ORDER

Per R.P. Garg, Senior Vice President. - The above cross appeals are against the order of the Commissioner of Income-tax (Appeals) for assessment year 2004-05. The sole issue involved in these appeals is against disallowance of interest by invoking the provisions of section 14A of the Income-tax Act. As contrary decisions have been rendered by the different Benches of the Tribunal, the President, Income-tax Appellate Tribunal constituted this Special Bench to dispose of and decide the appeal on the following point:

"Whether disallowance under section 14A of the Income-tax Act can be made in a year in which no exempt income has been earned or received by the assessee?"

2. The Assessing Officer noted that the assessee had invested Rs. 17,36,89,230 in purchase of shares earmarked as other than trade - long-term capital gain. The assessee borrowed funds of Rs. 8,51,65,000. It had paid interest of Rs. 1,21,02,367 thereon. It was observed that out of said unsecured loan, a sum of Rs. 6,88,70,000 was invested in shares which was shown as investment for the purpose of long-term capital gain by following the decision of Calcutta Bench of the Tribunal in the case K.V. Trading Co. Ltd. (formerly known as Kangra Valey Investment & Finance Co. Ltd.)v. Dy. CIT [IT Appeal No. 924 (Kol.) of 2003] for assessment year 1998-99 and of Twenty First Securities Ltd. v. Dy. CIT [IT Appeal No. 1126 (Kol.) of 2003] on proportionate basis i.e., interest paid on borrowed funds invested in the form of long- term investment other than the trading investment calculated as under:

3. The Commissioner of Income-tax (Appeals) held that the Assessing Officer was justified in disallowing the proportionate interest pertaining to investment for earning of dividend, though exempt income was not earned during the year. He however, agreed with the alternative submission of the assessee that the net interest amount debited to the P&L account was required to be apportioned and not the gross interest expenditure. The Assessing Officer was accordingly directed to work out the disallowable interest on pro rata basis of the net interest payment as reduced by the receipt of interest. The Commissioner of Income-tax (Appeals) further found that though the assessee did not earn the dividend income in the year under consideration, yet in the light of decision of the Tribunal, Calcutta Bench in Sri Devendra Prasad Jajodia v. ITO, Kolkata [IT Appeal No. 2420 (Kol.) of 2002] for assessment year 1998-99, order dated 3-12-2003 the provisions of section 14A applied. He, further observed that a similar view was taken in Asstt. CIT v. Dakshesh S. Shah [2004] 90 ITD 519 (Mum.) and in Harish Krishnakant Bhatt v. ITO [2004] 91 ITD 311 (Ahd.) . He observed:

"In case of Sri Devendra Prasad Jajodia v. ITO Ward 3(6), Kolkata in ITA No. 2420 (Kol.)/2002 for assessment year 1998-99, ITAT Kolkata B Bench, vide its order dated 3-12-2003 held that since the monies borrowed has been utilized in the purchase of shares held as investment, the interest paid on so borrowed monies is allowable against the income from dividend on such shares irrespective of whether or not there is any yield of dividends on the shares purchased and held as investment, in other words, in such a case, the interest is attributable to or relatable to earning of dividend on the shares purchased and held as investment. The dividend income is now exempted from tax by virtue of section 10(33) of the Act and, therefore, as a consequence thereof, the interest paid on borrowed capital utilized in purchase of shares held as investment, being the expenditure incurred in relation to exempted dividend income, cannot be allowed against any other taxable income inasmuch as the interest so paid is not relatable to the earning of taxable income. Similar view has been expressed in ACIT v. Dakshesh S. Shah 90 ITD 519 (Mum.); Harish Krishnakant Bhatt v. ITO 91 ITD 311 (Ahd.); 85 TTJ (Ahd.) 872."

4. The ld. Counsel of the assessee Shri Ajay Vohra submitted that the assessee deals in a portfolio investment on capital account as well as of trading account. The investment which is held as a capital gain was offered to tax and expenses were disallowed with regard thereto. Insofar as the trading activity is concerned, the sale of shares was shown as business income and interest and other expenses are claimed as a deduction. He further submitted that in the year under consideration, the interest received was Rs. 1.01 crore as against interest payment of Rs. 1.21 crore. In the year under consideration the assessee had not received any dividend on the shares in which it traded (and held as investment) and, therefore, it is claimed that the question of disallowing any interest would not arise by application of section 14A of the Act. He further submitted that interest is allowable under section 36(1)(iii) of the Act and, therefore, the disallowance under section 14A is not justified.

5. Pointing out the provisions of section 14A, the ld. Counsel for the assessee submitted that what is to be disallowed is the expenses in relation to income which does not form part of the total income under this Act. Therefore, there must be an income received or receivable and that does not form part of the total income. The word "does not" is a present tense and he referred to the dictionary meaning in this regard.

Collins Cobuild Student Dictionary

"'does' is the third person singular of the present tense of do."

"'Doesn't' is the usual spoken form of 'does not.'"

