# C.l.T., MUMBAI v. MIS. WALFORT SHARE & STOCK BROKERS P. L ro

- **Citation:** [2010] 7 S.C.R. 748
- **Court:** Supreme Court of India
- **Decided:** 2010-07-06
- **Case number:** Civil Appeal No. 4927 of 2010
- **Bench:** S.H. Kapadia, Swatanter Kumar
- **Source:** https://unisonlegal.in/judgment/supreme-court-of-india/c-l-t-mumbai-v-mis-walfort-share-stock-brokers-p-l-ro-26958
- **Pages:** 29

## Headnote

Income Tax Act, 1961:
c
ss. 10(33), 14A and 94(7) -
Dividend stripping
transaction - Cases prior to 1. 4. 2002 - Loss on sale of units
-
Exemption from income - Held: Losses pertaining to
exempted income, cannot be disallowed - After, 01042002,
losses over and above the amount of dividend received would
0 still be allowed - It will not be ignored u/s. 94(7) - Parliament
has not treated the dividend stripping transaction as sham or
bogus - It has not treated the entire loss as fictitious or only
a fiscal loss.
ss. 14A and 94(7) - Reconciliation of ss. 14A with ss. 94
E (7) - Held: ss. 14A and 94 (7) operate in different fields -
Section 14A comes in when there is claim for deduction of
expenditure whereas s. 94 (7) comes in when there is claim
for allowance for the business loss.
F
Accounting Standard AS-13 Para 12 - Applicability of -
Units bought at the ruling Net Asset Value with a right to
receive dividend as and when declared in future - Held: AS13 not applicable.
The respondent-assessee is engaged in trading of
G shares. During the assessment year 2000-01, the
assessee purchased some units of Mutual Funds on the
rncord date-24.03.2000 and earned dividend income.
Thereafter, the NAV (net asset value) of the units got
H
748
C.l.T., MUMBAI v. WALFORT SHARE & STOCK
749
BROKERS P. LTD.
reduced and the assessee sold these units at a lesser A
price and incurred losses. The assessee claimed the
dividend received as exempt from tax under section
10(33) of the Income Tax Act, 1961 and also claimed setoff
as loss incurred ori the sale of units. The Assessing
Authority did not allow the claim of loss on the ground
B
that the dividend stripping transaction was not business
transaction. The CIT (A) upheld the order of the
Assessing Officer. The tribunal allowed the appeal
holding that the assesee was entitled to set off the said
loss from the said transactions against its other income c
chargeable to tax. The High Court upheld the order of the
tribunal. Hence, these appeals.
Dismissing the appeals, the Court
HELD: 1.1.The insertion of section 14A of the Income o
Tax Act, 1961 with retrospective effect is the serious
attempt on the part of the Parliament not to allow
deduction in respect of any expenditure incurred by the
assessee in relation to income, which does not form part
E
F
of the total income under the Act against the taxa~le
iflcome (Circular No. 14 of 2001 dated 22.11.2001).
Section 14A clarifies that expenses incurred can be
allowed only to the extent they are relatable to the
earning of taxallle income. In many cases the nature of
expenses incurred by the assessee may be relatable
partly to the exempt income and partly to the taxable
income. In the absence of section 14A, the expenditure
incurred in respect of exempt income was being claimed
against taxable income. The mandate of section 14A is
clear. It desires to curb the practice to claim deduction
of expenses incurred in relation to exempt income G
against taxable income and at the same time avail th~ tax
incentive by way of exemption of exempt income without
making any apportionment of expenses incurred in
relation to exempt income. The basic reason for insertion
of section 14A is that certain incomes are not includible
H
750
SUPREME COURT REPORTS
[2010) 7 S.C.R.
A while computing total income as these are exempt under
certain provisions of the Act. [Para 14] [769-H; 770-A-E]
1.2. One needs to read the words 'expenditure
incurred' in section 14A in the context of the scheme of
8 the Act and, if so read, it is clear that it disallows certain
expenditures incurred to earn exempt income from being
deducted from other income which is includible in the
"total income" for the purpose of chargeability to tax. The
scheme of sections 30 to 37 is that profits and gains must
be computed subject to certain allowances for
C deductions/ expenditure. The charge is not on gross
receipts, it is on profits and gains. Profits have to be
computed after deducting losses and expenses incur

## Text

_Characters 0–39,349 of 56,154. This is a partial read: ask again with offset=39349 for what follows._

A
B
[2010] 7 S.C.R. 748
C.l.T., MUMBAI
v.
MIS. WALFORT SHARE & STOCK BROKERS P. L ro.
(Civil Appeal No. 4927 of 2010)
JULY 06, 2010
[S.H. KAPADIA, CJI AND SWATANTER KUMAR, J.)
