Issue and facts :– The brief facts, which are simple and undisputed, are that the assessee-company is a dealer and trader in shares and securities. Its various business segments are: Futures & Options (F&O) in shares and securities, shares transactions in the cash and derivative markets, speculation business therein (the above classifications may bear some overlapping). Shares in companies and Units of Mutual Funds (MFs) are also held by way of investments, on transfer of a part of which during the year the assessee has in fact disclosed long term capital gain (LTCG) at Rs 695.91 lacs, claimed tax exempt u/s.10(38) of the Act (PB pages 18-19). The assessee having earned dividend on shares at Rs 386.10 lacs, claimed & allowed tax-exempt u/s. 10(34), the AO proceeded to disallow the expenditure incurred by the assessee in relation thereto u/s. 14A (1) in terms of rule 8D; the said rule being applicable and mandatory for the current year, at Rs 140.69 lacs. The assessee challenged it before the ld. CIT(A) on several grounds. In appellate proceedings, it was also contended that the AO had not examined the correctness of the assessee’s claim as to the amount liable for disallowance u/s. 14A (1) at Rs 10 lacs. The assessee, in his opinion, had with facts and figures been able to show that the amount invested in shares and securities (Rs 13.44 crores) was funded by own, non-interest bearing funds, so that no disallowance on that account would arise. As regards indirect expenditure, the assessee had been able to show that of the total expenses debited in its accounts for the year, i.e., excluding depreciation, at Rs 558.55 lacs, the amount after deducting the sums already disallowed; direct expenditure; and those to be considered separately, is only at Rs 64.19 lacs. No disallowance toward direct expenditure having been made by AO himself, the suo motu disallowance by the assessee at Rs 10 lacs was thus considered appropriate by the ld. CIT(A). Aggrieved, the Revenue is in appeal.
Held :- The assessee, in the instant case, has suo motu disallowed Rs. 10 lacs. Its argument for non-application of s. 14A(1) is thus even otherwise infirm, so that the only issue that obtains is qua the quantum of the disallowance. In this regard, we may, in passing; being not germane in view of our decision detailed per the preceding paras, is that depreciation – an economic and accounting concept – statutorily recognized and provided, is only a charge on capital account, i.e., a capital expenditure. Reference in this regard be made to decisions, inter alia, in the case of CIT v. Society of Sisters of St. Anne  146 ITR 28 (Kar)] and CIT v. P. K. Badiani  76 ITR 369 (Bom). The disallowance by the Revenue, per r. 8D, works to Rs. 140.69 lacs, a part of which would, as indicated above, stand to be deleted and the balance confirmed. Under the circumstances, the assessee gets part relief. We decide accordingly.
INCOME TAX APPELLATE TRIBUNAL “D” BENCH, MUMBAI
BEFORE SHRI SANJAY ARORA, A. M. AND SHRI AMIT SHUKLA, J. M.
I.T.A. No.3029/Mum/2012 – (Assessment Year: 2008-09)
Date of Pronouncement: 17.07.2013
O R D E R
Per Sanjay Arora, A. M.:
This is an Appeal by the Revenue directed against the Order by the Commissioner of Income Tax (Appeals)-6, Mumbai (‘CIT(A)’ for short) dated 29.02.20 12, allowing the assessee’s appeal contesting its assessment u/s.143(3) of the Income Tax Act, 1961 (‘the Act’ hereinafter) for the assessment year (A.Y.) 2008-09 vide order dated 05.03.2010.
2. The only issue arising in this appeal is the maintainability in law of the disallowance in the facts and circumstances of the case u/s. 14A read with rule 8D by the Assessing Officer (A.O.) at Rs 1,40,69,402/-, since restricted by the first appellate authority to Rs 10 lacs, i.e., the amount disallowed suo motu by the assessee.