Oxford Dictionary

"'do': Verb (does past did, past part done) 1. perform or carry out (an action). 2. achieve or complete (a specified target) 3. act or progress in a specified way 4. work on (something) to bring it to a required state 5. have a specified result or effect on the walk will do me good. 6. work at for a living or take as one's subject of study what does she do? 7. make or provide 8. be suitable or acceptable he'll do 9. (be/have done with) give up concern for, have finished with informal regularly take (a narcotic drug)."

"'does': Third person singular present of Do."

6. He submits that the word 'does' refers to singular present tense of 'do', which means the act done in present and not in the future. This is in contradiction to the word "shall" which is defined as under :

By P. Ramanatha Aiyar's Advanced Law Lexicon Dictionary

Shall. In common parlance, a term which, it is said, has always a compulsory meaning, and in its common and ordinary usage, unless accompanied by qualifying words which show a contrary intent, always refers to the future, but it may be used in the sense of "must" of which it is a synonym.

Bouvier's Law Dictionary And Concise Encyclopedia - Volume II

SHALL. The various meanings of this word range under two general classes according as it is used as implying futurity or implying a mandate;

7. The expression "does not" used in sub-section (1), signifies that exempt income must in the first place be earned during the relevant previous year before provisions of section 14A can be applied. He further submitted that disallowance is envisaged under the aforesaid section, if exempt income has been earned during the relevant previous year. It was also submitted that the word "shall not" or "will not" (as opposed to 'does not') which might have covered expenses incurred to earn exempt income in future as well. It was further submitted that aforesaid distinction in "shall not" vis-a-vis "does not" also gets fortified from the provisions of Rule 8D of the Income-tax Rules, 1962, which was inserted by the Finance Act, 2006 with effect from 1-4-2007. Therefore, he submitted that "does not" mean no income in present and it does not mean future income.

8. In this regard, he referred to the Special Bench decision of the Tribunal in the case of ITO v. Daga Capital Management (P.) Ltd. [2009] 117 ITD 169 (Mum.) . In this decision the Tribunal did not agree to the proposition on the ground that there must be an expenditure to earn income. On the contrary, it held that if there were income, expenditure is to be disallowed. It was asserted that what is relevant to consider is the object of incurring the expenditure. If such object were for earning exempt income, then the disallowance is rightly called for under section 14A. If, however, it were for earning taxable income then no disallowance can be made, even if the assessee had incidentally earned some income which is exempt from tax. It further held that what is relevant is to work out the 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. Sub-section (1) of section 14A, clearly points out that the exercise of making disallowance starts with working out the expenditure incurred in relation to such exempt income. Ld. Counsel of the assessee further referred to the decision in the case of CIT v. Maharashtra Sugar Mills Ltd. [1971] 82 ITR 452 (SC) wherein it is held that in allowing the expenditure, "the fact that the income is exempt is not a relevant circumstance". He also referred to the decision of Supreme Court in the case of Rajasthan State Warehousing Corporation v. Commissioner Of Income Tax [2000] 242 ITR 450 which dealt with a non-divisible business and held if there is claim of one and indivisible business, the amount of expenditure is allowable under section 36(1)(iii) of the Act. After introduction of section 14A, it is still allowable, unless it is hit by this section 14A. He then referred to the provisions of section 37(1) and also section 36(1)(iii) and submitted that both these sections allow expenditure incurred wholly and exclusively for the purpose of business. He then referred to the decisions of the Supreme Court in the case of CIT v. Malyalam Plantation Ltd. [1964] 53 ITR 140 , CIT v. Birla Cotton Spg. & Wvg. Mills Ltd. [1971] 82 ITR 166 , Madhav Prasad Jatia v. Commissioner Of Income Tax, U.P Lucknow [1979] 118 ITR 200 and S.A. Builders Ltd. v. CIT (Appeals) [2007] 288 ITR 1 . He also referred to the decision of the Supreme Court in the case of Bombay Steam Navigation Co. (1953) (P.) Ltd. v. CIT [1965] 56 ITR 52 for the meaning of the term 'for the purpose of business'. It is submitted that section 57(iii) uses the word 'for the purpose of making or earning income' and that was the subject-matter of consideration before the Supreme Court in the case of CIT v. Rajendra Prasad Moody [1978] 115 ITR 519 , wherein it was held that even if there were no income the expenditure is allowable.

9. He also referred to the decision of the Bombay Bench of the Tribunal in the case of Delite Enterprises (P.) Ltd. v. ITO [2008] 22 SOT 245 , wherein it was held that interest paid to the firm for earning income which was exempt under section 10(2A) cannot be disallowed under section 14A as that would not be applicable because there was no income. The said decision according to him is upheld by the High Court by stating that applicability of section 14A in such situation does not arise. Ld. Counsel of the assessee also submitted a copy of the decision of the Bombay High Court in Income-tax Appeal No. 10 of 2009 in which the revenue raised the following question for consideration of the High Court, which was answered against the Revenue:

"Whether on the facts and in the circumstance of the case and in law the Hon'ble Tribunal was right in deleting the disallowance made by the Assessing Officer of interest paid by the assessee-company on borrowed funds amounting to Rs. 241.10 lakhs overlooking the fact that he borrowed funds were used by the assessee-company to invest in the capital or another partnership firm and since profits derived by the assessee-company from a partnership firm were exempt from tax under section 10(2A) of the Income-tax Act the interest expense related to such tax free profits is to be disallowed under section 14A of the Income-tax Act?"

