ITA 687/09 & Ors Page 1 of 38 * IN THE HIGH COURT OF DELHI AT NEW DELHI % Judgment delivered on: 18.11.2011 + ITA 687/2009 MAXOPP INVESTMENT LTD … Appellant - versus – COMMISSIONER OF INCOME-TAX, NEW DELHI … Respondent Advocates who appeared in this case: For the Appellant : Mr Ajay Vohra with Ms Kavita Jha, Ms Akanksha Aggarwal and Mr Amit Sachdeva For the Respondent/Revenue : Mr Sanjeev Sabharwal with Ms P. L. Bansal and Ms Sonia Mathur AND + ITA 112/2010 M/S EICHER GOODEARTH LTD ... Appellant - versus - COMMISSIONER OF INCOME TAX NEW DELHI ... Respondent Advocates who appeared in this case: For the Appellant : Mr Ajay Vohra with Ms Kavita Jha, Ms Akanksha Aggarwal and Mr Amit Sachdeva For the Respondent/Revenue : Mr Sanjeev Sabharwal with Mr Utpal Saha AND + ITA 263/2010 MOHAIR INVESTMENT & TRADING CO. (P) LTD ... Appellant - versus – COMMISSIONER OF INCOME TAX, NEW DELHI ... Respondent ITA 687/09 & Ors Page 2 of 38 Advocates who appeared in this case: For the Appellant : Mr Ajay Vohra with Ms Kavita Jha, Ms Akanksha Aggarwal and Mr Amit Sachdeva For the Respondent/Revenue : Mr Sanjeev Sabharwal with Mr Utpal Saha AND + ITA 805/2009 EICHER LTD ... Appellant - versus - COMMISSIONER OF INCOME TAX, NEW DELHI ... Respondent Advocates who appeared in this case: For the Appellant : Mr Ajay Vohra with Ms Kavita Jha, Ms Akanksha Aggarwal and Mr Amit Sachdeva For the Respondent/Revenue : Mr Sanjeev Sabharwal with Mr Utpal Saha AND + ITA 98/2009 COMMISSIONER OF INCOME TAX DELHI-IV ... Appellant - versus - ESCORTS FINANCE LTD ... Respondent Advocates who appeared in this case: For the Appellant/Revenue : Mr Sanjeev Sabharwal with Mr Utpal Saha For the Respondent : Mr R. M. Mehta AND + ITA 853/2009 CHEMINVEST LTD ... Appellant - versus - COMMISSIONER OF INCOME TAX, NEW DELHI ... Respondent Advocates who appeared in this case: For the Appellant : Mr Ajay Vohra with Ms Kavita Jha, Ms Akanksha Aggarwal and ITA 687/09 & Ors Page 3 of 38 Mr Amit Sachdeva For the Respondent/Revenue : Mr Sanjeev Sabharwal with Mr Utpal Saha AND + ITA 856/2009 CHEMINVEST LTD ... Appellant - versus - COMMISSIONER OF INCOME TAX, NEW DELHI ... Respondent Advocates who appeared in this case: For the Appellant : Mr Ajay Vohra with Ms Kavita Jha, Ms Akanksha Aggarwal and Mr Amit Sachdeva For the Respondent/Revenue : Mr Sanjeev Sabharwal with Mr Utpal Saha AND + ITA 932/2009 THE COMMISSIONER OF INCOME TAX, DELHI-V ... Appellant - versus - M/S NALWA INVESTMENTS LTD ... Respondent Advocates who appeared in this case: For the Appellant/Revenue : Ms Sonia Mathur For the Respondent : Mr Ajay Vohra with Ms Kavita Jha, Ms Akanksha Aggarwal and Mr Amit Sachdeva AND + ITA 958/2009 MINDA INDUSTRIES LTD ... Appellant - versus - COMMISSIONER OF INCOME TAX, NEW DELHI ... Respondent Advocates who appeared in this case: For the Appellant : Mr Ajay Vohra with Ms Kavita Jha, Ms Akanksha Aggarwal and Mr Amit Sachdeva ITA 687/09 & Ors Page 4 of 38 For the Respondent/Revenue : Mr Sanjeev Sabharwal with Mr Utpal Saha AND + ITA 1060/2009 MAXPAK INVESTMENT LTD ... Appellant - versus - COMMISSIONER OF INCOME TAX, NEW DELHI ... Respondent Advocates who appeared in this case: For the Appellant : Mr Ajay Vohra with Ms Kavita Jha, Ms Akanksha Aggarwal and Mr Amit Sachdeva For the Respondent/Revenue : Mr Sanjeev Sabharwal with Mr Utpal Saha AND + ITA 1096/2009 JAGATJIT INDUSTRIES LTD ... Appellant - versus - COMMISSIONER OF INCOME TAX & ANR ... Respondents Advocates who appeared in this case: For the Appellant : Mr Satyen Sethi with Mr Arta Trana Panda For the Respondent/Revenue : Ms P. L. Bansal AND + ITA 1114/2009 COMMISSIONER OF INCOME TAX, LTU ... Appellant - versus - SHARDA MOTORS INDUSTRIES LTD ... Respondent Advocates who appeared in this case: For the Appellant/Revenue : Mr Sanjeev Sabharwal with Mr Utpal Saha For the Respondent : Mr Satyen Sethi with Mr Arta Trana Panda ITA 687/09 & Ors Page 5 of 38 AND + ITA 936/2009 EICHER LTD ... Appellant - versus - COMMISSIONER OF INCOME TAX, NEW DELHI ... Respondent Advocates who appeared in this case: For the Appellant : Mr Ajay Vohra with Ms Kavita Jha, Ms Akanksha Aggarwal and Mr Amit Sachdeva For the Respondent/Revenue : Mr Sanjeev Sabharwal with Mr Utpal Saha AND + ITA 416/2010 MEDICARE INVESTMENTS LTD ... Appellant - versus - COMMISSIONER OF INCOME TAX, NEW DELHI ... Respondent Advocates who appeared in this case: For the Appellant : Mr Ajay Vohra with Ms Kavita Jha, Ms Akanksha Aggarwal and Mr Amit Sachdeva For the Respondent/Revenue : Mr Sanjeev Sabharwal with Mr Utpal Saha AND + ITA 57/2008 COMMISSIONER OF INCOME TAX, DELHI-VI ... Appellant - versus - VOU INVESTMENT PVT