Karur Vysya Bank Ltd. Vs CIT (Madras High Court)
Summary: Madras High Court allowed Karur Vysya Bank Ltd.’s appeals concerning AYs 1996-97, 1997-98 and 1998-99 and answered the substantial questions of law in favour of the assessee. The appeals questioned the Tribunal’s direction to apply Section 14A read with Rule 8D for determining proportionate expenditure relating to exempt income, despite the assessee’s claim that no expenditure had been incurred or claimed for earning such income and that its accounts were maintained under the Banking Regulation Act. Both parties agreed that the issues were covered by the High Court’s earlier order dated 20.02.2026. In that decision, the Court noted that the Assessing Authority had subsequently accepted that the assessee’s equity capital and demand deposits exceeded its investments yielding exempt income. Applying the Supreme Court ruling in South Indian Bank Ltd., it was held that proportionate disallowance of interest was not warranted where interest-free own funds exceeded the investments producing tax-free income. Although deduction under Section 80M is ordinarily computed on net dividend income, no disallowance or estimated expenditure was justified where the investments were made from sufficient own funds. Accordingly, the questions relating to Section 14A, Rule 8D and proportionate expenditure attributable to tax-free bonds were answered in favour of the assessee, and all three Tax Case Appeals were allowed without costs.
Cases Discussed
- Commissioner of Income-Tax vs United General Trust Ltd. (200 ITR 488) (Supreme Court) – Relied upon by the Assessing Authority for deducting proportionate expenditure, including management expenditure, while computing deduction under Section 80M.
- Distributors (Baroda) P. Ltd. vs Union of India and others (155 ITR 120) (Supreme Court) – Followed for the principle that deduction under Section 80M is computed with reference to dividend income forming part of the gross total income and not the gross dividend received.
- Income Tax Officer v Daga Capital Management Pvt. Ltd. (2009) 312 ITR (AT) 1 (Mumbai) (SB) – Relied upon by the Tribunal for treating Rule 8D as retrospective and remitting the matter to the Assessing Authority.
- South Indian Bank Ltd. v. Commissioner of Income-tax [2021] 130 taxmann.com 178 (Supreme Court) – Applied to hold that proportionate interest disallowance under Section 14A was not warranted where the assessee’s interest-free own funds exceeded the investments yielding exempt income.
FULL TEXT OF THE JUDGMENT/ORDER OF MADRAS HIGH COURT
Both Mr.R. Venkata Narayanan, learned counsel for the appellant and Mr.V.Mahalingam, learned Senior Standing Counsel for the respondent state that the issues arising in these appeals are covered by an earlier decision of this Court.
2. The substantial questions that have been admitted on 16.08.2010 are as follows:
‘(i) Whether on the facts and in the circumstances of the case, the order of the Tribunal directing the assessing office to apply Section 14-A read with Rule 8-D is valid in law, especially when no expenditure was incurred or claimed towards earning of those exempt incomes?
(ii) Whether the Tribunal was justified in law in directing to apply Section 14-A and Rule 8-D for working out the proportionate disallowance when the accounts are maintained in accordance with the Banking Regulation Act and the correctness of those accounts are also not disputed?’
3. We have by order dated 20.02.2026 in TCA.Nos.290, 291, 292, 293, 294, 295 and 663 of 2010 dealt with the identical questions in the following terms:
‘3. Substantial question of law arising in TC(A).Nos.290 of 2010 (A.Y.1996-97), 291 of 2010 (A.Y.1997-98) and 292 of 2010 (A.Y.1998-99) and admitted on 28.06.2010:
Whether on the facts and in the circumstances of the case, the Income Tax Appellate Tribunal was right in holding that the deduction u/s 80M should be worked out applying Rule 80D read with Section 14A without appreciating that it was not applicable for the dividend income for the Assessment Year under consideration, instead of upholding the Assessing Officer’s action in working out the expenditure to be deducted on the basis of the Supreme Court’s decision in 200 ITR 478?
