INTRODUCTION
Income generated under the head of ‘profit and gains of business or profession’ turns out to be the biggest source of revenue generation for the government of India.[1] The Income Tax Act, 1961 under section 37 provides for deductions of business expenditure under the same head while computing taxable income. It excludes from its scope any expenditure that is defined under section 30 to 36 of the Act; is in the nature of revenue or has been expended wholly and exclusively for the purposes of business or profession i.e. is not in personal nature.’[2]
It is due to this reason the subject of what constitutes a business gain and business expenditure is important for the assesse because in most cases the assesse trues to expand the scope of business expenditure in a way more beneficial for him as compared to the tax department. The more stringent and onerous interpretation of the sections tends to increase the chances of tax avoidance as it is deemed to be the inherent outcome of a strict and exhaustive regulation. However through various judgments the court has attempted to define the scope of what constitutes business expenditure under section 37 of the Income Tax Act.
The objective of this research paper is to briefly analyse the statutory interpretation of section 37 of the Income Tax Act, 1961. The second part of the project will examine the meaning and extent of the term expenditure used invariably under the section through various case laws. Lastly the author shall examine the difference between what constitutes a personal expenditure and does not come under the precondition of section 37.
THE STATUTORY UNDERSTANDING OF SECTION 37
“Clause 1 of Section 37 of the Income Tax Act lays down some pre-conditions for an expenditure to be incurred in the nature of business that is:
1. such expenditure shall not fall under the specific section i.e. sections 30 to 36
2. should not be in capital nature
3. should not be incurred during the previous year
4. shall not be in the nature of personal expenditure
5. should be incurred wholly or exclusively for the purpose of the business or profession and;
6. the business should be commenced.”[3]
For the purpose of this section expenditure suggest the basic idea of ‘spending’ or ‘paying out’, the amount which has been erased from the profit and gains account irrevocably.[4] The third exception to section 37 requires that the expenditure can be justified on the ground of commercial expediency, which further implies that such expenditure is not required to necessarily have direct or immediate relations with business operations. However, it shall be sufficient if the expenditure indirectly insures smooth conduct of business.
Commercial expediency under section 37 does not mandate the expenditure to be incurred solely for the purpose of profit and can be included even if it relates indirectly with business operations.[5] This results in expenditure incurred to be considered as a charge on profits instead of being an application of profits for the purpose of commercial expediency.[6] This pre-condition for expenditure has to be claimed as a deduction under section 37. Moreover, the conditions laid down under section 36 are interrelated for the purpose of expenditure.
Furthermore, in the case of C.I.T v. Malayalam Plantations Ltd,[7] the court held that such expenditure should be for the purposes of business but not necessarily for earning profits. The court also pointed out that business expenditure may include administration, managerial and operational costs, including payment of statutory dues and taxes imposed as a pre-condition to fulfil the operations of a business.[8] However, it also noted that contingent expenditure is outside the scope of this section.
In the case of C.I.T v. Nainital Bank Ltd[9], wherein in order to keep goodwill among customers the bank decided to do away with the recovery of loans from customers whose ornaments were pledged with the bank and were stolen by the dacoits. The apex court allowed the amount of uncovered loan to be termed as a business expenditure. However, if the assesse is not added it as a profit under the interest of business, it may constitute as a deductible expenditure. Herein, the court held that the expenditure does not necessarily mean actual delivery of or parting with money or property.
