Case Law Details
IN THE ITAT MUMBAI BENCH ‘L’
Joint Commissioner of Income-tax, Special Range-32
V/s.
American Express Bank Ltd.
IT APPEAL Nos. 5904 & 6022 (Mum.) of 2000
[Assessment Year 1997-98]
August 8, 2012
ORDER
R.S. Syal, Accountant Member
These two cross appeals – one by the assessee and the other by the Revenue – arise out of the order passed by the Commissioner of Income-tax (Appeals) on 26.09.2000 in relation to the assessment year 1997-1998.
2. First ground of the assessee’s appeal is against the confirmation of disallowance of expenses amounting to Rs. 6,39,13,217 incurred for solicitation of deposits from non-resident Indians on the ground that such expenses were covered by the provisions of section 44C of the Income-tax Act, 1961 (hereinafter called the ‘Act’) and should, therefore, be allowed as deduction in the manner and to the extent provided in that section. The second ground is against the confirmation of disallowance of expenses amounting to Rs. 13,50,87,275 incurred at the head office directly in relation to Indian branches on the ground that such expenses were covered by the provisions of section 44C and should, therefore, be allowed as deduction in the manner and to the extent provided in that section.
2.1 Briefly stated the facts of these two grounds are that the assessee, a non-resident banking company, claimed deduction of head office expenses and NRI expenditure amounting to Rs. 13.50 crore and Rs. 6.39 crore respectively in relation to the Indian branch. The assessee was called upon to explain as to why these expenses be not covered u/s 44C and hence disallowed as was held by the Tribunal for assessment year 1987-89. The assessee tendered its reply submitting that the deduction was claimed for head office expenses and NRI marketing expenses from income chargeable to tax which was not subject to the provisions of section 44C. It was stated that such expenses were : ‘direct in nature and incurred exclusively for the branch in India. There is no question of there being allocated / apportioned on a reasonable basis to the Indian branch as required under clause (c) of section 44C of the Act’. It was further explained that these expenses were incurred only in respect of Indian branch and were not expenses which needed to be attributed to it. Relying on the Tribunal order for assessment year 1987-88, the Assessing Officer restricted the deduction to 5% of the gross total income u/s 44C, which led to the denial of separate deduction on account of head office and NRI expenses. The learned CIT(A) sustained these two disallowances, against which the assessee has come up in appeal before us.
2.2 We have heard the rival submissions and perused the relevant material on record. There is no dispute about the fact that the Tribunal decided similar issue against the assessee for assessment year 1987-88 which has been followed by the authorities below for the instant year. However, it is relevant to note that the assessee assailed the said tribunal order before the Hon’ble Bombay High Court, which, vide its judgment dated 17th July, 2003, a copy available on record, decided the issue in assessee’s favour by relying on the judgment of the Hon’ble jurisdictional High Court in the case of CIT v. Emirates Commercial Bank Limited [2003] 262 ITR 55 (Bom). Eventually, the Hon’ble High Court held that the Tribunal was not right in holding that the allowability of direct expenses incurred at the head office on behalf of the Indian branch of the assessee was covered within section 44C and not section 37(1). It is further observed that the Tribunal, subsequently, in assessee’s own case for assessment years 1993-94 to 1996-97, has decided similar issue in assessee’s favour. A copy of the said Tribunal order for such later years dated 23rd July, 2010 in ITA No.1187/Mum/2001 etc. is placed on record.
2.3 The ld. DR contended that the ratio decidendi in the case of Emirates Commercial Bank Ltd. (supra) cannot be applied to the facts and circumstances of the present case because here the expenditure is allocated and not exclusive. In principle, we are in full agreement with this contention that the judgment in the case of Emirates Commercial Bank Ltd. (supra) can operate for allowing deduction in full u/s 37(1) where the expenditure is exclusive. In a case of allocated expenses, the amount can be considered only u/s 44C. The Mumbai bench of the tribunal in the case of ADIT (I.T.) v. Bank of Bahrain & Kuwait [2011] 44 SOT 693 (Mum) has canvassed similar view by holding that the exclusive expenses incurred by the head office for Indian branch are outside the purview of sec. 44C and only common head office expenses are governed by this section. There can be no quarrel over this proposition of law. But the fact of the matter is that the expenses which are subject matter of ground nos. 1 and 2 are exclusive and not common. It is amply borne out from the assessment order, where the AO has reproduced the reply filed by the assessee stating that these expenses were exclusive. Relevant part of such contention advanced on behalf of the assessee has been extracted verbatim in para 2.1 of this order. The AO has no where controverted this submission. Thus, it follows that the assessee’s contention of these amounts representing exclusive head office expenses was accepted by the AO. Once the amount is found to be exclusive expenditure incurred by the head office towards the Indian branch, the same is required to be allowed in terms of section 37(1), without clubbing it with shared head office expenses as per sec. 44C. This submission of the Revenue is jettisoned as shorn of merits. Accordingly, we hold that no adverse inference can be drawn against the assessee on this issue and such exclusive expenses incurred by the assessee are required to be allowed as deduction u/s 37(1) without any reference to section 44C. These two grounds are, therefore, allowed.
3.1 Ground no.3 of the assessee’s appeal is against sustenance of disallowance of Rs. 31,37,902 u/s 37(2) in respect of entertainment expenses as against Rs. 11,73,588 computed by the assessee. The facts apropos this ground are that the assessee estimated disallowance at 30% of expenses towards entertainment. The Assessing Officer increased the disallowance to 80%. The learned CIT(A) sustained the action of the AO.