10. He then posed a question that if a person advances interest-free loan for the purpose of business, the expenditure would still be allowable though there was no income. Similarly, the interest paid on a redeemable debenture to be converted into shares in the 5th year was to be allowed and it could not be said that in the 5th year the expenditure was for share capital. Ld. Counsel for the assessee also relied upon the decision of Asstt. CIT v. Lafarge India Holding (P.) Ltd. [2008] 19 SOT 121 (Mum.) in this regard. He also referred to the decision in the case of World Network Services (P.) Ltd. v. Dy. CIT [IT Appeal No. 1833/Mum./03, dated 25-8-2006] for assessment year 1999-2000 in which a case under section 10B has been examined and the expenditure was held to be capital by Assessing Officer but was disallowed by the CIT(A) under section 14A. The Tribunal held that it was in respect of income for which exemption was not claimed. He also referred to the decision in the case of V.C Gupta v. Commissioner Of Income-Tax. [2005] 94 ITD 309 (Hyd.) .

11. It is, thus, submitted that the provisions of section 14A(1) apply if and only if any exempt income were received by the assessee during the relevant previous year, which is not includible in the taxable total income. Unless the assessee receives or is entitled to receive any income during the relevant previous year (which does not form part of total income), the provisions of section 14A of the Act have no application.

12. He also referred to the decisions which are against the assessee and submitted that they are not correctly decided because the Tribunals have not appreciated the language of section 14A. These decisions are reported in Insaallah Investments Ltd. v. ITO [2008] 23 SOT 130 (Delhi) . In the Special Bench case of Aquarius Travels (P.) Ltd. v. ITO [2008] 111 ITD 53 (Delhi) (SB) , it was held that section 14A can be invoked for the first time. He then referred to the decision of the Supreme Court in the case of CIT v. Sun Engg. Works (P.) Ltd. [1992] 198 ITR 297 and the decision of the Tribunal in the case of Tarnik Investment & Trading Ltd. v. Joint CIT [2005] 94 ITD 183 (Delhi) (SMC) at page 183 and the decision in the case Dakshesh S. Shah's case (supra) and in the case of Harish Krishnakant Bhatt (supra) which was distinguished on the ground that it was a case of investors in shares and not a dealer and the language of section 57(iii) and section 36(1)(iii) are not same. He again referred to the decision of the Special Bench in the case of Daga Capital Management ( supra) dealing with the assessee's own case. He then referred to the provisions of section 8D which is to be construed by us insofar as this case is concerned.

13. Ld. Sr. DR Shri D.S. Srivastava, on the other hand, referred to paragraph 26 of the Supreme Court decision in the case of Sun Engg. Works (P.) Ltd. (supra) and apprised us the approach to be adopted to construing the ratio laid down in the decision of Supreme Court. He emphasized that the substance of the decision should be seen and not the words by picking a line from here and there. He submitted that section 14A would apply to an exempt income whether received/earned or not received or not earned. He referred to the memorandum explaining the provisions reported in 248 ITR 162 (St.) and 252 ITR 65 (St.) stating that expenditure is to be allowed only to the extent relating to the earning of income and the fact that the provisions of section 14A are introduced with retrospective effect from 1-4-1962, i.e., right from the inception of the Act is indicative of that. He further submitted that section 14A cannot be read de hors with sections 14A(2) and 14A(3) of the Act.

14. He submitted that to overrule the decision in Maharashtra Sugar Mills Ltd. case (supra) and Rajasthan State Warehousing Corpn.'s case (supra) and in order to disallow part of expenditure incurred by the assessee relatable to exempt income, even in a case where the assessee carries on indivisible business (and part of the income received is claimed as exempt), the provisions of section 14A have been brought on the statute. It is submitted that expenditure incurred in relation to exempt income were not allowable as deduction even prior to introduction of section 14A of the Act, except where the assessee carried on an indivisible business, profits from which were partly exempt and partly liable to tax. The provisions of section 14A were brought in to cover a situation where the assessee carries on indivisible business, resulting in both taxable as well as exempt income, where the Courts held that no part of expenditure could be disallowed merely because part of the income earned by the assessee is exempt from tax.

