2017 (2) TMI 125 - HC - Income Tax

High Court: Section 14A not applicable to exempt income from stock-in-trade.

The Pr. Commissioner of Income Tax, Patiala Versus State Bank of Patiala

The High Court ruled that Section 14A of the Income Tax Act does not apply to exempt income earned from securities held as stock-in-trade. It was ... Addition made on account of disallowance under section 14A - whether the assessee can be said to have incurred any expenditure at all or any part of the said expenditure in respect of the exempt income viz. dividend and interest that arose out of the securities that constituted the assessee’s stock-in-trade? - whether “return of investment” or “cost recovery” would fall within the expression “expenditure incurred” in section 14A? Held that:- What is disallowed is expenditure incurred to “earn” exempt income. The words “in relation to” in section 14A must be construed accordingly. Thus, the words “in relation to” apply to earning exempt income. The importance of the observation is this. We have held that the securities in question constituted the assessee’s stock-in-trade and the income that arises on account of the purchase and sale of the securities is its business income and is brought to tax as such. That income is not exempt from tax and, therefore, the expenditure incurred in relation thereto does not fall within the ambit of section 14A. Now, the dividend and interest are income. The question then is whether the assessee can be said to have incurred any expenditure at all or any part of the said expenditure in respect of the exempt income viz. dividend and interest that arose out of the securities that constituted the assessee’s stock-in-trade. The answer must be in the negative. The purpose of the purchase of the said securities was not to earn income arising therefrom, namely, dividend and interest, but to earn profits from trading in i.e. purchasing and selling the same. It is axiomatic, therefore, that the entire expenditure including administrative costs was incurred for the purchase and sale of the stock-in-trade and, therefore, towards earning the business income from the trading activity of purchasing and selling the securities. Irrespective of whether the securities yielded any income arising therefrom, such as, dividend or interest, no expenditure was incurred in relation to the same. Once it is found that no expenditure was incurred in earning this income, there would be no further expenditure in relation thereto that falls within the ambit of section 14A. All that the assessee does thereafter i.e. after dividend and interest is received is to protect, preserve and utilize the same. The expenditure incurred in that regard would be to administer and manage the same. In other words, such expenditure cannot be said to be for the purpose of earning the same. An amount once received as income loses its character as income and thereafter forms a part of the assets or wealth of the assessee. There is no concept, such as, once an income always an income. - Decided in favour of assessee Issues Involved:1. Applicability of Section 14A of the Income Tax Act, 1961 to exempt income earned from securities held as stock-in-trade.2. Determination of whether the expenditure incurred relates to earning exempt income.3. Interpretation of Section 14A and Rule 8D in the context of stock-in-trade versus investment.Issue-wise Detailed Analysis of the Judgment:1. Applicability of Section 14A to Exempt Income from Stock-in-Trade:The core issue was whether Section 14A of the Income Tax Act applies to exempt income, such as dividends or interest, earned from securities held as stock-in-trade by the assessee. The Tribunal and the High Court both concluded that Section 14A does not apply to such exempt income. The Tribunal referenced a CBDT Circular No.18/2015, which clarified that income from investments by a banking concern is attributable to the business of banking and falls under 'Profits and gains of business and profession.' The High Court upheld this view, stating that the securities held by the assessee were stock-in-trade and not investments, and thus the provisions of Section 14A were inapplicable.2. Determination of Expenditure in Relation to Earning Exempt Income:The High Court examined whether any expenditure was incurred by the assessee in relation to earning the exempt income. It was found that the purpose of purchasing securities was to earn profits from trading, not to earn dividend or interest income. The Court emphasized that the entire expenditure, including administrative costs, was incurred for the purchase and sale of stock-in-trade, and thus, no expenditure was incurred specifically for earning the exempt income. The Court cited the Supreme Court judgment in Commissioner of Income-Tax vs. Walfort Share and Stock Brokers P. Ltd., which clarified that for Section 14A to apply, there must be a proximate cause for disallowance, which is its relationship with the tax-exempt income. In this case, no such proximate cause existed.3. Interpretation of Section 14A and Rule 8D:The High Court addressed the interpretation of Section 14A and Rule 8D, particularly in the context of stock-in-trade versus investment. It was highlighted that Rule 8D applies to investments and not to stock-in-trade. The Court noted that the computational provisions of Rule 8D refer to 'investment' and not 'stock-in-trade,' thus reinforcing that Section 14A does not apply to stock-in-trade. The Court also referred to Accounting Standard (AS) 13, which distinguishes between investment and stock-in-trade, further supporting the view that Rule 8D's computational provisions do not apply to stock-in-trade.Conclusion:The High Court concluded that Section 14A does not apply to exempt income earned from securities held as stock-in-trade. The expenditure incurred by the assessee was for trading purposes and not for earning exempt income. The Court dismissed the appeal, affirming the Tribunal's decision in favor of the assessee. The question of law was answered in the affirmative, confirming that Section 14A is inapplicable in this context.