The income-tax laws in India contemplate deduction of expenses incurred in the carrying on of business. In running a business, which involves compliance with many statutory laws, and dealings with different organisations and people, litigation is a common incident. Litigation expenses incurred for business purposes are generally deductible as “ordinary and necessary” expenses of the business. Since almost the entire law relating to admissibility of Litigation expenses in India is based either on executive instructions or is judge-made law.
Object of litigation -
Significance of
For claiming deduction
for legal expenses, the object or purpose of the litigation has to be seen from
the facts of each case. In deciding whether an expenditure is allowable as a
deduction under section 37(1), the important thing to be seen is whether the
expenditure has been made as a measure of business expediency or for the
purpose of protecting or safeguarding the business itself or business assets of
the taxpayer.
True test in respect of
allowing the litigation expenses
For deciding whether any
expenditure is allowable as deduction under section 37 of 1961 Act, the
essential requirement must in every case be as to whether the expenditure was
either in reality or as a measure of business expediency necessary either for
the purpose of the assessee including goodwill or in connection with some
transaction or activity which is directly and substantially connected with the
running of the business of the assessee or is intimately connected with the
assessee’s business activities. Such expenses must necessarily pertain to the
business itself and must not be an expenditure merely connected with any
activity, however remote or ancillary.
Thus, true test in
respect of allowing the litigation expenses should be whether the litigation
concerned, affects carrying on of the business or the conduct of the business
of the assessee-company as a going concern. If the main purpose of the
litigation was to determine who would run a particular company or who should be
incharge of running the company, the litigation expenses may not as such affect
the carrying on of the business of the assessee. To justify the allowance, the court reasoned that the
main and primary purpose of the suit which petitioner defended was for an
accounting and any question of title was merely incidental thereto. There must
be a proximate relationship between the matter out of which the legal expenses
arise and the business of the taxpayer.
Expenditure incurred for
a purpose which is an offence or prohibited by law cannot be allowed as
deduction [Explanation 1 to Section 37(1)]
A bare perusal of
Explanation to section 37(1) indicates that incurring of any expenditure for a
purpose which is an offence or prohibited by law cannot be allowed as
deduction.
Explanation 1 to section
37(1) provides that 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.
Text
of Explanation 1 to section 37(1)
Explanation 1. - For the
removal of doubts, it is hereby declared that 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.
There existed a nexus of expenditure with offence
Mandate
of the Explanation to section 37(1) is crystal clear that, any
expenditure incurred for any purpose which is an offence or which is prohibited
by law cannot be allowed as deduction. It does not make any difference, whether
expenditure is direct or indirect. So long as there exists a nexus of the
expenditure with the offence, it will continue to be hit by the Explanation.
Language of Section 37 does not make any distinction between civil litigation and criminal litigation
Language of Section
37 does not make any distinction between civil litigation and criminal
litigation. In fact, expenses incurred in connection with litigation are not
separately dealt with under that provision. It makes. no difference whether the
proceedings are civil or criminal. All that the court has to see is whether the
legal expenses were incurred by the assessee in his character as a trader; in
other words, whether the transaction in respect of which proceedings are taken
arose out of and was incidental to assessee’s business. Further we have to see
whether the expenditure in question was bona fide incurred wholly and
exclusively for the purpose of business
Where
expenditures are allowable under section 37(1) from Business
Income
Deductibility
of litigation expenses is not straightforward and depends on who is paying these
and in what context. Deductibility of these expenses depend
on the taxpayer’s motive or purpose for incurring the expense in question. When
a legal expense is incurred in relation to the operation of a business to
produce assessable income, it is generally allowable as a deduction. Exceptions
are when the legal fee is capital, domestic or private in nature, if it is
specifically excluded by another section of income tax legislation, or is
incurred in earning exempt and non-assessable non-exempt income.
EXAMPLES
OF ALLOWABLE EXPENDITURES:
·
Litigation expenses in protecting the trade or
business.
·
Litigation expenditure
must arise in the course of or by reason of the taxpayer’s ordinary trading
operations.
·
Litigation expenses which are “ordinary and necessary”
(i) to carry on a trade or business or (ii) for the production or collection of
income, for the management of income-producing property, or in connection with
determining tax liability may be deducted currently.
·
Litigation expenses incurred in order to defend or
maintain an existing title to the business asset.
·
Expenses on litigation (whether civil or criminal) if
incurred wholly and exclusively for the purpose of the business.
·
The legal expenses incurred did not create or enhance
any asset, they did not bring about any advantage for the enduring benefit of
trade, and they were more closely related to the appellant’s income-earning
operations than to its income-earning structure.
·
Litigation expenses for making agreements, various
deeds, etc.
EXAMPLES
OF NOT ALLOWABLE EXPENDITURES:
·
Litigation expenditure incurred for
curing any defect in title of assets or completing that title.
·
Litigation expenditure is not of a capital nature;
·
Litigation expenditure is not incurred in respect of
any claim made against the taxpayer for the payment of damages or compensation;
·
Litigation expenditure is not incurred in respect of
any claim made by the taxpayer for the payment to him of any
Legal expenses incurred by assessee-company
to protect directors/shareholders in their individual capacity, not for their
conduct in carrying out business of assessee could not be allowed as business
expenditure under section 37(1)
There was a dispute
between two groups of shareholders, primarily for management and control of
assessee-company. Assessee-company incurred legal expenses for purpose of
defending its directors/shareholders in respect of complaints filed against
them by another group of shareholders. Assessing Officer disallowed such
expenses holding that same were not incurred by assessee-company for business
purpose. Since legal expenses were incurred so as to protect
directors/shareholders of assessee-company in respect of complaints filed
against them in their individual capacity and not in respect of their conduct
in course of carrying on business of assessee-company, same could not be
allowed as business expenditure under section 37(1). [In favour of revenue] (Related
Assessment years : 2005-06, 2007-08 to 2009-10) – [National Refinery (P.)
Ltd. v. CIT (2020) 424 ITR 267 : 272 Taxman 160 : 114 taxmann.com 614 (Bom.)]
Where High Court upheld
Tribunal’s order holding that legal/settlement expenses incurred by assessee in
his capacity of managing director of company ‘M’ could not be claimed as
deduction against income earned by exercising legal profession in his
individual capacity, SLP filed against said order was to be dismissed
Assessee was a managing director of Company ‘M’. He stood personal
guarantee in respect of loan taken by company ‘M’. On account of default in
repayment of said loan, assessee in capacity of lawyer, entered into settlement
with banks and paid agreed amount. Subsequently, assessee filed his return
wherein he claimed deduction of legal expenses in respect of aforesaid
settlement against income generated through legal profession. Assessee’s claim
was rejected on ground that said expenditure was of personal nature. Tribunal
upheld order passed by revenue authorities. - High Court confirmed Tribunal’s
order.
It is urged on behalf of the assessee that if the litigation expenses
claimed under Section 37 of the Act were not paid it would have been impossible
for him to carry on his profession as an advocate and that in these
circumstances, the amount was wholly and exclusively laid out for business. He
also cited Shanti Bhushan (supra) to say that there could be circumstance for
the expenses claimed by a professional, though seemingly personal, entitled
deduction under Section 37 of the Act. What is evident from the discussion of
facts by the lower authorities in this case is that the appellant initially was
a business entrepreneur, i.e. managing director of M/s Indian Magnetics Ltd.
That assessee's liability led to the appellant in his capacity as the guarantor
and entrepreneur, discharging its debt. The discharge of that liability was
claimed by him to be business expenditure in relation to subsequent income
generated through legal profession. In our opinion, such claim is clearly
inadmissible. The kind of expenditure which a legal professional can
legitimately and justly claim is entirely different from the basic expenditure
which a commercial entity can claim. Moreover, the commonality sought to be
urged, i.e. the persona of the assessee that obscures the fact is that the hat
donned by the assessee in the past was of a business entrepreneur whereas he is
now a legal professional; crossing of line is impermissible as the law stands
today. On facts, SLP filed against order of High Court was to be dismissed. [In
favour of revenue] – [Satinder Kapur v.
