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Whether 20% Deduction of Interest u/s 57 is on Gross Dividend or Net Dividend after Deduction u/s 80M


20-percent-deduction-interest-us-57-gross-dividend-net-dividend-deduction-us-80m

Subsequent to the abolishment of Dividend Distribution Tax (DDT) from the statute, Finance Act, 2020 has made the dividend income taxable in the hands of the recipients (shareholders). Section 57 of the Income Tax Act, 1961 (“Act”) has also been amended to provide for deduction of interest expended for earning such dividend income. Further, a new section 80M is inserted in the Act for allowing deduction in respect of certain inter-corporate dividends.


    Deduction under section 57 


    Section 57 of the Act provides for certain deductions that are allowed against income chargeable under the head "Income from other sources". Clauses (i), (ia), (ii), (iia), (ii) and (iv) of section 57 specifically mention the deductions available while computing the income chargeable under the head ‘Income from other sources’. 


    Out of these, deduction under clauses (i) and (iii) to section 57 are relevant for claiming and allowing a deduction from dividend income chargeable under the head ‘Income from other sources’. 


    Section 57(i) allows a deduction from any dividend income or interest on securities for any reasonable sum paid by way of commission or remuneration to a banker or any other person for the purpose of realising such dividend or interest on behalf of the assessee. This deduction is specific to dividend income or interest on securities only.


    Section 57(iii) is general in nature and allows deduction of any other expenditure (not being in the nature of capital expenditure) laid out or expended wholly and exclusively for the purpose of making or earning any income which is chargeable under the head “income from other sources“.


    For availing the deduction under Section 57(iii) of the Act, the assessee has to establish that the expenditure has been exclusively laid out or expended wholly and exclusively for the purpose of making or earning such income taxable under the head ‘income from other sources’.


    Section 57 provides for certain deductions to be made in computing the income chargeable under the head 'Income from other sources' and one of such deductions is that set out in clause (iii), which reads as follows:


    57. The income chargeable under the head "Income from other sources" shall be computed after making the following deductions, namely :—

    (iii) any other expenditure (not being in the nature of capital expenditure) laid out or expended wholly and exclusively for the purpose of making or earning such income;

    ….


    The expenditure to be deductible under section 57(iii) must be laid out or expended wholly and exclusively for the purpose of making earning such income. It is the purpose of the expenditure that is relevant in determining the applicability of section 57(iii) and that purpose must be making or earning income.


    When the borrowed funds have been utilized for the purpose of making the investment in shares on which dividend income is earned which is taxable under the head ‘income from other sources’, then the deduction for the interest on the borrowed funds is allowed under section 57(iii).


    Deductions for expenses from dividend income - Section 57(i) and section 57(iii)


    Therefore, from the dividend income, the following expenditures are allowed as a deduction under section 57-


    1. Collection Charges: Any reasonable sum paid by way of commission or remuneration to a banker or any other person for the purpose of realising the dividend. [Section 57(i)]


    2. Interest on money borrowed: Interest on money borrowed for purchasing the shares can be claimed as a deduction. [Section 57(iii)]


    Note: There is no specific clause in section 57 which allows for a deduction for interest expense on loans taken for investing in shares for earning dividend income. Hence, if interest is expended wholly and exclusively for earning the dividend income it will be allowed as a deduction under clause (iii) of section 57.


    3. Any other expenditure: Apart from the above, if the assessee incurs any other expenditure, not being in the nature of capital expenditure, wholly and exclusively for the purpose of making or earning the income, can be claimed as a deduction. [Section 57(iii)]


    Limit on deduction for interest expense from dividend income


    Finance Act, 2020 has amended section 57 and a proviso is inserted w.e.f. 01-04-2021 to provide that no deduction shall be allowed from the dividend income, or income in respect of units of a Mutual Fund specified under clause (23D) of section 10 or income in respect of units from a specified company defined in the Explanation to clause (35) of section 10, other than deduction on account of interest expense, and in any previous year such deduction shall not exceed 20 per cent of the dividend income, or income in respect of such units, included in the total income for that year, without deduction under section 57.


