![\"Akhilesh\"](\"https:\/\/www.itatonline.org\/articles_new\/wp-content\/uploads\/Akhilesh.jpg\")
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Shri. Akhilesh Kumar Sah, Advocate, has carefully analyzed numerous judicial pronouncements on the allowability of expenditure under section 37(1) of the Income-tax Act, 1961 and has explained the propositions arising from them<\/strong><\/p>\n According to section 37(1) of the Income Tax Act, 1961, any expenditure (not being expenditure of the nature described in sections 30 to 36 and not being in the nature of capital expenditure or personal expenses of the assessee), laid out or expended wholly and exclusively for the purposes of the business or profession shall be allowed in computing the income chargeable under the head “Profits and gains of business or profession.Also, according to Explanation inserted by the Finance (No. 2) Act, 1998, w.e.f. 1-4-1962 to section 37 (1), any expenditure incurred by an assessee for any purpose which is an offence or which is prohibited by law shall not be deemed to have been incurred for the purpose of business or profession and no deduction or allowance shall be made in respect of such expenditure.<\/p>\n <\/p>\n Recently, in Premier Breweries Ltd. vs. CIT, Cochin [372 ITR 180 (SC), date of judgment: 10. 03.2015], the Supreme Court has observed its earlier judgment in the case of Lachminarayan Madan Lal vs. CIT, West Bengal [1973 AIR 2330, 1973 SCR (2) 207, date of judgment: 13.09.1972]:<\/p>\n “The mere existence of an agreement between the assessee and its selling agents or payment of certain amounts as commission, assuming there was such payment, does not bind the Income Tax Officer to hold that the payment was made exclusively and wholly for the purpose of the assessee’s business. Although there might be such an agreement in existence and the payments might have been made. It is still open to the Income tax Officer to consider the relevant facts and determine for himself whether the commission said to have been paid to the selling agents or any part thereof is properly deductible under Section 37 of the Act.” <\/p>\n<\/blockquote>\n Under section 37(1) expenses which are not specifically allowed as deduction, can be claimed as deduction provided certain condition are fulfilled. For example expenditure incurred in organising a foot ball tournament has been held as allowable deduction under section 37 while computing income of the assessee (Delhi Cloth and General Mills Co. Ltd. Vs. CIT <\/em>(1999) 240 ITR 9 Del. In other words as per section 37(1) of the Act, an expenditure can be claimed as a deduction while computing income from "business or profession" if the following condition are fulfilled.<\/p>\n (i) Expenditure is not of the nature as described in sections 30 to 36 of the Act; The Apex Court in CIT Vs. Bharat Carbon & Ribbon Mfg. Co. (P) Ltd., <\/em>1999 XII SITC 218 <\/strong>has observed that whether the assessee is entitled to a particular deduction or not will depend on the provision of law relating thereto and not on the view which the assessee might take of his rights nor can the existence or absence of entries in the books of accounts be decisive or conclusive in the matter. The expression "wholly" in section 37(1) has been used with reference to the quantum, while the expression ‘exclusively’ refers to the nature or the purpose of the activity in which the expenditure is incurred. In other words, the whole of the expenditure must have been solely and exclusively incurred for business purposes, in order to qualify for allowance under section 37(1) of the Act if there is a dual purpose. Then it is obvious that the expenditure would not quality for allowance, for it will case to be wholly and exclusively laid out for business (CIT Vs. T.S. Hajee Moosa & Co. <\/em>(1986) 51 CTR (Mad) 200. The expression "Wholly & exclusively" used in section 10(2) (xv) of the Income-tax Act, 1922 (Which corresponds to section 37(1) of the Income-tax Act, 1961) does not mean "necessary". Ordinarily, it is for the assessee to decide whether any expenditure should be incurred in the course of his or its business. Such expenditure may be incurred voluntarily and without any necessity and if it is incurred for promoting the business and to earn profits. the assessee can claim deduction even though there was no compelling necessity to incur such expenditure. (Sasson J. David & Co. (P) Ltd. Vs. CIT <\/em>(1979) 118 ITR 261 (SC)). Thought the main objects of business is to earn profits, business purposes are wider than profit-making purposes. Business expediency does not require that expenses should be incurred only for earning immediate profits. Expenses incurred though not directly related to earning to income, may be allowable deductions if they are related to the carrying on of the business vide Birla Cotton Spinning & Weaving Mills Ltd. Vs. CIT <\/em>(1967) 64 ITR 568 (Cal)). It is for the assessee to decide how best to protect has own interest. It is not open to Income-tax department to prescribe what expenditure an assessee should incur and in what circumstances he should incur that expenditure (CIT Vs. Dhanrajgiri Raja Narasingiri <\/em>(1973) 91 ITR 544 (SC)). Expression "commercial expediency" is