LTD ... Respondent Advocates who appeared in this case: For the Appellant : Ms P. L. Bansal For the Respondent/Revenue : Mr Ajay Vohra with Ms Kavita Jha, Ms Akanksha Aggarwal and Mr Amit Sachdeva ITA 687/09 & Ors Page 6 of 38 AND + ITA 139/2009 THE COMMISSIONER OF INCOME TAX, DELHI-V ... Appellant - versus - M/S HCL PEROT SYSTEMS LTD ... Respondent Advocates who appeared in this case: For the Appellant : Ms P. L. Bansal and Ms Sonia Mathur For the Respondent/Revenue : Mr Ajay Vohra with Ms Kavita Jha, Ms Akanksha Aggarwal and Mr Amit Sachdeva AND + ITA 77/2009 THE COMMISSIONER OF INCOME TAX, DELHI-V ... Appellant - versus - M/S HCL PEROT SYSTEMS LTD ... Respondent Advocates who appeared in this case: For the Appellant : Ms P. L. Bansal and Ms Sonia Mathur For the Respondent/Revenue : Mr Ajay Vohra with Ms Kavita Jha, Ms Akanksha Aggarwal and Mr Amit Sachdeva AND + ITA 683/2008 COMMISSIONER OF INCOME TAX, DELHI-IV ... Appellant - versus - ICRA LTD ... Respondent ITA 687/09 & Ors Page 7 of 38 Advocates who appeared in this case: For the Appellant : Ms Prem Lata Bansal For the Respondent : Dr Rakesh Gupta with Ms Poonam Ahuja and Mr Johnson Bara AND + ITA 702/2008 COMMISSIONER OF INCOME TAX, DEHI-IV ... Appellant - versus - ICRA LTD ... Respondent Advocates who appeared in this case: For the Appellant : Ms Prem Lata Bansal For the Respondent : Dr Rakesh Gupta with Ms Poonam Ahuja and Mr Johnson Bara AND + ITA 217/2009 COMMISSIONER OF INCOME TAX, DELHI-I ... Appellant - versus - GLAD INVESTMENTS PVT LTD (Now merged with AKM SYSTEMS PVT LTD ... Respondent Advocates who appeared in this case: For the Appellant/Revenue : Ms P. L. Bansal with Ms Anshul Sharma For the Respondent : Mr Ajay Nair with Mr Rajat Joneja AND + ITA 389/2010 THE COMMISSIONER OF INCOME TAX (LTU) ... Appellant - versus - SHARDA MOTORS INDUSTRIES LTD ... Respondent Advocates who appeared in this case: For the Appellant/Revenue : Mr Sanjeev Sabharwal with Mr Utpal Saha For the Respondent : Mr Satyen Sethi with Mr Arta Trana Panda ITA 687/09 & Ors Page 8 of 38 CORAM: HON'BLE MR JUSTICE BADAR DURREZ AHMED HON'BLE MR JUSTICE SIDDHARTH MRIDUL 1. Whether Reporters of local papers may be allowed to see the judgment? YES 2. To be referred to the Reporter or not? YES 3. Whether the judgment should be reported in Digest? YES BADAR DURREZ AHMED, J 1. This is a batch of twenty one (21) appeals under section 260A of the Income Tax Act, 1961. Eleven (11) of these have been filed by assessees and ten (10) by the revenue. Eight of these appeals – four by assessees and four by the revenue -- have been admitted and questions have been framed in them. The other appeals were tagged along therewith. It was, however, clearly understood by all the counsel appearing on both sides that the appeals which had not been formally admitted would be deemed to have been admitted for hearing and it was on this basis that arguments were addressed. All these appeals are concerned with section 14A of the Income Tax Act, 1961 and Rule 8D of the Income Tax Rules, 1962. In particular, we are called upon to examine as to whether interest paid on funds borrowed for investing in shares of operating companies for acquiring and retaining a controlling interest therein is allowable under section 36(1)(iii) and is not hit by section 14A of the Income tax Act, 1961? And, consequently, we are also required to examine the retrospective applicability of the sub-sections (2) & (3) of the said section 14A and of the said Rule 8D to the assessment years in question which range from 1998-99 to 2005-06. Questions 2. Since, across these appeals, there were some minor differences in language insofar as the admitted and/or proposed questions were concerned, it was agreed that ITA 687/09 & Ors Page 9 of 38 the following substantial questions of law would, in general, cover all the cases before us:- 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 on such shares does not form part of the total income? 2. Whether the provisions of sub-section (2) and sub-section (3) of section 14A inserted by the Finance Act, 2006 with effect from 01/04/2007, would apply retrospectively to all pending proceedings? 3. Whether Rule 8D inserted by the Income -tax (Fifth Amendment) Rules, 2008 with effect from 24/03/2008 was procedural in nature and hence would apply retrospectively to all pending proceedings? 