SIRC OF ICAI WORKSHOP ON TAX AUDIT T.BANUSEKAR, FCA, CHENNAI

Transcription

1 SIRC OF ICAI WORKSHOP ON TAX AUDIT T.BANUSEKAR, FCA, CHENNAI SECTION 29 TO 38 ALLOWABLE EXPENSES The most important aspect in computation of business income after arriving at gross receipts is identifying expenditure which can be claimed as deduction under this head. Some provisions specifically allow certain expenditure as deduction, some provisions deny allowability of certain expenditure as deduction and some provisions deny allowability of expenditure under certain specific circumstances. This paper seeks to give an overview of the various expenses that are allowable as deduction in computing business income. Repairs Repairs can be claimed as a deduction in respect of building u/s.30 and in respect of machinery, plant and furniture u/s.31. The deduction is available in respect of these assets on current repairs. Current repairs indicate repairs which are attended to when the need for them arises from the businessman s point of view and which are not allowed to fall into arrears or to be accumulated. Humayun Properties Ltd. v CIT (1962) 44 ITR 73 (Cal.). However current repairs is not the same as petty repairs. CIT v Mahalakshmi Textiles Mills Ltd. (1967) 66 ITR 710 (SC). The proper tests to see whether a repair is in the revenue field or the capital field are: Repairing or replacing an existing asset to bring it to its original condition would be revenue expenditure. However if the new asset enhances productive capacity substantially, the expenditure is capital. Replacing subsidiary parts of a whole asset is revenue expenditure. However acquisition not of a subsidiary part but of the whole asset itself is capital. Expenditure on restoring an asset to its original state where it would continue to earn income is revenue. The Finance Act, 2003 amended section 31 to provide for the deduction in respect of repairs on machinery, plant or furniture to be allowed only where such repairs are not in the nature of a capital expenditure. The amendment notwithstanding, the Supreme Court in CIT v Saravana Spinning Mills Pvt Ltd [2007] 293 ITR 201 (SC) has held that replacement of machinery forming part of 1

2 an integrated plant will not be allowable as a deduction, though the claim for such expenditure u/s.37(1) is still open based on the decision of the Supreme Court in CIT v Ramaraju Surgical Cotton Mills & others [2007] 294 ITR 328 (SC). It may be noted that the Supreme Court in CIT v Sri Mangayarkarasi Mills (P) Ltd [2009] 315 ITR 114 (SC) has taken a view that replacement of machinery in a textile mill will also not qualify for deduction u/s.37(1) notwithstanding the accounting treatment accorded for the same in the books of account. Subsequent to this decision it has been held in CIT v Hindustan Textiles [2010] 36 DTR (SC) 131, CIT v Sugavaneeshwara Spg Mills Ltd [2009] 227 CTR (SC) 439 and in CIT v Bhojaraj Textile Mills Ltd 2010-TIOL-22-SC-IT-LB that the issue relating to the claim u/s.37(1) needs to be examined and in this light the Supreme Court has set aside the matter back to the High Court. It may be noted that the decision in CIT v Bhojaraj Textile Mills Ltd 2010-TIOL-22-SC-IT-LB is a decision of a Full Bench of the Supreme Court and that in this case the Supreme Court while setting aside the matter, did so directing the High Court to decide the matter in the light of its decisions in CIT v Saravana Spinning Mills Pvt Ltd [2007] 293 ITR 201 (SC) and CIT v Ramaraju Surgical Cotton Mills & others [2007] 294 ITR 328 (SC) without making a reference to Mangayarkarasi. The Madras High Court in the case of CIT Madurai v Madura Coats [2012] 205 taxman 357 (Mad) also observed that with effect from Assessment year once the concept of block of assets came into being, whether the mill is an integrated whole or not, whether the replacement of machines resulted in increased capacity or not, will have no bearing, and when any item belonging to the block is removed, its value is reduced and if any new item comes in its place, its value is added to the block. Therefore the expenditure was held to be not of a revenue nature and that it could not be claimed as a deduction. Following this decision the Chennai Bench of the Income tax Appellate Tribunal in The Kumaran Mills Ltd. v Assistant Commissioner of Income tax also held against the assessee. The following further decisions are worth noting: Replacement of wooden trolleys by stainless steel trolleys in a manufacturing concern is allowable. [CIT v Satya Dev Chemical Ltd [1997] 226 ITR 95 (Guj)] Expenditure on re-roofing and replacement of ceiling are allowable expenditures. [CIT v Jawahar Mills Ltd [1997] 226 ITR 230 (Mad), CIT v Asher Textiles Ltd [1999] 240 ITR 483 (Mad)] Replacement of materials like pumps, motors, chimney etc of a sugar mill is revenue expenditure. [CIT v Co-operative Sugars Ltd [1999] 239 ITR 908 (Ker)] 2