ACIT (2019) 266 Taxman 377 : 110 taxmann.com 25 (SC)]
Where assessee-company claimed deduction of legal and professional expenses incurred in relation to buyback of shares of company from its shareholders, since said expenditure would not in any manner enhance capital structure of assessee company, expenditure in question being revenue in nature was eligible for deduction under section 37(1)
During relevant year, assessee company debited legal and
professional expenses of Rs.10,25,500/-incurred in relation to buyback of
shares of company from its shareholders which pertained to reduction of share
capital of company. Assessing Officer disallowed such expenditure on ground
that expenditure incurred partook character of capital nature. Tribunal opined
that assessee had claimed deduction in respect of expenditure incurred in connection
with carrying out buy back scheme and buyback of shares would not in any manner
enhance capital structure of assessee company. Tribunal thus taking a view that
expenses incurred were in connection with existing business of assessee
company, allowed assessee’s claim for deduction. Since assessee claimed
deduction in respect of expenditure incurred for proceeding of implementation
of buyback of shares which would not in any manner enhance capital structure of
assessee, assessee’s claim was rightly allowed by Tribunal. [In favour of
assessee] (Related Assessment year : 2004-05) – [PCIT v. Bayer Vapi (P) Ltd.
(2019) 264 Taxman 182 : 106 taxmann.com 395 (Guj.)]
Where expenditure was incurred by assessee towards legal fee and other litigation charges to protect his business interests in relation to mining lease and not to acquire mining lease or to get rid of a defect in title and same did not create any capital asset, deduction was allowable under section 37, same being revenue expenditure
Section 37(1) of the Income-tax Act, 1961 [Corresponding to
section 10(2)(xv) of the Indian Income-tax Act, 1922] - In year 2006, certain
lands were leased out to assessee for purpose of mining iron ore by Department
of Mines and Geology. Assessee was working on said lease as a lessee of State
Government. Grant of lease to assessee was challenged in writ petitions filed
before instant court by two parties. Assessee contended that he incurred
expenditure towards legal fee and other allied expenditure in order to defend
and sustain his mining rights in respect of contentious lease. Assessing
Officer not being satisfied with assessee’s contention, held that expenditure
had to be construed to be capital expenditure, as it was an expenditure having
nexus to earning of profits in business. Accordingly, he disallowed assessee’s
claim. Since expenditure was incurred by assessee towards legal fee and other
litigation charges to protect his business interests in relation to mining lease
and not to acquire mining lease or to get rid of a defect in title and same did
not create any capital asset, deduction was allowable within meaning of section
37(1), same being revenue expenditure. [In favour of assessee] (Related Assessment
years : 2008-09 and 2009-10) – [DCIT, Bellary v. B. Kumara Gowda
(2017) 396 ITR 386 : 249 Taxman 377 : 83
taxmann.com 370 (Karn.)]
Legal fee paid by assessee to protect and maintain its right in a registered software was eligible for deduction under section 37(1)
During relevant year, assessee paid legal fee to Hammonds,
UK, to protect and maintain its right in a registered software. Assessing
Officer rejected assessee’s claim for deduction of said fee on ground that
legal fee was exorbitant and far in excess to compensation received from
entity, which had infringed its rights in registered software. Tribunal,
however, allowed assessee’s claim. Since registered software was a property of
assessee-company which could earn revenue for assessee from time-to-time as and
when it licenced its use by third parties, expenditure incurred to protect its
right in said software was to be allowed as deduction notwithstanding fact that
legal fee paid was more than compensation received by assessee. [In favour of
assessee] (Related Assessment year : 2005-06) – [PCIT v. Managed Information
Services (P) Ltd. (2017) 246 Taxman 409 : 80 taxmann.com 65 (Mad.)]
Legal charges incurred for defending criminal proceedings which has get nothing to do with Assessee profession is of personal nature and such expenditure cannot be allowed against income from business and Profession
Assessee, a film actor was implicated in some
criminal proceedings. He incurred legal expenses and claimed deduction of same
from his business income. Assessing Officer denied deduction treating said
expenses to be personal in nature. On appeal, the Commissioner (Appeals)
allowed the assessee's claim. On revenue’s appeal :
Held : It was found that the expenditure on legal charges were incurred for making the payments to eminent criminal lawyers for de- fending the assessee from criminal proceedings. However, no evidence was filed before the Assessing Officer or even Commissioner (Appeals) to show that criminal complaint arose out of the film shooting. The assessee simply gave evasive reply when confronted with the question that whether criminal proceedings arose out of any incident during the shooting of film. The criminal proceedings are always filed against individual. This has got nothing to do with assessee’s profession. Therefore, the expenditure was purely of the personal nature and such expenditure could not be allowed against the income from business and profession. Therefore, the order of the Commissioner (Appeals) in this respect was to be set aside and the order of the Assessing Officer was to be restored. (Related Assessment : years 2003-04 and 2004-05) – [DCIT v. Salman Khan (2011) 137 TTJ 15 : 130 ITD 81 : 9 Taxmann.com 74 (ITAT Mumbai)]
Deductibility of legal
expenses will depend on nature and purpose of legal proceeding in relation to
business whose profits are under computation and cannot be affected by final
outcome of that proceeding
Expense incurred in
defending criminal proceedings are generally regarded as personal
expenses. However, deductibility of such
expenses will depend on nature and purpose of legal proceeding in relation to
business whose profits are under computation and cannot be affected by final
outcome of that proceeding. Assessee made payment to an advocate for
representing assessee against order passed by Directorate of Enforcement, for
alleging that assessee had made contraventions of provisions of section
9(1)(c). Assessee’s claim for deduction in respect of said expenses was
disallowed by authorities below.
The principles that can be culled out from the various decided cases are that generally expenses incurred in defending criminal proceedings are regarded as personal expenses. The deductibility of such expenses will depend on the nature and purpose of the legal proceeding in relation to the business whose profits are under computation and cannot be affected by the final outcome of that proceeding.
In view of the legal principles above, the Assessing Officer was to be directed to verify the purpose for which these expenses were incurred and in case the expenses were in the nature relating to the business of the assessee then the expenses are allowable under section 37(1). After examining the nature of the charges and result of the appeal proceedings, if any, the Assessing Officer was free to consider the amount whether the same was incurred wholly and exclusively for the purpose of assessee’s business. The expenses could not be allowed as deduction if it was not incurred wholly and exclusively for the purpose of the business of the assessee. Since the facts were required to be verified this issue was also restored to the file of the Assessing Officer to examine the nature of the complaint, the appellate orders and pending proceedings, if any, and to arrive at a decision accordingly. This issue was to be restored to the file of the Assessing Officer directed to verify purpose for which these expenses were incurred and in case expenses were in nature relating to business of assessee then expenses were allowable under section 37(1). (Related Assessment years : 2004-05 and 2005-06) - [Vivek P Talwar v. ACIT(C) (2010) 8 Taxmann.com 268 (ITAT Mumbai)]
Assessee’s claim for litigation expenses incurred in connection with a suit instituted against a person for ejectment/possession and recovery of charges for use and occupation, being trespassers of building, as tenancy stood terminated, was disallowed by Assessing Officer on ground that expenses were not allowable under head ‘Income from house property’- Commissioner (Appeals) allowed such expenses at 6 per cent of Annual Letting Value under section 24 - Said expenditure was incurred to protect business interest of assessee and not for purpose of creating, curing or completing assessee’s title as regards property in question, and was, therefore, allowable as deduction under section 37(1)
Admittedly, the assessee had incurred a sum of Rs.
