SOUTH INDIAN BANK LTD. vs. COMMISSIONER OF INCOME TAX

CIVIL APPEAL No. 9606/2011Supreme Court[2021] 6 S.C.R. 15409 September 2021Bench: 2 JudgesAuthor: SANJAY KISHAN KAUL, HRISHIKESH ROY SUPREME COURT REPORTS15 pages
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What did the Supreme Court hold?

The Supreme Court held that proportionate disallowance of interest under Section 14A of the Income Tax Act, 1961, is not warranted for investments made in tax-free bonds/securities when the assessee bank has sufficient interest-free own funds exceeding its investments. The Court reasoned that a nexus between the expenditure disallowed and the earning of exempt income had not been established. The Court clarified that while an assessee has an obligation to provide full material disclosures, there is no corresponding legal obligation to maintain separate accounts for different types of funds. The Court also noted that the Revenue did not contend that the securities were held for maintaining Statutory Liquidity Ratio (SLR). The High Court erred in endorsing the proportionate disallowance solely on the ground that separate accounts were not maintained. The appeals filed by the assessee were allowed.

What were the facts?

The assessee, South Indian Bank Ltd., engaged in banking business, also made investments in bonds, securities, and shares, which generated tax-free interest and dividends. The Revenue sought to disallow a proportionate part of the interest expenses incurred by the bank under Section 14A of the Income Tax Act, 1961, arguing that these expenses were attributable to earning tax-exempt income. The bank contended that it had sufficient interest-free own funds exceeding its investments, making proportionate disallowance unwarranted. The Assessing Officer made the disallowance, which was upheld by the High Court, primarily because the assessee did not maintain separate accounts for its funds. The matter reached the Supreme Court.

What were the issues?

1. Whether proportionate disallowance of interest paid by banks is called for under Section 14A of the Income Tax Act, 1961, for investments made in tax-free bonds/securities when the assessee had sufficient interest-free own funds exceeding the investments made? (Question of law) Assessee's Contention: The assessee argued that proportionate disallowance of interest under Section 14A is not warranted when interest-free own funds available with the assessee exceed their investments in tax-free securities. They relied on the principle that if investments are made out of common funds and non-interest-bearing funds are larger than tax-free investments, no disallowance should be made. They also contended there is no legal obligation to maintain separate accounts for different types of funds. Revenue's Contention: The Revenue contended that proportionate disallowance was justified, primarily because the assessee did not maintain separate accounts for its funds, implying that interest-bearing funds could have been used for investments yielding tax-exempt income. They relied on the High Court's endorsement of the Assessing Officer's view.

Which sections of the Income-tax Act were involved?

Section 14A

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A B C D E F G H 154 SUPREME COURT REPORTS [2021] 6 S.C.R. SOUTH INDIAN BANK LTD. v. COMMISSIONER OF INCOME TAX (Civil Appeal No. 9606 of 2011) SEPTEMBER 09, 2021 [SANJAY KISHAN KAUL AND HRISHIKESH ROY, JJ.] Income Tax Act, 1961 – s.14A – Interpretation of – Assessees are scheduled banks and in course of their banking business, they also engage in the business of investments in bonds, securities and shares which earn the assessees, interests from such securities and bonds as also dividend income on investments in shares of companies and from units of UTI etc. which are tax free – Whether proportionate disallowance of interest paid by the banks is called for u/s.14A 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 – Held: Proportionate disallowance of interest is not warranted, u/s.14A 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 – High Court erred in endor

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