# MAXOPP INVESTMENT LTD v. COMMISSIONER OF INCOME TAX, NEW DELHI

- **Citation:** [2018] 2 S.C.R. 783
- **Court:** Supreme Court of India
- **Decided:** 2018-02-12
- **Case number:** Civil Appeal Nos. 104-109 of 2015
- **Bench:** A. K. Sikri, Ashok Bhushan
- **Source:** https://unisonlegal.in/judgment/supreme-court-of-india/maxopp-investment-ltd-v-commissioner-of-income-tax-new-delhi-32721
- **Pages:** 31

## Headnote

Income Tax Act, 1961:
s. 14A - Applicability of - To dividend income - In cases
where dominant purpose of investment was to retain controlling
interest in a Company/group of companies or where dominant
purpose was to have stock-in-trade - Whether dominant purpose
test or theory of apportionment to be applied for interpreting the
provision - Held: For interpreting s. 14A, dominant purpose for
which investment into shares is made by an assessee, may not be
relevant - Principle of appointment comes into play as that is the
principle which is engrained in s. 14A - s. 14A is applicable to the
dividend income irrespective of whether the shares are held to gain
control or as stock-in-trade - However, where shares are held as
stock-in-trade, the expenditure incurred in acquiring those shares
have to be apportioned - Only that expenditure which is "in relation
to" earning dividends can be disallowed u/s. 14A and s. 8D -
Assessing Officer needs to record satisfaction having regard to the
kind of assessee why the claim of assessee as to the quantum of suo
motu disallowance u/s. 14A was not correct - Income Tax Rules,
1962 - r. 8D.
Disposing of the appeals, the Court
HELD: 1. As per Section 14A(1) of the Income Tax 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 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
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from tax, and such expenditure would be allowed as business
expenditure. Such expenditure would then be considered as
incurred in respect of other income which is to be treated as part
of the total income. [Para 32][808-A-C]
2. For interpreting Section 14A of the Act, the dominant
purpose for which the investment into shares is made by an
assessee, may not be relevant. No doubt, the assessee 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. [Para 34][808-F-H; 809-A-B]
3. 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. The opinion
of Punjab & Haryana High Court which went by dominant purpose
theory,

