Taxpayer-Bank With Sufficient Surplus Funds Needs No Section

Taxpayer-Bank With Sufficient Surplus Funds Needs No Section 14A Disallowance On Exempt Income

Issue

Whether disallowance under Section 14A of the Income-tax Act, 1961, read with Rule 8D of the Income-tax Rules, 1962, can be sustained or estimated by the Department when the assessee, a banking company, possesses sufficient and adequate surplus interest-free funds to earn the exempt income.

Facts

The assessee is a banking company maintaining its accounts in compliance with the Banking Regulation Act, and the correctness of these accounts was not disputed.
The assessee earned income exempt from tax and asserted that no expenditure was incurred or claimed towards earning such exempt income.
The Assessing Officer noted that the assessee possessed sufficient/adequate surplus funds available in its hands.
Despite the availability of surplus funds, the Income Tax Appellate Tribunal directed the Assessing Officer to apply Section 14A read with Rule 8D to compute a proportionate disallowance of expenditure related to the exempt income.

Decision

The court held that given the Assessing Officer’s finding that the assessee had sufficient/adequate surplus funds, there was no justification for making any disallowance under Section 14A.
It was decided that under such circumstances, it was not open to the Revenue Department to estimate or attribute expenditure to the earning of exempt income.
Consequently, the impugned order of the Tribunal was set aside in favor of the assessee.

Key Takeaways

Presumption of Interest-Free Funds Usage: If an assessee possesses non-interest-bearing surplus funds exceeding the investments yielding exempt income, a legal presumption arises that the investments were made out of those interest-free surplus funds.
Restriction on Estimation: The Revenue cannot mechanically apply Section 14A read with Rule 8D to estimate disallowances when adequate self-owned/surplus funds are demonstrated.
Prerequisite of Satisfactory Findings: Assessing Officers cannot make ad-hoc or rule-based proportionate disallowances without disproving the availability and deployment of an assessee’s sufficient interest-free surplus funds.

HIGH COURT OF MADRAS

Karur Vysya Bank Ltd.

Commissioner of Income-tax

Dr. Anita Sumanth and C. KUMARAPPAN, JJ.

TCA Nos. 681, 682 & 683 of 2010^†

SEPTEMBER 1, 2026

R. Venkata Narayanan for the Appellant. V. Mahalingam, Sr. Standing Counsel for the Respondent.

JUDGMENT

Dr. Anita Sumanth J. – Both Mr. R. Venkata Narayanan, learned counsel for the appellant and Mr. V. Mahalingam, learned Senior Standing Counsel for the respondent state that the issues arising in these appeals are covered by an earlier decision of this Court.

2. The substantial questions that have been admitted on 16.08.2010 are as follows:

‘(i) Whether on the facts and in the circumstances of the case, the order of the Tribunal directing the assessing office to apply Section 14-A read with Rule 8-D is valid in law, especially when no expenditure was incurred or claimed towards earning of those exempt incomes?

(ii) Whether the Tribunal was justified in law in directing to apply Section 14-A and Rule 8-D for working out the proportionate disallowance when the accounts are maintained in accordance with the Banking Regulation Act and the correctness of those accounts are also not disputed?’

3. We have by order CIT-I v. Karur Vysya Bank Ltd. [TCA.Nos.290, 291, 292, 293, 294, 295 and 663 of 2010, dated 20.02.2026] dealt with the identical questions in the following terms:

‘3. Substantial question of law arising in TC(A).Nos.290 of 2010 (A.Y.1996-97), 291 of 2010 (A.Y.1997-98) and 292 of 2010 (A.Y.1998-99) and admitted on 28.06.2010:

Whether on the facts and in the circumstances of the case, the Income Tax Appellate Tribunal was right in holding that the deduction u/s 80M should be worked out applying Rule 80D read with Section 14A without appreciating that it was not applicable for the dividend income for the Assessment Year under consideration, instead of upholding the Assessing Officer’s action in working out the expenditure to be deducted on the basis of the Supreme Court’s decision in 200 ITR 478?

