section 14a – judicial pronouncements · claim for exemption - issue the bombay high court in...

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

14A - Judicial Pronouncements3/7/2014 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 theIncome-tax Act, 1961.

Mr. B earned dividend income of Rs. 20,000/-which was not claimed as exempt but wasvoluntarily offered to tax.

Mr. C has not earned any dividend incomeduring the year although Mr. C is holdingsecurities capable of generating exemptincome.


Claim for Exemption - issue

The Bombay High Court in Godrej and Boycehas held that “Once a proximate cause fordisallowance is established – which is therelationship of the expenditure with incomewhich does not form part of the total income –a disallowance u/s 14A has to be effected”

Whether disallowance can be made undersection 14A of the Income-tax Act, 1961 readwith Rule 8D of the Income-tax Rules, 1962 incomputing total taxable income of Mr. A, B andC?


Claim for Exemption – 14A

Section 14A(1) reads as under –

“For the purposes of computing the totalincome under this Chapter, no deduction shallbe allowed in respect of expenditure incurred bythe assessee in relation to income which doesnot form part of the total income under thisAct”


Claim for Exemption – Mr. A

Since Mr. A has earned income which is notincluded in the total income the provisions ofsection 14A are applicable.

The expenditure incurred in relation to earningof income not included in total income shall bedisallowed.

If Mr. A’s claim for incurring of expenditure isnot accepted by the AO then the disallowanceshall be made as per the method prescribed inRule 8D.


Claim for Exemption – Mr. B

Mr. B has earned dividend income which isexempt under the Act but offered the same totax thereby making an attempt to convert theexempt income into taxable income which isnot in accordance with the Income-tax Act,1961.

The Mumbai Tribunal in Binayak Tex ProcessorsLtd. [2014] 44 taxmann.com 179 has held thateven if the exempt income is offered to tax theprovisions of 14A are applicable anddisallowance is to be made as per Rule 8D.


Claim for Exemption – Mr. C

Mr. C has not earned any income which isexempt under the Act but holds securitiescapable of generating exempt income.

Judicial Pronouncements –◦ CIT vs. Corrtech Energy Pvt Ltd. Appeal no. 239 of2014 (Guj HC) dated 24.3.2014 – Since the Assesseedid not make any claim for exemption of any incomefrom payment of tax the disallowance under section14A 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 upheldthe order of Tribunal wherein it has been held:


Claim for Exemption – Mr. C

That there must be income taxable under the Act;

That this income must not form part of total incomeunder the Act;

That there must be an expenditure incurred by theAssessee; and

That the expenditure must have a relation to theincome which does not form part of the totalincome under the Act.

Therefore unless and until there is receipt ofexempted income for the concerned AY, section 14Aof the Act cannot be invoked.


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 thatexpenditure which is relatable to earning ofincome and it therefore follows that theexpenses which are relatable to earning ofexempt income have to be considered fordisallowance, irrespective of the fact whetherany such income has been earned during thefinancial year or not.



The above position is further clarified by the usageof term 'includible' in the Heading to section 14A ofthe Act and also the Heading to Rule-8D of I.T.Rules, 1962 which indicates that it is not necessarythat exempt income should necessarily be includedin a particular year's income, for disallowance to betriggered. Also, section 14A of the Act does not usethe word "income of the year" but "income underthe Act". This also indicates that for invokingdisallowance under section 14A, it is not materialthat assessee should have earned such exemptincome during the financial year underconsideration.



Thus, in light of above, Central Board of DirectTaxes, in exercise of its powers under section119 of the Act hereby clarifies that Rule 8D readwith section 14A of the Act provides fordisallowance of the expenditure even wheretaxpayer in a particular year has not earned anyexempt income.

Whether the Circular is applicable only if Rule8D is applied? Whether the Circular hasretrospective effect, if yes, then from AY 2008-09 onwards only?


Claim for Exemption – Representation

The ICAI in its Pre-Budget Memorandum 2014 haspointed out the issues relating to Rule 8D and alsosuggested the remedies for the same as under –

Issue/ Justification -

Rule 8D has created genuine hardships for taxpayers, as the calculation basis under rule 8D isarbitrary. In many cases, the disallowancecalculated as per rule 8D method exceeds theamount of total exempted income earned duringthe year. This is because of the following reasons:



Firstly, the interest expense, which does not formpart of exempted income, is disallowed.

Secondly, while working out half percent of theaverage investments, all the investments inshares/mutual funds are considered.

