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Text of the Article - (2009) 14 CPT 819
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SECTION 14A of INCOME TAX ACT – INTERPRETATION OF – A CRITIQUE
V SWAMINATHAN B.Sc., B.L., FCA
1. Introduction
A simplified income-tax law (the law) was conceived many years ago but still remains to be delivered. In the interim, the executive has continued to pursue aggressively but mindlessly its ‘change mania’, which has come to stay as the driving force behind legislation on income tax, More notably, the new millennium has brought with it a flurry of changes in the law. It is replete with instances where the statute as originally framed and enacted have come to be tampered with, that too in a sweeping frenzy. Many of the changes made are purported to be with full or partial retrospective effect. So much so, the tax regime has been proving as ever before a fertile ground for nurturing or flourishing of newer and newer kinds of disputes, leading to inconclusive litigation. The already existing complexities have thus been worse confounded. It is not at all surprising that as per a report in a professional journal, the White Paper that was to be issued to the public but yet to see the light of day would, contrary to the earlier assurances offered by the last Finance Minister, not be a full draft code; the excuses given are, - the “present complexities” and “the court cases, which run into several thousands”.
2. Lately, section 14A, inserted in the Income-tax Act (the Act) by the Finance Act, 2001 with full retrospective effect (that is, after 40 years, - right from the coming into force of the 1961 Act), has been the subject matter of one such vexing ongoing dispute. The issues raised on the implications of the section have been dealt with in a few orders of the appellate tribunal reported in Taxmann’s journals.
Backdrop
3. In the reported Order of the appellate tribunal in - ITO vs Daga Capital Management (P) Ltd. [2008] 26 SOT 603 (MUM)(SB) (the Daga case)), the matter of dispute is noted to have been gone into at an impressive length. It may be useful to closely read and keep the contents of the said Order in view, as a backdrop, for at least knowing - (a) the contentions respectively raised by the assessee and the Revenue, and (b) the reasons for/grounds on which the tribunal has handed down its opinion in the Revenue’s favour.
Law before insertion of section 14A
4. The admitted position under the existing law, that is before section 14A was entered on the statute, is open to be seen from a large number of judgments of the Apex Court and several High Courts. In some of the leading court cases, the dispute pertained to deductibility of expenditure such as, -managerial commission, salary and other employment costs, interest on borrowed capital, - against items of income not included in total income, being income from – agricultural land forming part of assessee’s business assets, a new or extension of business but not distinct or separate from but forming part of the existing business of assessee, dividend from company shares held by assessee as a trade asset. The opinion of the judiciary as culled from the case law may be summed up as follows: The deductibility or otherwise of any expenditure claimed by an assessee should be determined having regard to and in accordance with the applicable provisions of the Act. Deduction for an expenditure must be allowed, if so permitted/permissible under the provisions governing the computation of the chargeable income (or profits or gains) under the appropriate head of income; especially, if there is no specific prohibition against such an allowance spelt out in the Act. Deduction or allowance for any expenditure, if it is otherwise permitted, cannot be denied merely on the ground that it is either wholly or partly relatable, or can directly or indirectly be attributed to an item of income that is not includible and hence does not form part of the total income.
Law after insertion of Section 14A
5. The pith and substance of the departmental explanation for enacting section 14A was as follows: The legislative intention, since the inception, was not to allow deduction in respect of any “expenditure incurred by the assessee in relation to income which does not form part of the total income”. The opinion of the Apex Court and High Courts to the contrary was considered as not laying down the correct law in consonance with the intention of the Legislature. Therefore, the judicial opinion had to be invalidated by the insertion of the new section that was of a clarificatory nature.
6. Initially, section 14A inserted by the Finance Act 2001, with retrospective effect from 1-4-1962, read as under:
“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. “
The Proviso thereto, introduced later by the Finance Act 2002, with a partial retrospective effect from 11th May 2001, reads:
“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.”
Section 14A (supra) was renumbered as sub-section (1) by the Finance Act, 2006 which added two new sub-sections (sub-sections (2) and (3)) effective from 1st April 2007.
Thus, prior to the date of 1st April 2007, only the original provision, which now stands renumbered as sub-section (1) (herein after referred as - the subject provision), was on the statute. In the long gap of five years, that is from 1st April 2001 to 31st March 2006, the subject provision alone was in force. In view thereof, the discussion herein is mainly devoted to the subject provision. The two sub-sections (2) and (3) enacted subsequently, as also the rule (Rule 8D) framed thereafter, have been commented on herein afterwards.