15. Ld. DR, Shri Manish Gupta supplemented that investment is the base for determining of the disallowance. 'No income' also is included in sweap of section 14A. He further submitted that the terms "does" and "shall" do not make any difference because section 10 starts from "income which does not form part of the total income" and in second line it is mentioned "income shall not include". Under the Income-tax Act 'net income' is exempt and, therefore, the expenditure related to non-receipt of income would also be covered and disallowed. He then referred to the decision of the Supreme Court in the case of CIT v. Harprasad & Co. (P.) Ltd. [1975] 99 ITR 118 stating that income includes loss. Referring to Rule 8D(2)(2) of the Income-tax Rules, 1963, he stated that the term used 'does not' relate income or receipt, the disallowance is therefore is to be made. He then referred to the decision of the Calcutta High Court in the case of CIT v. Anglo India Jute Mills Co. Ltd. [1981] 129 ITR 352 wherein it is held that the assistance for machinery section for interpreting the statute can be taken. He then sought rule of mischief to be taken into consideration while interpreting the provision in view of the decision of the Madras High Court in the case of M.S.P. Raja v. CIT [1976] 105 ITR 295 , wherein it was held that if there is no income question of allowing any expenditure would not arise. He further stated that the term "in relation to" is wider than 'for making or earning income' and 'for the purpose of business' and, therefore, the decision in the case of Rajendra Prasad Moody (supra) would apply with more or equal force. He then referred to the provision of section 70 'providing for set-off losses'. He further submitted that section 14A does not use the word "income of the year", but income under this Act and, therefore, the receipt of income in a particular year is not material for disallowing the expenditure. He further referred to the decision of the Special Bench in the case of Aquarius Travels (P.) Ltd. (supra) and submitted that the matter stands resolved by this decision against the assessee. He also referred to the decision of Special Bench in the case of Daga Capital Management (P.) Ltd. (supra) wherein the assessee was an intervener.

16. Ld. Counsel for the assessee in reply submitted that the assessee's case in above case of Daga Capital Management (P.) Ltd. (supra) related to assessment year 2002-03 and not assessment year 2003-04 where there was no income in that year under consideration and also the dividend was taxable in that year. He also submitted that the case of Daga Capital Management (P.) Ltd. (supra) was that if there were no income there is no disallowance. The reasoning of Daga Capital Management (P.) Ltd. case (supra) should be followed and if there is no income, the question of finding out the expenditure does not arise. He referred to the provisions of section 2(45) and section 5 wherein the total income is stated to be of the year and, therefore, the case made out by the Ld. DR that the term used 'under the Act' has no significance. He submitted that one must keep in mind the definition the term "for the purpose of making or earning the income" as used in section 57(iii) and the term "for the purpose of business" used in sections 36(1)(iii) and 37 of the Act. The decision in the case of Aquarius Travels (P.) Ltd. (supra) was rendered in a different context. In the nutshell, he submitted that the decision in the case of Daga Capital Management (P.) Ltd. (supra) does not decide this controversy arising under this appeal and, therefore, it has to be decided by this Bench on the first principles.

17. We have heard the parties and considered the rival submissions. In the present case there is no dispute that interest expenditure incurred by the assessee is for borrowing used for the purposes of investment in shares, both held for trading as well as investment purposes. The interest in either case is allowable, in the former case under section 36(1)(iii) and in the later case under section 57 of the Act.

18. If any income were exempt from tax because it is not included in the total income by virtue of section 10, section 14A prohibits allowance of any expenditure incurred in relation thereto. Income from deployment of funds in shares earned by way of dividend is not included in total income by virtue of the provisions contained in section 10(34) of the Act, be the shares are held as stock-in-trade or held as investment. This section reads as under:

"(34) any income by way of dividends referred to in section 115-O.

Explanation.—For the removal of doubts, it is hereby declared that the dividend referred to in section 115-O shall not be included in the total income of the assessee, being a Developer or entrepreneur;

19. Section 115-O as is referred to in above section reads as under:

'115-O.(1) Notwithstanding anything contained in any other provision of this Act and subject to the provisions of this section, in addition to the income-tax chargeable in respect of the total income of a domestic company for any assessment year, any amount declared, distributed or paid by such company by way of dividends (whether interim or otherwise) on or after the 1st day of April, 2003, whether out of current or accumulated profits shall be charged to additional income-tax (hereafter referred to as tax on distributed profits) at the rate of twelve and one-half per cent.

20. As the dividend income does not form part of total income under the Act the provisions of section 14A would come into play. This section reads as under:

"14A. Expenditure incurred in relation to income not includible in total income.

(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 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."

21. The allowance of expenditure in relation to dividend income would thus be not admissible in computing the income of an assessee under this Act. It would again be so in both the situations i.e., whether the shares are held as investment as held in Harish Krishnakant Bhatt's case (supra) of Ahmedabad Bench of the Tribunal, as also not disputed by the assessee; or they are held on trading account as stock-in-trade, as held by the Special Bench of the Tribunal in Daga Capital Management's case (supra) wherein the assessee was an intervener. Therefore the contention of the assessee that interest is allowable as business deduction under section 36(1)(iii)/37 of the Act has already settled by the said Special Bench against it.

22. The controversy raised in this case is that the assessee had not earned or received any dividend in the year under consideration and, therefore, no disallowance can be made by invoking the provisions of section 14A of the Act. We do not find any force in this contention of the assessee. When the expenditure of interest is incurred in relation to income which does not form part of total income, it has to suffer the disallowance irrespective of the fact whether any income is earned by the assessee or not. Section 14A does not envisage any such exception. This is even if the interest paid on borrowings for the purchase of share were allowable under section 57 as an expenditure incurred for earning or making income as held by the Supreme Court in the case of Rajendra Prasad Moody (supra) or under section 36(1)(iii) as an expenditure incurred wholly and exclusively for the purposes of business as held by various decisions right from beginning of the Income-tax Act. When, prior to introduction of section 14A, an expenditure both under sections 36 and 57 was allowable to an assessee without such requirement of earning or receipt of income, we cannot import any such condition when it comes for disallowance of the same expenditure under section 14A of the Act. This is what is held by the Ahmedabad Bench of the Tribunal in the case of Harish Krishnakant Bhatt (supra) when it of observed that interest on monies borrowed for purchase of shares held as investment is not allowable whether or not there is any yield of dividend. It is so held by applying the decision of the Supreme Court in Rajendra Prasad Moody's case (supra) in the reverse case wherein it is that irrespective of dividend receipt, expenditure has to be allowed. Now since dividend is exempt, as a consequence thereof expenditure has to be disallowed.