3.2 The learned Counsel for the assessee contended that the Tribunal, vide the aforesaid order, was pleased to delete the disallowance so made and sustained under similar circumstances for the assessment years 1993-94 to 1996-97. It was submitted that the Department carried the Tribunal order before the Hon’ble High Court on other issues without challenging the finding on this aspect of the matter. To support this contention, he placed on record a copy of appeal preferred by the Department before the Hon’ble Hon’ble High Court.
3.3 Fairness in approach, being the hallmark of Sh. Pardiwala, it was candidly submitted by him that the Mumbai Bench of the Tribunal in the case of Bank of America NT & SA v. DCIT [2011- TII-114-ITAT-Mum-INTL has, vide its order dated 27th April, 2011, taken a contrary view from the one taken in assessee’s case for the earlier years by considering the language of Article 7(3) of Indo-US Treaty. A copy of the said order was also placed on record. Despite that, the learned AR argued that the view taken by the Tribunal in its own case should be given preference over the view expressed in another case. Per contra, the learned Departmental Representative submitted that the language of Article 7(3) clearly provides for restricting the deduction for expenses as per the limitations of the Indian Income-tax Act. He referred to three other orders passed by various benches of the Tribunal holding that the expenses are required to be allowed only subject to the limitations of the Indian Income-tax Act.
3.4 We have heard the rival submissions and perused the relevant material on record. There is no doubt about the fact that the Tribunal has decided similar issue in favour of the assessee in earlier years by holding that it is entitled to deduction towards entertainment expenses in full. At the same time it is equally true that in a subsequent decision in the case of Bank of America NT & SA (supra) a contrary view has been recorded by considering all the relevant facts and circumstances including the decision rendered in assessee’s own case for earlier years.
3.5 Ordinarily we would have followed the view taken by the co-ordinate bench of the Tribunal in assessee’s own case for the preceding year. However, we find that several orders have been subsequently rendered by various benches of the Tribunal taking contrary view. In such a situation it becomes imperative to examine the legal position in this regard rather than blindly following one view or the other.
3.6 Section 37(2), prior to its omission by the Finance Act, 1997 with effect from 01.04.1998, provided that any expenditure in the nature of entertainment expenditure incurred by the assessee shall be allowed as deduction to the extent of Rs. 10,000 in full and thereafter 50% of such expenditure. The restriction on deduction is qua the expenditure incurred on entertaining its guests and not on staff. Where a composite expenditure on entertainment is incurred, in that case, the expenditure to the extent of participation by the employees is required to be unloaded from the total expenditure before computing disallowance u/s 37(2). The assessee allocated 30% of the total expenditure as relating to guests and non-employees and offered disallowance accordingly, which has been increased by the authorities. Now, it has been claimed through the ground before us that the entire amount of entertainment expenditure including the amount initially offered by the assessee under a wrong notion, is allowable as per the terms of the Double taxation Avoidance Agreement between India and USA (hereinafter called the ‘DTA’).
3.7 Section 90(2) of the Act provides that where the Central Government has entered into an agreement with the Government of any country outside India or specified territory outside India, as the case may be, under sub-section (1) for granting relief of tax, or as the case may be, avoidance of double taxation, then, in relation to the assessee to whom such agreement applies, the provisions of this Act shall apply to the extent they are more beneficial to that assessee. The Hon’ble Supreme Court in CIT v. P.V.A.L. Kulandagan Chettiar [2004] 267 ITR 654 (SC) has held that the provisions of sections 4 and 5 are subject to the contrary provision, if any, in DTA. The crux of the matter is that the provision of the Act or of the DTA, whichever is more beneficial to the assessee, shall apply.
3.8 Having seen above the restriction on the allowability of entertainment expenditure under the Act, we shall now proceed to examine the position under the DTA. The assessee being a tax resident of USA is entitled to benefit, if any available, under the DTA. Article 7 of the DTA deals with ‘Business profits’. Paragraph (2) of Article 7 provides that ‘subject to the provision of paragraph 3’ where an enterprise of a Contracting State carries on business in the other Contracting State through a permanent establishment situated therein, there shall in each Contracting State be attributed to that permanent establishment the profits which it might be expected to make if it were a distinct and independent enterprise. That part of paragraph 3, which is relevant for our purpose, reads as under:-
“In the determination of the profits of a permanent establishment, there shall be allowed as deductions expenses which are incurred for the purposes of the business of the permanent establishment, including a reasonable allocation of executive and general administrative expenses, research and development expenses, interest, and other expenses incurred for the purposes of the enterprise as a whole (or the part thereof which includes the permanent establishment), whether incurred in the State in which the permanent establishment is situated or elsewhere, in accordance with the provisions of and subject to the limitations of the taxation laws of that State. ……”
(emphasis supplied by us)
3.9 A bare perusal of the above clause indicates that the assessee is entitled to deduction for the expenses which are incurred for the business of the permanent establishment including the allocation of executive and general administrative expenses etc. incurred whether in the State in which the permanent establishment is situated or elsewhere. The allowability of expenses in the determination of profits of the permanent establishment is with qualification stipulated in clause (3) itself as per which such expenses shall be deducted ‘in accordance with the provisions of and subject to the limitations of the taxation laws of that State’. But for this rider, the entire expenses would have been deductible in full. This stipulation has curtailed the allowability of expenses in conformity with the limitations set out under the taxation law of the respective State. As we are computing the income of the assessee in relation to the permanent establishment situated in India, the provisions of the Act shall apply. Going by the limitation provided in section 37(2), at the material time, the entire amount of entertainment expenditure cannot be allowed as deduction in full.
