2016 (3) TMI 75 - AT - Income Tax

Disallowance of legal costs on account of fees paid to M/s. AZB & Partners - capital gain computation - Held that - The undisputed facts brought before us are that legal fees has been paid to M/s AZB & Partners (advocates and solicitors) for protecting the investment of the assessee with Zandu. Further, an admitted fact is that as a result of the aforesaid legal exercise, the assessee earned larger amount of capital gains as initial open offer of ₹ 7,315/- per share was eventually enhanced to ₹ 16,500/- per share. The totality of facts and circumstances of the case and documentary evidences brought before us clearly suggest that undoubtedly, there was improvement in the value of the asset being shares of Zandu held by the assessee company. During the course of hearing, both the parties fairly agreed that even if impugned expenses may not be allowable as revenue expenses but these were, for sure, aimed for providing enhancement to the value of the shares. Under these circumstances, we do not find any hesitation in holding that these expenses should be added to the cost of shares as cost of improvement. The AO is directed to recompute the amount of capital gain earned by the assessee. - Decided partly in favour of assessee

Summary

Issues Involved:
1. Disallowance of legal expenses under section 14A read with rule 8.
2. Treatment of legal expenses as capital nature instead of business expenses under section 37(1).
3. Allowability of legal expenses as expenses to earn capital gain from transfer of shares.

Issue 1: Disallowance of Legal Expenses under Section 14A:
The appellant challenged the disallowance of Rs. 1,85,10,887 made by the Assessing Officer under section 14A read with rule 8. The legal expenses were incurred to safeguard the investment and business relationship with another company. The appellant approached lawyers and financial advisors to evaluate the maximum value of shares and prevent a takeover at a lower price. The legal fees paid to M/s AZB & Partners were claimed as expenses but were disallowed by the AO under section 14A, stating they were incurred to safeguard investment yielding exempt income. The CIT(A) confirmed the disallowance, leading to the appeal before the Tribunal. The Tribunal noted the genuine nature of the expenses and their relation to the appellant. It was established that the expenses aimed to enhance the value of shares and improve capital gains. Consequently, the Tribunal allowed the appeal, directing the AO to recompute the capital gains.

Issue 2: Treatment of Legal Expenses as Capital Nature:
The appellant contended that the legal expenses should be treated as revenue expenditure or added to the cost of shares for improvement. The AO treated the legal expenses as of capital nature and disallowed them as business expenses under section 37(1). The appellant argued that the expenses were incurred to maintain the business and protect the investment, thus should be allowed as revenue expenditure. The Tribunal, after considering submissions from both sides, concluded that while the expenses may not be allowable as revenue expenses, they were aimed at enhancing the value of shares. Therefore, the expenses were directed to be added to the cost of shares as cost of improvement.

Issue 3: Allowability of Legal Expenses for Capital Gain:
The appellant sought to allow the legal expenses as expenses incurred wholly and exclusively to earn capital gain from the transfer of shares. The Tribunal acknowledged the purpose of the expenses in increasing the capital gains income by enhancing the value of shares through legal interventions. It was established that the expenses were genuine and related to the appellant. The Tribunal held that the expenses should be added to the cost of shares for improvement, leading to the allowance of ground number 3 while dismissing grounds 1 and 2.

In conclusion, the Tribunal partially allowed the appeal, emphasizing the genuine nature of the legal expenses, their relation to the appellant, and their role in enhancing the value of shares to improve capital gains. The judgment highlighted the importance of considering the purpose and impact of expenses in determining their treatment for tax purposes.