not a term of art. It mean everything that serves to promote commerce and includes every means suitable to that end commercial men are best experienced in commercial expediency (Indian Steel & Wire Products Ltd. Vs. CIT <\/em>(1968) 69 ITR 379 (Cal)). In applying the test of commercial expediency for determining whether the expenditure was wholly and exclusively laid out for the purposes of the business, reasonableness of the expenditure has to be adjudged from the point of view of the businessman and not of the revenue (Jamshedpur Motor Accessories Stores Vs. CIT <\/em>(1974) 95 ITR 664 (Pat); J.K. Woollen Manufacturers Vs CIT <\/em>(1969) 72 ITR 612 (SC). In order that an expenditure may be admissible as a deduction under section 10(2) (xv), it is not necessary that the primary motive in incurring is must be directly to earn income thereby (Sree Meenakshi Mills Ltd. Vs. CIT <\/em>(1967) 63 ITR 207 (SC). In CIT Vs. Malayalam Plantations Ltd. <\/em>(1960) 53 ITR 140 the Supreme Court has observed at page 150, that:<\/p>\n "The expression" for the purpose of the businesses is wider in scope than the expression ‘for the purpose of earning profits’. Its range is wide; it may take in not only the day to day running of a business but also the rationalisation of its administration and modernisation of its machinery; it may include measures for the preservation of the business and for the protection of its assets and property from expropriation, coercive process or assertion of hostile; it may also comprehend payment of statutory dues and taxes imposed as a precondition to commence or for the carrying on of a business; it may comprehend many other acts incidental to the carrying on of a business. However wide the meaning of the expression may be, its limits are implicit in it. The purpose shall be for the purpose of the business, that is to say, that expenditure incurred shall be for the carrying on of the business and the assessee shall incur it in his capacity as a person carrying on the business. It can not include sum spent by the assessee as agent of a third party, whether the origin of the agency is voluntary or statutory………………."<\/p>\n In CIT Vs. Chandulal Keshavlal & Co. <\/em>(1960) 38 ITR 601 (SC), it was held by the SC that in deciding whether a payment of money is a deductible expenditure one has to take into consideration questions of commercial expediency and the principles of ordinary commercial trading. If the payment or expenditure is incurred for the purpose of the trade of the assessee it does not matter that the payment may incur to the benefit of a third party. It has been observed in the case of Bombay Steam Navigation Co. (1953) (P) Ltd. Vs. CIT <\/em>(1965) 56 ITR 52 (at page 59); CIT Vs Gwalior Rayon Silk Mfg. Co. Ltd. <\/em>(1999) 148 Taxation 592 (Bom) (at page 601) that in considering, whether expenditure is revenue expenditure the court has to consider the nature and the ordinary course of the business and the objects for which the expenditure is incurred. The question whether a particular expenditure is revenue expenditure incurred for the purpose of the business must be viewed in the large context of business necessity or expediency. If the outgoing or expenditure is so related to the carrying on or conduct of the business that it may be regarded as an integral part of the profit-earning process and not for acquisition of an asset or a right of a permanent character, the possession of which is a condition to the carrying on the business, the expenditure may be regarded as revenue expenditure (See also Addl. CIT Vs. Akkamba Textiles Ltd. <\/em>(1971) 117 ITR 294 (AP)).. If a trader considers that the revenue seeks to take too large a share and to leave him with too little, the expenditure which the trader incurs in endeavoring to correct the mistake is adjustment laid out for the purpose of his trade (CIT Vs. Birla Cotton Spinning & Weaving Mills Ltd. <\/em>(1971) 82 ITR 166 (SC)). Spending in the sense of "paying out or away" of money is the primary meaning of "expenditure". "Expenditure is what is paid out or away and is some thing which is gone irretrievably. Expenditure, which is deductible for income-tax purposes is one which is towards a liability actually existing at the time but the putting aside of money which may become expenditure on the happening of an actual liability in presenti<\/em> and a liability de futuro<\/em> which, for the time being, is only contingent. The former is deductible but not be latter (Indian Molasses Co. (P) Ltd. Vs. CIT <\/em>(1959) 37 ITR 66 (SC); CIT Vs. Motor industries Co. Ltd. <\/em>(1998) 142 Taxation 779 (Kar). Expenditure means something which comes out of the traders’ pocket. In 1972, a larger bench of the Supreme Court expressed the view in the case of Indian Aluminium Co. Ltd. Vs. CIT <\/em>(1972) 84 ITR 736 (SC), that the test adopted in Travancore Titanium Products Ltd. Vs CIT <\/em>(1966) 60 ITR 277 (SC), case that "to be a permissible deduction there must be a direct and intimate connection between the expenditure and the business, i.e., between the expenditure and the character of the assessee as a trader, and not as owner of assets, even if they are assets of the business" needs to be qualified by stating