Holding

When a bank’s interest‑free funds exceed the amount invested in tax‑free securities, the investment is deemed to be made from those funds and Section 14A does not permit a proportionate disallowance of interest.

Summary

South Indian Bank Ltd. and other scheduled banks earned tax‑free income from bonds, securities and shares. The Assessing Officer, unable to identify the exact funds used for these investments, proportionately disallowed interest expense under Section 14A of the Income Tax Act. The banks argued that they had sufficient interest‑free funds and could appropriate investments from those funds, making the disallowance impermissible. The Supreme Court held that when interest‑free funds exceed the amount invested, the investment is deemed to be made from those funds and the revenue cannot estimate a proportionate disallowance. Consequently, the Court found no nexus between the disallowed interest and the exempt income and set aside the proportionate disallowance. The appeals of the banks were allowed, overturning the High Court’s order.

Issues considered

Whether proportionate disallowance of interest paid by banks is required under Section 14A for investments in tax‑free bonds/securities when the banks have sufficient interest‑free own funds.
Whether the absence of separate accounts for interest‑free and interest‑bearing funds obliges the Assessing Officer to apportion interest expense.
Whether the revenue can presume that investments were made from interest‑bearing funds in the presence of adequate interest‑free funds.

Legislation cited

Income Tax Act, 1961s. 14A

Subjects

Section 14Atax‑free incomeinterest disallowancemixed fundsbanking sectorseparate accountsproportionate disallowanceIncome Tax Act

Judgment

154 [2021]
SUPREME COURT 6 S.C.R. 154
REPORTS [2021] 6 S.C.R.

A SOUTH INDIAN BANK LTD.
v.
COMMISSIONER OF INCOME TAX
(Civil Appeal No. 9606 of 2011)
B SEPTEMBER 09, 2021
[SANJAY KISHAN KAUL AND HRISHIKESH ROY, JJ.]
Income Tax Act, 1961 – s.14A – Interpretation of – Assessees
are scheduled banks and in course of their banking business, they
also engage in the business of investments in bonds, securities and
C
shares which earn the assessees, interests from such securities and
bonds as also dividend income on investments in shares of
companies and from units of UTI etc. which are tax free – Whether
proportionate disallowance of interest paid by the banks is called
for u/s.14A for investments made in tax free bonds/ securities which
D yield tax free dividend and interest to assessee Banks when assessee
had sufficient interest free own funds which were more than the
investments made – Held: Proportionate disallowance of interest
is not warranted, u/s.14A 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
E
with the Assessee, exceeded their investments – High Court erred
in endorsing the proportionate disallowance made by the Assessing
Officer u/s.14A to the extent of investments made in tax-free bonds/
securities primarily because, separate account was not maintained
by assessee – Though an assessee definitely has the obligation to
F 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.
Tax/Taxation – In taxation regime, there is no room for
G presumption and nothing can be taken to be implied.
Allowing the appeals filed by the assessee, the Court
HELD:1. 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
H
154
SOUTH INDIAN BANK LTD. v. COMMISSIONER 155
OF INCOME TAX

investment must be considered to have been made out of the A
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
B
proportionate figure. [Para 17][162-C-D]
2. 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 Income Tax Act,
1961. In other words, if investments in securities is made out
C
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. [Para 20][163-E]
3. The High Court endorsed the proportionate D
disallowance made by the Assessing Officer under Section 14A
of the Income Tax Act to the extent of investments made in
tax-free bonds/securities primarily because, separate account was
not maintained by assessee. Though 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 E
obligation upon the assessee to maintain separate accounts for
different types of funds held by it. [Para 22][164-B-C; 164-E-F]
4. The Central Board of Direct Taxes (CBDT) had issued
the Circular no. 18 of 2015 dated 02.11.2015, which had analyzed
F
and then explained that all shares and securities held by a bank
which are not bought to maintain Statutory Liquidity Ratio (SLR)
are its stock-in-trade and not investments and income arising
out of those is attributable, to business of banking. Reverting
back to the situation here, the Revenue does not contend that
the Assessee Banks had held the securities for maintaining the G
Statutory Liquidity Ratio (SLR), as mentioned in the circular. In
view of this position, when there is no finding that the
investments of the Assessee are of the related category, tax
implication would not arise against the appellants, from the said
circular. [Paras 25, 26][167-B-C, E-F]
H
156 SUPREME COURT REPORTS [2021] 6 S.C.R.

