Holding

Section 14A disallows any expenditure incurred in relation to exempt dividend income, and the apportionment principle under Rule 8D applies irrespective of the dominant purpose of the investment.

Summary

The Supreme Court examined whether interest expenditure incurred by Maxopp Investment Ltd. on shares held to acquire controlling interest, or held as stock‑in‑trade, could be deducted when the dividend income from those shares is exempt under Section 10. The Court held that the dominant‑purpose test is irrelevant; Section 14A(1) disallows any expenditure "in relation to" exempt income and the principle of apportionment under Rule 8D must be applied. Where shares are held as stock‑in‑trade, the expenditure must be apportioned between taxable business profit and exempt dividend, and the Assessing Officer must record satisfaction before making a suo‑motu disallowance. The Court dismissed the assessees' appeals and the Revenue's appeals (except one), affirming that Section 14A applies and that Rule 8D is prospective.

Issues considered

The applicability of Section 14A(1) to interest expenditure on shares acquired for controlling interest when dividend income is exempt.
Whether the dominant‑purpose test should govern the interpretation of Section 14A or the apportionment principle under Rule 8D.
Whether shares held as stock‑in‑trade attract Section 14A and require apportionment of expenditure.
Whether the Assessing Officer must record satisfaction before invoking suo‑motu disallowance under Section 14A.
Whether Rule 8D is prospective and can be applied to assessment years prior to its insertion.

Legislation cited

Banking Regulation Act, 1949
Finance Act, 2001
Finance Act, 2002
Finance Act, 2006
Income Tax Act, 1961s. 10(34), s. 10(35), s. 14A, s. 28, s. 29, s. 30, s. 31, s. 32, s. 33, s. 34, s. 35, s. 36, s. 36(1)(iii), s. 37, s. 56, s. 57
Income Tax Rules, 1962s. Rule 8D

Subjects

Income TaxSection 14ADividendExempt incomeApportionmentDominant purpose testStock‑in‑tradeRule 8DAssessing OfficerSuo‑motu disallowanceRetrospective legislation

Judgment

[2018] 2 S.C.R. 783 783

MAXOPP INVESTMENT LTD. A
v.
COMMISSIONER OF INCOME TAX, NEW DELHI
(Civil Appeal Nos. 104-109 of 2015)
FEBRUARY 12, 2018 B
[A. K. SIKRI AND ASHOK BHUSHAN, JJ.]
Income Tax Act, 1961:
s. 14A – Applicability of – To dividend income – In cases
where dominant purpose of investment was to retain controlling C
interest in a Company/group of companies or where dominant
purpose was to have stock-in-trade – Whether dominant purpose
test or theory of apportionment to be applied for interpreting the
provision – Held: For interpreting s. 14A, dominant purpose for
which investment into shares is made by an assessee, may not be
D
relevant – Principle of appointment comes into play as that is the
principle which is engrained in s. 14A – s. 14A is applicable to the
dividend income irrespective of whether the shares are held to gain
control or as stock-in-trade – However, where shares are held as
stock-in-trade, the expenditure incurred in acquiring those shares
have to be apportioned – Only that expenditure which is “in relation E
to” earning dividends can be disallowed u/s. 14A and s. 8D –
Assessing Officer needs to record satisfaction having regard to the
kind of assessee why the claim of assessee as to the quantum of suo
motu disallowance u/s. 14A was not correct – Income Tax Rules,
1962 – r. 8D.
F
Disposing of the appeals, the Court
HELD: 1. As per Section 14A(1) of the Income Tax 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 G
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
H
783
784 SUPREME COURT REPORTS [2018] 2 S.C.R.

A from tax, and such expenditure would be allowed as business
expenditure. Such expenditure would then be considered as
incurred in respect of other income which is to be treated as part
of the total income. [Para 32][808-A-C]
2. For interpreting Section 14A of the Act, the dominant
B purpose for which the investment into shares is made by an
assessee, may not be relevant. No doubt, the assessee may have
made the investment in order to gain control of the investee
company. However, that does not appear to be a relevant factor
in determining the issue at hand. Fact remains that such dividend
income is non-taxable. In this scenario, if expenditure is incurred
C on earning the dividend income, that much of the expenditure
which is attributable to the dividend income has to be disallowed
and cannot be treated as business expenditure. Keeping this
objective behind Section14A of the Act in mind, the said provision
has to be interpreted, particularly, the word ‘in relation to the
D income’ that does not form part of total income. Considered in
this hue, the principle of apportionment of expenses comes into
play as that is the principle which is engrained in Section 14A of
the Act. [Para 34][808-F-H; 809-A-B]
3. Delhi High Court, therefore, correctly observed that prior
E to introduction of Section 14A of the Act, the law was that when
an assessee had a composite and indivisible business which had
elements of both taxable and non-taxable income, the entire
expenditure in respect of said business was deductible and, in
such a case, the principle of apportionment of the expenditure
relating to the non-taxable income did not apply. The principle of
F
apportionment was made available only where the business was
divisible. It is to find a cure to the aforesaid problem that the
Legislature has not only inserted Section 14A by the Finance
(Amendment) Act, 2001 but also made it retrospective, i.e., 1962
when the Income Tax Act itself came into force. The aforesaid
G intent was expressed loudly and clearly in the Memorandum
explaining the provisions of the Finance Bill, 2001. The opinion
of Punjab & Haryana High Court which went by dominant purpose
theory, is not acceptable. The aforesaid reasoning would be
applicable in cases where shares are held as investment in the
H
MAXOPP INVESTMENT LTD. v. COMMISSIONER OF 785
INCOME TAX, NEW DELHI

investee company, may be for the purpose of having controlling A
interest therein. [Para 35][809-E-H; 810-A]

4. In the cases, where shares are held as stock-in-trade,
the main purpose is to trade in those shares and earn profits
therefrom. When the shares are held as ‘stock-in-trade’, certain
dividend is also earned, though incidentally, which is also an B
income. However, by virtue of Section 10 (34) of the Act, this
dividend income is not to be included in the total income and is
exempt from tax. This triggers the applicability of Section 14A of
the Act which is based on the theory of apportionment of
expenditure between taxable and non-taxable income. Therefore, C
to that extent, depending upon the facts of each case, the
expenditure incurred in acquiring those shares will have to be
apportioned. [Para 39][811-A-C]

5. The cases where shares are held as ‘stock-in-trade’, it
becomes a business activity of the assessee to deal in those shares D
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. [Para 40][811-F-G]
E
6. Having regard to the language of Section 14A(2) of the
Act, read with Rule 8D of the Income Tax Rules, it is made clear
that before applying the theory of apportionment, the AO needs
to record satisfaction that having regard to the kind of the
assessee, suo moto disallowance under Section 14A was not
F
correct. 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. Further, while recording such a
satisfaction, nature of loan taken by the assessee for purchasing
the shares/making the investment in shares is to be examined G
by the AO. [Para 41][812-C-D]

CIT v. Walfort Share and Stock Brokers P Ltd. (2010)
326 ITR 1 (SC) – relied on.

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786 SUPREME COURT REPORTS [2018] 2 S.C.R.