3 Expenditure on asphalting of existing roads in a factory premises is an allowable revenue deduction. [CIT v Venkateswara Hatchery Pvt Ltd [1997] 227 ITR 116 (AP)] Resurfacing of roads so as to make it usable is an allowable deduction. [CIT v Himalaya Drug Pvt Ltd [1998] 234 ITR 167 (All)] Replacement of motors to enable continuous production is a revenue expenditure. [CIT v Sree Narasimha Textiles Pvt Ltd [1999] 238 ITR 351 (Mad)] Renovation of a restaurant involving a huge outlay in replacement of air conditioning plants and parts of electric motor to renovate the same after the fire is an allowable expenditure. [CIT v Volga Restaurant [2002] 253 ITR 405 (Delhi)] Replacement of rolls in a steel rolling mill was held as allowable by the Tribunal and the Court held that no substantial question of law arose out of the order of the Tribunal. [Malhotra Industrial Corporation [2002] 254 ITR 635 (P&H)] Depreciation Depreciation is presently available u/s.32 in respect of Building, machinery, plant or furniture being tangible assets Knowhow, patents, copyrights, trademarks, licences, franchises or any other business or commercial right of similar nature being intangible assets acquired on or after Depreciation is normally allowable on written down value of the block of assets except in case of undertakings engaged in generation or generation and distribution of power. The conditions precedent for the claim of depreciation are: The assessee must be the owner or part owner of the asset. The assessee must have put the asset to use during the previous year. One may remember in this context that where the asset is put to use for less than 180 days depreciation would be allowable at half the rates prescribed else at full rates prescribed. Asset Put to Use It is a settled issue that use of the asset includes its passive user and it is not necessary that the asset should be actively put to use. One issue that arises is as to whether after the introduction of block of assets concept depreciation can 3

4 be allowed only if the asset is actually put to use. The Nagpur Bench of the Tribunal in South Eastern Coal Fields Ltd v JCIT [2003] 85 ITD 608 (Nag) has held that with the introduction of the block of assets concept the identity of individual items has been done away with in view of the definition of the term written down value and that the requirement of law is to establish use of the concerned block of assets as such and not the use of any equipment individually for the claim of depreciation. It is however felt that this decision of the tribunal would not have applicability in the first year of acquisition of the asset and that in the first year the claim for depreciation will be allowable only if the asset is put to use as else it would not enter the block of assets. With regard to personal user of the asset, the controversy has been reasonably put to rest by the decision of the Special Bench of the Income Tax Appellate Tribunal in Gulati Saree Centre v ACIT (1999) 71 ITD 73 (Chand.)(SB). The Tribunal in this case held that even after the introduction of the system of block of assets a fair proportion of the depreciation could be disallowed to the extent to which the asset is used for personal purposes. One may note in this context that section 38 provides for a disallowance of expenditures of the nature referred to in sections 30, 31 and 32, which shall be restricted to fair proportionate part having regard to the user of such assets for the purpose of business or profession. Under the block of assets concept deprecation can be claimed even where the asset is not put to use in subsequent years after the first year in which it enters the block or even if the asset is discarded because it cannot be used. In CIT v Bharat Aluminium Co Ltd. ITA No.659/2007 and 1484/2006, the Delhi High Court held that after the first year of use of an asset, it is the use of the block of assets and not the use of the individual asset which becomes the yardstick for determining whether depreciation is allowable. Depreciation on passive user Even when there is passive use of assets, i.e. where the machines were ready to use but could not be used due to paucity of raw materials, depreciation was allowable Madras High Court in CIT v Chennai Petroleum Corporation Ltd. [2013] 358 ITR 314 (Mad). Depreciation on Goodwill With the introduction of depreciation on intangible assets, the question arises as to whether depreciation would be allowable on goodwill. The term goodwill is not specially set out in section 32. Therefore depreciation can be allowed on goodwill only if it will fit into the words or commercial rights of similar nature. One would be inclined to believe that goodwill would fall within the meaning of these words and that therefore depreciation would be allowable on goodwill. This view is expressed because the term goodwill may be defined as the ability of a business to generate income in excess of normal rate on assets due to superior 4

5 managerial skill, market position, new product technology etc., and is a right eligible for depreciation. In Commissioner of Income Tax v. Smifs Securities Ltd., [2012] 348 ITR 302 (SC), the Hon ble Supreme Court has held that goodwill is an intangible asset eligible for depreciation under the provisions of section 32. Depreciation on Non-compete fee A similar view can be taken in respect of non compete fee as well. However courts have held otherwise. Non-compete fee is not an intangible asset to which provisions of Section 32(1)(ii) apply and therefore depreciation could not be allowed on Non-compete fee. The Chennai Bench of the Income tax Appellate Tribunal in Arkema Peroxides India (P) Ltd. v ACIT [2013] 56 SOT 64 (Chennai) (URO) Similar view has been taken by the Mumbai Bench of the Income tax Appellate Tribunal in Gujarat Glass Pvt Ltd. v ACIT [2013] 36 CCH 014 (Mum Trib). In this case the non-compete fee was however allowed to be spread over the tenor of the agreement. The Delhi High Court in the case of Sharp Business System v CIT [2012] 254 CTR (Del) 233, held that to be an intangible asset the rights must be in rem and transferable, and concluded that non-compete fee is not an intangible asset but goodwill is. In a recent decision the Madras High Court in Pentasoft Technologies Ltd. v DCIT [2014] 264 CTR (Mad) 187 allowed claim of depreciation on non-compete fees paid since the non-compete clause was included in order to strengthen the transfer of rights, copyrights, trademarks, etc. Depreciation Mandatory or Optional Whether the claim for depreciation is mandatory or optional has been a matter of debate. This issue was settled by the Supreme Court in CIT v Mahendra Mills (1999) 109 Taxman 225 (SC), where the Court held that it was optional. The Finance Act, 2001 has however amended section 32 to make the claim of depreciation mandatory. This amendment by the insertion of explanation (5) to section 32 would only be prospective and not retrospective. This means that the claim for depreciation is mandatory only with reference to assessment year and onwards. Reference in this connection may be made to the decisions of the Kerala High Court in CIT v Kerala Electric Lamp Works Ltd [2003] 261 ITR 721 (Ker) and of the Madras High Court in CIT v Sree Senhavalli Textiles Pvt Ltd [2003] 259 ITR 77 (Mad). 5