61,329 as litigation/legal expenses. However, the Assessing Officer had not
properly appreciated the position of law. In the instant case, the assessee had
incurred the expenses for securing its ‘title’ as regards the said property,
which was a capital asset of the assessee-firm. The Assessing Officer had also
not appreciated the fact that the said legal expenses were incurred by the
assessee-firm for protecting the assessee’s title as regards the said capital
asset and had not been incurred for the purpose of creating, curing or completing
the assessee’s title as regards the said capital asset and, accordingly, the
assessee was entitled to claim the expenses. Both the authorities below had not
denied the fact that the expenses in question were incurred to protect the
business interest of the assessee and, therefore, it could be safely held that
the expenses were definitely of the revenue nature. Furthermore, there was no
material on record to controvert the above contentions of the assessee.
Accordingly, it was to be held that in view of the decision of the Supreme
Court in Dalmia Jain & Co. Ltd. v. CIT (1971) 81 ITR 753, the assessee was
entitled to claim the entire litigation expenses. The Commissioner (Appeals)
was not justified in presuming that only 6 per cent of the A.L.V. (annual
letting value) was allowable to the assessee on account of collection charges
because the assessee never claimed at any stage that the expenses incurred by
it were related to the collection charges. On the other hand, it was the claim
of the assessee that the expenses were incurred to protect its interest in the
disputed business property. Accordingly, the claim of the assessee had to be
allowed. (Related Assessment year : 1985-86) - [Prince Rubber & Plastics v. DCIT (2003) 131 Taxman 130 (ITAT
Amritsar)]
Legal expenses for
protecting source of income or/and protection of assets have to be deductible. – [State
of Tamil Nadu v. C. H. Simpson (1992) 197 ITR 237 (Mad.)]
Expenditure incurred by the
assessee in its litigation with the Company Law Board was an expenditure
incurred wholly and exclusively for the purposes of the business of the
assessee-company
Assessee-company appointed its
former managing agents as special officers with almost same powers and same
remuneration payable to them in their capacity as managing agents. However,
assessee had to incur certain expenditure in litigation with Company Law Board
with regard to aforesaid appointments. Assessee claimed deduction of Rs. 29,190
as business expenditure in respect of said litigation expenses. Tribunal
allowed assessee’s claim. In view of decision of this court in Rampur
Distillery and Chemical Co. Ltd. v. CIT (1983) 140 ITR 725 (All.), Tribunal
was justified in allowing assessee’s claim. [In favour of assessee] (Related
Assessment year : 1970-71) – [CIT v. Rampur Distillery & Chemical Co. Ltd. (1991) 190
ITR 327 (All.)]
For defending structure and conduct of business, legal expenses must be allowable
Two shareholders of
assessee-company filed suit questioning validity of two special resolutions
passed in an extraordinary general meeting adopting new articles of association
and appointing managing agents - Assessee claimed deduction of litigation
expenses on defending said suit -
Whether said legal expenses were deductible as revenue expenditure.
The Tribunal, finding that the impugned expenditure had been incurred by the assessee wholly and exclusively in respect of its business was not vitiated in any way. The position in law is now well settled that the expenditure which is incurred in resisting an attack on the structure and assets of a company is always an allowable deduction. In the present case the attack was on the validity of the two resolutions which had been passed by the company in its extraordinary general meeting. In defending the validity of the said resolutions, the company was really resisting an attack on its structure and on the conduct of its business which had gone on since 20.10.1947. It could not be contended that the assessee-company incurred the expenses in question in any non-trading capacity. Accordingly, the said expenditure was incurred wholly and exclusively for the business of the company as envisaged in Section 10(2)(xv) of the Indian Income-tax Act, 1922 [corresponding to section 37(1) of the Income-tax Act, 1961]. Further, the impugned expenses could not be treated as of capital nature and disallowed on that ground. In defending the suit questioning the validity of the said two resolutions, the company was not seeking to bring into existence any capital asset. It was a situation which could be said to be analogous to a serious attack on the company’s title or on its business. It was not an expenditure which was incurred to cure any imperfection in the title or to acquire any new advantage or new assets. In this view of the matter, the impugned expenditure was a permissible deduction. - [CIT v. Muir Mills Co. Ltd. (1984) 148 ITR 418 : (1985) 20 Taxman 132 (All.)]
Legal expenses incurred by the assessee to protect the source of his income or the title to his business or to preserve or maintain his business assets to be regarded as expenditure incurred wholly and exclusively for the purpose of his business and, therefore, allowable as deduction for the purpose of computing the profits for income-tax purpose. – [CIT v. O. P. N. Arunachala Nadar (1983) 141 ITR 620 : 13 Taxman 39 (Mad.)]
Assessee company claimed legal expenses for defending two suits, one filed by its shareholders against its then managing agents and directors for frittering away company’s funds by unwise investments/making commitments for benefit of unsound concerns, and the other filed by another company against its then managing agents and chairman for alleged breach of contract and mismanagement of company’s funds impleading assessee as defendant - It could be said these suits were launched against assessee because of its business activity and, therefore, assessee was entitled to deduction of expenditure incurred on these suits
The assessee-company, in the assessment for the assessment
years 1968-69 and 1969-70, claimed deduction of legal expenses incurred by it
in defending two suits in which the assessee was impleaded as defendent. One of
the suits was filed by two of its shareholders against the then managing agents
and directors alleging that the funds or assets of the company were being
frittered away and dissipated by unwise investments or by making commitments
for the benefit of unsound concerns. The other suit was filed by another
company against the then managing agents and chairman in which the allegations
primarily related to alleged breach of contract in respect of sale of the
managing agents' holdings in the assessee-company and mismanagement of the
funds of the company. The ITO disallowed the assessee’s claim for deduction of
impugned legal expenses. On appeal, the AAC upheld the ITO’s orders. On further
appeal, the Tribunal noted that the first suit was primarily against the
assessee and the other dependents were not basically interested in the
subject-matter of the suit. Hence, it held that the entire expenses were for
the purpose of the assessee’s business. Regarding the second suit also, it held
that it was launched against the assessee-company because of its business activity,
and hence the litigation expenses were allowable as business expenditure. On
reference :
Held : In the instant case, the first suit was primarily concerned with the wise or unwise investments and making commitments for the benefit of unsound concerns. These were the questions which were intrinsically connected with the carrying on of the business of the assessee-company. The second suit was concerned with the question of mismanagement of the funds of the company, that is to say, the question as to how the funds of the company were to be applied. The primary object of the assessee was the carrying on of its business and the litigation affected the carrying on of the business. In view of the nature of the suits, the Tribunal was right in coming to the conclusion that the expenses incurred on these suits were allowable expenses. [In favour of the assessee] – [CIT v. Indo-Burmah Petroleum Co. Ltd. (1983) 142 ITR 141 : (1982) 31 CTR 165 : 11 Taxman 13 (Cal.)]
