The South Indian Bank Ltd. vs The Commissioner Of Income Tax on 9 September, 2021


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Supreme Court of India

The South Indian Bank Ltd. vs The Commissioner Of Income Tax on 9 September, 2021

Author: Hrishikesh Roy

Bench: A.M. Khanwilkar, Hrishikesh Roy, C.T. Ravikumar

                                                                [REPORTABLE]

                             IN THE SUPREME COURT OF INDIA
                              CIVIL APPELLATE JURISDICTION

                             CIVIL APPEAL NO. 9606 OF 2011


          SOUTH INDIAN BANK LTD.                          APPELLANT(S)


                                         VERSUS


          COMMISSIONER OF INCOME TAX                      RESPONDENT(S)


                                          WITH


                             CIVIL APPEAL NO.        OF 2021
                         [Arising out of SLP(C) No. 32761 OF 2018]

                             CIVIL APPEAL NO. 9609 OF 2011

                             CIVIL APPEAL NO. 9610 OF 2011

                             CIVIL APPEAL NO. 9611 OF 2011

                             CIVIL APPEAL NO. 9615 OF 2011

                             CIVIL APPEAL NO. 9608 OF 2011

                             CIVIL APPEAL NO. 9612 OF 2011
Signature Not Verified

Digitally signed by
                             CIVIL APPEAL NO. 9614 OF 2011
DEEPAK SINGH
Date: 2021.09.09
19:20:53 IST
Reason:
                             CIVIL APPEAL NO. 9613 OF 2011

                             CIVIL APPEAL NO. 9607 OF 2011
                                        Page 1 of 22
                CIVIL APPEAL NO. 3367 OF 2012

                CIVIL APPEAL NO. 2963 OF 2012



                           J U D G M E N T

Hrishikesh Roy, J.

1. Leave granted in SLP(C) No. 32761/2018 for analogous

consideration with the related appeals.

2. The question of law to be answered in the present batch

of appeals is on interpretation of Section 14A of the Income

Tax Act (for short “the Act”) and the same reads as follows:

“Whether proportionate disallowance of interest
paid by the banks is called for under Section 14A
of Income Tax Act for investments made in tax free
bonds/ securities which yield tax free dividend
and interest to assessee Banks when assessee had
sufficient interest free own funds which were more
than the investments made”

3. While common arguments have been advanced by the

learned counsel for the parties, to place the legal issues

in the appropriate perspective, the relevant facts are

adverted from the Civil Appeal No. 9606 of 2011 (South

Page 2 of 22
Indian Bank Ltd. Vs. CIT, Trichur), for the purpose of this

judgment.

4. The assessees are scheduled banks and in course of

their banking business, they also engage in the business of

investments in bonds, securities and shares which earn the

assessees, interests from such securities and bonds as also

dividend income on investments in shares of companies and

from units of UTI etc. which are tax free.

5. Chapter IV of the Act provides for the Heads of Income

for computation of Total Income. In Section 14, the various

incomes are classified under Salaries, Income from house

property, Profit & Gains of business or profession, Capital

Gains & Income from other sources. The Section 14A relates

to expenditure incurred in relation to income which are not

includable in Total Income and which are exempted from tax.

No taxes are therefore levied on such exempted income. The

Section 14A had been incorporated in the Income Tax Act to

ensure that expenditure incurred in generating such tax

exempted income is not allowed as a deduction while

calculating total income for the concerned assessee.