4. The Assessing Authority, while considering the grant of deduction under Section 80M of the Act, proceeded on net basis, in granting deduction of expenditure proportionate to the total income. The total income determined as taxable was a sum of Rs.63.22 Crores (approx.), and dividend received from Corporate Companies was Rs.37,06,331/-. Relief under Section 80M was allowed on net income and proportionate expenses relating to dividend income was disallowed.

5. The Assessing Authority relied on the judgment of the Supreme Court in the case of Commissioner of Income-Tax v. United General Trust Ltd. 200 ITR 488 and in deducting proportionate expenses and taking into account management expenses as well. As the proportionate expenditure was of a sum of Rs.31,35,470/-, the deduction was computed using the following formula, and the relevant portion of the assessment order reads thus:

6. In first appeal, the assessee assailed the aforesaid restriction, being of the view that no expenditure ought to have been deducted at all. The Commissioner of Income Tax (Appeals) (in short, CIT(A)) takes a tangential view. While accepting the position that it would not be proportionate expenses that would have to be disallowed, he estimates the expenditure at 2% of the dividend. The findings of the CIT(A) are as follows:

12.3 . I have carefully considered the submissions thus made by the appellant. This issue too has been discussed at length in the appellate order for the assessment year 199091. It has been held in the said order that the stand taken by the Assessing Officer that deduction u/s 80M could be allowed only in respect of the net dividend is correct. In the case of Distributors (Baroda) P. Ltd. v. Union of India and others, 155 ITR 120, the Hon’ble Supreme Court had categorically held that the deduction required to be allowed under the provisions of section 80M(1) had to be calculated with reference to the amount of dividend computed in accordance with the provisions of the Act and forming part of the gross total income, and not with reference to the full amount of dividends received by an assessee. Therefore, there is no scope for any debate that deduction u/s 80M will have to be computed only with reference to net dividends and not the gross. The appellant’s argument that in the case of Commissioner of Income-tax v. Union General Trust Ltd. 200 ITR 488, only managerial expenses had been held to be netted from the gross dividends is not correct. The only issue before the Hon’ble Court in the above case was whether any portion of the managerial expenses could be attributed to dividends and accordingly could be deducted from the gross dividends in order to arrive at the net dividends. The court did not have any occasion to look into the other expenses. It was only in this context that the Hon’ble Court had ruled on the deductibility of managerial expenses alone.

12.4 . In view of the foregoing, I would hold that the Assessing Officer was perfectly justified in considering disallowance of expenses with reference to the dividends claimed for deduction u/s 80M. However, the moot question is how much of the expenses could be said to have been incurred by the appellant for earning the dividends. Only such expenditure as could be related to the dividends on the ground of having been wholly and exclusively laid out could be disallowed u/s 57(iii). Earlier on, while dealing with the subject of proportionate disallowance of expenses relatable to interest on tax-free securities, it has been seen that the appellant had substantial interest-free funds at its disposal and, therefore, no part of the interest-bearing borrowals could be said to have been used for making investments in shares. In the circumstances, no financial expenditures could be attributed to the dividends claimed u/s 80M. Coming to the managerial expenses, I find merit in the appellant’s submission that as the dividend warrants involved were negligible in number and the vouchers transacted were also very few, the managerial expenses attributable would also be negligible. However, as the appellant itself has offered the attributable expenses to be taken at 2% of the dividends, which offer must be regarded as reasonable, the attributable expenses are hereby directed to be taken at 2% of the dividends. The Assessing Officer shall recompute the deduction admissible to the appellant u/s 80M accordingly.

