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Supreme Court of India
The South Indian Bank Ltd. vs The Commissioner Of Income Tax on 9 September, 2021Author: Hrishikesh Roy
Bench: A.M. Khanwilkar, Hrishikesh Roy, C.T. Ravikumar
[REPORTABLE]
IN THE SUPREME COURT OF INDIA
CIVIL APPELLATE JURISDICTION
CIVIL APPEAL NO. 9606 OF 2011
SOUTH INDIAN BANK LTD. APPELLANT(S)
VERSUS
COMMISSIONER OF INCOME TAX RESPONDENT(S)
WITH
CIVIL APPEAL NO. OF 2021
[Arising out of SLP(C) No. 32761 OF 2018]
CIVIL APPEAL NO. 9609 OF 2011
CIVIL APPEAL NO. 9610 OF 2011
CIVIL APPEAL NO. 9611 OF 2011
CIVIL APPEAL NO. 9615 OF 2011
CIVIL APPEAL NO. 9608 OF 2011
CIVIL APPEAL NO. 9612 OF 2011
Signature Not Verified
Digitally signed by
CIVIL APPEAL NO. 9614 OF 2011
DEEPAK SINGH
Date: 2021.09.09
19:20:53 IST
Reason:
CIVIL APPEAL NO. 9613 OF 2011
CIVIL APPEAL NO. 9607 OF 2011
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CIVIL APPEAL NO. 3367 OF 2012
CIVIL APPEAL NO. 2963 OF 2012
J U D G M E N T
Hrishikesh Roy, J.
1. Leave granted in SLP(C) No. 32761/2018 for analogous
consideration with the related appeals.
2. The question of law to be answered in the present batch
of appeals is on interpretation of Section 14A of the Income
Tax Act (for short “the Act”) and the same reads as follows:
“Whether proportionate disallowance of interest
paid by the banks is called for under Section 14A
of Income Tax Act for investments made in tax free
bonds/ securities which yield tax free dividend
and interest to assessee Banks when assessee had
sufficient interest free own funds which were more
than the investments made”
3. While common arguments have been advanced by the
learned counsel for the parties, to place the legal issues
in the appropriate perspective, the relevant facts are
adverted from the Civil Appeal No. 9606 of 2011 (South
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Indian Bank Ltd. Vs. CIT, Trichur), for the purpose of this
judgment.
4. The assessees are scheduled banks and in course of
their banking business, they also engage in the business of
investments in bonds, securities and shares which earn the
assessees, interests from such securities and bonds as also
dividend income on investments in shares of companies and
from units of UTI etc. which are tax free.
5. Chapter IV of the Act provides for the Heads of Income
for computation of Total Income. In Section 14, the various
incomes are classified under Salaries, Income from house
property, Profit & Gains of business or profession, Capital
Gains & Income from other sources. The Section 14A relates
to expenditure incurred in relation to income which are not
includable in Total Income and which are exempted from tax.
No taxes are therefore levied on such exempted income. The
Section 14A had been incorporated in the Income Tax Act to
ensure that expenditure incurred in generating such tax
exempted income is not allowed as a deduction while
calculating total income for the concerned assessee.
6. Section 14A was introduced to the Income Tax Act by the
Finance Act, 2001 with retrospective effect from 01.04.1962.
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The new section was inserted in aftermath of judgment of
this Court in the case of Rajasthan State Warehousing
Corporation Vs. CIT1. The said Section provided for
disallowance of expenditure incurred by the assessee in
relation to income, which does not form part of their total
income. As such if the assessee incurs any expenditure for
earning tax free income such as interest paid for funds
borrowed, for investment in any business which earns tax
free income, the assessee is disentitled to deduction of
such interest or other expenditure. Although the provision
was introduced retrospectively from 01.04.1962, the
retrospective effect was neutralized by a proviso later
introduced by the Finance Act, 2002 with effect from
11.05.2001 whereunder, re-assessment, rectification of
assessment was prohibited for any assessment year, up-to the
assessment year 2000-2001, when the proviso was introduced,
without making any disallowance under Section 14A. The
earlier assessments were therefore permitted to attain
finality. As such the disallowance under Section 14A was
intended to cover pending assessments and for the assessment
years commencing from 2001-2002. It may be noted that in the
present batch of appeals, we are concerned with
1 [(2000) 242 ITR 450 SC] / (2000) 3 SCC 126.