7. On a plain and straightforward reading, the purport and import of the subject provision seems to be loud and clear. For realizing and appreciating it in the proper perspective, the crucial terms used would require to be duly stressed and understood, on the lines suggested herein below:
(1) The opening words of section 14A are, - “For the purpose of computing the total income under this Chapter”. The significance of the mentioned expression needs to be understood having particular regard to the following features of the Act: - “Total income” means / refers to the sum total of the varying types of income on which tax is chargeable. The chargeable income is required to be computed under anyone or more of the specific heads listed in section 14. That is dependent on the type of income, mainly in reference to its source and distinguishing characteristics. The method of computing the income is provided, separately, for each one of the specified heads of income and covered in the set of provisions especially applicable thereto. What really are of relevance are the special provisions applicable / applied to each type of income in computing it under the relevant head. To put it succinctly, computation of total income is not a single composite exercise; but it is to be arrived at by aggregating the chargeable income as computed under each source / head, by applying the appropriate method.
Accordingly, the disallowing ambit of section 14A is necessarily to be determined by taking into account all those other provisions of the Act that essentially are of relevance. For instance, if, in a given case, the item of income not included in the assessee’s total income is in the nature of income chargeable under the head of – “profits and gains of business” (business profits), then the provisions of sections 28 to 44DB be relevant. And, as such, section 14A will require to be read into and understood as if it were a part and in the parcel of the scheme of the aforementioned sections, and read and understood in that setting.
It calls for a pointed mention that, section 14A is not prefixed with a non-obstante clause. In the Act, in several contexts, the phrase – “notwithstanding anything contained in..” has been used. That is a phrase conventionally used to give the enacting part of the section, in case of a conflict, an overriding effect, over the other provisions of the Act mentioned or specified in the non -obstante clause. Such a clause is a legislative device to modify the ambit of the provision of law mentioned in the non-obstante clause or to override it in specified circumstances. As, however, section 14 A has no non obstante clause prefixed to it, it is not intended to be, or cannot by any means be regarded as, a special provision either modifying or overriding the other computation provisions.
(2) Another crucial expression in section 14A, which needs to be closely read and incisively understood, is, - “expenditure incurred by the assessee in relation to.. ”. It is important to recognize and understand the connotation and significance of each one of the words / phrases, - ‘expenditure’, “expenditure incurred” and “incurred in relation to” comprised therein. That needs to be done on the lines indicated below:
(A) The word ’expenditure’ has not been specially defined in the Act. It has therefore to be understood in its ordinary meaning or legal connotation, It is an accepted proposition that the word ‘profits’ has to be understood in its natural and proper sense, a sense in which no commercial man would misunderstand. As a corollary, and by the same token of logic and reasoning, the word ‘expenditure’ would require to be understood likewise. Further, the word is copiously used in the Act in several contexts, and its meaning, especially for its deduction or allowance under the Act, should pose no problem. And even if there be any, solution should be readily available from the case law.
(B) Again, the word ‘incurred’ again is not specially defined in the Act. It has to be necessarily read and understood in conjunction with the preceding word - ‘expenditure’ as well as the succeeding phrase “in relation to”. A clinical examination essentially suggests that, - (i) ‘the expenditure’ must have been incurred, in the sense - the ‘liability to pay’ must have arisen, in the year of account, and (ii) such liability must have a direct relation or nexus to the item of income not forming part of the total income of the year of account.
Under the scheme of the Act, especially of the provisions for computing business profits, generally a deduction is permissible, provided the expenditure has been incurred in the relevant year of account. Though, in exceptional circumstances the aforesaid general rule is relaxed. The most common and predominant exception is the case where the assessee follows mercantile (i.e. ‘accrual’) method of accounting. In such a case, deduction is admissible in accordance with the method of accounting adopted by the assessee; that is, in the year of account in which the expenditure is debited in the accounts as ‘accrued due’.
The word ‘paid’, which is used in a number of places in the Act, has been specially defined to mean ‘actually paid or incurred according to the method of accounting ……… “. Conspicuously, in section 14A, the word used is’ incurred’; it is used in isolation, not in conjunction with the words – “ in accordance with the method of accounting”. Hence, for the purpose of section 14A, the word ’incurred’ used therein is required to be understood purely in its general meaning – namely, ‘liability to pay’. Accordingly, on a proper construction, a given expenditure, in order to be caught within the disallowing mischief of section 14A, must be one for which the ‘liability to pay’ arose in the relevant year of account.