3.10 The learned AR emphasized that the aforesaid rider limiting the deductibility of expenses in accordance with the provisions of the Act is applicable only to the later part of the clause (3) starting with ‘a reasonable allocation of executive and general administrative expenses………’. It was submitted that by virtue of this qualification, these expenses which have been included within the ambit of section 44C would be allowable subject to the limit provided in that section. As regards all other expenses including the entertainment expenses, it was stated that these shall be allowable in full.
3.11 We are not convinced with the way in which the ld. AR has interpreted paragraph (3) of Article 7 of the DTA. A glance at the language of paragraph (3) indicates that the deductibility of all the expenses is subject to the limits set out under various sections under Chapter IV-D and it is not confined to section 44C alone. The vivid reason is that the provision limiting the expenses in accordance with the subject to the limitations under the Act has been set out at the end of the sentence. Such sentence initially provides that ‘there shall be allowed as deductions expenses which are incurred for the purpose of business of the permanent establishment’, thereafter the word ‘including’ has been employed which connects with the subsequent words ‘a reasonable allocation of executive and general administrative expenses……’. Thus it is evident that the rider is applicable to all the expenses incurred for the purpose of the business of the permanent establishment. The use of word ‘including’ before the words ‘a reasonable allocation of executive and general administrative expenses’ makes it abundantly clear that the limitations for the allowability of expenses as per the provisions under the Act are on all the expenses incurred for the purposes of the business of the permanent establishment, which also inter alia, include executive and general administrative expenses. If the intention had been to limit the deductibility only in respect of allocation of executive and general administrative expenses, thereby granting deduction in full for all other expenses, then the reference would have been made to section 44C of the Act and its parallel under the American Income-tax Act. Since a wider expression has been employed and that too at the end of the sentence and the earlier part refers to the expenses incurred for the purposes of the business of the permanent establishment, including executive and general administrative expenses, in our considered opinion there can be no question of reading the limit as applicable only to the executive and general administrative expenses. In our considered opinion the restriction on the allowability of expenses in accordance with and subject to the limitations of the Act extends not only to the expenses covered u/s 44C but under all other relevant sections allowing deductions and allowances which also include section 37(2). It, therefore, follows that the deductibility of expenses in assessee’s case is subject to the relevant provisions including section 37(2) under the provisions of DTAA. In that view of the matter, we feel that the view canvassed in Bank of America NT & SA (supra) is more convincing than that taken in the assessee’s case.
3.12 The contention of the ld. AR that since the tribunal in the earlier year has decided such issue in favour of the assessee and hence the same view must be taken, is difficult to accept in the present set of facts and circumstances. We would have no hesitation in accepting this proposition in an ordinary course. It is always judicious to follow the principle of consistency. But it is imperative to note that this rule is not infallible or sacrosanct. At times, it can be subjected to certain exceptions. Where correct legal or factual position was not placed before the bench earlier and the decision came to be rendered on the strength of such half baked facts or legal position, then such earlier decision can be taken as an exception to the principle of consistency. However we would like to add a word of caution that the subsequent bench must be very slow in reaching the conclusion that the correct position was not placed before the earlier bench which led to the passing of an erroneous order. It is only in such exceptional circumstances that the slip in earlier year can be made good subsequently. Our view is fortified by the judgment of the Hon’ble jurisdictional High Court in the case of Godrej & Boyce Mfg. Co. Ltd. v. DCIT [2010] 328 ITR 81 (Bom) in which it has held that : ‘The fact that the Tribunal failed to consider the applicability of section 14A in its proper perspective, for the assessment year 2001-02 would not bar the Tribunal from considering disallowance under section 14A in the assessment year 2002-03’. In view of this clear enunciation of law by the Hon’ble jurisdictional High Court it is apparent that the principle of consistency is subject to limited exceptions and in certain compelling circumstances, the view canvassed by the tribunal in an earlier year can be deviated from in the befitting circumstances.
3.13 Turning to the facts of the instant case it is seen that the tribunal earlier decided this issue in favour of the assessee. When similar issue subsequently came up for consideration before the tribunal in the case of Bank of America NT & SA (supra), the bench considered all the relevant parameters about the deductibility of expenses and thereafter took a view in favour of the Revenue, of course, after due deliberation of the order passed in assessee’s case. This later view has been followed in a number of cases brought to our notice by the ld. DR. No material has been brought on record to demonstrate that the latter view of the tribunal has been modified or reversed by the Hon’ble High Court. We are, therefore, more inclined to accept the latest view on this issue, whose correctness has been tested by us above in the light of discussion on Article 7 of the DTA. Accordingly it is held that the provisions of section 37(2) are attracted for limiting the deductibility of entertainment expenses under DTA.
3.14 From the facts of the case it is noticed that the assessee initially offered qualifying amount for disallowance u/s 37(2) at the rate of 30% of the expenses as relatable to non-employees participation, which was increased by the Assessing Officer to 80%. The Hon’ble Karnataka High Court in the case of CIT v. Mysore Minerals Ltd. [(1986) 162 ITR 562 (Kar.)] has held that allocation of 50% of expenses as qualifying for disallowance u/s 37(2) is reasonable. No other judgment has been brought to our notice by the ld. DR. We, therefore, hold that the disallowance be computed u/s 37(2) by taking 50% of total expenses towards entertainment. This ground is partly allowed.
