CPT V24P7-Art1 (Content).pmd - Taxmann

Direct Tax Laws
as deduction under section 37(1), if the same
is against the law and prohibited by law or
where expenditure incurred by an assessee is
not wholly and exclusively for the business
purpose of the assessee.
Now the question arises to what extent and
under what circumstances can the expenditure
incurred in a criminal proceeding or other
litigation related to any business be allowed
as deduction under section 37(1)? This article
attempts to outline and consolidate the principles
to be kept in mind for deciding as to whether
certain expenditure on litigation can be allowed
as deduction under the scheme of the Act?
EXPENDITURE WHEN DEDUCTIBLE?
2. Profits and gains of business expenditure,
in the commercial sense, whether specifically
provided for or not, may also be deducted
under section 37(1) itself. 2 An amount would
be deductible under section 37(1) only where
it is an expenditure connected with or arising
out of trade or is a commercial loss. 3 To be
deductible, a business expense must be both
ordinary and necessary, though need not be
indispensible to be considered necessary.
Legitimacy or necessity for expenditure cannot
be probed into. 4
To be an allowable expenditure under section
37(1), the money paid out or away must be:
(a) paid out wholly and exclusively for the
purpose of the business or profession; and
further, (b) must not be: (i) capital expenditure;
(ii) personal expense; or (iii) an allowance of
the character described in sections 30 to 36
and section 80VV. 5 Apart from these prequalifications,
the expenditure should not be
caught by the mischief of the Explanation to
section 37(1).
EXPENDITURE INCURRED ON
DEFENDING EMPLOYEES IN CRIMINAL
PROCEEDINGS
3. In J.N. Singh & Co. (P) Ltd. v. CIT 6 , it has
been held that the expenditure incurred to
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defend assessee’s employee against criminal
prosecution with regard to a transaction carried
out in the ordinary course of business will be
business expenditure and allowable as deduction.
In J.B. Advani & Co. Ltd. v. CIT 7 and Excess
Profits Tax, the assessee was a trading Private
Ltd. Company in which Director had a controlling
interest. The assessee’s director and manager
were prosecuted for offences under the Hoarding
and Profiteering Prevention Ordinance and
Defence of India Rules. The expenses incurred
in “successfully defending” them were held to
have been incurred wholly and exclusively for
the purpose of assessee’s business and were
allowable deductions under section 10(2)(xv)
of the Indian Income-tax Act, 1922.
In CIT v. National Rayon Corpn. Ltd. 8 it has
been held that where the assessee is an individual
or a firm and incurs expenditure in defending
the assessee-owner or a partner, it incurs the
expenditure not wholly and exclusively for its
business. The company protects its business
interests and goodwill in such situations and
the expenditure could be said to be wholly
and exclusively incurred for the purposes of
its business.
In I.C.B. Ltd. v. ITO [2005] 93 ITD 418 (Mum.)
the expenditure was incurred to defend the
employees from criminal proceeding. It was
held that the criminal act, did not seem to be
for the purpose of ‘carrying on assessee’s
business, nor did the same seem to be incidental
thereto. Incurring of expenditure for defending
an employee from criminal proceeding/
prosecution for activities which are violative
of or in contravention of the provisions of law
tantamounts to incurring of expenditure for a
purpose which is an offence or which is
prohibited by law. Under Explanation to section
37(1), the same shall be deemed to have not
been incurred for the purpose of business or
profession and, in turn, no deduction in respect
of such an expenditure will be allowable. Relying
on Haji Aziz & Abdul Shakoor Bros. v. CIT
[1961] 41 ITR 350 (SC) decision, the expenditure
was not allowed as deduction.