[Post by Akash
Santosh Loya, 3rd
year B.A. LL.B.(Hons.) student from National University of Advanced Legal
Studies, Kochi.]
In the case of Godrej Boyce & Manufacturing Ltd. v.
Deputy Commissioner of Income Tax and Anr decided last month, the Supreme
Court of India decided on the issue relating to the disallowance of expenditure
under section 14A of the Income Tax Act, 1961 (the ‘Act’) incurred with respect
to the earning of dividend income and income from mutual funds in the hands of a
shareholder and unitholder respectively.
Deputy Commissioner of Income Tax and Anr decided last month, the Supreme
Court of India decided on the issue relating to the disallowance of expenditure
under section 14A of the Income Tax Act, 1961 (the ‘Act’) incurred with respect
to the earning of dividend income and income from mutual funds in the hands of a
shareholder and unitholder respectively.
In this post, I will at the outset state and elaborate
on the provisions relevant towards understanding of the issue. Thereafter, I
will discuss the decision of the Supreme Court. Lastly, I will provide an
analysis of the said decision.
on the provisions relevant towards understanding of the issue. Thereafter, I
will discuss the decision of the Supreme Court. Lastly, I will provide an
analysis of the said decision.
Relevant
provisions
provisions
Section
10(34)
10(34)
Section 10 of the Act exempts certain income. Such
income is not chargeable to tax under any provisions of the Act. In accordance
with sub-section (34), dividend income referred to in section 115-O was exempt
from tax. Before 2003, the said provision was numbered as section 10(33).
income is not chargeable to tax under any provisions of the Act. In accordance
with sub-section (34), dividend income referred to in section 115-O was exempt
from tax. Before 2003, the said provision was numbered as section 10(33).
Section
10(35)
10(35)
Section 10(35) exempts income received in
respect of units mutual fund or a specified company. Before 2003, the said
provision was part of section 10(33).
respect of units mutual fund or a specified company. Before 2003, the said
provision was part of section 10(33).
Section
14A
14A
Section 14A was enacted by the Finance Act,
2001. It states that any expenditure incurred by assessee with respect to
income which does not form part of total income will be disallowed. Therefore,
any expenditure incurred with respect to exempt income is disallowed. Further
sub-sections (2) and (3) state that the assessing officer (‘AO’) shall
determine the expenditure incurred as per the method prescribed in rule 8D of
the Income Tax Rules, 1962, provided the AO is not satisfied with the
expenditure claimed by the assessee.
2001. It states that any expenditure incurred by assessee with respect to
income which does not form part of total income will be disallowed. Therefore,
any expenditure incurred with respect to exempt income is disallowed. Further
sub-sections (2) and (3) state that the assessing officer (‘AO’) shall
determine the expenditure incurred as per the method prescribed in rule 8D of
the Income Tax Rules, 1962, provided the AO is not satisfied with the
expenditure claimed by the assessee.
By
virtue of decisions of the Supreme Court in Rajasthan
State Warehousing Corporation v. C.I.T.,[1] C.I.T. v. Maharashtra Sugar Mills
Limited[2] and C.I.T. vs. Indian Bank Limited,[3]
the settled position of law was that in case of composite and individual
businesses which earned both taxable and non-taxable income, expenditure
towards non-taxable income could not be isolated by apportionment, and a
disallowance could not be made. Thus, section 14A was enacted to remove the
basis of the aforesaid decisions.
virtue of decisions of the Supreme Court in Rajasthan
State Warehousing Corporation v. C.I.T.,[1] C.I.T. v. Maharashtra Sugar Mills
Limited[2] and C.I.T. vs. Indian Bank Limited,[3]
the settled position of law was that in case of composite and individual
businesses which earned both taxable and non-taxable income, expenditure
towards non-taxable income could not be isolated by apportionment, and a
disallowance could not be made. Thus, section 14A was enacted to remove the
basis of the aforesaid decisions.
Section
115-O
115-O
Section 115-O was introduced by the Finance Act,
2003. Sub-section (1) of section 115-O states that an additional income tax
will be charged on the profits distributed by the company. This income tax will
be in addition to the tax paid by the Co. on its total income. Therefore, firstly, the company will be liable to
pay normal income tax with respect to its total income mentioned in the tax return
(which will include the profits distributed by the company). Secondly, it will be liable to pay the
additional tax on the profits distributed by the company. Sub-section (2)
states that the aforesaid additional income tax will be payable by the company
even if it is liable to pay zero tax on its total income. Sub-section (4) states
that no credit can be claimed either by the company or by the shareholder with
respect to the amount of the tax paid under this section. The tax paid will be
treated as the final payment of tax. Further sub-section (5) states that no
deduction will be allowed to either the company or the shareholder in respect
of the tax paid under this section.