6. Section 14A was introduced to the Income Tax Act by the

Finance Act, 2001 with retrospective effect from 01.04.1962.
Page 3 of 22
The new section was inserted in aftermath of judgment of

this Court in the case of Rajasthan State Warehousing

Corporation Vs. CIT1. The said Section provided for

disallowance of expenditure incurred by the assessee in

relation to income, which does not form part of their total

income. As such if the assessee incurs any expenditure for

earning tax free income such as interest paid for funds

borrowed, for investment in any business which earns tax

free income, the assessee is disentitled to deduction of

such interest or other expenditure. Although the provision

was introduced retrospectively from 01.04.1962, the

retrospective effect was neutralized by a proviso later

introduced by the Finance Act, 2002 with effect from

11.05.2001 whereunder, re-assessment, rectification of

assessment was prohibited for any assessment year, up-to the

assessment year 2000-2001, when the proviso was introduced,

without making any disallowance under Section 14A. The

earlier assessments were therefore permitted to attain

finality. As such the disallowance under Section 14A was

intended to cover pending assessments and for the assessment

years commencing from 2001-2002. It may be noted that in the

present batch of appeals, we are concerned with
1 [(2000) 242 ITR 450 SC] / (2000) 3 SCC 126.

Page 4 of 22

disallowances made under Section 14A for assessment years

commencing from 2001-2002 onwards or for pending

assessments.

7. At outset it is clarified that none of the assessee

banks amongst the appellants, maintained separate accounts

for the investments made in bonds, securities and shares

wherefrom the tax-free income is earned so that

disallowances could be limited to the actual expenditure

incurred by the assessee. In other words, the expenditure

incurred towards interest paid on funds borrowed such as

deposits utilized for investments in securities, bonds and

shares which yielded the tax-free income, cannot

conveniently be related to a separate account, maintained

for the purpose. The situation is same so far as overheads

and other administrative expenditure of the assessee.

8. In absence of separate accounts for investment which

earned tax free income, the Assessing Officer made

proportionate disallowance of interest attributable to the

funds invested to earn tax free income. The assessees in

these appeals had earned substantial tax-free income by way

of interest from tax free bonds and dividend income which

also is tax free. It is manifest that substantial
Page 5 of 22
expenditure is incurred for earning tax free income. Since

actual expenditure figures are not available for making

disallowance under Section 14A, the Assessing Officer worked

out proportionate disallowance by referring to the average

cost of deposit for the relevant year. The CIT (A) had

concurred with the view taken by the Assessing Officer.

9. The ITAT in Assessee’s appeal against CIT(A) considered

the absence of separate identifiable funds utilized by

assessee for making investments in tax free bonds and shares

but found that assessee bank is having indivisible business

and considering their nature of business, the investments

made in tax free bonds and in shares would therefore be in

nature of stock in trade. The ITAT then noticed that

assessee bank is having surplus funds and reserves from

which investments can be made. Accordingly, it accepted the

assessee’s case that investments were not made out of

interest or cost bearing funds alone. In consequence, it was

held by the ITAT that disallowance under Section 14A is not

warranted, in absence of clear identity of funds.

10. The decision of the ITAT was reversed by the High Court

by acceptance of the contentions advanced by the Revenue in

their appeal and accordingly the Assessee Bank is before us
Page 6 of 22
to challenge the High Court’s decision which was against the

assessee.

11. Since, the scope of Section 14A of the Act will require

interpretation, the Section with sub-clauses (2) and (3)

along with the proviso is extracted hereinbelow: –

“14A. Expenditure incurred in relation to
income not includible in total income – (1)
For the purposes of computing the total income
under this Chapter, no deduction shall be
allowed in respect of expenditure incurred by
the assessee in relation to income which does
not form part of the total income under this
Act.

(2) The Assessing Officer shall determine the
amount of expenditure incurred in relation to
such income which does not form part of the
total income under this Act in accordance with
such method as may be prescribed, if the
Assessing Officer, having regard to the
accounts of the assessee, is not satisfied
with the correctness of the claim of the
assessee in respect of such expenditure in
relation to income which does not form part of
the total income under this Act.

(3) The provisions of sub-section (2) shall
also apply in relation to a case where an
assessee claims that no expenditure has been
incurred by him in relation to income which
does not form part of the total income under
this Act:

Provided that nothing contained in this
section shall empower the Assessing Officer
either to reassess under section 147 or pass

Page 7 of 22
an order enhancing the assessment or reducing
a refund already made or otherwise increasing
the liability of the assessee under section
154
, for any assessment year beginning on or
before the 1st day of April, 2001.”