6 Set off of earlier year depreciation against other incomes For the Assessment years to there was a restriction on the period for which the unabsorbed depreciation could be carried forward. From Assessment year this restriction was removed. Post this amendment, whether the unabsorbed depreciation of the period to can be carried forward for set off was answered by the Gujarat High Court in the case of General Motors India Pvt Ltd v DCIT SCA 1773 / 2012 Guj HC. The Hon ble Gujarat High Court held that current depreciation could be first set off against income of the year from the business to which it related and then set off against any other business income. Any unabsorbed amount could be set off against any income from any source under any other head of income. Balance left over could be carried forward and would be part of the current depreciation of the succeeding year and if there was no depreciation in that year the carried forward depreciation would become the current depreciation of that year. The depreciation of the specified period of Assessment year to also would be treated in the same manner. Incremental Depreciation Incremental depreciation can be claimed on new plant & machinery not being ships or aircrafts acquired and installed after This deduction is available only to an assessee who is engaged in the business of manufacture or production of an article or thing. It is not necessary that the new plant or machinery must have been used in the manufacture. What is necessary is that the assessee must be engaged in the manufacture of production of an article or thing. This view is supported by the decision of the Madras High Court in Hi Tech Arai Ltd [2010] 321 ITR 477 (Mad) and CIT v VTM Limited 2009 TIOL 521 HC MAD IT. The deduction is allowable at 20%. This deduction is not allowable on Machinery or plant already used by any other person Machinery or plant installed in an office, residence or guest house Office appliances or road transport vehicles Machinery or plant on which the actual cost has been claimed as a deduction in full in one year The Madras High Court in MM Forgings Ltd. v Addl Commissioner of Income tax [2012] 349 ITR 673 (Mad) held that incremental depreciation should be restricted to 50% of the entitlement where the asset was put to use for less than 180 days in the year of acquisition. 6

7 Where the new machinery / plant was put to use for less than 180 days in the first year, only 50% of this incremental depreciation could be claimed in that year. However in the subsequent year, the balance 50% of the incremental depreciation can be claimed (Dy. CIT v.cosmo Films Ltd. (2012) 24 taxmann.com 189 (Trib.); MITC Rolling Mills (P.) Ltd. v. Asstt. CIT [IT Appeal No (Mum.) of 2012, dated ]; Apollo Tyres Ltd. v ACIT (2014) 45 taxmann.com 337 (Cochin - Trib.); M/s. Rittal India Pvt. Ltd vs ACIT (LTU)) Amendment by Finance Act 2017 In line with the Government s avowed objective of discouraging cash transactions, the Finance Act 2017 has amended Section 43(1) to provide that where an assessee incurs any expenditure for acquisition of any asset in respect of which a payment (or aggregate of payments made to a person in an day) otherwise than by account payee cheque / draft/ electronic clearing system through a bank account, exceeds Rs.10,000, such payment shall be ignored for the purposes of determination of actual cost of such asset. Consequently depreciation u/s 32 on such value cannot be claimed, as also investment allowance under Section 32AD. Interest on Capital Borrowed Interest on capital borrowed will be allowed as a deduction u/s.36(1)(iii) provided the capital is borrowed for the purpose of the business or profession. The Finance Act 2003 however inserted a proviso to section 36(1)(iii). Under this proviso interest paid for the period beginning from the date of borrowal to the date on which the asset was first put to use in respect of capital borrowed for acquisition of an asset for extension of an existing business or profession will not be allowed as a deduction. This will apparently mean that the same will have to be capitalised and claimed by way of depreciation. It may be noted that this amendment would be effective only from assessment year This view is supported by the decision of the Supreme Court in DCIT v Core Health Care Ltd [2008] 298 ITR 194 (SC). Apparently the amendment is to get over the decision of the Bombay High Court in CIT v Tata Chemicals Ltd [2002] 256 ITR 395 (Bom). Subject to this, the allowability will be irrespective of whether the capital borrowed is used for acquiring capital assets or for working capital requirements so long as the capital is borrowed for the purpose of business or profession. In respect of interest paid to a Public Financial Institution, State Financial Institution, State Industrial Investment Corporation or a scheduled bank on loan or advance borrowed from that bank, the same will be allowed as a deduction only if it is paid within the previous year or atleast before the due date for furnishing the return of income u/.139(1). If it is not paid within the above referred time, the same will be allowed as a deduction in the previous year in which it is paid. 7