A ITO v. Daga Capital Management (Private) Ltd.
312 ITR (AT) 1 ; Principal Commissioner of Income
Tax v. State Bank of Patiala (2017) 391 ITR 218
(P&H) ; CCI Ltd. v. Joint Commissioner of Income Tax,
Udupi Range (2012) 206 Taxman 563 ; Commissioner
of Income Tax, Mumbai v. M/s. Essar Teleholdings Ltd.
B
through its Manager 2018 (1) SCALE 681 ; Doypack
Systems Pvt. Ltd. v. Union of India (1988) 2 SCC 299 :
[1988] 2 SCR 962 ; CIT v. Nawanshahar Central
Co-operative Bank Ltd. (2007) 289 ITR 6 (SC) ;
Commissioner of Income Tax v. G.K.K. Capital Markets
C (P.) Ltd. (2017) 392 ITR 196 (Cal) ; Dhanuka and Sons
v. CIT (2011) 339 ITR 319 (Cal) – referred to.
Case Law Reference
312 ITR (AT) 1 referred to Para 6
D (2017) 391 ITR 218 (P&H) referred to Para 10
(2012) 206 Taxman 563 referred to Para 10
2018 (1) SCALE 681 referred to Para 12
[1988] 2 SCR 962 referred to Para 16
E (2010) 326 ITR 1 (SC) relied on Para 16
(2007) 289 ITR 6 (SC) referred to Para 21
(2017) 392 ITR 196 (Cal) referred to Para 25
(2011) 339 ITR 319 (Cal) referred to Para 26
F CIVIL APPELLATE JURISDICTION : Civil Appeal Nos. 104-
109 of 2015.
From the Judgment and Order dated 18.11.2011 of the High Court
of Delhi at New Delhi in ITA No. 687, 853, 856, 1060 of 2009, 263 and
416 of 2010
G WITH
Civil Appeal Nos.3267 and 10096 of 2013, Civil Appeal
Nos. 8596 of 2014, Civil Appeal Nos.1423, 130, 110-112, 115, 123, 6590
of 2015, Civil Appeal No.18019 of 2017, Civil Appeal Nos.1500, 1508,
1505, 1576, 1579, 1578, 1580, 1575, 2802, 2791, 2792, 1577, 2793 and
2794 of 2018.
H
MAXOPP INVESTMENT LTD. v. COMMISSIONER OF 787
INCOME TAX, NEW DELHI

Jehangir D. Mistri, K. Radhakrishnan, Ajay Vohra, Sanjay Kumar A
Bansal, Sr. Advs., Ms. Vanita Bhargava, Ajay Bhargava, Rony O. John,
Abhisaar Bairagi, M/S. Khaitan & Co., Arijit Prasad, Rupesh Kumar,
D. L. Chidananda, Ms. Sadhna Sandhu, Ms. Gargi Khanna, Manish
Pushkarna, Ritin Rai, Mrs. Anil Katiyar, Satyen Sethi, Ms. Gargi S.,
Rameshwar Prasad Goyal, Arta Trana Panda, Brajesh Kumar, Rajiv
B
Tyagi, D. Kumar, Dr. Rakesh Gupta, Ambhoj Kumar Sinha, Ms. Monika
Ghai, Somil Agarwal, Ms. Kavita Jha, Udit Haresh, Ms. Kavita Jha,
Amit Prasad, Aljo K. Joseph, Ashish Somvashi, Ms. Shelna K., Mayank
Nagi, Tarun Singh, Shubham, Shekhar Prit Jha, Shrey Cathly, Nikhil Gupta,
Apoorv Chandra Saxena, Sumit K. Batra, Pranjal Srivastava, Subodh S.
Patil, Advs. for the appearing parties. C
The Judgment of the Court was delivered by
A. K. SIKRI, J. 1. Chapter IV of the Income Tax Act, 1961
(hereinafter referred to as the ‘Act’) contains the provisions pertaining
to ‘computation of total income’. Section 14 which is the first provision
under this Chapter enumerates five heads of income within which all D
income are to be classified. Under the scheme of the Act, certain types
of income are exempt from tax and, in this behalf, specific provisions
are made stipulating that such incomes would not form part of the total
income under the Act as fortiorari, they are not included under any of
the heads of income and, therefore, no taxes levied on such exempted E
incomes. It is in this backdrop, Section 14A of the Act clarifies that if
any expenditure is incurred in earning that income which does not form
part of the total income, such expenditure shall also not be allowed as
deduction. Though, Section 14A was inserted by the Finance Act, 2001,
but it was given retrospective effect from April 1, 1962. Original Section
was in the following terms: F

“Section 14A - 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.”
G
2. By the Finance Act, 2006, the aforesaid provision was amended
whereby it was renumbered as sub-section (1) and sub-sections (2) and
(3) were added thereto. Before that, a proviso was also added by
amendment vide Finance Act, 2002 which was to operate retrospectively
from May 11, 2001. In these batch of appeals, we are not concerned
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788 SUPREME COURT REPORTS [2018] 2 S.C.R.

A with sub-sections (2), (3) or the proviso and it is only interpretation that
has to be given to sub-section (1), which arises for consideration.
3. Though, it is clear from the plain language of the aforesaid
provision that no deduction is to be allowed in respect of expenditure
incurred by the assessee in relation to income which does not form part
B of the total income under the Act, the effect whereof is that if certain
income is earned which is not to be included while computing total income,
any expenditure incurred to earn that income is also not allowed as a
deduction. It is well known that tax is leviable on the net income. Net
income is arrived at after deducting the expenditures incurred in earning
that income. Therefore, from the gross income, expenditure incurred to
C earn that income is allowed as a deduction and thereafter tax is levied
on the net income. The purpose behind Section 14A 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
D 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. For example, income in the form of dividend
earned on shares held in a company is not taxable. If a person takes
interest bearing loan from the Bank and invests that loan in shares/stocks,
dividend earned therefrom is not taxable. Normally, interest paid on the
E loan would be expenditure incurred for earning dividend income. Such
an interest would not be allowed as deduction as it is an expenditure
incurred in relation to dividend income which itself is spared from tax
net. There is no quarrel upto this extent.
4. However, in these appeals, the question has arisen under varied
F circumstances where the shares/stocks were purchased of a company
for the purpose of gaining control over the said company or as ‘stock-in-
trade’. However, incidentally income was also generated in the form of
dividends as well. On this basis, the assessees contend that the dominant
intention for purchasing the share was not to earn dividends income but
G control of the business in the company in which shares were invested or
for the purpose of trading in the shares as a business activity etc. In this
backdrop, the issue is as to whether the expenditure incurred can be
treated as expenditure ‘in relation to income’ i.e. dividend income which
does not form part of the total income. To put it differently, is the dominant
or main object would be a relevant consideration in determining as to
H
MAXOPP INVESTMENT LTD. v. COMMISSIONER OF 789
INCOME TAX, NEW DELHI [A. K. SIKRI, J.]

whether expenditure incurred is ‘in relation to’ the dividend income. In A
most of the appeals, including in Civil Appeal Nos. 104-109 of 2015,
aforesaid is the scenario. Though, in some other cases, there may be
little difference in fact situation. However, all these cases pertain to
dividend income, whether it was for the purpose of investment in order
to retain controlling interest in a company or in group of companies or
B
the dominant purpose was to have it as stock-in-trade.
5. Before we proceed further, we may briefly note the facts of
Civil Appeal Nos. 104-109 of 2015, for better understanding of the issue
involved.
The appellant company is engaged, inter alia, in the business of C
finance, investment and dealing in shares and securities. The appellant
holds shares/securities in two portfolios, viz. (a) as investment on capital
account; and, (b) as trading assets for the purpose of acquiring and
retaining control over investee group companies, particularly Max India
Ltd., a widely held quoted public limited company. Any profit/loss arising
on sale of shares/securities held as ‘investment’ is returned as income D
under the head ‘capital gains’, whereas profit/loss arising on sale of
shares/securities held as ‘trading assets’ (i.e. held, inter alia, with the
intention of acquiring, exercising and retaining control over investee group
companies) has been regularly offered and assessed to tax as business
income under the head ‘profits and gains of business or profession’. E
Consistent with the aforesaid treatment regularly followed, the
appellant filed return for the previous year relevant to the Assessment
Year 2002-03, declaring income of Rs.78,90,430/-. No part of the interest
expenditure of Rs.1,16,21,168/- debited to the profit and loss account, to
the extent relatable to investment in shares of Max India Limited, yielding F
tax free dividend income, was considered disallowable under Section
14A of the Act on the ground that shares in the said company were
acquired for the purposes of retaining controlling interest and not with
the motive of earning dividend. According to the appellant, the dominant
purpose/intention of investment in shares of Max India Ltd. was acquiring/
retaining controlling interest therein and not earning dividend and, G
therefore, dividend of Rs.49,90,860/- earned on shares of Max India
Ltd. during the relevant previous year was only incidental to the holding
of such shares. The Assessing Officer (AO), while passing the
assessment order dated August 27, 2004, under Section 143(3) worked
out disallowance under Section 14A of the Act at Rs.67,74,175/- by H
790 SUPREME COURT REPORTS [2018] 2 S.C.R.