4.1 Ground no.1 of the Revenue’s appeal reads as under :-
‘On the facts and circumstances of the case and in law, the ld. CIT(A) has erred in deleting the disallowance of estimated expenses claimed of Rs. 7,25,40,737 on earning the tax free interest (of Rs. 9,91,97,534) on bonds’.
4.2 Briefly stated the facts of the ground are that the assessee earned interest on tax free bonds to the tune of Rs. 9.91 crore. This interest was claimed as exempt u/s 10(15)(iv). The Assessing Officer observed that the assessee claimed exemption on gross amount without reducing any expenditure incurred for earning interest on tax free bonds. It was opined that only the net income would be eligible for exemption. On being called upon to explain as to why the expenditure for earning the exempt income be not deducted, the assessee submitted that it was dealing in securities as part of its business operations and no direct specific expenses were incurred for earning such interest on tax free bonds. The Assessing Officer did not accept the assessee’s contention and came to hold that the gross interest from bank cannot be allowed as exemption. Considering the language of section 10, he held that the exemption is available only in respect of ‘income’ and not the ‘gross receipts’. He, therefore, went on to compute the ‘Proportionate expenditure for earning Tax free income’ which amount was determined by a mathematical exercise at Rs. 7.25 crore. After reducing the so calculated proportionate expenditure of Rs. 7.25 crore from the gross tax free interest, the exempt income u/s 10(15)(iv) was determined at Rs. 2.66 crore. The learned CIT(A) observed that there was no indivisible business carried on by the assessee in respect of such bonds from which tax free income was earned. Relying on the judgment of the Hon’ble Supreme Court in the case of Rajasthan State Warehousing Corporation v. CIT [(2000) 242 ITR 450 (SC)], the learned CIT(A) held that there was no justification for making the disallowance of Rs. 7.25 crore. The Revenue is aggrieved against this finding of the learned CIT(A).
4.3 We have heard the rival submissions and perused the relevant material on record. Insofar as the question of exemption u/s 10(15)(iv) is concerned, we find that the relevant provision clearly refers to the exemption in respect of ‘interest payable by any public sector company in respect of such bonds or debentures and subject to such condition………’. The crucial words used in this provision are ‘interest payable’ in respect of the bonds or debentures etc. as notified by the Central Government in the Official Gazette. There is no reference to allowing exemption in respect of any income arising out of interest payable to the assessee. When the legislature has exempted the amount of ‘interest payable’ in respect of specified bonds, there can be no logic in curtailing the exemption by reducing the expenditure from such interest income. The learned Departmental Representative was fair enough to concede and rightly so that the Revenue was not aggrieved against the allowing exemption u/s 10(15) on gross interest. He submitted that the ground raised by the Revenue restricts itself to the granting of deduction of expenses incurred for earning such exempt income against the taxable income. It was submitted that section 14A inserted by the Finance Act, 2001 with retrospective effect from 01.04.1962, governs the non-deductibility of such expenses incurred on earning exempt income against the taxable income. He relied on the order passed by the Mumbai Bench of the Tribunal in the case of Dresdner Bank AG v. Addl. CIT [(2007) 108 ITD 375 (Mum.)] in which it has been held that exemption u/s 10(15)(iv) is allowable in respect of gross interest but any expenditure incurred in relation to earning of such exempt income is to be disallowed u/s 14A. He submitted that the Tribunal in that case was pleased to remit the matter back to the A.O. for quantifying the expenditure incurred, if any, for earning exempt income. The learned Departmental Representative further submitted that the assessment year in that case was 1998-99, much prior to the insertion of section 14A, as is the case under consideration and hence the decision in that case be applied here also for sustaining the disallowance u/s 14A which was made by the AO on the general principles of law, which subsequently came to be statutorily recognized by way of insertion of section 14A with retrospective effect covering the relevant assessment year under consideration.
4.4 In the opposition, the ld. AR stated that the securities on which exempt income was earned were stock-in-trade of the assessee bank. Relying on the judgment of the Hon’ble Supreme Court in the case of CIT v. Indian Bank Limited [(1965) 56 ITR 77 (SC)], the learned AR argued that the interest paid by bank in that case on deposits received in the course of its business and utilized for buying such tax free securities was held to be deductible in arriving at the taxable profit of the business notwithstanding that the interest earned by the bank on tax free securities could not be taxed. It was stated that the facts of the instant case are similar to those considered and decided by the Hon’ble Supreme Court. The learned AR submitted that no specific ground has been taken by the Revenue for sustaining any disallowance u/s 14A and as such it was too late in the day for the Revenue to request for sustaining disallowance under this section. Without prejudice to such submissions and taking his argument to next level, it was submitted that where exempt income is earned from securities held as stock-in-trade, no disallowance can be made u/s 14A as the income from such securities is only incidental to the holding of shares. For this proposition he relied on the judgment dated 14.06.2010 of the Hon’ble Kerala High Court in the case of CIT v. Smt. Leena Ramachandran [(2011) 339 ITR 296 (Ker.)]. When the attention of the ld. was drawn towards the judgment of the Hon’ble Bombay High Court in the case of Godrej & Boyce Mfg. Co. Ltd. v. DCIT (supra) and the special bench order in the case of ITO v. Daga Capital Management (P.) Ltd. [(2009) 117 ITD 169 (Mum.) (SB)], it was submitted that the ratio in the case of Godrej & Boyce (supra) is not applicable where the disallowance u/s 14A is in respect of exempt income from securities held as stock-in-trade. As regards the special bench decision in Daga Capital (supra), it was stated that albeit it has been laid down in this case that section 14A applies whether or not the shares are held as stock in trade, but the judgment in the case of Smt. Leena Ramachandran (supra) will prevail over the special bench order.