A 5. 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. The above conclusion is reached because
B nexus has not been established between expenditure disallowed
and earning of exempt income. The respondents have failed to
substantiate their argument that assessee was required to
maintain separate accounts. [Paras 27, 28][167-G; 168-B]
6. In taxation regime, there is no room for presumption
C and nothing can be taken to be implied. The tax an individual
or a corporate is required to pay, is a matter of planning for a
tax payer and the Government should endeavour to keep it
convenient and simple to achieve maximization of compliance.
Just as the Government does not wish for avoidance of tax
equally it is the responsibility of the regime to design a tax
D system for which a subject can budget and plan. If proper balance
is achieved between these, unnecessary litigation can be avoided
without compromising on generation of revenue. [Para 29][168-
D-F]
HDFC Bank Ltd. v. Deputy Commissioner of Income
E Tax (2016) 383 ITR 529 (Bom) : 2016 SCC Online
Bom 1109 ; CIT vs. Suzlon Energy Ltd. (2013) 354 ITR
630 (Guj) : 2013 SCC Online Guj 8613 ; CIT vs.
Microlabs Ltd. (2016) 383 ITR 490 (Karn) : 2016
SCC Online Kar 8490 ; and CIT v. Max India Ltd.
(2016) 388 ITR 81 (P & H) : 2016 SCC Online P&H
F
6788 – approved.
SA Builders v. CIT (2007) 1 SCC 781 : [2006] 10
Suppl. SCR 1077; and Honda Siel Power Products Ltd.
v. DCIT (2012) 12 SCC 762 – distinguished.

G Rajasthan State Warehousing Corporation v. CIT
(2000) 242 ITR 450 SC : (2000) 3 SCC 126 : [2000]
1 SCR 1113 ; Commissioner of Income Tax (Large Tax
Payer Unit) v. Reliance Industries Ltd. (2019) 410 ITR
466 SC : (2019) 20 SCC 478 ; Maxopp Investment Ltd.
v. CIT (2018) 15 SCC 523 : [2018] 2 SCR 783 ;
H Godrej and Boyce Manufacturing Company Ltd.v.
SOUTH INDIAN BANK LTD. v. COMMISSIONER 157
OF INCOME TAX

DCIT (2017) 7 SCC 421 : [2017] 3 SCR 602 ; and A
CIT v. Nawanshahar Central Cooperative Bank Ltd.
(2007) 15 SCC 611 : (2007) 160 TAXMAN 48 (SC)
– referred to.
Pr. CIT v. Bombay Dyeing and Mfg. Co. Ltd I.T.A.
No.1225 of 2015 [Decision of Bombay High Court] B
and Pr. CIT, v. State Bank of Patiala 2017 (393) ITR
476 (P&H) – referred to.
Case Law Reference
[2000] 1 SCR 1113 referred to Para 6
C
(2019) 20 SCC 478 referred to Para 18
(2016) 383 ITR 529 (Bom) approved Para 19
(2013) 354 ITR 630 (Guj) approved Para 19
(2016) 383 ITR 490 (Karn) approved Para 19
D
(2016) 388 ITR 81 (P & H) approved Para 19
[2006] 10 Suppl. SCR 1077 distinguished Para 21
(2012) 12 SCC 762 distinguished Para 22
[2018] 2 SCR 783 referred to Para 23 E
[2017] 3 SCR 602 referred to Para 24
(2007) 15 SCC 611 referred to Para 25
2017 (393) ITR 476 (P&H) referred to Para 25
CIVIL APPELLATE JURISDICTION : Civil Appeal No.9606 F
of 2011.
From the Judgment and Order dated 21.10.2010 of the High
Court of Kerala at Ernakulam in ITA No.730 of 2009.
With
G
Civil Appeal No. 5610 of 2021, Civil Appeal Nos.9609, 9610, 9611,
9615, 9608, 9612, 9614, 9613, 9607 of 2011 and Civil Appeal
Nos.3367,2963 of 2012.
Vikramjit Banerjee, ASG, S. Ganesh, Jehangir Mistri, Ranjit
Kumar, Joseph Markose, Arijit Prasad, Sr. Advs., S. Sukumaran, Anand H
158 SUPREME COURT REPORTS [2021] 6 S.C.R.