3. The brief facts, which are simple and undisputed, are that the assessee-company is a dealer and trader in shares and securities. Its various business segments are: Futures & Options (F&O) in shares and securities, shares transactions in the cash and derivative markets, speculation business therein (the above classifications may bear some overlapping). Shares in companies and Units of Mutual Funds (MFs) are also held by way of investments, on transfer of a part of which during the year the assessee has in fact disclosed long term capital gain (LTCG) at Rs 695.91 lacs, claimed tax exempt u/s.10(38) of the Act (PB pages 18-19). The assessee having earned dividend on shares at Rs 386.10 lacs, claimed & allowed tax-exempt u/s. 10(34), the AO proceeded to disallow the expenditure incurred by the assessee in relation thereto u/s. 14A (1) in terms of rule 8D; the said rule being applicable and mandatory for the current year, at Rs 140.69 lacs. The assessee challenged it before the ld. CIT(A) on several grounds. In appellate proceedings, it was also contended that the AO had not examined the correctness of the assessee’s claim as to the amount liable for disallowance u/s. 14A (1) at Rs 10 lacs. The assessee, in his opinion, had with facts and figures been able to show that the amount invested in shares and securities (Rs 13.44 crores) was funded by own, non-interest bearing funds, so that no disallowance on that account would arise. As regards indirect expenditure, the assessee had been able to show that of the total expenses debited in its accounts for the year, i.e., excluding depreciation, at Rs 558.55 lacs, the amount after deducting the sums already disallowed; direct expenditure; and those to be considered separately, is only at Rs 64.19 lacs. No disallowance toward direct expenditure having been made by AO himself, the suo motu disallowance by the assessee at Rs 10 lacs was thus considered appropriate by the ld. CIT(A). Aggrieved, the Revenue is in appeal.
4. Before us, the Revenue’s case was primarily in terms of section 14A (1) as well as Rule 8D being applicable in respect of shares held as stock-in-trade (at an average of Rs 37.98 crores), i.e., apart from that held as investments (at an average of Rs 13.26 crores). Similarly, rule 8D, which only seeks to effectuate section 14A, providing for a reasonable and uniform basis for estimating the disallowance there-under, draws no exception for shares held as stock-in-trade. The assessee, on the other hand, would plead its inapplicability. However, a query was made by the Bench to the effect that even assuming applicability of section 14A as well as rule 8D in a case, as in the instant case, where dividend income (also) arises on shares held as stock-in-trade, the question is that the shares giving rise to two streams of income, i.e., share trading income (taxable) and dividend income (tax-free), could the entire expenses attributable to these shares by way of indirect and interest expenditure be disallowed u/s. 14A read with rule 8D, i.e., considered as in respect of income not forming part of total income? Both the parties could not furnish any satisfactory answer, and were amenable to some reasonable basis for allocating such expenditure, i.e., as between the two income streams afore-said arising there-from.
5. We have heard the parties, and perused the material on record.
5.1 We may first address the question as to whether section 14A would apply to the shares held as stock-in-trade; it being admittedly applicable to shares held as investment. This is relevant on two counts. Firstly, the entire basis of the assessee’s claim in having made a reasonable disallowance u/s. 14A at Rs 10 lacs, which it further claims the AO to have not satisfactorily impugned, rests on the dividend income on such shares being not liable to any disallowance u/s. 14A(1). Two, though this aspect has been dealt with in extenso by the special bench of the Tribunal in ITO vs. Daga Capital & Management Services Pvt. Ltd. [117 ITD 169 (Mum)(SB), 312 ITR (AT) 1], which should normally be conclusive of the matter (as far as the Tribunal is concerned), the controversy arises in view of decisions as in the case of CCI Ltd. vs. Jt. CIT  71 DTR (Kar.) 141 and CIT v. Smt. Leena Ramachandran  339 ITR 296 (Ker). The Revenue has in this respect relied, per its sole ground of appeal, on the decision in the case of Dhanuka & Sons vs. CIT [339 ITR 319 (Cal)], besides of course on the decision in the case of Godrej & Boyce Manufacturing Mfg. Co. Ltd. vs. Dy. CIT  328 ITR 81 (Bom).
