In case of group of companies, normally a company hold shares in various subsidiaries / group companies. The dividend paid by these group companies is exempt in the hands of the parent company under section 10(34) of the Income-tax Act, 1961 (Act). Also, banking and investment companies are engaged in the business of trading of securities. They earn tax free income which is incidental to their main business.
Section 14A provides that any expenditure incurred in relation to exempt income is not allowed as a deduction for computing taxable income. There was a controversy that whether section 14A would be applicable in case where the shares are not held with the intention of earning dividend, but for retaining control over the subsidiaries (often referred to as ‘strategic investment’) or as stock-in-trade. Whether the intention or dominant purpose of holding shares would be relevant in determining applicability of section 14A.
There was conflict of opinions among st various High Courts on the above aspect. Supreme Court in the case of Max opp Investments Ltd vs. Commissioner of Income-tax (Civil appeal nos. 104-109 of 2016) has marked an end to this controversy by holding that the dominant purpose for which the investment into shares is made is not relevant. As the dividend earned on shares held in the companies is non-taxable, it would trigger the applicability of section 14A and consequently, expenditure which is attributable to the dividend income must be disallowed.
Summary of the judgement:
The appellant company was engaged in the business of finance, investment and dealing in shares and securities. The appellant holds shares/securities in two portfolios, viz. (a) as investment on capital account; and, (b) as trading assets for the purpose of acquiring and retaining control over investee group companies, particularly Max India Ltd., a widely held quoted public limited company. Any profit/loss arising on sale of shares/securities held as ‘investment’ is returned as income under the head ‘capital gains’, whereas profit/loss arising on sale of shares/securities held as ‘trading assets’ (i.e. held, inter alia, with the intention of acquiring, exercising and retaining control over investee group companies) has been regularly offered and assessed to tax as business income.
During AY 2002-03, the appellant had earned dividend of Rs.49,90,860 on shares of Max India Ltd. 78,90,430/- and incurred interest expenditure of Rs.1,16,21,168/-. Admittedly, the borrowed funds were partly utilized for investment in shares held as trading assets. No part of the aforesaid interest expenditure was considered dis allowable under Section 14A of the Act on the ground that shares in the said company were acquired for the purposes of retaining controlling interest and not with the motive of earning dividend.
In the assessment order, the Assessing Officer (AO) worked out dis allowance under Section 14A at Rs. 67,74,175/- by apportioning the interest expenditure of Rs. 1,16,21,168/- in the ratio of investment in shares of Max India Ltd. (on which dividend was received) to the total amount of unsecured loan. The AO, however, restricted dis allowance to Rs. 49,90,860/- being the amount of dividend received and claimed exempt. In appeal, the Commissioner of Income Tax (Appeals) upheld the order of the AO. The appellant preferred an appeal before the Income-tax Appellant Tribunal (ITAT). In view of the conflicting decisions of various Benches by the ITAT with respect to the interpretation of Section 14A of the Act, a Special Bench was constituted in the matter of ITO vs. Daga Capital Management (Private) Ltd [312 ITR (AT) 1]. The appeal of the appellant was also tagged and heard by the aforesaid Special Bench.
The Special Bench of the ITAT in the case of Daga Capital Management (Private) Ltd., dismissing the appeal of the appellant inter alia, held that investment in shares representing controlling interest did not amount to carrying on of business and, therefore, interest expenditure incurred for acquiring shares in group companies was hit by the provisions of Section 14A of the Act. The Special Bench further held that holding of shares with the intention of acquiring/retaining controlling interest would normally be on capital account, i.e. as investment and not as ‘trading assets’.
On further appeal, the Delhi High Court held that the provisions of Section 14A will apply regardless of the intention/motive behind making the investment. Thereafter, the appellant preferred the present appeal before the Supreme Court.
Here, it would be pertinent to point note that Punjab and Haryana (P&H) High Court in a recent judgment in the case of Principal Commissioner of Income Tax v. State Bank of Patiala [(2017) 391 ITR 218 (P&H)] has taken a view which runs contrary to the aforesaid view taken by the Delhi High Court. P&H High Court held that since the shares, bonds, debentures purchased by the assessees constituted its stock-in-trade, the provisions of Section 14A were not applicable.
It had followed the judgment of Karnataka High Court in CCI Ltd. v. Joint Commissioner of Income Tax, Udupi [(2012) 206 Taxman 563]. In case of CCI, the High Court held that when the assessee has not retained shares with the intention of earning dividend income and the dividend income is incidental to his business of sale of shares, which remained unsold by the assessee, it cannot be said that the expenditure incurred in acquiring the shares has to be apportioned to the extent of dividend income and that should be disallowed from deductions.
Calcutta High Court in Commissioner of Income Tax v. G.K.K. Capital Markets (P.) Ltd.[ (2017) 392 ITR 196 (Cal)] had also agreed with the above view taken by the Karnataka High Court.
Aggrieved by the above orders of the High Courts, the Revenue has filed appeals challenging the correctness of the decisions. Thus, in view of conflict of opinions of various High Courts, the present batch of appeals are by those assessees who were lost before the High Court and by the Income Tax Department against the judgments of the High Court where the view taken is favorable to the assessee and against the Revenue.
In the present case, the Supreme Court after considering the argument of counsel for the parties on both sides and in the light of various judgments held as under:
1. Dominant purpose test
The first and foremost issue that falls for consideration is as to whether the dominant purpose test would apply while interpreting Section 14A of the Act or we have to go by the theory of apportionment. We are of the opinion that the dominant purpose for which the investment into shares is made by an assessee may not be relevant. No doubt, the assessee like Max opp Investment Limited may have made the investment in order to gain control of the investee company. However, that does not appear to be a relevant factor in determining the issue at hand. Fact remains that such dividend income is non-taxable. In this scenario, if expenditure is incurred on earning the dividend income, that much of the expenditure which is attributable to the dividend income has to be disallowed and cannot be treated as business expenditure.
2. Strategic investment
We, thus, agree with the view taken by the Delhi High Court, and are not inclined to accept the opinion of P&H High Court which went by dominant purpose theory. The aforesaid reasoning would be applicable in cases where shares are held as investment in the investee company, may be for the purpose of having controlling interest therein. On that reasoning, appeals of Max opp Investment Limited as well as similar cases where shares were purchased by the assessees to have controlling interest in the investee companies have to fail and are, therefore, dismissed.
In case where shares are held as stock-in-trade as part of its business activities, certain dividend is also earned, though incidentally, which is also an income. However, by virtue of Section 10 (34) of the Act, this dividend income is not to be included in the total income and is exempt from tax. This triggers the applicability of Section 14A of the Act which is based on the theory of apportionment of expenditure between taxable and non-taxable income as held in Walfort Share and Stock Brokers P Ltd. [(2010) 326 ITR 1 (SC)] case.
(The author can be reached at email@example.com)