Expenditure incurred in relation to exempt income

HELD Section 14 provides the heads of income, which are chargeable to tax while computing the income of the assessee. Separate heads of income have been provided for computing the income under each head independently and separately. Section 14A was inserted by the Finance Act, 2001, with retrospective effect from 1-4-1962. Further section 2(24) defines income, which in addition to all the other incomes also includes dividend as per clause (ii) to section 2(24). Section 2(45) defines total income as total amount of income referred to in section 5 and computed in the manner laid down in this Act. Section 10 specifies the incomes which shall not be included in total income. Section 10(33) provides that income received by way of dividend as referred to in section 115-O is exempt from tax. Section 115-O talks of tax on distributed profits of domestic companies. In other words, the dividend distributed by domestic companies is not taxable in the hands of the recipient i.e., the shareholder of the domestic company by virtue of provisions of section 10(33), but tax is charged on distribution of such profits by way of dividend on the domestic companies as per the provisions of section 115-O. In other words, tax is charged on the distributor of income and no tax is charged in the hands of the recipient by virtue of section 10(33). [Para 8] Section 14A inserted by the Finance Act, 2001 with retrospective effect from 1-4-1962 provides for disallowance of expenditure in relation to income which does not form part of total income. In view of the provisions of section 14A, while allowing the claim of the expenditure, it is to be seen whether the aforesaid expenditure is relatable to any income forming part of total income assessable in the hands of the assessee. [Para 9] By virtue of insertion of section 10(33), with effect from 1-4-1998 by the Finance Act, 1997, dividend income received by the assessee became exempt. During the year under consideration, the assessee had claimed the interest paid on the borrowed funds as a deduction though the dividend income was exempt. The similar issue was considered at length by the Ahmedabad Bench of the Tribunal in the case of Harish Krishnakant Bhatt v. ITO [2004] 91 ITD 311. The Tribunal after considering the issue of the dividend not being taxable and the insertion of the provision of section 14A concluded that income being exempt from tax, no part of expenditure attributable to earning of such exempted income was to be allowed after the insertion of section 14A. The Tribunal also considered the issue of allowability of expenditure in past and held that the dividend income became non-includible only with effect from the assessment year 1998-99 and since the expenditure was incurred for earning taxable income at that time, it would not change its character by subsequent event. [Para 10] In the instant case, it was an admitted position that part of the borrowed money was utilized for the purpose of investment in shares, from which dividend income was received, which was exempt from tax. In view of the decision of the Ahmedabad Bench of the Tribunal in the case of Harish Krishnakant Bhatt (supra), the expenditure being interest paid on such borrowings utilized for the purpose of investment in shares, dividend from which was exempt under section 10(33) was not to be allowed as an expenditure in view of the provisions of section 14A. The assessee had also claimed to have utilized its borrowings raised during the year for the purpose of investments made in foreign companies, dividend from which was not governed by the provisions of section 115-O and, hence, was not exempt under section 10(33). These facts were not brought on record before the Assessing Officer and, thus, the matter had to go back to the file of Assessing Officer for quantifying the amount of interest attributable to the borrowings utilized for investments made in foreign companies during the year under consideration and the interest thereon. The interest on borrowings attributable to investments made in foreign companies was to be considered for allowance under section 57(iii) and the same would be considered by the Assessing Officer as per the provisions of the Act. The assessee had also utilized part of the borrowings raised during the year for investment made in units of growth fund. The claim being of investment in growth plan, no income from which was received from year to year and the annual accretions were added to the NAV of the growth fund without any distribution of income which was taxable in the hands of the assessee for the year under consideration. Therefore, the income from such investments was not amenable to tax, the interest on such borrowings utilized for making investments in the units of the growth fund was not allowable as an expenditure in view of the provisions of section 14A. [Para 11] The alternate claim of the assessee was to allow the interest paid on borrowings for investment in shares as part of its cost of acquisition. Similar claim had also been considered and deliberated upon by the Ahmedabad Bench of the Tribunal in the case of Harish Krishnakant Bhatt (supra) and the Tribunal had held that the expenditure would not be allowable at all to the assessee even while computing the income under the head capital gains and on the theory of indivisibility of source of income. [Para 12] The Assessing Officer had made ad hoc disallowance of 10 per cent of the total administrative and other expenses being attributable to earning of dividend income and, thus, hit by section 14A. The Commissioner (Appeals) restricted the disallowance to some extent. No part of administrative expenses were directly relatable to the earning of dividend income and there was no merit in making ad hoc disallowance of portion of the expenditure being attributable to earning of dividend income. Accordingly, the Assessing Officer was directed not to disallow any expenditure towards earning of dividend income. [Paras 14, 15]