5.2 In our view, the matter being legal, would have to be considered from the stand¬point of whether the decision by the jurisdictional high court in case of Godrej & Boyce Mfg. Co. Ltd. (supra), upholding the constitutionality of section 14A as well as of rule 8D, deliberating on the various associated issues arising in the matter, answers this aspect of the matter as well. This is as, if it does, the same being judicially binding on the tribunal at the Mumbai benches, would be determinative of the matter. The decision by other high courts would be relevant in-so-far as they approve or disapprove the principles laid down in Godrej & Boyce (supra), or have been rendered without considering and de hors the said judgment by the jurisdictional high court.
5.3 We next consider the question of the applicability of section 14A to a case where shares, on which dividend income arises, are held as stock-in-trade. We do not think that the purpose for which the shares are purchased and held would in any manner impact the applicability of section 14A, which gets attracted on incurring the expenditure in relation to a tax-exempt income, as dividend income. It may impact the head of the income under which the income arising there-from would stand to be assessed, i.e., were it to be taxable, but nothing more. The same is irrelevant as section 14A is independent of the head of the income under which the tax exempt income would be otherwise liable to tax. In fact, dividend income has been specifically provided under the statute for being assessable u/s.56, so that the fact that it arises in respect of shares held as stock-in-trade, i.e., as a part of the business income, and as such there is under the circumstances not even a change in the head of income, as would generally be the case, would be of no consequence. Succinctly put, section 14A would come into play irrespective of the head of income (on account of it arising qua a trading asset), under which the income not forming part of the total income would be otherwise liable to be assessed. The hon’ble court in the case of Godrej & Boyce Mfg. Co. Ltd. (supra), examining the genesis of the provision of section 14A, clarified that the basic principle of taxation being that only the net income, i.e., gross income minus expenditure, is taxable, holding sec. 14A as curative and declaratory of the intent of the Parliament. The same was required to be enacted to overcome the incidence of non-disallowance of expenditure – in view of the judicial precedents by the apex court – where there is a one, indivisible business giving rise to taxable as well as exempt incomes. Reference in this context may be made to the section of the Decision under the heading ‘Enactment of s.14A’ with the hon’ble court proceeding to meet the various arguments advanced, summarizing its findings under the heading ‘A summation of our conclusions on the interpretation of the provisions’. This position stands independently observed by the hon’ble Calcutta High Court in Dhanuka & Sons (supra). The factual situation obtaining in the instant case, where the share trading business yields both taxable income in the form of share trading profit and tax-exempt income by way of dividend income, is the same. The said decisions thus squarely cover the facts of the instant case as well. Therefore, to say that section 14A would not apply as shares are held as stock-in-trade would not hold.
The rationale, view and verdict of the hon’ble jurisdictional court, drawn on the basis of the decisions by the apex court rendered prior to the insertion of s. 14A; the interpretation of the provision, including as to the purpose of it having been brought on the statute-book, as well as its placement therein; and the decision by the apex court in the case of CIT vs. Walfort Share and Stock Brokers P. Ltd.  326 ITR 1 (SC), having been stated explicitly, has been made abundantly clear by it in Godrej & Boyce Mfg. Co. Ltd. (supra). Reference in this context may also be made to the decision by the Special Bench in the case of Daga Capital Management Pvt. Ltd. (supra), wherein this issue stands deliberated at length, being, rather, the issue under reference, as in fact was also the case in Dhanuka & Sons (supra) (refer Q # 2 referred to the hon’ble court). The larger Bench of the tribunal has clarified that the expenditure in relation to the tax exempt incidental income is not immune to section 14A, which would apply irrespective of the fact that the shares are held as stock-in-trade (refer paras 24, 25 & 26 of its order). Further, in this view of the matter, the assessee ’s claim that the AO had not satisfactorily impugned its suo motu disallowance, which he is required to u/s. 14A(2), would not hold; the entire basis of the assessee ’s claim being the inapplicability of s. 14A(1) to income/s arising, or that may arise, on shares held as stock-in-trade, so that the expenditure in relation to the same would have to be excluded in estimating the amount liable for disallowance thereunder.