4.5 It has been noticed above that the Revenue is not aggrieved, and rightly so, on the question of availability of exemption on interest u/s 10(15)(iv)(h) on gross basis. The only view point canvassed before us by the learned Departmental Representative is to sustain disallowance u/s 14A of the Act. It is patent that the learned CIT(A) passed order on 26.09.2000 and at that time section 14A was not on statute. This provision came to be introduced by the Finance Act, 2001 with retrospective effect from 01.04.1962. From the assessment order it is manifest that the Assessing Officer computed a sum of Rs. 7.25 crore as ‘proportionate expenditure for earning tax free income‘. Even though there is no direct reference to the provisions of section 14A, which naturally could not have been because of this insertion coming on the statute at a later point of time but with retrospective effect, but the essence of the action of the A.O. was not to allow any expenditure incurred for earning tax free income against the taxable income. The view of the AO came to be statutorily recognized by way of insertion of section 14A. Now the Revenue is aggrieved against the ‘disallowance of estimated expenses …on earing the tax free interest‘. The Mumbai Bench of the Tribunal in the case of Dresdner Bank AG (supra) dealt with assessment year 1998-99 and the question therein was also about the exemption u/s 10(15)(iv) on gross or net interest basis. The bench, inter alia, held that section 14A is applicable and for computing the disallowance the matter was sent back to the AO. The extant position prevailing before us herein is more or less identical. Here also when the order was passed by the learned CIT(A), section 14A was not there and naturally the recourse to such action could not have been taken. Since the disallowance was made by the Assessing Officer on the ground that the proportionate expenditure for earning tax free income cannot be allowed as deduction, in a way he applied the same spirit as is there in section 14A. Even though there is no reference to section 14A in the ground taken by the Revenue, which naturally could not have been possible because of this provision being inserted later on, but challenging the deletion of proportionate expenditure in relation to exempt income in a wider sense amounts to requesting for the sustenance of disallowance u/s 14A itself. No material has been placed on record to indicate that the view taken by the co-ordinate bench in the case of Dresdner Bank AG (supra) has been modified or reversed by the Hon’ble jurisdictional High Court. Respectfully following the precedent, we hold that recourse to the provisions of section 14A for making disallowance of proportionate expenditure incurred for earning exempt income, has been validly taken on behalf of the Revenue.
4.6 We now proceed to deal with the arguments put forth by the learned AR on the non-applicability of section 14A. First part of his submissions was devoted to relying on the judgment of the Hon’ble Supreme Court in the case of Indian Bank Ltd. (supra) for bringing home the point that the interest paid by the bank on deposits utilized for purchasing tax free securities has to be allowed as deduction in entirety against the taxable profit of the business. It is observed that almost similar view was taken by the Hon’ble Supreme Court in CIT v. Maharashtra Sugar Mills Ltd. [(1971) 82 ITR 452 (SC)] which was reiterated by the Hon’ble Apex Court in the case of Rajasthan State Warehousing Corporation (supra). In this latter case, the Hon’ble Summit Court held that in computing the profits and gains of business or profession when an assessee is carrying on business in various ventures and some among them yield taxable income and the others do not, the question of allowability of expenditure u/s 37 will depend on – (i) fulfillment of requirements of that provision, and (ii) on the fact whether all the ventures carried on by him constitute one indivisible business. It was held that if all the ventures constitute one indivisible business then the entire expenditure, including that which was incurred for earning the tax free income, would be a permissible deduction against the taxable income.
4.7 It is noticed that after the advent of the judgment in the case of Rajasthan State Warehousing Corporation (supra), the legislature inserted section 14A with retrospective from 1st April, 1962 with the intention, as emanating from the Memorandum explaining the provisions of the Finance Bill that : ‘Certain incomes are not includible while computing the total income as these are exempt under various provisions of the Act. There have been cases where deductions have been claimed in respect of such exempt income. This in effect means that the tax incentive given by way of exemption to certain categories of income is being used to reduce also the tax payable on the non-exempt income by debiting the expenses incurred to earn the exempt income against the taxable income. This is against the basic principles of taxation whereby only the net income, i.e., gross income minus the expenditure, is taxed. On the same analogy, the exemption is also in respect of the net income. Expenses incurred can be allowed only to the extent they are relatable to the earning of exempt income’. The Special Bench of the Tribunal in the case of ITO v. Daga Capital Management Pvt. Ltd. (supra) considered the provisions of section 14A in the light of the above referred three Supreme Court judgments granting deduction of interest u/s 36(1)(iii) incurred in respect of borrowings utilized for making investments resulting into exempt income, against the taxable income on the theory of composite basis. In this case, the Special Bench has held that these judgments were rendered at time when the provisions of section 14A were not there and as such the insertion of section 14A has diluted their mandate. The special bench has also held that this section applies to all the heads of income and aims at disallowing expenditure incurred in relation to income which does not form part of the total income even though such expenditure may be allowable under any other provisions such as section 36(1)(iii). It has further been held in this case that provisions of section 14A are applicable with respect to the dividend income earned by the assessee engaged in the business of dealing in shares and securities, on the shares held as stock-in-trade. Insofar as the computation of disallowance u/s 14A is concerned, the Special Bench sent the matter back to the file of A.O. for computing the disallowance as per rule 8D. The said Special Bench order was followed by the co-ordinate bench of the tribunal in the case of Godrej & Boyce Mfg. Co. Ltd. This later case came up before the Hon’ble jurisdictional High Court in Godrej & Boyce Mfg. Co. Ltd. v. DCIT (supra). In this case it has been held that the dividend income and income from mutual funds falling within the ambit of section 10(33) is not includible in computing the total income of the assessee and consequently no deduction can be allowed in respect of expenditure incurred by the assessee in relation to such income by virtue of the provisions of section 14A(1). It has also been held in this case that the provisions of Rule 8D providing for computation of disallowance u/s 14A are not ultra vires but apply only from assessment year 2008-2009. Since the assessment year involved was 2002-2003, the Hon’ble jurisdictional High Court held that the disallowance be computed u/s 14A on some ‘reasonable basis’ and not as per Rule 8D. From the above judgment it emerges beyond any shadow of doubt that the special bench decision in Daga Capital (supra) laying down the making of disallowance of expenditure incurred in earning exempt income has been upheld, except the manner of computation of such disallowance as per rule 8D for the years anterior to A.Y. 2008-09. In the light of the above discussion it is manifest that the reliance by the ld. AR on the judgment in the case of Indian Bank Limited (supra), is no more relevant insofar as the question of disallowance of expenditure u/s 14A in relation to exempt income is concerned.