Income Tax Act, 1961:
c
ss. 10(33), 14A and 94(7) -
Dividend stripping
transaction - Cases prior to 1. 4. 2002 - Loss on sale of units
-
Exemption from income - Held: Losses pertaining to
exempted income, cannot be disallowed - After, 01042002,
losses over and above the amount of dividend received would
0 still be allowed - It will not be ignored u/s. 94(7) - Parliament
has not treated the dividend stripping transaction as sham or
bogus - It has not treated the entire loss as fictitious or only
a fiscal loss.
ss. 14A and 94(7) - Reconciliation of ss. 14A with ss. 94
E (7) - Held: ss. 14A and 94 (7) operate in different fields -
Section 14A comes in when there is claim for deduction of
expenditure whereas s. 94 (7) comes in when there is claim
for allowance for the business loss.
F
Accounting Standard AS-13 Para 12 - Applicability of -
Units bought at the ruling Net Asset Value with a right to
receive dividend as and when declared in future - Held: AS13 not applicable.
The respondent-assessee is engaged in trading of
G shares. During the assessment year 2000-01, the
assessee purchased some units of Mutual Funds on the
rncord date-24.03.2000 and earned dividend income.
Thereafter, the NAV (net asset value) of the units got
H
748
C.l.T., MUMBAI v. WALFORT SHARE & STOCK
749
BROKERS P. LTD.
reduced and the assessee sold these units at a lesser A
price and incurred losses. The assessee claimed the
dividend received as exempt from tax under section
10(33) of the Income Tax Act, 1961 and also claimed setoff
as loss incurred ori the sale of units. The Assessing
Authority did not allow the claim of loss on the ground
B
that the dividend stripping transaction was not business
transaction. The CIT (A) upheld the order of the
Assessing Officer. The tribunal allowed the appeal
holding that the assesee was entitled to set off the said
loss from the said transactions against its other income c
chargeable to tax. The High Court upheld the order of the
tribunal. Hence, these appeals.
Dismissing the appeals, the Court
HELD: 1.1.The insertion of section 14A of the Income o
Tax Act, 1961 with retrospective effect is the serious
attempt on the part of the Parliament not to allow
deduction in respect of any expenditure incurred by the
assessee in relation to income, which does not form part
E
F
of the total income under the Act against the taxa~le
iflcome (Circular No. 14 of 2001 dated 22.11.2001).
Section 14A clarifies that expenses incurred can be
allowed only to the extent they are relatable to the
earning of taxallle income. In many cases the nature of
expenses incurred by the assessee may be relatable
partly to the exempt income and partly to the taxable
income. In the absence of section 14A, the expenditure
incurred in respect of exempt income was being claimed
against taxable income. The mandate of section 14A is
clear. It desires to curb the practice to claim deduction
of expenses incurred in relation to exempt income G
against taxable income and at the same time avail th~ tax
incentive by way of exemption of exempt income without
making any apportionment of expenses incurred in
relation to exempt income. The basic reason for insertion
of section 14A is that certain incomes are not includible
H
750
SUPREME COURT REPORTS
[2010) 7 S.C.R.
A while computing total income as these are exempt under
certain provisions of the Act. [Para 14] [769-H; 770-A-E]
1.2. One needs to read the words 'expenditure
incurred' in section 14A in the context of the scheme of
8 the Act and, if so read, it is clear that it disallows certain
expenditures incurred to earn exempt income from being
deducted from other income which is includible in the
"total income" for the purpose of chargeability to tax. The
scheme of sections 30 to 37 is that profits and gains must
be computed subject to certain allowances for
C deductions/ expenditure. The charge is not on gross
receipts, it is on profits and gains. Profits have to be
computed after deducting losses and expenses incurred
for business. A deduction for expenditure or loss which
is not within the prohibition must be allowed if it is on the
D facts of the case a proper Debit Item to be charged
against the oncomings of the business in ascertaining
the true profits. A return of investment or a pay-back is
not such a Debit Item, hence, it is not 'expenditure
incurred' in terms of section 14A. Expenditure is a payE out. It relates to disbursement. A pay-back is not an
expenditure in the scheme of section 14A. For attracting
section 14A, there has to be a proximate cause for
disallowance, which is its relationship with the tax exempt
income. Pay-back or return of investment is not such
F proximate cause, hence, section 14A is not applicable in
the instant case. Thus, in the absence of such proximate
cause for disallowance, section 14A cannot be invoked.
Return of investment cannot be construed to mean
"expenditure" and if it is construed to mean
G "expenditure" in the sense of physical spending still the
expenditure was not such as could be claimed as an
"allowance" against the profits of the relevant accounting
year under sections 30 to 37 of the Act and, therefore,
section 14A cannot be invoked. Hence, the two asset
H theory is not applicable as there is no expenditure
C.l.T., MUMBAI v. WALFORT SHARE & STOCK
751
BROKERS P. LTD.
incurred in terms of section 14A. [Para 14] (771-G-H; 772A
A-E]
1.3. The AO disallowed the loss of Rs. 1,82, 12,862 on
the sale of 40% tax-free units of the mutual fund. The
Department submitted that the assessee is getting taxB
free divid~nd; that at the same time it is claiming loss on
the sale of the,units; that the assessee had purposely and
in a planned manner entered into a pre-meditated
transaction of buying and selling units yielding exempted
dividends with full knowledge about the fall in the NAV
C
after the record date and the payment of tax-free dividend
and, therefore, loss on sale was not genuine and
disallowed the loss, cannot be accepted. The instant
case is with regard to the assessment years prior to
insertion of section 94(7) vide Finance Act, 2001 w.e.f.