2003. Sub-section (1) of section 115-O states that an additional income tax
will be charged on the profits distributed by the company. This income tax will
be in addition to the tax paid by the Co. on its total income. Therefore, firstly, the company will be liable to
pay normal income tax with respect to its total income mentioned in the tax return
(which will include the profits distributed by the company). Secondly, it will be liable to pay the
additional tax on the profits distributed by the company. Sub-section (2)
states that the aforesaid additional income tax will be payable by the company
even if it is liable to pay zero tax on its total income. Sub-section (4) states
that no credit can be claimed either by the company or by the shareholder with
respect to the amount of the tax paid under this section. The tax paid will be
treated as the final payment of tax. Further sub-section (5) states that no
deduction will be allowed to either the company or the shareholder in respect
of the tax paid under this section.
Section
115-R
115-R
Section 115-R states that additional tax will be
paid by the specified company or the mutual fund with respect to the income
distributed to the shareholders or unit holders respectively. The other
provisions of section 115-R are similar to that of section 115-O. Therefore, a
reference to the aforesaid explanation can be made.
paid by the specified company or the mutual fund with respect to the income
distributed to the shareholders or unit holders respectively. The other
provisions of section 115-R are similar to that of section 115-O. Therefore, a
reference to the aforesaid explanation can be made.
The statutory provisions summarised above can be
found here.
found here.
Section 10(34) [which was then numbered as section
10(33)] and section 115-O were introduced in the Act by the Finance Act, 1997. Subsequently,
both the provisions were deleted by the Finance Act, 2002. However, by virtue
of Finance Act, 2003, sections 10(34) and 115-O were reintroduced into the Act.
Similarly, sections 10(35) and 115-R were reintroduced together by the Finance
Act, 2003.
10(33)] and section 115-O were introduced in the Act by the Finance Act, 1997. Subsequently,
both the provisions were deleted by the Finance Act, 2002. However, by virtue
of Finance Act, 2003, sections 10(34) and 115-O were reintroduced into the Act.
Similarly, sections 10(35) and 115-R were reintroduced together by the Finance
Act, 2003.
Background
The assesse, Godrej Boyce, had earned a total
income of Rs. 34.34 crores in the assessment year 2002-03. The following is the
division of dividend income towards various sources:
income of Rs. 34.34 crores in the assessment year 2002-03. The following is the
division of dividend income towards various sources:
|
1.
|
Sister Godrej companies
|
98%
|
|
2.
|
Non-Godrej companies
|
0.05%
|
|
3.
|
Mutual Funds
|
1.95%
|
A substantial part of the investment was in form
of bonus shares. Further, on the last date of the relevant financial year, i.e.,
31 March 2002, Godrej Boyce had total reserves, surplus, share capital of Rs. 280.64
crores by way of interest-free funds.
of bonus shares. Further, on the last date of the relevant financial year, i.e.,
31 March 2002, Godrej Boyce had total reserves, surplus, share capital of Rs. 280.64
crores by way of interest-free funds.
Accordingly, Godrej Boyce claimed exemption of
the aforesaid dividend income under sections 10(33) and 10(34). It contended
that it had incurred zero expenditure in earning the said income and,
therefore, no disallowance should be made section 14A. The AO rejected the
claim of Godrej Boyce and made the disallowance. This order was upheld by
Income Tax Appellate Tribunal (‘ITAT’). Godrej Boyce filed an appeal before the
High Court of Bombay. The High Court upheld the view of ITAT and dismissed Godrej
Boyce’s appeal.
the aforesaid dividend income under sections 10(33) and 10(34). It contended
that it had incurred zero expenditure in earning the said income and,
therefore, no disallowance should be made section 14A. The AO rejected the
claim of Godrej Boyce and made the disallowance. This order was upheld by
Income Tax Appellate Tribunal (‘ITAT’). Godrej Boyce filed an appeal before the
High Court of Bombay. The High Court upheld the view of ITAT and dismissed Godrej
Boyce’s appeal.
In the previous assessment years as well, i.e.,
1998-99, 1999-2000 and 2001-02, the AO had disallowed expenditure towards
earning of dividend income and income from mutual funds under section 14A.