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disallowances made under Section 14A for assessment years
commencing from 2001-2002 onwards or for pending
assessments.
7. At outset it is clarified that none of the assessee
banks amongst the appellants, maintained separate accounts
for the investments made in bonds, securities and shares
wherefrom the tax-free income is earned so that
disallowances could be limited to the actual expenditure
incurred by the assessee. In other words, the expenditure
incurred towards interest paid on funds borrowed such as
deposits utilized for investments in securities, bonds and
shares which yielded the tax-free income, cannot
conveniently be related to a separate account, maintained
for the purpose. The situation is same so far as overheads
and other administrative expenditure of the assessee.
8. In absence of separate accounts for investment which
earned tax free income, the Assessing Officer made
proportionate disallowance of interest attributable to the
funds invested to earn tax free income. The assessees in
these appeals had earned substantial tax-free income by way
of interest from tax free bonds and dividend income which
also is tax free. It is manifest that substantial
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expenditure is incurred for earning tax free income. Since
actual expenditure figures are not available for making
disallowance under Section 14A, the Assessing Officer worked
out proportionate disallowance by referring to the average
cost of deposit for the relevant year. The CIT (A) had
concurred with the view taken by the Assessing Officer.
9. The ITAT in Assessee’s appeal against CIT(A) considered
the absence of separate identifiable funds utilized by
assessee for making investments in tax free bonds and shares
but found that assessee bank is having indivisible business
and considering their nature of business, the investments
made in tax free bonds and in shares would therefore be in
nature of stock in trade. The ITAT then noticed that
assessee bank is having surplus funds and reserves from
which investments can be made. Accordingly, it accepted the
assessee’s case that investments were not made out of
interest or cost bearing funds alone. In consequence, it was
held by the ITAT that disallowance under Section 14A is not
warranted, in absence of clear identity of funds.
10. The decision of the ITAT was reversed by the High Court
by acceptance of the contentions advanced by the Revenue in
their appeal and accordingly the Assessee Bank is before us
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to challenge the High Court’s decision which was against the
assessee.
11. Since, the scope of Section 14A of the Act will require
interpretation, the Section with sub-clauses (2) and (3)
along with the proviso is extracted hereinbelow: –
“14A. Expenditure incurred in relation to
income not includible in total income – (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) 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
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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. The sub-Section (2) and (3) were introduced to the main
section by the Finance Act, 2006 with effect from
01.04.2007.
13. The question therefore to be answered is whether
Section 14A, enables the Department to make disallowance on
expenditure incurred for earning tax free income in cases
where assessees like the present appellant, do not maintain
separate accounts for the investments and other expenditures
incurred for earning the tax-free income.
14. We have heard Mr. S. Ganesh, Mr. S.K. Bagaria, Mr.
Jehangir Mistri and Mr. Joseph Markose, learned Senior
Counsel appearing for the appellants. Also heard Mr.
Vikramjit Banerjee, learned Additional Solicitor General and
Mr. Arijit Prasad, learned Senior Counsel on behalf of the
respondent/Revenue.
15. The appellants argue that the investments made in bonds
and shares should be considered to have been made out of
interest free funds which were substantially more than the
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investment made and therefore the interest paid by the
assessee on its deposits and other borrowings, should not be
considered to be expenditure incurred in relation to tax
free income on bonds and shares and as a corollary, there
should be no disallowance under Section 14A of the Act. On
the other hand, the counsel for the revenue refers to the
reasoning of the CIT(A) and of the High Court to project
their case.
16. As can be seen, the contention on behalf of the
assessee was rejected by the CIT(A) as also by the High
Court primarily on the ground that the assessee had not kept
their interest free funds in separate account and as such
had purchased the bonds/shares from mixed account. This is
how a proportionate amount of the interest paid on the
borrowings/deposits, was considered to have been incurred to
earn the tax-free income on bonds/shares and such
proportionate amount was disallowed applying Section 14A of
the Act.