4. The Assessing Authority, while considering the grant of deduction under Section 80M of the Act, proceeded on net basis, in granting deduction of expenditure proportionate to the total income. The total income determined as taxable was a sum of Rs.63.22 Crores (approx.), and dividend received from Corporate Companies was Rs.37,06,331/-. Relief under Section 80M was allowed on net income and proportionate expenses relating to dividend income was disallowed.
5. The Assessing Authority relied on the judgment of the Supreme Court in the case of Commissioner of Income-Tax vs United General Trust Ltd1 and in deducting proportionate expenses and taking into account management expenses as well. As the proportionate expenditure was of a sum of Rs.31,35,470/-, the deduction was computed using the following formula, and the relevant portion of the assessment order reads thus:
‘3706331
————— X 1770524044 = Rs.31,35,471
2092875007
The balance of net income from dividend Rs.5,70,860.
60% thereon works out to Rs.3,42,516. This will be
allowed as deduction u/s 80M. Rs. 3,42,516
——————————————
Rs.63,18,82,774
or Rs.63,18,82,770.’
6. In first appeal, the assessee assailed the aforesaid restriction, being of the view that no expenditure ought to have been deducted at all. The Commissioner of Income Tax (Appeals) (in short, CIT(A)) takes a tangential view. While accepting the position that it would not be proportionate expenses that would have to be disallowed, he estimates the expenditure at 2% of the dividend. The findings of the CIT(A) are as follows:
12.3. I have carefully considered the submissions thus made by the appellant. This issue too has been discussed at length in the appellate order for the assessment year 1990-91. It has been held in the said order that the stand taken by the Assessing Officer that deduction u/s 80M could be allowed only in respect of the net dividend is correct. In the case of Distributors (Baroda) P. Ltd. vs Union of India and others, 155 ITR 120, the Hon’ble Supreme Court had categorically held that the deduction required to be allowed under the provisions of section 80M(1) had to be calculated with reference to the amount of dividend computed in accordance with the provisions of the Act and forming part of the gross total income, and not with reference to the full amount of dividends received by an assessee. Therefore, there is no scope for any debate that deduction u/s 80M will have to be computed only with reference to net dividends and not the gross. The appellant’s argument that in the case of Commissioner of Income-tax vs Union General Trust Ltd. 200 ITR 488, only managerial expenses had been held to be netted from the gross dividends is not correct. The only issue before the Hon’ble Court in the above case was whether any portion of the managerial expenses could be attributed to dividends and accordingly could be deducted from the gross dividends in order to arrive at the net dividends. The court did not have any occasion to look into the other expenses. It was only in this context that the Hon’ble Court had ruled on the deductibility of managerial expenses alone.
12.4. In view of the foregoing, I would hold that the Assessing Officer was perfectly justified in considering disallowance of expenses with reference to the dividends claimed for deduction u/s 80M. However, the moot question is how much of the expenses could be said to have been incurred by the appellant for earning the dividends. Only such expenditure as could be related to the dividends on the ground of having been wholly and exclusively laid out could be disallowed u/s 57(iii). Earlier on, while dealing with the subject of proportionate disallowance of expenses relatable to interest on tax-free securities, it has been seen that the appellant had substantial interest-free funds at its disposal and, therefore, no part of the interest-bearing borrowals could be said to have been used for making investments in shares. In the circumstances, no financial expenditures could be attributed to the dividends claimed u/s 80M. Coming to the managerial expenses, I find merit in the appellant’s submission that as the dividend warrants involved were negligible in number and the vouchers transacted were also very few, the managerial expenses attributable would also be negligible. However, as the appellant itself has offered the attributable expenses to be taken at 2% of the dividends, which offer must be regarded as reasonable, the attributable expenses are hereby directed to be taken at 2% of the dividends. The Assessing Officer shall recompute the deduction admissible to the appellant u/s 80M accordingly.