However, the same was reversed and an order in favor of Godrej Boyce was
granted by the ITAT. Therefore, the end result in previous assessment years was
that the entire dividend income was exempt without any deductions.
1998-99, 1999-2000 and 2001-02, the AO had disallowed expenditure towards
earning of dividend income and income from mutual funds under section 14A.
However, the same was reversed and an order in favor of Godrej Boyce was
granted by the ITAT. Therefore, the end result in previous assessment years was
that the entire dividend income was exempt without any deductions.
Issues
Raised
Raised
I. Whether the
phrase ‘income which does not form part of total income’ appearing in section 14A
includes dividend income and mutual fund income on which tax is payable under
sections 115-O and 115-R?
phrase ‘income which does not form part of total income’ appearing in section 14A
includes dividend income and mutual fund income on which tax is payable under
sections 115-O and 115-R?
II. Whether on
the findings provided by lower authorities over a period of time, can there be
any question of disallowance under section 14A in Godrej Boyce’s case?
the findings provided by lower authorities over a period of time, can there be
any question of disallowance under section 14A in Godrej Boyce’s case?
Decision
Issue I
The Supreme Court upheld the judgement of Bombay
High Court on the said issue. It held that section 14A would apply to dividend
income on which tax is payable under section 115-O and income from mutual funds
on which tax is payable under section 115-R. It came to the aforesaid
conclusion on the basis of following grounds:
High Court on the said issue. It held that section 14A would apply to dividend
income on which tax is payable under section 115-O and income from mutual funds
on which tax is payable under section 115-R. It came to the aforesaid
conclusion on the basis of following grounds:
– Section 14A
states that expenditure incurred by an assessee for earning an income will be
disallowed if the said income does not form part of the total income of the
assessee. Therefore, on a plain reading of section 14A, it is very clear that
section 14A does not cover a situation where firstly, income is exempt in the hands of an assessee shareholder
and secondly, the tax on the said
income is payable by the dividend paying company. Therefore, only by virtue of
tax being paid by the dividend paying company on the said income, it does not confer
the benefit to the shareholder assessee in whose hands the income is exempt.
Further, it was held that the wordings of section 14A do not give rise to any
absurdity and, therefore, section14A should be construed strictly.
states that expenditure incurred by an assessee for earning an income will be
disallowed if the said income does not form part of the total income of the
assessee. Therefore, on a plain reading of section 14A, it is very clear that
section 14A does not cover a situation where firstly, income is exempt in the hands of an assessee shareholder
and secondly, the tax on the said
income is payable by the dividend paying company. Therefore, only by virtue of
tax being paid by the dividend paying company on the said income, it does not confer
the benefit to the shareholder assessee in whose hands the income is exempt.
Further, it was held that the wordings of section 14A do not give rise to any
absurdity and, therefore, section14A should be construed strictly.
– There are
various species of dividends other than those covered under section 115-O. However,
the only specie of dividend exempt under section 10(33) (later engrafted as
section 10(34)) is dividend covered under section 115-O. Therefore, section 14A
will not be applicable to other species of dividend. However, whenever the
dividend covered under section 115-O is earned, the applicability of section
14A will be beyond doubt.
various species of dividends other than those covered under section 115-O. However,
the only specie of dividend exempt under section 10(33) (later engrafted as
section 10(34)) is dividend covered under section 115-O. Therefore, section 14A
will not be applicable to other species of dividend. However, whenever the
dividend covered under section 115-O is earned, the applicability of section
14A will be beyond doubt.
– The fact
that section 10(33) (later engrafted as section 10(34)) and section 115-O were
introduced, deleted and reintroduced together does not conclude that the
intention of the legislature was to propose a composite scheme of taxation. The
composite scheme being that on one hand the dividend income is taxed in the
hands of dividend paying company, and on the other hand the same income is not
being included in the total income of the assesse shareholder.
that section 10(33) (later engrafted as section 10(34)) and section 115-O were
introduced, deleted and reintroduced together does not conclude that the
intention of the legislature was to propose a composite scheme of taxation. The
composite scheme being that on one hand the dividend income is taxed in the
hands of dividend paying company, and on the other hand the same income is not
being included in the total income of the assesse shareholder.
– Sub-sections
(4) and (5) of section 115-O clearly state that no benefit can be availed of
the payments made either by the company or the shareholder. Therefore, the
proposition that the tax on dividend income is paid by the company on behalf of
the assesse shareholder cannot stand.
