2016 (7) TMI 948 - AT - Income Tax

Disallowance towards compounding fees paid by the assessee to the Reserve Bank of India - Held that - Such a compounding fees charged to the assessee being compensatory in nature as is evident from the fact that though the amount to be charged could be up to ₹ 30.25 crores, the assessee was asked to pay sum of ₹ 45 lakhs in order to meet the ends of justice, established the case of assessee that the same was not in the form of penalty. Where the amount paid by the assessee is compensatory payment and was not by way of any penalty levied under the provisions of FEMA, then such amount is to be allowed as deduction in the hands of assessee. Coming to the stand of authorities below that such payment is covered by Explanation to section 37(1) of the Act. We find no merit in the said stand of CIT(A). The Explanation to section 37(1) of the Act was inserted in respect of any expenditure incurred for any purpose which was an offence or which was prohibited by law. The Circular of Reserve Bank of India itself provided that where the assessee had committed an irregularity while dealing in foreign earnings or expenditure outgoes, then such an action of applicant could be compounded as per Rules and Regulations provided in the said Circular. It is not a case where the assessee has been held to have committed an offence or the amount has been paid for purpose, which was prohibited in law, hence the provisions of Explanation to section 37(1) of the Act are not attracted. In view thereof, we hold that the assessee is entitled to the claim of deduction under section 37(1) of the Act. - Decided in favour of assessee

Summary

Issues Involved:
1. Disallowance of ?45,00,000/- paid to the Reserve Bank of India towards compounding fee.
2. Applicability of Explanation to section 37(1) of the Income-tax Act, 1961.

Issue-wise Detailed Analysis:

1. Disallowance of ?45,00,000/- paid to the Reserve Bank of India towards compounding fee:

The assessee, engaged in the business of development and selling of real estate, faced scrutiny after search and seizure operations on 11.09.2009. During the assessment proceedings, the Assessing Officer (AO) questioned the ?45 lakhs paid to the Reserve Bank of India (RBI) as compounding fees for obtaining External Commercial Borrowings (ECBs) from Porto Limited, Mauritius, which was not a recognized lender under FEMA guidelines. Despite the assessee's claim that the borrowing was made in good faith and the RBI had granted initial permission, the AO disallowed the expenditure, considering it a penalty for non-compliance with FEMA regulations.

The CIT(A) upheld the AO's decision, stating that the compounding fees fell within the mischief of Explanation to section 37(1) of the Act, which disallows any expenditure incurred for purposes that are an offence or prohibited by law.

2. Applicability of Explanation to section 37(1) of the Income-tax Act, 1961:

The assessee argued that the compounding fees were compensatory and not penal. The compounding was due to a technical default where the lender was not recognized, despite initial RBI approval. The RBI's compounding order, as per the assessee, indicated that the fees were compensatory, not penal, and thus should be deductible under section 37(1) of the Act.

The Tribunal examined the RBI's compounding order, which noted that the contravention involved raising ECBs without prior approval, with a potential penalty up to ?30.25 crores. However, considering the circumstances, the RBI compounded the contravention for ?45 lakhs to meet the ends of justice. The Tribunal concluded that the compounding fees were compensatory, not penal, and thus deductible.

The Tribunal also addressed the applicability of Explanation to section 37(1), which disallows expenditures for purposes that are offences or prohibited by law. It clarified that the RBI's compounding mechanism under FEMA does not equate to an offence or prohibition under law, thus the Explanation to section 37(1) was not applicable.

Conclusion:

The Tribunal held that the ?45 lakhs paid as compounding fees to the RBI was compensatory and deductible under section 37(1) of the Act. The appeal of the assessee was allowed, and the AO was directed to allow the claim. The reliance on the Pune Bench decision in Modi Builders Vs. JCIT was distinguished, as the facts differed significantly, particularly regarding the nature of the compounding fees and the regulatory framework involved.