Litigation expenses incurred for evicting tenant to utilise premises for expanding business was allowable deduction
The ITO disallowed the assessee’s claim of Rs. 440 as
litigation expenses incurred for evicting a tenant by observing that on being
successful it would get a benefit of enduring nature. The ITO stated that the
litigation expenses for evicting a tenant in possession of a shop belonging to
the assessee could not be said to have been incurred solely and wholly for the
purposes of carrying on the assessee’s business. On the contrary, the
assessee’s case has been that the extra space shall further enhance its
business. It was held that the expense incurred for expected increase in
business would come within the ambit of section 37 and should have been
allowed. The addition of Rs. 440 is vacated. – [Barnala Silk Store v. ITO (1982) 11 Taxman 22 (ITAT
Calcutta)]
Assessee-company instituted a suit for ejectment of a sub-tenant and on settlement, sub-tenant surrendered and vacated a portion of its sub-tenancy – Assessee claimed suit expenses as deduction from rental income – ITO held that expense were capital in nature as same were incurred for obtaining possession of a portion of its office premises i.e. a capital asset – On appeal before Tribunal, assessee contended that as a result of said suit sub tenant not only vacated a portion of its sub-tenancy but also increased rent of portion still occupied by it – It was, thus, Contended that said litigation expenses were incurred wholly and exclusively for increasing assessee’s rental income and were an allowable deduction – Tribunal held that expenditure in question was allowable expenditure under head ‘Income from other sources’ - Since ejectment suit had ultimately led to a substantial increase of rental income of assessee, Tribunal’s conclusion that expenses were allowable as deduction under section 57(iii), could not be said to be perverse
The assessee-company carrying on business of share-dealings,
had income by way of commission from managing agency and from sub-letting a
portion of its office premises. It had sub-let two portions of its office
premises to two companies. The assessee filed a suit for ejectment of its
sub-tenant. The said suit was ultimately settled and the sub-tenant surrendered
and vacate a portion of its sub-tenancy. The assessee's claim for deduction of
the suit expenses was rejected on the ground that it was capital in nature as
the assessee incurred the same for obtaining possession of a capital asset and
not for the purpose of earning any rental income. On appeal before the
Tribunal, the assessee contended that as a result of said suit sub tenant not
only vacated a portion of its sub tenancy but also increased the rent of the
portion still occupied by it. It was, therefore, contended that said
litigationexpenses were incurred wholly and exclusively for increasing the
rental income of the assessee and was an allowable deduction. The Tribunal held
that the expenditure in question was an allowable expenditure under the head ‘Income
from other sources’. On reference:
Held : On the relevant facts before it the Tribunal had held that the said expenses were incurred wholly and exclusively for making or earning rental income. The said ejectment suit had ultimately led to a substantial increase of the rental income of the assessee. The only contention of the revenue before the Tribunal was that the said expenses were not directly related to the earning of the rental income but were at the most incidental thereto. The conclusion of the Tribunal on the facts before it that the said expenses were allowable as deduction under section 57(iii), therefore, could not be said to be perverse. [In favour of the assessee] (Related Assessment year : 1965-66) – [CIT v. East India Development Co. (P) Ltd. (1979) 120 ITR 655 (Cal.)]
Assessee was carrying on business of growing and manufacturing tea - It purchased a tea estate at auction and deposited bid money by taking loan from a bank - However, sale was ultimately set aside at instance of original owners of tea estate and deposited amount was refunded to assessee - Tribunal found that transaction entered into by assessee in purchasing tea estate was made in execution or rather in expansion of its tea business and that there was one unit of management and control and business of assessee could not be said to be separate from business that assessee sought to enter into by purchasing said tea estate - Amount of interest paid on loan and traveling and litigation expenses incurred for acquiring said tea estate were allowable as revenue expenditure even though transaction did not ultimately materialise
The
assessee-company was carrying on business of growing and manufacturing tea. It
purchased a tea garden at an auction sale and it was required to deposit 25 per
cent of the bid money immediately on the close of the bid. The assessee took a
loan from the Bank against its fixed deposits and deposited the amount with the
Court. However, the auction sale was challenged by the original owners of the
tea estate and the sale was ultimately set aside. The amount paid by the
assessee was accordingly refunded. But the assessee had paid certain sum as
interest on the loan. The assessee had also incurred
traveling expenses and litigation expenses in connection
with the transaction of purchase. The amount of interest and
these expenses were held to be capital expenditure and the ITO
disallowed them in computation of assessee’s total income. On appeal, the AAC
held the amounts to be allowable expenditure. The Revenue's appeal to the Tribunal
was dismissed. On reference :
The Tribunal
had found that though, ultimately, the sale was set aside at the instance of
the owners of the tea estate, the transaction entered into by the assessee was
made in execution or rather in expansion of its tea business and that there was
one unit of management and control and the business of the assessee could not
be said to be separate from the business that the assessee sought to enter into
by purchasing the said tea estate. That being so, the interest on the loan that
was taken for purchasing the tea estate and travelling and litigation
expenses connected therewith must be held to be a revenue expenditure.
Therefore the Tribunal was justified in allowing the interest payment, the
court expenses and the travelling expenses incurred for
acquiring the tea estate even though the transaction did not materialise. [In
favour of the assessee] (Related Assessment year :
1969-70) – [CIT v. Abhoyjan Tea Estate (P) Ltd.
(1977) 110 ITR 251 (Gauh.)]
Where Registrar of
Companies was satisfied that affairs of assessee-company were mismanaged and,
therefore, submitted a report to Government for investigating its affairs,
legal expenses incurred in resisting appointment of a Government Inspector
could not be regarded as expenses incurred for preserving its fair name and,
hence, it was not a permissible deduction under section 10(2)(xv) of 1922 Act
Section 37(1) of the
Income-tax Act, 1961 (corresponding to section 10(2)(xv) of the Indian
Income-tax Act, 1922) - It is well settled that so far as expenses incurred in
civil litigations are concerned the general tests are whether the legal
expenses were incurred by the assessee in his character as a trader and the
liability fell on him as a trader and whether the transaction in respect of
which the proceedings are taken arose out of and was incidental to the
assessee's business or profession.
As regards, the sum
claimed as deduction for the legal expenses incurred in resisting the
appointing of a Government inspector in report on the affairs of the
assessee-company. It is clear that having regard to the provisions of the
Companies Act, 1956 the Registrar of Companies was satisfied that the affairs
of the assessee were mismanaged and, therefore, submitted a report to the
Government for investigating the affairs of the assessee-company. It was
pursuant to this report that an investigator was appointed for investigating
its affairs. Actually if the idea of the assessee was to preserve its fair
name, then naturally it ought to have satisfied the investigator that its
affairs were clean and tidy and no case existed for making an adverse report as
regards the affairs of the company. Instead of adopting such a course the
assessee started proceedings so as to prevent investigation of its affairs.
Such proceedings could not be regarded as proceedings instituted for preserving
the fair name of the assessee-company. On the contrary, the main underlying
object of such proceeding was to save the skin of the persons who might have
been guilty of acts of mismanagement of the affairs of the company. The
expenses incurred for such litigation could not, therefore, be regarded as
permissible deduction under section 10(2)(xv) of the 1922 Act. [In favour of
revenue] - [Harinagar Sugar Mills
Ltd. v. CIT (1979) 117 ITR 945 (Bom.)]
I One of partners’ of assessee-firm, carrying on business of
import and export of iron and steel, was prosecuted for contravening provisions
of Foreign Exchange Regulation Act, 1947 but was subsequently acquitted -
Assessee-firm claimed amount spent in defending its partner as business
expenditure - Litigation expenditure in question was not wholly and exclusively
for purpose of business of assessee-firm and fact that acquittal of partner was
important for reputation of assessee-firm would not make said expenditure a
permissible allowance under section 10(2)(xv) of 1922 Act
Section 37(1) of the Income-tax Act, 1961 (Corresponding to
section 10(2)(xv) of the Indian Income-tax Act, 1922) - An accused
charged with an offence under section 4(3), read with section 23 of the Foreign
Exchange Regulation Act, can be sentenced to undergo imprisonment which may
extend to two years. The nature of charge in the criminal case against the
partner was of a contravention alleged to have been personally committed by him
and the object of spending money on his defence in that case was to save him
from being sent to jail. It could not consequently, be said that the
expenditure of Rs. 6,000 was wholly and exclusively for the purpose of the
business of the assessee-firm. The fact that his acquittal was important for
the reputation of the assessee-firm would not detract from the above
conclusion. Therefore, the expenditure of Rs. 6,000 was not a permissible allowance
under section 10(2)(xv ). [In favour of the revenue] (Related Assessment year : 1958-59) – [CIT v. Chaman Lal and Bros (1970) 77 ITR 383 (Del.)]