To elaborate: For instance, take for consideration expenditure incurred by way of interest on capital borrowed. It is allowable as a deduction in accordance with the governing section 36(1)(iii). Allowance is permitted in any year, provided the interest is ‘paid’ in that year. However, because of the special meaning of the word ‘paid’ under the Act, deduction, as per the accepted position, is allowable for the interest actually paid or ‘accrued due’ (that is, if the assessee has adopted ‘accrual’ method, which is presently mandatory for companies to follow).
Borrowing may be of varying types –e.g. an overdraft, a term loan or a debenture loan. Broadly speaking, liability to pay interest on any monies borrowed may have to be regarded to arise at the point of time when the borrowing is made / money is received. In respect of a debenture loan, if interest is payable upfront, it is at that time the liability to pay interest arises. In respect of an overdraft arrangement, liability to pay interest arises if and when there is a withdrawal exceeding the amount lying to the credit of the account holder. By and large, except rarely - such as, for funding a new project or business venture of a significant size, a business enterprise uses a bank account with overdraft (or cash credit) facility for meeting its requirements, particularly for working capital. That is an account from which withdrawals are made for business purposes, and into which business receipts are deposited, In the nature of things, therefore, it would not be obligatory for an assessee, in any case be quite cumbersome, rather impracticable, to relate any particular withdrawal, to the purpose for which it is utilized. For these or other reasons, the debit in the accounts of any year for the interest payable on any such borrowing may well be not necessarily one for which ‘liability to pay’ arose in that year. That might be so also if a debit in the accounts for expenditure is in accordance with the accepted accounting theory/principle – such as, ‘matching concept’, or ‘amortization’ (over a period of years), etc. To put it differently, the debit in the accounts is not necessarily conclusive; the factual position will require to be investigated, for ascertaining as to in which year of account the liability to pay the interest arose.
(C) In the Daga case, it is seen from the tribunal’s order, the Revenue had placed great stress and mostly relied on its interpretation of the words ‘in relation to’ used in section 14A, The astoundingly large number of court and tribunal decisions cited and relied on by the Revenue are also confined to that purpose. However, the way the Revenue has sought to place a construction by harping merely on the phrase – “in relation to” is prima facie ill founded, illogical, and fallacious. The reason, in one’s firm conviction, is more than obvious: The ordinary meaning of the word - ‘relation’ is, - a connection or relationship between one thing and another. It necessarily postulates existence of two things for a relationship to obtain. The derivative phrase – ‘in relation to’ means, – in reference to or with respect to. Underlying the expression is the idea of a nexus between two things. The phrase has to be accordingly construed and understood in its simple sense. It can be validly urged that, there is seemingly no scope or warrant to construe the phrase any differently by subjecting it or resorting to any complicated process of thinking or reasoning, or to a long drawn process of interpretation.
In brief, the above-referred words have to necessarily be paired and read in a coherent manner, for appreciating the true purport and implications of the subject provision.
Proceeding on that premise, there appears to be no room for a genuine doubt that the law clearly envisages a nexus or interlink between – (a) the particular liability/debt that has given rise to the expenditure and (b) the item of income not included in the total income.
8. There is yet another aspect, which has a vital bearing and is bound to pose an insurmountable challenge to the Revenue in its endeavor to straightaway invoke and apply the subject provision on a stand alone basis to a given case. As pointed out herein before, for giving effect to section 14A, the provision has to be necessarily read into and understood in the context / setting of the relevant computation provisions. For instance, if it is interest on capital borrowed, then for giving effect to section 14A, it must be read and understood as a part or limb of, among others, the applicable section 36(1)(iii).
Now, in terms of section 36 (1)(iii), as per the case law, the only condition /sole consideration for allowing a deduction for interest expenditure is that the borrowing must be for the purposes of the assessee’s business. The well-accepted and finally settled position in law is that the term - “for the purposes of the business” should be construed to have very wide and sweeping amplitude. As such, even if section 14A is read as part /limb of section 36(1)(iii), there is, for obvious reasons, no way for section 14A to modify or override in any manner the existing legal position under section 36(1)(iii). In other words, that will push back the Revenue to square one. To put it differently, if the subject provision is construed in the manner canvassed above, in one’s submission tightly so, that would have the necessary consequence of rendering it non est; or in any event, restricting its application to only exceptional circumstances, if any.
9. Sub-section (2) later inserted in section 14A with effect from 1-4-2007 reads as under:
“(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) ………… “
It was in pursuance of sub-section (2) that the procedural Rule 8A came to be made, vide. the Fifth Amendment Rules, with effect from the specified date of 24th March 2008.