A Sukumar, Bhupesh Pathak, Ms. Meera Mathur, Sandeep Karhail,
G. M. Kawoosa, Ashok Mathur, M. P. Vinod, E. M. S. Anam, Pratap
Venugopal, Ms. Surekha Raman, Akhil Abraham Roy, Vijay Valsan,
M/s K J John And Co., Sidharth Sinha, Sanosh Kumar, Raj Bahadur
Yadav, A. V. Rangam, A. Raghunath, B. V. Balaram Das, Mrs. Anil
Katiyar, H. S. Parihar, Kuldeep S. Parihar, Ms. Ikshita Parihar, Advs.
B
for the appearing parties.
The Judgment of the Court was delivered by
HRISHIKESH ROY, J.
1. Leave granted in SLP(C) No. 32761/2018 for analogous
C consideration with the related appeals.
2. The question of law to be answered in the present batch of
appeals is on interpretation of Section 14A of the Income Tax Act (for
short “the Act”) and the same reads as follows:

D “Whether proportionate disallowance of interest paid by the banks
is called for under Section 14A of Income Tax Act for
investments made in tax free bonds/ securities which yield tax
free dividend and interest to assessee Banks when assessee had
sufficient interest free own funds which were more than the
investments made”
E
3. While common arguments have been advanced by the learned
counsel for the parties, to place the legal issues in the appropriate
perspective, the relevant facts are adverted from the Civil Appeal No.
9606 of 2011 (South Indian Bank Ltd. Vs. CIT, Trichur), for the purpose
of this judgment.
F
4. The assessees are scheduled banks and in course of their
banking business, they also engage in the business of investments in
bonds, securities and shares which earn the assessees, interests from
such securities and bonds as also dividend income on investments in
shares of companies and from units of UTI etc. which are tax free.
G
5. Chapter IV of the Act provides for the Heads of Income for
computation of Total Income. In Section 14, the various incomes are
classified under Salaries, Income from house property, Profit & Gains
of business or profession, Capital Gains & Income from other sources.
The Section 14A relates to expenditure incurred in relation to income
H which are not includable in Total Income and which are exempted from
SOUTH INDIAN BANK LTD. v. COMMISSIONER 159
OF INCOME TAX [HRISHIKESH ROY, J.]

tax. No taxes are therefore levied on such exempted income. The A
Section 14A had been incorporated in the Income Tax Act to ensure
that expenditure incurred in generating such tax exempted income is
not allowed as a deduction while calculating total income for the
concerned assessee.
6. Section 14A was introduced to the Income Tax Act by the B
Finance Act, 2001 with retrospective effect from 01.04.1962. The new
section was inserted in aftermath of judgment of this Court in the case
of Rajasthan State Warehousing Corporation Vs. CIT 1. The said
Section provided for disallowance of expenditure incurred by the
assessee in relation to income, which does not form part of their total
income. As such if the assessee incurs any expenditure for earning tax C
free income such as interest paid for funds borrowed, for investment
in any business which earns tax free income, the assessee is disentitled
to deduction of such interest or other expenditure. Although the provision
was introduced retrospectively from 01.04.1962, the retrospective effect
was neutralized by a proviso later introduced by the Finance Act, 2002 D
with effect from 11.05.2001 whereunder, re-assessment, rectification
of assessment was prohibited for any assessment year, up-to the
assessment year 2000-2001, when the proviso was introduced, without
making any disallowance under Section 14A. The earlier assessments
were therefore permitted to attain finality. As such the disallowance
under Section 14A was intended to cover pending assessments and for E
the assessment years commencing from 2001-2002. It may be noted
that in the present batch of appeals, we are concerned with
disallowances made under Section 14A for assessment years
commencing from 2001-2002 onwards or for pending assessments.
7. At outset it is clarified that none of the assessee banks F
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 G
for investments in securities, bonds and shares which yielded the tax-
free income, cannot conveniently be related to a separate account,
maintained for the purpose. The situation is same so far as overheads
and other administrative expenditure of the assessee.
1
[(2000) 242 ITR 450 SC] / (2000) 3 SCC 126. H
160 SUPREME COURT REPORTS [2021] 6 S.C.R.