5.4 Next, we may examine the assessee’s claim that no disallowance u/s. 14A(1) would arise as no expenditure at all has been incurred in relation to the tax-exempt dividend income; the same arising only incidentally to its share trading activity, i.e., on the shares being retained for the time being, and held as on the record date, yielding dividend, the quantum of which is again uncertain. That is, no specific expenditure has been incurred for earning the dividend in-as-much as all the expenditure which stands incurred is for the purpose of its share trading business, so that no additional expenditure can be said to have been incurred for earning dividend, and which therefore is at nil. In fact, it is this aspect of the matter that has been subject to varying understanding, i.e., between the assessees and the Revenue, resulting in varying decisions.
Toward this, we firstly clarify that though no such claim was taken specifically before us; the assessee having in fact disallowed a sum of Rs. 10 lacs, so that it could not possibly assume such a stand. The same, however, forms the basis of the decisions in the case of Smt. Leena Ramachandran (supra) and Yatish Trading Company Pvt. Ltd. (supra) relied upon by it. The algorithm being applicable in the instant case, the said reliance cannot be said to be bad; the assessee’s said stand being made in the alternative. In this regard, without doubt a proximate cause is to be established between the expenditure and the relevant income, for it to qualify as an expenditure in relation to an income which does not form part of the total income and, consequently, liable for disallowance u/s.14A(1). The question, therefore, boils down to determination as to whether this proximate cause would imply a relationship of only first degree, i.e., having a direct nexus as conveyed by the words ‘derived from’, or would it also include a broader relationship, as indicated by the words ‘attributable to’, and which would include within its ambit both direct as well as indirect expenditure qua the relevant income. Without doubt, the scope would stand to be gathered from the words employed by the statute, i.e., ‘in relation to’. In our clear view, the said words would, and for more than one reason, signify a broader relationship, i.e., of a first as well as second degree. That is, the choice of words used, which are to be primarily considered for ascertaining the legislative intent, indicate a connection or association, i.e., in the sense or meaning conveyed by the word ‘relation’ as used in common parlance. A strict correspondence, where so envisaged, would have been brought out by use of restrictive words, as, for example, ‘derived from’. Rather, what better than to – in that case – use the words ‘direct expenditure’ or ‘direct costs’ itself. The concept of the direct and indirect expenditure is fairly well understood under the Act; in fact being employed and defined in some provisions, as in Explanation to section 80-HHC. The scope of the words ‘in relation to’ stands also examined by the special bench in the case of Daga Capital Management Pvt. Ltd. (supra). It clarified that the words have to be interpreted contextually, and that in the instant case the answer is provided by s.14A (2) itself, i.e., in accordance with the method as may be prescribed, which (method) includes both direct as well as indirect expenditure (refer para 23.6). Secondly, it may be noted that the provision of section 14A would in fact itself not be required to be enacted if only direct expenditure was contemplated for exclusion and/or disallowance. This is for the simple reason that the direct expenditure incurred for earning an income not forming part of the total income would even otherwise, i.e., even in the absence of section 14A, not stand to be allowed in computing the total income. This is as the principle of only the net (and not gross) income (from any source or activity) as being liable to tax is axiomatic in tax jurisprudence. Could, one may ask, the expenditure on an activity yielding only one income, which is tax-exempt, be claimed against any other income forming part of the total income, where flowing from a similar or an allied activity? For example, could the interest expenditure on agricultural inputs (seeds, fertilizers, etc.) yielding agricultural produce, which is subject to further processing to generate processed food product/s, be deducted in computing the business income on such products? Certainly not; the same being deductible only in computing agricultural income. As explained in the case of Godrej & Boyce (supra), it is only to mitigate and transcend the issues relating to attribution that the provision of section 14A has been brought in place, viz. where one composite indivisible business gives rise to more than one stream of income, of which (at least) one does not form part of the total income. Prior to insertion of section 14A, it was impermissible for the A.O. to apportion the expenditure incurred in relation to such income as between the taxable and the tax-exempt income. That is, the very situation that arises and confronts us in the instant case. This aspect stands amply clarified by the hon ’ble court in the said case, stating, with reference to the decision in the case of CIT vs. Walfort Share and Stock Brokers P. Ltd.  326 ITR 1 (SC), that the theory of apportionment of expenditure between the taxable and non taxable income has, in principle, been now widened under section 14A. The expenditure subject to disallowance u/s. 14A would, therefore, mean just that, i.e., any expenditure falling u/ss. 15 to 59 of the Act, where incurred in relation to the tax-exempt income. Again, it clarifies (at pg. 137, para 86(e)) that section 14A has brought in material changes, setting aside the argument made with reference to consistency and definiteness in the approach of the Revenue. The argument as being advanced in the instant case stood also raised in the case of Daga Capital (supra); in fact, finding favour with the dissenting member of the constitution, though did not find approval of the larger Bench. The said decision stands impliedly approved in Godrej & Boyce (supra); the hon’ble court striking it down only in-so-far as the retrospective operation of rule 8D is concerned. In fact, as its reading would show, Rule 8D putting in place or articulating a method for estimating the expenditure that can be regarded as relating to income that does not form part of the total income, was also responsible for the hon’ble court for holding that the said rule is not retrospective.