17. In a situation where the assessee has mixed fund (made
up partly of interest free funds and partly of interest-
bearing funds) and payment is made out of that mixed fund,
the investment must be considered to have been made out of
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the interest free fund. To put it another way, in respect of
payment made out of mixed fund, it is the assessee who has
such right of appropriation and also the right to assert
from what part of the fund a particular investment is made
and it may not be permissible for the Revenue to make an
estimation of a proportionate figure. For accepting such a
proposition, it would be helpful to refer to the decision of
the Bombay High Court in Pr. CIT v. Bombay Dyeing and Mfg.
Co. Ltd2 where the answer was in favour of the assessee on
the question, whether the Tribunal was justified in deleting
the disallowance under Section 80M of the Act on the
presumption that when the funds available to the assessee
were both interest free and loans, the investments made
would be out of the interest free funds available with the
assessee, provided the interest free funds were sufficient
to meet the investments. The resultant SLP of the Revenue
challenging the Bombay High Court judgment was dismissed
both on merit and on delay by this Court. The merit of the
above proposition of law of the Bombay High Court would now
be appreciated in the following discussion.
2 I.T.A. No.1225 of 2015
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18. In the above context, it would be apposite to refer to
a similar decision in Commissioner of Income Tax (Large Tax
Payer Unit) Vs. Reliance Industries Ltd3 where a Division
Bench of this Court expressly held that where there is
finding of fact that interest free funds available to
assessee were sufficient to meet its investment it will be
presumed that investments were made from such interest free
funds.
19. In HDFC Bank Ltd. Vs. Deputy Commissioner of Income
Tax4, the assessee was a Scheduled Bank and the issue
therein also pertained to disallowance under Section 14A. In
this case, the Bombay High Court even while remanding the
case back to Tribunal for adjudicating afresh observed
(relying on its own previous judgment in same assessee’s
case for a different Assessment Year) that, if assessee
possesses sufficient interest free funds as against
investment in tax free securities then, there is a
presumption that investment which has been made in tax free
securities, has come out of interest free funds available
with assessee. In such situation Section 14A of the Act
would not be applicable. Similar views have been expressed
3 (2019) 410 ITR 466 SC/ (2019) 20 SCC 478.
4 (2016) 383 ITR 529 (Bom) / 2016 SCC Online Bom 1109
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by other High Courts in CIT Vs. Suzlon Energy Ltd.5, CIT Vs.
Microlabs Ltd.6 and CIT Vs. Max India Ltd.7 Mr. S Ganesh
the learned Senior Counsel while citing these cases from the
High Courts have further pointed out that those judgments
have attained finality. On reading of these judgments, we
are of the considered opinion that the High Courts have
correctly interpreted the scope of Section 14A of the Act in
their decisions favouring the assessees.
20. Applying the same logic, the disallowance would be
legally impermissible for the investment made by the
assessees in bonds/shares using interest free funds, under
Section 14A of the Act. In other words, if investments in
securities is made out of common funds and the assessee has
available, non-interest-bearing funds larger than the
investments made in tax- free securities then in such cases,
disallowance under Section 14A cannot be made.
21. On behalf of Revenue Mr. Arijit Prasad, the learned
Senior Advocate refers to SA Builders v. CIT8 where this
Court ruled on issue of disallowance in relation to funds
lent to sister concern out of mixed funds. The issue in SA
5 (2013) 354 ITR 630 (Guj)/ 2013 SCC Online Guj 8613
6 (2016) 383 ITR 490 (Karn)/ 2016 SCC Online Kar 8490
7 (2016) 388 ITR 81 (P & H) / 2016 SCC Online P&H 6788
8 [(2007) 1 SCC 781]
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Builders is pending consideration before the larger bench of
this Court in SLP (C) No. 14729 of 2012 titled as Addl. CIT
v. Tulip Star Hotels Ltd. The counsel therefore, argues that
there is no finality on the issue of disallowance, when
mixed funds are used. On this aspect, since the issue is
pending before a larger Bench, comments from this Bench may
not be appropriate. However, at the same time it is
necessary to distinguish the facts of present appeals from
those in SA Builders/Tulip Star Hotels Ltd. In that case,
loans were extended to sister concern while here the
Assessee- Banks have invested in bonds/securities. The
factual scenario is different and distinguishable and
therefore the issue pending before the larger Bench should
have no bearing at this stage for the present matters.
