2014 (7) TMI 83 - AT - Income Tax

Disallwance u/s 37 of payment made to job worker / related parties - consideration paid without obtaining prior approval of the Central Government in accordance with the provisions of section 297 of the Companies Act, 1956 - assessee submitted that the post facto approval for the transactions with the related parties undertaken during the year, was obtained from the Company Law Board on payment of compounding charges for the condonation of delay and hence there was no violation of law - Manufacture and export of surgical blades Whether it can be said that the assessee incurred an expenditure for any purpose which is an offence or which is prohibited by law - Held that - If the 'purpose' of expenditure is not to commit an offence or is otherwise not prohibited by law, then any breach of some procedural statutory provision necessary to be complied with before incurring such expenditure, would not per se convert the otherwise lawful purpose into an offence or prohibition under law so as to attract the wrath of the Explanation - A line of distinction needs to be drawn between the cases where the purpose of the expenditure incurred itself is unlawful on one hand and the cases where the purpose of expenditure is lawful but there is some lapse in complying with the procedural provisions for incurring such expenditure on the other. Relying upon CIT v. Dhanpat Rai & Sons 2014 (1) TMI 1086 - PUNJAB & HARYANA HIGH COURT - the expenditure has been instantly disallowed on account of job work charges paid by the assessee to M/s Razormed Inc. - when the language of the Explanation is crystal clear and does not encompass the incurring of expenses for a lawful purpose, such as the job charges, within its ambit, it is wholly impermissible to import a further requirement in the language of the Explanation to make the otherwise lawful purpose as unlawful for lack of the prior approval of the Central Government - the 'purpose' of incurring the expenditure of job charges is neither an offence nor is prohibited by law, we fail to comprehend as to how the otherwise lawful purpose would become contingent upon obtaining or not obtaining the prior approval of the Central Government - such expenditure in itself is neither an offence nor prohibited by any law and there is a valid and lawful quid pro quo for the same - CIT(A) erred in sustaining the disallowance of ₹ 41.24 lac incurred on payment of job work charges Decided in favour of Assessee.

Summary

Issues Involved:
1. Confirmation of addition of Rs. 41,24,129/- for job work charges paid to a related party without prior approval from the Central Government.
2. Applicability of Explanation to section 37(1) of the Income-tax Act, 1961.

Detailed Analysis:

Issue 1: Confirmation of Addition of Rs. 41,24,129/-
The assessee, engaged in the manufacture and export of surgical blades, entered into transactions with M/s Razormed Inc., a related party, without obtaining prior approval from the Central Government as required under section 297 of the Companies Act, 1956. The Assessing Officer (AO) disallowed the job work charges of Rs. 41,24,129/- on the grounds that the necessary approval was not obtained at the time of payment, invoking the Explanation to section 37(1) of the Income-tax Act, 1961. The CIT (A) upheld this disallowance.

Issue 2: Applicability of Explanation to Section 37(1)
The Tribunal examined whether the disallowance was justified under the Explanation to section 37(1), which disallows any expenditure incurred for purposes that are an offence or prohibited by law. The Tribunal noted that section 297 of the Companies Act, 1956, requires prior approval for transactions with related parties but also provides that if such approval is not obtained, the contract is voidable at the option of the Board, not void ab initio. Since the Board did not object to the contract, it was valid under sub-section (5) of section 297.

The Tribunal further analyzed the Explanation to section 37(1) and concluded that the disallowance applies only if the purpose of the expenditure is an offence or prohibited by law. In this case, the payment for job work was lawful, and the lack of prior approval was a procedural lapse, not an unlawful purpose. The Tribunal emphasized that a deeming provision like the Explanation to section 37(1) should be strictly construed and not extended beyond its express language.

The Tribunal cited various judgments, including CIT v. Amarchand N. Shroff and CIT v. Ace Builders P. Ltd., to support the principle that a deeming provision should not be extended beyond its legitimate field. It concluded that since the purpose of the expenditure (job work charges) was lawful and not an offence or prohibited by law, the disallowance under the Explanation to section 37(1) was not applicable.

Conclusion:
The Tribunal overturned the CIT (A)'s order and deleted the disallowance of Rs. 41,24,129/-, holding that the expenditure was lawful and not disallowable under the Explanation to section 37(1) of the Income-tax Act, 1961. The appeal was allowed.