23. The contention of Shri Vohra that the decision of the Supreme Court in the case of Rajendra Prasad Moody ( supra), dealt with issue of admissibility of deduction in section 57(iii) and the language of the said section is materially different from the language of section 14A of the Act and secondly, that the aforesaid decision was rendered in the context of purchase of shares held as 'investment', in which case deduction of expenses is claimed under section 57(iii), whereas in the present case the assessee is undisputedly entitled to deduction of expenses under section 36(1)(iii) of the Act and, therefore, section 14A cannot be applied in the case of a person engaged in the business of dealing in shares claiming deduction under section 36(1)(iii) of the Act, has no force. Though it is true that language of section 57 for allowance of expenditure and the language of section 14A for disallowance of such expenditure are different but it is not so material in deciding the issue. Whereas section 57 allows the expenditure incurred for making or earning the income, section 14A disallows the expenditure 'in relation to income which does not form part of total income'. The term 'expenditure in relation to' is wider in scope and provides for disallowance if it related to income not forming part of total income.

24. The second aspect of the argument also has no force as the provisions of section 14A are controlling the computation of income and other provisions of the Act and has the supervening effect over other provisions. Therefore, even if the expenditure were allowable under any provision of the Act, it has to suffer the disallowance because of the overriding effect of section 14A of the Act, be that section 36(1)(iii) or section 57 of the Act.

25. While considering the said expression incurred for 'making or earning such income', the Supreme Court held that it does not mandate that any income should in fact have been earned as a condition precedent for claiming the expenditure. It observed :—

"What section 57(iii) requires is that the expenditure must be laid out or expended wholly and exclusively for the purpose of making or earning income. It is the purpose of the expenditure that is relevant in determining the applicability of section 57(iii) and that purpose must be making or earning of income, section 57(iii) does not require that this purpose must be fulfilled in order to qualify the expenditure for deduction. It does not say that the expenditure shall be deductible only if any income is made or earned. There is in fact nothing in the language of section 57(iii) to suggest that the purpose for which the expenditure is made should fructify into any benefit by way of return in the shape of income. The plain natural construction of the language of section 57(iii) irresistibly leads to the conclusion that to bring a case within the section, it is not necessary that any income should in fact have been earned as a result of the expenditure. It may be pointed out that an identical view was taken by this court in Eastern Investments Ltd v. Commissioner Of Income Tax, West Bengal [1951] 20 ITR 1 , 4 (SC) , where interpreting the corresponding provision in section 12(2) of the Indian Income-tax Act, 1922, which was ipsissima verba in the same terms as section 57(iii). Bose J., speaking on behalf of the court, observed :—

"'It is not necessary to show that the expenditure was a profitable one or that in fact any profit was earned.'

It is indeed difficult to see how, after this observation of the court, there can be any scope for controversy in regard to the interpretation of section 57(iii)."

26. It is true that the Court, while considering the expression 'for the purpose of making or earning such income', held that in order to claim deduction under the aforesaid section 57(iii) of the Act, it is not necessary that income should have actually been earned or made. The actual earning or receipt of income on parity of reasoning would also not be a condition for disallowance of such interest under the provisions of section 14A of the Act which employs the expression 'in relation to income which does not form part of the total income'. The ratio of the decision can be used in the converse situation also to hold that even if no income were received, expenditure incurred can be disallowed under section 14A of the Act. The expenditure incurred by way of interest on acquisition of shares is, in the case of the assessee, is allowable deduction in terms of section 36(1)(iii)/37(1) of the Act as the expenditure by way of interest incurred 'for purposes of business', a term wider than 'for making or earning income' as held by the Supreme Court in the case of Malayalam Plantations Ltd. (supra). At page 150 it says :—

"The aforesaid discussion leads to the following result: The expression 'for the purpose of the business' is wider in scope than the expression 'for the purpose of earning profits'. Its range is wide: it may take in not only the day to day running of a business but also the rationalization of its administration and modernization of its machinery...."

27. The term 'expenditure incurred in relation to income' used in section 14A is still wider than the 'expenditure incurred for the purposes of business'. Irrespective of the fact that the expenditure incurred by way of interest is an allowable deduction in terms of the aforesaid sections of the Act which introduces a caveat of section 14A providing to disallow expenditure which is otherwise allowable in the circumstances mentioned in that section(s). The Legislature, using the expression 'expenditure in relation to income which does not form part of the total income' in section 14A of the Act, in no way indicates that it does not encompass the disallowance of expenditure incurred in relation to the income in absence of actual receipt of income during the relevant previous year. On the contrary, as stated above, the term 'in relation to' is wide enough to include in its sweep the expenditure both 'for making or earning income' and 'incurred wholly and exclusively for the purposes of business carried on by the assessee'.