    In other words, the proviso to section 57 restricts the deduction for interest expense against gross dividend income (before allowing deduction u/s 57) and the maximum amount of interest expenses that can be allowed as a deduction in a previous year is limited to 20% of the dividend income included in the total income.


    One should note that the proviso is placed below section 57 which stipulates that no deduction other than interest expense shall be allowed from the dividend income and that too maximum at 20% of dividend income included in the total income. However, section 57(i) allows a deduction for collection charges from the realization of dividend income. 


    However, from a plain reading of the proviso, it follows that only interest expenses, subject to the stated limit of 20%, will only be allowed as a deduction from the dividend income and no other deduction will be allowed therefrom. Does it mean that the collection charges from the realization of dividend income as stipulated in clause (i) shall also be disallowed from dividend income? 


    If this view is taken then clause (i) will become otiose and redundant. It should be further noted that clause (i) is also amended by the Finance Act, 2020 to amend the word ‘dividend’. Prior to the amendment, clause (i) refers to “dividends, other than dividends referred to in section 115-O”. Since section 115-O is withdrawn from 01.04.2021 (AY 2021-22) the reference was amended to refer to ‘dividends’ only. The expression “dividends, other than dividends referred to in section 115-O” is substituted with the word ‘dividends’.


    Therefore, the legislature did not omit the dividend from the clause (i) but in its wisdom retained the same in clause (i).


    In this context, reference is made to the observations made by the Andhra Pradesh High Court in the case of S. Deepthi And Ors. vs. Ntr University Of Health 2001 (6) ALD 571, 2001 (6) ALT 308.


    A statute must be read as a whole and the provisions thereunder should be construed with reference to the other provisions of the same statute so as to make the whole statute consistent. While interpreting the provisions of the Act it has to be borne in mind that one section of a statute cannot be used to defeat the provisions of other section unless reconciliation between the two sections is impossible. When a particular provision is found to be repugnant to another provision of the same Act, it is not for the Courts to lightly assume that the privilege conferred under a particular provision has been taken away by another provision of the same statute. While interpreting two apparently repugnant or inconsistent provisions of an Act the Courts will have to adopt harmonious interpretation keeping in view the intendment and purpose of the Act so that no provision or any part thereof is rendered otiose.


    In Sultana Begum vs. Prem Chand Jain, the Supreme Court held that the Rule of interpretation requires that while interpreting two inconsistent or obviously repugnant provisions of an Act, the Courts should make an effort to so interpret the provisions as to harmonise them so that the purpose of the Act may be given effect to and both the provisions may be allowed to operate without rendering either of them otiose.


    It is a settled law that a proviso does not travel beyond the provision to which it is a proviso. Therefore, the golden rule is to read the whole section, inclusive of the proviso, in such manner that they mutually throw light on each other and result in a harmonious construction. This is laid down in Dwarka Prasad vs. Dwarka Das Saraf, (1976) 1 SCC 128. It was further held that a proviso must be limited to the subject-matter of the enacting clause. It is a settled rule of construction that a proviso must prima facie be read and considered in relation to the principal matter to which it is a proviso. It is not a separate or independent enactment. 


    Therefore, the proper interpretation of the proviso is that deduction under clause (i) will be allowed from the dividend income. The proviso intends to disallow any other deduction under clause (iii) of section 57 other than interest expense. This view is further fortified from the Memorandum to the Finance Bill, 2020 which states that it is proposed to carry out amendments so that dividend or income from units are taxable in the hands of shareholders or unit holders at the applicable rate and the domestic company or specified company or mutual funds are not required to pay any DDT. It is also proposed to provide that the deduction for expense under section 57 of the Act shall be maximum 20 per cent of the dividend or income from units. [Emphasis supplied]. This invariably refers to expense that is allowed under clause (iii) of section 57.