7. As against the aforesaid conclusion of the CIT(A), cross appeals were filed by both the assessee as well as the revenue before the Income Tax Appellate Tribunal. The Tribunal relying on the decision of the Special Bench of the Income Tax Appellate Tribunal, Bombay in Income Tax Officer v Daga Capital Management Pvt. Ltd.2, held that Rule 8D provided for a formula for computation of expenses retrospectively, and remitted the matter to the file of the Assessing Authority with a direction to follow the decision of the Special Bench and decide the matter in accordance with law.
8. Both the assessee and the revenue had filed Tax Case (Appeals) before this Court. The assessee’s appeals were numbered as T.C.(A) Nos.509 to 511 of 2010 and by order dated 08.02.2022, the matter stood remanded to the Assessing Officer in light of the judgment of the Supreme Court in South Indian Bank Ltd. v. Commissioner of Income-tax3. Unfortunately, the revenue appeals were not heard along with the assessee’s appeals.
9. The Assessing Authority took the matter up and passed consequential orders on 29.06.2022. Applying the judgment of the Supreme Court in South Indian Bank Ltd4, he accepted the claim of the assessee and the discussion reads as follows:
‘It was claimed that the exempted investment held in shares and MF as on 31/03/1996 was Rs.20.86 Cr, from out of total investments of Rs.407 Crores which constitute 5.12% of total investments. The bank was having own funds by way of equity capital of Rs.89 crores and demand deposit of Rs.272 crores. Therefore, equity and demand deposits was more than the investment in exempted investments. Hence, no disallowance is warranted on proportionate expenses on earning exempted income as held by Hon’ble Supreme Court verdicts in South Indian Bank case and requested to delete the addition made. Out of the total disallowance of Rs.22,23,799/-, already an amount of Rs.21,79,323/- was given relief in the giving effect order. Hence, the balance of Rs.44,476/- is to be allowed.’
10. The grant of relief as sought for by the assessee under order dated 29.06.2022 has attained finality and no proceedings for either revision or re-assessment have been initiated by the Department. Technically, therefore, the present appeals are infructuous as the connected revenue appeals have been dismissed as withdrawn on 21.08.2025 on the ground of low tax effect.
11. As far as Section 80M is concerned, the position that deduction is to be computed on net basis only is settled by the judgment of the Supreme Court in the case of Distributors (Baroda) Pvt. Ltd vs Union Of India5. This is also clear from the scheme of Chapter VIA of the Income Tax Act 1961. Section 80A provides for computation of relief under various provisions in Chapter VIA based on the computation of total income, wherein the assessee is to reduce such expenditure that has a direct nexus to the earning of the income on which deduction is granted.
12. However, in the present case, the financials of the assessee reveal sufficient surplus funds for making of investments leading to the earning of dividends. The question of restriction of the dividend would thus not arise seeing as the investment has been made, not out of interest bearing funds, but from out of assessee’s own funds.
13. In light of the categoric finding of the assessing authority relating to the sufficiency/adequacy of surplus funds in the assessee’s hands, there is no justification for any disallowance, and in such circumstances, it is not open to the Department to estimate such expenditure. This question is hence answered in favour of the assessee.’
‘18. Substantial question arising in TCA.Nos.293, 294 & 295 of 2010 (AY 1996-97, 1997-98, 1998-99) and admitted on 16.08.2010:
Whether on the facts and in the circumstances of the case, the Income Tax Appellate Tribunal was right in not dealing with the disallowance of a sum of [as follows] as proportionate expenditure related to tax-free bonds deleted by the Commissioner of Income Tax (Appeals)?
A.Y. 1996-97 : Rs.2,24,38,091/-
A.Y. 1997-98 : Rs.3,35,46,751/-
A.Y. 1998-99 : Rs.7,38,81,028/-
19. As both parties agree that this question is to be answered in favour of the assessee in light of the judgment in South Indian Bank Ltd6, this question is answered in favour of the assessee.’
4. In light of the above, the questions are answered in favour of the assessee and these Tax Case (Appeals) are allowed. No costs.
Notes:
1 (200 ITR 488)
2 (2009) 312 ITR (AT) 1 (Mumbai)(SB)
3 [2021] 130 taxmann.com 178(SC)
4 Foot Note Supra (3)
5 (155 ITR 120)
