By TIOL News Service

NEW DELHI, MAY 08, 2017: THE issue before the Bench is - Whether provisions of Sec 14A apply to dividend income on which taxes are payabnle u/s 115-O. YES is the verdict.

Facts of the case

The assessee is engaged in the business of manufacture of steel furniture, security equipments, typewriters, electrical equipments and a host of other related products. It is also a promoter of various other companies and invests its funds in such companies in order to maintain control of such concerns as sister concerns. For the A.Y 2002-2003, the assessee filed its return declaring a total loss of Rs.45,90,39,210/-. In the said return, it had shown income by way of dividend from companies and income from units of mutual funds to the extent of Rs.34,34,78,686. Dividend income to the extent of 98% of the said amount was contributed by the Godrej group companies whereas only 0.05% thereof amounting to Rs.1,71,000/- came from non-Godrej group companies. A sum of Rs.66,79,000/-, constituting 1.95% of the aforesaid dividend income, came from mutual funds. Admittedly, a substantial part of the assessee's investment in the group companies was in the form of bonus shares which did not involve any fresh capital investment or outlay. As against the investment of Rs.125.54 crore as on 31st March, 2002, on the said date the assessee had a total of Rs.280.64 crore by way of interest free funds in the form of share capital as well as Reserves and Surplus. On the other hand, as against the investment of Rs.127.19 crore on the first day of the previous year i.e. 1st April, 2001, the assessee had a total of Rs.270.51 crore by way of interest free funds in the form of share capital and Reserves and Surplus.

Though for the A.Ys 1998-99 to 2001-02, the AO had allowed assessee's dividend income in full with regard to exemption u/s 10(33) without disallowing any expenditure incurred in relation to earning such income. However, for the present A.Y 2002-2003, the AO did not allow interest expenditure to the extent of Rs.6,92,06,000/- holding the same to be attributable to earning of dividend income of Rs. 34,34,78,686/-. The said figure of interest expenditure disallowed was worked out from the total interest expenditure for the year on a notional basis in the ratio of the cost of the investments in shares and units of mutual funds to the cost of the total assets appearing in the balance sheet. Though the aforesaid order of AO was reversed by the CIT(A) following the earlier orders pertaining to the previous A.Ys, the ITAT held that sub-sections (2) and (3) of Section 14A were retrospectively applicable to the A.Y 2002-2003 and, therefore, the matter should be remanded to the AO for recording his satisfaction/findings in the light of the said sub-sections of Section 14A. of the Act. This was notwithstanding the fact that the only disallowance made by the AO which was reversed in appeal by the CIT(A) was in respect of interest expenditure what was worked out on a notional basis.

When the matter reached High Court, it was held that Section 14A had to be construed on a plain grammatical construction thereof and the said provision was attracted in respect of dividend income referred to in Section 115-O as such income was not includible in the total income of the shareholder. Sub-sections (2) and (3) of Section 14A and rule 8D would, however, not apply to the AY 2002-03 as the said provisions do not have retrospective effect. Notwithstanding the above, the High Court upheld the remand as made by the Tribunal to the AO though for a slightly different reason. The High Court in its impugned judgment also held that the tax paid u/s 115-O was an additional tax on that component of profits of the dividend distributing company which was distributed by way of dividends and that the same was not a tax on dividend income of the assessee.

Held that,

++ the object behind the introduction of Section 14A by the Finance Act of 2001 is clear and unambiguous. The legislature intended to check the claim of allowance of expenditure incurred towards earning exempted income in a situation where an assessee has both exempted and non-exempted income or includible or non-includible income. While there can be no scintilla of doubt that if the income in question is taxable and, therefore, includible in the total income, the deduction of expenses incurred in relation to such an income must be allowed, such deduction would not be permissible merely on the ground that the tax on the dividend received by the assessee has been paid by the dividend paying company and not by the recipient assessee, when u/s 10(33) such income by way of dividend is not a part of the total income of the recipient assessee. A plain reading of Section 14A would go to show that the income must not be includible in the total income of the assessee. Once the said condition is satisfied, the expenditure incurred in earning the said income cannot be allowed to be deducted. The section does not contemplate a situation where even though the income is taxable in the hands of the dividend paying company the same to be treated as not includible in the total income of the recipient assessee, yet, the expenditure incurred to earn that income must be allowed on the basis that no tax on such income has been paid by the assessee. Such a meaning, if ascribed to Section 14A, would be plainly beyond what the language of Section 14A can be understood to reasonably convey. While it is correct that Section 10(33) exempts only dividend income u/s 115-O and there are other species of dividend income on which tax is levied under the Act, we do not see how the said position in law would assist the assessee in understanding the provisions of Section 14A. What is required to be construed is the provisions of Section 10(33) read in the light of Section 115-O of the Act. So far as the species of dividend income on which tax is payable u/s 115-O is concerned, the earning of the said dividend is tax free in the hands of assessee and not includible in the total income of the said assessee. If that is so, we do not see how the operation of Section 14A to such dividend income can be foreclosed. The fact that Section 10(33) and Section 115-O were brought in together; deleted and reintroduced later in a composite manner, also, does not assist the assessee;

++ the aforesaid facts would countenance a situation that so long as the dividend income is taxable in the hands of the dividend paying company, the same is not includible in the total income of the recipient assessee. At such point of time when the said position was reversed by the Finance Act of 2002 and reintroduced again by the Finance Act, 2003, it was the assessee who was liable to pay tax on such dividend income. In such a situation, the assessee was entitled u/s 57 to claim the benefit of exemption of expenditure incurred to earn such income. Once Section 10(33) and 115-O was reintroduced the position was reversed. The above, actually fortifies the situation that Section 14A would operate to disallow deduction of all expenditure incurred in earning the dividend income u/s 115-O which is not includible in the total income of assessee. So far as the provisions of Section 115-O are concerned, even if it is assumed that the additional income tax under the aforesaid provision is on the dividend and not on the distributed profits of the dividend paying company, no material difference to the applicability of Section 14A would arise. Sub-sections (4) and (5) of Section 115-O makes it very clear that the further benefit of such payments cannot be claimed either by the dividend paying company or by the recipient assessee. The provisions of Sections 194, 195, 196C and 199 of the Act, would further fortify the fact that the dividend income u/s 115-O 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. Therefore, this court holds that Section 14A would apply to dividend income on which tax is payable u/s 115-O of the Act.

(See 2017-TIOL-212-SC-IT)