1.4.2002. The AO had erred in disallowing the loss. [Paras
D
15, 16 and 17] [772-G-H; 773-E-F; B-C]
1.4. On facts, it is established that there was a "sale".
The sale-price was received by the assessee. That, the
assessee did receive dividend. The fact that the dividend
E
received was tax-free is the position recognized under
section 10(33) of the Act. The assessee had made use of
the said provision of the Act. That such use cannot be
called "abuse of law"., Even assuming that the
transaction was pre-planned there is nothing to impeach
F
the genuineness of the transaction. (Para 17] (773-G-H;
774-A]
Vijaya Bank v. Additional Com.missioner of Income Tax
(1991) 1_87 ITR 541; McDowell & Co. Ltd. v. Commercial Tax
Officer 154 ITR 148(SC); Union of India v. Azadi Bachao
G
Ando/an 263 ITR 706(SC), referred to.
1.5. In the cases arising before 1.4.2002, losses
pertaining to exempted income cannot be disallowed.
However, after 1.4.2002, Sl!Ch losses to the. extent of H
752
SUPREME COURT REPORTS
[2010) 7 S.C.R.
A dividend received by the assessee could be ignored by
the AO in view of section 94(7). The object of section 94(7)
is to curb the short term losses. Applying section 94(7)
in a case for the assessment year(s) falling after 1.4.2002,
the loss to be ignored would be only to the extent of the
B dividend received and not the entire loss. In other words,
losses over and above the amount of the dividend
received would still be allowed from which it follows that
the Parliament has not treated the dividend stripping
transaction as sham or bogus. It has not treated the
c entire loss as fictitious or only a fiscal IG>ss. After 1.4.2002,
losses over and above the dividend received will not be
ignored under section 94(7). If the argument of the
Department is to be accepted, it would mean that before
1.4.2002 the entire loss would be disallowed as not
0 genuine but, after 1.4.2002, a part of it would be allowable
under section 94(7) which cannot be the object of section
94(7) which is inserted to curb tax avoidance by certa•n
types of transactions in securities. [Para 17] [774-C-G]
1.6. Sections 14A and 94(7) were simultaneously
E inserted by the same Finance Act, 2001. Section 1.itA was
inserted w.e.f. 1.4.1962 whereas section 94(7) was
inserted w.e.f. 1.4.2002. The Parliament realized that
several public sector undertakings and public sector
enterprises had invested huge amounts over last couple
F of years in the impugned dividend stripping transactions
so also declaration of dividends by mutual fund are
being vetted and regulated by SEBI for last couple of
years. If section 94(7) would have been brought into
effect from 1.4.19&2, as in the case of section 14A, it
G would have resulted in reversal of large number of
transactions. This could be one reason why the
Parliament intended to give effect to section 94(7) only
w.e.f. 1.4.2002. However, it is the duty of the court to
examine the circumstances and reasons why section
14A inserted by Finance Act 2001 stood inserted w.e.f.
H
C.l.T., MUMBAI v. WALFORT SHARE & STOCK
753
BROKERS P. LTD.
1.4.1962 while section 94(7) inserted by the same Finance
A
Act as brought into force w.e.f. 1.4.2002. [Para 17] [774G-H; 775-A-C]
1.7. Sections 14A and 94(7) operate in different fields.
Section 14A deals with disallowance of expenditure
8
incurred in earning tax-free income against the profits of
the accounting year under sections 30 to 37 of the Act.
On the other hand, section 94(7) refers to disallowance
of the loss on the acquisition of an asset whi~h situation
is not there in cases falling under section 14A. Under C
section 94(7), the dividend goes to reduce the loss. It
applies to cases where the loss is more than the
dividend. Section 14A applies to cases where the
assessee incurs expenditure to earn tax fre~ income but
where there is no acquisition of an asset. In cases falling
under section 94(7), there is acquisition of an asset and
D
existence of the loss which arises at a point of time
subsequent to the purchase of units and receipt of
/ exempt income. It occurs only when the sale t.akes place.
Section 14A comes in when there is claim for deduction
of an expenditure whereas section 94(7) comes in when
E
there. is claim for allowance for the business loss. One
must keep in ·mind the conceptual difference between
loss, expenditure, cost of acquisition, etc. while
in~erpreting the scheme of the Act. [Para 18] [775-D-G]
1.8. Para 12 of the Accounting Standard AS-13 F
indicates that interest/ dividends received on investments
are generally regarded as return on investment and not
return of investment. It is only in certain circumstances
where the purchase price includes the rigtit to receive
crystallized and accrued dividends/ interest, that have
G
already accrued and become due for payment before the
date of purchase of the units, that the same has got to
be reduced from the purchase cost of the investment. A
mere receipt of dividend subsequent to purchase of
units, on the basis of a person holding units at the time
H
754
SUPREME COURT REPORTS
[2010] 7 S.C.R.