22. The High Court herein endorsed the proportionate
disallowance made by the Assessing Officer under Section 14A
of the Income Tax Act to the extent of investments made in
tax-free bonds/securities primarily because, separate
account was not maintained by assessee. On this aspect we
wanted to know about the law which obligates the assessee to
maintain separate accounts. However, the learned ASG could
not provide a satisfactory answer and instead relied upon
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Honda Siel Power Products Ltd. v. DCIT9 to argue that it is
the responsibility of the assessee to fully disclose all
material facts. The cited judgment, as can be seen, mainly
dealt with re-opening of assessment in view of escapement of
income. The contention of department for re-opening was that
the assessee had earned tax-free dividend and had claimed
various administrative expenses for earning such dividend
income and those (though not allowable) was allowed as
expenditure and therefore the income had escaped assessment.
On this, suffice would be to observe that the action in
Honda Siel (supra) related to re-opening of assessment where
full disclosure was not made. An assessee definitely has the
obligation to provide full material disclosures at the time
of filing of Income Tax Return but there is no corresponding
legal obligation upon the assessee to maintain separate
accounts for different types of funds held by it. In absence
of any statutory provision which compels the assessee to
maintain separate accounts for different types of funds, the
judgment cited by the learned ASG will have no application
to support the Revenue’s contention against the assessee.
9 [(2012) 12 SCC 762]
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23. It would now be appropriate to advert in some detail to
Maxopp Investment Ltd. v. CIT10. This case interestingly is
relied by both sides’ counsel. Writing for the Bench,
Justice Dr. A.K. Sikri noted the objective for incorporation
of Section 14A in the Act in the following words: –
“3…………. The purpose behind Section 14-A 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……..”
The following was written explaining the scope of Section
14-A(1):
“41. In the first instance, it needs to be
recognised that as per Section 14-A(1) of the 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 from tax, and such
expenditure would be allowed as business
expenditure. To put it differently, such
10 (2018) 15 SCC 523
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expenditure would then be considered as incurred
in respect of other income which is to be treated
as part of the total income.”
Adverting to the law as it stood earlier, this Court
rejected the theory of dominant purpose suggested by the
Punjab & Haryana High Court and accepted the principle of
apportionment of expenditure only when the business was
divisible, as was propounded by the Delhi High Court.
Finally adjudicating the issue of expenditure on shares held
as stock-in-trade, the following key observations were made
by Justice Sikri:
“ 50. It is to be kept in mind that in those 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. The situation here
is, therefore, different from the case
like Maxopp Investment Ltd. [Maxopp Investment
Ltd. v. CIT, 2011 SCC OnLine Del 4855 : (2012)
347 ITR 272] where the assessee would continue to
hold those shares as it wants to retain control
over the investee company. In that case, whenever
dividend is declared by the investee company that
would necessarily be earned by the assessee and
the assessee alone. Therefore, even at the time
of investing into those shares, the assessee
knows that it may generate dividend income as
well and as and when such dividend income is
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generated that would be earned by the assessee.
In contrast, where the shares are held as stock-
in-trade, this may not be necessarily a
situation. The main purpose is to liquidate those
shares whenever the share price goes up in order
to earn profits……….”
The learned Judge then considered the implication of Rule 8D
of the Rules in the context of Section 14-A(2) of the Act
and clarified that before applying the theory of
apportionment, the Assessing Officer must record
satisfaction on Suo Moto disallowance only in those cases
where, the apportionment was done by the assessee. The
following is relevant for the purpose of this judgment:
51. ……………….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.………….”
24. Another important judgment dealing with Section 14A
disallowance which merits consideration is Godrej and Boyce
Manufacturing Company Ltd. V. DCIT11. Here the assessee had
access to adequate interest free funds to make investments
and the issue pertained to disallowance of expenditure
incurred to earn dividend income, which was not forming part
11 [(2017) 7 SCC 421.