8 The Supreme Court in S.A.Builders Ltd v CIT & Anr [2007] 288 ITR 1 (SC) has held that interest on capital borrowed can be allowed as a deduction even in a case where such borrowed funds are used for lending without any return by way of interest. The Supreme Court in this case observed as follows: 31. We agree with the view taken by the Delhi High Court in CIT vs. Dalmia Cement (Bharat) Ltd. (2002) 174 CTR (Del) 188 : (2002) 254 ITR 377 (Del) that once it is established that there was nexus between the expenditure and the purpose of the business (which need not necessarily be the business of the assessee itself), the Revenue cannot justifiably claim to put itself in the armchair of the businessman or in the position of the board of directors and assume the role to decide how much is reasonable expenditure having regard to the circumstances of the case. No businessman can be compelled to maximize its profit. The IT authorities must put themselves in the shoes of the assessee and see how a prudent businessman would act. The authorities must not look at the matter from their own viewpoint but that of a prudent businessman. As already stated above, we have to see the transfer of the borrowed funds to a sisterconcern from the point of view of commercial expediency and not from the point of view whether the amount was advanced for earning profits. 32. We wish to make it clear that it is not our opinion that in every case interest on borrowed loan has to be allowed if the assessee advances it to a sisterconcern. It all depends on the facts and circumstances of the respective case. For instance, if the directors of the sister-concern utilize the amount advanced to it by the assessee for their personal benefit, obviously it cannot be said that such money was advanced as a measure of commercial expediency. However, money can be said to be advanced to a sister-concern for commercial expediency in many other circumstances (which need not be enumerated here). However, where it is obvious that a holding company has a deep interest in its subsidiary, and hence if the holding company advances borrowed money to a subsidiary and the same is used by the subsidiary for some business purposes, the assessee would, in our opinion, ordinarily be entitled to deduction of interest on its borrowed loans. This gives a view that lending to a sister concern free of interest out of borrowed funds will entitle the assessee to deduction in respect of interest on borrowed capital in the normal course unless it can be shown that the lending to sister concern is not out of genuine business interest. The Kerala High Court in CIT v Accelerated Freeze Drying Co. Ltd [2010] 34 (I) ITCL 256 (Ker) has however held that the decision of the Supreme Court in S. A. Builders case [2007] 288 ITR 1 (SC) could be applied only if, on facts, the assessee establishes commercial expediency in advancing interest free loans. The Madras High Court in CIT v Hotel Savera [1999] 239 ITR 795 (Mad) has held that unless the revenue is able to establish a nexus between the capital borrowed on interest and the lending or drawings by a partner, there can be no 8

9 question of disallowance merely on the basis that had such sums not been lent or withdrawn there would have been no need for the borrowal resulting in the requirement to pay interest. Effect of 14A on interest expenditure claimed Where the assessee is deriving exempt income, expenditure incurred in relation to such exempt income is not allowed as deduction by virtue of Section 14A read with Rule 8D. In this scenario where the capital borrowed has been invested in exempt income earning assets, the interest expenditure relating to such investment is liable to be disallowed. Satisfaction to be recorded Satisfaction should be recorded by Assessing Officer that expenditure has been incurred in relation to exempt income. In the absence of such recording, disallowance u/s 14A was not justifiable. Maxopp Investment Ltd. &Ors. v. CIT [2011] 347 ITR 272 (Del.) (HC); Balarampur Chini Mills Ltd. v DCIT [ 2011] 140 TTJ (Kol) (UO) 73; Balarampur Chini Mills Ltd. v DCIT [ 2011] 140 TTJ (Kol) (UO) 73 Nil exempt income In the event that during a particular year, the assessee has not derived any income from such investments, would the disallowance apply? CBDT Circular 5/2014 dated clarifies that even if the taxpayer has not earned any exempt income during the relevant year, the disallowance u/s 14A would still be applicable on the expenditure incurred in relation to exempt income, since Section 14A does not state income of the year but income under the Act. In Bellwether Microfinance Fund v Income tax Officer ITA 1743 / Hyd / 2013, decision rendered on , the Hyderabad Bench of the Income tax Appellate Tribunal held that Assessing Officer cannot disallow expenditure relating to investment which has not yielded any exempt income during the relevant year. In Assistant Commissioner of Income tax v M Baskaran ITA 1717 / Mds/2013, decision rendered on , the Chennai Bench of the Income tax Appellate Tribunal held that where the assessee had not earned / received any exempt income during the relevant year, no disallowance could be made u/s 14A. The Delhi High Court in Cheminvest Limited v CIT [2015]378 ITR 33 (Del) as also held that disallowance u/s 14A could be made only when during the relevant previous year there is an actual receipt of income which is not includible in total income. 9