Further on, what better proof of a pudding than in its eating? Rule 8D, which only seeks to give effect to the provision of section 14A(1), since held as constitutionally valid by the hon’ble court, seeks to apportion not only direct but also indirect expenditure, so that the latter also falls within the scope of the words ‘in relation to’ occurring in section 14A(1). Reference in this context may also be drawn to the discussion by the hon’ble court under the head ‘C.5 The order of restoration passed by the Tribunal’ at pages 134 to 137 of the judgment. Repelling the argument that investment in shares yielding tax-free dividend income has been made out of own funds, so that no interest expenditure has been incurred in relation to the dividend income, it clarified that the said fact was no longer dispositive of the matter, and that, even so, a disallowance in respect of interest would have to be made, and no presumption of investment of own funds, on ground of its sufficiency, could be drawn, distinguishing its own decision in the case of CIT Vs. Reliance Utilities & Power Ltd. 313 ITR 340 (Bom.); its relevant observations (at placitum 5, pg. 135) reading as under :
“In all these decisions, the Tribunal held that no nexus had been established between borrowed funds and investments by the assessee in dividend yielding shares/income yielding mutual funds. Now assuming that this is so, the only conclusion which emerges is that the assessee had utilized its own funds for the purpose of making the investments. The fact that the assessee has utilized its own funds in making the investments would not be dispositive of the question as to whether the assessee had incurred expenditure in relation to the earning of such income. Even if the assessee has utilized its own funds for making investments which have resulted in income which does not form part of the total income under the Act, the expenditure which is incurred in the earning of that income would have to be disallowed. That is exactly a matter which the Assessing Officer has to determine.”
To the same effect are the observations by the hon’ble court in Dhanuka & Sons (supra), stating that the object of s. 14A is to disallow both direct and indirect expenditure incurred in relation to income not forming part of the total income (para 8 of the decision). The hon ’ble court went on to validate the apportionment of interest expenditure on shares purchased years ago in the absence of the assessee leading evidence as to the utilization of borrowed funds, so that, on a general pool of funds hypothesis, they stood also invested in business and, thus, also in shares held as trading stock. The same situation marks the instant case as well.
We have dwelled on the matter at length, as the argument raised moves on the premise that as long as no expenditure stands specifically incurred for earning dividend, no disallowance u/s. 14A(1), where shares are held as stock-in-trade, could be made; the expenditure incurred having been so for the dominant purpose of share trading activity yielding taxable income by way of share trading income. In other words, as long as there is no expenditure that could be said to fall u/.57(iii), no disallowance qua dividend income could be made. There is, we may clarify, no warrant for the classification of the exempt income, either u/c. IV-F or any other, or for that matter the expenditure which is to be disallowed, under any specific section. The exempt income falls under Chapter III, which precedes Chapter IV, providing for the heads of income, which is only toward classifying the income forming part of the total income under different heads of income for the purpose of computing the same. The exempt income, on the other hand, does not enter the computation process and, accordingly, does not fall under, nor is required to be allocated to, any specific head of income. That is, the dividend income may well have been in law, in some circumstances, assessable as business income, to no effect or consequence. Likewise, the expenditure to be disallowed could fall under any of the sections, i.e., from section 15 to section 59. The disallowance of expenditure is governed completely by section 14A, which is a separate and complete code in itself, and as long as its ingredients are satisfied, a disallowance in its terms would follow.