Page 17 of 22
of total income of the Assessee. Justice Ranjan Gogoi
writing the opinion on behalf of the Division Bench observed
that for disallowance of expenditure incurred in earning an
income, it is a condition precedent that such income should
not be includible in total income of assessee. This Court
accordingly concluded that for attracting provisions of
Section 14A, the proof of fact regarding such expenditure
being incurred for earning exempt income is necessary. The
relevant portion of Justice Gogoi’s judgment reads as
follow:
“36. ……… what cannot be denied is that the
requirement for attracting the provisions of
Section 14-A (1) of the Act is proof of the fact
that the expenditure sought to be
disallowed/deducted had actually been incurred in
earning the dividend income………….”
25. Proceeding now to another aspect, it is seen that the
Central Board of Direct Taxes (CBDT) had issued the Circular
no. 18 of 2015 dated 02.11.2015, which had analyzed and then
explained that all shares and securities held by a bank
which are not bought to maintain Statutory Liquidity Ratio
(SLR) are its stock-in-trade and not investments and income
arising out of those is attributable, to business of
banking. This Circular came to be issued in the aftermath of
Page 18 of 22
CIT Vs. Nawanshahar Central Cooperative Bank Ltd.12 wherein
this Court had held that investments made by a banking
concern is part of their banking business. Hence the income
earned through such investments would fall under the head
Profits & Gains of business. The Punjab and Haryana High
Court, in the case of Pr. CIT, vs. State Bank of Patiala13
while adverting to the CBDT Circular, concluded correctly
that shares and securities held by a bank are stock in
trade, and all income received on such shares and securities
must be considered to be business income. That is why
Section 14A would not be attracted to such income.
26. Reverting back to the situation here, the Revenue does
not contend that the Assessee Banks had held the securities
for maintaining the Statutory Liquidity Ratio (SLR), as
mentioned in the circular. In view of this position, when
there is no finding that the investments of the Assessee are
of the related category, tax implication would not arise
against the appellants, from the said circular.
27. The aforesaid discussion and the cited judgments advise
this Court to conclude that the proportionate disallowance
of interest is not warranted, under Section 14A of Income
12 [(2007) 15 SCC 611] / [(2007) 160 TAXMAN 48 (SC)]
13 2017 (393) ITR 476 (P&H)
Page 19 of 22
Tax Act for investments made in tax free bonds/ securities
which yield tax free dividend and interest to Assessee Banks
in those situations where, interest free own funds available
with the Assessee, exceeded their investments. With this
conclusion, we unhesitatingly agree with the view taken by
the learned ITAT favouring the assessees.
28. The above conclusion is reached because nexus has not
been established between expenditure disallowed and earning
of exempt income. The respondents as earlier noted, have
failed to substantiate their argument that assessee was
required to maintain separate accounts. Their reliance on
Honda Siel (Supra) to project such an obligation on the
assessee, is already negated. The learned counsel for the
revenue has failed to refer to any statutory provision which
obligate the assessee to maintain separate accounts which
might justify proportionate disallowance.
29. In the above context, the following saying of Adam
Smith in his seminal work – The Wealth of Nations may aptly
be quoted:
“The tax which each individual is bound to pay ought
to be certain and not arbitrary. The time of payment,
the manner of payment, the quantity to be paid ought
all to be clear and plain to the contributor and to
every other person.”
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Echoing what was said by the 18th century economist, it
needs to be observed here that in taxation regime, there is
no room for presumption and nothing can be taken to be
implied. The tax an individual or a corporate is required to
pay, is a matter of planning for a tax payer and the
Government should endeavour to keep it convenient and simple
to achieve maximization of compliance. Just as the
Government does not wish for avoidance of tax equally it is
the responsibility of the regime to design a tax system for
which a subject can budget and plan. If proper balance is
achieved between these, unnecessary litigation can be
avoided without compromising on generation of revenue.
30. In view of the forgoing discussion, the issue framed in
these appeals is answered against the Revenue and in favour
of the assessee. The appeals by the Assessees are
accordingly allowed with no order on costs.
……………………………………………………J.
[SANJAY KISHAN KAUL]
……………………………………………………J.
[HRISHIKESH ROY]
NEW DELHI
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SEPTEMBER 09, 2021
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