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Issues Involved:
1. Disallowance of payment for settlement of a patent infringement dispute. 2. Application of Explanation to section 37(1) of the Income-tax Act, 1961. Issue-wise Detailed Analysis: 1. Disallowance of Payment for Settlement of a Patent Infringement Dispute: The primary issue in this appeal concerns the disallowance of Rs. 3,12,57,152 paid by the assessee to settle a dispute with Semco Inc., USA, regarding a patent infringement. The assessee contended that this payment was incurred wholly and exclusively for business purposes and should be allowed as a business expenditure under section 37 of the Income-tax Act, 1961. The Assessing Officer (AO) disallowed the payment, considering it akin to a penalty for patent infringement, which is prohibited by law. The AO argued that since the payment was made to avoid legal expenses and potential conviction, it was not a normal business expense. The AO's decision was upheld by the CIT(A), who emphasized that the infringement of the US Patent Law by the assessee was clear and that the payment was to avoid penal consequences, thus falling under the purview of Explanation to section 37(1). The assessee argued that the payment was compensatory and made to avoid exorbitant litigation costs. The assessee further contended that no court had found them guilty of patent infringement and that the payment was made out of commercial expediency. 2. Application of Explanation to Section 37(1) of the Income-tax Act, 1961: The Explanation to section 37(1) disallows any expenditure incurred for purposes that are an offense or prohibited by law. The CIT(A) held that the payment made by the assessee fell under this Explanation as it was related to an act prohibited by law (patent infringement). The assessee's counsel argued that the terms "offense" and "prohibited by law" should be understood in the context of Indian law and that the infringement of a US patent does not constitute an offense under Indian law. They also argued that the payment was compensatory and not penal in nature. The Tribunal examined the facts and circumstances, including the settlement agreement and the legal advice received by the assessee. It was noted that the settlement was made to avoid litigation costs and uncertainties, and there was no court finding of patent infringement against the assessee. The Tribunal concluded that the payment was not a fine or penalty but a settlement to avoid litigation costs, making it an allowable business expenditure. Conclusion: The Tribunal allowed the appeal, holding that the payment made by the assessee to Semco was not hit by the provisions of Explanation to section 37(1) and was an allowable deduction as a business expenditure. The Tribunal emphasized that the payment was made out of commercial expediency to avoid litigation costs and was not a penalty for any proven offense.
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