Both sub-section (2) and Rule 8D speak of determination by the assessing officer, having regard to the accounts of the assessee, the amount of expenditure incurred/attributable to the tax exempt income, That is prima facie inconsistent or in conflict with what is provided in the subject provision. To be precise, the subject provision, in terms, does not contemplate or lend any scope for a disallowance being made on any notional basis or in the manner as prescribed in Rule 8D.
Further, having special regard to the language /terms of sub-section (2), one would submit that, - it is clearly a substantive (substantial) provision. And, in any view, it is essentially an integral part of sub-section (1) (as renumbered), which is in the nature of a charging / computation provision – not simply in the nature of a ‘machinery’ provision (in the sense as normally understood). This is an essential criterion, which also goes against sub-section (2) (also, sub-section (3) and the rule there under), being considered to have a retroactive effect. Further, Besides, Rule 8D is a subordinate legislation, and cannot override the subject provision.
It is all the more puzzling that the enactment of section 14A has been made piecemeal. That constitutes an unconventional and a sad departure from the basic norms and principles of a good and legally valid legislation.
Key Note: For knowing more intimately or making a detailed study of any one or more of the aspects dealt with herein above, the expert commentary and citations of the case law in the latest edition of the leading Book on Income Tax by Kanga, Palkhivala and Vyas may be of useful guidance
Constitutional propriety / Legal validity
10. In the words of late Nani A. Palkhivala, an outstanding expert in constitutional law: “The Constitution of India provides for a just balance between the legislature, the executive and the judiciary. Each has a specific field to cover. The courts are there to maintain the most fundamental equilibriums of our society. They are the agency of a sovereign people to enforce the laws; also to expound the Constitution and to ensure that its mandates are respected. The courts are vested with exclusive powers to interpret the law. Any interpretation of the law especially by the apex court has a binding force.”
The essence or implication of the referred expert opinion is this: The legislature is no doubt vested with plenary powers to legislate on among others the subject of taxation of income, Nonetheless, any legislation which has the object or consequence of rewriting the case law, and thereby undermining the settled position in law, will clearly be tantamount to a deliberate abuse by the legislature of its powers. While it is the prerogative of the legislature to make the law, by no logic it has the power to interpret the law of which it itself is the maker, Just as, that it is within the province of the judiciary to interpret the law, but not to legislate under the guise of interpreting the law.
On the question of the legal validity or otherwise of a legislation with retrospective or retroactive effect, the view consistently taken by the judiciary is to the following effect:
Ø Retrospective legislation may be held to be invalid on the ground that it is unreasonable, or not in general public interest, or is beyond the legislative competence.
Ø An amendment cannot be made retrospectively only for the purpose of nullifying a Court judgment where there was no lacuna or defect in the original law. On this point, there is a line of decisions in support.
Section 14A, as admitted by the executive, was enacted for the only purpose of invalidating the binding judicial opinion that has held the field all these years. Thus, the enactment by the executive of this section prima facie verges on abuse or an unholy intervention in the judicial process. Hence, the constitutional propriety /legal validity of the enactment becomes questionable.
To sum up:
Following the lines of reasoning set out and on the strength of the points made herein before, one would make the following submissions:
(I) Even granting the legal validity of section 14A, in order to be caught within the disallowing ambit of section 14A, two conditions must be satisfied: (a) The debit in the accounts of any year for a given expenditure must represent the liability to pay which arose in that year; and (b) the liability should be such that it is clearly relatable to, by reason of its having a direct nexus with the item of income not included in the total income.
(II) In any case, section 14A will be rendered ineffective, and no disallowance there under can arise, if, as is warranted under the law, it is read into the applicable computation provisions.
(III) The decision of the tribunal in the Daga case needs to be reviewed and reconciled with the points of view supported by the line of arguments as brought to focus in the foregoing discussion.
CONCLUSION
Historically, the lawmakers have, by simply accepting, as a matter of routine, the proposals as commended to them by the executive, that too year after year, been resorting to retrospective legislation on income-tax, with impunity, and without having any regard to the overriding salutary principles. Section 14A is one such enactment. In the larger public interest, the mentioned disgusting tradition has to, sooner than never, undergo a revolutionary change and be put an end to. For, that alone could help in arresting any further muddling of the current deplorable scenario in the tax regime.
As the esteemed jurist of yester years, Oliver Wendell Holmes wrote:
“Life and language are alike sacred. Homicide and verbicide – that is, violent treatment of a word with fatal results to its legitimate meaning, which is its life - are alike forbidden.”