12. The sub-Section (2) and (3) were introduced to the main

section by the Finance Act, 2006 with effect from

01.04.2007.

13. The question therefore to be answered is whether

Section 14A, enables the Department to make disallowance on

expenditure incurred for earning tax free income in cases

where assessees like the present appellant, do not maintain

separate accounts for the investments and other expenditures

incurred for earning the tax-free income.

14. We have heard Mr. S. Ganesh, Mr. S.K. Bagaria, Mr.

Jehangir Mistri and Mr. Joseph Markose, learned Senior

Counsel appearing for the appellants. Also heard Mr.

Vikramjit Banerjee, learned Additional Solicitor General and

Mr. Arijit Prasad, learned Senior Counsel on behalf of the

respondent/Revenue.

15. The appellants argue that the investments made in bonds

and shares should be considered to have been made out of

interest free funds which were substantially more than the

Page 8 of 22
investment made and therefore the interest paid by the

assessee on its deposits and other borrowings, should not be

considered to be expenditure incurred in relation to tax

free income on bonds and shares and as a corollary, there

should be no disallowance under Section 14A of the Act. On

the other hand, the counsel for the revenue refers to the

reasoning of the CIT(A) and of the High Court to project

their case.

16. As can be seen, the contention on behalf of the

assessee was rejected by the CIT(A) as also by the High

Court primarily on the ground that the assessee had not kept

their interest free funds in separate account and as such

had purchased the bonds/shares from mixed account. This is

how a proportionate amount of the interest paid on the

borrowings/deposits, was considered to have been incurred to

earn the tax-free income on bonds/shares and such

proportionate amount was disallowed applying Section 14A of

the Act.

17. In a situation where the assessee has mixed fund (made

up partly of interest free funds and partly of interest-

bearing funds) and payment is made out of that mixed fund,

the investment must be considered to have been made out of
Page 9 of 22
the interest free fund. To put it another way, in respect of

payment made out of mixed fund, it is the assessee who has

such right of appropriation and also the right to assert

from what part of the fund a particular investment is made

and it may not be permissible for the Revenue to make an

estimation of a proportionate figure. For accepting such a

proposition, it would be helpful to refer to the decision of

the Bombay High Court in Pr. CIT v. Bombay Dyeing and Mfg.

Co. Ltd2 where the answer was in favour of the assessee on

the question, whether the Tribunal was justified in deleting

the disallowance under Section 80M of the Act on the

presumption that when the funds available to the assessee

were both interest free and loans, the investments made

would be out of the interest free funds available with the

assessee, provided the interest free funds were sufficient

to meet the investments. The resultant SLP of the Revenue

challenging the Bombay High Court judgment was dismissed

both on merit and on delay by this Court. The merit of the

above proposition of law of the Bombay High Court would now

be appreciated in the following discussion.

2 I.T.A. No.1225 of 2015
Page 10 of 22

18. In the above context, it would be apposite to refer to

a similar decision in Commissioner of Income Tax (Large Tax

Payer Unit) Vs. Reliance Industries Ltd3 where a Division

Bench of this Court expressly held that where there is

finding of fact that interest free funds available to

assessee were sufficient to meet its investment it will be

presumed that investments were made from such interest free

funds.

19. In HDFC Bank Ltd. Vs. Deputy Commissioner of Income

Tax4, the assessee was a Scheduled Bank and the issue

therein also pertained to disallowance under Section 14A. In

this case, the Bombay High Court even while remanding the

case back to Tribunal for adjudicating afresh observed

(relying on its own previous judgment in same assessee’s

case for a different Assessment Year) that, if assessee

possesses sufficient interest free funds as against

investment in tax free securities then, there is a

presumption that investment which has been made in tax free

securities, has come out of interest free funds available

with assessee. In such situation Section 14A of the Act

would not be applicable. Similar views have been expressed

3 (2019) 410 ITR 466 SC/ (2019) 20 SCC 478.

