it is by the requirement of an objective satisfaction, must, therefore, bescrupulously observed. An objective satisfaction contemplates a notice to the assessee, an opportunity to the assessee to place on record all the relevant facts including his accounts and recording of reasons by the Assessing Officer in the event that he comes to the conclusion that he is not satisfied with the claim of the assessee. 40
Own vs. Borrowed funds precedents CIT vs. Hero Cylces (P & H) If the investment in the shares is out of the non-interest bearing funds, disallowance u/s 14A is not sustainable; The contention of the revenue even if the assessee has made investments in shares out of its own funds, the said own funds are merged with the borrowed funds in a common kitty and, therefore, disallowance u/s 14A can bemade is also not justified. 41
Own vs. Borrowed funds precedents Godrej & Boyce Mfg. Co. Ltd. Vs. DyCIT (Bom HC) In Reliance Utilities & Power Ltd. s case (supra), the Division Bench has held that if there be interest-free funds available to an assessee sufficient to meet its investments and at the same time the assessee had raised a loan it can be presumed that the investments were from the interest-free funds available. The said decision turned on a finding of fact by the Tribunal that there were sufficient interestfree funds available in that case. The judgment in Reliance Utilities & Power Ltd. s case (supra) shows that there were interest-free owned funds available and not merely reserves. 42
Own vs. Borrowed funds case law Whether on the date of investment it is necessary that the Assessee should have own funds in order to escape the applicability of 14A read with Rule 8D(2)(ii)? Binayak Tex Processors Ltd vs. ACIT [2014] 44 taxmann.com 179 (Mum) We may observe that in day to day business, it is for the assessee to see how to manage its business. Even if on the date of investment/expenditure, own funds may not be available with the assessee but if the investment/ expenditure is made in anticipation of availability of own funds and the own funds are available to the assessee within a very short period of 43
Own vs. Borrowed funds case law time, then under such circumstances disallowance cannot be made on the entire loan amount but a very reasonable proportionate disallowance can be made and even in certain cases can be ignored due to the shortness of the period between the date of advancement/expenditure and date of availability of own funds. The principle underlying this proposition is that a businessman has to circulate his money according to the day to day requirements and the likely inflow and outflow of money in the near future is taken into consideration while making investments. 44
Share of Profit in Firms case law Safal Reality Pvt Ltd vs. ACIT ITA No.2334/Ahd/2012 & 1842/Ahd/2013 (Ahd) Under the totality of the facts and circumstances of the case, we are of the considered opinion that when the interest income was more than the interest expenditure then the AO was not justified to invoke the provisions of Section 14A read with Rule 8D of IT Act. We hereby reverse the findings of the authorities below and direct to delete the disallowance. 45
46