Monday, April 11, 2016

Bombay High Court on Disallowance under Section 14A of the Income Tax Act and the Binding Nature of Judicial Precedents

[The following guest post is contributed by Kruthika Prakash, Advocate, Madras High Court]

The Bombay High Court has recently issued an important judgment in HDFC Bank v. DCIT [2016] 67 42 (Bom.). The High Court has dealt with the issue of applicability of section 14A of the Income Tax Act [hereinafter “the Act”] in respect of the tax-free income earned on investments in case a party possesses interest-free funds in excess of the investments made in tax-free securities. Furthermore, the Court passed strictures against the Tribunal for disregarding decisions of the jurisdictional High Court and in this process revisited the law on the binding nature of judicial precedents.

To briefly recapitulate the facts: The assesse, while filing returns for the AY 2008-2009, declared a tax exempt income from investment in securities and treated the same as stock-in-trade. It is pertinent to note that during the same assessment year the assessee had paid interest on borrowed funds and treated the same as expenditure. The assessee did not disallow any expenditure on interest earned on tax free securities. However, both the Assessing officer and the CIT-Appeals disallowed a sum of Rs. 3.39 crores as per section 14A read with Rule 8D on the ground that the assessee did not provide evidence that the investment was made from interest-free funds.          

Being aggrieved, the assessee appealed to the Appellate Tribunal. The assessee raised two issues. First, that disallowance under section 14A could not be made in view of assessee’s own case in CIT v. HDFC [366 ITR 505] as it possessed interest-free funds which were more than the tax-free investments. Secondly, that the tax free securities were held by it as its stock-in-trade and hence no disallowance of any expenditure under Section 14A of the Act could be made in view of decision of the Bombay High Court in CIT v. India Advantages Securities Ltd. [ITA 1131/13 decided on 30 April 2014]. The Tribunal rejected the assessee’s contentions relying on another decision of the Bombay High Court in Godrej and Boyce Manufacturing v. Co. Ltd. v. Deputy Commissioner of Income Tax, [328 ITR 81]. Against the order of the Tribunal, the assessee filed a writ petition.

High Court Decision: The High Court noted that the issue on disallowance of interest expenditure in case assessee makes a tax-free investment when it has both interest-free funds and interest bearing funds is covered by judgment in CIT v. HDFC 366 ITR 505 [HDFC Bank Ltd.]. In CIT v. HDFC, the Bombay High Court had held that no disallowance for interest could be made based on the reasoning that if the assessee has more interest free funds than the tax free investments, then a presumption would arise that tax free investments would be out of the interest-free funds. The Bombay High Court relied upon the decision in CIT v. Reliance Utilities and Power Ltd 313 ITR 340 (Bom).

Furthermore, the Court noted that the decision in Godrej and Boyce Manufacturing Co. Ltd. does not provide any ruling on the issue of presumption and restores the entire issue of determining whether the assessee had incurred any expenditure in relation to the earning of tax free income to the Assessing Officer. In Godrej and Boyce Manufacturing Co. Ltd, the court upheld the validity of section 14A of the Act and Rule 8D and the Rules. Taking note of this, the Bombay High Court in HDFC v. DCIT clarifies that there is no conflict between the decisions of the Bombay High Court in Godrej and Boyce Manufacturing Co. Ltd. and HDFC Bank Ltd. The analysis of this issue is in Para 13,

The test to decide whether or not two decisions are in conflict with each other is to first determine the ratio of both the cases and if the ratio in both the cases are in conflict with each other, then alone, can it  be said that the two decisions are in conflict. We find that no such exercise has been done. If it was done, the Tribunal would have noted that this Court in Godrej & Boyce Mfg. Co. Ltd. has not decided the issue of applicability of Reliance Utilities & Power Ltd. inasmuch as it has restored the entire issue to the Assessing officer after upholding the constitutional validity of Section 14A of the Act.

On the ancillary issue of the investment in securities being treated as stock-in trade, the Bombay High Court again agreed with the assessee that the issue is covered by the decision of the Bombay High Court in CIT v. India Advantages Securities Ltd.

Binding Nature of Judicial Precedents

Incidents of Tribunals and lower courts disregarding binding decisions of jurisdictional High Courts raise serious concerns. Taking note of the same in this case, the High Court assumed jurisdiction under Article 227 of the Constitution of India. It noted that the Tribunal had committed a patent error by disregarding binding decisions of the jurisdictional court and passed strictures against the Tribunal. The Court referred to several important cases including Union of India v. Raghuvir Singh 1989 (2) SCC 754 and Collector of Central Excise v. Dunlop India Ltd. 154 ITR 172, revisiting the law on the binding nature of judicial precedents. The Court summarised the position in Para 22,

Once there is a binding decision of this Court, the same continues to be binding on all authorities within the State till such time as it stayed and / or set aside by the Apex Court or this very Court takes a different view on an identical factual matrix or larger bench of this Court takes a view different from the one already taken.

It is pertinent to note this incident of the Tribunal disregarding a High Court order and the High Court disapproving of such a practice is not a one-off incident. The Gujarat High Court in Commissioner of Income Tax v. G. Dalabhai & Co. [1997 226 ITR 922 Guj] notes a statement of the Income Tax officer in his Assessment Order. The shocking statement being - “With due respect to the decision of the Gujarat High Court, I do not follow the same”. This indicates a clear disregard towards the principle of stare decisis Further, in National Textile Corporation Ltd. (M.P.) v. Commissioner of Income Tax [2008]171TAXMAN339(MP), the Madhya Pradesh High Court held the Tribunal has no jurisdiction to find fault with the decision of a jurisdictional High Court so as to avoid its binding effect.

In conclusion, it may be said that the clarificatory nature of this decision adds to the existing jurisprudence on the issue of disallowance of expenditure relating to tax-free investment when the investor has both interest-free funds and interest bearing funds. It is to be hoped that the strictures passed by the Bombay High Court would create a sense of responsibility in lower courts and tribunals to ensure uniformity. Otherwise, the very essence of stare decisis will be uprooted and it would lead to an atmosphere of uncertainty and lack of confidence in the judicial system. In sum, it may be aptly said:  

This conflict between the High Court and the Tribunals and other subordinate courts involves more than a mere dispute among forums as to proper statutory constructions. It exposes a jurisprudentially unhealthy situation in which the law is unevenly enforced and in which there is no finality until the Supreme Court speaks. [Modifications Mine – Inspired by a quote made in the Duke Law Journal- Note, Controversy Between the Tax Court and Courts of Appeals: Is the Tax Court Bound by the Precedent of its Reviewing Court?, 7 Duke L.J. 45, 50-51 (1957)]

- Kruthika Prakash

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