28. Let us see whether the words 'does not' appearing in the term 'income which does not form part of total income' in section 14A excludes a case of no earning or non receipt of income from its ambit. When there is no income, it cannot form part of anything and certainly it does not, in any case form part of total income. In a contrast, to put it differently, can one say 'does it form part of total income', the answer is No. The words "does not" of course, denotes the present situation, and not the future events as apprehended by the ld. Counsel to have been contemplated/ attempted by the revenue. In present tense also, 'no income or non receipt of income' does not exist in something and therefore cannot form part of assessee's total income under the Act of the year, not because of its exemption but because of its absence and it is a fact. In such a situation it cannot be said the no disallowance is to be made or that the disallowance is resorted to by the revenue in relation to future income. It is for the present current years' total income which does not include the income from dividend as specie because of its absence. A thing which is absent cannot exist in and consequently does not form part of anything.

29. We may refer to the object of introducing the provision of this inserted section 14A by the Finance Act, 2001, with retrospective effect from 1-4-1962 as clarified in the provisions as well as in the memorandum explaining the provisions, notes on clauses relating to the Finance Bill, 2001 and in the Board's Circular No. 14 of 2001, dated 22-11-2001 and Circular No. 8 of 2002, dated 27-8-2002 in the following way :—

"Certain incomes are not includible 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 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 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 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."

30. It is thus clear, that from whatever angle one may look at the transaction, result is the same, viz., when the dividend is not taxable at all the interest pertaining to that would also not be allowable because there is no taxable income of the assessee against which such interest can be allowed. The another way to consider the issue is that if interest is allowable, it would be allowable against dividend income and the net dividend income after allowing that, alone would be excluded from total income under section 10(4). Section 14A was inserted to clarify this intention of the Legislature to set the existing controversy on this issue at rest.

31. In the present case, we find that the borrowed money has been utilized in purchase of shares held both as investment as well as stock-in-trade. As the monies borrowed have been utilized in purchase of shares held, the interest paid on so borrowed monies is allowable against the income from dividend income either as incurred for making or earning dividend income on such shares or as incurred wholly and exclusively for the purposes of business carried by the assessee, if he deals in such shares. It is in both the situations, irrespective of whether or not there is any yield of dividend on the shares purchased. In other words, the interest incurred is to be relatable to earning of dividend on the shares purchased. The dividend income is now exempted from tax by virtue of section 10(34) of the Act and, therefore, as a consequence thereof, the interest paid on borrowed capital utilized in purchase of shares, being the expenditure incurred in relation to dividend income not forming part of assessee's total income, cannot be allowed as a deduction. There is no chargeable income against which it can be allowed as a deduction. It cannot also be allowed against any other taxable income inasmuch as the interest so paid is not relatable to the earning of taxable income. This is what is provided by the Legislature in the scheme of the Income-tax Act even without the existence of section 14A of the Act with retrospective effect from 1-4-1962.

32. It is true that the Supreme Court held in Maharastra Sugar Mills Ltd.'s case (supra) that the fact that the income is exempt is not a relevant circumstance and in the case of Rajasthan State Warehousing Corpn.'s case (supra) that if there is one indivisible business, the entire expenditure is allowable under section 36(1)(iii) of the Act but these decisions were rendered prior to the introduction of section 14A by the Finance Act, 2001, with retrospective effect and, therefore, they would have no application after introduction of section 14A where the expenditure is not to be allowed if it related to income not included in the total income of the assessee. Similarly, the decisions in the cases of Malyalam Plantation (supra), Birla Cotton Spinning & Weaving Mills Ltd. (supra), Madhav Prasad Jatia (supra) and S.A. Builders Ltd. (supra) had no application in view of the introduction of section 14A in the statute in cases where the expenditure relates to the income which does not form part of the total income under the Act. In the decision of the Mumbai Bench of the Tribunal in the case of Delite Enterprises (P.) Ltd. (supra) the assessee company had made investment in a partnership firm, income from which was exempt from tax under section 10(2A) of the Act. Since investment in the partnership firm was made by the assessee out of borrowed funds, in the assessment orders for the assessment years 2001-02 and 2002-03, the Assessing Officer disallowed interest expenditure claimed by the assessee under section 14A holding that since income derived from the partnership firm would be exempt under section 10(2A) of the Act, the expenditure relatable to the earning of the income was to be disallowed in terms thereof. The appeal preferred by the assessee against the assessment orders was allowed by the CIT(A). In second appeal the Tribunal, after noting the facts that in one year no interest was received from the partnership firms, while in the second year, the interest income was offered for tax, held that since in both the years the assessee had not claimed any exemption under section 10(2A), there was no question of application of provisions of section 14A of the Act. The observations of the Tribunal read as under :—

"For the assessment year 2001-02 the assessee had in fact earned interest of Rs. 99,01,000 and the Assessing Officer has brought it to tax. The first appellate authority has rightly held that this receipt is taxable under the head 'Profits and gains of business or profession' under section 28(v) of the Act. There is no exemption claimed under section 10(2A) of the Act by the assessee. Section 10(14) clearly states that expenditure incurred by the assessee in relation to income which does not form part of total income under the Act will not be allowed. In this case, for both the assessment years, there is no income earned by the assessee which does not form part of the total income under the Act. Under these circumstances we do not see any reason why the claim of the assessee is not allowable under section 36(1)(iii). Coming to the argument of the learned departmental representative that the judgment of the Hon'ble Apex Court in the case of Rajendra Prasad Moody (supra) is not applicable to this case, we find that the Hon'ble Madras High Court in the case of M. Ethurajan (supra) has held that the propositions laid down in Rajendra Prasad Moody's case (supra) for allowability under section 57(iii) are equally applicable for deductions claimed under section 36(1)(iii) or section 37. Thus this argument of the Revenue is without any merit."