3. In order to provide some factual basis behind the above mentioned questions, we shall refer to the appeal in the case of Maxopp Investment Limited v. CIT [ ITA No.687/2009]. The assessee company is in the business of finance, investment and of 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 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 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 said 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 and retain a controlling interest in the aforesaid company and that the receipt of dividend thereon was merely incidental. ITA 687/09 & Ors Page 10 of 38 4. In respect of the said assessment year 2002-03, the assessee had filed a return of income declaring an income of Rs.78,90,430/-. The assessee had received the following incomes: – 1. Interest on loans advanced Rs. 1,94,70,181 2. Dividend received Rs. 49,90,860 3. Profit on sale of shares Rs. 1,49,285 The aforesaid dividend of Rs. 49,90,860/- was received on the shares of Max India Ltd, held by the assessee as "trading assets". By an order dated 27/08/2004, the assessing officer, invoking section 14A of the said act, apportioned the said interest expenditure in the ratio of investment in shares of Max India Ltd, on which dividend was received, to the principal amount of unsecured loans, which worked out to Rs. 67,74,175/-. However, the assessing officer restricted the disallowance under section 14A of the said act to Rs. 49,90,860/-, being the amount of dividend received. On appeal, the CIT (A), by the order dated 12/01/2005, upheld the order of the assessing officer. Thereafter, the case of the assessee was heard by a Special Bench constituted in the case of Daga Capital Management (P) Ltd. The Special Bench of the Tribunal held that the expenditure claimed was hit by the provisions of section 14A of the said Act. Pursuant to the majority decision of the Special Bench of the Tribunal, the issue of quantum of expenditure to be disallowed was restored to the assessing officer to be recomputed in terms of Rule 8D of the Income Tax Rules, 1961 (hereinafter referred to as “the said rules”), which was held to be retrospective. 5. As regards Question 1, it has been contended on behalf of the assessees that holding of shares for acquiring and retaining control of operating companies amounts to business and, consequently, dividend income on such shares is in the nature of business income. It was further submitted that the intention behind acquiring such shares was not to earn dividend but to acquire and retain a controlling interest in the ITA 687/09 & Ors Page 11 of 38 operating companies. Dividend was merely incidental. It was thus contended that the interest paid on the funds borrowed to acquire such shares was allowable as a business expenditure as it was not directed at earning dividend income, which was incidental. Legislative History of Section 14A and Rule 8D 6. Before we delve deeper into the questions at hand it would be appropriate to not only examine the provisions of section 14A of the said act but also to notice its legislative history. Section 14A was inserted into the said Act by the Finance Act, 2001 with retrospective effect from 01/04/1962. “Expenditure incurred in relation to income not includible in total income . 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.” 7. By virtue of the Finance Act, 2002, the following proviso was inserted in section 14A and was deemed to have been inserted with effect from 11/05/2001:- “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 section 154, for any assessment year beginning on or before the 1st day of April, 2001.” 8. As a result of the insertion of the said proviso, Section 14A was as follows:- “Expenditure incurred in relation to income not includible in total income. 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. ITA 687/09 & Ors Page 12 of 38 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 section 154, for any assessment year beginning on or before the 1st day of April, 2001.” 9. Then, by the Finance Act, 2006, Section 14A was numbered as sub-section (1) thereof and after sub-section (1) as so numbered, the following sub-sections were inserted, with effect from 01/04/2007:- “(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 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 the total income under this Act.” 10. Consequent upon the Finance Act, 2006, section 14A as it now stands is as under:- “Expenditure incurred in relation to income not includible in total income . 14A. (1) 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. (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 ITA 687/09 & Ors Page 13 of 38 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. (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 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.” 