Thirdly, this method does not demarcate betweeninvestments that have generated or not generatedincome during the year.

Lastly, no distinction has been made for companiesearning dividend income due to holding strategicinvestments in group companies and very littleexpenditure is attributable to earn such dividendincome.



It is suggested that –

Only those expenses which are directly related toearning of exempt income shall be disallowed.

Further, the overall maximum limit of expense to bedisallowed should not exceed the tax payable onexempted income earned.

Overall maximum limit of expense to be disallowedin case of dividend income earned from holdingstrategic investment in group companies shallbe capped.


Investment vs. Stock in Trade

Rule 8D provides for the method fordetermining amount of expenditure in relationto income not includible in total income.

As per Rule 8D(2)(ii) and (iii) the disallowance isbased on the average value of investments theincome from which does not or shall not formpart of the total income.

Interpretation of the word investment leads todifferent opinions and views for entitiestransacting in shares and having investment andtrading portfolio or only trading portfolio.



Decisions in favour –

CCI Ltd. v. Jt. CIT [2012] 206 Taxman 563/20taxmann.com 196 (Kar. HC)

Dy. CIT v. India Advantage Securities Ltd., [ITAppeal No.6711 (Mum.) of 2011 dated14/09/2012.]

Ambit Securities Broking (P.) Ltd., v. Addl. CIT [ITAppeal No. 7856(Mum) of 2011, dated 6-07-2013]



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] 138ITD 288/24 taxmann.com 50 (Mum.)

Dy. CIT v. Damani Estates and Finance (P.) Ltd.[IT Appeal No. 3029 (Mum.) of 2012, dated17.1.2013]

D.H. Securities P Ltd. Vs Dy. CIT [2014] 41taxmann.com 352 (Mum) (TM) dated27.11.2013


Investment vs. Stock in Trade – GulshanInvestment Co. Ltd.

Facts of the case –

The Assessee was engaged in the business ofshare trading having no investments.

During the assessment year under scrutiny theAssessee had earned dividend income on sharesheld as stock in trade.

The Assessee did not make any disallowanceunder section 14A read with Rule 8D.

The AO computed the disallowance as per Rule8D and considered the value of stock in trade asinvestment for the purpose of Rule 8D.


Investment vs. Stock in Trade – GulshanInvestment 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 appliedin the situations in which shares are held asinvestments, and that this rule will not have anyapplication when the shares are held as stock-in-trade.

It is so for the elementary reason that the one ofthe variables on the basis of which disallowanceunder rules 8D(2)(ii) and (iii) is to be computed isthe value of 'investments, income from which doesnot or shall not form part of total income, and,when there are no such investments, the rulecannot have any application.



However, that does not exclude the applicationof rule 8D(2)(i) which refers to the 'amount ofexpenditure directly relating to income whichdoes not form part of total income'.

So far as disallowance under section 14A in asituation in which the exempt income yieldingasset, such as shares is held as stock-in-trade,and not as investment, the disallowance will beof related direct and indirect expenditure,whereas disallowance under rule 8D will berestricted to disallowance of only directexpenses.



It is also clarified that the provisions of section14A are indeed attracted whether or not theshares are held as stock-in-trade or asinvestments, even though the provisions of rule8D(2)(ii) and (iii) cannot be invoked in such acase, and even though the provisions of rule8D(2)(i) are much narrower in scope than thescope of section 14A simplicitor.


Investment vs. Stock in Trade – D.H. Securities Pvt. Ltd.

Facts of the case –

The Assessee is a private limited company andearned dividend income during the impugnedassessment year.

The dividend income was earned on shares heldas stock in trade and not as investment.

The Assessee disallowed certain expenditureunder section 14A but not as per Rule 8D.

The AO disallowed expenditure for earningexempt income as per Rule 8D considering stockin trade as investment.



Decision of Tribunal (TM) –

1. Whether decision of Karnataka High Court in caseof CCI Ltd. be followed?

The issue under appeal is squarely covered by theprinciples laid down by the Hon'ble jurisdictionalHigh Court in Godrej & Boyce Mfg. Co. Ltd.

The assessee has mainly relied upon the decision ofthe Hon'ble Karnataka High Court in the case of CCILtd. (supra) and other Tribunal decisions includingthree decisions in which CCI Ltd.'s decision has beenfollowed.



There is nothing in the said judgment of the Hon'bleKarnataka High Court to show that the judgment ofthe Hon'ble jurisdictional High Court in Godrej &Boyce Mfg. Co. Ltd. (supra) was brought to itsnotice or considered by it.