33. In further appeal preferred by the revenue against the aforesaid order of the Tribunal, the High Court dismissed the question raised, by observing as under :—

Revenue is in appeal on the following questions :—

"Whether on the facts and in the circumstances of the case and in Law the Hon'ble Tribunal was right in deleting the disallowance made by the Assessing Officer of interest paid by the assessee-company on borrowed funds amounting to Rs. 241.10 lakhs overlooking the fact that the borrowed funds were used by the assessee- company to invest in the capital of another partnership firm and since profits derived by the assessee-company from a partnership firm were exempt from tax under section 10(2A) of the Income-tax Act, the interest expense related to such tax free profits is to be disallowed under section 14A of the Income-tax Act?

..........................

Insofar as question (A) is concerned, on facts we find that there is no profit for the relevant assessment year. Hence the question as framed would not arise.

...........

Consequently appeal dismissed."

34. What the High Court has held is that the question framed does not arise. It does not hold that where no exemption is claimed there can be no question of application of provisions of section 14A of the Act. In any case the Tribunal held that interest income was taxable as business income under section 28(iv) of the Act and in that context the Tribunal held that "in this case, for both the assessment years, there is no income earned by the assessee which does not form part of the total income under the Act." Under these circumstances we do not see any reason why the claim of the assessee was not allowable under section 36(1)(iii). This case does not help the assessee at all as it was not a case of no income at all but a case income chargeable to tax under section 28(iv) of the Act and expenditure was in relation thereto.

35. It has been similarly held by the Mumbai Bench of the Tribunal in the case of Asstt. CIT v. Lafarge India Holding (P.) Ltd. (supra). In that case, the Tribunal held that three conditions should be satisfied before invoking the provisions of section 14A, namely, (i) the assessee should have incurred expenditure; (ii) such expenditure should be in relation to income; and (iii) such income does not form part of the total income under this Act. It is only if these conditions are cumulatively satisfied, the provisions of section 14A are attracted. It then found that the assessee had incurred expenditure in relation to income which is exempt under section 10(33) of the Act as it then existed. The assessee has not earned any dividend income. The only income is interest on fixed deposits with the bank. As against this income, the assessee had claimed expenditure of Rs. 2,69,85,000. Thus, it is seen that in the year in question there is no income of the assessee which is exempt under section 10(33) of the Act. Relying on the decision by the Mumbai Bench of the Tribunal in the case of World Network Services (P.) Ltd. (supra) the Tribunal held that the provisions of section 14A cannot be applied. It held that section 14A is not applicable to the facts of the case and the assessee was carrying on the business. In these circumstances, the natural consequence that flows is that expenses claimed by the assessee are deductible in full under the head "profit and gains from business or profession" It has been similarly held in the cases of Shree Shyamkamal Finance & Leasing Co. (P.) Ltd. v. ITO [2008] 21 SOT 42 (Mum.) (SMC) and V.C. Nannapeni (supra). These are the cases before rendering of Special Bench decision in the Daga's case and the expenditure was held to be allowable under section 36(1)(iii) and not because of absence of exempt income. In any case that view is not in consonance with the clear language of section 14A as discussed above.

36. Delhi Bench of the Tribunal in the case of Insaallah Investment Ltd. (supra) held that the receipt of dividend in the relevant year is irrelevant which is by following the decision of the Special Bench of the Tribunal in the case of Aquarius Travel (P.) Ltd. (supra). In this case of Aquarius Travel (P.) Ltd. (supra) the issue whether the provisions of section 14A can be invoked in the appellate proceedings for the first time or not was held in affirmative.

37. We are conscious of the decision of Sun Engg. (P.) Ltd. (supra), for the proposition that it is not permissible to pick a word or a sentence in a decision totally out of its context and the Supreme Court in the case of Padmasundara Rao (Decd.) v. State of Tamil Nadu [2002] 255 ITR 147 at p. 153 observing that the Courts should not place reliance on the decision without discussing as to how the factual situation fits in with the fact situation of the decision on which reliance is placed.

38.It may not correct to state that the decision of the Aquarius Travels was decided on the basis of the concession of the counsel and the issue in the present case was neither considered nor argued before the Special Bench. A dispute was raised before the Special Bench as is evident from the following extract from the order :—

"6.11 It was finally pointed out by the learned counsel Shri Mehta that the assessee was not having any tax-free income in this assessment year and. therefore, there was no question for making disallowance under section 14A."