A apportioning the interest expenditure of Rs.1,16,21,168/- in the ratio of
investment in shares of Max India Ltd. (on which dividend was received)
to the total amount of unsecured loan. The AO, however, restricted
disallowance under that Section to Rs.49,90,860/- being the amount of
dividend received and claimed exempt.
B 6. In appeal, the Commissioner of Income Tax (Appeals)
{CIT(A)} vide order dated January 12, 2005 upheld the order of the
AO. The appellant herein carried the matter in further appeal to the
Income Tax Appellate Tribunal, New Delhi (for short the ‘ITAT’). In
view of the conflicting decisions of various Benches by the ITAT with
respect to the interpretation of Section 14A of the Act, a Special Bench
C was constituted in the matter of ITO v. Daga Capital Management
(Private) Ltd.1 The appeal of the appellant was also tagged and heard
by the aforesaid Special Bench.
7. The Special Bench of the ITAT in the case of Daga Capital
Management (Private) Ltd., dismissing the appeal of the appellant,
D inter alia, held that investment in shares representing controlling interest
did not amount to carrying on of business and, therefore, interest
expenditure incurred for acquiring shares in group companies was hit by
the provisions of Section 14A of the Act. The Special Bench further
held that holding of shares with the intention of acquiring/retaining
E controlling interest would normally be on capital account, i.e. as investment
and not as ‘trading assets’. For that reason too, the Special Bench held
that there existed dominant connection between interest paid on loan
utilized for acquiring the aforesaid shares and earning of dividend income.
Consequently, the provisions of Section 14A of the Act were held to be
attracted on the facts of the case.
F
8. On the interpretation of the expression ‘in relation to’, the
majority opinion of the Special Bench was that the requirement of there
being direct and proximate connection between the expenditure incurred
and exempt income earned could not be read into the provision.
According to the majority view, ‘what is relevant is to work out the
G expenditure in relation to the exempt income and not to examine whether
the expenditure incurred by the assessee has resulted into exempt income
or taxable income’. As per the minority view, however, the existence of
dominant and immediate connection between the expenditure incurred
and dividend income was a condition precedent for invoking the provisions
H 1
312 ITR (AT) 1
MAXOPP INVESTMENT LTD. v. COMMISSIONER OF 791
INCOME TAX, NEW DELHI [A. K. SIKRI, J.]

of Section 14A of the Act. It was accordingly held, as per the minority, A
that mere receipt of dividend income, incidental to the holding of shares,
in the case of a dealer in shares, would not be sufficient for invoking
provisions of Section 14A of the Act.
9. Against the aforesaid order of the Special Bench, the appellant
preferred appeal under Section 260A of the Act to the High Court. The B
High Court of Delhi has, vide impugned judgment dated November 18,
2011, held that the expression ‘in relation to’ appearing in Section 14A of
the Act was synonymous with ‘in connection with’ or ‘pertaining to’,
and, that the provisions of that Section apply regardless of the intention/
motive behind making the investment. As a consequence, proportionate
disallowance of the expenditure incurred by the assessee is maintained. C

10. It would be pertinent to point out at this stage that Punjab and
Haryana High Court in a recent judgment in the case of Principal
Commissioner of Income Tax v. State Bank of Patiala2 has taken a
view which runs contrary to the aforesaid view taken by the Delhi High
Court. The Punjab and Haryana High Court followed, with approval, D
the judgment of the High Court of Karnataka in CCI Ltd. v. Joint
Commissioner of Income Tax, Udupi Range3 The Revenue has filed
appeals challenging the correctness of the aforesaid decisions. Thus, in
view of conflict of opinions of various High Courts, these batch of appeals
are by those assessees who were lost before the High Court and by the E
Income Tax Department against the judgments of the High Court where
the view taken is favourable to the assessee and against the Revenue.
11. Before adverting to the discussions on these judgments, let us
go through the relevant statutory provisions, as that would enable us to
appreciate the ratio of these cases more appropriately. Since the focus F
of discussion is Section 14A of the Act, we reproduce Section 14A in its
entirety hereinbelow:
“Expenditure incurred in relation to income not includible in total
income.
14A. (1) For the purposes of computing the total income under G
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
(2017) 391 ITR 218 (P&H)
3
(2012) 206 Taxman 563 H
792 SUPREME COURT REPORTS [2018] 2 S.C.R.

A (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
B
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
C 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
an order enhancing the assessment or reducing a refund already
made or otherwise increasing the liability of the assessee under
D section 154, for any assessment year beginning on or before the
1st day of April, 2001.”
12. Sub-section (2) of Section 14A deals with the proportionality
as it empowers the AO to extricate that amount of expenditure which is
incurred in relation to such income which does not form part of the total
E income under the Act. However, this is to be done ‘in accordance with
such method as may be prescribed.’ This prescription is provided by the
delegated legislation, in the form of Rule 8D of the Income Tax Rules,
1962 (for short ‘Rules’) which Rule was inserted w.e.f. March 24, 2008
vide Income Tax (Fifth Amendment) Rules, 20084. We, thus, reproduce
F Rule 8D hereunder:
“Method for determining amount of expenditure in relation
to income not includible in total income.
8D.(1) Where the Assessing Officer, having regard to the accounts
of the assessee of a previous year, is not satisfied with—
G
(a) the correctness of the claim of expenditure made by the
assessee; or

4
In Civil Appeal No. 2165 of 2012 (Commissioner of Income Tax, Mumbai v. M/s.
Essar Teleholdings Ltd. through its Manager pronounced on January 31, 2018, this
H Court has held that Rule 8D is prospective in nature.
MAXOPP INVESTMENT LTD. v. COMMISSIONER OF 793
INCOME TAX, NEW DELHI [A. K. SIKRI, J.]

(b) the claim made by the assessee that no expenditure has been A
incurred,
in relation to income which does not form part of the total income
under the Act for such previous year, he shall determine the amount
of expenditure in relation to such income in accordance with the
provisions of sub-rule (2). B
(2) The expenditure in relation to income which does not form
part of the total income shall be the aggregate of following
amounts, namely:—
(i) the amount of expenditure directly relating to income which
does not form part of total income; C

(ii) in a case where the assessee has incurred expenditure by
way of interest during the previous year which is not directly
attributable to any particular income or receipt, an amount
computed in accordance with the following formula, namely:—
D

Where A = amount of expenditure by way of interest other than
the amount of interest included in clause (i) incurred during the
previous year; E
B = the average of value of investment, income from which does
not or shall not form part of the total income, as appearing in the
balance sheet of the assessee, on the first day and the last day of
the previous year;
C = the average of total assets as appearing in the balance sheet F
of the assessee, on the first day and the last day of the previous
year;
(iii) an amount equal to one-half per cent of the average of the
value of investment, income from which does not or shall not
form part of the total income, as appearing in the balance sheet of G
the assessee, on the first day and the last day of the previous
year.
(3) For the purposes of this rule, the “total assets” shall mean,
total assets as appearing in the balance sheet excluding the increase
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794 SUPREME COURT REPORTS [2018] 2 S.C.R.