## Text

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MAXOPP INVESTMENT LTD.
v.
COMMISSIONER OF INCOME TAX, NEW DELHI
(Civil Appeal Nos. 104-109 of 2015)
FEBRUARY 12, 2018
[A. K. SIKRI AND ASHOK BHUSHAN, JJ.]
Income Tax Act, 1961:
s. 14A - Applicability of - To dividend income - In cases
where dominant purpose of investment was to retain controlling
interest in a Company/group of companies or where dominant
purpose was to have stock-in-trade - Whether dominant purpose
test or theory of apportionment to be applied for interpreting the
provision - Held: For interpreting s. 14A, dominant purpose for
which investment into shares is made by an assessee, may not be
relevant - Principle of appointment comes into play as that is the
principle which is engrained in s. 14A - s. 14A is applicable to the
dividend income irrespective of whether the shares are held to gain
control or as stock-in-trade - However, where shares are held as
stock-in-trade, the expenditure incurred in acquiring those shares
have to be apportioned - Only that expenditure which is "in relation
to" earning dividends can be disallowed u/s. 14A and s. 8D -
Assessing Officer needs to record satisfaction having regard to the
kind of assessee why the claim of assessee as to the quantum of suo
motu disallowance u/s. 14A was not correct - Income Tax Rules,
1962 - r. 8D.
Disposing of the appeals, the Court
HELD: 1. As per Section 14A(1) of the Income Tax 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 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
 [2018] 2 S.C.R. 783
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from tax, and such expenditure would be allowed as business
expenditure. Such expenditure would then be considered as
incurred in respect of other income which is to be treated as part
of the total income. [Para 32][808-A-C]
2. For interpreting Section 14A of the Act, the dominant
purpose for which the investment into shares is made by an
assessee, may not be relevant. No doubt, the assessee 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. [Para 34][808-F-H; 809-A-B]
3. 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. The opinion
of Punjab & Haryana High Court which went by dominant purpose
theory, is not acceptable. The aforesaid reasoning would be
applicable in cases where shares are held as investment in the
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785
investee company, may be for the purpose of having controlling
interest therein. [Para 35][809-E-H; 810-A]
4. In the cases, where shares are held as stock-in-trade,
the main purpose is to trade in those shares and earn profits
therefrom. 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. Therefore,
to that extent, depending upon the facts of each case, the
expenditure incurred in acquiring those shares will have to be
apportioned. [Para 39][811-A-C]
5. The 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. [Para 40][811-F-G]
6. Having regard to the language of Section 14A(2) of the
Act, read with Rule 8D of the Income Tax Rules, it is made 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. [Para 41][812-C-D]
CIT v. Walfort Share and Stock Brokers P Ltd. (2010)
326 ITR 1 (SC) - relied on.
MAXOPP INVESTMENT LTD. v. COMMISSIONER OF
INCOME TAX, NEW DELHI
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ITO v. Daga Capital Management (Private) Ltd.
312 ITR (AT) 1 ; Principal Commissioner of Income
Tax v. State Bank of Patiala (2017) 391 ITR 218
(P&H) ; CCI Ltd. v. Joint Commissioner of Income Tax,
Udupi Range (2012) 206 Taxman 563 ; Commissioner
of Income Tax, Mumbai v. M/s. Essar Teleholdings Ltd.
through its Manager 2018 (1) SCALE 681 ; Doypack
Systems Pvt. Ltd. v. Union of India (1988) 2 SCC 299 :
[1988] 2 SCR 962 ; CIT v. Nawanshahar Central
Co-operative Bank Ltd. (2007) 289 ITR 6 (SC) ;
Commissioner of Income Tax v. G.K.K. Capital Markets
(P.) Ltd. (2017) 392 ITR 196 (Cal) ; Dhanuka and Sons
v. CIT (2011) 339 ITR 319 (Cal) - referred to.
Case Law Reference
312 ITR (AT) 1
referred to
Para 6
(2017) 391 ITR 218 (P&H)
referred to
Para 10
(2012) 206 Taxman 563
referred to
Para 10
2018 (1) SCALE 681
referred to
Para 12
[1988] 2 SCR 962
referred to
Para 16
(2010) 326 ITR 1 (SC)
relied on
Para 16
(2007) 289 ITR 6 (SC)
referred to
Para 21
(2017) 392 ITR 196 (Cal)
referred to
Para 25
(2011) 339 ITR 319 (Cal)
referred to
Para 26
CIVIL APPELLATE JURISDICTION : Civil Appeal Nos. 104109 of 2015.
From the Judgment and Order dated 18.11.2011 of the High Court
of Delhi at New Delhi in ITA No. 687, 853, 856, 1060 of 2009, 263 and
416 of 2010
WITH
Civil Appeal Nos.3267 and 10096 of 2013, Civil Appeal
Nos. 8596 of 2014, Civil Appeal Nos.1423, 130, 110-112, 115, 123, 6590
of 2015, Civil Appeal No.18019 of 2017, Civil Appeal Nos.1500, 1508,
1505, 1576, 1579, 1578, 1580, 1575, 2802, 2791, 2792, 1577, 2793 and
2794 of 2018.
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Jehangir D. Mistri, K. Radhakrishnan, Ajay Vohra, Sanjay Kumar
Bansal, Sr. Advs., Ms. Vanita Bhargava, Ajay Bhargava, Rony O. John,
Abhisaar Bairagi, M/S. Khaitan & Co., Arijit Prasad, Rupesh Kumar,
D. L. Chidananda, Ms. Sadhna Sandhu, Ms. Gargi Khanna, Manish
Pushkarna, Ritin Rai, Mrs. Anil Katiyar, Satyen Sethi, Ms. Gargi S.,
Rameshwar Prasad Goyal, Arta Trana Panda, Brajesh Kumar, Rajiv
Tyagi, D. Kumar, Dr. Rakesh Gupta, Ambhoj Kumar Sinha, Ms. Monika
Ghai, Somil Agarwal, Ms. Kavita Jha, Udit Haresh, Ms. Kavita Jha,
Amit Prasad, Aljo K. Joseph, Ashish Somvashi, Ms. Shelna K., Mayank
Nagi, Tarun Singh, Shubham, Shekhar Prit Jha, Shrey Cathly, Nikhil Gupta,
Apoorv Chandra Saxena, Sumit K. Batra, Pranjal Srivastava, Subodh S.
Patil, Advs. for the appearing parties.
The Judgment of the Court was delivered by
A. K. SIKRI, J. 1. 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
MAXOPP INVESTMENT LTD. v. COMMISSIONER OF
INCOME TAX, NEW DELHI
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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-intrade'. 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
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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
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 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
MAXOPP INVESTMENT LTD. v. COMMISSIONER OF
INCOME TAX, NEW DELHI [A. K. SIKRI, J.]
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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,
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
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of Section 14A of the Act. It was accordingly held, as per the 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 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 (2017) 391 ITR 218 (P&H)
 3(2012) 206 Taxman 563
MAXOPP INVESTMENT LTD. v. COMMISSIONER OF
INCOME TAX, NEW DELHI [A. K. SIKRI, J.]
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(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 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
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.
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(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:-
(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
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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 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. 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,
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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:-
"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 Incometax 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 Incometax Act.
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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 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
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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 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
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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 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.
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
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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 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?"
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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-intrade.