10 Similar view has been taken in the following decisions Redington (India) Ltd. v Addl CIT [2017] 77 taxmann.com 257 (Mad) CIT v Shivam Motors (P) Ltd [2015] 230TAXMAN63(All)(HC) CIT v Delite Enterprises 2009 (2) TMI 498 (Bom)(HC) CIT v Corrtech Energy Pvt Ltd in Tax Appeal No.239 of 2014 (Guj HC) CIT v Lakhani Marketing Ltd. in ITA No.970/2008 (P&H)(HC) CIT v Holcim India Pvt Ltd [2014] 90 CCH 81 (Del)(HC) Disallowance cannot exceed exempt income The Delhi High Court in Joint Investments Pvt Ltd v CIT [2015] 372 ITR 0694 (Del.) observed that disallowance u/s.14a cannot be more than the exempt income. Where the interest expenditure is not related to exempt income In the case of ACIT v Champion Commercial Co Ltd [2012] 139 ITD 108 (Kol) it was held that expenses directly related to taxable income could not form part of disallowance u/s 14A Investments on account of commercial expediency to be excluded for Rule 8D computation Where the funds were invested in tax free income yielding investments on account of commercial expediency and not for the purpose of earning income, the disallowance u/s.14a could not be invoked. EIH Associated Hotels Ltd v DCIT 2013 (9) TMI 604 ITAT Chennai; JM Financial Consultants Pvt. Ltd. v DCIT 2015 (11) TMI ITAT MUMBAI; Interglobe Enterprises Ltd v DCIT [2014] 40 CCH 22 Del Trib Employee Welfare Funds Employer s contribution to employee welfare funds will be allowed as a deduction under sections 36(1)(iv) and 36(1)(v) subject to the provisions of section 43B. Section 43B prior to the amendment made by the Finance Act, 2003, disallowed such contributions, if the same are not paid within the due dates prescribed under the relevant Act, Rule, Order or Notification. The same applied even in respect of employee s contribution to a welfare fund. Employee s contribution is first treated as an income u/s.2(24)(x) and thereafter allowed as deduction u/s.36(1)(va) subject to the above condition being fulfilled. It may be noted that the Madras High Court in CIT v Shri.Ganapathy Mills Company Ltd [2000] 243 ITR 879 (Mad) has held that payments within the days of grace will amount to payment within the due date and that in such a case the deduction will be allowed. 10

11 The Finance Act, 2003 amended section 43B with effect from the assessment year so as to provide that the employer s contribution to an employee welfare fund will be allowed as a deduction provided it is paid in the previous year in which it is payable or before the due date for furnishing the return of income for that year. If the same is paid beyond the due date for furnishing the return of income, the same would be allowed in the year of actual payment. It may also be noted that no corresponding amendment has been made to section 36(1)(va). This would mean that the old provisions would still govern the employee contribution to an employee welfare fund and there will be no relaxation in respect thereof. The Delhi High Court in CIT v AIMIL Ltd in ITA No.1063 / 2008 has taken a view that in the context of section 36(1)(va), the deduction in respect of employee contribution will also be available so long as it is paid within the due date for filing the return. The Supreme Court in CIT v Vinay Cement Ltd [2007] 213 CTR (SC) 268 has held that the amendment made to section 43B is retrospective in operation. A similar view has been taken by the Supreme Court in CIT v Alom Extrusions Ltd 2009-TIOL-125-SC-IT. The Gujarat High Court has taken a contrary view in Commissioner of Income Tax v Gujarat State Road Transport Corporation [2014] 366 ITR 170 (Guj) and has held that if employees contribution received by the assessee is not credited to the employees account in the relevant fund or funds on or before the due date mentioned in the Explanation to section 36(1)(va) [i.e. due dates under PF Act, ESI Act/other law], the assessee shall not be entitled to deduction of such amount in computing the income referred to in section 28 of the Act even if contributions deposited on or before due date under section 43B [i.e. due date for filing income tax return under section 36(1)(va)] for depositing employers contributions to those funds. The Central Board of Direct Taxes has recently issued a circular dated in which it has clarified that the ratio of the decision of the Supreme Court in Commissioner of Income Tax v Alom Extrusions Ltd. [2009] 319 ITR 0306 (SC) has settled the issue on retrospective applicability of the amendments to Section 43B, viz. deletion of the second proviso and amendment to the first proviso. Therefore where the employer has paid the contributions to provident and other welfare funds before the due date applicable u/s 139(1), the disallowance u/s 43B will not be attracted. It has also been clarified that this Circular does not apply to claim of deduction relating to employee s contribution to welfare funds governed by Section 36(1)(va) of the Income Tax Act. However the Hon ble Madras High Court in CIT v Industrial Security & Intelligence India Pvt Ltd in TC(A) Nos.585 and 586 of 2015 dated 24 July, 2015 (Madras HC) has held that employee contribution will be allowable if the same is paid within the due date for filing the return of income. 11

12 Bad Debts Any debt will be allowed as a deduction subject to the following conditions being fulfilled: The debt or any part thereof has become bad It has been written off as irrecoverable in the accounts of the assessee. It has been taken into account in computing the income of the previous year or any earlier previous year. Relaxation is however available in respect of the third condition in as much as a debt or part thereof which represents money lent in the ordinary course of the business of banking or money lending may be allowed subject to satisfying the other two conditions. For a debt to be allowed as bad, the Special Bench of the Tribunal in DCIT v Oman International Bank SAOG [2006] 100 ITD 285 (Mum)(SB) has held that the write off of the debt in the books of account would suffice for the allowability and it is not necessary to prove that the debt is in fact become bad. This view has been affirmed by the Bombay High Court in Director of Income Tax (International Taxation) v Oman International Bank SAOG [2009] 313 ITR 128 (Bom) and by the Supreme Court in T.R.F. Ltd v CIT [2010] 323 ITR 397 (SC). The Supreme Court in Vijaya Bank v CIT [2010] 323 ITR 166 (SC) has held that though a mere debit to the profit and loss account is not sufficient for the claim of deduction in respect of bad debt, a corresponding reduction in the loans and advances or debtors on the asset side of the balance sheet will amount to write off for the grant of deduction and this will apply even if each individual debtors account is not closed in the books of account. Allowability of Capital Expenditure as a Deduction The Act permits the claim of capital expenditure as a deduction. These provisions are as follows: Section 32AC Investment in new plant and machinery Section 32AS Investment in new plant and machinery in notified backward areas in certain states. Section 35 Research and development expenditure Section 35A Expenditure on acquisition of patent rights or copyrights Section 35AB Expenditure on knowhow Section 35ABB Expenditure for obtaining license to operate telecommunication facilities Section 35AC Expenditure on eligible projects and schemes Section 35AD Expenditure on specified business Section 35CCA Expenditure to associations and institutions carrying on rural development programmes. Section 35CCB Expenditure to associations and institutions for carrying out programmes of conservation of natural resources 12