    Therefore, after Finance Act, 2020, from the dividend income, the following expenditures are allowed as a deduction under section 57-


    1. Collection Charges: Any reasonable sum paid by way of commission or remuneration to a banker or any other person for the purpose of realising the dividend. [Section 57(i)]


    2. Interest on money borrowed: Interest on money borrowed for investing in the shares can be claimed as a deduction subject to a ceiling of 20% of dividend income. [Section 57(iii) read with Proviso to Section 57]


    3. Any other expenditure: No other expenses will be allowed as deduction from the dividend income. [Proviso to Section 57]


    Deduction under section 80M for inter-corporate dividend


    Finance Act, 2020 has inserted a new section 80M relating to deduction in respect of certain inter-corporate dividends.


    Sub-section (1) of the new section 80M provides that Where the gross total income of a domestic company in any previous year includes any income by way of dividends from any other domestic company or a foreign company or a business trust, there shall, in accordance with and subject to the provisions of this section, be allowed in computing the total income of such domestic company, a deduction of an amount equal to so much of the amount of income by way of dividends received from such other domestic company or foreign company or business trust as does not exceed the amount of dividend distributed by it on or before the due date.


    Read more on New Section 80M – Deduction for Inter Corporate Dividend


    Hence, the deduction under section 80M for dividend income is available only to a domestic company under certain circumstances.


    Interplay between deduction under section 57 and deduction under section 80M


    Section 80M is placed in Chapter-VI of the Income Tax Act, 1961. Hence, this deduction is allowed from the gross total income of the assessee company which includes dividend income. After the deduction under section 80M is allowed, the total income of the assessee company is computed which undisputedly includes dividend income.


    The proviso to section 57 states that the maximum amount of interest expenses that can be allowed as a deduction in a previous year is limited to 20% of the dividend income included in the total income.


    Therefore, a question arises whether the deduction under section 57 on interest expense will be allowed @ 20% of net dividend income included in total income after allowing deduction under section 80M or on gross dividend income.


    This is explained in the following example.


    A Limited receives dividend income of Rs. 1,00,000 during the financial year 2020-21. It paid interest on money borrowed for investment in the shares amounting to Rs. 40,000. Deduction allowable under section 80M is Rs. 30,000. Calculate the amount of interest expense to be allowed under section 57 under the two alternatives-

    (i) On Gross Dividend

    (ii) On Net Dividend


    Particulars

    On Gross Dividend

    On Net Dividend

    Dividend Income

    1,00,000

    1,00,000

    Less: Interest Expense u/s 57

    20,000*

    14,000**

    Gross Total Income

    80,000

    86,000

    Less: Deduction u/s 80M

    30,000

    30,000

    Total Income

    50,000

    56,000

    * 20% on gross dividend income of Rs. 1,00,000

    ** 20% on Net dividend income Rs.(1,00,000 - 30,000=70,000)


    Hence, it can be seen that a wrong interpretation of the provision can lead to income by Rs. 6,000 in the given example.


    Now consider that company A Ltd. distributes dividend of Rs. 1,00,000 and Rs. 80,000. Let's check the position.



    Particulars

    On Gross Dividend

    On Net Dividend

    Dividend Income

    1,00,000

    1,00,000

    Less: Interest Expense u/s 57

    20,000*

    Nil**

    Gross Total Income

    80,000

    1,00,000

    Less: Deduction u/s 80M

    1,00,000

    1,00,000

    Total Income

    Nil***

    Nil

    * 20% on gross dividend income of Rs. 1,00,000

    ** 20% on Net dividend income Rs.(1,00,000 - 1,00,000=0)

    *** As per section 80A, amount of deduction cannot exceed the gross total income.



    Particulars

    On Gross Dividend

    On Net Dividend

    Dividend Income

    1,00,000

    1,00,000

    Less: Interest Expense u/s 57

    20,000*

    4,000**

    Gross Total Income

    80,000

    96,000

    Less: Deduction u/s 80M

    80,000

    80,000

    Total Income

    Nil

    16,000

    * 20% on gross dividend income of Rs. 1,00,000

    ** 20% on Net dividend income Rs.(1,00,000 - 80,000=20,000)


    When the entire dividend income of Rs. 1,00,000 is paid as dividend, no interest expense is allowed to A Ltd. despite incurring interest expense. 