A of declaration of dividend on the record date, cannot go
to offset the cost of acquisition of the units. Therefore,
AS-13 has no application to the facts of the instant cases
where units are bought at the ruling NAV with a right to
receive dividend as and when declared in future and did
B not carry any vested right to claim dividends which had
already accrued prior to the purchase. [Para 19] [775-H;
776-A-D]
Rajasthan
State Warehousing Corporation
v.
Commissioner of Income-Tax 242 ITR 450; Commissioner
C of Income-Tax, Madras v. Indian Bank Limited 56 ITR 77,
referred to.
Case Law Reference:
242 ITR 450
Referred to.
Para 9
D
56 ITR 77
Referred to.
Para 9
(1991) 187 ITR 541
Referred to.
Para 16
154 ITR 148(SC)
Referred to.
Para 17
E
263 ITR 706(SC)
Referred to.
Para 17
CIVIL APPELLATE JURISDICTION : Civil Appeal No.
4927 of 2010.
From the Judgment and Order dated 8.8.2008 of the High
F Court of Judicature at Bombay in Income Tax Appeal No. 18
G
H
of 2006.
C.A. No. 4928 of 2010
C.A. No. 4929 of 201 O
C.A. No. 4930 of 2010
C.A. No. 4931 of 2010
C.A. No. 4932 of 201 O
C.A. No. 4933 of 2010
C.l.T., MUMBAI v. WALFORT SHARE & STOCK
755
BROKERS P. LTD.
C.A. No. 4934 of 2010
A
C.A. No. 4935 of 2010
C.A. No. 4936 of 2010
C.A. No. 4937 of 2010
. B
C.A. No. 4938 of 2010
C.A. No. 4939 of 2010
C.A. No. 4940 of 21il10
c
C.A. No. 4941 of 2010
/
C.A. No. 4942 of 2010
C.A. No. 4943 of 2010
D
C.A. No. 4944 of 201 O
C.A. No. 4945 of 2010
C.A. No. 4954 of 2010
E
C.A. No. 4946 of 2010
C.A. No. 4947 of 2010
C.A. No. 4948 of 201 O
F
C.A. No. 4949 of 2010
C.A. No. 4950 of 2010
C.A. No. 4951 of 2010
G
C.A. No. 4952 of 2010
C.A. No. 4953 of 2010
H
756
SUPREME COURT REPORTS
[201 O] 7 S.C.R.
A
Parag P. Tripathi, ASG., Preetesh Kapoor, C.V. Subba
B
Rao, Arijit Prasad, Kunal Bahri, B.M. Chatterjee, Varun Sarin,
Farrukh Rashid, Vikas Malhotra, Fuzail A. Ayyubi, Amey
Nargolkar, Satyakam, Balaji, B.V. Balaram Das for the
Appellant.
Soli E. Dastur, C.S. Aggarwal, R. Murlidhar, Rustom B.
Hathikhanawala, B.S. Banthia, Jitendra Jain, Ankur Saigal Bina
Gupta, Gaurav Singh, Ashok Kumar Sharma, T N. Chopra,
Debasis Misra, Jatin Zaveri, Rajeev Wagle, Rukhsana
Choudhury, Sridevi Pannikar, Vijay Kumar, Bharat L. Gandhi,
C R. Chandrachud, Bhargava V. Desai, Rahul Gupta, Nikhil
Sharma, Ajay Vohra, Kavita Jha, Sandeep S. Karhail,
Rashmikumar Manila! Vithlani and Gaurav Agrawal for the
Respondent.
D
The Judgment of the Court was delivered by
5. H. KAPADIA, J. 1. Delay condoned.
2. Leave granted.
E
3. Whether the loss arising in the course of dividend
stripping transaction taking place prior to 1.4.2002 was
disallowable on the ground that such loss was artificial as the
dividend stripping transaction was not a business transaction,
is the question which arises for determination in this batch of
F Civil Appeals; the lead matter of which is C. /. T., Mumbai v. Ml
s. Walfort Share & Stock Brokers Pvt. Ltd.
4. The facts in the lead matter are as follows:
The assessee is a member of Bombay Stock Exchange
G and it earns income mainly from share trading and brokerage.
During the financial year 1999-2000, relevant to the assessment
year 2000-01, the Chola Freedom Technology Mutual Fund
came out with an advertisement stating that tax free dividend
income of 40% could be earned if investments were made
H before the record date, i.e., 24.3.2000. The assessee by virtue
C.l.T., MUMBAI v. WALFORT SHARE & STOCK
757
BROKERS P. LTD. [S.H. KAPADIA, CJI.]
of its purchase on 24.3.2000 became entitled to the dividend
A
on the units at the rate of Rs. 4/- per unit and earned a dividend
of Rs. 1,82, 12,862.80. As a result of the dividend payout, the
NAV of the said mutual fund which was Rs. 17.23 per unit on
24.3.2000, at which rate it was purchased, stood reduced to
Rs. 13.23 per unit on 27.3.2000, which was the succeeding
B
working day in the stock exchange. This fall in the NAV was
equal to the amount of the dividend payout. The assessee sold
all the units on 27 .3.2000 at the NAV of Rs. 13.23 per unit and
collected an amount of Rs. 5,90,55,207.75. The assessee also
received an incentive of Rs. 23,76,778/- in respect of the said c
transaction. Thus, the assessee thereby received back Rs.