(4) and (5) of section 115-O clearly state that no benefit can be availed of
the payments made either by the company or the shareholder. Therefore, the
proposition that the tax on dividend income is paid by the company on behalf of
the assesse shareholder cannot stand.
The Court
also referred to its judgement in the case of Commissioner of
Income-Tax vs. Walfort Share and Stock
Brokers P. Ltd.[4] to reach the
aforesaid conclusion.
also referred to its judgement in the case of Commissioner of
Income-Tax vs. Walfort Share and Stock
Brokers P. Ltd.[4] to reach the
aforesaid conclusion.
Issue II
The Supreme Court
reversed the ruling of the Bombay High Court on the said issue. It held that normally
the principle of res judicata does not apply to assessment proceedings.
However, strong reasons should be provided by the AO to deviate from the
consistent findings made over the years. In the instant case, since no strong
reasons were provided by the AO for deviating from the consistent findings over
the years, Godrej Boyce is entitled for full benefit of exemption of dividend
income without any deduction.
reversed the ruling of the Bombay High Court on the said issue. It held that normally
the principle of res judicata does not apply to assessment proceedings.
However, strong reasons should be provided by the AO to deviate from the
consistent findings made over the years. In the instant case, since no strong
reasons were provided by the AO for deviating from the consistent findings over
the years, Godrej Boyce is entitled for full benefit of exemption of dividend
income without any deduction.
Implications
In the instant case, Godrej
Boyce had no tax implications whatsoever. Even though Issue I was decided
against it, by virtue of a decision in its favor with respect to Issue II the
end result was that no tax liability was to be discharged by Godrej Boyce. Therefore,
looking at the decision from a monetary angle, the revenue was the one who
lost.
Boyce had no tax implications whatsoever. Even though Issue I was decided
against it, by virtue of a decision in its favor with respect to Issue II the
end result was that no tax liability was to be discharged by Godrej Boyce. Therefore,
looking at the decision from a monetary angle, the revenue was the one who
lost.
Analysis
It is a well settled
principle of interpretation of statutes that one has to adopt a construction that
will promote the general legislative intent and purpose underlying the provisions.[5]
One
of the sources for ascertaining the intention of the Legislature is the Memorandum of Finance
Bill. Section 115-O and amended section 10(34) were introduced by virtue of
Finance Act, 2003. The Memorandum of Finance Bill, 2003 should be referred to
ascertain the intention of the legislature for the introduction of the aforesaid
provisions. It states:
principle of interpretation of statutes that one has to adopt a construction that
will promote the general legislative intent and purpose underlying the provisions.[5]
One
of the sources for ascertaining the intention of the Legislature is the Memorandum of Finance
Bill. Section 115-O and amended section 10(34) were introduced by virtue of
Finance Act, 2003. The Memorandum of Finance Bill, 2003 should be referred to
ascertain the intention of the legislature for the introduction of the aforesaid
provisions. It states:
It has been argued that it is easier to collect tax at a single
point, i.e., from the
company rather than compel the company to compute the tax deductible in
the hands of the shareholders.
point, i.e., from the
company rather than compel the company to compute the tax deductible in
the hands of the shareholders.
It is, therefore, proposed to substitute
sub-section (1) of section 115-O of the Income-tax Act to provide that the
amounts declared, distributed or paid on or after 1st April 2003 by a domestic
company by way of dividends shall be charged to additional income-tax at the
flat rate of twelve and one-half per cent, in addition to the normal income-tax
chargeable on the income of the company.
sub-section (1) of section 115-O of the Income-tax Act to provide that the
amounts declared, distributed or paid on or after 1st April 2003 by a domestic
company by way of dividends shall be charged to additional income-tax at the
flat rate of twelve and one-half per cent, in addition to the normal income-tax
chargeable on the income of the company.
From the Memorandum of Finance Bill, 2003 it is apparent that
the intention for the introduction of the aforesaid provision was only for the
purpose of simplification of procedure. There was no intention to exempt any
kind of income. Initially, when dividend income was chargeable in the hands of
the shareholder, the company had to calculate and deduct the tax deducted at
source on the dividend income earned by every shareholder. Considering the
large number of shareholders that may be present in a corporation, the entire
procedure was very cumbersome and time consuming. Therefore, in order to simply
the procedure, the legislature imposed an additional burden on the company by
making it liable to pay the additional tax. Further, in order to prevent the
same income from being doubly taxed, an exemption under section 10(34) was granted.