    When dividend income of Rs. 80,000 is paid as dividend by A Ltd., then on a gross deduction basis the total income is coming to Nil. The dividend of Rs. 80,000 will be taxable in the hands of the recipient shareholder. But on a Net deduction basis, the total dividend which is suffering tax is Rs. 16,000 in the hands of A Ltd. and Rs. 80,000 in the hands of the shareholder of A Ltd.; which aggregates to R. 96,000 despite the fact A Ltd. has incurred high interest cost.


    Therefore, the general logic is that deduction u/s 57 for interest expense shall be allowed on Gross Dividend income basis and not on net dividend income basis.


    The scheme of the Act is that the total amount of each head of income is aggregated into 'Gross Total Income' and then, deductions specified under Chapter VI-A are deducted therefrom to arrive at the 'Total Income' of a previous year. In other words, head-wise income is computed after allowing deduction prescribed under the respective heads of income. For example, standard deduction is allowed from computing income under the head salary. The salary income after the standard deduction will qualify for inclusion in gross total income. Similarly, deduction for interest expense shall come into picture at the first stage whereas the provisions for deduction of Inter-Corporate dividend under section 80M finds place in Chapter VI-A of the Act, as stated above and shall come into picture at a later stage. Hence, if the scheme of the Act is followed, it would mean that while computing the quantum of deduction for interest expense, one cannot have regard to the deduction for Inter-Corporate dividend under section 80M. Accordingly, the 20% limit for deduction of interest expense should be applied on the gross dividend income.


    On the other hand, section 57 itself states that the amount of deduction for interest expense from dividend income in a previous year is limited to 20% of the dividend income included in the total income which in turn derived after allowing deduction under section 80M, if any. A literal interpretation of this provision suggests that the 20% limit should be applied on the net dividend income i.e. gross dividend income minus deduction u/s 80M. This argument does not have force in the sense that a dividend income gets included in total income only after the dividend income is determined as per the provisions of section 56 and section 57.


    It can be seen from the above that  both the views have their own supporting arguments. At this juncture, it is important to decide the issue on the basis of certain decided cases.


    Now consider a case where the assessee has loss, say business loss. The above example is extended with additional fact that A Ltd. has business loss of Rs. 2,75,000 for the AY 2021-22.


    In this case would A Ltd. be able to claim deduction under section 80M at all? Let us try to make the computation of A Ltd. for AY 2021-22 on Net Dividend Income Approach:


    Particulars

    Amount

    Business Loss

    (-) 2,75,000

    Income from Other Sources

    Dividend Income

    1,00,000

    Less: Interest expense

    ??

    (How to compute)

    Deduction u/s 80M

    How can there be any deduction under chapter VI-A when the gross total income is a loss


    It can be seen that the deduction u/s 57 cannot be computed on the net dividend basis. 


    1. Can it be argued that there is no deduction u/s 80M so no deduction to be allowed u/s 57 for interest expense. Interest expense u/s 57 should be zero and hence business loss should be Rs. 1,75,000/- (Rs. 2,75,000 - Rs. 1,00,000). This is despite the fact that the assessee has incurred interest expense for earning the dividend.


    2. Can it be said that deduction u/s 80M of Rs. 30,000 (equal to dividend declared) will be allowed and then deduction u/s 57 for interest expense shall be allowed for Rs. 14,000 to be computed @ 20% on Rs. (1,00,000 - 30,000)= Rs. 70,000/-. Therefore, business loss should be Rs. 1,14,000/- [Rs. 2,75,000 - Rs. (1,00,000 - 86,000)].