Footnote: The views of the author against the propriety of retrospective legislation are covered in greater detail in his earlier published article – 169 Taxman 14 (Mag)
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Text of the Article - (2009) 14 CPT 819
(Copied Below - To facilitate READY READ (only) )
SECTION 14A of INCOME TAX ACT – INTERPRETATION OF – A CRITIQUE
V SWAMINATHAN B.Sc., B.L., FCA
1. Introduction
A simplified income-tax law (the law) was conceived many years ago but still remains to be delivered. In the interim, the executive has continued to pursue aggressively but mindlessly its ‘change mania’, which has come to stay as the driving force behind legislation on income tax, More notably, the new millennium has brought with it a flurry of changes in the law. It is replete with instances where the statute as originally framed and enacted have come to be tampered with, that too in a sweeping frenzy. Many of the changes made are purported to be with full or partial retrospective effect. So much so, the tax regime has been proving as ever before a fertile ground for nurturing or flourishing of newer and newer kinds of disputes, leading to inconclusive litigation. The already existing complexities have thus been worse confounded. It is not at all surprising that as per a report in a professional journal, the White Paper that was to be issued to the public but yet to see the light of day would, contrary to the earlier assurances offered by the last Finance Minister, not be a full draft code; the excuses given are, - the “present complexities” and “the court cases, which run into several thousands”.
2. Lately, section 14A, inserted in the Income-tax Act (the Act) by the Finance Act, 2001 with full retrospective effect (that is, after 40 years, - right from the coming into force of the 1961 Act), has been the subject matter of one such vexing ongoing dispute. The issues raised on the implications of the section have been dealt with in a few orders of the appellate tribunal reported in Taxmann’s journals.
Backdrop
3. In the reported Order of the appellate tribunal in - ITO vs Daga Capital Management (P) Ltd. [2008] 26 SOT 603 (MUM)(SB) (the Daga case)), the matter of dispute is noted to have been gone into at an impressive length. It may be useful to closely read and keep the contents of the said Order in view, as a backdrop, for at least knowing - (a) the contentions respectively raised by the assessee and the Revenue, and (b) the reasons for/grounds on which the tribunal has handed down its opinion in the Revenue’s favour.
Law before insertion of section 14A
4. The admitted position under the existing law, that is before section 14A was entered on the statute, is open to be seen from a large number of judgments of the Apex Court and several High Courts. In some of the leading court cases, the dispute pertained to deductibility of expenditure such as, -managerial commission, salary and other employment costs, interest on borrowed capital, - against items of income not included in total income, being income from – agricultural land forming part of assessee’s business assets, a new or extension of business but not distinct or separate from but forming part of the existing business of assessee, dividend from company shares held by assessee as a trade asset. The opinion of the judiciary as culled from the case law may be summed up as follows: The deductibility or otherwise of any expenditure claimed by an assessee should be determined having regard to and in accordance with the applicable provisions of the Act. Deduction for an expenditure must be allowed, if so permitted/permissible under the provisions governing the computation of the chargeable income (or profits or gains) under the appropriate head of income; especially, if there is no specific prohibition against such an allowance spelt out in the Act. Deduction or allowance for any expenditure, if it is otherwise permitted, cannot be denied merely on the ground that it is either wholly or partly relatable, or can directly or indirectly be attributed to an item of income that is not includible and hence does not form part of the total income.
Law after insertion of Section 14A
5. The pith and substance of the departmental explanation for enacting section 14A was as follows: The legislative intention, since the inception, was not to allow deduction in respect of any “expenditure incurred by the assessee in relation to income which does not form part of the total income”. The opinion of the Apex Court and High Courts to the contrary was considered as not laying down the correct law in consonance with the intention of the Legislature. Therefore, the judicial opinion had to be invalidated by the insertion of the new section that was of a clarificatory nature.
6. Initially, section 14A inserted by the Finance Act 2001, with retrospective effect from 1-4-1962, read as under:
“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. “
The Proviso thereto, introduced later by the Finance Act 2002, with a partial retrospective effect from 11th May 2001, reads:
“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.”
Section 14A (supra) was renumbered as sub-section (1) by the Finance Act, 2006 which added two new sub-sections (sub-sections (2) and (3)) effective from 1st April 2007.
Thus, prior to the date of 1st April 2007, only the original provision, which now stands renumbered as sub-section (1) (herein after referred as - the subject provision), was on the statute. In the long gap of five years, that is from 1st April 2001 to 31st March 2006, the subject provision alone was in force. In view thereof, the discussion herein is mainly devoted to the subject provision. The two sub-sections (2) and (3) enacted subsequently, as also the rule (Rule 8D) framed thereafter, have been commented on herein afterwards.