that if the expenditure is laid out by the assessee as owner-cum-trader, and the expenditure is really incidental to the carrying on of his business, it must be treated to have been laid out by him as a trader and as incidental to his business. It was held in Indian Aluminium Co. Ltd. Vs. CIT <\/em>(supra) case that the wealth-tax on assets held by the assessee for the purpose of his business was deductible as a business expense in computing the assessee’s income from business. As per the amendment brought by section 284 of the Income-tax (Amendment) Act, 1972, any sum paid as wealth-tax for the assessment year 1957-58 or any subsequent assessment year cannot be deductible in the computation of the income of any assessee. But the above amendments do not touch the principle laid down by the Supreme Court in the Indian Aluminium <\/em>case (as cited above), that when a person has a dual capacity of a trader-cum-owner and he pays tax in respect of property which is used for the purpose of trade, the payment must be taken to be in the capacity of a trader. The Amendment Act of 1972 only adds the sum paid on account of wealth-tax to the list of amounts not deductible in computing the assessee’s income from business. Therefore, any amount paid by the assessee on account of a tax other than wealth-tax on his business assets would be outside the scope of above-mentioned Amendment Act and would continue to be governed by the law laid down in above cited Indian Aluminium <\/em>case (Mitsui Steamsip Co. Ltd Vs. CIT <\/em>(1975) 99 ITR 7 (SC). The Patna High Court in Motipur Sugar Factory Ltd. vs. CIT (1955) 28 ITR 128 (Pat), has observed (at page 133) that the profit of a trade or business is the surplus by which the receipts from trade or business exceeded the expenditure necessary for the purpose of earning those receipts. The deductions expressly mentioned under section 10(2) of the Income-tax Act, 1922 (which corresponds to section 29 of the Income-tax Act, 1961) are not exhaustive.<\/p>\n The Supreme Court in CIT Vs. Kalyanji Mavji & Co. <\/em>(1980) 122 ITR 49 (SC), has observed (at page 53) that on accepted commercial practice and trading principles an item of business expenditure must be deducted in order to arrive at the true figure of profits and gains for the tax purposes.<\/p>\n The Gujarat High Court in CIT Vs. Navsari Cotton & Silk Mills Ltd. <\/em>(1982) 135 ITR 546 (Guj) has evolved some positive and negative tests on first principles to claim deduction of an expenditure as business expenditure.<\/p>\n A. Positive Tests:<\/p>\n If the expenditure is incurred: B. Negative Tests:<\/p>\n If the expenditure is incurred: Conclusion:<\/strong><\/p>\n Section 37(1) in general speaks that an expenditure incurred wholly and exclusively for the purpose of business will be allowed as deduction. But from the above discussion it is clear that scope of the abovementioned section is wide enough for claiming a particular deduction, if certain conditions laid down therein are satisfied.<\/p>\n The jurisdiction of the revenue is confined to deciding the reality of the expenditure, namely, whether the amount claimed for deduction was factually expended or not, and whether is was wholly and exclusively for the purpose of the business. Once that conclusion is reached in favour of the assessee, deduction of the entire amount should follow as a matter of course (Sanjeevi & Co. Vs. CIT <\/em>(1966) 62 ITR 156 (Mad)). It is well settled that the deductions allowed in determining the income enumerated in the Income-tax Act are not exhaustive. A business expenditure is a voluntary act on the part of a businessman to spend money for carrying on his business with a view to earning profits (Kamplapat Motilal V. CIT <\/em>(1976) 104 ITR 783 (All)).<\/p>\n Income-tax is not regarded as the expenditure laid down for earning the profit, in fact it has been considered as the application of the profits after being earned, therefore, it is not allowed as deduction (A.V. Thomas & Co. Ltd. Vs. CIT <\/em>(1986) 159 ITR 431 (Ker)(FB)). Also, personal expenses like expenses by an assessee on his fooding, clothing are not allowed as a deduction under section 37(1) (See, State of Madras Vs. G.J. Coelho<\/em> (1964) 53 ITR 186 (SC)).<\/p>\n The test to find out whether a particular expenditure is wholly or partly justified or exclusively incurred for the purpose of the business is not to see whether it was necessary, nor would it be proper to see whether any other person similarly situated would have thought it reasonable to incur expenditure to that extent. The true test is to find out whether the businessman, when he expended the money, was acting reasonably in the interests of his own business uninfluenced by any irrelevant and extraneous consideration (CIT Vs S. Krishna Rao <\/em>(1970) 76 ITR 664 (AP)) and the expenditure was laid out for the purpose of the assessee’s normal business activity (Dalmia Dairy Industries Ltd. (Formerly known as Dalmia Cement Ltd. Vs. CIT <\/em>(2000) 154 Taxation 139 (Del). Expenses incurred though not directly related to the earning of income may be allowable deduction if they are related to the efficient carriage of the business even indirectly (Indian Steel & Wire Products Ltd. Vs. CIT <\/em>(supra). Also the Calcutta High Court in CIT Vs. Shree Krishan Gyanoday Sugar Mills Ltd. <\/em>(1990) 186 ITR 541 (Cal) has observed the business expediency may not require that all the expenses be incurred for earning immediate profits. The Supreme Court in Calcutta Co. Ltd. Vs. CIT <\/em>(1959) 37 ITR 1 (SC) has observed that the expression "profits or gains" in section 10(1) of Income-tax Act, 1922 (which corresponds to section 28 of the Income-tax Act, 1961) has to be understood in its commercial sense and there can be no computation of such profits and gains until the expenditure which is necessary for the purpose of earning the receipts is deducted therefrom. The burden of proving the necessary fact than the amount contended to be an expenditure, falls under section 37 (1) is on the assessee (CIT Vs. Calcutta Agency Ltd. <\/em>(1951) 19 ITR 191 (SC). The Supreme Court in Swadeshi Cotton Mills Co. Ltd. Vs. CIT <\/em>(1967) 63 ITR 57 (SC), has held that the question whether an amount claimed as an expenditure has been laid out or expended wholly and exclusively for the purpose of the assessee’s business or profession or vocation has to be decided on the facts and in the light of the circumstances of each case. But the final conclusion on the admissibility of an allowance is one of law.<\/p>\n Once it is held that no expense was incurred by the appellant the question of any allowable expenses being deducted in computing the income from the profits & gains of the appellant does not arise (New India Mining Corporation (P) Ltd. vs. CIT (2000) 15 SITC 1 (SC).<\/p>\n Recently, the Karnataka High Court in Diffusion Engineers Ltd vs The DCIT [ITA NO.1010 OF 2008, decided on 17 April, 2015], on the facts and circumstances of the case, has held <\/strong>that the expenditure incurred by the assessee towards the procurement of technical know how by paying a lumpsum consideration for use in the course of business is a revenue expenditure falling u.\/s 37 of the Act and the provisions of Section 35 AB of the Act are not applicable to the present case.<\/p>\n Bottomline:<\/strong><\/p>\n The above study with case laws is of practical use and makes the general nature of section 37 to be practical.<\/p>\n Shri. Akhilesh Kumar Sah, Advocate, has carefully analyzed numerous judicial pronouncements on the allowability of expenditure under section 37(1) of the Income-tax Act, 1961 and has explained the propositions arising from them<\/p>\n\n
\n (ii) Expenditure is of revenue in nature not of capital in nature;
\n (iii) Expenditure is not personal expense of the assessee;
\n (vi) Expenditure has been laid down or expended wholly and exclusively for the purposes of business or profession of the assessee;
\n (v) Expenditure has not been incurred for any purpose which is an offence or which is prohibited by law.<\/p>\n
\n (1) with a view to bring profits or monetary advantage today or tomorrow;
\n (2) to render the assessee immune from impending or reasonably apprehended litigation;
\n (3) in order to save losses in foreseeable future;
\n (4) for effecting economy in working which may pay dividends today or tomorrow;
\n (5) for increasing efficiency in working;
\n (6) for removing inefficiency in the working;
\n (7) where the expenditure incurred is such as a wise, prudent, pragmatic and ethical man of the world of business would conscientiously incur with an eye on promoting his business prospects subjects to the expenditure being genuine and within reasonable limits;
\n (8) where it is incurred solely by way of a civil duty owed by the assessee to the society having regard to the nature of his business which brings him profits but results in some detriment to the public at large either by way of health hazard or ecological pollution or serious inconvenience to the citizens with a view to mitigate the aforesaid evil consequences and consequences of a like nature, subject to its being genuine and within reasonable limits.<\/p>\n
\n (1) for a mere altruistic consideration;
\n (2) mainly in order to satisfy his philanthropic urges;
\n (3) mainly in order to win applause or public appreciation;
\n (4) for illegal, immoral or corrupt purposes or by any such means or for any such reasons;
\n (5) mainly in order to oblige a relative or an official;
\n (6) to earn the goodwill of a political party or a politician;
\n (7) to show off or impress others with his affluence or for ostentatious purposes.
\n (8) apparently for a factor listed as a positive factor but in reality for one of the obnoxious purpose listed as a negative factor;
\n (9) on a nebulous plea or pretext but really for one or the other of the purposes listed as negative tests;
\n (10) it must not be a bogus, fictitious or sham transaction;
\n (11) is must not be unreasonable and out of proportion;
\n (12) it must not be an expenditure merely with a view to avoid tax liability without any genuine purpose or reason in good faith; and
\n (13) the advantage to be secured by incurring the expenditure must not be of the nature of a remote possible advantage depending on "ifs’ and "buts" and, if at all, to be secured at an uncertain future date which may be considered too remote.<\/p>\n\n
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