Analysis of the SC Decision on Section 14A of the Income Tax Act, Invoking the Adam Smith Principle
The appellant banks were listed banks and as part of their banking activities also engaged in the business of investing in bonds, securities and stocks which in turn provided interest and dividends to banks which were essentially free tax. None of the banks kept a separate account for investments made in stocks, securities and bonds from which tax-free income was earned, so the rejections are limited to the expenses incurred. In the absence of segregated accounts, the valuation officer proportionately rejected interest attributable to funds invested to earn tax-free income. The banks contacted CIT, who agreed with the reviewers’ opinion. On appeal, the Income Tax Appeal Tribunal ruled that the rejection under section 14A was not justified, in the absence of a clear identity of the funds. On appeal, the Delhi High Court overturned the ITAT decision, ruling in favor of the respondents. Affected by the said order, the appellants applied to the Supreme Court by means of a special authorization.
Under section 14 of the Income Tax Act, various income is classified in this section under main wages, home ownership income, business and professional profits and earnings. , capital gains and income from other sources which ultimately form part of total income. .
Article 14A stipulates that the expenses incurred to generate non-taxable income are not deducted when calculating the total income of the appraised concerned..
The appellants’ thesis
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The appellants argued that the investments made in bonds and stocks should be considered to have been made from interest-free funds, which were more than the investments made, and that the interest paid by the bank on deposits and other borrowings therefore should not be considered to be expenses incurred as part of tax-exempt income. They leaned on the Income Tax Commissioner (Large Taxpayers Unit) Vs. Reliance Industries Ltd. this declared where there was a finding of fact that the interest-free funds available to the appraised were sufficient to meet his investment, it would be presumed that the investments were made from those interest-free funds
The Respondents’ Thesis
The respondents argued that the High Court’s decision was sound in law and required no interference from this Court. They relied on SA Builders v. CIT, where the Court ruled on the disallowance issue regarding funds loaned to a sister company from mixed funds. They argued that the matter was pending before a larger judiciary and that, therefore, the disallowance decision when mixed funds were at stake had not yet achieved its finality.
Reasons for decision
The Court noted that the High Court ruled primarily in favor of the respondents based solely on the fact that the appellants had not kept a separate account and by inquiring of the respondents, they were not able to justify this reasoning because of the lack of legal support. The Court noted that no law required appellants to maintain a separate account. The Court relied on Maxopp Investment Ltd. vs. CIT, who held that the purpose of section 14A was to prevent the double benefit from being provided to an affected assessor. He also stated that if an expense incurred was not causally related to the exempt income, then such expense would be considered unrelated to the tax exempt income. The Court also relied on the decision rendered in Godrej and Boyce Manufacturing Company Ltd. V. DCIT ruled that, for the rejection of expenses incurred to earn income, it was a condition precedent that this income should not be included in the total income of the appraised.
The court’s decision
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The Court hesitantly accepted the decision of the Income Tax Appeals Tribunal, ruling in favor of the appraised in terms of exemptions and observed that a proportional denial of interest was not justified, in under section 14A of the Income Tax Act for investments made in tax-free bonds. / securities that have yielded tax-free dividends and interest to value banks in situations where the interest-free equity available with the valued has exceeded their investment. The court also cited 18th century economist Adam Smith to push the government to relax the tax system to ensure better compliance.
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