2006 (1) TMI 72 - HC - Income Tax

Expenditure prohibited by law - assessee had received deposits from its members and as against this, the assessee had distributed articles by way of gift/free present items and under this scheme, the assessee could retain a sum of Rs. 14,65,729 for a period of five years, use it the way she wants it, and return thereafter the depositors money without any interest. In our view, this scheme has all the basic ingredients of a money circulation scheme, which is banned under section 3 of the Prize Chits and Money Circulation Schemes (Banning) Act, 1978, and therefore, the expenditure incurred by the assessee is an expenditure prohibited by law and therefore, in view of the Explanation inserted by the Finance (No. 2) Act, 1998 to section 37(1), which has come into force with effect from April 1, 1962, the expenditure shall not be deemed to have been incurred for the purpose of business and therefore, no deduction or allowance can be made in respect of such expenditure in computing the income chargeable under the head Profits and gains of business or profession . - One cannot travel outside the provisions of the Income-tax Act and deny the benefit of deduction under that section on the ground that the payment is unauthorised or has been prohibited by some statute.

Issues Involved:
1. Whether the "deposit linked incentive scheme" floated by the assessee constitutes a "money circulation scheme" prohibited by law.
2. Whether the expenditure incurred under the scheme can be allowed as a revenue expenditure under section 37 of the Income-tax Act, 1961.
3. Whether the matter requires remand to the Tribunal due to the retrospective amendment to section 37 by the Finance (No. 2) Act, 1998.

Detailed Analysis:

Issue 1: Whether the "deposit linked incentive scheme" constitutes a "money circulation scheme" prohibited by law.

The assessee launched a "deposit linked incentive scheme" to raise additional funds, where members deposited money and received goods worth 75% of the deposit as a gift, with the deposit being refundable after 5 to 10 years without interest. The Revenue argued that this scheme was a "money circulation scheme" prohibited by law, referencing the Supreme Court case of Registrar of Firms, Societies and Chits v. Secured Investment Co., which deprecates such schemes. The court examined whether the scheme met the definition of a "money circulation scheme" under the Prize Chits and Money Circulation Schemes (Banning) Act, 1978. The court found that the scheme involved collecting deposits, giving gifts worth 75% of the deposit, and retaining the remaining 25% for five years without interest. This arrangement was deemed to meet the criteria of a "money circulation scheme," which is banned under the Act.

Issue 2: Whether the expenditure incurred under the scheme can be allowed as a revenue expenditure under section 37 of the Income-tax Act, 1961.

The assessee claimed the expenditure on the goods given as incentives as a revenue expenditure under section 37 of the Income-tax Act, 1961. The first appellate authority allowed the claim, stating that the expenditure was incurred wholly and exclusively for business purposes. The Tribunal upheld this view. However, the Revenue contended that the expenditure was not allowable due to the retrospective amendment to section 37 by the Finance (No. 2) Act, 1998, which disallows expenditures incurred for purposes prohibited by law. The court agreed with the Revenue, stating that the scheme was prohibited by law, and thus, the expenditure could not be allowed as it was deemed not to have been incurred for business purposes per the amended section 37.

Issue 3: Whether the matter requires remand to the Tribunal due to the retrospective amendment to section 37 by the Finance (No. 2) Act, 1998.

The Revenue argued that the matter need not be remanded to the Tribunal because the High Court could decide the issue based on the retrospective amendment to section 37. The court cited the Supreme Court's decision in CST v. Bijli Cotton Mills and its own decision in Sterling Foods v. CIT, which held that when the law is amended with retrospective effect, the High Court must apply the amended law. Therefore, the court concluded that it could decide the issue without remanding the matter to the Tribunal.

Conclusion:

The court concluded that the "deposit linked incentive scheme" floated by the assessee was a "money circulation scheme" prohibited by law. Consequently, the expenditure incurred under the scheme could not be allowed as a revenue expenditure under section 37 of the Income-tax Act, 1961, due to the retrospective amendment by the Finance (No. 2) Act, 1998. The court also determined that there was no need to remand the matter to the Tribunal. The reference proceedings were disposed of in favor of the Revenue and against the assessee.

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