4.8 The next contention of the ld. AR was that the provisions of section 14A are not applicable where the shares are held as stock in trade. For this proposition he relied on the case of Smt. Leena Ramachandran (supra). It was argued that since the shares were held as the assessee bank as its stock in trade, no disallowance was called for even u/s 14A. Let us examine the facts and ratio of Smt. Leena Ramachandran (supra). The assessee therein was running a business of trading of goods. During the year she paid an interest of Rs. 17,44,310 on funds borrowed for purchase of shares in a company called M/s Homefit Leasing Ltd. The assessee’s claim was that the acquisition of shares with the borrowed funds was for the purpose of controlling the company which was engaged in leasing business. Since the borrowed funds were utilised for acquisition of shares of the company under the control of the assessee, she contended that the utilisation of the borrowed funds was for the business purpose entitling her to deduction of interest under section 36(1)(iii). The Assessing Officer disallowed the claim of interest. First appeal was dismissed confirming the assessment. The Tribunal relying, inter alia, on decision of the Supreme Court in S.A. Builders Ltd. v. CIT (Appeals) [2007] 288 ITR 1 (SC) substantially allowed the claim, but made a disallowance of Rs. 2 lakhs, being the interest stated to be attributable to the dividend income of Rs. 3 lakhs. Against this order, the Revenue preferred an appeal before the Hon’ble High Court. Reversing the order of the Tribunal and restoring the disallowance made by the AO, the Hon’ble High Court observed that any expenditure incurred for earning any income which is not taxable under the Act, is not an allowable expenditure. From the facts of the this case, it is evident that the assessee therein borrowed funds for acquiring shares of the company under its control claiming it as a business purpose. The said ‘business purpose’ was not denied either by the Hon’ble High Court or the authorities under the Act. Obviously, the dividend income from such investment in shares was incidental to the holding of shares of company under its control for the purpose of its business. When the disallowance has been held to be sustainable in that case despite the dividend being incidental income, we are unable to find any logic in not applying the command of the said judgment to the facts of the case under consideration. Here also the assessee has tried to make out a case that the main purpose of the holding of shares was to earn income from sale and the dividend income was just incidental to such holding. Section 14A talks of making disallowance of expenses incurred in relation to an income not chargeable to tax. No exception, such as the dividend being main or incidental income, has been carved out in the provision. The relation of expenses for disallowance is with the exempt income irrespective of the source or nature of the exempt income. When the legislature in its wisdom has not spelt out any exception coming in the way of applicability of section 14A, it is wholly impermissible to artificially find any such exception contrary to the language of the provision and the intention of the legislature. The relevant criterion for making disallowance of expenditure is the exempt income and not whether such exempt income arises intentionally or just incidentally.
4.9 In support of his case, the ld. AR accentuated on the following sentences from the above judgment : ‘In fact, in our view, the assessee would be entitled to deduction of interest under section 36(1)(iii) of the Act on the borrowed funds utilised for the acquisition of shares only if shares are held as stock in trade which arises only if the assessee is engaged in trading in shares. So far as acquisition of shares is in the form of investment and the only benefit the assessee derived is dividend income which is not assessable under the Act, the disallowance under section 14A is squarely attracted and the Assessing Officer, in our view, rightly disallowed the claim.’ It was emphasized that from the above sentences it was clear that the mandate of section 14A has been held to be not applicable in case of the holding of shares as stock in trade. We are unable to find any sanction given by the Hon’ble High Court for not making disallowance u/s 14A when the shares are held as stock in trade. What is provided in the first sentence is that the assessee would be entitled to deduction of interest under section 36(1)(iii) of the Act on the borrowed funds utilised for the acquisition of shares only if shares are held as stock in trade, which arises only if the assessee is engaged in trading of shares. It is obvious that these observations are in the context of allowing deduction u/s 36(1)(iii) and not for making disallowance u/s 14A. The provisions of section 14A come into play only when there is some exempt income. In these observations it has been nowhere said that the disallowance u/s 14A will not be made in respect of exempt dividend income arising from the shares held as stock-in-trade. It is the second sentence, which refers to the receipt of exempt dividend and mandates the making of disallowance under section 14A.