    Both the above propositions are wrong. This is due to the reason that under section 80A(1) of the Act, in computing the total income of an assessee, the Act allows deductions specified in Chapter VI-A from the assessee's gross total income. Section 80A(2) provides that the aggregate amount of such deductions under Chapter VI-A should not exceed the gross total income of the assessee. The gross total income under section 80B(5) of the Act is the total income computed under the provisions of the Act, prior to making any deduction either under Chapter VI-A of the Act. 


    In a case where deduction is claimed by the assessee under sections 80C to 80U of the Act, the first step to be taken is to find out the assessee's gross total income and if the gross total income is found to be a positive figure, only then, it is possible and permissible to allow the deductions under Chapter VI-A and not otherwise. Where, therefore, the gross total income, as in this case, is a negative figure, viz., loss, no deduction is permissible either under sections 80C to 80U of the Act.


    In CIT vs. Merchantile Bank Ltd. [1988] 169 ITR 44 (Bom), the assessee claimed the benefit of deduction under sections 80L and 80M of the Act with reference to its negative income in the relevant assessment years in question. The authorities declined to allow the deduction so claimed by the assessee. In dealing with the question, whether the authorities were right in doing so, the Bombay High Court pointed out, referring to sections 80A(1), 80A(2) and 80B(5) of the Act, that, for the purpose of applying the provisions of Chapter VI-A, the first enquiry to be made is, whether the assessee's gross total income includes any income by way of dividends and if it does, the next step would be to compute the assessee's gross total income, which would be the total income computed under the Act without deductions under Chapter VI-A or under section 280-O of the Act and only if the gross total income is found to be a positive figure, the deductions permissible under Chapter VI-A can be given and, therefore, the authorities were not in error in disallowing the claim made by the assessee for deduction under the provisions of section 80L and 80M of the Act having regard to its negative income in the years in question. 


    To similar effect is the decision in CIT vs. Rambal (P.) Ltd. [198] 1169 ITR 50 (Mad). In that case, the assessee, a private limited company, in respect of the assessment year 1970-71, claimed the benefit of deduction allowable under section 80I of the Act. The Income-tax Officer rejected this on the ground that as the total income for that assessment year was determined as "nil", no deduction under section 80I was permissible or could be given. However, the Appellate Assistant Commissioner accepted the claim of the assessee and the tribunal took the view that relief under section 80I of the Act was, in its nature, an independent relief and the deduction permissible thereunder, should, be given from the business income, as computed before setting on the loss pertaining to the earlier years. On a reference, the Madras High Court, referring to CIT vs. Madras Motors (P.) Ltd. [1984] 150 ITR 150, held that in view of section 80A, section 80A(2) and section 80B(5) occurring in Chapter VI-A, if the total income, as computed under section 80B(5) of the Act is "nil", then, no relief could be granted based on the other sections in view of the limitations contained in section 80A(2) according to which, the aggregate amount of deduction under Chapter VI-A shall not, in any case, exceed the gross total income of the assessee and if the gross total income of the assessee is determined as "nil", then, there is no question of any deduction being allowed under Chapter VI-A as that will clearly exceed the gross total income of the assessee. 


    In the case of National Engineering Industries Ltd. vs. CIT (Income Tax Reference No. 464 of 1975  decided on 13-03-1978), [followed by the same court in the case of CIT vs. Mcleod and Co. Ltd Income Tax Reference No. 173 of 1977  decided on 24-03-1981] a Division Bench of Calcutta High Court considered the question whether deduction under Section 80M could be claimed by an assessee where his total income was computed at a loss. It was held that the assessee was entitled to deduction under Section 80M but the amount of deductions cannot exceed its gross total income under Section 80A. Such gross total income means the total income computed in accordance with the provisions of the Act before making any deductions under Chapter VI-A. In the instant case, such gross total income is found to be a net loss in the year concerned, because of the losses suffered during the year. Therefore, there is no question of any further deduction of 60 per cent of the dividend earned under Section 80M. The said dividend is to be adjusted against the business loss and the net income of the assessee computed at a negative figure.