5.5 We may also address the assessee’s other arguments in the matter. The first one is that the dividend being incidental, no expenditure can be said to have a proximate relationship therewith; the income itself being uncertain both in terms of time and quantum. We have already examined the matter from the legal stand-point, clarifying that all the direct and indirect expenditure shall fall within the scope of the words ‘in relation to’, as occurring in section 14A(1). We may examine the matter from the factual stand-point also. The expenditure, it may be appreciated, is incurred by the assessee for the purpose of its business of share trading. All the expenditure, therefore, is incurred by the assessee in the regular course of its business, and for its purposes. That represents the input, in terms of an activity/s as well as the attendant costs. The same would, therefore, stand to be deducted from the output in computing the income, be it in the form of share trading income or dividend income, which would also, though tax exempt, bear the character of business income. The dividend income, it needs to be appreciated, also arises from and forms an integral part of the said business. The net result, i.e., output minus the input, would give us the income or loss, as the case may be, from the business. As regards the uncertainty aspect, take the example of a share bought at Rs. 1000 (say). Could it be said as to when it will be sold, and at what rate? The answers to both (questions) lie only in the womb of future. What is certain though is the incurring of the cost at Rs. 1000/-, with profit motive, and which would, therefore, need to be deducted, irrespective of the time and value for which the share is sold. It is this, a direct cost, which would therefore stand to be deducted in determining the income or loss, as the case may be, on sale, as and when it occurs. Uncertainty as to both the timing as well as the quantum of income that would finally inure, obtains, but that would not in any manner detract from the fact that expenditure by way of purchase cost stands incurred and in relation to such income or loss. Being a direct expenditure, the same would not be attributed against any other income, including the dividend income, which is in the nature of a holding income. The assessee’s argument qua the uncertainty of dividend income, is, therefore, to no consequence; the same being not relevant. It is only the shares acquired in the normal course of business as a part of stock-in-trade, as are held on the record date, which yield dividend income, and which, therefore, though tax exempt, is as much a part of the business income as any other. The shares have been bought for the business, which activity has overhead costs and, further, being retained, entail holding cost as well. To say that no separate effort has been made for earning dividend income misses the point that the effort or activity is one, integral activity of purchase and holding the shares, which though generates two separate streams of income. Even so, is it necessary that every item of income should require a separate and distinct effort in its respect? Interest, where borrowed capital is employed, is incurred. But could one say how much income by way of share trading profit it would generate? Of course, not. The dividend received being only on such shares being held as stock-in-trade, to say that no separate effort has been made, and the cost incurred in its respect is, therefore, nil, is not correct on facts.
In sum, expenses are incurred during and in the regular course of business, and with a view to earn income. No direct relationship or correspondence therewith, particularly for costs other than direct costs, on account of a variety of factors, hold. A proximate relationship though exists. Even for direct expenditure, the relationship (with income) cannot be said to be linear, though we are primarily here concerned with allocation of indirect expenditure. All such expenditure is deductible and, therefore, would be required to be apportioned between the taxable and non-taxable incomes where the business generates more than one income stream, at least one of which is not taxable. Clearly, the direct expenditure would stand to be set off against the relevant income/s and the apportionment, in substance, comes into play only for the indirect expenditure.
5.6 We may now come to the actual apportionment, for which rule 8D has been provided and, as held in the case of Godrej & Boyce (supra), is operative w.e.f. A.Y. 2008-09, the current year. Continuing further, with regard to the actual apportionment of costs, we find that r. 8D(2), which provides the formula for apportionment; r. 8D(1) stating the basis for the application of r. 8D itself, consists of three parts, each in relation to a separate set of expenses. The first sub-clause (i) is in respect of direct expenditure relating to income which does not form part of the total income. The second, i.e., sub-clause (ii), concerns the interest expenditure (other than that directly attributable to any particular income or receipt), while sub-clause (iii), which is qua indirect expenditure, provides for an amount equal to one half per cent of the average value (as appearing in the books of account) of the investment, income from which does not form part of the total income. The rule is self explanatory. There could be no quarrel with regard to the allocation of direct expenditure, which in fact states the obvious, and would in any case warrant a disallowance, i.e., even in the absence of the rule. No disallowance thereunder, in any case, has been made by the AO in the instant case.
