2009 (3) TMI 225 - AT - Income Tax

Disallowance on Payment of grants and royalty - Whether such grants constituted an expenditure as envisaged in s. 37(1) or could be allowed u/s. 36(1)(xii) - Grants given by the assessee to various entities and royalty to State Government - HELD THAT - It can be seen that s. 37 deals with expenditure in general referred to here for brevity as business expenditure. It lays down that any expenditure not being expenditure of the nature described in s. 30 to s. 36 and not being in the nature of capital expenditure or personal expenses of the assessee laid out or expended wholly and exclusively for the purpose of business or profession shall be allowed in computing the income chargeable under the head Profits and gains of business or profession . Essential and positive condition of allowance is that the expenditure should have been laid out or expended wholly and exclusively for the purpose of such business. Therefore the expenses which are permitted as deduction are such as are made for the purpose of carrying on the business i.e. to enable a person to carry on and earn profit in that business. It is not enough that the disbursements are made in the course of or arise out of or are concerned with or made out of the profit of the business but that must also be for the purpose of earning profits of the business and reference can be made to the decision of Hon ble Supreme Court in the case of Haji Aziz Abdul Shakoor Brothers vs. CIT 1960 (11) TMI 15 - SUPREME COURT . The grants given by the assessee even though they are in accordance with the objects stated in the Act and even if they are made or disbursed as per directions of Central Government and in the public interest but the same does not fulfill the criteria as laid down in the s. 37 to come within the purview of allowability as the same cannot be said to be an expenditure incurred wholly and exclusively for the purpose of business. Therefore. the claim of the assessee that these grants should be allowed u/s. 37(1) cannot be accepted and is liable to be rejected. Accordingly rejected. Whether such grants can be called to be capital expenditure so as to exclude these expenditures from the ambit of s. 36(1)(xii) - According to well-established law capital expenditure is an expenditure which is made for acquiring or bringing into existence an asset or advantage for the enduring benefit of the assessee. Thus the primary condition to bring such grants to be termed as capital expenditure is that it should be made for acquiring or bringing into existence an asset or advantage for the enduring benefit of the business of the assessee and reference in this regard can be made to the decision of Full Bench in the case of Praga Tools Ltd. vs. CIT 1979 (11) TMI 80 - ANDHRA PRADESH HIGH COURT . In the present case the grants and royalty paid to State Government and claimed under the head Expenses on direct operations/grants cannot be said to be for acquiring or bringing into existence an asset or advantage for the enduring benefit of the business of the assessee as by making such grants assessee has not acquired any asset and such grants have not brought any advantage of enduring benefit to the assessee. Therefore these grants and payment of royalty cannot be called to be capital expenditure incurred by the assessee. Therefore it has to be held that these grants and payment of royalty are allowable u/s. 36(1)(xii) as assessee has fulfilled all the conditions specified in that section. To conclude it is held that these grants and payment of royalty claimed under the head Expenses on direct operations/grants are not allowable u/s. 37(1) but they are allowable u/s. 36(1)(xii).

Issues Involved:
1. Applicability of Section 36(1)(xii) of the Income Tax Act, 1961.
2. Assessment of income and disallowance of expenditure.
3. Deductibility of grants as business expenditure under Section 37(1) of the Income Tax Act, 1961.
4. Classification of grants as capital expenditure.
5. Application of Section 234B regarding interest calculations.

Issue-wise Detailed Analysis:

1. Applicability of Section 36(1)(xii) of the Income Tax Act, 1961:
The assessee contended that the grants made should be allowed as a deduction under Section 36(1)(xii). The Tribunal noted that Section 36(1)(xii) was introduced by the Finance Act, 2003, and further amended by the Finance Act, 2007. The section allows deductions for expenditures incurred by a corporation or body corporate established by a Central, State, or Provincial Act for the objects and purposes authorized by the Act under which such corporation or body corporate was constituted or established. The Tribunal concluded that the grants and royalty payments made by the assessee are allowable under Section 36(1)(xii) as they fulfill the conditions specified in the section, including not being capital expenditure and being incurred for the objects and purposes authorized by the Act.

2. Assessment of Income and Disallowance of Expenditure:
For the assessment years 2003-04 and 2004-05, the AO assessed the income at amounts significantly higher than what the assessee had returned. The AO disallowed the expenditure claimed by the assessee, considering it as grants in aid and not allowable as a deduction under Section 37(1). The Tribunal noted that the primary issue was the deductibility of grants as an expenditure.

3. Deductibility of Grants as Business Expenditure under Section 37(1):
The assessee argued that the grants should be considered as business expenditure under Section 37(1) since they were incurred in the course of business. However, the Tribunal held that the grants did not fulfill the criteria under Section 37(1) as they were not incurred wholly and exclusively for the purpose of business. The Tribunal emphasized that for an expenditure to be deductible under Section 37(1), it must be laid out wholly and exclusively for the purpose of the business, which was not the case here.

4. Classification of Grants as Capital Expenditure:
The Tribunal examined whether the grants could be classified as capital expenditure. It concluded that the grants and royalty payments did not result in acquiring any asset or advantage of enduring benefit to the assessee's business. Therefore, these expenditures could not be classified as capital expenditure and were allowable under Section 36(1)(xii).

5. Application of Section 234B Regarding Interest Calculations:
The assessee contended that the provisions of Section 234B, which deals with interest for default in payment of advance tax, were not applicable in their case. The Tribunal did not address this issue in detail, as only the issue regarding the deductibility of grants was permitted to be contested by the Committee on Disputes (COD).

Conclusion:
The Tribunal concluded that the grants and royalty payments claimed under the head "Expenses on direct operations/grants" were not allowable under Section 37(1) but were allowable under Section 36(1)(xii). The appeals were partly allowed in favor of the assessee to the extent of allowing the deductions under Section 36(1)(xii). Other grounds raised by the assessee were dismissed as they were not permitted to be contested by the COD.

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