On the other hand, the said judgment of theHon'ble jurisdictional High Court has been, asrightly observed by the ld. AM, duly considered bythe Hon'ble Calcutta High Court, which hassubsequently been followed by the Division Benchesof this Tribunal in American Express Bank Ltd.(supra) and Damani Estates & Finance (supra).


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 anymanner impact the applicability of section 14A,which gets attracted on incurring the expenditurein relation to the tax exempt income.

The hon'ble court in the case of Godrej & BoyceMfg. Co. Ltd. (supra), after examining the genesisof the provision of section 14A, held that thesame has been enacted to overcome the incidenceof non-disallowance of expenditure - in view ofthe judicial precedents by the apex court -


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 tradingbusiness yields both taxable income in the form ofshare trading profit and tax-exempt income byway of dividend income. Therefore, to say thatsection 14A would not apply as shares are held asstock-in-trade would again not hold.

In view of the foregoing, it is held thatdisallowance under section 14A can be made inconformity with law even in cases where dividendincome has been earned on the shares held asstock-in-trade.



3. Whether Rule 8D is to be applied summarily andentire stock in trade is to be included in the valueof investments?

The rule is self- explanatory. There could be noquarrel with regard to the allocation of directexpenditure, which in fact states the obvious, andwould 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 ratioin respect of indirect expenditure (rule 8D(2)(iii))cannot be altered on account of (say) hardship.


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 heldas stock-in-trade, also yield share trading income,which is taxable. Therefore, to say that the entireinterest relatable to the average share holding isto be attributed to the tax exempt dividendincome would be patently incorrect on facts.

However, considering that the dominant objectiveof the share holding, which in our view should bedispositive of the matter, is the share tradingincome, we propose a ratio of 20% toward the taxexempt dividend income.


14A and 115JB - issue

Section 14A provides for disallowance ofexpenditure incurred in relation to exemptincome.

Section 115JB(2)(f) provides for addition ofexpenditure related to any income which isincome exempt under section 10 except section10(38), 11 or 12.

There is no direct reference to provisions ofsection 14A in section 115JB.

In the above scenario can the amountdisallowable as per 14A be directly disallowed insection 115JB also?


14A and 115JB – Case law

ITO vs. RBK Sharebroking P Ltd. [2013] 37taxmann.com 128 (Mum) – The Assesseeearned dividend income and claimed itexempt under the Act. The Assessee paidtaxes on books profit under section 115JB ofthe Act. The Tribunal held that the amountdisallowable u/s 14A is covered under clause(f) of Explanation (1) to section 115JB(2).

No apportionment formula if exempt incomeis in the nature of LTCG exempt u/s 10(38)???


Claim in the books of account – case law

Whether the AO has to record its satisfactionregarding incorrectness of the claim of Assessee?

Sitsons India P Ltd vs. ACIT [2014] 44taxmann.com 340 (Mum) –

A careful reading of the provisions of 14A(2)would show that the assessing officer is requiredto determine the amount of expenditure incurredin relation to exempted income, if he is notsatisfied with the correctness of the claim madeby the assessee, having regard to the accounts ofthe assessee.



The said section no where states that thesatisfaction needs to be recorded in writing.

The very fact that the assessing officer hasproceeded to invoke the provisions of sec. 14A(2)shows that the assessing officer was not satisfiedwith the correctness of the claim made by theassessee.

In the instant case, the assessee has claimed thatit did not incur any expenditure in relation toearning of the dividend income. According to sec.14A(3), the provisions of sec. 14A(2) shall haveautomatic application when such a claim is made.



In that kind of situation, in our view, thequestion of examining about satisfaction ofthe assessing officer with regard to the claimof the assessee does not arise, due to legalfiction embodied in sub-section (3) of the Act.



Harendra Thanawala vs. ACIT [2013] 38taxmann.com 111 (Mum) -

The A.O. may record his reasons fordissatisfaction, which would in fact enable theappellate authority in review proceedings toexamine the same. At the same time, there beingno express requirement in law for recording thereasons, his dissatisfaction may be implicit.

In the instant case, the assessee has segregatedthe expenditure, debiting the same, whererelating to his business, as claimed, to the profitand loss account, and where not so, to his capitalaccount.



So, however, it cannot be denied that theassessee, by bifurcating or allocating theexpenditure has made out a prima facie caseof no expenditure in relation to the tax-freeincome having been claimed per the return ofincome.

