Section 10(33) of the Income-tax Act, 1961, provides that income received by way of dividend as referred to in section 115-O of the Act is exempt from tax. Section 115-O of the Act pertains to tax on distributed profits of domestic companies. Section 14-A, inserted by the Finance Act, 2001, with retrospective effect from April 1, 1962, provides for disallowance of expenditure in relation to income which does not form part of total income. In the light of the provisions of section 14-A, while allowing the claim of deduction of expenditure, it needs to be considered whether the expenditure is relatable to any income not forming part of total income assessable in the hands of the assessee.

Although normally no disallowance can be made on estimated basis or in relation to any proportion of the receipts shown from various sources, in a case where the sole activity of the assessee is that of an investment company, the total infrastructure would generally be used for the purpose of attainment of its objects which include investment in group concerns and other companies. The income earned on such investments by way of dividend is exempt under the provisions of section 10(33) of the Act and by invoking the provisions of section 14-A of the Act, such expenditure attributable to earning of dividend would be disallowed under the provisions of the Act.

In an interesting case on this point, the issue was whether expenditure on salary of personnel who are involved in running an investment company had to be apportioned for the purpose of disallowance of part of their remuneration under section 14-A of the Act. In CIT v Tata Investment Corporation Ltd (295 ITR (AT) 330), the assessee was an investment company, which during the year under consideration, received gross dividend of Rs 2,679.29 lakh which it claimed as exempt under the provisions of section 10(33) of the Act. No part of the expenditure had been allocated towards the earning of this income.

The assessing officer invoking the provisions of section 14-A asked the assessee to explain why the expenditure incurred to earn the income including the interest expenditure should not be disallowed. The assessee replied that such expenses relatable to the earning of dividend income were only the bank collection charges and submitted details of expenditure attributable to the earning of dividend income. This was not accepted by the tax department.

A sum of Rs 139.51 lakh was determined as expenditure attributable to earning of dividends and disallowed by the assessing officer being 57.34% of the total expenses of Rs 243.31 lakh, since the proportion of tax free dividends to total income was 57.34%.

The commissioner (appeals) held that no disallowance was merited out of salary expenditure and deleted the disallowance of Rs 63.74 lakh made by the assessing officer, allocating 57.34% of Rs 111.97 lakhs out of the payments made to employees for salaries and personnel cost.

On further appeal, the Mumbai Bench of the Income-tax Appellate Tribunal held that in the case of an investment company where the business of the company is to invest its funds in shares of sister concerns and other companies and also deposits with group concerns on which interest is received, the infrastructure of the company is utilised for the purpose of carrying out its objects, i.e., investment in other concerns and earning income on such investments.

Therefore, the assessing officer was justified in disallowing a portion of salary expenditure incurred during the year under consideration which in turn had been incurred for the purpose of carrying on the objects of the assessee. The assessee was to furnish the break up of salary expenditure incurred during the year under consideration, where services of such employees had been utilised for the purpose of carrying out the objectives of the assessee.

In case of failure on the part of the assessee to furnish the requisite details, the assessing officer would be left with no option but to estimate such expenditure attributable to earning of dividend income, which in turn was to be limited to the extent of the percentage of dividend income earned vis-?-vis the total income earned during the year under consideration. In coming to this decision, the court referred on the decision of the special bench of the Chandigarh Tribunal in Punjab State Industrial Development Corporation Ltd v CIT (292 ITR (AT) 268), wherein it was held that the assessing officer has to allow deduction of actual expenses which were incurred by the assessee. They were deductible from the dividend income under the head ?Income from other sources?.

However, in this case the Income-tax Appellate Tribunal held that where the sole activity of the assessee is that of an investment company; the total infrastructure is used for the purpose of attainment of its objects which include investment in group concerns and other companies.

The income earned on such investments by way of dividend income is exempt under the provisions of section 10(33) of the Income-tax Act and by invoking the provisions of section 14-A of the Income-tax Act, such expenditure attributable to earning of dividend income is to be disallowed under the provisions of the Act.

Therefore, the Appellate Tribunal directed the assessing officer to disallow the portion of salary expenditure incurred during the year under consideration which in turn has been incurred for the purpose of carrying out the objects of the assessee. The assessee was also directed to furnish the break-up of the salary expenditure incurred during the year.

In case of failure on the part of the assessee to furnish the requisite details, the assessing officer would be left with no option but to estimate such expenditure which is attributable to earning of dividend income, which in turn can be limited to the extent of percentage of dividend earned vis-?-vis the total income earned during the year under consideration.

In conclusion, it needs to be pointed out that while the assessee company may go in appeal to the high court as a question of law is involved, it appears that the decision of the tribunal is on a sound footing especially since it relates to an investment company which is exclusively involved in financial transactions.

The author is advocate, Supreme Court