4 (2016) 383 ITR 529 (Bom) / 2016 SCC Online Bom 1109
Page 11 of 22
by other High Courts in CIT Vs. Suzlon Energy Ltd.5, CIT Vs.

Microlabs Ltd.6 and CIT Vs. Max India Ltd.7 Mr. S Ganesh

the learned Senior Counsel while citing these cases from the

High Courts have further pointed out that those judgments

have attained finality. On reading of these judgments, we

are of the considered opinion that the High Courts have

correctly interpreted the scope of Section 14A of the Act in

their decisions favouring the assessees.

20. Applying the same logic, the disallowance would be

legally impermissible for the investment made by the

assessees in bonds/shares using interest free funds, under

Section 14A of the Act. In other words, if investments in

securities is made out of common funds and the assessee has

available, non-interest-bearing funds larger than the

investments made in tax- free securities then in such cases,

disallowance under Section 14A cannot be made.

21. On behalf of Revenue Mr. Arijit Prasad, the learned

Senior Advocate refers to SA Builders v. CIT8 where this

Court ruled on issue of disallowance in relation to funds

lent to sister concern out of mixed funds. The issue in SA

5 (2013) 354 ITR 630 (Guj)/ 2013 SCC Online Guj 8613
6 (2016) 383 ITR 490 (Karn)/ 2016 SCC Online Kar 8490
7 (2016) 388 ITR 81 (P & H) / 2016 SCC Online P&H 6788
8 [(2007) 1 SCC 781]
Page 12 of 22
Builders is pending consideration before the larger bench of

this Court in SLP (C) No. 14729 of 2012 titled as Addl. CIT

v. Tulip Star Hotels Ltd. The counsel therefore, argues that

there is no finality on the issue of disallowance, when

mixed funds are used. On this aspect, since the issue is

pending before a larger Bench, comments from this Bench may

not be appropriate. However, at the same time it is

necessary to distinguish the facts of present appeals from

those in SA Builders/Tulip Star Hotels Ltd. In that case,

loans were extended to sister concern while here the

Assessee- Banks have invested in bonds/securities. The

factual scenario is different and distinguishable and

therefore the issue pending before the larger Bench should

have no bearing at this stage for the present matters.

22. The High Court herein endorsed the proportionate

disallowance made by the Assessing Officer under Section 14A

of the Income Tax Act to the extent of investments made in

tax-free bonds/securities primarily because, separate

account was not maintained by assessee. On this aspect we

wanted to know about the law which obligates the assessee to

maintain separate accounts. However, the learned ASG could

not provide a satisfactory answer and instead relied upon

Page 13 of 22
Honda Siel Power Products Ltd. v. DCIT9 to argue that it is

the responsibility of the assessee to fully disclose all

material facts. The cited judgment, as can be seen, mainly

dealt with re-opening of assessment in view of escapement of

income. The contention of department for re-opening was that

the assessee had earned tax-free dividend and had claimed

various administrative expenses for earning such dividend

income and those (though not allowable) was allowed as

expenditure and therefore the income had escaped assessment.

On this, suffice would be to observe that the action in

Honda Siel (supra) related to re-opening of assessment where

full disclosure was not made. An assessee definitely has the

obligation to provide full material disclosures at the time

of filing of Income Tax Return but there is no corresponding

legal obligation upon the assessee to maintain separate

accounts for different types of funds held by it. In absence

of any statutory provision which compels the assessee to

maintain separate accounts for different types of funds, the

judgment cited by the learned ASG will have no application

to support the Revenue’s contention against the assessee.