The highest court of the
land held that it could make no difference whether the proceedings were civil
or criminal. All that the Court had to see was whether legal
expenses were incurred by
assessee in his character as trader, i.e., whether
transaction, in respect of which proceedings were taken, arose out of and was
incidental to business? Further, whether expenditure was bona fide and
incurred wholly and exclusively for business ? - [CIT v. Dhanrajgirji Raja
Narasingiriji AIR 1974 SC 1366 (1973) 91 ITR 544 : (1974) 3 SCC 520
(SC)]
Where on account of
disputes amongst partners of assessee’s managing agency firms, inter se
litigation was initiated by one partner against other and assessee-company was
made a party to such litigation, assessee could not claim deduction under
section 10(2)(xv) of 1922 Act in respect of expenses incurred in such litigation
- Where one of partners of managing agency firm was appointed as Controller of
assessee-company by Central Government which was challenged by another partner
by a writ petition, expenses incurred by assessee-company in defending said
appointment could not be claimed as deduction under section 10(2)(xv) of 1922
Act even if assessee had been arrayed as petitioner in that writ petition
Section 37(1) of the
Income-tax Act, 1961 [Corresponding to section 10(2)(xv) of the Indian
Income-tax Act, 1922] - In the instant case, in regard to assessment year
1953-54, the Tribunal found inter alia, that the counsel for the two companies,
including the assessee company, was JS whereas KLM was the counsel for KNK and
RNK but law charges claimed and disallowed were mostly in respect of fees paid
to KLM and his juniors. Even if there was a mistake in the records and the fees
were really paid to the counsel for the assessee-company, the expenses were not
deductible as there was no material on which it could be held that the company
at any material time was faced with a situation which actually hampered the
carrying on of its business or even that there was any such serious apprehended
threat to the smooth working or management of the company's business as
necessitated the expenditure of any sum by way of litigation expenses to secure
the smooth working of the company and to prevent any hindrance or obstacle in
the way of the smooth management of the company's business. Moreover, the
finding recorded by the Tribunal on the basis of material on record was a
finding of fact. On this finding no question of law could really arise as to
whether the litigation expenses were covered by section 10(2)(xv) of 1922 Act.
Under the circumstances the assessee-company was rightly held not to be
entitled to any deduction under section 10(2)(xv) of the 1922 Act in the
assessment year 1953-54.
As regards expenses for
the assessment year 1954-55 incurred in connection with writ petition, there
was nothing to show that any expenditure had been incurred for the protection
of the assets of the company's business; much less, had it been shown that the
expenditure was laid out wholly and exclusively for the purpose of the business
of the company. In fact, as observed by the Tribunal, the litigations in
reality were litigations arising out of disputes between the partners of the
managing agency firms inter se. It was immaterial that the assessee-company had
also been arrayed as a petitioner in the writ petition or that the
assessee-company had incurred some expense in defending the appointment of KNK
as authorised controller so long as it was not shown that such expenditure was
necessary and had been incurred for the purpose of the company, that is, either
for the safeguard of the company’s business assets or preventing or removing
any hindrance or obstacle in the way of the smooth running of the company's
business. There was no material on record to show this fact. Further in the
writ petition before the Supreme Court the assessee-company being one of the
petitioners, it would be incongruous to say that expenses for opposing the
petition had to be provided by the company. There was nothing on the record to
show that the company had objected to its being made a co-petitioner with ONK
and had got itself transposed to the array of opposite parties. Nothing was
also shown, as mentioned in the order of the Income-tax Officer, to establish
that the company either in law or under the order by which KNK was appointed
authorised controller was bound to meet the expenses for defending his
appointment as authorised controller. Therefore, the expenditure could not be
claimed deduction under section 10(2) (XV) of 1922 Act. [In favour of revenue]
(Related Assessment years : 1953-54 and 1954-55) – [Ishwari Khetan Sugar Mills (P) Ltd. v. CIT (1972) 86 ITR 635 (All.)]
TO disallowed expenses incurred by assessee-company for
representing its case before Investigation Commission - Expenditure in
prosecuting a civil proceeding cannot be denied as a permissible deduction if
it is reasonably and honestly incurred to promote interest of business - To
preserve business from an investigation which, according to assessee, was
unlawful and from inroads of a piece of legislation which was unconstitutional
and was so held by Supreme Court later in decisions, assessee was justified in
taking proper steps and spending monies therefor - Therefore expenditure which
was incurred by assessee in opposing a coercive Governmental action with object
of saving taxation and safeguarding business was justified by commercial
expendiency and was, therefore, allowable under section 10(2)(xv) of 1922 Act
Section 37(1) of the
Income-tax Act, 1961 [Corresponding to section 10(2)(xv) of the Indian
Income-tax Act, 1922] - For the assessment years 1952-53 to 1954-55, the
assessee-company incurred expenses for representing its case before the
Investigation Commission relating to past assessment years and claimed as
deduction under section 10(2)(xv), or in the alternative, under section
10(1). The ITO disallowed the claim, and the disallowance was upheld by the
Tribunal. On reference, the High Court was of the view that the proceeding
before the Investigation Commission was not a civil proceeding; but it was a
statutory proceeding with a view to collecting of materials for more taxation;
therefore, if the proceeding touched the business of the assessee the
expenditure incurred by the assessee in safeguarding its interest before the
Commission would be an allowable deduction. It, therefore, held that the
expenditure incurred by the assessee in opposing an illegal and coercive
Government action with the object of saving taxation and safeguarding the
business was justified by commercial expediency and was an allowable
expenditure. On appeal to the Supreme Court :
Held : As a result of investigation into the affairs of the Birla group of concerns the case of the assessee was referred to the Commission while it was functioning for investigation. The assessee engaged eminent lawyers and incurred the expenses in question in conducting appropriate proceedings before the Commission as also in Courts where the vires of the aforesaid Investigation Commission Act were challenged. It is well-settled by now that the deductibility of expenditure incurred in prosecuting the civil proceedings to resist the enforcement of a measure, legislative or executive, which means restriction on the carrying on of a business or to obtain a declaration that the measure is invalid, would, if other conditions are satisfied, be admissible as a deduction under section 10(2)(xv). Deductibility of such expenditure does not depend on the final outcome of those proceedings. However wrong-headed, ill-advised, unduly optimistic or over-confident in his conviction the assessee might appear in the light of the ultimate decision, expenditure in prosecuting a civil proceeding cannot be denied as a permissible deduction if it is reasonably and honestly incurred to promote the interest of the business.
The essential
test which has to be applied is whether the expenses were incurred for the
preservation and protection of the assessee's business from any such process or
proceedings which might have resulted in the reduction of its income and
profits and whether the same were actually and honestly incurred. It was not
possible to understand how the expenditure on the proceedings in respect of the
Investigation Commission by the assessee would not fall within the above rule.
Even otherwise, the expenditure was incidental to the business and was
necessitated or justified by commercial expediency. The earning of profits and
the payment of taxes are not isolated and independent activities of a business.
These activities are continuous and take place from year to year during the
whole period for which the business continues. If the assessee takes any steps
for reducing its liability to tax which results in more funds being left for
the purpose of carrying on the business there is always a possibility of higher
profits.
The Commission
was holding an investigation on a suspected escapement of income to the tune of
about Rs. 4 crores. Taxes levied on that income and the penalties imposed would
naturally have been very heavy for the business of the assessee and might have
either crippled or annihilated it. To preserve the business from an
investigation which, according to the assessee, was unlawful the assessee was
justified in taking proper steps and spending monies therefor. Such an
expenditure was no doubt for earning profits but was aimed at preservation of
business from the inroads of a piece of legislation which, it was maintained,
was unconstitutional and was so held by the Supreme Court later in certain
decisions. The expenditure which was incurred by the assessee in opposing a
coercive governmental action with the object of saving taxation and
safeguarding business was justified by commercial expediency and was,
therefore, allowable under section 10(2)(xv) Thus, the approach of the High
Court and its ultimate decision were fully justified on principle and
authority. The appeals were accordingly dismissed. [In favour of assessee] (Related Assessment years : 1952-53
to 1954-55) – [CIT, West Bengal v. Birla Cotton Spinning & Weaving Mills Ltd. (1971) 82 ITR 166 (SC)]
Assessee took on lease from Government Murli Hills for
purpose of quarrying limestone for a period of one year - Thereupon Government
appointed assessee at its agent for working quarry with understanding that
Murali Hills would be ultimately leased out to it - Meanwhile, ‘K’ on basis of
leasehold rights granted to it initially filed a suit against Government for
specific performance in which assessee was also impleaded as one of defendants
- Suit was resisted by Government as well as assessee - Litigation expenses incurred
by assessee on aforesaid suit were allowable under section 10(2)(xv) of 1961
Act
Section 37(1) of the Income-tax Act, 1961 [Corresponding to
section 10(2)(xv) of the Indian Income-tax Act, 1922] - The
assessee-company took on lease from the Govt. the Murli Hills for the purpose
of quarrying limestone for a period of one year. Thereafter, the Govt.
appointed the assessee as its agent for working in the quarry with an
understanding that the Murli Hills would be leased out to the assessee if the
Govt. succeeded in the litigation against one ‘K’. ‘K’ on the basis of lease
hold rights granted to it initially by the Govt., filed a suit against the
Government and impleaded the assessee also as one of the defendants, and sought
specific performance. Ultimately, the suit was decreed for damages and the assessee
was also made liable for damages.