This arrangement ensured that the same income was not doubly taxed.
the intention for the introduction of the aforesaid provision was only for the
purpose of simplification of procedure. There was no intention to exempt any
kind of income. Initially, when dividend income was chargeable in the hands of
the shareholder, the company had to calculate and deduct the tax deducted at
source on the dividend income earned by every shareholder. Considering the
large number of shareholders that may be present in a corporation, the entire
procedure was very cumbersome and time consuming. Therefore, in order to simply
the procedure, the legislature imposed an additional burden on the company by
making it liable to pay the additional tax. Further, in order to prevent the
same income from being doubly taxed, an exemption under section 10(34) was granted.
This arrangement ensured that the same income was not doubly taxed.
Further, a careful reading of section 14A also shows that the
intention of legislature was not to disallow the expenditure incurred for
earning dividend income and income from mutual funds.[6] For understanding the same,
it is necessary to take closer look at the section 14A (1) and (2).
intention of legislature was not to disallow the expenditure incurred for
earning dividend income and income from mutual funds.[6] For understanding the same,
it is necessary to take closer look at the section 14A (1) and (2).
Expenditure
incurred in relation to income not includible in total income.
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.
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) 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 AssessingOfficer, 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.
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 AssessingOfficer, 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.
From a perusal of the above provision, the two highlighted terms
need to be taken into consideration for providing a correct understanding regarding
the intention of legislature
need to be taken into consideration for providing a correct understanding regarding
the intention of legislature
– Total income under this Chapter –
It means the total income of the assessee computed under Chapter IV, i.e.,
sections 14 to 59;
It means the total income of the assessee computed under Chapter IV, i.e.,
sections 14 to 59;
– Total income under this Act – It
means the total income computed under the entire Act. Thus, the income
chargeable to tax under sections 115-O and 115-R also falls within the ambit of
this expression.
means the total income computed under the entire Act. Thus, the income
chargeable to tax under sections 115-O and 115-R also falls within the ambit of
this expression.
Therefore, from a careful reading of the aforesaid provision,
the intention of legislature is very clear. It is to not disallow expenditure
incurred for earning income which is chargeable not only under Chapter IV of
the Act but also under any other Chapters of the Act. Further, the intention is
also to allow expenditure with respect to income directly or indirectly earned
by the assesse. If the intention was only to allow expenditure incurred towards
income which forms a part of Chapter IV or towards income which is earned
directly by assesse, the same would have been expressed clearly. The aforesaid
intention would have been expressed by using words ‘total income under this
Chapter’ or ‘total income of assessee’ instead of ‘total income under this
Act’.
the intention of legislature is very clear. It is to not disallow expenditure
incurred for earning income which is chargeable not only under Chapter IV of
the Act but also under any other Chapters of the Act. Further, the intention is
also to allow expenditure with respect to income directly or indirectly earned
by the assesse. If the intention was only to allow expenditure incurred towards
income which forms a part of Chapter IV or towards income which is earned
directly by assesse, the same would have been expressed clearly. The aforesaid
intention would have been expressed by using words ‘total income under this
Chapter’ or ‘total income of assessee’ instead of ‘total income under this
Act’.
Further, this
intention is clear by virtue of sub-section (2) of section 14A as well. It
states that the AO can compute the disallowable expenditure when the said
income does not form part of total income under this Act. Therefore, the AO
will compute the disallowable expenditure when the income does not form part of
the total income under the Act, and not when the income does not form part of
total income of assessee.
– Akash Santosh Loya
intention is clear by virtue of sub-section (2) of section 14A as well. It
states that the AO can compute the disallowable expenditure when the said
income does not form part of total income under this Act. Therefore, the AO
will compute the disallowable expenditure when the income does not form part of
the total income under the Act, and not when the income does not form part of
total income of assessee.
– Akash Santosh Loya
[1] (2000) 109 Taxman 145.
[2] (1971) 3 SCC 543
[3] AIR 1965 SC 1473
[4] (2010)
326 ITR 1 (SC)
326 ITR 1 (SC)
[5] The
Sole Trustee, Lok Shikshana Trust v. CIT, Mysore, AIR 1976 SC 10.
Sole Trustee, Lok Shikshana Trust v. CIT, Mysore, AIR 1976 SC 10.
[6] CA Dev Kumar Kothari, ‘S. 14A: Scope of
disallowance explained’, available at http://www.itatonline.org/articles_new/section-14a-scope-of-disallowance-explained/.
disallowance explained’, available at http://www.itatonline.org/articles_new/section-14a-scope-of-disallowance-explained/.