In giving the advice, a bench of Justices Sanjay K Kaul and Hrishikesh Roy quoted 18th century economist Adam Smith, who in his ‘Wealth of Nations’ had said, “The tax which each individual is bound to pay ought to be certain and not arbitrary. The time of payment, the manner of payment, the quantity to be paid ought all to be clear and plain to the contributor and to every other person”.
“Just as the government does not wish for avoidance of tax equally, it is the responsibility of the regime to design a tax system for which a subject can budget and plan. If proper balance is achieved between these, unnecessary litigation can be avoided without compromising on generation of revenue,” Justice Roy said, writing the judgement for the bench.
Justice Roy said, “It needs to be observed here that in the taxation regime, there is no room for presumption and nothing can be taken to be implied. The tax an individual or a corporate is required to pay, is a matter of planning for a taxpayer and the Government should endeavour to keep it convenient and simple to achieve maximization of compliance.”
The assessee banks had raised the following question before the SC — “Whether proportionate disallowance of interest paid by the banks is called for under Section 14A of Income Tax Act for investments made in tax free bonds/ securities which yield tax free dividend and interest to assessee Banks when assessee had sufficient interest free own funds which were more than the investments made.”
The assessees are scheduled banks and in course of their banking business, they also engage in the business of investments in bonds, securities and shares which earn them, interests from such securities and bonds as also dividend income on investments in shares of companies and from units of UTI etc. which are tax free.
Section 14 of the Income Tax Act classifies various incomes under Salaries, Income from house property, Profit & Gains of business or profession, Capital Gains & Income from other sources. Section 14A relates to expenditure incurred in relation to income which are not includable in Total Income and which are exempted from tax. No taxes are therefore levied on such exempted income. Section 14A had been incorporated in the Act to ensure that expenditure incurred in generating such tax exempted income is not allowed as a deduction while calculating total income for the concerned assessee.
The banks clarified that none of them maintain separate accounts for the investments made in bonds, securities and shares wherefrom the tax-free income is earned so that disallowances could be limited to the actual expenditure incurred by the assessee. In other words, the expenditure incurred towards interest paid on funds borrowed such as deposits utilized for investments in securities, bonds and shares which yielded the tax-free income, cannot conveniently be related to a separate account, maintained for the purpose.
Ruling in favour of the banks, the bench said, “Shares and securities held by a bank are stock in trade, and all income received on such shares and securities must be considered to be business income. That is why Section 14A would not be attracted to such income.”
“The revenue has failed to refer to any statutory provision which obligates the assessee to maintain separate accounts which might justify proportionate disallowance. The issue framed in these appeals is answered against the Revenue and in favour of the assessee. The appeals by the assessees are accordingly allowed,” the bench said.