For the assessment year 1951-52, the ITO held that
the litigation expenses were incurred for acquiring a new asset. Thus, said
expenses being capital in nature, could not be allowed as deduction. The
Tribunal, however, took the view that the expenditure was incurred to protect
the assessee's business. It, accordingly, allowed the assessee’s claim. On
reference, the High Court restored the ITO’s orders. On appeal to the Supreme
Court :
The Hon’ble Supreme Court has held as under :
“Where litigation expenses are incurred by the assessee for
the purpose of creating, curing or completing the assessees title to the
capital, then the expenses incurred must be considered as capital expenditure.
But if the litigation expenses are incurred to protect the business of the
assessee, they must be considered as a revenue expenditure.”
From the facts, the only reasonable inference that could be
drawn was that the assessee resisted the suit in order to protect its business
and not with a view to safeguard its prospects of getting a new lease. At any
rate, the view taken by the Tribunal on the facts before it that the assessee
incurred the expenditure in question to protect its business interest could not
be considered as an unreasonable view. In the instant case, the assessee did
not initiate the proceedings. It merely defended the claim made against it. The
claim was made against it because it was working the Murli Hills though as an
agent of the Government. Therefore, the civil proceedings were launched against
it because of one of its business activities. Under those circumstances, the
High Court was not right in holding that the expenditure in question was not a
revenue expenditure. [In favour of the assessee] (Related Assessment year :
1951-52) – [Dalmia Jain & Co. Ltd. v. CIT
(1971) 81 ITR 754 (SC)]
Expenditure
incurred to resist in a civil proceeding the enforcement of a legislative or
executive, measure which imposes restrictions on the carrying on of a business,
or to obtain a declaration that the measure is invalid would, if other
conditions are satisfied, be admissible, under section 37(1) as a permissible
deduction in the computation of taxable income.
Section 37(1) of the Income-tax Act, 1961 [Corresponding to section 10(2)(xv) of the Indian Income-tax Act, 1922] - Assessee-company was engaged in business of cotton spinning and weaving - It was distributing a part of yarn produced to weavers outside factory to weave said yarn into cloth - Provincial Textile Commissioner issued an order directing assessee-company to deliver yarn to certain notified categories of persons only - Against said order, assessee-company filed writ petition in High Court and got certain relief - Amount spent by assessee in aforesaid litigation was claimed as business expenditure - On facts, litigation expenses incurred by assessee-company were deductible under section 10(2)(xv) of 1922 Act
The assessee-company was engaged in the business of cotton spinning
and weaving. In the premises of the factory of the company there were installed
80 handlooms. These handlooms were found inadequate to weave the yarn produced
by the factory and a part of the yarn produced was distributed to weavers
outside the factory who were engaged by the company to weave the yarn into
cloth. Under clause 18B of the Cotton Cloth and Yarn (Control) Order, 1945,
issued by the Government of India, the Textile Commissioner was authorised to
direct any manufacturer or dealer or any class of manufacturers or dealers,
inter alia, not to sell or deliver any yarn or cloth of specified description
except to such person or persons and subject to such conditions as the Textile
Commissioner might specify. On 07.02.1946, the Textile Commissioner issued an
order directing the company not to sell or deliver any yarn manufactured by the
company except to such person or persons as the Textile Commissioner might
specify. The company continued notwithstanding the prohibition to deliver yarn
to weavers and did so till 20.02.1946. This yarn was seized under the orders of
the Textile Commissioner. On 20.02.1946, the Provincial Textile Commissioner
issued an order directing assessee-company to deliver yarn to certain notified
categories of persons only. The assessee filed a writ in the High Court and got
relief. The amount spent by the assessee in the litigation was claimed as
business expenditure for the assessment years 1949-50 and 1950-51. The claims
were rejected by the departmental authorities and by the Tribunal. On
reference, the High Court also answered the question in favour of the revenue. On
appeal to the Supreme Court :
Held : Under section 10(2)(xv) of 1922 Act as amended, the expenditure
even though not directly related to the earning of income may still be
admissible as a deduction. Expenditure on civil litigation commenced or carried
on by an assessee for protecting the business is admissible as expenditure
under section 10(2)(xv) of 1922 Act provided other conditions are fulfilled,
even though the expenditure does not directly relate to the earning of income.
Expenditure incurred not with a view to the direct and immediate benefit for
purposes of commercial expediency and in order indirectly to facilitate the
carrying on of the business is, therefore, expenditure laid out wholly and
exclusively for the purposes of the trade.
The object of the petition filed by the assessee was to
secure a declaration that the order dated 20-2-1946, in so far as it sought to
put restrictions upon the right of the company to carry on its business in the
manner in which it was accustomed to do was unauthorised and to prevent
enforcement of that order; thereby the company was seeking to obtain an order
from the Court enabling the business to be carried on without interference.
Expenditure incurred in that behalf would without doubt be expenditure laid out
wholly and exclusively for the purpose of the business of the company.
It was unfortunate that the High Court took the facts not
from the statement of the case, but apparently from the judgment of the
Judicial Committee. The High Court assumed that the company had contravened the
law because it delivered yarn to weavers in contravention of the order, dated
20.02.1946. But the assumption on which the discussion was founded was
erroneous.
The High Court also thought that expenditure to fall within
the terms of section 10(2)(xv) of 1922 Act must be one for the purpose of
earning income, and there was no material on the record to show that the
expenditure was so incurred. If it was intended thereby to imply that the
primary motive in incurring the expenditure admissible to deduction under
section 10(2)(xv) of 1922 Act must be directly to earn income thereby, the
Court with respect unable to agree with that view.
Expenditure incurred to resist in a civil proceedings the
enforcement of a measure-legislative or executive-which imposes restrictions on
the carrying on of a business, or to obtain a declaration that the measure is
invalid would, if other conditions are satisfied, be admissible, under section
10(2)(xv) of 1922 Act as a permissible deduction in the computation of taxable
income. The appeals were to be allowed accordingly. [In favour of the assessee]
(Related Assessment years : 1949-50 and 1950-51) -
[Sree
Meenakshi Mills Ltd. v. CIT (1967) 63 ITR 207 (SC)]
A foreign concern filed a suit against assessee alleging repudiation of contract by assessee in relation to supply of moulds – Court allowed suit of foreign concern and awarded damages of certain sum along with costs – Litigation expenses incurred by assessee in that suit was claimed as revenue expenditure allowable under section 10(2)(xv) of 1922 Act – Since litigation arose in course of proceedings for acquisition of capital asset, these litigation expenses were not expenditure allowable under section 10(2)(xv) of 1922 Act
Section 37(1) of the
Income-tax Act, 1961 [Corresponding to section 10(2)(xv) of the Indian
Income-tax Act, 1922] - In this case, it is
clearly stated in the statement of the case that the transaction between the
United Kindgom company and the assessee related to purchase of moulds which
were being acquired in the nature of capital assets. It is to be noted that the
litigation occurred while the process of acquiring those moulds was still going
on. There had been correspondence between the parties and, according to the
United Kingdom company, some moulds were supplied to the assessee and the
assessee wrongly refused to accept those moulds and committed breach of contract.
