A two-judge Bench of the Supreme Court comprising of Justice Sanjay Kishan Kaul and Justice Hrishikesh Roy has held that the Government should endeavour to keep the taxation regime convenient and simple to achieve maximization of compliance.
"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.", observed the Court. The Court further noted that if proper balance is achieved between these, unnecessary litigation can be avoided without compromising on generation of revenue.
In the case at hand, the Assessing Officer, in absence of separate accounts for investment which earned tax-free income, made proportionate disallowance of interest attributable to the funds invested to earn tax-free income. In an appeal presented before the Income Tax Appellate Tribunal (ITAT), it was held that disallowance under Section 14A is not warranted, in absence of a clear identity of funds. However, this order was reversed by the High Court.
Various appeals had been filed before the Supreme Court against an Judgment of theKerala High Court which raised the following issue:
"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 appellants contended that the investments made in bonds and shares should be considered to have been made out of interest-free funds which were substantially more than the investment made and therefore the interest paid by the assessee on its deposits and other borrowings, should not be considered to be expenditure incurred in relation to tax-free income on bonds and shares and as a corollary, there should be no disallowance under Section 14A of the Act. While the Respondents contended that the Appellants did not make separate accounts for the investments and other expenditures incurred for earning tax-free income.
The issue which arose before the Bench for consideration was whether Section 14A enables the Department to make disallowance on expenditure incurred for earning tax free income in cases where assessees like the present appellant do not maintain separate accounts for the investments and other expenditures incurred for earning the tax-free income.
The Court opined, "The proportionate disallowance of interest is not warranted, 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 in those situations where, interest free own funds available with the Assessee, exceeded their investments."
The Court further held that the Respondents had failed to establish a nexus between the expenditure disallowed and earning of the exempt income and failed to substantiate their argument that the Respondents were required to maintain separate bank accounts.
"The learned counsel for the revenue has failed to refer to any statutory provision which obligate the assessee to maintain separate accounts which might justify proportionate disallowance," the Bench noted.
The Court quoted the 18th century economist Adam Smith and asserted, "In 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 tax payer and the Government should endeavour to keep it convenient and simple to achieve maximization of compliance."
The Court accordingly set aside the impugned judgment of the Kerala High Court and allowed the appeal with no order on costs.