7,96,44,847 (Rs. 1,82, 12,862.80 + Rs. 5,90,55,207.75 + Rs.
23,76,778) against the initial payout of Rs. 8,00,00,000/-. For
the income tax purposes, the assessee, in its return, claimed
the dividend received of Rs. 1,82, 12,862.80 as exempt from
0
tax under Section 10(33) of the Income Tax Act, 1961 ("the Act"
for short) and also claimed a set-off of Rs. 2,09,44,793 as loss
incurred on the sale of the units thereby seeking to reduce its
overall tax liability.
The AO in his assessment order dated 21.3.2003
E
accepted that the dividend income amounting to Rs.
1,82, 12,862.80 was exempt under Section 10(33) of the Act.
However, the AO disallowed the loss of Rs. 2,09,44,793
claimed by the assessee inter alia on the ground that a dividend
stripping transaction was not a business transaction and since
F
such a transaction was primarily for the purpose of tax
avoidance, the loss so-called was an artificial loss created by
a pre-designed set of transaction. Accordingly, the AO
deducted the incentive income of Rs. 23,76,778 received by
the assessee + transaction charges from the loss of Rs.
G
2,09,44,793 and added back the reduced loss of Rs.
1,82, 12,862.80 to the repurchase price/ redemption value
amounting to Rs. 5,90,55,207.75. (See page 77 of the SLP
Paper Book)
H
758
SUPREME COURT REPORTS
[2010] 7 S.C.R.
A
Being aggrieved by the disallowance of the reduced loss
of Rs. 1,82, 12,862.80, the assessee filed an appeal before
CIT(A) who by his order dated 12.12.2003 confirmed the order
of the AO saying that the loss of Rs. 1,82, 12,862.80 incurred
by the assessee on the sale of units should be totally ignore<i.
B and that the same should not be allowed to be set-off or carried
forward. Thus, the Department disal!Jwed the reduced loss of
Rs. 1,82, 12,862.80 which amount was equal to the dividend,
on the units declared by the mutual fund, of Rs. 1,82, 12,862.80.
In other words, by the impugned orders passed by the AO, the
c Department sought to tax the dividend income of the assessee
during the relevant assessment year of Rs. 1,82, 12,862.80.
To complete the chronology of events, it may be stated that
the assessee moved the tribunal against the order dated
12.12.2003. The disallowance stood deleted by the Special
D Bench of the Tribunal vide its impugned order dated 15.7.2005
by holding that the assessee was entitled to set-off the said loss
from the impugned transactions against its other income
chargeable to tax. This view of the tribunal has been affirmed
by the High Court vide its impugned judgment dated 8.8.2008,
E hence this civil appeal.
5. According to Shri Parag P. Tripathi, learned Additional
Solicitor General and Shri Preetesh Kapur, learned counsel for
the Department, the amount received by the assessee as
F "dividend", in fact and in law, constitutes a "return of investment"
in the hands of the assessee and, therefore, it follows that the
said amount is required to be adjusted against the cost of
purchase of the original units and once that is done there is in
fact no loss suffered by the assessee on subsequent sale/
G redemption. Alternatively, if the so-called "dividend" did not
constitute a return of investment, then since the price of units
necessarily included the price of dividend as an identifiable
element embedded therein to which a definite value could be
assigned at the time of the purchase, the "dividend" is in effect
"paid for". In such circumstances that part of the price of units
H
C.l.T., MUMBAI v. WALFORT SHARE & STOCK
759
BROKERS P. LTD. [S.H. KAPADIA, CJI.]
which clearly represented the cost of the dividend, is the
A
expenditure incurred for obtaining exempt income and if that
is the case then Section 14A requires that such expenditure
should be netted against the receipt of dividend. Before us, it
was also submitted that in any event "loss" is a commercial
concept under the Act. if a transaction is such that a "tax loss"
B
is created or contrived without suffering any corresponding
financial I commercial loss inasmuch as the money has in fact
been recouped in some other form (such as dividend), then
such a loss needs to be ignored for tax purposes, only to the
extent that the loss has in fact been recouped in another form. c
This is because such a loss. not being a "commercial loss".
was never intended to be allowed under the Act. As.a corollary,
it was submitted that introduction of Section 94(7) prospectively
w.e.f. 1.4.2002 does not obliterate the aforementioned last
submission since a prospective amendment, by its very
D
definition, did not alter the existing law in respect of the past
transactions. Moreover, Section 94(7) specifically adopts the
above principle of tax avoidance and modifies it for the purpose
of dealing with what is called as "dividend stripping
transactions".
6. On facts it was submitted that the assessee had the
option to buy three different kinds of assets. Option was
available to the assessee to buy either the unit (ex-dividend)
or the unit and the dividend (cum-dividend) or only the dividend.
E
As far as the first two assets. there was no issue. If an
F
assessee wanted to buy a unit after declaration of the dividend,
then he can buy the ex-dividend unit as soon as possible after
the record date so that he pays only for the NAV relatable to
ex-dividend unit. after declaration of the dividend, without being
affected by market fluctuations. Similarly, if an assessee wants
G
to buy an asset consisting of the dividend and the unit, he can
buy cum-dividend unit at any point of time after the declaration
of the dividend but before the record date. According to the
Department, the problem arises in cases where an assessee
is desirous of buying only the dividend. In order to do so, he
H
760
SUPREME COURT REPORTS
[2010) 7 S.C.R.