A 8. In absence of separate accounts for investment which earned
tax free income, the Assessing Officer made proportionate disallowance
of interest attributable to the funds invested to earn tax free income.
The assessees in these appeals had earned substantial tax-free income
by way of interest from tax free bonds and dividend income which also
is tax free. It is manifest that substantial expenditure is incurred
B
for earning tax free income. Since actual expenditure figures are not
available for making disallowance under Section 14A, the Assessing
Officer worked out proportionate disallowance by referring to the
average cost of deposit for the relevant year. The CIT (A) had
concurred with the view taken by the Assessing Officer.
C
9. The ITAT in Assessee’s appeal against CIT(A) considered the
absence of separate identifiable funds utilized by assessee for making
investments in tax free bonds and shares but found that assessee bank
is having indivisible business and considering their nature of business,
the investments made in tax free bonds and in shares would therefore
D be in nature of stock in trade. The ITAT then noticed that assessee
bank is having surplus funds and reserves from which investments can
be made. Accordingly, it accepted the assessee’s case that investments
were not made out of interest or cost bearing funds alone. In
consequence, it was held by the ITAT that disallowance under Section
14A is not warranted, in absence of clear identity of funds.
E
10. The decision of the ITAT was reversed by the High Court
by acceptance of the contentions advanced by the Revenue in their
appeal and accordingly the Assessee Bank is before us to challenge
the High Court’s decision which was against the assessee.
F 11. Since, the scope of Section 14A of the Act will require
interpretation, the Section with sub-clauses (2) and (3) along with the
proviso is extracted hereinbelow: -
“14A. Expenditure incurred in relation to income not
includible in total income - (1) For the purposes of computing
G the total income under this Chapter, no deduction shall be allowed
in respect of expenditure incurred by the assessee in relation to
income which does not form part of the total income under this
Act.
(2) The Assessing Officer shall determine the amount of
H expenditure incurred in relation to such income which does not
SOUTH INDIAN BANK LTD. v. COMMISSIONER 161
OF INCOME TAX [HRISHIKESH ROY, J.]

form part of the total income under this Act in accordance with A
such method as may be prescribed, if the Assessing Officer,
having regard to the accounts of the assessee, is not satisfied
with the correctness of the claim of the assessee in respect of
such expenditure in relation to income which does not form part
of the total income under this Act.
B
(3) The provisions of sub-section (2) shall also apply in relation
to a case where an assessee claims that no expenditure has been
incurred by him in relation to income which does not form part
of the total income under this Act:
Provided that nothing contained in this section shall empower the C
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
section 154, for any assessment year beginning on or before the
1st day of April, 2001.”
D
12. The sub-Section (2) and (3) were introduced to the main
section by the Finance Act, 2006 with effect from 01.04.2007.
13. The question therefore to be answered is whether Section
14A, enables the Department to make disallowance on expenditure
incurred for earning tax free income in cases where assessees like the E
present appellant, do not maintain separate accounts for the investments
and other expenditures incurred for earning the tax-free income.
14. We have heard Mr. S. Ganesh, Mr. S.K. Bagaria, Mr. Jehangir
Mistri and Mr. Joseph Markose, learned Senior Counsel appearing for
the appellants. Also heard Mr. Vikramjit Banerjee, learned Additional F
Solicitor General and Mr. Arijit Prasad, learned Senior Counsel on behalf
of the respondent/Revenue.
15. The appellants argue that the investments made in bonds and
shares should be considered to have been made out of interest free
funds which were substantially more than the investment made and
G
therefore the interest paid by the assessee on its deposits and other
borrowings, should not be considered to be expenditure incurred in
relation to tax free income on bonds and shares and as a corollary, there
should be no disallowance under Section 14A of the Act. On the other
hand, the counsel for the revenue refers to the reasoning of the CIT(A)
and of the High Court to project their case. H
162 SUPREME COURT REPORTS [2021] 6 S.C.R.