A on account of revaluation of assets but including the decrease on
account of revaluation of assets.”
13. With the aforesaid statutory scheme in mind, we traverse
through the judgments of the Delhi High Court in Maxopp Investment
Ltd. and that of Punjab and Haryana High Court in State Bank of
B Patiala.
JUDGMENT OF DELHI HIGH COURT IN MAXOPP
INVESTMENT LTD.
14. Three questions fell for consideration before the High Court.
For the purpose of these appeals, it is only question No. 1 which is
C relevant, and formulation thereof by the High Court was as under:
“1. Whether expenditure (including interest paid on funds borrowed)
in respect of investment in shares of operating companies for
acquiring and retaining a controlling interest therein is hit by section
14A of the Income tax Act, 1961 inasmuch as the dividend received
D on such shares does not form part of the total income?”
15. On facts, it was noted that the assessee company is in the
business of finance, investment and was dealing in shares and securities.
The assessee held shares and securities, partly as investments on the
“capital account” and partly as “trading assets” for the purpose of
E acquiring and retaining control over its group companies, primarily Max
India Ltd. As per the assessee, any profit resulting on the sale of shares
held as trading assets was duly offered to tax as business income of the
assessee. During the previous year relevant to the assessment year
2002-03, the assessee incurred total interest expenditure of
F Rs. 1,61,21,168/-, which was claimed as business expenditure under
section 36(1)(iii) of the Income Tax Act, 1961 (hereinafter referred to
as “the said act”). According to the assessee, the expenditure claimed
was not hit by section 14A of the Act, on the ground that although
borrowed funds were partly utilised for investment in shares held as
trading assets, such investment was made with the intention to acquire
G and retain a controlling interest in the aforesaid company and that the
receipt of dividend thereon was merely incidental. The High Court then
took note of legislative history of Section 14A of the Act and Rule 8D of
the Rules. Thereafter, the Court went on to discuss the law which stood
prior to insertion of Section 14A. Taking note of certain judgments, the
High Court observed that prior to the insertion of Section 14A in the Act,
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MAXOPP INVESTMENT LTD. v. COMMISSIONER OF 795
INCOME TAX, NEW DELHI [A. K. SIKRI, J.]

the law was that when an assessee had a composite and indivisible A
business, which had elements of both taxable and non-taxable income,
the entire expenditure in respect of the said business was deductible
and, in such a case, the principle of apportionment of the expenditure
relating to the non-taxable income did not apply. However, where the
business was divisible, the principle of apportionment of the expenditure
B
was applicable and the expenditure apportioned to the ‘exempt’ income
or income not exigible to tax, was not allowable as a deduction. The
High Court, then, took cognizance of the legislative intent and objective
behind the insertion of Section 14A by referring to the Memorandum
Explaining the Provisions of the Finance Bill, 2001. It also reproduced
passages from few judgments of this Court. Since, for the purpose of C
the present case, it is necessary to keep in mind the objectives behind
this provision, we reproduce that part of the discussion hereunder:
“Objective behind insertion of section 14A
15. The object behind the insertion of section 14A in the said Act
is apparent from the Memorandum explaining the provisions of D
the Finance Bill 2001 which is to the following effect:-
“Certain incomes are not includable while computing the total
income as these are exempt under various provisions of the
Act. There have been cases where deductions have been
claimed in respect of such exempt income. This in effect means E
that the tax incentive given by way of exemptions to certain
categories of income is being used to reduce also the tax payable
on the non-exempt income by debiting the expenses incurred
to earn the exempt income against taxable income. This is
against the basic principles of taxation whereby only the net F
income, i.e., gross income minus the expenditure is taxed. On
the same analogy, the exemption is also in respect of the net
income. Expenses incurred can be allowed only to the extent
they are relatable to the earning of taxable income.
It is proposed to insert a new section 14A so as to clarify the G
intention of the Legislature since the inception of the Income-
tax Act, 1961, that no deduction shall be made in respect of
any expenditure incurred by the assessee in relation to income
which does not form part of the total income under the Income-
tax Act.
H
796 SUPREME COURT REPORTS [2018] 2 S.C.R.

A The proposed amendment will take effect retrospectively from
April 1, 1962 and will accordingly, apply in relation to the
assessment year 1962-63 and subsequent assessment years.”
16. As observed by the Supreme Court in the case of CIT v.
Walfort Share and Stock Brokers P Ltd: 326 ITR 1 (SC), the
B insertion of section 14 A with retrospective effect reflects the
serious attempt on the part of Parliament not to allow deduction in
respect of any expenditure incurred by the assessee in relation to
income, which does not form part of the total income under the
said act against the taxable income. The Supreme Court further
observed as under:-
C
“.. In other words, section 14 A clarifies that expenses incurred
can be allowed only to the extent that they are relatable to the
earning of taxable income. In many cases the nature of
expenses incurred by the assessee may be relatable partly to
the exempt income and partly to the taxable income. In the
D absence of section 14A, the expenditure incurred in respect of
exempt income was being claimed against taxable income. The
mandate of section 14A is clear. It desires to curb the
practice to claim deduction of expenses incurred in relation
to exempt income against taxable income and at the same
time avail of the tax incentive by way of an exemption of
E
exempt income without making any apportionment of
expenses incurred in relation to exempt income…”
“..Expenses allowed can only be in respect of earning taxable
income. This is the purport of section 14A. In section 14A, the
first phrase is “for the purposes of computing the total income
F under this Chapter” which makes it clear that various heads of
income as prescribed in the Chapter IV would fall within section
14A. The next phrase is, “in relation to income which does
not form part of total income under the Act”. It means that
if an income does not form part of total income, then the
G related expenditure is outside the ambit of the applicability
of section 14A..
(Emphasis supplied)”
17. The Supreme Court also clearly held that in the case of an
income like dividend income which does not form part of the total
H
MAXOPP INVESTMENT LTD. v. COMMISSIONER OF 797
INCOME TAX, NEW DELHI [A. K. SIKRI, J.]

income, any expenditure/deduction relatable to such (exempt or A
non-taxable) income, even if it is of the nature specified in sections
15 to 59 of the said Act, cannot be allowed against any other
income which is includable in the total income. The exact words
used by the Supreme Court are as under:-
“Further, section 14 specifies five heads of income which are B
chargeable to tax. In order to be chargeable, an income has to
be brought under one of the five heads. Sections 15 to 59 lay
down the rules for computing income for the purpose of
chargeability to tax under those heads. Sections 15 to 59
quantify the total income chargeable to tax. The permissible
deductions enumerated in sections 15 to 59 are now to be C
allowed only with reference to income which is brought
under one of the above heads and is chargeable to tax. If
an income like dividend income is not a part of the total income,
the expenditure/deduction though of the nature specified in
sections 15 to 59 but related to the income not forming part of D
the total income could not be allowed against other income
includable in the total income for the purpose of chargeability
to tax. The theory of apportionment of expenditure between
taxable and non-taxable has, in principle, been now
widened under section 14 A.
E
(emphasis supplied)”
16. The High Court then undertook the exercise of analysing the
provisions of Section 14A of the Act and, in the process, examined the
contours and scope of the expressions ‘in relation to’ and ‘expenditure
incurred’ occurring therein. The High Court pointed out that contention F
of the assessees, in this behalf, was that the word ‘incurred’ must be
taken literally in the sense that the expenditure must have actually taken
place. Moreover, the expenditure must also have taken place in relation
to income which does not form part of total income. Further, the
expression “in relation to” implies that there must be a direct and
proximate connection with the subject matter. In other words, only that G
actual expenditure which is made directly and for the object of earning
exempt income (in the present appeals - dividend income) could be
disallowed under section 14A of the Act. If the dominant and main
objective of spending was not the earning of ‘exempt’ income then, the
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798 SUPREME COURT REPORTS [2018] 2 S.C.R.