A buys the cum-dividend unit, after declaration of dividend but as
close as possible to the record date (so as to isolate himself
from market fluctuations), whereby he becomes entitled to
receive the dividend payout on the record date and
immediately after the record date is able to sell the ex-dividend
B unit. Consequently, by a series of fiscal transactions, the
assessee ends up buying the dividenJ. Therefore, if 'x' is the
price/ expenditure associated with the purchase of dividend,
'y' is the price/ expenditure associated with the unit without
dividend then, 'x' + 'y' would be the price of cum-dividend unit.
c Then price may be called 'z' in which event, the equation is:
'x' i· 'y' = 'z'
There is no dispute as to the identity of 'z', which is the
price/ expenditure for purchasing cum-dividend unit, i.e., Rs.
D 17.23. In that event, 'y' would represent the sale price of exdividend unit, i.e., Rs. 13.23. Thus, 'x' can be found by the
simple mathematical formula:
E
'x' = 'z' - 'y'
'x' is equal to Rs. 17.23 ('z') - Rs. 13.23 ('y') =Rs. 4
7. According to the Department, therefore, in the present
case, Rs. 4 will be expenditure, attributable towards earning tax
free dividend income which is disallowable under Section 14A
F of the Act. That, the newspaper advertisements issued by the
Mutual Fund in the present case'8s on March 8, March 18 and
March 22 amounted to an offer by Mutual Fund to the target
buyers, i.e., a buyer who wants to claim losses in the trade of
shares and securities so as to set it off against his other
G
~ncome. The effect of the newspaper advertisements is to
segregate the unit into two assets, namely, the asset of the tax
free dividend and the ex-dividend unit which will have an NAV
reduced by the amount of the dividend payout per unit. Since
there are two assets which are sold to the buyer of the cumH dividend units, it follows that the difference between the
C.l.T., MUMBAI v. WALFORT SHARE & STOCK
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purchase and sale price of the unit, is nothing but the
A
expenditure incurred for purchasing the asset of tax free
dividend. In this connection, reliance is placed on the
Explanatory Memorandum accompanying the Finance Bill of
2001 reported in 248 ITR 195 (St.).
8. In conclusion, it was submitted before us that the tax free
dividend income was really in essence a cost recovery
mechanism which finds an independent support in Accounting
Standard No: 13, i.e., to the effect that such a return should go
B
to reduce the cost of acquisition as such a return is really a
C
return of investment and not return on investment.
9. On behalf of assessee(s), Shri S.E. Dastur, learned
senior counsel, Shri Ajay Vohra, learned counsel and Shri O.S.
Bajpai, learned senior counsel, submitted that the basic
submission of the Department to the effect that the amount
D
received by the assessee as "dividend", in. fact and in law,
constitutes "return of investment" is fallacious for several
reasons. Firstly, the question whether an amount is a "cost
return" depends on the terms of the contract. Secondly, the
argument of the Department runs counter to Section 94(7). That
E
sub-section clearly accepts that payment by way of dividend is
a revenue receipt but it is exempt from tax under Section
10(33). According to the assessee, if the argument of the
Department is to be accepted that the amount represents
"return of investment" then it would constitute a capital receipt
F
and not a revenue receipt. Thirdly, if the dividend of Rs. 4 per
unit is treated as "expenditure" covered by Section 14A and
not as "dividend" as required by Section 94(7), it would mean
that for the assessment years 2000-01 and 2001-02 the
assessee would be in a worse position because for the relevant
G
assessment years based on the "fiscality principle" the entire
loss of Rs. 1,85,68,015 would be disallowed whereas for the
subsequent years after insertion of Section 94(7) w.e.f.
1.4.2002 only loss to the extent of the "dividend" amounting to
1 Rs. 1,82, 12,862 would stand disallowed leaving Rs. 3,55, 153/
H
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A - as loss allowable. That was never the intention of the
Parliament for inserting Section 94(7). The said sub-section
was not intended to be beneficial. Fourthly, the fact that Section
94(7) allows loss in excess of dividend means that it accepts
that the transaction is genuine and in course of business. If the
B transaction was a nullity, the entire loss would have been
disallowed and not only to the extent of the dividend. Moreover,
if losses could be disallowed on fiscality/ first principles then
Section 94(7) is redundant. Fifthly, Section 14A is enacted for
non-deduction of expenditure whereas Section 94(7) is enacted
c to curb creation of short-term losses. Lastly, there is nothing to
show that the NAV felron the next trading date after the record
date on account of the dividend payout. In this connection, it
was submitted that fall or increase in NAV depended upon the
value of the underlying assets and not on the basis of the
0 dividend payout. On interpretation of Sections 14A and 94(7)
it was submitted that Section 14A deals with expenditure in
relation to income whereas Section 94(7) deals with acquisition
and sale of securities or units and provides for a consequence
where the purchase and sale take place within a specified time
E period. Each provision operates in its own field. When Section
14A refers to disallowance of expenditure in relation to nontaxable income for computing the total income, what is meant
is that such expenditure should be taken into account only for
determining the quantum of the non-taxable income. This would
result in the exempt dividend being reduced by the alleged
F expenditure. The only impact on the exempting provision of
Section 10(33) for unit income is by Section 94(7) and one
cannot interpret Section 14A as leading to the same conclusiori
as then Section 94(7) will be rendered nugatory. In other words.
the two provisions operate in different time and space zones.
