2013 (7) TMI 739 - HC - Income Tax

Disallowance u/s 40A(2) - Addition made on 50% amount - Tribunal deleted addition - Held that - any expenditure laid out or expended wholly and exclusively for the purposes of the business or profession shall be allowed in computing the income chargeable under the head Profits and gains of business or profession - agreement between the assessee and the subsidiary company is not in dispute - subsidiary company was not able to comply with or perform its part of the contract. Merely because, a subsidiary company did not fulfil its obligations, that will not render the transaction illegal and consequently, it cannot be held that the expenditure laid out or incurred is not wholly for the business of the assessee-company - Following decision of Commissioner of Income-tax Versus V. S. Dempo and Co. P. Ltd. 2010 (10) TMI 711 - Bombay High Court - Decided against Revenue.

Summary

Issues:
1. Disallowance of expenditure under Section 40A(2)(b) of the Income Tax Act.
2. Interpretation of the provisions of Section 40A(2) in relation to expenditure incurred by the assessee.
3. Application of Section 37(1) of the Income Tax Act regarding expenditure laid out for business purposes.

Issue 1: Disallowance of Expenditure under Section 40A(2)(b) of the Income Tax Act:

The case involved an appeal by the revenue challenging the Tribunal's decision to delete the disallowance of expenditure claimed by the assessee. The assessee had entered into an agreement with a subsidiary company for the manufacture of footwear soles. The Assessing Officer disallowed Rs. 24,00,000 under Section 40A(2)(b) of the Income Tax Act, which was confirmed by the appellate authority. However, the Tribunal found no reason to allow only 50% of the claimed expenditure and directed the deletion of the disallowance. The revenue contended that the payment made by the assessee was excessive as the subsidiary company had incurred lesser costs. The Tribunal, however, held that the genuineness of the agreement and the services rendered were not in doubt, and there was no evidence to show that the payment was excessive. Therefore, the Tribunal allowed the appeal and permitted the deletion of the disallowance.

Issue 2: Interpretation of the Provisions of Section 40A(2) in Relation to Expenditure Incurred by the Assessee:

The Court analyzed Section 40A(2) which allows the disallowance of expenditure if the Assessing Officer deems it excessive or unreasonable. In this case, the payment was made to a subsidiary company and not to any director or relative, as required by the provision. Citing a judgment by the Bombay High Court, it was established that a subsidiary company does not fall under the related persons mentioned in the clause. Additionally, it was argued that the expenditure could be allowed under Section 37(1) if it was laid out wholly and exclusively for business purposes. The Court found that the subsidiary company's failure to fulfill its obligations did not render the transaction illegal, and the expenditure was incurred for the business of the assessee. The profit margin of the subsidiary company was not taken into account, and the Tribunal's decision to delete the disallowance was upheld.

Issue 3: Application of Section 37(1) of the Income Tax Act Regarding Expenditure Laid Out for Business Purposes:

Section 37(1) allows the deduction of expenditure laid out wholly and exclusively for business purposes. The revenue argued that since the subsidiary company's actual expenditure was less than the amount paid by the assessee, the disallowance was justified. However, the Court found that the payment was made as per the agreement, and the subsidiary company faced challenges that affected its performance. The Court held that the expenditure was for the business of the assessee, considering the circumstances, and upheld the Tribunal's decision to delete the disallowance. The substantial question of law was answered in favor of the assessee, and the appeal by the revenue was dismissed.

This detailed analysis of the judgment highlights the key legal issues, interpretations of relevant provisions, and the Court's reasoning behind upholding the Tribunal's decision in favor of the assessee.