Purpose for which shares are purchased is insignificant to determine applicability of Section 14A of the Income Tax Act, 1961

Section 14A Income Tax Act, 1961 provides for the assessment of income not forming part of the total income.

Section 14A Income Tax Act, 1961 provides for the assessment of income not forming part of the total income. It does not specify any head of income vis-à-vis applicability thereof. The share trading business generates both the taxable as well as tax-exempt income in form of dividend.

It was held that the purpose for which shares are purchased is insignificant to determine applicability of section 14A. The provision is independent of the head of the income under which the tax exempt income would otherwise be liable to tax. The dividend income even if is in respect of shares held as stock-in-trade, i.e., as a part of the business, it is not immune from the applicability of Section 14A. A contention was raised that no disallowance under Section 14A(1) would arise when no expenditure has been incurred in relation to the tax-exempt dividend income as the same was only incidental to the share trading activity wherein shares are retained for the time being yielding dividend on the record date, the quantum of which is uncertain.

The disallowance of expenditure is governed completely by section 14A and as long as its ingredients are satisfied, a disallowance in its terms would follow. Rule 8D of the Income Tax Rules 1962 apportions both direct and indirect expenditure. The effort or activity in earning dividend income is one integral activity of purchase and holding the shares. This activity however generates two separate streams of income. Expenses are incurred during and in the regular course of business to earn income. The expenditure, since deductible, needs to be apportioned as taxable and non-taxable incomes, which in substance is in respect of the indirect expenditure.

The shares are bought and held primarily for share trading income. A ratio of 20% was proposed toward the tax-exempt dividend income on the premise that an indirect expenditure, including by way of interest, has no direct relation with the income and also that the share trading is the dominant object of the share-holding.

Accordingly, to determine disallowance under Rule 8D, the amount as per rule 8D (2)(ii) qua shares held as stock-in-trade would stand to be restricted to 20% thereof. No adjustment however would arise in case of shares held as ‘investments’ as investment activity is more stable in character in comparison to the trading activity. The investment component is inbuilt in any purchase and toward which the allocation of indirect expenditure is prescribed per Rule 8D(2)(iii). The fact that trading shares also yield dividend income, which is not taxable, i.e., besides share trading income, is relevant and sufficient to attract Section14A(1).

Dy. CIT, Circle 3(1), Mumbai vs. Damani Estates & Finance Pvt. Ltd.
(17.07.2013, ITAT, Mumbai – Bench)