THE issue before the Bench is - Whether there should be an actual receipt of income, which is not includible in the total income during the relevant previous year, for the purpose of disallowing any expenditure u/s 14A incurred in relation to the said income. YES is the answer.
Facts of the case
The assessee is engaged in the business of making investment in shares and accepting/granting of loans. The Assessee is also among one of the co-promoters of Max India Ltd. In the AY in question, the assessee had borrowed funds on which interest expenditure of Rs.1,21,03,367/- was incurred. The factual assertion of the assessee, which had not been controverted, was that in the relevant AY no dividend income was earned from the amount invested in various shares. The assessee had filed its return declaring loss of Rs.13,84,086/-. The case was picked up for scrutiny and the AO completed the assessment u/s 143(3) disallowing Rs.97,87,570/- out of the total expenditure incurred during the year u/s 14A. The reason recorded by the AO for this disallowance was that the borrowed funds were utilized for the purpose of purchase of shares for the purpose to earn dividend income which was exempted u/s 10(33), and thus, not forming a part of the total income, and therefore the interest paid thereon had to be disallowed u/s 14A.
On appeal, the CIT(A) upheld the applicability of Section 14A but agreed with the contention of the assessee that only the net interest amount debited in the profit and loss account was required to be proportionately disallowed u/s 14A. Thereafter, a Special Bench was constituted to decide the question regarding applicability of Section 14A in an year when no exempt income had been earned, wherein it was held that "when the expenditure of interest is incurred in relation to income which does not form part of total income, it has to suffer the disallowance irrespective of the fact whether any income is earned by the assessee or not. Section 14A does not envisage any such exception. This is even if the interest paid on borrowings for the purchase of share were allowable u/s 57 as an expenditure incurred for earning or making income". The Special Bench negatived the submission of the assessee that the language of both Sections 57 (iii) and Section 14A were materially different. On further appeal, the Regular Bench of the Tribunal remanded the matter back to the file of AO for reconsideration afresh.
Having heard the parties, the High Court held that,
++ it is found that the complete answer to the issue is provided by the decision of this Court in CIT v. Holcim India (P) Ltd., wherein a similar question arose, viz., whether the ITAT was justified in deleting the disallowance u/s 14A when no dividend income had been earned by the assessee in the relevant A.Y? The Court answered that "income exempt u/s 10 in a particular A.Y may not have been exempt earlier and can become taxable in future years. Further, whether income earned in a subsequent year would or would not be taxable, may depend upon the nature of transaction entered into in the subsequent A.Y. For example, long term capital gain on sale of shares is presently not taxable where security transaction tax has been paid, but a private sale of shares in an off market transaction attracts capital gains tax". On facts, it was noticed in CIT v. Holcim India (P) Ltd. that the Revenue had accepted the genuineness of the expenditure incurred by the Assessee in that case and that expenditure had been incurred to protect investment made. In the present case, the factual position that has not been disputed is that the investment by the Assessee in the shares of Max India Ltd. is in the form of a strategic investment. Since the business of the Assessee is of holding investments, the interest expenditure must be held to have been incurred for holding and maintaining such investment. In light of the clear exposition of the law in Holcim India (P) Ltd. and in view of the admitted factual position in this case that the Assessee has made strategic investment in shares of Max India Ltd. that no exempted income was earned by the assessee in the relevant A.Y and since the genuineness of the expenditure incurred by the Assessee is not in doubt, the question framed is required to be answered in favour of the assessee;
++ since the Special Bench has relied upon the decision of the Supreme Court in Rajendra Prasad Moody, it is considered necessary to discuss the true purport of the said decision. It is noticed to begin with that the issue before the Supreme Court in the said case was whether the expenditure u/s 57(iii) could be allowed as a deduction against dividend income assessable under the head "income from other sources". U/s 57(iii) deduction is allowed in respect of any expenditure laid out or expended wholly or exclusively for the purpose of making or earning such income. The Supreme Court explained that the expression "incurred for making or earning such income', did not mean that any income should in fact have been earned as a condition precedent for claiming the expenditure. There is merit in the contention of assessee's counsel that the decision of the Supreme Court in Rajendra Prasad Moody case was rendered in the context of allowability of deduction u/s 57(iii), where the expression used is 'for the purpose of making or earning such income'. Section 14A on the other hand contains the expression 'in relation to income which does not form part of the total income.' The decision in Rajendra Prasad Moody case cannot be used in the reverse to contend that even if no income has been received, the expenditure incurred can be disallowed u/s 14A. In the context of the facts enumerated hereinbefore the Court answers the question framed by holding that the expression 'does not form part of the total income' in Section 14A envisages that there should be an actual receipt of income, which is not includible in the total income, during the relevant previous year for the purpose of disallowing any expenditure incurred in relation to the said income. Consequently, the impugned order of the ITAT is set aside and the appeal is allowed in the above terms