4.10 Be that as it may and without prejudice to above finding, it is seen that the Hon’ble High Court in this case was confronted with a question of disallowance in a situation in which dividend was earned from the shares held for business purpose, which has been decided against the assessee. So the ratio decidendi of the judgment is this disallowance of interest u/s 14A and the other observations are simply obiter dicta, which have been made without there being any question before it. It is a trite law that it is the ratio of a decision which is binding and not its obiter dicta.
4.11 At this juncture it will be relevant to note the facts of Godrej & Boyce (supra), which case also deals with the question of disallowance u/s 14A and, being that of the Hon’ble jurisdictional High Court, has a binding force on us. In that case the assessee claimed a dividend of Rs. 34.34 crores as exempt from the total taxable income under section 10(33). On being called upon to show as to why the net dividend income from tax free securities should not be exempted instead of the gross dividend receipts as claimed in the return, the assessee stated that a major portion of its dividend amounting to Rs. 19.86 crores was received from group companies and the shares of Godrej Soaps Limited were acquired several years earlier as a promoter of that company. The AO made disallowance u/s 14A. The tribunal following the special bench order in Daga Capital (supra) restored the matter to the AO for computing disallowance. On appeal by the assessee, the Hon’ble High Court, has accepted in principle that the disallowance of interest is called for.
4.12 It can be seen from the facts of Godrej & Boyce (supra) that the earning of the dividend income in that case was also incidental to the holding of shares. As the shares were of group concerns and held by that assessee as promoter, naturally there could have been no intention of the assessee to reap the benefit of increase in the price of such shares in the market by parting with them. The assessee was supposed to hold the shares irrespective of any dividend income. The amount of dividend income can, by no stretch of imagination, be characterized as main income and not incidental to the holding of shares. Without going deep into the determination of the character of such shares and drawing a parity from the case of Smt. Leena Ramachandran (supra), which has been relied on by the ld. AR in his support, it can be seen that in both these cases the shares were held in group concerns or for controlling interest. Since in both the cases it has been held that the disallowance u/s 14A is warranted, we see no reason to hold that where the dividend income is only incidental to the shares held as stock in trade, the operation of section 14A shall cease.
4.13 Further, the ld. AR failed to point out, after thoroughly going through the judgment in Godrej & Boyce Mfg. Co. Ltd. (supra), that reference in this case has been made to compute disallowance u/s 14A only in respect of shares held as investment and not as stock in trade. In that view of the matter, the obvious conclusion which follows is that the decision of the Special Bench in the case of Daga Capital Management Pvt. Ltd. (supra), which has been referred to at several places in this judgment, about the applicability of the provisions of section 14A with respect to dividend income earned by the assessee from the shares held as stock-in-trade also, has not been disturbed.
4.14 We, therefore, hold that the contention raised by the learned AR for not applying the provisions of section 14A in respect of dividend income from shares held as stock-in-trade cannot be accepted. As the Assessing Officer computed proportionate expenditure for earning tax free income by certain mathematical exercise, which has also been challenged by the assessee before us, we are of the considered opinion that the ends of justice will meet adequately if the Assessing Officer is directed to compute the disallowance u/s 14A on some ‘reasonable basis’ as per the mandate of the Hon’ble jurisdictional High Court in the case of Godrej & Boyce Mfg. Co. Ltd. (supra). The view taken by the learned CIT(A) in deleting the disallowance is accordingly set aside.
5.1 Second ground of the Revenue’s appeal is as under:-
“On the facts and circumstances of the case and in law, the ld. CIT(A) has erred in holding (indirectly) that the expenses attributable to earning the interest income and dividend income of Rs. 43,47,247 and Rs. 40,51,189 are allowable against the income other than interest income and dividend income.”
5.2 The factual matrix apropos this ground is that the assessee earned gross dividend income of Rs. 43,39,411 and also gross interest on foreign currency deposits given to Indian enterprises amounting to Rs. 46,61,509, both eligible for tax at lower rate u/s 115A(1). This amount was offered for taxation on gross basis for the purposes of applying the special rate of tax. The Assessing Officer computed proportionate expenditure incurred for earning these items of income liable to tax u/s 115A at Rs. 40,51,189 and Rs. 43,47,247 respectively in the body of the order and also expressed opinion there itself that such proportionate expenditure at Rs. 83.90 lakh could not be allowed as deduction against the regular income, but shall slice away the amount chargeable to tax at lower rate. That is how, he applied lower rate of tax on the net income amounting to Rs. 6.12 lacs. However, while computing total income of the assessee at the end of the assessment order, he started with the gross total income as per the return of income. Then, he made certain disallowances, but omitted to disallow the proportionate expenditure of Rs. 83.90 lacs against the income chargeable to tax at the normal rate. Thereafter, he computed income chargeable to tax at lower rate u/s 115A on net basis at Rs. 6.12 lac. In this way he committed an error by allowing deduction of Rs. 83.90 lacs twice, firstly, by not adding it to the total income and then by specifically computing income u/s 115A on net basis. Unaware of the overall effect of the AO’s action, the assessee challenged the computation u/s 115A made by the AO on net basis, before the ld. CIT(A). The ld. first appellate authority decided this issue in assessee’s favour by holding that the provisions of section 115A apply on gross income. The Revenue has accepted the finding of the ld. CIT(A) on the question of taxability of the gross amount for the purposes of applying lower rate of taxation. It is evident from the language of the ground reproduced above and also the arguments put forth by the ld. DR that the Revenue now wants that the expenses of Rs. 83.90 lacs should not be allowed as deduction against the income chargeable to tax at the normal rate. In view of the above discussion it is discernible that the issue of not allowing deduction of such expenses against the income chargeable to tax at the normal rate does not emanate from the order of the authorities below. The AO, though discussed the issue in the body of the order and also computed the amount disallowable at Rs. 83.90 lac but committed a mistake by not disallowing such amount in the final computation of total income chargeable to tax at the normal rate. Then, the ld. CIT(A) also never held that such expenses are deductible against the other income. He was called upon to decide the question of gross or net amount eligible for taxation at special rate, which he decided in assessee’s favour, which finding has been accepted by the Revenue.