A expenditure could not be disallowed under section 14A of the Act provided
it was otherwise allowable under sections 15 to 59 of the said Act. The
High Court, however, did not agree with the aforesaid propositions
advanced by the learned counsel for the assessees which according to it
was mired by several difficulties. Distinguishing the case law cited by
the assessees where the expression ‘in relation to’ was interpreted by
B
this Court, as not applicable in the present context, the High Court, instead,
referred to the judgment in the case of Doypack Systems Pvt. Ltd. v.
Union of India5 wherein this Court has held that expressions ‘pertaining
to’, ‘in relation to’ and ‘arising out of’ used in the deeming provisions,
are used in an expansive sense. It also referred to the judgment of this
C Court in CIT v. Walfort Share and Stock Brokers P Ltd.6 wherein this
Court has held that the basic principle of taxation is to tax the net income,
i.e., gross income minus the expenditure and on the same analogy the
exemption is also in respect of net income. In other words, where the
gross income would not form part of total income, it’s associated or
related expenditure would also not be permitted to be debited against
D
other taxable income.
17. Likewise, explaining the meaning of ‘expenditure incurred’,
the High Court agreed that this expression would mean incurring of
actual expenditure and not to some imagined expenditure. At the same
time, observed the High Court, the ‘actual’ expenditure that is in
E contemplation under section 14A(1) of the said Act is the ‘actual’
expenditure in relation to or in connection with or pertaining to exempt
income. The corollary to this is that if no expenditure is incurred in relation
to the exempt income, no disallowance can be made under section 14A
of the said Act. On the basis of the aforesaid discussion, the High Court
F answered the question formulated by it in the affirmative.
JUDGMENT OF PUNJAB AND HARYANA HIGH COURT IN
STATE BANK OF PATIALA
18. This case arose in the context where exempt income in the
form of dividend was earned by the Bank from securities held by it as its
G
stock in trade. The assessee filed its return declaring an income of
about Rs.670 crores which was selected for scrutiny. The return showed
dividend income exempt under section 10(34) and (35) of about Rs.11.07
crores and net interest income exempt under section 10(15)(iv)(h) of
5
(1988) 2 SCC 299
H 6
(2010) 326 ITR 1 (SC)
MAXOPP INVESTMENT LTD. v. COMMISSIONER OF 799
INCOME TAX, NEW DELHI [A. K. SIKRI, J.]

about Rs.1.12 crores. The total exempt income claimed in the return A
was, therefore, Rs.12,19,78,015/-. The assessee while claiming the
exemption contended that the investment in shares, bonds, etc. constituted
its stock-in-trade; that the investment had not been made only for earning
tax free income; that the tax free income was only incidental to the
assessee’s main business of sale and purchase of securities and, therefore,
B
no expenditure had been incurred for earning such exempt income; the
expenditure would have remained the same even if no dividend or interest
income had been earned by the assessee from the said securities and
that no expenditure on proportionate basis could be allocated against
exempt income. The assessee also contended that in any event it had
acquired the securities from its own funds and, therefore, section 14A C
was not applicable. The AO restricted the disallowance to the amount
which was claimed as exempt income by applying the formula contained
in Rule 8D holding that Section 14A would be applicable. The CIT(A)
issued notice of enhancement under Section 251 of the Act and held that
in view of Section 14A of the Act, the assessee was not to be allowed
D
any deduction in respect of income which is not chargeable to tax.
Therefore, he disallowed the entire expenditure claimed instead of
restricting the disallowance to the amount which was claimed as exempt
income as done by the AO. The ITAT set aside the order of the AO as
well as CIT(A). It referred to a CBDT Circular No.18/2015 dated
02.11.2015 which states that income arising from investment of a banking E
concern is attributable to the business of banking which falls under the
head “Profits and gains of business and profession”. The circular states
that shares and stock held by the bank are ‘stock-in-trade’ and not
‘investment’. Referring to certain judgments (which we will also refer
to) and the earlier orders of the Tribunal, it was held that if shares are
F
held as stock-in-trade and not as investment even the disallowance under
rule 8D would be nil as rule 8D(2)(i) would be confined to direct expenses
for earning the tax exempt income. In the aforesaid factual backdrop, in
appeal filed by the Revenue, the High Court noted that following
substantial question of law arose for consideration:
G
“Whether in the facts and circumstances of the case, the Hon’ble
ITAT is right in law in deleting the addition made on account of
disallowance under section 14A of the Income Tax Act, 1961?”

H
800 SUPREME COURT REPORTS [2018] 2 S.C.R.

A 19. In its analysis, the High Court accepted the contention of the
counsel for the assessee that the assessee is engaged in the purchase
and sale of shares as a trader with the object of earning profit and not
with a view to earn interest or dividend. The assessee does not have an
investment portfolio. The securities constitute the assessee’s stock-in-
trade. The Department, in fact, rightly accepted, as a matter of fact, that
B
the dividend and interest earned was from the securities that constituted
the assessee’s stock-in-trade. The same is, in any event, established.
The assessee carried on the business of sale and purchase of securities.
It was supported by Circular No.18, dated November 02, 2015, issued
by the CBDT, which reads as under:-
C “Subject: Interest from Non-SLR securities of Banks – Reg.
It has been brought to the notice of the Board that in the case of
Banks, field officers are taking a view that, “expenses relatable
to investment in non-SLR securities need to be disallowed u/s
57(i) of the Act as interest on non-SLR securities is income from
D other sources.”
2. Clause (id) of sub-section (1) of Section 56 of the Act provides
that income by way of interest on securities shall be chargeable
to income-tax under the head “Income from Other Sources”, if,
the income is not chargeable to income-tax under the head “Profits
E and Gains of Business and Profession”.
3. The matter has been examined in light of the judicial decisions
on this issue. In the case of CIT Vs Nawanshahar Central
Cooperative Bank Ltd. [2007] 160TAXMAN 48(SC), the Apex
Court held that the investments made by a banking concern are
F part of the business of banking. Therefore, the income arising
from such investments is attributable to the business of banking
falling under the head “Profits and Gains of Business and
Profession”.
3.2 Even though the abovementioned decision was in the context
G of co-operative societies/Banks claiming deduction under section
80P(2)(a)(i) of the Act, the principle is equally applicable to all
banks/commercial banks, to which Banking Regulation Act, 1949
applies.

H
MAXOPP INVESTMENT LTD. v. COMMISSIONER OF 801
INCOME TAX, NEW DELHI [A. K. SIKRI, J.]

4. In the light of the Supreme Court’s decision in the matter, the A
issue is well settled. Accordingly, the Board has decided that no
appeals may henceforth be filed on this ground by the officers of
the Department and appeals already filed, if any, on this ground
before Courts/Tribunals may be withdrawn/not pressed upon. This
may be brought to the notice of all concerned.
B
(emphasis supplied)”
20. The High Court pointed out that the Circular carves out a
distinction between stock-in-trade and investment and provides that if
the motive behind purchase and sale of shares is to earn profit then the
same would be treated as trading profit and if the object is to derive C
income by way of dividend then the profit would be said to have accrued
from the investment. If the assessee is found to have treated the shares
and securities as stock-in-trade, the income arising therefrom would be
business income. A loss would be a business loss. Thus, an assessee
may have two portfolios, namely, investment portfolio and a trading
portfolio. In the case of the former, the securities are to be treated as D
capital assets and in the latter as trading assets.
21. Further, as a banking institution, the assessee was also
statutorily required to place a part of its funds in approved securities, as
held in CIT v. Nawanshahar Central Co-operative Bank Ltd. 7. Since,
the shares, bonds, debentures purchased by the assessees constituted E
its stock-in-trade, the provisions of Section 14A were not applicable.
Here, the Court noted distinction between stock-in-trade and investment
and made the following observations:
“17. Under section 14A, an expenditure can be disallowed only if
it is incurred by the assessee in relation to income exempt from F
tax. The dividend or interest from the assessee’s stock-in-trade
i.e. the securities was exempt from tax in view of sections
10(15)(iv)(h),(34) and (35). This was incidental to its business of
banking. The business income on account of the assessee trading
in the securities is assessable under the head “Profits and gains of G
business and profession”. The expenditure incurred in relation to
stock-in-trade arising as a result of investment in shares and
debentures is deductible under sections 28 to 37. There is a
distinction between stock-in-trade and investment. The object of
7
(2007) 289 ITR 6 (SC)
H
802 SUPREME COURT REPORTS [2018] 2 S.C.R.

