2025 (4) TMI 216 - HC - Income Tax

Deduction u/s 36(1)(viii) - special reserve created in an amount not exceeding 20% of the profit derived from eligible business - HELD THAT - We are of the view that no exception can be taken to the methodology followed by the assessee in its return which was sustained by the First Appellate Authority and the Appellate Tribunal in appeal for the purposes of computation of deduction u/s 36(1)(viii). It is the admitted position that the accounts maintained by the assessee did not show the actual expenditure incurred for the purposes of earning the income for the eligible business. As already noticed the assessee s accounts showed the figures relating to gross income of the entire business and the gross expenditure incurred for earning the said gross income from the entire business. The accounts also showed the gross income earned in respect of the eligible business. The only figure that was not discernible from the accounts was the gross expenditure incurred for the eligible business. It was under these circumstances that the assessee had computed the proportionate expenses for the eligible business by taking the ratio of the income earned and expenditure incurred in respect of the entire business and applying the said ratio to the income earned in respect of the eligible business. The resulting figure representing the proportionate expenditure for the eligible business was reduced from the income earned in respect of the eligible business to arrive at the profit of the eligible business. Thereafter 20% of that figure was taken for the purposes of deduction under Section 36(1)(viii) of the I.T. Act. Decided in favour of assessee.

Summary

ISSUES PRESENTED and CONSIDERED

The core legal questions considered in this judgment involve the interpretation and application of Section 36(1)(viii) of the Income Tax Act concerning the computation of deductions for a special reserve created by a banking company. The specific issues are:

(i) Whether the Tribunal correctly computed the quantum of deduction under Section 36(1)(viii) of the Income Tax Act.

(ii) Whether the Tribunal's interpretation and understanding of Section 36(1)(viii) were correct.

(iii) Whether the Tribunal erred in not considering the absence of separate books of accounts for eligible business, which could lead to non-eligible expenses being included in the computation of net income from eligible business.

ISSUE-WISE DETAILED ANALYSIS

Issue (i) and (ii): Computation and Interpretation of Deduction under Section 36(1)(viii)

Relevant legal framework and precedents: Section 36(1)(viii) of the Income Tax Act allows a deduction for a special reserve created by financial institutions, not exceeding 20% of the profits derived from eligible business. The provision aims to incentivize financial institutions to allocate profits towards reserves.

Court's interpretation and reasoning: The Court upheld the methodology used by the assessee to compute deductions under Section 36(1)(viii). The assessee did not maintain separate accounts for the eligible business but estimated expenses by applying the ratio of total business expenses to income. This estimation was deemed acceptable as the accounts showed gross income and expenses for the entire business, and the only missing figure was the expenditure for the eligible business.

Key evidence and findings: The accounts maintained by the assessee displayed gross income and expenditure for the entire business, including gross income from eligible business. The lack of specific expenditure figures for eligible business led to the use of a proportional estimation method.

Application of law to facts: The Court found that the assessee's method of estimating expenses for eligible business by applying a ratio derived from the entire business was reasonable and consistent with the objectives of Section 36(1)(viii). This method ensured that only the proportionate expenses were deducted from the gross income of the eligible business to determine the profit, from which the 20% deduction was calculated.

Treatment of competing arguments: The Revenue argued that the absence of separate accounts could lead to inaccuracies in the computation of net income from eligible business. However, the Court found that the estimation method used by the assessee was a logical approach given the circumstances and was consistent with the statutory framework.

Conclusions: The Court concluded that the assessee's methodology for computing deductions under Section 36(1)(viii) was valid and upheld the decisions of the First Appellate Authority and the Appellate Tribunal.

Issue (iii): Absence of Separate Books of Accounts

Relevant legal framework and precedents: The Income Tax Act does not explicitly require separate books of accounts for eligible business when claiming deductions under Section 36(1)(viii), but accurate computation of profits is necessary.

Court's interpretation and reasoning: The Court determined that while separate books of accounts could provide clarity, the estimation method used by the assessee was sufficient to ensure accurate computation of profits for eligible business.

Key evidence and findings: The assessee's accounts provided comprehensive details of gross income and expenses for the entire business, allowing for a reasonable estimation of eligible business expenses.

Application of law to facts: The Court applied the principle that in the absence of specific statutory requirements for separate accounts, a reasonable estimation method that aligns with the statutory purpose is acceptable.

Treatment of competing arguments: The Revenue's argument that non-eligible expenses could be included in the computation was addressed by the Court's acceptance of the proportional estimation method as a valid approach.

Conclusions: The Court concluded that the absence of separate accounts did not invalidate the assessee's deduction claim, as the estimation method used was justified and accurate for the purpose of Section 36(1)(viii).

SIGNIFICANT HOLDINGS

The Court held that the methodology employed by the assessee for computing deductions under Section 36(1)(viii) was valid. The Court emphasized that in the absence of specific expenditure figures for eligible business, a proportional estimation method based on total business figures was appropriate. The Court stated, "We see no reason to take a different view from what was expressed by the First Appellate Authority and the Appellate Tribunal while sustaining the claim of the assessee."

The core principles established include the acceptance of proportional estimation methods for computing deductions under Section 36(1)(viii) when separate accounts are not maintained, provided they align with statutory objectives and ensure accurate profit computation.

The final determination was that the Revenue's appeal was dismissed, and the questions of law were answered in favor of the assessee, affirming the decisions of the lower authorities.