Section 14A applies to dividend income u/s 115-O on which tax is paid by the dividend paying company-Supreme Court explains
ABCAUS Case Law Citation:
ABCAUS 1235 (2017) (05) SC
The issue:
The issue in the present appeal was related to the admissibility or otherwise of deduction of expenditure incurred in earning dividend income which is not includible in the total income of the Assessee by virtue of the provisions of Section 10(33) of the Income Tax Act, 1961 (“the Act”) as in force during the relevant Assessment Year.
The Question for determination:
(a) Whether the phrase “income which does not form part of total income under this Act” appearing in Section 14A includes within its scope dividend income on shares in respect of which tax is payable under Section 115-O of the Act and income on units of mutual funds on which tax is payable under Section 115-R.
(b) Whether there could at all be any question of the provisions of Section 14A in the appellant’s case.
Assessment Year : 2002-2003
Date/Month of Pronouncement: May, 2017
Important Case Laws Cited relied upon:
K.P. Varghese vs. Income-Tax Officer, Ernakulam and Anr (1981) 131 ITR 597 (SC)
C.I.T. vs. Walfort Share & Stock Brokers P. Ltd. (2010) 326 ITR 1 (SC)
Radhasoami Satsang vs. Commissioner of Income-Tax (1992) 193 ITR (SC) 321 [At Page 329]
Contentions of the appellant assessee:
It was contended that the section 14A applies only in situations where income is tax free; non-taxable and there is no incidence of tax per se. Dividend on shares is subjected to tax under Section 115-O of the Act whereas returns of units or mutual funds is subjected to tax under Section 115R. The fact that the tax on such dividend is paid by the dividend paying company and not by the recipient of the dividends, is of no consequence.
It was also argued that under Section 10(33) of the Act, income by way of dividend referred to in Section 115-O of the Act or income received in respect of units from the UTI or of mutual funds alone is exempted. It is only one specie of dividend income which is exempted under Section 10(33) of the Act whereas other species of such (dividend) income, say for example, dividend from foreign companies is still liable to tax. As tax has already been paid on such dividend, though by the dividend paying company, Section 14A will not apply to exclude expenditure incurred to earn such dividend income as the said income, really, is not tax-free.
It was further submitted that that there is a discernible correlation between Section 10(33) and Section 115-O of the Act inasmuch as both the Sections were inserted in the Act by the Finance Act, 1997. When the earlier status was restored by the Finance Act, 2002 shareholders once again became liable for tax on dividends which position continued until the provisions of Section 10(33) of the Act [engrafted as Section 10(34)] and Section 115-O were reintroduced by the Finance Act, 2003 with effect from 1st April, 2003. It is, therefore, argued that both the Sections 10(33) and Section 115-O of the Act constitute a composite scheme for taxation of dividend income wherein the legislative policy is clear that dividend, though to be taxed in the hands of the company distributing the same, is not to be included in the total income of the recipient Assessee. The mere fact that the amount is not to be included in the total income of the recipient Assessee, would not attract the provisions of Section 14A of the Act, inasmuch as the cardinal test is whether the dividend income is tax-free or not. The person paying the tax, according to the learned counsel, is not relevant for the aforesaid purpose.
It was also submitted that the above position had been accepted by the Revenue in its counter affidavit wherein it has been admitted that the exemption granted under Section 10(33) is consequent upon collection of tax on dividend income from the dividend distributing company under Section 115-O of the Act. It was , therefore, argued that a literal interpretation of Section 14A must be avoided.
It was specifically contended that tax on the dividend paid is not a tax on profits out of which dividend is distributed inasmuch as under Section 115-O of the Act dividend can be paid either from accumulated profits or current profits. In fact, Section 205 of the Companies Act permits payment of dividend out of accumulated profits in the year though the company may have incurred losses.
Furthermore, it was contended that the dividend paying company would be charged to tax under Section 115-O of the Act even in a case where no tax is payable under the regular provisions of the Act because its entire income, say, is otherwise eligible for deductions. In other words, tax under Section 115-O of the Act is payable by the dividend paying company even when no tax is payable on the income of such company under the regular provisions of the Act.
Observations made by the Supreme Court:
It was observed by Hon’ble Supreme Court that the object behind the introduction of Section 14A of the Act by the Finance Act of 2001 is clear and unambiguous. The legislature intended to check the claim of allowance of expenditure incurred towards earning exempted income in a situation where an assessee has both exempted and non-exempted income or includible or non-includible income.
Hon’ble Supreme Court opined that undoubtedly if the income in question is taxable and, therefore, includible in the total income, the deduction of expenses incurred in relation to such an income must be allowed. Howeer, such deduction would not be permissible merely on the ground that the tax on the dividend received by the assessee has been paid by the dividend paying company and not by the recipient assessee, when under Section 10(33) of the Act such income by way of dividend is not a part of the total income of the recipient assessee.