G In support of the above contention, the assessee (s) has relied
on the Memorandum as well as Circular No. 14 which clearly
states that losses referred to in Section 94(7) are allowable
from the assessment year 2002-03 subject to reduction of the
actual computed loss to the extent of the dividend. If Section
H 14A is also to apply simultaneously then Section 94(7) will
C.l.T., MUMBAI v. WALFORT SHARE & STOCK
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become nugatory. Whereas Section 14A applies to
A
expenditure incurred to earn tax free income from the inception
of the Act, Section 94(7) seeks to reduce the quantum of the
loss with reference to the dividend earned from the assessment
year 2002-03. The two terms "expenditure" and "loss" are
conceptually different. Section 94(7) is a provision to set at
B
naught "avoidance of tax". If Sections 14A and 94(7) are
applied to the same transaction, it will result in Section 94(7)
being a "tax levying provision" and not an "avoidance of tax
provision". The effect of accepting the submission of the
Department is that in the present case the sum of Rs. c
1,82, 12,862 would have to be considered twice, once, by way
of expenditure to earn the dividend income and the second
time by way of ignoring the loss to the extent it does not exceed
the dividend income of Rs. 1,82, 12,862. According to the
assessee (s), the embargo in Section 14A on the deductibility
D
of expenditure applies where admittedly an expenditure has
been incurred and a deduction is claimed specifically in respect
thereof. In this connection, reliance was placed on the word
"allowed" in the said Section. In the present case, the assessee
(s) has not made any claim for deduction of Rs. 1,82, 12,862
and, therefore, the question of the said sum being disallowed
E
did not arise. On the other hand, Section 94(7) proceeds on
the footing that the entire dividend income falls within Section
10(33) and the only adjustment is that the loss which has arisen
and would otherwise be allowable shall be ignored to the extent
it does not exceed the Section 10(33) income. Therefore,
according to the assessee (s), in applying Section 94(7) there
F
is no question of making a deduction at the stage of Section
14A as suggested by the learned Solicitor General Shri Gopal
Subramanium. According to the assessee (s), under Section
94(7) the dividend should go to reduce the loss already worked
G
out which implies that the loss is more than the dividend income
because it is only then that the question of reducing the loss to
some extent would arise. In this connection, the assessee(s)
submitted that for the assessment year 2002-03 the loss was
Rs. 1,85,68,015 which exceeded the dividend of Rs.
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A 1,82, 12,862 and, therefore, the loss allowable applying Section
94(7) stood at Rs. 3,55, 153. Therefore, in order to reconcile
Section 14A with Section 94(7) it was suggested on behalf of
the assessee(s) that Section 14A should be confined to a case
where there is expenditure on earning tax free income but
B where there is no acquisition of an asset and Section 94(7)
should be confined to a case where there is acquisition of an
asset thereby indicating a distinction between a claim for
deduction of an expenditure and a claim for allowance of a
business loss. Section 14A deals with disallowance of
c expenditure per se and not with a disallowance of a loss which
arises at a point of time subsequent to the purchase of units
and the receipt of exempt income and occurring only when there
is a sale of the purchased units. Section 14A is not concerned
with a purchase and subsequent sale of an asset which is dealt
D with in Section 94(7) alone. In other words, Section 14A does
not apply to the case of a claim for set off of a loss which is
dealt with only in Section 94(7) and that too from assessment
year 2002-03. Section 14A was inserted to meet cases where
deductions have been claimed in respect of expenditure for
earning exempt income like dividend income and the said
E Section was never intended and does not apply to the case of
a claim for set off of a loss which as stated above is dealt with
in Section 94(7) alone and that too with effect from the
assessment year 2002-03. Thus, whereas Section 14A was
designed to overcome the problem created by certain
F decisions of this Court in Rajasthan State Warehousing
Corporation v. Commissioner of Income-Tax [242 ITR 450]
and in the case of Commissioner of Income-Tax, Madras v.
Indian Bank Limited [56 ITR 77], Section 94(7) had no such
object. The two, therefore, operate in different fields and they
G have different objects and because the two provisions operated
in two different fact situations Section 14A was made effective
from assessment year 1962-63 whereas Section 94(7) is made
effective from the assessment year 2002-03. Thus, the
Parliament has treated both the sections as dealing with
H separate circumstances and, therefore, one must confine
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Section 14A to expenditure of the type.referred to in Sections
A
30 to 43B of the Act which relates to expenditure which does
not result in acquisition of an asset. It is clear that where the
asset so acquired is sold and results in a loss Section 94(7)
steps in.
