The top court, which allowed a batch of appeals filed by banks against an order of the Kerala High Court, held that the proportionate disallowance of interest is not warranted 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 in those situations where, interest free own funds available with them, exceeded their investments. Section 14A of Income Tax Act deals with expenditure incurred in relation to income not includible in total income.
A bench of Justices Sanjay Kishan Kaul and Hrishikesh Roy said “With this conclusion, we unhesitatingly agree with the view taken by the ITAT favouring the assessees.”
Referring to the work of 18th century economist Adam Smith in ‘The Wealth of Nations’, the bench said 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 bench said, “The tax an individual or a corporate is required to pay, is a matter of planning for a taxpayer 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”.
The top court said that if proper balance is achieved, unnecessary litigation can be avoided without compromising on generation of revenue.
“In view of the foregoing 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”, it said.
The bench said that its conclusion is reached because nexus has not been established between expenditure disallowed and earning of exempt income.
“The respondents (Revenue department), have failed to substantiate their argument that assessee was required to maintain separate accounts…The counsel for the Revenue(department) has failed to refer to any statutory provision which obligate the assessee to maintain separate accounts which might justify proportionate disallowance”, it said.
The bench said that the Central Board of Direct Taxes (CBDT) had issued the Circular on November 2, 2015, which had explained 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.
“Hence the income earned through such investments would fall under the head Profits and Gains of business. The Punjab and Haryana High Court, in the case…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,” the top court said.
It said that in the present case the Kerala High Court had 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 the banks.
The bench said that when it enquired on this aspect about the law which obligates the banks to maintain separate accounts, the Revenue department could not provide a satisfactory answer and instead relied upon an earlier verdict to argue that it is the responsibility of the banks to fully disclose all material facts.
“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”, it said.
The bench said that in absence of any statutory provision which compels the banks to maintain separate accounts for different types of funds, the judgement cited by the Revenue department will have no application.
The top court was interpreting whether Section 14A enables the Department to make disallowance on expenditure incurred for earning tax free income in cases where some banks who are before the court do not maintain separate accounts for the investments and other expenditures incurred for earning the tax-free income.
In absence of separate accounts for investment which earned tax free income, the assessing officer had made proportionate disallowance of interest attributable to the funds invested to earn 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 Commissioner of Income Tax (A) had concurred with the view taken by the Assessing Officer.
The Income Tax Appellate Tribunal(ITAT), however, accepted the banks’ case and held that disallowance under Section 14A is not warranted in absence of clear identity of funds.
The decision of the ITAT was reversed by the Kerala High Court by accepting the contention of the revenue department and thereafter banks have approached the top court.