7. On a plain and straightforward reading, the purport and import of the subject provision seems to be loud and clear. For realizing and appreciating it in the proper perspective, the crucial terms used would require to be duly stressed and understood, on the lines suggested herein below:
(1) The opening words of section 14A are, - “For the purpose of computing the total income under this Chapter”. The significance of the mentioned expression needs to be understood having particular regard to the following features of the Act: - “Total income” means / refers to the sum total of the varying types of income on which tax is chargeable. The chargeable income is required to be computed under anyone or more of the specific heads listed in section 14. That is dependent on the type of income, mainly in reference to its source and distinguishing characteristics. The method of computing the income is provided, separately, for each one of the specified heads of income and covered in the set of provisions especially applicable thereto. What really are of relevance are the special provisions applicable / applied to each type of income in computing it under the relevant head. To put it succinctly, computation of total income is not a single composite exercise; but it is to be arrived at by aggregating the chargeable income as computed under each source / head, by applying the appropriate method.
Accordingly, the disallowing ambit of section 14A is necessarily to be determined by taking into account all those other provisions of the Act that essentially are of relevance. For instance, if, in a given case, the item of income not included in the assessee’s total income is in the nature of income chargeable under the head of – “profits and gains of business” (business profits), then the provisions of sections 28 to 44DB be relevant. And, as such, section 14A will require to be read into and understood as if it were a part and in the parcel of the scheme of the aforementioned sections, and read and understood in that setting.
It calls for a pointed mention that, section 14A is not prefixed with a non-obstante clause. In the Act, in several contexts, the phrase – “notwithstanding anything contained in..” has been used. That is a phrase conventionally used to give the enacting part of the section, in case of a conflict, an overriding effect, over the other provisions of the Act mentioned or specified in the non -obstante clause. Such a clause is a legislative device to modify the ambit of the provision of law mentioned in the non-obstante clause or to override it in specified circumstances. As, however, section 14 A has no non obstante clause prefixed to it, it is not intended to be, or cannot by any means be regarded as, a special provision either modifying or overriding the other computation provisions.
(2) Another crucial expression in section 14A, which needs to be closely read and incisively understood, is, - “expenditure incurred by the assessee in relation to.. ”. It is important to recognize and understand the connotation and significance of each one of the words / phrases, - ‘expenditure’, “expenditure incurred” and “incurred in relation to” comprised therein. That needs to be done on the lines indicated below:
(A) The word ’expenditure’ has not been specially defined in the Act. It has therefore to be understood in its ordinary meaning or legal connotation, It is an accepted proposition that the word ‘profits’ has to be understood in its natural and proper sense, a sense in which no commercial man would misunderstand. As a corollary, and by the same token of logic and reasoning, the word ‘expenditure’ would require to be understood likewise. Further, the word is copiously used in the Act in several contexts, and its meaning, especially for its deduction or allowance under the Act, should pose no problem. And even if there be any, solution should be readily available from the case law.
(B) Again, the word ‘incurred’ again is not specially defined in the Act. It has to be necessarily read and understood in conjunction with the preceding word - ‘expenditure’ as well as the succeeding phrase “in relation to”. A clinical examination essentially suggests that, - (i) ‘the expenditure’ must have been incurred, in the sense - the ‘liability to pay’ must have arisen, in the year of account, and (ii) such liability must have a direct relation or nexus to the item of income not forming part of the total income of the year of account.
Under the scheme of the Act, especially of the provisions for computing business profits, generally a deduction is permissible, provided the expenditure has been incurred in the relevant year of account. Though, in exceptional circumstances the aforesaid general rule is relaxed. The most common and predominant exception is the case where the assessee follows mercantile (i.e. ‘accrual’) method of accounting. In such a case, deduction is admissible in accordance with the method of accounting adopted by the assessee; that is, in the year of account in which the expenditure is debited in the accounts as ‘accrued due’.
The word ‘paid’, which is used in a number of places in the Act, has been specially defined to mean ‘actually paid or incurred according to the method of accounting ……… “. Conspicuously, in section 14A, the word used is’ incurred’; it is used in isolation, not in conjunction with the words – “ in accordance with the method of accounting”. Hence, for the purpose of section 14A, the word ’incurred’ used therein is required to be understood purely in its general meaning – namely, ‘liability to pay’. Accordingly, on a proper construction, a given expenditure, in order to be caught within the disallowing mischief of section 14A, must be one for which the ‘liability to pay’ arose in the relevant year of account.