The second component, qua interest expenditure in r. 8D(2)(ii), however, presents a problem in a case as the instant case. This is as the sub-rule, as would be readily seen, seeks to quantify the interest on the investments, income from which is not taxable, on a proportionate basis, and which though is not only understandable, but is as appropriate and justifiable as a general formula could be. However, in the instant case, shares, which yield the tax exempt dividend income, interest qua which is to be disallowed, being held as stock-in-trade, also yield share trading income, which is taxable. Therefore, to say that the entire interest relatable to the average share holding is to be attributed to the tax exempt dividend income would be patently incorrect on facts. That, in fact, the shares are bought and held primarily for share trading income, further accentuates the apparent incongruity of the situation arising on the mechanical application of r. 8D(2)(ii). Clearly, therefore, the amount as per r. 8D(2)(ii) would need to be scaled down, bifurcating the expenditure so arrived at between these two incomes. As regards the ratio of such scaling down, no hard and fast rule for the purpose would hold, each fact situation being different. However, considering that the dominant objective of the share holding, which in our view should be dispositive of the matter, is the share trading income, we propose a ratio of 20% toward the tax-exempt dividend income. One could argue that the percentage suggested by us is ad hoc or not scientific. We have already explained that an indirect expenditure, including by way of interest, has no direct relation with the income, much less its quantum, allocating it on the basis of the income generated or arising would not be appropriate, and neither does rule 8D support the same. Further, that in arriving at the suggested rate of 20%, we have been guided principally by the fact that the share trading is the dominant object of the share-holding. We also consider it pertinent to mention that though the average share-holding may be the same, the share composition, in view of the share trading activity, would vary continuously; the turnover for a year being easily in the range of 4 to 5 times the average share-holding. Accordingly, in arriving at the disallowance u/r. 8D, the amount as per r. 8D(2)(ii) qua shares held as stock-in-trade would stand to be restricted to 20% thereof.
As regards the legal mandate for the adjustment aforesaid, we have already clarified of the manifestly incorrect, if not absurd results that would otherwise follow. In fact, in our view, the language of r. 8D(2)(ii) itself provides the mandate inasmuch as it prescribes or authorizes a disallowance only qua investment, income from which is not taxable, so that in limiting the amount worked out with reference to the total investment; the same also yielding taxable income, we have only sought to operationalize and implement the said rule. It would also be appreciated that not doing so would also violate the principle of only the net income (from any source) being subject to tax inasmuch as disallowance of the total interest as per r. 8D(2)(ii) would in effect bring the share trading income to tax without deduction of the interest expenditure allocable or attributable thereto. Needless to add that no adjustment would arise in respect of shares held as ‘investments’, so that the two parts would need to be separately computed, which is otherwise manifest in the computation itself.
