The Hindu Business Line : A problem of bifurcation

Can Section 14A can be invoked even when the various types of businesses are found to represent a single integrated venture where no apportionment of expenditure is possible?

Chief Justice Beasley of the Madras High Court once famously declared that income-tax is only one tax, levied on the sum total of the income classified and chargeable under the various heads. It is not a collection of distinct taxes levied separately on each head of income (CIT vs Namberumal — 1 ITR 32 Act, 37).

Section 14 of the Income-Tax Act, 1961 enumerates five heads of income and the rules for computing income. The permissible deductions vary with the different heads of income. But that does not detract from the fact that assessment to income-tax is one whole and not a group of assessments of different heads or items of income — Section 4 charges total income; Section 5 defines its range; Section 14 classifies it; and Sections 15-59 quantify the same.

Assessments under various heads are made as per the principles laid down by the judiciary. But complications arose when attempts were made to deal separately with a sixth head, namely, tax-free income, under Section 10.

While the judiciary had laid down the law for determining taxable and tax-free incomes, the legislature thought it fit to intervene by interposing new Section 14A by the Finance Act, 2001 with retrospective effect from April 1, 1962. It has been declared that for computing total income under Chapter IV, no deduction shall be allowed in respect of expenditure incurred by the assessee in relation to income that does not form part of the total income under the Act.

Judicial pronouncements

In CIT vs Jamnagar Jilla Sahakari Kharidevchan Sangh Ltd (283 ITR 116 Gujarat), the Gujarat High Court exhaustively researched the rulings on the question of apportionment of expenditure between tax-free and taxable incomes. On page 140, the court pointed out that there are two lines of judgments on the question taking two different views.

In the Sabarkantha Zilla Kharid Vechan Sangh Ltd (203 ITR 1027) case, the Supreme Court laid down that the expenditure qua taxable and non-taxable activities has to be apportioned on a proportionate basis. In the Rajasthan State Warehousing Corporation (242 ITR 450) case, the apex court ruled that where the expenditure is one and indivisible, the entire expenditure will be a permissible deduction.

The Gujarat High Court was considering the case of a co-operative society deriving income from dividend, interest and trading in agricultural commodities both with members and non-members. Profits resulting from trading with members were exempt but not profits arising out of trading with non-members.

The assessing officer found that common expenses relating to all the activities have been amalgamated in such a manner that expenses relating to the taxable and tax-free incomes cannot be easily ascertained. He applied the rule of apportionment and bifurcated the overhead expenses pro-rata.

The Tribunal, however, permitted the deduction of all the expenditures. It observed:

"The expenditure sought to be apportioned being common expenditure there is no question of deducting the same from the profits the tax-free activities because such expenditure has no direct nexus with such activities nor can it be said that such expenditure cannot be related to non-taxable activities."

The Gujarat High Court agreed with the findings of the Tribunal. According to the court, where the business of the assessee is one and invisible and there are common overhead expenses, it is not possible to bifurcate the expenses as exempted and non-exempted activities (Para 48 of the judgment).

Basis of deduction

If two views are possible, the one favourable to the taxpayer has to be adopted. The High Court chose to follow the Supreme Court ruling in the Rajasthan Warehousing (242 ITR 450) case and decided that the income-tax officer should allow deduction as claimed by the assessee on the gross income and not on the net income worked out by him.

The judgment is exhaustive. The surprise element is that in a case decided in December 2005, there is no mention of the retrospective amendment made to Section 14A enabling the Department to disallow such expenditure in relation to income which does not form part of the total income.

The latest Finance Act has made a prospective amendment to Section 14A, empowering the Central Board of Direct Taxes (CBDT) to prescribe the manner of apportioning the expenditure between taxable and tax-free incomes. Chapter III of the Act deals with incomes which do not form part of total income and this is covered by, among others, Section 10A. Chapter VIA, on the other hand, allows deductions to be made in computing total income. The Board will have to clarify whether Section 14A will cover incentive relief, too, under Chapter VIA.

Among the issues to be decided will be whether Section 14A can be invoked even when the various types of businesses are found to represent a single integrated venture where no apportionment of expenditure is possible. The two streams of thought referred to by the Gujarat High Court will also have to be studied in-depth. Section 14A will apply even in relation to a case where an assessee claims that no expenditure has been incurred by him in relation to income which does not form part of the total income. The CBDT will have to clarify how Section 14A will be made applicable in such a situation.

(The author is a former Chief Commissioner of Income-Tax.)

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