A 16. As can be seen, the contention on behalf of the assessee was
rejected by the CIT(A) as also by the High Court primarily on the
ground that the assessee had not kept their interest free funds in
separate account and as such had purchased the bonds/shares from
mixed account. This is how a proportionate amount of the interest paid
B on the borrowings/deposits, was considered to have been incurred to
earn the tax-free income on bonds/shares and such proportionate
amount was disallowed applying Section 14A of the Act.
17. In a situation where the assessee has mixed fund (made up
partly of interest free funds and partly of interest- bearing funds) and
C 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
D proportionate figure. For accepting such a proposition, it would be helpful
to refer to the decision of the Bombay High Court in Pr. CIT v. Bombay
Dyeing and Mfg. Co. Ltd2 where the answer was in favour of the
assessee on the question, whether the Tribunal was justified in deleting
the disallowance under Section 80M of the Act on the presumption that
E when the funds available to the assessee were both interest free and
loans, the investments made would be out of the interest free funds
available with the assessee, provided the interest free funds were
sufficient to meet the investments. The resultant SLP of the Revenue
challenging the Bombay High Court judgment was dismissed both on
F merit and on delay by this Court. The merit of the above proposition of
law of the Bombay High Court would now be appreciated in the
following discussion.
18. In the above context, it would be apposite to refer to a similar
decision in Commissioner of Income Tax (Large Tax Payer Unit) Vs.
G Reliance Industries Ltd 3 where a Division Bench of this Court
expressly held that where there is finding of fact that interest free funds
available to assessee were sufficient to meet its investment it will be
presumed that investments were made from such interest free funds.

2
I.T.A. No.1225 of 2015
H 3
(2019) 410 ITR 466 SC/ (2019) 20 SCC 478.
SOUTH INDIAN BANK LTD. v. COMMISSIONER 163
OF INCOME TAX [HRISHIKESH ROY, J.]

19. In HDFC Bank Ltd. Vs. Deputy Commissioner of Income A
Tax4, the assessee was a Scheduled Bank and the issue therein also
pertained to disallowance under Section 14A. In this case, the Bombay
High Court even while remanding the case back to Tribunal for
adjudicating afresh observed (relying on its own previous judgment in
same assessee’s case for a different Assessment Year) that, if assessee
possesses sufficient interest free funds as against investment in tax free B
securities then, there is a presumption that investment which has been
made in tax free securities, has come out of interest free funds available
with assessee. In such situation Section 14A of the Act would not be
applicable. Similar views have been expressed by other High Courts in
CIT Vs. Suzlon Energy Ltd.5, CIT Vs. Microlabs Ltd.6 and CIT Vs. C
Max India Ltd.7 Mr. S Ganesh the learned Senior Counsel while citing
these cases from the High Courts have further pointed out that those
judgments have attained finality. On reading of these judgments, we
are of the considered opinion that the High Courts have correctly
interpreted the scope of Section 14A of the Act in their decisions
favouring the assessees. D
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 E
investments made in tax- free securities then in such cases, disallowance
under Section 14A cannot be made.
21. On behalf of Revenue Mr. Arijit Prasad, the learned Senior
Advocate refers to SA Builders v. CIT8 where this Court ruled on issue
of disallowance in relation to funds lent to sister concern out of mixed F
funds. The issue in SA Builders is pending consideration before the
larger bench of this Court in SLP (C) No. 14729 of 2012 titled as
Addl. CIT v. Tulip Star Hotels Ltd. The counsel therefore, argues that
there is no finality on the issue of disallowance, when mixed funds are
used. On this aspect, since the issue is pending before a larger Bench,
comments from this Bench may not be appropriate. However, at the G

4
(2016) 383 ITR 529 (Bom) / 2016 SCC Online Bom 1109
5
(2013) 354 ITR 630 (Guj)/ 2013 SCC Online Guj 8613
6
(2016) 383 ITR 490 (Karn)/ 2016 SCC Online Kar 8490
7
(2016) 388 ITR 81 (P & H) / 2016 SCC Online P&H 6788
8
[(2007) 1 SCC 781] H
164 SUPREME COURT REPORTS [2021] 6 S.C.R.