B
10. According to the learned Solicitor General of India,
Section 14A was inserted by Finance Act 2001 with effect from
1.4.1962. According to him, the fundamental principle
underlying Section 14A is that income which is not taxable or
exempt falls in a separate stream distinct from income taxable
C
under the Act. That, expenditure which is incurred in relation to
income subject to tax would be admissible under Sections 30
to 43B whereas expenditure incurred to earn exempt income
would be extraneous in the computation of taxable income
under the Act. Thus, only that expenditure is deductible which
is incurred·in relation to business or profession. Expenditure
D
producing non-taxable income would not be permitted to be
claimed as admissible expenditure. Thus, in all cases where
the assessee has some exempt income, 'his total expenditure
has got to be apportioned between taxable income and exempt
,income and the latter would have to be 'tlisallowed. The only
E
event that triggers Section 14A is that the 'assessee has both
taxable and exempt income and, therefor~. one need not go
by the "two asset" theory. According to the learned SGI, Section
14A is not concerned with whether the assessee makes a profit
or a loss. According to the learned SGI, application of Section
94(7) will not rule out Section 14A. It was submitted that both
the provisions can apply simultaneously. In this connection, it
was urged that in the first stage Section 14A can be applied
F
to determine the expenditure to be excluded. After excluding
such expenditure from the cost of purchase, what remains may
G
be called as adjusted purchase cost. If units qre bought and
sold within 3/9 months period, then, the adjusted purchase cost
must be deducted from the sale. If this leads to a profit then
Section 94(7) will not apply. However, if there is a loss, such
loss will have to be ignored to the extent of the dividend
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A received. This was the suggested mode for reconciling Section
14A with Section 94(7) by the learned SGI, which according to
the assessee(s) would result in double counting of the dividend
amount of Rs. 1,82, 12,862, one as dividend and the other as
a loss.
B
11. In this batch of cases, we are required to decide three
distinct points which are as follows:
(i)
Whether "return of investment" or "cost recovery"
would fall within the expression "expenditure
C
incurred" in Section 14A?
D
E
F
G
H
(ii)
Impact of Section 94(7) w.e.f. 1.4.2002 on the
impugned transactions.
(iii)
Reconciliation of Section 14A with Section 94(7) of
the Act.
12. To answer the above, we need to reproduce
hereinbelow Sections 10(33), 14A, 94(7) and the relevant paras
of Circular No. 14 of 2001 issued by the CBDT:
Section 10 - Incomes not included in total income
In computing the total income of a previous year of any
person, any income falling within any of the following
clauses shall not be included-
(33) any income by way of -
(i)
dividends referred to in section 115-0; or
(ii)
income received in respect of units from the Unit
Trust of India established under the Unit Trust of
India Act, 1963 (52 of 1963); or
(iii)
income received in respect of the units of a mutual
fund specified under clause (230):
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Provided that this clause shall not apply to any
A
income arising from transfer of units of the Unit Trust of
India or of a mutual fund, as the case may be.
Section 14A - Expenditure incurred in relation to income
not includible in total income
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.
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
B
c
or reducing a refund already made or otherwise increasing
D
the liability of the assessee under section 154, for any
assessment year beginning on or before the 1st day of
April, 2001.
Chapter : X - SPECIAL PROVISIONS RELATING TO
A VO/DANCE OF TAX
E
Section 94 - Avoidance of tax by certain transactions in
securities
(7) Where -
(a) any person buys or acquires any securities or unit within
a period of three months prior to the record date ;
(b) such person sells or transfers such securities or within
F
a period of three months after such date;
G
(c) the dividend or income on such securities or unit
received or receivable by such person is exempt,
then, the loss, if any, arising to him on account of such
purchase and sale of securities or unit, to the extent such
H
768
A
B
c
D
E
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G
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SUPREME COURT REPORTS
[2010] 7 S.C.R.
loss does not exceed the amount of dividend or income
received or receivable on such securities or unit, shall be
ignored for the purposes of computing his income
chargeable to tax.
Circular No. 14 of 2001
56. Measures to curb creation of short-term losses by
certain transactions in securities and units
56.1 Under the existing provisions contained in Section 94,
where the owner of any securities enters into transactions
of sale and repurchase of those securities which result in
the interest or dividend in respect of such securities being
received by a person other than such owner, the
transactions are to be ignored and the interest or dividend
from such securities is required to be included in the total
income of the owner.
56.2 The existing provisions did not cover a case where
a person buys securities (including units of a mutual fund)
shortly before the record date fixed for declaration of
dividends, and sells the same shortly after the record date.
Since the cum-dividend price at which the securities are
purchased would normally be higher than the ex-dividend
price at which they are sold, such transactions would result
in a loss which could be set off against other income of
the year. At the same time, the dividends received would
be exempt from tax under Section 10(33). The net result
would be the creation of a tax loss, without any actual
outgoings.
56.3 With a view to curb the creation of such short-term
losses, the Act has inserted a new Sub-section (7) in the
section to provide that where any person buys or acquires
securities or units within a period of three months prior to
the record date fixed for declaration of dividend or
distribution of income in respect of the securities or units,
C.l.T., MUMBAI v. WALFORT SHARE & STOCK
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