    Readers should note that there used to be a section namely section 80AA which was inserted by the Finance (No. 2) Act of 1980 but this amendment was with retrospective effect from April 1, 1968.


    In the statement of objects explaining the reasons for the insertion of section 80AA, it was specifically stated that the clause was being introduced so that the effect of the Supreme Court decision in Cloth Traders (P.) Ltd.’s case reported in (1979) 118 ITR 243 (SC), may not be allowed to continue.


    Section 80AA was related to computation of deduction under section 80M. This section provided that “where any deduction is required to be allowed under section 80M in respect of any income by way of dividends from a domestic company which is included in the gross total income of the assessee, then, notwithstanding anything contained in that section, the deduction under that section shall be computed with reference to the income by way of such dividends as computed in accordance with the provisions of this Act (before making any deduction under this Chapter) and not with reference to the gross amount of such dividends”


    In Cloth Traders P. Ltd.'s case (supra), it had been held by the Supreme Court that deduction under Section 80M can be made with reference to the full amount as dividend received by the assessee and not on the amount of dividend computed in accordance with the provisions of the Act.


    On the contrary, in the case of Cambay Electric Supply Industrial Co. Ltd. vs. CIT (1978) 113 ITR 84 (SC), the Supreme Court had construed Section 80E of the Act and held that the deduction permissible under the said section in respect of profits and gains attributable to the business of generation or distribution of electricity would have to be given in respect of such profits and gains computed in accordance with the provisions of the Act taking into account unabsorbed depreciation and unabsorbed development rebate before arriving at the figure of such profits and gains for the purpose of further deduction under Section 80E of the Act.


    The Apex Court in the case of Distributors (Baroda) P. Ltd. vs. Union of India (1985) 155 ITR 120 (SC) has overruled its earlier decision in Cloth Traders P. Ltd.'s case (supra) and followed its earlier decision in Cambay Electric Supply Industrial Co. Ltd.’s case. It was held that income by way of dividends from a domestic company to be included in the gross total income of the assessee within the meaning of Section 80B(5) of the Act would be income computed in accordance with the other provisions of the Act, viz., after deduction of interest on moneys borrowed for earning such income. The assessee would be entitled to obtain relief under Section 80M only on the amount of dividend so computed as income and not on the gross dividend.


    Their Lordships in the Distributors (Baroda) P. Ltd.’s case had observed that “the Parliament to clearly manifest the legislative intent and to indicate that the decision [of Cloth Traders P. Ltd.'s case (supra)]  did not reflect the true intention of the Legislature introduced by amendment Section 80AA with retrospective effect.” It should be noted that this decision was rendered after the introduction of Section 80AA in the statute.


    However, section 80AA was omitted from the statute by the Finance Act, 1997, w.e.f. 1-4-1998 after the introduction of Dividend Distribution Tax (DDT). Finance Act, 2020 has abolished the DDT and re-introduced the deduction under section 80M but there is no corresponding amendment in section 80AA to re-introduce this section.


    However, despite the fact that there is no section 80AA in the statute as of now, but, as observed by the Hon’ble Supreme Court in the Distributors (Baroda) P. Ltd.’s case that the allowability of deduction under section 80M with reference to gross dividend does not represent the true intent of the legislature and hence the first step is to compute the net dividend income as per the provisions of section 57 and then deduction under section 80M will be allowed. Hence, at the first step, the deduction for interest expense under section 57 will be allowed on the gross dividend income without making any reference to the deduction that will be allowed under section 80M.


    Read Also:

    Changes in TDS and TCS Provisions in Union Budget 2020

    New Section 80M – Deduction for Inter Corporate Dividend

    Abolishment of Dividend Distribution Tax (DDT) and Consequential Amendments by Finance Bill, 2020

    Amended Section 194: TDS on Dividend on Shares from FY 2020-21

    Section 194K - TDS on Income from Mutual Fund Units and furnishing Form 15G/Form 15H


     

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