A earning profit from trading in securities is different from the object
of earning income, such as, dividend and interest arising therefrom.
The object of trading in securities does not constitute the activity
of investment where the object is to earn dividend or interest.”
22. The High Court then discussed in detail the judgment in Walfort
B Share and Stock Brokers P Ltd. which related to dividend stripping.
After explaining the objective behind Section 14A of the Act (which is
already noted above), this Court in the facts of that case, had held that a
payback does not constitute an ‘expenditure incurred’ in terms of Section
14A as it does not impact the profit and loss account. This expenditure,
in fact, is a payout.
C
23. According to the High Court, what is to be disallowed is the
expenditure incurred to “earn” exempt income. The words ‘in relation
to’ in Section 14A must be construed accordingly. Applying that principle
to the facts at hand, the High Court concluded as under:
D “Now, the dividend and interest are income. The question then is
whether the assessee can be said to have incurred any expenditure
at all or any part of the said expenditure in respect of the exempt
income viz. dividend and interest that arose out of the securities
that constituted the assessee’s stock-in-trade. The answer must
be in the negative. The purpose of the purchase of the said
E securities was not to earn income arising therefrom, namely,
dividend and interest, but to earn profits from trading in i.e.
purchasing and selling the same. It is axiomatic, therefore, that
the entire expenditure including administrative costs was incurred
for the purchase and sale of the stock-in-trade and, therefore,
F towards earning the business income from the trading activity of
purchasing and selling the securities. Irrespective of whether the
securities yielded any income arising therefrom, such as, dividend
or interest, no expenditure was incurred in relation to the same.”
24. We may also note here that the High Court referred to the
G judgment of the Karnataka High Court in CCI Ltd. case and concurred
therewith. This judgment in CCI Ltd. is, however, a very short judgment
which records the submission of counsel for the parties very briefly and
thereafter the entire discussion is contained in para 5 that reads as under:
“5. When no expenditure is incurred by the assessee in earning
the dividend income, no notional expenditure could be deducted
H
MAXOPP INVESTMENT LTD. v. COMMISSIONER OF 803
INCOME TAX, NEW DELHI [A. K. SIKRI, J.]

from the said income. It is not the case of the assessee retaining A
any shares so as to have the benefit of dividend. 63% of the
shares, which were purchased, are sold and the income derived
therefrom is offered to tax as business income. The remaining
37% of the shares are retained. It has remained unsold with the
assessee. It is those unsold shares have yielded dividend, for
B
which, the assessee has not incurred any expenditure at all.
Though the dividend income is exempted from payment of tax, if
any expenditure is incurred in earning the said income, the said
expenditure also cannot be deducted. But in this case, when the
assessee has not retained shares with the intention of earning
dividend income and the dividend income is incidental to his business C
of sale of shares, which remained unsold by the assessee, it cannot
be said that the expenditure incurred in acquiring the shares has
to be apportioned to the extent of dividend income and that should
be disallowed from deductions. In that view of the matter, the
approach of the authorities is not in conformity with the statutory
D
provisions contained under the Act. Therefore, the impugned
orders are not sustainable and require to be set aside.”
25. At this stage, it will also be useful to refer a judgment of
Calcutta High Court in Commissioner of Income Tax v. G.K.K. Capital
Markets (P.) Ltd.8 which has also agreed with the view taken by the
Karnataka High Court. In that case, the assessee was engaged in the E
business of share trading. In the computation of income, the assessee
claimed long-term capital gains as exempt income and declared
expenditure disallowable against it under Section 14A of the Act. The
AO treated the long-term capital gains as business income. The Appellate
Tribunal found that the assessee did not have any investment and all the F
shares were held as stock-in-trade as was evident from the orders of
the lower authorities. On those facts it held that once the assessee had
kept the shares as stock-in-trade, Rule 8D of the Rules would not apply.
On the questions whether the Appellate Tribunal was justified in deleting
the disallowance under Section 14A computed in accordance with Rule
8D and in holding the investments as shares stock-in-trade, the High G
Court held that the AO had accepted the correctness of the disallowable
expenditure offered by the assessee on its claim of the amount as long-
term capital gains. He had not allowed the claim itself treating the amount

8
(2017) 392 ITR 196 (Cal) H
804 SUPREME COURT REPORTS [2018] 2 S.C.R.

A as business income to thereafter disallow the offered expenditure.
According to the High Court, since the finding of fact was recorded by
the AO regarding the exempt income claimed being treated as business
income and the shares held by the assessee having been treated as
stock-in-trade, there could not have been disallowance of expenditure
under Section 14A of the Act and that provision had no application.
B
26. It would be pertinent to mention that earlier judgment of the
same High Court in the case of Dhanuka and Sons v. CIT9 was cited
by the Revenue. However, this judgment was distinguished on the ground
that, in that case, there was no dispute that part of the income of the
assessee from its business was from dividend whereas the assessee
C was unable to produce any material before the authorities below showing
the source from which such shares were acquired. For better
understanding, it would be necessary to note the discussion in the case
of Dhanuka and Sons, which was reproduced by the High Court in
G.K.K. Capital Markets (P.) Ltd. Para 6 to para 9 of Dhanuka and
D Sons read as under:
“6. Mr. Sarkar, the learned advocate appearing on behalf of the
revenue, has, on the other hand, supported the order passed by
the Tribunal and has contended that the assessee itself having
failed to produce material in support of its contention, the Assessing
E Officer rightly assessed the deductible income on proportionate
basis. Mr. Sarkar submits that the same is in conformity with
Rule 8D of the Income tax Rule and thus, we should not interfere
with the order passed by the Tribunal.
7. After hearing the learned counsel appearing for the parties
F and after going through the materials on record and the decisions
cited by Mr. Khaitan, we find that the Supreme Court in the cases
of CIT v. Maharastra Sugar Mills Ltd. [1971] 82 ITR 452 and
Rajasthan State Warehousing Corpn. v. CIT [2000] 242 ITR 450/
109 Taxman 145 having held that where there is one indivisible
business giving rise to taxable income as well as exempt income,
G the entire expenditure incurred in relation to that business would
have to be allowed even if a part of the income earned from the
business is exempt from tax, section 14A of the Act was enacted
to overcome those judicial pronouncements. The object of section
14A of the Act is to disallow the direct and indirect expenditure
H 9
(2011) 339 ITR 319 (Cal)
MAXOPP INVESTMENT LTD. v. COMMISSIONER OF 805
INCOME TAX, NEW DELHI [A. K. SIKRI, J.]

incurred in relation to income which does not form part of the A
total income.
8. In the case before us, there is no dispute that part of the
income of the assessee from its business is from dividend which
is exempt from tax whereas the assessee was unable to produce
any material before the authorities below showing the source from B
which such shares were acquired. Mr. Khaitan strenuously
contended before us that for the last few years before the relevant
previous year, no new share has been acquired and thus, the loan
that was taken and for which the interest is payable by the assessee
was not for acquisition of those old shares and, therefore, the
authorities below erred in law in giving benefit of proportionate C
deduction.
9. In our opinion, the mere fact that those shares were old ones
and not acquired recently is immaterial. It is for the assessee to
show the source of acquisition of those shares by production of
materials that those were acquired from the funds available in the D
hands of the assessee at the relevant point of time without taking
benefit of any loan. If those shares were purchased from the
amount taken in loan, even for instance, five or ten years ago, it is
for the assessee to show by the production of documentary
evidence that such loaned amount had already been paid back E
and for the relevant assessment year, no interest is payable by the
assessee for acquiring those old shares. In the absence of any
such materials placed by the assessee, in our opinion, the authorities
below rightly held that proportionate amount should be disallowed
having regard to the total income and the income from the exempt
source. In the absence of any material disclosing the source of F
acquisition of shares which is within the special knowledge of the
assessee, the assessing authority took a most reasonable approach
in assessment.”
27. We have already stated as to how the two divergent opinions
have emerged from different High Courts and the respective reasons in G
support of these conflicting outcome. Obviously, assessees are banking
upon the reasons which prevailed with the High Courts that have taken
the view which are favourable to the assessees and the Revenue is
relying upon the reasoning given by Delhi High Court as well as Calcutta
H
806 SUPREME COURT REPORTS [2018] 2 S.C.R.