Continuing further, the part of the rule prescribing the ratio in respect of indirect expenditure (r. 8D(2)(iii)) cannot be altered on account of hardship (reference is drawn to the section of the judgment in Godrej & Boyce (supra) on the constitutionality of sub-sections (2) & (3) of section 14A and rule 8D/pgs. 113 – 123). Even so, the rule prescribes the same as the ratio of indirect expenditure required to support an investment. We say so as the expenditure prescribed for disallowance is based only on one variable, i.e., the value of the investment (on an average). Investment activity, it may be appreciated, is much stabler in character in comparison to the trading activity, which involves continuous churning of funds and, thus, activity, requiring a much higher level of organizational support/expenditure. Investments, on the other hand, are long term and strategic, requiring only periodic review of performance with reference to the investment objective/s, besides on account of environmental changes, if any. Why, the prescribed allocation ratio of 0.5% of the investment value qua indirect expenditure is very nominal, recommending itself to easy acceptance, is itself based, even as observed by the hon’ble court (at 116 of the report), on the 2% to 2.5% (of the investment) usually charged by the Portfolio Management Service (PMS) providers, of which around 1% (of the portfolio value) would be their profit. The nominal rate of 0.5% also eschews the charge of it being harsh, while being at the same time clarificatory of its purpose; the investment activity being essentially sporadic and episodic. In fact, the assessee itself explains of no change in its investment portfolio during the year except for one switch from a company share to units of a Mutual Fund (HDFC Liquid Fund). Our discussion is, however, only toward the nominality and purport of the charge, and does not in any manner imply of it being confined only to shares held as investment. This is as even though purchased with a short term perspective, the shares are purchased only with profit objective, i.e., as representing a good investment opportunity, so that it is perceived as under-priced, and its market price would appreciate in time, yielding ‘good’ return and, rather, in a shorter period of time. That is, the investment component or element is inbuilt in any purchase and toward which the allocation of indirect expenditure is prescribed per r. 8D(2)(iii). The fact that trading shares also yield dividend income, which is not taxable, i.e., besides share trading income, is itself relevant and sufficient for attracting the provision of s.14A(1). In fact, an argument to this effect, i.e., r. 8D(2)(iii) as being not applicable to shares held as stock-in-trade, was specifically assumed in the case of Daga Capital (supra). The tribunal rejected the argument, made with reference to the language of r.8D, clarifying that the words used are ‘value of investment’ and not ‘held as investment’. We may reproduce the relevant part of the order for the sake of better clarity: (pg. 233 of the report in ITD)
“23.9 The learned Counsel for the assessee………………. We are not impressed with this submission raised on behalf of the assessee for the out and-out reason that the reference in this rule is to the ‘value of investment’ and not the assets ‘held as investment’. A person may make investment in shares and the shares so purchased may be held either as “Stock-in-trade’ or ‘Investment’. The word ‘investment’ in this rule refers to the making of purchase of shares and not holding it as investment.”
We decide accordingly.
6. Before parting with the matter, we may clarify, as would also be evident from a reading of this order, that in deciding the issue under reference, we have been guided primarily by the decision by the hon’ble high court in the case of Godrej and Boyce (supra). The same being by the jurisdictional high court, is judicially binding. That answers our departure from the decisions in the case of Yatish Trading Company Pvt. Ltd. (supra) and CCI Ltd. (supra); the latter in fact having been rendered without considering the decision in the case of Godrej and Boyce (supra). We are, in fact, in deciding on the applicability of s. 14A as well as rule 8D, in a case where shares are held as stock-in¬trade, supported by the decisions as in the case of Dhanuka & Sons (supra) and American Express Bank Ltd. (in ITA No. 5904 & 6022/Mum/2010 dated 08.08.2012). The hon’ble high court in Dhanuka & Sons (supra), following Walfort Share and Stock Brokers (supra), came to the same conclusion as did the hon’ble jurisdictional high court in Godrej and Boyce (supra). The tribunal, in American Express Bank Ltd. (supra), has also considered the decisions, among others, in the case of Smt. Leena Ramachandran (supra) and Yatish Trading Co. (supra).
7. The assessee, in the instant case, has suo motu disallowed Rs. 10 lacs. Its argument for non-application of s. 14A(1) is thus even otherwise infirm, so that the only issue that obtains is qua the quantum of the disallowance. In this regard, we may, in passing; being not germane in view of our decision detailed per the preceding paras, is that depreciation – an economic and accounting concept – statutorily recognized and provided, is only a charge on capital account, i.e., a capital expenditure. Reference in this regard be made to decisions, inter alia, in the case of CIT v. Society of Sisters of St. Anne  146 ITR 28 (Kar)] and CIT v. P. K. Badiani  76 ITR 369 (Bom). The disallowance by the Revenue, per r. 8D, works to Rs. 140.69 lacs, a part of which would, as indicated above, stand to be deleted and the balance confirmed. Under the circumstances, the assessee gets part relief. We decide accordingly.
8. In the result, the Revenue’s appeal is partly allowed.
Order pronounced in the open court on July 17, 2013.