11. By Notification No.45/2008 dated 24/03/2008, the Central Board of Direct Taxes (CBDT), in exercise of its powers under section 295 of the said Act read with sub-section (2) of section 14A of the said Act, made the “Income-tax (Fifth Amendment) Rules, 2008” to further amend the said Rules (i.e., the Income-tax Rules, 1962) by introducing Rule 8D therein. Clause 1(2) of the Income-tax (Fifth Amendment) Rules, 2008 clearly stipulated that the rules would come into force from the date of publication in the Official Gazette. The said Rule 8D is as under:- “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— (a) the correctness of the claim of expenditure made by the assessee; or (b) the claim made by the assessee that no expenditure has been 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). ITA 687/09 & Ors Page 14 of 38 (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; (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:— Where A = amount of expenditure by way of interest other than the amount of interest included in clause (i) incurred during the previous year ; 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 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 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 on account of revaluation of assets but including the decrease on account of revaluation of assets.” ITA 687/09 & Ors Page 15 of 38 The law prior to insertion of Section 14A 12. Prior to the introduction of section 14A in the said Act, the position in law was as laid down by the Supreme Court in CIT v. Maharashtra Sugar Mills Ltd: 82 ITR 452 (SC) and Rajasthan State Warehousing Corporation v. CIT: 242 ITR 450 (SC). In Maharashtra sugar Mills Ltd (supra) the assessee’s business comprised of two parts, namely, (1) cultivation of sugar cane and (2) the manufacture of sugar. The revenue had contended that as the income from the cultivation of sugar cane, being the result of an agricultural operation, was not exigible to tax, therefore, any expenditure incurred in respect of that activity was not deductible. The Supreme Court repelled this contention in the following manner:- "This contention proceeds on the basis that only expenditure incurred in respect of a business activity giving rise to income, profit or gains taxable under the Act can be given deduction to and not otherwise. We see no basis for this contention. To find out whether the deduction claimed is permissible under the Act or not, all that we have to do is to examine the relevant provisions of the Act. Equitable considerations are wholly out of place in construing the provisions of a taxing statute. We have to take the provisions of the statute as they stand. If the amount claimed is permissible under the Act then the same has to be deducted from the gross profit. If it is not permissible under the Act, it has to be rejected. As mentioned earlier, it is not disputed that the cultivation of sugar-cane and the manufacture of sugar constituted one single and indivisible business. Section 10(2) says that profits under section 10(1) in respect of a business should be computed after deducting the allowances mentioned therein. One of the allowances allowed is that mentioned in section 10(2)(xv) which says that any expenditure laid out or expended wholly an exclusively for the purpose of such business shall be deducted as an allowance. The mandate of section 10(2) (xv) is plain and unambiguous. Undoubtedly, the allowance claimed in this case was laid out or expended for the purpose of the business carried on by the assessee. The fact that the income arising from a part of that business is not exigible to tax under the act is not a relevant circumstance." (Emphasis supplied) ITA 687/09 & Ors Page 16 of 38 13. In Rajasthan State warehousing Corporation (supra), the Supreme Court after, inter alia, considering its earlier decisions in CIT v. Indian bank Ltd: 56 ITR 77 (SC) and Maharashtra Sugar Mills Ltd (supra) laid down the following principles:- "(i) if income of an assessee is derived from various heads of income, he is entitled to claim deduction admissible under the respective head whether or not computation under each head results in taxable income; (ii) if income of an assessee arises under any of the heads of income but from different items, e.g., different house properties or different securities, etc., and income from one or more items alone is taxable whereas income from the other item is exempt under the Act, the entire permissible expenditure in earning the income from that head is deductible; and (iii) in computing "profits and gains of business or profession" when an assessee is carrying on business