Income Tax Act - Disallowance Under Section 14A Can't Be Made Just Because Assessee Has Not Maintained Separate Accounts For Expenditures Incurred For Tax-Free Income : Supreme Court
Giving tax relief to a group of scheduled banks, the Supreme Court has observed that the assessing officer cannot make disallowance of deduction under Section 14A of the Income Tax Act merely because the assessee has not maintained separate accounts for expenses incurred in earning tax-free income.In the case South Indian Bank Ltd v. Commissioner of Income Tax, the Court observed...
Giving tax relief to a group of scheduled banks, the Supreme Court has observed that the assessing officer cannot make disallowance of deduction under Section 14A of the Income Tax Act merely because the assessee has not maintained separate accounts for expenses incurred in earning tax-free income.
In the case South Indian Bank Ltd v. Commissioner of Income Tax, the Court observed that proportionate disallowance of interest under Section 14A of Income Tax Act is not warranted 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.
The bench of Justices Sanjay Kishan Kaul and Hrishikesh Roy was considering the appeals filed by various banks in which the issue raised was whether Section 14A of the Income Tax Act enables the Department to make disallowance on expenditure incurred for earning tax free income in cases where assessees do not maintain separate accounts for the investments and other expenditures incurred for earning the tax-free income.
Section 14A deals with expenditure incurred in relation to income not includible in total income. It provides for disallowance of expenditure incurred by the assessee in relation to income, which does not form part of their total income. 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.
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.
In this case, the Assessing Officer made proportionate disallowance of interest attributable to the funds invested to earn tax free income. 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.
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 CIT (A) had concurred with the view taken by the Assessing Officer.
The ITAT, allowing assessee's appeal, held that disallowance under Section 14A is not warranted, in absence of clear identity of funds. This was reversed by the High Court and thus the assessee banks approached the Apex Court.
The appellant banks contended that investments made in bonds and shares should be considered to have been made out of interest free funds which were substantially more than the 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.
The Supreme Court framed the issue before it as follows :
"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"
The Court noted that the assessees claims for deduction were primarily disallowed on the on the ground that the assessees had not kept their interest free funds in separate account and as such had purchased the bonds/shares from mixed account.
In this connection, the Supreme Court observed :
"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 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".
The Court made a reference to the precedent in Commissioner of Income Tax (Large Tax Payer Unit) Vs. Reliance Industries Ltd (2019) 20 SCC 478 where it was 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.
Approving the views taken by some High Courts in this regard, the Supreme Court observed:
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
The court also noted that the revenue has failed to refer to any statutory provision which obligate the assessee to maintain separate accounts which might justify proportionate disallowance.
"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", the judgment authored by Justice Kaul stated.
In conclusion, the Court said :
"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 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.", the court observed.
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Case: South Indian Bank Ltd. Vs. Commissioner of Income Tax ; CA 9606 OF 2011Citation: LL 2021 SC 435Coram: Justices Sanjay Kishan Kaul and Hrishikesh RoyCounsel: Senior Advocates S. Ganesh, S.K. Bagaria, Jehangir Mistri and Joseph Markose, for appellants, ASG Vikramjit Banerjee, Sr. Adv Arijit Prasad for respondents
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