7. As against the aforesaid conclusion of the CIT(A), cross appeals were filed by both the assessee as well as the revenue before the Income Tax Appellate Tribunal. The Tribunal relying on the decision of the Special Bench of the Income Tax Appellate Tribunal, Bombay in Income Tax Officer v. Daga Capital Management Pvt. Ltd. (2009) 312 ITR (AT) 1 (Mumbai)(SB) , held that Rule 8D provided for a formula for computation of expenses retrospectively, and remitted the matter to the file of the Assessing Authority with a direction to follow the decision of the Special Bench and decide the matter in accordance with law.

8. Both the assessee and the revenue had filed Tax Case (Appeals) before this Court. The assessee’s appeals were numbered as T.C.(A) Nos.509 to 511 of 2010 and by order dated 08.02.2022, the matter stood remanded to the Assessing Officer in light of the judgment of the Supreme Court in South Indian Bank Ltd. v. Commissioner of Income-tax (SC). Unfortunately, the revenue appeals were not heard along with the assessee’s appeals.

9. The Assessing Authority took the matter up and passed consequential orders on 29.06.2022. Applying the judgment of the Supreme Court in South Indian Bank Ltd. Supra (3), he accepted the claim of the assessee and the discussion reads as follows:

It was claimed that the exempted investment held in shares and MF as on 31/03/1996 was Rs.20.86 Cr, from out of total investments of Rs.407 Crores which constitute 5.12% of total investments. The bank was having own funds by way of equity capital of Rs.89 crores and demand deposit of Rs.272 crores. Therefore, equity and demand deposits was more than the investment in exempted investments. Hence, no disallowance is warranted on proportionate expenses on earning exempted income as held by Hon’ble Supreme Court verdicts in South Indian Bank case Supra and requested to delete the addition made. Out of the total disallowance of Rs.22,23,799/-, already an amount of Rs.21,79,323/- was given relief in the giving effect order. Hence, the balance of Rs.44,476/- is to be allowed. ‘

10. The grant of relief as sought for by the assessee under order dated 29.06.2022 has attained finality and no proceedings for either revision or re-assessment have been initiated by the Department. Technically, therefore, the present appeals are infructuous as the connected revenue appeals have been dismissed as withdrawn on 21.08.2025 on the ground of low tax effect.

11. As far as Section 80M is concerned, the position that deduction is to be computed on net basis only is settled by the judgment of the Supreme Court in the case of Distributors (Baroda) Pvt. Ltd v. Union Of India (155 ITR 120)

. This is also clear from the scheme of Chapter VIA of the Income Tax Act 1961. Section 80A provides for computation of relief under various provisions in Chapter VIA based on the computation of total income, wherein the assessee is to reduce such expenditure that has a direct nexus to the earning of the income on which deduction is granted.

12. However, in the present case, the financials of the assessee reveal sufficient surplus funds for making of investments leading to the earning of dividends. The question of restriction of the dividend would thus not arise seeing as the investment has been made, not out of interest bearing funds, but from out of assessee’s own funds.

13. In light of the categoric finding of the assessing authority relating to the sufficiency/adequacy of surplus funds in the assessee’s hands, there is no justification for any disallowance, and in such circumstances, it is not open to the Department to estimate such expenditure. This question is hence answered in favour of the assessee.’

’18. Substantial question arising in TCA.Nos.293, 294 & 295 of 2010 (AY 1996-97, 1997-98, 1998-99) and admitted on 16.08.2010:

Whether on the facts and in the circumstances of the case, the Income Tax Appellate Tribunal was right in not dealing with the disallowance of a sum of [as follows] as proportionate expenditure related to tax-free bonds deleted by the Commissioner of Income Tax (Appeals)?

A.Y. 1996-97 :Rs.2,24,38,091/-

A.Y. 1997-98 :Rs.3,35,46,751/-

A.Y. 1998-99 :Rs.7,38,81,028/-

19. As both parties agree that this question is to be answered in favour of the assessee in light of the judgment in South Indian Bank Ltd⁶, this question is answered in favour of the assessee.’

4. In light of the above, the questions are answered in favour of the assessee and these Tax Case (Appeals) are allowed. No costs.