13 Section 35CCC Expenditure on agricultural extension project Section 35CCD Expenditure on skill development project Section 35D Amortization of certain preliminary expenditure Section 35DD Amortization of expenditure on amalgamation or demerger. Section 35DDA Amortization of expenditure incurred under a VRS Section 35E Deduction of expenditure on prospecting etc. of certain minerals General (Section 37) Any expenditure would be allowed as a deduction provided the following conditions are satisfied: The expenditure is not of the nature referred to in sections 30 to 36. The expenditure is not capital in nature. The expenditure is not the personal expenditure of the assessee. The expenditure is laid out or expended wholly or exclusively for the purpose of business or profession. The expenditure is not incurred for any purpose which is an offence or which is prohibited by law. The following principle laid down by Viscount Cave L.C. in Atherton v. British Insulated & Helsby Cables Ltd. 10 TC 191 (HL) may be useful in determining whether the expenditure is laid down for the purpose of the business. Wholly or Exclusively A sum of money expended not of necessity and with a view to a direct and immediate benefit to the trade, but voluntarily and on the grounds of commercial expediency and in order indirectly to facilitate the carrying on of the business, may yet be expended wholly and exclusively for the purposes of the trade. Also in CIT v Nainital Bank Ltd. 62 ITR 638 (SC). This test was quoted with approval and applied by the Supreme Court in Eastern Investment Ltd. v CIT 20 ITR 1 (SC) and in CIT v Chandulal Keshavlal 38 ITR 601, 611 (SC). It may further be remembered that the expenditure need not be incurred solely for the purpose of earning profits in the year of account Mysore Spg. Mfg. Co. Ltd. v CIT 61 ITR 572 affirmed CIT v Mysore Spg. Mfg. Co. Ltd. 78 ITR 4 (SC). Further there is no requirement that profit should have in fact been earned by the expenditure in question. This principle has been affirmed by the Supreme Court in Eastern Investments Ltd. v CIT 20 ITR 1,4(SC). The principle has also found favour with the House of Lords in Huges v Bank of New Zealand 21 TC 472, 524; 6 ITR 636, 644 (HL). To quote Lord Thankerton in this decision Expenditure in course of trade which is remunerative is nonetheless a proper deduction, if wholly and exclusively made for the purposes 13

14 of the trade. It does not require the presence of a receipt on the credit side to justify the deduction of an expense. Capital and Revenue Expenditure The test in judging whether an expenditure is revenue or capital has been listed by the Andhra Pradesh High Court in Hylam Ltd v CIT [1973] 87 ITR 210 (AP) after review of English and Indian decisions on the subject, they are reproduced below: 1. If the expenditure is for the initial outlay or for acquiring or bringing into existence an asset or advantage of an enduring benefit to the business that is being carried on, or for extension of the business that is going on, or for a substantial replacement of an existing business asset, it would be capital expenditure. 2. If, on the other hand, the expenditure, although for the purpose of acquiring an asset or advantage, is for running of the business or for working out that asset with a view to produce profit, it would be revenue expenditure 3. If the outgoing is so related to the carrying on or the conduct of the business that it may be regarded as an integral part of the profit earning process or operations, and not for the acquisition of an asset of a permanent character, the possession of which is a condition precedent for the running of the business, then it would be expenditure of a revenue nature. 4. Special knowledge, or technical knowledge, or a patent, or a trade mark, is an asset and if it is required by payment for use and exploitation for a limited period, and what is acquired is not an asset or advantage of an enduring nature and at the end of the agreed period that advantage or asset reverts back intact to the giver of that special knowledge or the owner of the patents or trade marks, it would be expenditure of a revenue nature. 5. If it is intrinsically a capital asset, it is immaterial whether the price for it is paid once and for all, or periodically, or whether it is paid out of capital or income, or linked up with the net sales. The outgoing, in such a case, would be of the nature of capital expenditure. 6. If the amount paid for the acquisition of an asset of an enduring nature is settled, the mere fact that the amount so settled is chalked out into various small amounts or periodic instalments, the capital nature of expenditure would not cease to be so or alter into the nature of a revenue expenditure. 14