Ultimately, the matter was settled by a compromise under which the assessee did
acquire moulds of the value of £ 6,000 and that was the capital asset finally
acquired by the assessee. In these circumstances, it is clear that all the
litigation expenses that were incurred by the assessee were incurred in the
course of the acquisition of these moulds as capital assets. The expenditure
was not incurred after the acquisition of those moulds as capital assets and
was not for the protection of capital assets which might have already been
acquired by the assessee-company. The expenditure having been incurred in the
course of acquisition of capital assets it must be held to be expenditure of a
capital nature. The cases that have been brought to our notice by the learned
counsel for the assessee only deal with the aspect where litigation expenses
have been incurred for protection of capital assets which already existed in
the hands of the assessee or had already been acquired by the assessee. In
those, it has been held that litigation expenses incurred for the protection of
capital assets were a legitimate charge as revenue expenditure. The facts of
the case before us are quite different. Here no capital assets had been
acquired when these litigation expenses were incurred. The litigation arose in
the course of the proceedings for acquisition of the capital assets. In these
circumstances we have no hesitation in holding that these litigation expenses
were not expenditure “allowable” under section 10(2)(xv) of the Income-tax Act,
being expenses of a capital nature. [In favour of revenue] – [Plastic Products
Ltd. v. CIT (1966) 62 ITR 209 (All.)]
Section 37(1) of the Income-tax Act, 1961 (Corresponding to
section 10(2)(xv) of the Indian Income-tax Act, 1922) - The assessee was a
partner of a firm. He filed a suit against certain partners of the firm for
rendition of accounts. The question was whether the amount of on spent on
litigation was an expenditure laid out or expended wholly and exclusively for
the purpose of the business. The Tribunal held that the expenditure was not
incurred for the purposes of the activities of the business but to enforce a
right against a partner which, according to the Tribunal, was quite a different
thing and was, therefore, not allowable as an admissible business expenditure. On
reference :
Held : On the finding recorded by the Tribunal that the
amount was not laid out or expended wholly and exclusively for the purposes of
the business, it could not come under the provisions of section 10(2)(xv) of
the 1922 Act. Thus, the litigation expenses did not represent admissible
business expenditure. (Related Assessment year : 1945-46) –
[Raghunath
Prasad v. CIT (1955) 28 ITR 45 (All.)]
Assessee carrying on business as selling agents of certain
company, was prosecuted under Hoarding and Profiteering Cordinance, 1943, on
charge of selling goods at prices higher than that were reasonable in
contravention of provisions of section 6 thereof - Assessee defended case and
incurred certain expenditure - He claimed deduction in respect of said
expenditure under section 10(2)(xv) of 1922 Act - Amount spent in defending
criminal proceeding was not expenditure laid out or expended wholly and exclusively
for purpose of business as contemplated by section 10(2)(xv) of 1922 Act, therefore,
assessee’s claim was to be disallowed
Section 37(1) of the
Income-tax Act, 1961 [Corresponding to section 10(2)(xv) of the Indian
Income-tax Act, 1922] - The finding of
the Tribunal was vitiated by its refusal to consider the possibility of the
criminal proceeding terminating in the conviction and imprisonment of the
assessee. The assessee was prosecuted under section 13 of 1943 ordinance and
was charged with contravention of section 6, which by sub-section (1) prohibits
the sale by a dealer or producer of an article for a consideration which is
unreasonable and sub section (2) defines “unreasonable consideration”. The
framers of the Ordinance thus appeared to have regarded the offence as one
calling for a deterrent punishment in view of its anti-social character, and it
is idle to suggest that it is for the income-tax authorities to prove in such
cases that the conviction might result in a sentence of imprisonment and that,
in the absence of such proof, there was, at the most, only a chance of
conviction and fine. If, in every criminal prosecution where the matter is
defended to protect the good name of a business or a professional man, the fear
of possible fine or imprisonment must always be there, it must ordinarily be
difficult for any Court to say, that the expenses incurred for the defence,
even if they are not to be regarded as the "personal expenses" of the
person accused, constituted “expenditure laid out or expended wholly and
exclusively for the purposes of the business”.
The deductibility of such expenses under section
10(2)(xv) of 1922 Act must depend on the nature and purpose of the legal
proceeding in relation to the business whose profits are under computation, and
cannot be affected by the final outcome of the proceeding. Income-tax
assessments have to be made for ever year and cannot be held up until the final
result of a legal proceeding, which may pass through several Courts, is
announced.
It was, therefore, held that the Tribunal was not
right in holding that the sum spent in defending the criminal proceeding was an
expenditure laid out or expended wholly and exclusively for the purpose of
business as contemplated by section 10(2)(xv) of 1922 Act. [In favour of the
revenue] (Related Assessment year : 1945-46) – [CIT v. H. Hirjee (1953) 23
ITR 427 (SC)]
Assessee was
money-lender – It took mortgages from a person who was subsequently adjudged
insolvent – On a suit filed by receiver, Court held mortgages to be void – It
further held that mortgages were taken with object of preserving a portion of
property for assessee’s relation – Assessee claimed that litigation expenses
incurred in aforesaid proceeding be allowed as deduction under section
10(2)(xv) of 1922 Act – On facts, it could be concluded that litigation
expenses were not expended wholly and exclusively for purpose of assessee’s
business under section 10(2)(xv) of 1922 Act, therefore, assessee’s claim was
to be rejected
Section 37(1) of the
Income-tax Act, 1961 [Corresponding to section 10(2)(xv) of the Indian
Income-tax Act, 1922] – The assessee was a money-lender. He took from one ‘U’
four mortgages of the aggregate value of Rs. 1 lakh. Three of these mortgages
were for Rs. 20,000 each and the fourth one was for Rs. 40,000. On an
application by a creditor, ‘U’ was adjudged an insolvent. The receiver appointed
by the Court filed a suit under sections 53 and 54 of the Provincial Insolvency
Act for annulment of the four mortgages on various grounds. The Court
ultimately held that the four mortgages were void. The Court further held that
the intention was that since ‘U’ was going to be ruined, as much of his
property as could be saved might be saved for his cousin. The Court further
came to the conclusion that only Rs. 15,000 was the money out of Rs. 1,00,000
which had come out of the stock-in-trade of the assessee, while Rs. 16,000 was
not a money-lending advance but was a deposit with the insolvent debtor for
meeting the expenses of marriage of a female relation of the assessee. The
assessee had spent a sum of Rs. 9,070 in defending his title on the basis of these
four mortgages in the suit brought against him by the receiver. He claimed this
amount as an admissible deduction under section 10(2)(xv) of 1922 Act. The ITO
rejected the assessee's claim. On appeals, the AAC and, the Tribunal upheld the
ITO’s order. On reference :
The
assessee entered into four mortgage transactions not in the course of his
money-lending business but with the object of preserving a portion of the
property for his relation and on that finding of fact it could not be held that
the expenditure was wholly and exclusively for the purposes of the business of
the assessee. It could not be said that the assessee got these mortgages
executed in his favour in the course of his money-lending business and that
they were not foreign to that business. The expenditure incurred to be an
admissible deduction under section 10(2)(xv) of 1922 Act, must be an
expenditure wholly and exclusively for the purpose of such business. It could
not be said that the sum in question was spent wholly and exclusively for the
purpose of such business, nor did the assessee claim any right of
apportionment. In such circumstances, the assessee’s claim was to be
disallowed. [In favour of revenue] (Related Assessment year : 1942-43) – [Seth
Kaluram Kankaria, In re (1947) 15 ITR 209 (All.)]
