2017 (5) TMI 403 - SC - Income Tax

Section 14A applies to dividend income taxed under Section 115-O as it's non-includible in total income

GODREJ & BOYCE MANUFACTURING COMPANY LIMITED Versus DY. COMMISSIONER OF INCOME-TAX & ANR.

The SC held that Section 14A applies to dividend income taxed under Section 115-O, as such income does not form part of total income under the Act. The ... Applicability of Section 14A with regard to dividend income on which tax is paid under Section 115-O - Whether the phrase “income which does not form part of total income under this Act” appearing in Section 14A includes within its scope dividend income on shares in respect of which tax is payable under Section 115-O of the Act and income on units of mutual funds on which tax is payable under Section 115-R? - Held that:- Section 14A of the Act would operate to disallow deduction of all expenditure incurred in earning the dividend income under Section 115-O which is not includible in the total income of the assessee. The provisions of Sections 194, 195, 196C and 199 of the Act, quoted above, would further fortify the fact that the dividend income under Section 115-O of the Act is a special category of income which has been treated differently by the Act making the same non-includible in the total income of the recipient assessee as tax thereon had already been paid by the dividend distributing company. The other species of dividend income which attracts levy of income tax at the hands of the recipient assessee has been treated differently and made liable to tax under the aforesaid provisions of the Act. In fact, if the argument is that tax paid by the dividend paying company under Section 115-O is to be understood to be on behalf of the recipient assessee, the provisions of Section 57 should enable the assessee to claim deduction of expenditure incurred to earn the income on which such tax is paid. Such a position in law would be wholly incongruous in view of Section 10(33) of the Act. Thus holding that Section 14A of the Act would apply to dividend income on which tax is payable under Section 115-O of the Act the first question formulated in the appeal has to be answered against the appellant-assessee. Application of Section 14A r.w.rule 8D - whereas in the earlier years AO did not make any disallowance - Held that:- Sub-sections (2) and (3) of Section 14A of the Act read with Rule 8D of the Rules merely prescribe a formula for determination of expenditure incurred in relation to income which does not form part of the total income under the Act in a situation where the Assessing Officer is not satisfied with the claim of the assessee. Whether such determination is to be made on application of the formula prescribed under Rule 8D or in the best judgment of the Assessing Officer, what the law postulates is the requirement of a satisfaction in the Assessing Officer that having regard to the accounts of the assessee, as placed before him, it is not possible to generate the requisite satisfaction with regard to the correctness of the claim of the assessee. It is only thereafter that the provisions of Section 14A(2) and (3) read with Rule 8D of the Rules or a best judgment determination, as earlier prevailing, would become applicable. In the present case, we do not find any mention of the reasons which had prevailed upon the Assessing Officer, while dealing with the Assessment Year 2002-2003, to hold that the claims of the Assessee that no expenditure was incurred to earn the dividend income cannot be accepted and why the orders of the Tribunal for the earlier Assessment Years were not acceptable to the Assessing Officer, particularly, in the absence of any new fact or change of circumstances While it is true that the principle of res judicata would not apply to assessment proceedings under the Act, the need for consistency and certainty and existence of strong and compelling reasons for a departure from a settled position has to be spelt out which conspicuously is absent in the present case. Second question formulated must go in favour of the assessee and it must be held that for the Assessment Year in question i.e. 2002-2003, the assessee is entitled to the full benefit of the claim of dividend income without any deductions. Issues Involved:1. Admissibility of deduction of expenditure incurred in earning dividend income under Section 10(33) of the Income Tax Act, 1961.2. Applicability of Section 14A of the Income Tax Act to dividend income on which tax is payable under Section 115-O of the Act.3. Consistency in the application of the law across different assessment years.Detailed Analysis:1. Admissibility of Deduction of Expenditure Incurred in Earning Dividend Income:The appellant company, engaged in manufacturing and investment activities, filed a return for the Assessment Year 2002-2003 declaring a substantial loss. The company reported significant dividend income, primarily from group companies, and claimed deductions for the expenditure incurred in earning this income. The Assessing Officer disallowed a portion of the interest expenditure, attributing it to the earning of dividend income, a decision reversed by the Commissioner of Income Tax (Appeals). However, the Tribunal remanded the matter back to the AO, invoking sub-sections (2) and (3) of Section 14A of the Act retrospectively, a decision upheld by the High Court.2. Applicability of Section 14A to Dividend Income Under Section 115-O:The core issue was whether Section 14A, which disallows deductions for expenditure incurred in earning income not includible in total income, applies to dividend income taxed under Section 115-O. The appellant argued that since tax on such dividends is paid by the distributing company, not the recipient, Section 14A should not apply. The Revenue countered that Section 14A aims to prevent deductions for expenses related to exempt income, regardless of who pays the tax on the dividends.The Court held that Section 14A applies to dividend income under Section 115-O, emphasizing that the income must not be includible in the total income of the assessee for the expenditure to be disallowed. The Court rejected the appellant's interpretation, stating that the clear language of Section 14A supports the disallowance of expenses incurred to earn such income, aligning with the Act's scheme and purpose.3. Consistency Across Different Assessment Years:The appellant had previously succeeded in similar claims for earlier assessment years, where the Revenue failed to establish a nexus between the disallowed expenditure and the dividend income. The Court noted that while each assessment year is a separate unit, consistency and certainty in tax proceedings are crucial. The Court found no new facts or changes in circumstances justifying a different view for the Assessment Year 2002-2003. The absence of any material proving that borrowings were used to earn tax-free income, despite available surplus funds, supported the appellant's case.Conclusion:The Supreme Court concluded that Section 14A applies to dividend income on which tax is payable under Section 115-O. However, for the Assessment Year 2002-2003, the appellant is entitled to the full benefit of the claimed dividend income without any deductions, due to the lack of evidence showing a nexus between the disallowed expenditure and the dividend income. The appeal was allowed, setting aside the High Court's order, subject to the Court's conclusions on the applicability of Section 14A.