According to Hon’ble Supreme Court, a plain reading of Section 14A would go to show that the income must not be includible in the total income of the assessee. Once the said condition is satisfied, the expenditure incurred in earning the said income cannot be allowed to be deducted. The section does not contemplate a situation where even though the income is taxable in the hands of the dividend paying company the same to be treated as not includible in the total income of the recipient assessee, yet, the expenditure incurred to earn that income must be allowed on the basis that no tax on such income has been paid by the assessee. Such a meaning, if ascribed to Section 14A, would be plainly beyond what the language of Section 14A can be understood to reasonably convey.
Hon’ble Supreme Court went on to clarify that so far as the species of dividend income on which tax is payable under Section 115-O of the Act is concerned, the earning of the said dividend is tax free in the hands of the assessee and not includible in the total income of the said assessee. If that is so, there is no way the operation of Section 14A of the Act to such dividend income can be foreclosed. The fact that Section 10(33) and Section 115-O of the Act were brought in together; deleted and reintroduced later in a composite manner, also, does not assist the assessee. Rather, the aforesaid facts would countenance a situation that so long as the dividend income is taxable in the hands of the dividend paying company, the same is not includible in the total income of the recipient assessee. At such point of time when the said position was reversed (by the Finance Act of 2002; reintroduced again by the Finance Act, 2003), it was the assessee who was liable to pay tax on such dividend income. In such a situation the assessee was entitled under Section 57 of the Act to claim the benefit of exemption of expenditure incurred to earn such income. Once Section 10(33) and 115-O was reintroduced the position was reversed. The above, actually fortifies the situation that Section 14A of the Act would operate to disallow deduction of all expenditure incurred in earning the dividend income under Section 115-O which is not includible in the total income of the assessee.
Hon’ble Supreme Court also clarified that in the context of section 115-O of the Act, even if it is assumed that the additional income tax under the aforesaid provision is on the dividend and not on the distributed profits of the dividend paying company, no material difference to the applicability of Section 14A would arise. Sub-sections (4) and (5) of Section 115-O of the Act makes it very clear that the further benefit of such payments cannot be claimed either by the dividend paying company or by the recipient assessee. The provisions of Sections 194, 195 196C and 199 of the Act, quoted above, would further fortify the fact that the dividend income under Section 115-O of the Act is a special category of income which has been treated differently by the Act making the same non-includible in the total income of the recipient assessee as tax thereon had already been paid by the dividend distributing company. The other species of dividend income which attracts levy of income tax at the hands of the recipient assessee has been treated differently and made liable to tax under the aforesaid provisions of the Act. In fact, if the argument is that tax paid by the dividend paying company under Section 115-O is to be understood to be on behalf of the recipient assessee, the provisions of Section 57 should enable the assessee to claim deduction of expenditure incurred to earn the income on which such tax is paid. Such a position in law would be wholly incongruous in view of Section 10(33) of the Act.
On the second question Hon’ble Supreme Court observed that sub-sections (2) and (3) of Section 14A of the Act read with Rule 8D of the Rules merely prescribe a formula for determination of expenditure incurred in relation to income which does not form part of the total income under the Act in a situation where the Assessing Officer is not satisfied with the claim of the assessee. Whether such determination is to be made on application of the formula prescribed under Rule 8D or in the best judgment of the Assessing Officer, what the law postulates is the requirement of a satisfaction in the Assessing Officer that having regard to the accounts of the assessee, as placed before him, it is not possible to generate the requisite satisfaction with regard to the correctness of the claim of the assessee. It is only thereafter that the provisions of Section 14A(2) and (3) read with Rule 8D of the Rules or a best judgment determination, as earlier prevailing, would become applicable.
It was observed that in the present case, there was no mention of the reasons which had prevailed upon the Assessing Officer, while dealing with the Assessment Year 2002-2003, to hold that the claims of the Assessee that no expenditure was incurred to earn the dividend income cannot be accepted and why the orders of the Tribunal for the earlier Assessment Years were not acceptable to the Assessing Officer, particularly, in the absence of any new fact or change of circumstances. Neither any basis has been disclosed establishing a reasonable nexus between the expenditure disallowed and the dividend income received. That any part of the borrowings of the assessee had been diverted to earn tax free income despite the availability of surplus or interest free funds available.
Hon’ble Supreme Court opined that though the principle of res judicata would not apply to assessment proceedings under the Act, the need for consistency and certainty and existence of strong and compelling reasons for a departure from a settled position has to be spelt out which conspicuously is absent in the present case.
Held:
The first question formulated in the appeal was answered against the appellant-assessee by holding that Section 14A of the Act would apply to dividend income on which tax is payable under Section 115-O of the Act.
The second question formulated went in favour of the assessee and itwas held that for the Assessment Year in question i.e. 2002-2003, the assessee was entitled to the full benefit of the claim of dividend income without any deductions.
The appeal was allowed and the order of the High Court was set aside subject to the conclusions, on the applicability of Section 14A with regard to dividend income on which tax is paid under Section 115-O of the Act.
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