For purpose of his
business, assessee purchased a building which was used as godown for storage of
goods – A suit for pre-emption of this property was filed against assessee who
had to spend certain amount in defending that suit – Litigation expenses
incurred by assesse did not result in acquisition, improvement or alternation
of capital asset, and, therefore, expenditure incurred by assessee was not
capital expenditure but allowable revenue expenditure under section 10(2)(xii)
of 1922 Act
Section 37(1) of the
Income-tax Act, 1961 [Corresponding to section 10(2) of the Indian Income-tax
Act, 1922 – The assessee was plumber and a dealer in cement and sanitary goods
and fittings. For purpose of his business he purchased a building which was
used as a godown for the storage of his goods. Thereafter, a suit for
pre-emption of this property was instituted against the assessee who had to
spend certain amount in the prevision year 1940-41 in defending that suit. The
suit was dismissed but an appeal from the decree was pending in the court. In
his return of income for the assessment year 1941-42, the assessee claimed to
deduct that sum as a business expense under section 10(2)(xii) of the 1922 Act.
The ITO, however, disallowed the same. The AAC and the Tribunal also confirmed
the said disallowance on the ground that it was an expenditure of a capital
nature. On reference, the Division Bench of the High Court having divergent
view on the point as to whether the expenditure on defending the suit for pre-emption
was or was not in the nature of capital expenditure, referred the question to
the Full Bench.
Held : The question
whether legal expenses are in a particular case capital or revenue expenditure
should be decided according to the test suggested by Lord Cave and subsequently
approved in a large number of cases, in particular by Lawrence, J., whether the
expenses were incurred in acquiring a new capital asset or in improving or
altering an existing capital asset. In the instant case, the asset to defend
for which the expenditure was incurred was an existing asset and was not
acquired in consequence of the expenditure. Nor was there any improvement or
alteration made in that asset because the attack on the capital asset was
successfully repelled. In view of the decree of the civil court dismissing the
suit for pre-emption, it must be held that the attack on the assessee’s title
to the asset was unfounded and no improvement in the title was effected by the
dismissal of the suit. There was no analogy between the instant case and the
case assumed because exhypothesi in the latter case the asessee purchased the
property with knowledge of defect in the title, and perfected it by further
payment. He, therefore, improved his asset and the expenditure was capital even
according to the test laid down by Lawrence, J. The same would be the case
where the assessee knowingly takes an imperfect title and subsequently makes it
good by compromising with the party entitled to object to the sale. In the
instant case, however, there was neither any acquisition nor any improvement
nor any alteration in the capital asset.
The title of a purchaser
may be attacked on several grounds and the right to pre-empt is only one of
them. The essential point is that the plaintiff of the pre-emption suit sought
to dispossess the assessee from his business premises, and the grounds on which
he sought to dispossess him are wholly immaterial, the eventual decision being
in favour of the assessee. The expenditure has so far been incurred only once
but there was no guarantee that it may not recur, though it was not likely to
recur in connection with a suit for pre-emption. It is as necessary for a
business man to protect his business premises as his stock-in-trade, and there
can not be any distinction in principle between litigation expenses incurred to
defend the business premises and those incurred to defend the stock-in-trade.
Both are incurred wholly and exclusively for the purposes of the business and
do not result in the acquisition, improvement or alteration of a capital asset.
For these reasons, expenditure incurred was a revenue expenditure and not a
capital expenditure. [In favour of the assessee] (Related Assessment year : 1941-42)
– [Mahabir Parshad and Sons
v. CIT (1945) 13 ITR 340
(Lahore)]
Litigation expenditure incurred during accounting year for recovery of previous dues was an allowable deduction in law in computing profits of accounting year – Assessee running money lending business entered into a partnership with one ‘S’ and became financing partner for implementing a contract – Partnership dissolved and as per agreement amount due to assessee was to be paid by new financing partner of ‘S’ – Dues were not paid – Assessee incurred litigation expenses for realising it – Since assessee was still carrying on business of money lending, deduction of litigation expenses could not be denied on ground that said expenditure was related to business of same earlier years as money spend was necessary to recover an investment attended with same profits
Section 37(1) of the
Income-tax Act, 1961 [Corresponding to section 10(2)(xv) of the Indian Income-tax
Act, 1922] – The
assessee was entitled to succeed. It was not disputed that that amount was
incurred as litigation expense in the previous year, that it was spent to
realise the capital invested in the business of the assessee as a money-lender and
to realise some profits also which had accrued to the assessee in that
money-lending business and which were agreed to be paid to him by successor of
the partnership. If the assessee had not shown any profits from that business
to the Income-tax Department in. the year in which the profits were earned, he
may have escaped from taxation but that is no ground whatsoever for disallowing
him this business expenditure.
Upon the termination of the business
connection with ‘S’ money fell due to him was composed principally of the
capital. However, it also contained some profits which had accrued to him
either by way of interest or otherwise. The assessee was a money-lender and was
entitled to set off against the profits of the previous year any expenses which
he incurred in that business in the previous year. It was not correct to say
that he was entitled to litigation expenses only if the partnership had been
dissolved in the previous year. The finding that the claim was not in respect
of any business carried on by the assessee during the previous year was
erroneous in law because it was admitted that the assessee was carrying on
money-lending business in the previous year. Now if the assessee was carrying
business, the fact that the expenditure incurred in the previous year referred
to business which was carried on in some earlier years made no difference at
all. The Appellate Tribunal was not right when it said that this was not one of
the many transactions of the same sort and that the money spent in realising
the investment could not be said to have been spent to protect his
stock-in-trade because it was clear that the money spent was necessary in order
to recover an investment attended with some profits which had been made by the
assessee in some earlier years. For those reasons it was held that in the
circumstances of the case the litigation expenses were an allowable deduction
in computing the profits of the assessee in the accounting year. [In favour of
the assessee]. – [Jutharam Jankidas v. CIT
(1944) 12 ITR 344 (Pat.)]
Assessee carried on money-lending business – He advanced a loan to a company in which he was a shareholder – A suit was filed against assessee alleging that said advance was made as a part of promise to finance said company which assessee failed to implement – Suit was ultimately dismissed – Assessee claimed deduction of expenses incurred in defending suit – Since expenditure in question was incurred solely for purpose of earning profits or gains of money-lending business, assessee was entitled to deduction claimed
Section 37(1) of
the Income-tax Act, 1961 [Corresponding to section 10(2) of the Indian
Income-tax Act, 1922] – The father of the respondent-assessee
carried on money lending business. He had advanced a loan to a company in which
he was a shareholder. A suit for recovery of damages was filed by the other
shareholder against the father alleging that he failed to implement his
promises to finance the company as a part of which he had made said advance.
During the pendency of the suit, the father died on 03.07.1929, and the
respondent who continued the money lending business and his brother were
substituted for their father. The suit was dismissed by the Court, in February
1931. For the assessment year 1931-32 the assessee claimed deduction of the
litigation expenditure in defending the aforesaid case. The ITO disallowed the
assessee’s claim. On appeal, the Assistant Commissioner upheld the
disallowance. However, on reference, the High Court allowed the assessee’s
claim. On appeal to the Privy Council :
In the instant case the loan already
advanced was part of the promises made in the alleged agreement under which the
father was to finance the company. The allegations of fraud,
conspiracy, etc., were merely the extravagant embroidery which is
commonly found in such actions ; they did not alter the main character of the
action as being directed against the deceased as the money-lender, and the
latter’s defence to the action was just as essential for the full protection of
his rights as the creditor in the loan as was his suit for the recovery of the
loan. It had to be remembered that money is the stock in trade of a
money-lender. The appellant might well have come to a different conclusion, if
he had realised the close connection of this loan with the transactions alleged
in the suit. The alleged transaction was not foreign to the money lending
business of the respondent and his father. Therefore, the facts stated by the
Commissioner could not justify the opinion expressed by him, but that the
expenditure in question was incurred solely for the purpose of earning the
profits or gains of the money-lending business, and that the High Court was
right in holding that the respondent was entitled to the deduction claimed. [In
favour of the assessee] (Related Assessment year
: 1931-32) – [CIT v. Maharajadhiraja Sir Kameshwar Singh (1942) 10 ITR 214 (PC)]
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