2017 (3) TMI 1183 - HC - Income Tax

Deduction under Section 37 - legal fee and expenses incurred towards Professional Indemnity Insurance - legal fee paid was more than the compensation received - Held that - The test to be employed for examining as to whether or not a particular expenditure incurred by an Assessee, be allowed, is that, which is, provided in Section 37 itself. Therefore, what is required to be ascertained is, whether or not, the expenditure in issue is laid out or incurred wholly and exclusively for the purpose of business, and that, it is not an expenditure, which is described under Sections 30 to 36 of the Act, or an expenditure in the nature of capital expenditure or, if, an Assessee is an individual, it involves defrayment of personal expenses. In ascertaining as to whether the expenditure has been laid out or expended wholly and exclusively for the purpose of business, what is to be borne in mind, is that, it is incurred on account of commercial expediency of the Assessee. The fact that the expenditure incurred by an Assesseee is not propelled on account of any legal obligation, or that, it benefits a third party, would not come in the way of it being allowed, as long as it is incurred due to commercial expediency. As to what is commercial expediency is to be looked at by Income Tax Authorities by placing themselves in the shoes of a prudent business person. Further, the fact that a particular expense does result in a profit for the Assessee in the immediate proximity cannot form the basis of its disallowance. In incurring an expense, a business person could have a short and a long term perspective. The fact that in the short term the expense incurred does lead to a profit, cannot rule out the possibility of accretions of profits to the Assessee in the long run. These are business decisions best left to the wisdom of those who run and manage the business. Therefore, as long an expense is incurred, wholly and exclusively for the purpose of the business carried on by the Assessee, it ought to be, ordinarily, allowed under Section 37 of the Act. (See Sassoon J. David & Co. (P) Ltd., V. CIT, (1979 (5) TMI 3 - SUPREME Court)). Thus, if, the aforesaid principles are applied, it is clear that notwithstanding the fact that the legal fee paid was more than the compensation received by the Assessee, the same, was amenable for deduction under Section 37 of the Act. Likewise, in so far as the expense incurred towards Provisional Indemnity Insurance was concerned, it could not have been disallowed, merely, by reason of the fact that Hammonds, U.K., was required to take out the insurance. - Decided in favour of assessee.

Summary

Issues:
1. Disallowance of expenditure claimed by the Assessee for legal fee and Professional Indemnity Insurance.
2. Whether the legal fee and insurance expenses can be allowed as deductions under Section 37 of the Income Tax Act, 1961.

Analysis:
The judgment of the Madras High Court pertains to an appeal against the Income Tax Appellate Tribunal's decision regarding the Assessment Year 2006-07. The main issue before the Tribunal was whether the order of the Commissioner of Income Tax (Appeals) reversing the findings of the Assessing Officer on the disallowance of legal fee and insurance expenses should be sustained. The Assessing Officer disallowed the deduction claimed by the Assessee for legal fees and Professional Indemnity Insurance, stating that the legal fees were exorbitant compared to the compensation received. The CIT(A) reversed this decision, allowing the expenses under Section 37(1) of the Act.

The CIT(A) held that the legal fees were incurred to protect the source of income and maintain title to capital assets, making them a valid business expense. The Assessing Officer's conversion of foreign currency into Indian Rupees was deemed incorrect, as the expenses were reasonable under UK Standards. Additionally, the mode of payment through a personal account was considered genuine by the CIT(A). The Tribunal upheld the CIT(A)'s decision, emphasizing the commercial expediency of the expenses.

The High Court noted that the legal fees were justified as the Assessee was protecting its rights in a registered software, which could generate revenue. Comparing the legal fees to the compensation received was deemed fallacious, and the genuineness of the transaction was affirmed. The Court highlighted the principles of commercial expediency in allowing business expenses under Section 37, emphasizing that expenses incurred for business purposes should be permitted, even if they exceed immediate profits. The appeal was dismissed, with no substantial question of law identified.

In conclusion, the judgment affirms the allowance of legal fee and insurance expenses as deductions under Section 37, emphasizing the commercial necessity and business purpose of the expenditures. The decision underscores the importance of assessing expenses based on commercial expediency and business requirements rather than immediate profitability.