5.3 It is therefore, palpable that the grouse of the Department through this ground in requiring us to hold that such expenses should not be allowed as deduction against the other income chargeable to tax at normal rate, does not emanate from the impugned or the assessment order. It is axiomatic that the tribunal is not a forum for rectifying such mistakes committed by the AO. For that purpose, there are other provisions, such as, revision u/s 263 and rectification u/s 154. On this very short point, this ground is liable to be dismissed.
5.4 We find that it is recurring issue in other years as well. Further, the ld. AR has not argued on this line of reasoning. Rather both the sides have made submissions on merits, for or against the deductibility of such expenses against the income chargeable to tax at normal rate. As such, we are proceeding to dispose of this issue on merits by considering the arguments put forth by the rival parties.
5.5 The learned Departmental Representative vehemently contended that the proportionate expenditure incurred for earning dividend and interest income liable for tax at special rate u/s 115A, could not have been allowed as deduction against the other incomes chargeable to tax at the normal rate. It was submitted that if a lower rate of tax is applied to a particular income and the expenditure incurred on earning such income is allowed to be set off against other incomes, it amounts to undue benefit to the assessee, contrary to the intent of the statute. He submitted that the action of the ld. CIT(A) has unduly favoured the assessee, firstly, by the application of the reduced rate of taxation u/s 115A on such income and secondly, by allowing the deduction of expenditure incurred for earning income liable to tax at lower rate, against the income liable for tax at regular rates.
5.6 We are not convinced with the submissions made on behalf of the Revenue. It is undisputed that the Revenue is aggrieved against the allowability of expenditure incurred in respect of earning dividend and interest income liable to tax at special rate u/s 115A, against the income chargeable to tax at normal rate. It is not a case and cannot be that such dividend and interest income are not at all chargeable to tax. The contention which has been made is that the expenses incurred by the assessee in respect of income liable to tax at special rate u/s 115A should not be allowed as deduction against the income chargeable to tax at normal rate. This contention, in our considered opinion, is devoid of merits. The judgment of the Hon’ble Supreme Court in Rajasthan State Warehousing Corporation (supra) is authority for the proposition that if an assessee is carrying an indivisible business then the entire expenditure including that which was incurred for earning the tax free income would be a permissible deduction. The legislature introduced section 14A with an intention to set at naught the ratio of this and such other judgments by providing that expenditure incurred in relation to ‘income which does not form part of total income under this Act‘ shall not be allowed as deduction. In other words, the deductibility of expenses incurred for earning exempt income has been inhibited. But for that, the ratio of these judgments is intact. To put it simply, the decision of allowing entire expenditure incurred by the assessee in an indivisible business against the taxable income has been statutorily altered by forbidding the allowability of expenses incurred in relation to exempt income. If the income is not exempt but chargeable to tax at a lower rate, then two consequences follow. Firstly, the provisions of section 14A shall cease to apply and secondly, the position will stand covered by the judgment in the case of Rajasthan State Warehousing Corporation (supra) for allowing the expenses in full without any apportionment. Section 14A does not provide that if income is liable to tax at a lower rate then also the proportionate expenditure should not be allowed as deduction against the other business income. As the assessee in the instant case is carrying on one composite business earning incomes, which are either not at all chargeable to tax, or chargeable tax at the lower rate or chargeable to tax at regular rate, what has been inhibited by section 14A is the deduction of expenses incurred by the assessee in relation to income not at all chargeable to tax and not the income chargeable to tax at lower rate of tax. We, therefore, do not find any force in this submission advanced by the ld. DR. Ex consequenti, it is held that the assessee is entitled to deduction of Rs. 83.90 lac against the income chargeable to tax at the regular rate of tax, which has, in fact, been inadvertently allowed by the AO. This ground is dismissed on merits as per law and on facts as having become academic.
6.1 Last effective ground of the Revenue’s appeal is against the deletion of disallowance of club expenses amounting to Rs. 12,64,546. The Assessing Officer made disallowance of the above referred sum towards payment made to club. The learned CIT(A) deleted the disallowance.
6.2 Having heard the rival submissions and perused the relevant material on record, we find that the issue raised in this ground is covered in favour of the assessee by the judgment of the Hon’ble jurisdictional High Court in the case of Otis Elevator Co. (India) Ltd. v. CIT [(1992) 195 ITR 682 (Bom.)] and the judgment of the Hon’ble Madras High Court in CIT v. Sundaram Industries Ltd. [(1999) 240 ITR 335 (Mad.)]. This position has not been disputed by the ld. DR as well. Accordingly this ground is not allowed.
7. In the result, both the appeals stand partly allowed.