9 [(2012) 12 SCC 762]
Page 14 of 22

23. It would now be appropriate to advert in some detail to

Maxopp Investment Ltd. v. CIT10. This case interestingly is

relied by both sides’ counsel. Writing for the Bench,

Justice Dr. A.K. Sikri noted the objective for incorporation

of Section 14A in the Act in the following words: –

“3…………. The purpose behind Section 14-A of the
Act, by not permitting deduction of the
expenditure incurred in relation to income, which
does not form part of total income, is to ensure
that the assessee does not get double benefit.

Once a particular income itself is not to be
included in the total income and is exempted from
tax, there is no reasonable basis for giving
benefit of deduction of the expenditure incurred
in earning such an income……..”

The following was written explaining the scope of Section

14-A(1):

“41. In the first instance, it needs to be
recognised that as per Section 14-A(1) of the Act,
deduction of that expenditure is not to be allowed
which has been incurred by the assessee “in
relation to income which does not form part of the
total income under this Act”. Axiomatically, it is
that expenditure alone which has been incurred in
relation to the income which is includible in
total income that has to be disallowed. If an
expenditure incurred has no causal connection with
the exempted income, then such an expenditure
would obviously be treated as not related to the
income that is exempted from tax, and such
expenditure would be allowed as business
expenditure. To put it differently, such
10 (2018) 15 SCC 523
Page 15 of 22
expenditure would then be considered as incurred
in respect of other income which is to be treated
as part of the total income.”

Adverting to the law as it stood earlier, this Court

rejected the theory of dominant purpose suggested by the

Punjab & Haryana High Court and accepted the principle of

apportionment of expenditure only when the business was

divisible, as was propounded by the Delhi High Court.

Finally adjudicating the issue of expenditure on shares held

as stock-in-trade, the following key observations were made

by Justice Sikri:

“ 50. It is to be kept in mind that in those cases
where shares are held as “stock-in-trade”, it
becomes a business activity of the assessee to
deal in those shares as a business proposition.

Whether dividend is earned or not becomes
immaterial. In fact, it would be a quirk of fate
that when the investee company declared dividend,
those shares are held by the assessee, though the
assessee has to ultimately trade those shares by
selling them to earn profits. The situation here
is, therefore, different from the case
like Maxopp Investment Ltd. [Maxopp Investment
Ltd. v. CIT
, 2011 SCC OnLine Del 4855 : (2012)
347 ITR 272] where the assessee would continue to
hold those shares as it wants to retain control
over the investee company. In that case, whenever
dividend is declared by the investee company that
would necessarily be earned by the assessee and
the assessee alone. Therefore, even at the time
of investing into those shares, the assessee
knows that it may generate dividend income as
well and as and when such dividend income is
Page 16 of 22
generated that would be earned by the assessee.

In contrast, where the shares are held as stock-
in-trade, this may not be necessarily a
situation. The main purpose is to liquidate those
shares whenever the share price goes up in order
to earn profits……….”

The learned Judge then considered the implication of Rule 8D

of the Rules in the context of Section 14-A(2) of the Act

and clarified that before applying the theory of

apportionment, the Assessing Officer must record

satisfaction on Suo Moto disallowance only in those cases

where, the apportionment was done by the assessee. The

following is relevant for the purpose of this judgment:

51. ……………….It will be in those cases where the
assessee in his return has himself apportioned
but the AO was not accepting the said
apportionment. In that eventuality, it will have
to record its satisfaction to this effect.………….”

24. Another important judgment dealing with Section 14A

disallowance which merits consideration is Godrej and Boyce

Manufacturing Company Ltd. V. DCIT11. Here the assessee had

access to adequate interest free funds to make investments

and the issue pertained to disallowance of expenditure

incurred to earn dividend income, which was not forming part

11 [(2017) 7 SCC 421.