A High Court in Dhanuka and Sons case. Therefore, it may not be
necessary to give a detailed narrative of the arguments which were
advanced by various counsel appearing for the assessees as well as
counsel for the Revenue. A brief resume of their submissions would
serve the purpose.
B 28. Insofar as assessees are concerned, their arguments are
recapitulated in brief hereinbelow:
(i) The holding of investment in group companies representing
controlling interest, amounts to carrying on business, as held in
the various cases.
C (ii) Notwithstanding that dividend income is assessable under the
head “income from other sources”, in view of the mandatory
prescription in Section 56 of the Act, the nature of dividend income
has to be ascertained on the facts of the case. Where dividend
is earned on shares held as stock-in-trade/shares purchased for
D acquiring/retaining controlling interest, dividend income is in the
nature of business income.
(iii) Interest paid on loans borrowed for acquiring shares representing
controlling interest in the investee company is allowable business
expenditure in terms of Section 36(1)(iii) of the Act, since
E acquiring controlling interest in companies and managing,
administering, financing and rehabilitating such companies are
for business and/or professional purposes and not for earned
dividend.
(iv) Conversely, interest paid on funds borrowed for investment in
F shares representing controlling interest does not represent
expenditure incurred for earning dividend income and is not
allowable under Section 57(iii) of the Act (prior to introduction
of Section 14A).
29. Basing their case on the aforesaid principles, it was argued
that when the shares were acquired, as part of promoter holding, for the
G
purpose of acquiring controlling interest in the company, the dominant
object is to keep control over the management of the company and not
to earn the dividend from investment in shares. Whether dividend is
declared/earned or not is immaterial and, in either case, the assessee
would not liquidate the shares in investee companies. Therefore, no
H
MAXOPP INVESTMENT LTD. v. COMMISSIONER OF 807
INCOME TAX, NEW DELHI [A. K. SIKRI, J.]

expenditure was made ‘in relation to’ the income i.e. the dividend income A
and, therefore, Section 14A would not be attracted. In this hue, it was
submitted that Section 14A was to be accorded plain and grammatical
interpretation meaning thereby mandating and requiring a direct and
proximate nexus/link between the expenditure actually incurred and the
earning of the exempt income. It was also argued that even if contextual/
B
purposive interpretation is to be given, that also called for direct and
proximate connection between the expenditure incurred and earning of
dividend. According to the learned counsel appearing for the assessees,
the legislative intention behind inserting Section 14A in this statute was
to exclude both, viz. the receipts which are exempt under the provisions
of the Act as well as expenditure actually incurred ‘in relation thereto’ C
from entering into the computation of assessable income, so as to remove
the double benefit to the assessee (i) in the form of exempt income, on
which no tax is leviable; and (ii) providing deduction in respect of
expenditure actually incurred which directly resulted in the earning of
exempt income by the assessee.
D
30. Mr. K. Radhakrishnan, learned senior counsel appearing for
the Revenue, on the other hand, made a fervent plea to accept the view
taken by the Delhi High Court. He submitted that the objective behind
insertion of Section 14A of the Act manifestly pointed out that expenditure
incurred in respect of income earned, which is exempted from tax, has
to be disallowed. He also pointed out that this message was eloquently E
brought out by this Court in Walfort Share and Stock Brokers P Ltd.
case. Otherwise, argued the learned senior counsel, the assessee will
get double benefit, one, in the form of exemption from income tax insofar
as dividend income is concerned and other by getting deduction on
account of expenditure as well. He, thus, submitted that expression ‘in F
relation to’ had to be given expansive meaning in order to sub-serve the
purpose of the said provision. He also emphasised that literal meaning
of Section 14A of the Act pointed towards that and that was equally the
purpose behind the insertion of Section 14A as well.
31. We have given our thoughtful consideration to the argument G
of counsel for the parties on both sides, in the light of various judgments
which have been cited before us, some of which have already been
taken note of above.

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808 SUPREME COURT REPORTS [2018] 2 S.C.R.

A 32. In the first instance, it needs to be recognised that as per
section 14A(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
B
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 expenditure would then be considered as incurred in
C respect of other income which is to be treated as part of the total income.
33. There is no quarrel in assigning this meaning to section 14A of
the Act. In fact, all the High Courts, whether it is the Delhi High Court
on the one hand or the Punjab and Haryana High Court on the other
hand, have agreed in providing this interpretation to section 14A of the
D Act. The entire dispute is as to what interpretation is to be given to the
words ‘in relation to’ in the given scenario, viz. where the dividend income
on the shares is earned, though the dominant purpose for subscribing in
those shares of the investee company was not to earn dividend. We
have two scenarios in these sets of appeals. In one group of cases the
main purpose for investing in shares was to gain control over the investee
E company. Other cases are those where the shares of investee company
were held by the assessees as stock-in-trade (i.e. as a business activity)
and not as investment to earn dividends. In this context, it is to be
examined as to whether the expenditure was incurred, in respective
scenarios, in relation to the dividend income or not.
F 34. Having clarified the aforesaid position, the first and foremost
issue that falls for consideration is as to whether the dominant purpose
test, which is pressed into service by the assessees would apply while
interpreting Section 14A of the Act or we have to go by the theory of
apportionment. We are of the opinion that the dominant purpose for
G which the investment into shares is made by an assessee may not be
relevant. No doubt, the assessee like Maxopp Investment Limited may
have made the investment in order to gain control of the investee company.
However, that does not appear to be a relevant factor in determining the
issue at hand. Fact remains that such dividend income is non-taxable. In
this scenario, if expenditure is incurred on earning the dividend income,
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MAXOPP INVESTMENT LTD. v. COMMISSIONER OF 809
INCOME TAX, NEW DELHI [A. K. SIKRI, J.]

that much of the expenditure which is attributable to the dividend income A
has to be disallowed and cannot be treated as business expenditure.
Keeping this objective behind Section14A of the Act in mind, the said
provision has to be interpreted, particularly, the word ‘in relation to the
income’ that does not form part of total income. Considered in this hue,
the principle of apportionment of expenses comes into play as that is the
B
principle which is engrained in Section 14A of the Act. This is so held in
Walfort Share and Stock Brokers P Ltd., relevant passage whereof is
already reproduced above, for the sake of continuity of discussion, we
would like to quote the following few lines therefrom.
“The next phrase is, “in relation to income which does not
form part of total income under the Act”. It means that if an C
income does not form part of total income, then the related
expenditure is outside the ambit of the applicability of section
14A..
xxx xxx xxx
D
The theory of apportionment of expenditure between taxable
and non-taxable has, in principle, been now widened under
section 14 A.”
35. The Delhi High Court, therefore, correctly observed that prior
to introduction of Section 14A of the Act, the law was that when an E
assessee had a composite and indivisible business which had elements
of both taxable and non-taxable income, the entire expenditure in respect
of said business was deductible and, in such a case, the principle of
apportionment of the expenditure relating to the non-taxable income did
not apply. The principle of apportionment was made available only where
the business was divisible. It is to find a cure to the aforesaid problem F
that the Legislature has not only inserted Section 14A by the Finance
(Amendment) Act, 2001 but also made it retrospective, i.e., 1962 when
the Income Tax Act itself came into force. The aforesaid intent was
expressed loudly and clearly in the Memorandum explaining the provisions
of the Finance Bill, 2001. We, thus, agree with the view taken by the G
Delhi High Court, and are not inclined to accept the opinion of Punjab &
Haryana High Court which went by dominant purpose theory. The
aforesaid reasoning would be applicable in cases where shares are held
as investment in the investee company, may be for the purpose of having
controlling interest therein. On that reasoning, appeals of Maxopp
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810 SUPREME COURT REPORTS [2018] 2 S.C.R.