A same time it is necessary to distinguish the facts of present appeals
from those in SA Builders/Tulip Star Hotels Ltd. In that case, loans
were extended to sister concern while here the Assessee- Banks have
invested in bonds/securities. The factual scenario is different and
distinguishable and therefore the issue pending before the larger Bench
should have no bearing at this stage for the present matters.
B
22. The High Court herein endorsed the proportionate
disallowance made by the Assessing Officer under Section 14A of the
Income Tax Act to the extent of investments made in tax-free bonds/
securities primarily because, separate account was not maintained by
assessee. On this aspect we wanted to know about the law which
C obligates the assessee to maintain separate accounts. However, the
learned ASG could not provide a satisfactory answer and instead relied
upon Honda Siel Power Products Ltd. v. DCIT9 to argue that it is
the responsibility of the assessee to fully disclose all material facts. The
cited judgment, as can be seen, mainly dealt with re-opening of
D assessment in view of escapement of income. The contention of
department for re-opening was that the assessee had earned tax-free
dividend and had claimed various administrative expenses for earning
such dividend income and those (though not allowable) was allowed
as expenditure and therefore the income had escaped assessment. On
this, suffice would be to observe that the action in Honda Siel (supra)
E related to re-opening of assessment where full disclosure was not made.
An assessee definitely has the obligation to provide full material
disclosures at the time of filing of Income Tax Return but there is no
corresponding legal obligation upon the assessee to maintain separate
accounts for different types of funds held by it. In absence of any
F 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.
23. It would now be appropriate to advert in some detail to
G Maxopp Investment Ltd. v. CIT10. This case interestingly is relied by
both sides’ counsel. Writing for the Bench, Justice Dr. A.K. Sikri noted
the objective for incorporation of Section 14A in the Act in the following
words: -
9
[(2012) 12 SCC 762]
10
H (2018) 15 SCC 523
SOUTH INDIAN BANK LTD. v. COMMISSIONER 165
OF INCOME TAX [HRISHIKESH ROY, J.]

“3…………. The purpose behind Section 14-A of the Act, by A
not permitting deduction of the expenditure incurred in relation
to income, which does not form part of total income, is to ensure
that the assessee does not get double benefit. Once a particular
income itself is not to be included in the total income and is
exempted from tax, there is no reasonable basis for giving benefit
B
of deduction of the expenditure incurred in earning such an
income.... . .”
The following was written explaining the scope of Section 14-
A(1):
“41. In the first instance, it needs to be recognised that as per C
Section 14-A(1) of the Act, deduction of that expenditure is not
to be allowed which has been incurred by the assessee “in relation
to income which does not form part of the total income under
this Act”. Axiomatically, it is that expenditure alone which has
been incurred in relation to the income which is includible in total
D
income that has to be disallowed. If an expenditure incurred has
no causal connection with the exempted income, then such an
expenditure would obviously be treated as not related to the
income that is exempted from tax, and such expenditure would
be allowed as business expenditure. To put it differently, such
expenditure would then be considered as incurred in respect of E
other income which is to be treated as part of the total income.”
Adverting to the law as it stood earlier, this Court rejected the
theory of dominant purpose suggested by the Punjab & Haryana High
Court and accepted the principle of apportionment of expenditure only
when the business was divisible, as was propounded by the Delhi High F
Court.
Finally adjudicating the issue of expenditure on shares held as
stock-in-trade, the following key observations were made by Justice
Sikri:
“ 50. It is to be kept in mind that in those cases where shares G
are held as “stock-in-trade”, it becomes a business activity of
the assessee to deal in those shares as a business proposition.
Whether dividend is earned or not becomes immaterial. In fact,
it would be a quirk of fate that when the investee company
declared dividend, those shares are held by the assessee, though H
166 SUPREME COURT REPORTS [2021] 6 S.C.R.

A the assessee has to ultimately trade those shares by selling them
to earn profits. The situation here is, therefore, different from
the case like Maxopp Investment Ltd. [Maxopp Investment
Ltd. v. CIT, 2011 SCC OnLine Del 4855 : (2012) 347 ITR 272]
where the assessee would continue to hold those shares as it
wants to retain control over the investee company. In that case,
B
whenever dividend is declared by the investee company that
would necessarily be earned by the assessee and the assessee
alone. Therefore, even at the time of investing into those shares,
the assessee knows that it may generate dividend income as well
and as and when such dividend income is generated that would
C be earned by the assessee. In contrast, where the shares are
held as stock- in-trade, this may not be necessarily a situation.
The main purpose is to liquidate those shares whenever the share
price goes up in order to earn profits.... .”
The learned Judge then considered the implication of Rule 8D
D of the Rules in the context of Section 14-A(2) of the Act and clarified
that before applying the theory of apportionment, the Assessing Officer
must record satisfaction on Suo Moto disallowance only in those cases
where, the apportionment was done by the assessee. The following is
relevant for the purpose of this judgment:

E 51. ……………….It will be in those cases where the assessee
in his return has himself apportioned but the AO was not
accepting the said apportionment. In that eventuality, it will have
to record its satisfaction to this effect. ........ .”
24. Another important judgment dealing with Section 14A
disallowance which merits consideration is Godrej and Boyce
F
Manufacturing Company Ltd. V. DCIT 11 . Here the assessee had
access to adequate interest free funds to make investments and the
issue pertained to disallowance of expenditure incurred to earn dividend
income, which was not forming part of total income of the Assessee.
Justice Ranjan Gogoi writing the opinion on behalf of the Division Bench
G observed that for disallowance of expenditure incurred in earning an
income, it is a condition precedent that such income should not be
includible in total income of assessee. This Court accordingly concluded
that for attracting provisions of Section 14A, the proof of fact regarding
such expenditure being incurred for earning exempt income is
11
H (2017) 7 SCC 421.
SOUTH INDIAN BANK LTD. v. COMMISSIONER 167
OF INCOME TAX [HRISHIKESH ROY, J.]

necessary. The relevant portion of Justice Gogoi’s judgment reads as A
follow:
“36. ……… what cannot be denied is that the requirement for
attracting the provisions of Section 14-A (1) of the Act is proof
of the fact that the expenditure sought to be disallowed/deducted
had actually been incurred in earning the dividend income… “ B
25. Proceeding now to another aspect, it is seen that the Central
Board of Direct Taxes (CBDT) had issued the Circular no. 18 of 2015
dated 02.11.2015, which had analyzed and then explained that all shares
and securities held by a bank which are not bought to maintain Statutory
Liquidity Ratio (SLR) are its stock-in-trade and not investments and C
income arising out of those is attributable, to business of banking. This
Circular came to be issued in the aftermath of CIT Vs. Nawanshahar
Central Cooperative Bank Ltd.12 wherein this Court had held that
investments made by a banking concern is part of their banking
business. Hence the income earned through such investments would D
fall under the head Profits & Gains of business. The Punjab and
Haryana High Court, in the case of Pr. CIT, vs. State Bank of Patiala13
while adverting to the CBDT Circular, concluded correctly that shares
and securities held by a bank are stock in trade, and all income received
on such shares and securities must be considered to be business income. E
That is why Section 14A would not be attracted to such income.
26. Reverting back to the situation here, the Revenue does not
contend that the Assessee Banks had held the securities for maintaining
the Statutory Liquidity Ratio (SLR), as mentioned in the circular. In view
of this position, when there is no finding that the investments of the F
Assessee are of the related category, tax implication would not arise
against the appellants, from the said circular.
27. The aforesaid discussion and the cited judgments advise this
Court to conclude that the proportionate disallowance of interest is not
warranted, under Section 14A of Income Tax Act for investments made G
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
12
[(2007) 15 SCC 611] / [(2007) 160 TAXMAN 48 (SC)]
13
2017 (393) ITR 476 (P&H) H
168 SUPREME COURT REPORTS [2021] 6 S.C.R.

A conclusion, we unhesitatingly agree with the view taken by the learned
ITAT favouring the assessees.
28. The above conclusion is reached because nexus has not been
established between expenditure disallowed and earning of exempt
income. The respondents as earlier noted, have failed to substantiate
B their argument that assessee was required to maintain separate
accounts. Their reliance on Honda Siel (Supra) to project such an
obligation on the assessee, is already negated. The learned counsel for
the revenue has failed to refer to any statutory provision which obligate
the assessee to maintain separate accounts which might justify
proportionate disallowance.
C
29. In the above context, the following saying of Adam Smith in
his seminal work – The Wealth of Nations may aptly be quoted:
“The tax which each individual is bound to pay ought to be
certain and not arbitrary. The time of payment, the manner
D of payment, the quantity to be paid ought all to be clear and
plain to the contributor and to every other person.”
Echoing what was said by the 18th century economist, it needs
to be observed here that in taxation regime, there is no room for
presumption and nothing can be taken to be implied. The tax an
E individual or a corporate is required to pay, is a matter of planning for
a tax payer and the Government should endeavour to keep it convenient
and simple to achieve maximization of compliance. Just as the
Government does not wish for avoidance of tax equally it is the
responsibility of the regime to design a tax system for which a subject
can budget and plan. If proper balance is achieved between these,
F unnecessary litigation can be avoided without compromising on
generation of revenue.
30. In view of the forgoing discussion, the issue framed in these
appeals is answered against the Revenue and in favour of the assessee.
The appeals by the Assessees are accordingly allowed with no order
G on costs.

Bibhuti Bhushan Bose Appeals allowed.

H