To elaborate: For instance, take for consideration expenditure incurred by way of interest on capital borrowed. It is allowable as a deduction in accordance with the governing section 36(1)(iii). Allowance is permitted in any year, provided the interest is ‘paid’ in that year. However, because of the special meaning of the word ‘paid’ under the Act, deduction, as per the accepted position, is allowable for the interest actually paid or ‘accrued due’ (that is, if the assessee has adopted ‘accrual’ method, which is presently mandatory for companies to follow).
Borrowing may be of varying types –e.g. an overdraft, a term loan or a debenture loan. Broadly speaking, liability to pay interest on any monies borrowed may have to be regarded to arise at the point of time when the borrowing is made / money is received. In respect of a debenture loan, if interest is payable upfront, it is at that time the liability to pay interest arises. In respect of an overdraft arrangement, liability to pay interest arises if and when there is a withdrawal exceeding the amount lying to the credit of the account holder. By and large, except rarely - such as, for funding a new project or business venture of a significant size, a business enterprise uses a bank account with overdraft (or cash credit) facility for meeting its requirements, particularly for working capital. That is an account from which withdrawals are made for business purposes, and into which business receipts are deposited, In the nature of things, therefore, it would not be obligatory for an assessee, in any case be quite cumbersome, rather impracticable, to relate any particular withdrawal, to the purpose for which it is utilized. For these or other reasons, the debit in the accounts of any year for the interest payable on any such borrowing may well be not necessarily one for which ‘liability to pay’ arose in that year. That might be so also if a debit in the accounts for expenditure is in accordance with the accepted accounting theory/principle – such as, ‘matching concept’, or ‘amortization’ (over a period of years), etc. To put it differently, the debit in the accounts is not necessarily conclusive; the factual position will require to be investigated, for ascertaining as to in which year of account the liability to pay the interest arose.
(C) In the Daga case, it is seen from the tribunal’s order, the Revenue had placed great stress and mostly relied on its interpretation of the words ‘in relation to’ used in section 14A, The astoundingly large number of court and tribunal decisions cited and relied on by the Revenue are also confined to that purpose. However, the way the Revenue has sought to place a construction by harping merely on the phrase – “in relation to” is prima facie ill founded, illogical, and fallacious. The reason, in one’s firm conviction, is more than obvious: The ordinary meaning of the word - ‘relation’ is, - a connection or relationship between one thing and another. It necessarily postulates existence of two things for a relationship to obtain. The derivative phrase – ‘in relation to’ means, – in reference to or with respect to. Underlying the expression is the idea of a nexus between two things. The phrase has to be accordingly construed and understood in its simple sense. It can be validly urged that, there is seemingly no scope or warrant to construe the phrase any differently by subjecting it or resorting to any complicated process of thinking or reasoning, or to a long drawn process of interpretation.
In brief, the above-referred words have to necessarily be paired and read in a coherent manner, for appreciating the true purport and implications of the subject provision.
Proceeding on that premise, there appears to be no room for a genuine doubt that the law clearly envisages a nexus or interlink between – (a) the particular liability/debt that has given rise to the expenditure and (b) the item of income not included in the total income.
8. There is yet another aspect, which has a vital bearing and is bound to pose an insurmountable challenge to the Revenue in its endeavor to straightaway invoke and apply the subject provision on a stand alone basis to a given case. As pointed out herein before, for giving effect to section 14A, the provision has to be necessarily read into and understood in the context / setting of the relevant computation provisions. For instance, if it is interest on capital borrowed, then for giving effect to section 14A, it must be read and understood as a part or limb of, among others, the applicable section 36(1)(iii).
Now, in terms of section 36 (1)(iii), as per the case law, the only condition /sole consideration for allowing a deduction for interest expenditure is that the borrowing must be for the purposes of the assessee’s business. The well-accepted and finally settled position in law is that the term - “for the purposes of the business” should be construed to have very wide and sweeping amplitude. As such, even if section 14A is read as part /limb of section 36(1)(iii), there is, for obvious reasons, no way for section 14A to modify or override in any manner the existing legal position under section 36(1)(iii). In other words, that will push back the Revenue to square one. To put it differently, if the subject provision is construed in the manner canvassed above, in one’s submission tightly so, that would have the necessary consequence of rendering it non est; or in any event, restricting its application to only exceptional circumstances, if any.
9. Sub-section (2) later inserted in section 14A with effect from 1-4-2007 reads as under:
“(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) ………… “
It was in pursuance of sub-section (2) that the procedural Rule 8A came to be made, vide. the Fifth Amendment Rules, with effect from the specified date of 24th March 2008.