A Investment Limited as well as similar cases where shares were purchased
by the assessees to have controlling interest in the investee companies
have to fail and are, therefore, dismissed.
36. There is yet another aspect which still needs to be looked into.
What happens when the shares are held as ‘stock-in-trade’ and not as
B ‘investment’, particularly, by the banks? On this specific aspect, CBDT
has issued circular No. 18/2015 dated November 02, 2015.
37. This Circular has already been reproduced in Para 19 above.
This Circular takes note of the judgment of this Court in Nawanshahar
case wherein it is held that investments made by a banking concern are
C part of the business or banking. Therefore, the income arises from such
investments is attributable to business of banking falling under the head
‘profits and gains of business and profession’. On that basis, the Circular
contains the decision of the Board that no appeal would be filed on this
ground by the officers of the Department and if the appeals are already
filed, they should be withdrawn. A reading of this circular would make
D it clear that the issue was as to whether income by way of interest on
securities shall be chargeable to income tax under the head ‘income
from other sources’ or it is to fall under the head ‘profits and gains of
business and profession’. The Board, going by the decision of this Court
in Nawanshahar case, clarified that it has to be treated as income falling
E under the head ‘profits and gains of business and profession’. The Board
also went to the extent of saying that this would not be limited only to co-
operative societies/Banks claiming deduction under Section 80P(2)(a)(i)
of the Act but would also be applicable to all banks/commercial banks,
to which Banking Regulation Act, 1949 applies.

F 38. From this, Punjab and Haryana High Court pointed out that
this circular carves out a distinction between ‘stock-in-trade’ and
‘investment’ and provides that if the motive behind purchase and sale of
shares is to earn profit, then the same would be treated as trading profit
and if the object is to derive income by way of dividend then the profit
would be said to have accrued from investment. To this extent, the High
G Court may be correct. At the same time, we do not agree with the test
of dominant intention applied by the Punjab and Haryana High Court,
which we have already discarded. In that event, the question is as to on
what basis those cases are to be decided where the shares of other
companies are purchased by the assessees as ‘stock-in-trade’ and not
H as ‘investment’. We proceed to discuss this aspect hereinafter.
MAXOPP INVESTMENT LTD. v. COMMISSIONER OF 811
INCOME TAX, NEW DELHI [A. K. SIKRI, J.]

39. In those cases, where shares are held as stock-in-trade, the A
main purpose is to trade in those shares and earn profits therefrom.
However, we are not concerned with those profits which would naturally
be treated as ‘income’ under the head ‘profits and gains from business
and profession’. What happens is that, in the process, when the shares
are held as ‘stock-in-trade’, certain dividend is also earned, though
B
incidentally, which is also an income. However, by virtue of Section 10
(34) of the Act, this dividend income is not to be included in the total
income and is exempt from tax. This triggers the applicability of Section
14A of the Act which is based on the theory of apportionment of
expenditure between taxable and non-taxable income as held in Walfort
Share and Stock Brokers P Ltd. case. Therefore, to that extent, C
depending upon the facts of each case, the expenditure incurred in
acquiring those shares will have to be apportioned.
40. We note from the facts in the State Bank of Patiala cases that
the AO, while passing the assessment order, had already restricted the
disallowance to the amount which was claimed as exempt income by D
applying the formula contained in Rule 8D of the Rules and holding that
section 14A of the Act would be applicable. In spite of this exercise of
apportionment of expenditure carried out by the AO, CIT(A) disallowed
the entire deduction of expenditure. That view of the CIT(A) was clearly
untenable and rightly set aside by the ITAT. Therefore, on facts, the
Punjab and Haryana High Court has arrived at a correct conclusion by E
affirming the view of the ITAT, though we are not subscribing to the
theory of dominant intention applied by the High Court. 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 F
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. where the assessee would continue to hold
those shares as it wants to retain control over the investee company. In G
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
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812 SUPREME COURT REPORTS [2018] 2 S.C.R.

A such dividend income is 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. In the result,
the appeals filed by the Revenue challenging the judgment of the Punjab
and Haryana High Court in State Bank of Patiala also fail, though law in
B
this respect has been clarified hereinabove.
41. Having regard to the language of Section 14A(2) of the Act,
read with Rule 8D of the Rules, we also make it clear that before applying
the theory of apportionment, the AO needs to record satisfaction that
having regard to the kind of the assessee, suo moto disallowance under
C Section 14A was not correct. 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. Further, while recording such a satisfaction, nature of
loan taken by the assessee for purchasing the shares/making the
D investment in shares is to be examined by the AO.
42. Civil Appeal No. 1423 of 2015 is filed by M/s. Avon Cycles
Limited, Ludhiana, wherein the AO had invoked section 14A of the Act
read with Rule 8D of the Rules and apportioned the expenditure. The
CIT(A) had set aside the disallowance, which view was upturned by the
E ITAT in the following words:
“...Admittedly the assessee had paid total interest of Rs.2.92 crores
out of which interest paid on term loan raised for specific purpose
totals to Rs.1.70 crores and balance interest paid by the assessee
is Rs.1.21 crores. The funds utilized by the assessee being mixed
F funds and in view of the provisions of Rule 8D(2)(ii) of the Income
Tax Rules the disallowance is confirmed at Rs.10,49,851/-, we
find no merit in the ad hoc disallowance made by the CIT (Appeals)
at Rs.5,00,000/-. Consequently, ground of appeal raised by the
Revenue is partly allowed and ground raised by the assessee in
cross-objection is allowed...”
G
Taking note of the aforesaid finding of fact, the High Court has
dismissed the appeal of the assessee observing as under:
“In the present case, after examining the balance-sheet of the
assessee, a finding of fact has been recorded that the funds utilized
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MAXOPP INVESTMENT LTD. v. COMMISSIONER OF 813
INCOME TAX, NEW DELHI [A. K. SIKRI, J.]

by the assessee being mixed funds, therefore, the interest paid by A
the assessee is also an interest on the investments made. Such
being a finding of fact, we do not find that any substantial question
of law arises for consideration of this Court.”
After going through the records and applying the principle of
apportionment, which is held to be applicable in such cases, we do not B
find any merit in Civil Appeal No. 1423 of 2015, which is accordingly
dismissed.
43. Few appeals are filed by the Revenue against the assessees
which pertained to the period prior to the introduction of Rule 8D of the
Rules. Here, the case is decided in favour of the assessees also on the C
ground that Rule 8D of the Rules is prospective in nature and could not
have been made applicable in respect of the Assessment Years prior to
2007 when this Rule was inserted. This view has already been upheld
by this Court in Civil Appeal No. 2165 of 2012 (Commissioner of Income
Tax, Mumbai v. M/s. Essar Teleholdings Ltd. through its Manager),
pronounced on January 31, 2018, that the said Rule is prospective in D
nature. On this ground alone, these appeals of the Revenue fail as it is
not necessary to go into the other issues.
44. To sum up:
(a) Appeals of the assessees, i.e. Civil Appeal Nos. 104-109, 110- E
112, 130, 1423 of 2015, are dismissed.
(b) Appeals of the Revenue, i.e. Civil Appeal Nos. 3267, 19614,
10096 of 2013, 8596 of 2014, 18019 of 2017, 115, 123, 6590 of
2015, Civil Appeals arising out of SLP (C) Nos. 27054, 31417
of 2016, 20475, 23123, 32405 of 2017, Diary Nos. 36413, 39820, F
39823, 41890, 41903, 41922 of 2017 and 1146 of 2018 are
dismissed.
(c) Appeal of the Revenue, i.e. Civil Appeal arising out of Diary
No. 41203 of 2017, is allowed.
G
Kalpana K. Tripathy Appeals disposed of.

H