15 7. A lump sum amount for liquidating recurring claims would not cease to be revenue expenditure or get converted into capital expediture merely because its payment is spread over a number of years. It is the intention and object with which the asset is acquired, that determines the nature of the expenditure incurred over it, and not the method or the manner in which the payment is made, or the source of such payment. 8. If the expenditure is recurring and is incurred during the course of business or manufacture, it would be revenue expenditure. 9. An asset or advantage of an enduring nature does not mean that it should last for ever. If the capital asset is, in its nature, a short-lived one, the expenditure incurred over it does not, for that reason, cease to be a capital expenditure. 10. It is not the law that if an enduring advantage is obtained, the expenditure for securing it must always be treated as capital expenditure. If the advantage acquired is to get the stock-in-trade of the business, then it would be revenue expenditure. But if what is acquired is not the advantage of getting the stock-in-trade of the business, then it would be revenue expenditure. But if what is acquired is not the advantage of getting the stock-in-trade directly, but of something which has to be dressed up or processed before it is converted into stock-in-trade, the expenditure incurred over it would be capital expenditure. Though the decision in the particular facts of the case was overruled in a subsequent decision of the Full Bench in Praga Tools Ltd v CIT [1980] 123 ITR 773 (AP) holding that the lump sum payment towards consultancy was a capital expenditure, the tests have not lost their validity. The Supreme Court in Assam Bengal Cement Co. Ltd. v CIT [1955] 27 ITR 34 (SC) laid down the following principles for the allowability of deduction in respect of expenditure u/s.37(1) as revenue expenditure: 1. Outlay is deemed to be capital when it is made for the initiation of a business, for extension of a business, or for a substantial replacement of equipment vide Lord Sands in IRC vs. Granite City Steamship Co. (1927) 13 Tax Cases 1. In City of London Contract Corpn. vs. Styles (1887) 2 Tax Cases 239 Bowen, L.J., observed as to the capital expenditure as follows: You do not use it for the purpose of your concern, which means, for the purpose of carrying on your concern, but you use it to acquire the concern. 2. Expenditure may be treated as properly attributable to capital when it is made not only once and for all, but with a view to bringing into existence 15

16 an asset or an advantage for the enduring benefit of a trade : vide Viscount Cave, L.C., in Atherton vs. British Insulated & Helsby Cables Ltd. (1925) 10 Tax Cases 155. If what is got rid of by a lump sum payment is an annual business expense chargeable against revenue, the lump sum payment should equally be regarded as a business expense, but if the lump sum payment brings in a capital asset, then that puts the business on another footing altogether. Thus, if labour saving machinery was acquired, the cost of such acquisition cannot be deducted out of the profits by claiming that it relieves the annual labour bill, the business, has acquired a new asset, that is, machinery. The expression enduring benefit or of a permanent character were introduced to make it clear that the asset or the right acquired must have enough durability to justify its being treated as a capital asset. 3. Whether for the purpose of the expenditure, any capital was withdrawn, or, in other words, whether the object of incurring the expenditure was to employ what was taken in as capital of the business. Again, it is to be seen whether the expenditure incurred was part of the fixed capital of the business or part of its circulating capital. Fixed capital is what the owner turns to profit by keeping it in his own possession. Circulating or floating capital is what he makes profit of by parting with it or letting it change masters. Circulating capital is capital which is turned over and in the process of being turned over yields profit or loss. Fixed capital, on the other hand, is not involved directly in that process and remains unaffected by it. In this context it would also be useful to refer to the following decisions: Empire Jute Co. Ltd. v CIT [1980] 124 ITR 1 (SC) Alembic Chemical Works Co. Ltd. v CIT [1989] 177 ITR 377 (SC) CIT v Southern Roadways Ltd. [2007] 288 ITR 15 (Mad) Accounting and Allowability The way in which an item of expenditure is treated in the assessee s account is not conclusive against or in favour of the assessee CIT v Parekh & Co. (India) Ltd. [1956] 29 ITR 661 (SC). A deduction may be allowed in respect of a statutory liability even if no provision is made for it in the account Kedarnath Jute Mfg. Co. Ltd. v CIT [1971] 82 ITR 363 (SC). Loss Incidental to Business Any loss incurred in the course of business or revenue in nature may also be claimed as a business deduction such as loss of stock in trade on account of fire or embezzlement, theft of cash, during the course of business. These deductions 16

17 do not depend on any specific provision in the Act but arise out of common principles of accounting and experience. The leading decisions on this issue are: Badridas Daga v CIT (1958) 34 ITR 10 (SC) CIT v Nainital Bank Ltd. (1965) 55 ITR 707 (SC) Ramchandra Shiv Narayan v CIT (1978) 111 ITR 263 (SC) CIT v S.N.S.S.A.Annamalai Chettiar (1972) 86 ITR 607 (SC) There has however been a controversy on loss arising consequent to devaluation. The decision in favour of its allowability is in Davidson India Private Limited v CIT (1983) 140 ITR 344 (Cal). The decisions against the allowability are: CIT v Hindustan Aluminium Corporation (1994) 207 ITR 670 (Bom.) CIT v Sandoz (I) Ltd. (1994) 206 ITR 599 (Bom.) Prohibited by law Expenditure not incurred for any purpose which is an offence or which is prohibited by law will not be allowed as deduction while computing business income. It has been consistently held by courts that only expenditure incurred.in connection with infraction of law would call for disallowance. Fines / penalties paid in case of certain irregularities committed while carrying on the business in normal course do not call for disallowance. Goldcrest Capital Markets Ltd. Vs. ITO [2010] 130 TTJ 446 (Bom.); Master Capital Services Ltd. Vs. DCIT [2007] 108 TTJ 0389 (Chd.). In Khushal Singh Subhash Chander v Commissioner of Income Tax [1997] 228 ITR 0608 (HP) it was held that in a case where contract was allotted to assessee for cutting blazes on trees for collecting resin and the assessee had to pay penalty for cutting blazes on trees not allotted to him, the penalty paid could not be allowed as deduction. In Commissioner of Income Tax v H.P.State Forest Corporation [2010] 320 ITR 0170 (HP) it was held that interest on delayed payment of sales tax was compensatory in nature and not a penalty and therefore was deductible as business expenditure. DCIT v Syncom Formulations (I) Ltd (ITA No. 6429/Mum/2013, decision rendered on ) - While receiving of gifts by doctors was prohibited by MCI guidelines, giving of the same by manufacturer is not prohibited under any law for the time being in force and therefore no disallowance was called for. In Confederation of Indian Pharmaceutical Industry (SSI) v Central Board of Direct Taxes [2013] 353 ITR 0388 (HP) it was held that if the assessee satisfies the assessing authority that the expenditure is not in violation of the regulations framed by the medical council then it may legitimately claim a deduction u/s 37 17