The Revenue's stand for application of rule 8D,i.e., that the assessee has not affected any suomotu disallowance, is untenable and cannothold; the assessee having ostensibly debitedsuch expenditure to the capital account.



The A.O. shall, we may though add, restrict hisexamination only to the profit and lossaccount of the assessee's business, as it is onlyin case the same bears any (indirect)expenditure qua income that does not formpart of the total income, that disallowanceu/r.8D could be made by him.



DCIT vs. Ashish Jhunjunwala I.T.A No.1809/Kol/2012 –

We find from the facts of the above case that theAO has not examined the accounts of the assesseeand there is no satisfaction recorded by the AOabout the correctness of the claim of the assesseeand without the same he invoked Rule 8D of theRules.

While rejecting the claim of the assessee withregard to expenditure or no expenditure, as thecase may be, in relation to exempted income, theAO has to indicate cogent reasons for the same.



Godrej & Boyce Mfg Co Ltd vs. DCIT [2010] 194TAXMAN 203 (BOM.) –

Sub-section (2) of section 14A does not enable theAssessing Officer to apply the method prescribed byrule 8D without determining in the first instance thecorrectness of the claim of the assessee, havingregard to the accounts of the assessee. Sub-section (2)of section 14A mandates that it is only when havingregard to the accounts of the assessee, the AssessingOfficer is not satisfied with the correctness of theclaim of the assessee in respect of expenditureincurred in relation to income which does not formpart of the total income under the Act, that he canproceed to make a determination under the Rules.



The satisfaction envisaged by sub-section (2) ofsection 14A is an objective satisfaction that has to bearrived at by the Assessing Officer having regard tothe accounts of the assessee. The safeguardintroduced by sub-section (2) of section 14A for a fairand reasonable exercise of power by the AssessingOfficer, conditioned as it is by the requirement of anobjective satisfaction, must, therefore, be scrupulouslyobserved. An objective satisfaction contemplates anotice to the assessee, an opportunity to the assesseeto place on record all the relevant facts including hisaccounts and recording of reasons by the AssessingOfficer in the event that he comes to the conclusionthat he is not satisfied with the claim of the assessee.


Own vs. Borrowed funds – precedents

CIT vs. Hero Cylces (P & H) –

If the investment in the shares is out of thenon-interest bearing funds, disallowance u/s14A is not sustainable;

The contention of the revenue even if theassessee has made investments in shares outof its own funds, the said own funds aremerged with the borrowed funds in a commonkitty and, therefore, disallowance u/s 14A canbe made is also not justified.


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 beinterest-free funds available to an assesseesufficient to meet its investments and at the sametime the assessee had raised a loan it can bepresumed that the investments were from theinterest-free funds available”.

The said decision turned on a finding of fact bythe Tribunal that there were sufficient interest-free funds available in that case. The judgment inReliance Utilities & Power Ltd.’s case (supra)shows that there were interest-free owned fundsavailable and not merely reserves.


Own vs. Borrowed funds – case law

Whether on the date of investment it is necessarythat the Assessee should have own funds in order toescape the applicability of 14A read with Rule8D(2)(ii)?

Binayak Tex Processors Ltd vs. ACIT [2014] 44taxmann.com 179 (Mum) –

We may observe that in day to day business, it is forthe assessee to see how to manage its business.

Even if on the date of investment/expenditure, ownfunds may not be available with the assessee but ifthe investment/ expenditure is made in anticipation ofavailability of own funds and the own funds areavailable to the assessee within a very short period of


Own vs. Borrowed funds – case law

time, then under such circumstances disallowancecannot be made on the entire loan amount but avery reasonable proportionate disallowance canbe made and even in certain cases can be ignoreddue to the shortness of the period between thedate of advancement/expenditure and date ofavailability of own funds.

The principle underlying this proposition is that abusinessman has to circulate his money accordingto the day to day requirements and the likelyinflow and outflow of money in the near future istaken into consideration while makinginvestments.


Share of Profit in Firms – case law

Safal Reality Pvt Ltd vs. ACIT ITANo.2334/Ahd/2012 & 1842/Ahd/2013 (Ahd) –

Under the totality of the facts andcircumstances of the case, we are of theconsidered opinion that when the interestincome was more than the interest expenditurethen the AO was not justified to invoke theprovisions of Section 14A read with Rule 8D ofIT Act. We hereby reverse the findings of theauthorities below and direct to delete thedisallowance.


section 14a – judicial pronouncements · claim for exemption - issue the bombay high court in...

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