Disallowance under section 14A – SC ruling on Godrej & Boyce

The Supreme Court has finally put to rest a long-drawn controversy as to whether disallowance under section 14A would be applicable on expenditure incurred in earning tax free dividend income which already suffers taxation in form of Dividend Distribution Tax (‘DDT’).

Taxpayers had argued that Section 14A ought not to apply to tax free dividend income since DDT is paid on it under section 115-O of the Act and hence it cannot be said to be tax free income. The fact that the tax is paid by the company and not by the shareholder should not be relevant as long as there is incidence of tax on the same.

The Supreme Court decided the controversy in favour of revenue and held that the disallowance under Section 14A would be applicable to tax free dividend income. Thereby, ruling that no expenditure to be allowed against tax free incomes. The following important aspects needs to be noted from this rulings.

• Supreme Court has decided on the principle of the matter that, when on a plain and literal reading of the words of a statute are clear and unambiguous, no other principle of interpretation other than literal interpretation can be applied.
• For the applicability of section 14A, it is imperative to establish a nexus between expenditure incurred and earning of tax free income. Absent nexus, 14A cannot be invoked.
• Where the AO is to invoke the provisions of section 14A (2) and (3) read with Rule 8D or do a best judgment determination, the pre-requisite condition is that the AO has to be satisfied that having regard to the accounts of the assessee, as placed before him, it is not possible to generate the requisite satisfaction with regard to the correctness of the claim of the assessee.
• Supreme Court has also clarified that, even if DDT is considered to be tax paid on behalf of the shareholders, section 115-O makes it clear that no further benefit can be claimed either by the dividend payment company or by the shareholders.
• Tax Authority’s appeal on retrospective application of Rule 8D wherein the Bombay High Court has ruled that the same is prospective has not been adjudicated by the Supreme Court in this ruling.

It is important to note that the in the Finance Act, 2016 / 2017 a new provision has been introduced to charge tax @10% in hands of recipient (being all taxpayers except a domestic company; notified funds and charitable trusts) where dividend received is in excess of INR 1 Million. The rationale to tax the same as provided in the memorandum was that the DDT is applicable @ 15% and hence this creates vertical inequality amongst the taxpayers as those who have high dividend income are subjected to tax only at the rate of 15% whereas such income in their hands would have been chargeable to tax at the rate of 30%. Given the amendment, the provisions of Section 14A of the Act should be relooked.

The ruling of the Supreme Court is welcome, as it brings clarity on interpretation of section 14A and its ambit. Taxpayers would still be able to argue on the nexus point between the expenditure incurred (to be disallowed) and the earnings of tax free income.