18 Amendment to Section 37 by the Finance (No.2) Act 2014 Explanation to Section 37 (with effect from AY ) - Expenditure incurred on activities related to Corporate Social Responsibility (CSR) referred to in Section 135 of the Companies Act shall not be deemed to be expenditure incurred for the purpose of business or profession of the assessee. The memorandum explaining the Finance bill however clarifies that where the expenditure on CSR is of the nature described in Sections 30 to 36 the same will be allowed under those sections. Such deductions could possibly be envisaged under Sections 35AC, 35CCA, 35CCB, 35CCC and 35CCD, which deal with expenditure incurred on a project or scheme for promoting a social and economic welfare or uplift of the public, as approved by the National Committee set up for this purpose, expenditure incurred by way of payment to an institution for carrying out rural development program, payment to an institution for carrying out programmes of conservation of natural resources, expenditure incurred on agricultural extension project, as notified by the Board under Section 35CCC and expenditure incurred on skill development project, as notified by the Board, under Section 35CCD. The expenditures dealt with under these Sections are also those which are permissible as CSR activities under the Companies Act. Share Issue Expenses Section 35D of the Act permits the amortisation of certain preliminary expenditure for a period of five years subject to an overall ceiling. In the case of Indian Company 5% of the cost of project or at the option of the company, 5% of the capital employed. One of the items covered by section 35D is the expenditure incurred by the assessee company in connection with the issue of public subscription of shares or debentures of the company. Considerable debate has been generated on whether the expenditure incurred on the issue of shares to increase the share capital would be allowable as a revenue expenditure under section.37(1). This issue has since been settled by the decision of the Supreme Court in Brooke Bond India Ltd. v CIT (1997) 225 ITR 798 (SC). The Supreme Court has come to the conclusion that such expenditure would not be allowable as revenue expenditure under section.37(1). In coming to this conclusion, the Court has analysed its own decision in Punjab State Industrial Development Corporation Ltd. v CIT (1997) 225 ITR 792 (SC) where it has held that fees paid to the ROC for enhancement of capital is a capital expenditure and not revenue expenditure. Therefore one can say that it is a settled issue that share issue expenses and fees paid to the ROC for increasing the authorised capital are in the capital field and will not be allowed as a deduction. The only possibility is to amortize this expenditure in accordance with section 35D. However even under section.35d the amortisation is possible only if the assessee is an industrial undertaking. Thus any share issue expenses incurred by companies not for 18

19 setting up or extension of industrial undertakings, such as finance companies cannot get the benefit of section 35D. The Supreme Court in CIT v General Insurance Corporation [2006] 286 ITR 232 (SC) has however held that expenditure on issue of bonus shares is an allowable business deduction In this connection one may consider the possibility of issuing convertible debentures. The expenses on such issue may be allowed as a deduction. This point is however not beyond doubt. A favourable view has been taken by the Mumbai Bench of the Tribunal in Voltas Limited v DCIT [1998] 61 TTJ (Mumbai) 543 and J.M.Shares & Stock Brokers Ltd. v DCIT [2004] 83 TTJ (Mumbai) 1052 while a view unfavourable to the assessee has been taken by the Ahmedabad Bench of the Tribunal in Banco Products (India) Limited v DCIT [1997] 63 ITD 370 (Ahd). It is submitted with respect that the decision of the Mumbai Bench seems to be the better one because for the purpose of allowance of expenditure it is the present purpose that is relevant and not the remote purpose. The Rajasthan High Court in Commissioner of Income Tax v Secure Meters Ltd. [2010] 321 ITR 0611 (Raj) held that since the debentures when issued were a loan, the expenditure incurred on issue of the debentures was allowable as revenue expenditure, whether the debentures were convertible or not. The Supreme Court, in SLP No. CC10548/2009 (SC), dismissed the appeal of the Revenue thereby affirming the view of the High Court. Discount on Issue of Debentures This issue too has been settled by the Supreme Court in Madras Industrial Investment Corporation Ltd. v CIT (1997) 225 ITR 802 (SC). The Court has held that such expenditure is in the revenue field and is allowable under section.37(1). It is also held that the expenditure is to be spread over the number of years for which the debenture is issued and is to be claimed as expenditure accordingly. This rule will apply not only to the discount on issue of debentures but also where the debentures are issued at par and redeemed at premium. This view is based on the observation of the Court in the above referred decision that when a company issues debentures at a discount, it incurs a liability to pay a larger amount than what it has borrowed at a future date which will be equally applicable in case of premium on redemption of debentures. It was held thus by the Gujarat High Court in DCIT v Gujarat Narmada Valley Fertilisers Co Ltd. [2013] 33 taxmann.com 265 (Guj). 19