39. It finally restored this issue to the file of the Assessing Officer for quantification of interest for the period 1-6-1997 to 31-3-1998 in respect of borrowings utilized for investment in shares and held the same to be disallowed. It was however a case of investment in shares and not stock-in-trade but that as we have held earlier is not material for disallowing interest to borrowing utilized in purchase of shares.

40. To support his contention that there must be exempt income to invoke section 14A Mr. Vohra referred to the Special Bench of the Tribunal in assessee's own case for the assessment years 2001-02 and 2002-03 as bunched with appeals of other assessees in Daga Capital Management (P.) Ltd.'s case (supra ) held (by a majority view) wherein it is held that in order to apply the provisions of said section, the exercise of making disallowance starts from tracing out the exempt income. Only once exempt income is traced, the process of working out the expenditure incurred in relation to the said exempt income gets initiated. These observations were because exempt income was there in consideration and that is why the Special Bench used this language. It should be read as a reference of the source of exempt income whether received or not.

41. The contention of the assessee before the Special Bench was that the Bench had to view the items of expenditure first and if these have resulted in exempt income, only then the disallowance is to be considered. In other words, the starting point for applying section 14A is to consider the amount of expenditure and then moving forward for examining if it had resulted in the exempt income or not. This is exactly what the assessee is contending in this case though in different phraseology that there must be exempted income earned to disallow the expenditure. It was rightly rejected, by stating: 'We are not convinced with the view point of the learned A.R. that section 14A speaks about making disallowance of expenditure which has resulted into exempt income. The language of sub-section (1) of section 14A clearly provides that no deduction shall be allowed "in respect of expenditure incurred by the assessee in relation to income which does not from part of the total income under this Act". On going through the simple and plain language, it is abundantly clear that the relation has to be seen "between the exempt income and the expenditure incurred in relation to it and not vice versa. What is relevant is to work out the 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. If the view point of the learned AR is accepted then it would mean putting the cart in front of the horse and redrafting sub-section (1) of section 14A. On going through sub-section (1), it can be clearly noticed that the exercise of making disallowance starts with firstly tracing out the exempt income and then initiating the process of working out the expenditure incurred in relation to such exempt income. It is clearly borne out from, rule 8D as has been discussed infra that it has three clauses of sub-rule (2), being the expenditure directly relating to the exempt income as per clause (i); expenditure by way of interest which is not directly attributable to particular income as per-clause (ii) and; an amount equal to one half per cent of the average of the value of investment as per clause (iii). The sum total of these three amounts is the amount disallowable under section 14A. From here it clearly emerges that stipulation of section is to compute the amount of expenditure which is not allowable under section 14A as is relatable to the exempt income and not in considering all the expenses one by one for ascertaining if either of them have resulted into exempt income and thereafter considering such amount as disallowable under section 14A. If this way of interpretation of section 14A as suggested by the ld. AR is accepted, then the method of computing the expenditure as relatable to the exempt income as provided in rule 8D, would become meaningless and the words 'in accordance with such method as may be prescribed' in sub-section (2) for determining the amount disallowable would require obliteration, which in our considered opinion is not possible'..... We have already repelled the contention raised on behalf of the assessee that the object of the expenditure is to be viewed as a determinative factor for making any disallowance under this section. It is simple and plain that the disallowable expenditure is to be worked out which has relation with the exempt income and not otherwise. We are, therefore, not inclined to accept the assessee's version that if the exempt income is incidental to the main business whose income is taxable, then the provisions of section 14A will be defeated."

42. Reference to exempt income was made because it was a case of exempted income earned and received by the assessee and not a case of no income earned or received. In the context of later position it be read as 'exempted income/no income resulted' as the expenditure that is allowed or disallowed is for making or earning income or for the purposes of business or in relation to such income. If read in this way there would be no confusion in understanding the order of the Special Bench.

43. What one has to see is whether any expenditure were incurred by an assessee in relation to an income that does not form part of total income of the assessee under this Act, and if the answer is in affirmative then that expenditure cannot be allowed irrespective of the fact that it was allowable under different provisions of the Act where a different phraseology is used in allowing that expenditure as the focus has to on disallowance within parameters of section 14A, an overriding provision over allowance provisions. It would result in disallowance even of no income has resulted or made or earned by the assessee in the year under consideration. We also make it clear that the disallowance has to be of the entire, amount of the expenditure so related and, as claimed in revenue's appeal, cannot be reduced by the receipt of interest which has no relation to such expenditure.

44. An attempt was made by the assessee to show the overreaching effect of rule 8D and wanted to raise an additional ground but we did not allow him to address on these issues because of the limited scope of reference to this Special Bench which is to dispose and decide the appeal on the question referred to by the President of the Tribunal. The assessee may if so advised take up the issues before the Division Bench in accordance with law.

45. The intervener has exempted income and therefore would not be fall within the scope of the issue for which is constituted to dispose of the case of disallowance in cases where no exempted income is earned or received. We are therefore excluding this case from our consideration.

46. In the result, the question, whether disallowance under section 14A of the Income-tax Act can be made in a year in which no exempt income has been earned or received by the assessee, is answered affirmatively against the assessee and in favour of the revenue.

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