Indian Supreme Court: dominant purpose of investment is irrelevant in determining whether expenditure is ‘in relation to’ exempt dividend income
Indian law provides that the dividends paid by domestic companies to their shareholders are liable to a dividend distribution tax at the company level. As a corollary, such dividends are exempt in the hands of shareholders, subject to certain exclusions.
The law also provides that a taxpayer will not be allowed any deduction for expenditure incurred "in relation to" exempt income (section 14A of the Income-tax Act, 1961). This provision has been the subject matter of considerable litigation over the years, particularly in the context of expenditure incurred in relation to dividends which are exempt in the hands of the shareholder.
Over the years, arguments have been advanced by some taxpayers that this limitation under section 14A should not apply where the shareholder's dominant purpose behind acquiring shares (from which the exempt dividends arose) was not to earn dividends, but to instead obtain control over the company, or to hold the shares as stock in trade. This issue was addressed by the Supreme Court in the recent case of Maxopp Investment v Commissioner of Income Tax, New Delhi (Civil Appeal Numbers 104-109 of 2015 [Supreme Court, February 12 2018]).
Key conclusions of the Supreme Court:
The court reiterated that for section 14A to apply, there must be a causal connection between the expenditure incurred and the exempt income.
It was argued by the taxpayers that shares had been acquired as part of the promoter holding for acquiring a controlling interest in the company, and that the dominant object was to keep control over the management of the company, rather than earning dividend income from the investment. They therefore contended that considering this purpose, the expenditure could not be said to have been made in relation to exempt dividend income, and hence the expenditure should not be disallowed. This argument was rejected by the Supreme Court, which held that the dominant purpose for which an investment in shares is made by a taxpayer is not relevant. If any expenditure is incurred for earning exempt dividend income, that much of the expenditure that is attributable to the dividend income must be disallowed.
The court noted that in cases where shares are held as stock in trade, the main purpose may be to trade in such shares and earn profits, even though dividend income may also be incidentally received. However, the court reiterated that the dominant purpose test was not relevant, and the earning of dividend income triggered the disallowance. In such cases, the court noted that depending on the facts of each case, the expenditure incurred in acquiring such shares would have to be apportioned between taxable and non-taxable income.
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