1992 (1) TMI 86 - HC - Income Tax

Business Expenditure, Deduction U/S 36(1)(viii), Disallowance, Entertainment Expenditure, Financial Corporation, Special Reserve

Summary

Issues Involved:
1. Computation of deduction under section 36(1)(viii) of the Income-tax Act, 1961.
2. Disallowance of expenditure as entertainment expenditure under section 37(2A) of the Income-tax Act, 1961.

Detailed Analysis:

Issue 1: Computation of Deduction under Section 36(1)(viii)
The primary controversy revolves around the computation of total income for the purpose of allowing a 40% deduction under section 36(1)(viii) of the Income-tax Act, 1961. The Income-tax Officer (ITO) allowed the deduction before deduction under Chapter VI-A but after all other deductions. The Commissioner of Income-tax (Appeals) ("the Commissioner") and the Tribunal held that the deduction should be computed on the total income before any deductions under Chapter VI-A and section 36(1)(viii).

Section 36(1)(viii) as it stood at the relevant time specified that the deduction should be based on the total income before making any deduction under Chapter VI-A. The Revenue argued that all deductions except those under Chapter VI-A should be made first. However, the court found this interpretation difficult to comprehend and stated that once the deduction under section 36(1)(viii) is worked out, it gets exhausted. The court emphasized that the total income for the purpose of section 36(1)(viii) should be computed before any deductions under that section and Chapter VI-A.

The court disagreed with the Karnataka High Court's decision in Karnataka State Financial Corporation v. CIT [1988] 174 ITR 206, which supported the Revenue's view. Instead, the court aligned with the decisions of the Patna High Court, Andhra Pradesh High Court, Madhya Pradesh High Court, and Kerala High Court, which supported the assessee's interpretation. The court concluded that the deduction under section 36(1)(viii) should be worked out by applying the proper percentage to the total income computed before making any deduction under that clause and Chapter VI-A. Thus, question No. 1 was answered in the affirmative and against the Revenue.

Issue 2: Disallowance of Expenditure as Entertainment Expenditure
The second issue concerned the disallowance of Rs. 49,832 as entertainment expenditure under section 37(2A) of the Income-tax Act. The ITO disallowed this amount, considering it as entertainment expenditure. The Commissioner and the Tribunal, however, found that the expenditure was not high or lavish and was incurred in providing tea, coffee, and refreshments to staff and customers in the normal course of business.

The court referred to its earlier decision in CIT v. Patel Brothers and Co. Ltd. [1977] 106 ITR 424, which held that such expenses could not be considered entertainment expenditure if they were not lavish. Given the factual findings by the lower authorities and the precedent set by Patel Brothers, the court upheld the Tribunal's decision that no part of the Rs. 49,832 could be disallowed as entertainment expenditure. Consequently, question No. 2 was answered in the affirmative and against the Revenue.

Conclusion:
Both issues were resolved in favor of the assessee. The court affirmed that the deduction under section 36(1)(viii) should be computed on the total income before any deductions under Chapter VI-A and that the expenditure of Rs. 49,832 was not disallowable as entertainment expenditure. The reference was answered accordingly, with no order as to costs.