Both sub-section (2) and Rule 8D speak of determination by the assessing officer, having regard to the accounts of the assessee, the amount of expenditure incurred/attributable to the tax exempt income, That is prima facie inconsistent or in conflict with what is provided in the subject provision. To be precise, the subject provision, in terms, does not contemplate or lend any scope for a disallowance being made on any notional basis or in the manner as prescribed in Rule 8D.
Further, having special regard to the language /terms of sub-section (2), one would submit that, - it is clearly a substantive (substantial) provision. And, in any view, it is essentially an integral part of sub-section (1) (as renumbered), which is in the nature of a charging / computation provision – not simply in the nature of a ‘machinery’ provision (in the sense as normally understood). This is an essential criterion, which also goes against sub-section (2) (also, sub-section (3) and the rule there under), being considered to have a retroactive effect. Further, Besides, Rule 8D is a subordinate legislation, and cannot override the subject provision.
It is all the more puzzling that the enactment of section 14A has been made piecemeal. That constitutes an unconventional and a sad departure from the basic norms and principles of a good and legally valid legislation.
Key Note: For knowing more intimately or making a detailed study of any one or more of the aspects dealt with herein above, the expert commentary and citations of the case law in the latest edition of the leading Book on Income Tax by Kanga, Palkhivala and Vyas may be of useful guidance
Constitutional propriety / Legal validity
10. In the words of late Nani A. Palkhivala, an outstanding expert in constitutional law: “The Constitution of India provides for a just balance between the legislature, the executive and the judiciary. Each has a specific field to cover. The courts are there to maintain the most fundamental equilibriums of our society. They are the agency of a sovereign people to enforce the laws; also to expound the Constitution and to ensure that its mandates are respected. The courts are vested with exclusive powers to interpret the law. Any interpretation of the law especially by the apex court has a binding force.”
The essence or implication of the referred expert opinion is this: The legislature is no doubt vested with plenary powers to legislate on among others the subject of taxation of income, Nonetheless, any legislation which has the object or consequence of rewriting the case law, and thereby undermining the settled position in law, will clearly be tantamount to a deliberate abuse by the legislature of its powers. While it is the prerogative of the legislature to make the law, by no logic it has the power to interpret the law of which it itself is the maker, Just as, that it is within the province of the judiciary to interpret the law, but not to legislate under the guise of interpreting the law.
On the question of the legal validity or otherwise of a legislation with retrospective or retroactive effect, the view consistently taken by the judiciary is to the following effect:
Ø Retrospective legislation may be held to be invalid on the ground that it is unreasonable, or not in general public interest, or is beyond the legislative competence.
Ø An amendment cannot be made retrospectively only for the purpose of nullifying a Court judgment where there was no lacuna or defect in the original law. On this point, there is a line of decisions in support.
Section 14A, as admitted by the executive, was enacted for the only purpose of invalidating the binding judicial opinion that has held the field all these years. Thus, the enactment by the executive of this section prima facie verges on abuse or an unholy intervention in the judicial process. Hence, the constitutional propriety /legal validity of the enactment becomes questionable.
To sum up:
Following the lines of reasoning set out and on the strength of the points made herein before, one would make the following submissions:
(I) Even granting the legal validity of section 14A, in order to be caught within the disallowing ambit of section 14A, two conditions must be satisfied: (a) The debit in the accounts of any year for a given expenditure must represent the liability to pay which arose in that year; and (b) the liability should be such that it is clearly relatable to, by reason of its having a direct nexus with the item of income not included in the total income.
(II) In any case, section 14A will be rendered ineffective, and no disallowance there under can arise, if, as is warranted under the law, it is read into the applicable computation provisions.
(III) The decision of the tribunal in the Daga case needs to be reviewed and reconciled with the points of view supported by the line of arguments as brought to focus in the foregoing discussion.
CONCLUSION
Historically, the lawmakers have, by simply accepting, as a matter of routine, the proposals as commended to them by the executive, that too year after year, been resorting to retrospective legislation on income-tax, with impunity, and without having any regard to the overriding salutary principles. Section 14A is one such enactment. In the larger public interest, the mentioned disgusting tradition has to, sooner than never, undergo a revolutionary change and be put an end to. For, that alone could help in arresting any further muddling of the current deplorable scenario in the tax regime.
As the esteemed jurist of yester years, Oliver Wendell Holmes wrote:
“Life and language are alike sacred. Homicide and verbicide – that is, violent treatment of a word with fatal results to its legitimate meaning, which is its life - are alike forbidden.”
Footnote: The views of the author against the propriety of retrospective legislation are covered in greater detail in his earlier published article – 169 Taxman 14 (Mag)
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