Page 17 of 22

of total income of the Assessee. Justice Ranjan Gogoi

writing the opinion on behalf of the Division Bench observed

that for disallowance of expenditure incurred in earning an

income, it is a condition precedent that such income should

not be includible in total income of assessee. This Court

accordingly concluded that for attracting provisions of

Section 14A, the proof of fact regarding such expenditure

being incurred for earning exempt income is necessary. The

relevant portion of Justice Gogoi’s judgment reads as

follow:

“36. ……… what cannot be denied is that the
requirement for attracting the provisions of
Section 14-A (1) of the Act is proof of the fact
that the expenditure sought to be
disallowed/deducted had actually been incurred in
earning the dividend income………….”

25. Proceeding now to another aspect, it is seen that the

Central Board of Direct Taxes (CBDT) had issued the Circular

no. 18 of 2015 dated 02.11.2015, which had analyzed and then

explained that all shares and securities held by a bank

which are not bought to maintain Statutory Liquidity Ratio

(SLR) are its stock-in-trade and not investments and income

arising out of those is attributable, to business of

banking. This Circular came to be issued in the aftermath of

Page 18 of 22
CIT Vs. Nawanshahar Central Cooperative Bank Ltd.12 wherein

this Court had held that investments made by a banking

concern is part of their banking business. Hence the income

earned through such investments would fall under the head

Profits & Gains of business. The Punjab and Haryana High

Court, in the case of Pr. CIT, vs. State Bank of Patiala13

while adverting to the CBDT Circular, concluded correctly

that shares and securities held by a bank are stock in

trade, and all income received on such shares and securities

must be considered to be business income. That is why

Section 14A would not be attracted to such income.

26. Reverting back to the situation here, the Revenue does

not contend that the Assessee Banks had held the securities

for maintaining the Statutory Liquidity Ratio (SLR), as

mentioned in the circular. In view of this position, when

there is no finding that the investments of the Assessee are

of the related category, tax implication would not arise

against the appellants, from the said circular.

27. The aforesaid discussion and the cited judgments advise

this Court to conclude that the proportionate disallowance

of interest is not warranted, under Section 14A of Income

12 [(2007) 15 SCC 611] / [(2007) 160 TAXMAN 48 (SC)]
13 2017 (393) ITR 476 (P&H)
Page 19 of 22
Tax Act for investments made in tax free bonds/ securities

which yield tax free dividend and interest to Assessee Banks

in those situations where, interest free own funds available

with the Assessee, exceeded their investments. With this

conclusion, we unhesitatingly agree with the view taken by

the learned ITAT favouring the assessees.

28. The above conclusion is reached because nexus has not

been established between expenditure disallowed and earning

of exempt income. The respondents as earlier noted, have

failed to substantiate their argument that assessee was

required to maintain separate accounts. Their reliance on

Honda Siel (Supra) to project such an obligation on the

assessee, is already negated. The learned counsel for the

revenue has failed to refer to any statutory provision which

obligate the assessee to maintain separate accounts which

might justify proportionate disallowance.

29. In the above context, the following saying of Adam

Smith in his seminal work – The Wealth of Nations may aptly

be quoted:

“The tax which each individual is bound to pay ought
to be certain and not arbitrary. The time of payment,
the manner of payment, the quantity to be paid ought
all to be clear and plain to the contributor and to
every other person.”
Page 20 of 22
Echoing what was said by the 18th century economist, it

needs to be observed here that in taxation regime, there is

no room for presumption and nothing can be taken to be

implied. The tax an individual or a corporate is required to

pay, is a matter of planning for a tax payer and the

Government should endeavour to keep it convenient and simple

to achieve maximization of compliance. Just as the

Government does not wish for avoidance of tax equally it is

the responsibility of the regime to design a tax system for

which a subject can budget and plan. If proper balance is

achieved between these, unnecessary litigation can be

avoided without compromising on generation of revenue.

30. In view of the forgoing discussion, the issue framed in

these appeals is answered against the Revenue and in favour

of the assessee. The appeals by the Assessees are

accordingly allowed with no order on costs.

……………………………………………………J.

[SANJAY KISHAN KAUL]

……………………………………………………J.

[HRISHIKESH ROY]
NEW DELHI
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SEPTEMBER 09, 2021

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