UNDERSTANDING THE SCOPE OF BUSINESS EXPENDITURE VIS A VI PERSONAL EXPENDITURE
For the purpose deduction, the court has clarified that personal expenses shall be kept outside the scope of business expenditure even though other conditions are fulfilled. For instance, in case where assesse carrying out operations relating to sale and purchase of furnished premises, occupies a rented a space due to increase in demand for his personal consumption cannot claim the rent as a deduction under business expenditure.[10] The court has reaffirmed the meaning of personal expenditure through a variety of cases. In another such case where the assesse claimed medical expenses for illness contracted as a result of his professional activities, was deemed me to solely personal in nature and could not have been laid out for the purposes of the profession.[11]
However, the amount spent towards educational expenses of a student in which the assesse is carrying on its business was allowable under section 37(1) notwithstanding that the student was son of managing director.[12] Although, in a similar fact scenario, the court has disallowed the education expenditure of son of director who is not working for the company. The court has time and again relied on the commercial expediency of the firm in case of deciphering the nature of expenditure. In one such case where the firm incurred expenditure on foreign education of partner, the court disallowed the expenditure as one in the nature of business and treated it as a personal one. However, a recent ruling by the Income Tax Appellate Tribunal, accepted the claim of Senior Advocate Harish Salve for deduction of the foreign scholarship given to him to two Indian students as “expenditure solely and exclusively for the purpose of business”.[13]
In deciding cases relating to the ambit of business expenditure the courts have invariably relied on the nature and purpose of the expenditure especially cases wherein the assesse incurred on legal proceeding in relation to business whose profits are under computation and cannot be affected by final outcome of that proceeding.[14] However, legal expenditure incurred for defending criminal proceedings which has little to no relation with the profession of such person is in the nature of personal expenditure and cannot be allowed against income from business and profession[15]. However, in case where the assesse was barred from doing business by SEBI, and wherein he incurred expenses in keeping his business running, the court held that such legal expenses shall come under revenue expenditure.[16]
The court while deciding the question of deduction as a business expenditure look at the facts from case to case basis and have noted that the difference between personal expenditure and business expenditure is not very fine and subtle.[17] With the incessant increase in hotel tariff rates and the travelling needs of a business for various things like advertisement, procurement of goods and booking orders, it will unfair on the part of the government to coerce the assesse for charging such meagre residue of their taxed income.[18] Even though such expenses are spent on the person but it is indirectly spent so for the purpose of flourishing his business. Hence, it becomes difficult for the income tax department to draw a line between what comes under domestic or private expenditure as opposed to the expenses genuinely incurred for the purpose of business.
CONCLUSION
From the above analyses it becomes amply clear that the scope of “for the purposes of business” is wider in scope than the expression “for earning of profits”. It may not include only the expenses of the day to day business but may comprehend many other acts incidental to the carrying of business operations. However, the expenses shall draw a direct nexus between the expenditure and the character of the assesse while carrying his business operation for an expenditure to be termed as “for the purposes of business”. But whether a particular item of expenditure has been incurred wholly and exclusively for the purpose of business is a mixed question of fact and law. Although while deciding such cases the court looks at the merits of each case, the final deduction depends of what the law says.
However, the main issue with respect to interpretation of the section occurs when expenditure incurred by the assesse is wholly or exclusively incurred for the purposes of business. These two terms “for the purpose of business” and “wholly and exclusively” are not interpreted taking into account the usual practice followed in the trade or takes the reasonability of action in the best interest of his trade. The person incurring business expenditure will try best to eliminate the cost of acquisition, production or manufacture in order to increase his business turn over. Thus, the courts have actively tried to scrutinize the deduction to constitute it as an actual business expenditure thus providing the traders with a sort of relaxation in order to promote the business culture.
[1] S.S. Alur, Meaning and Scope of Bonafide Business Expenses; (Vol. 21 No. 24) Indian Law Institute. https://www.jstor.org/stable/pdf/43950656.pdf?refreqid=excelsior%3A3ddbf3a87c1e49e8156dc040b5393895
[2] Priya Garg, Non-deductibility of CSR Expenditure under the Income Tax Act: Some Concerns; IndiaCorpLaw. https://indiacorplaw.in/2018/09/non-deductibility-csr-expenditure-income-tax-act-concerns.html
[3] Manish Kumar Agarwal, S.37 Allowability of Business Expenditure & case laws; taxguru. https://taxguru.in/income-tax/understanding-allowability-business-expenditure-section-37-income-tax-act-1961-latest-case-laws.html
[4] Ibid Note 1.
[5] Manish Kumar; Supra Note 3.
[6] Ibid Note 2.
[7] 53 I.T.R. 140(1964).
[8] Ibid Note 1.
[9] 62. I.T.R 638 (1966).
[10] Manish Kumar Agarwal, S.37 Allowability of Business Expenditure & case laws; taxguru. https://taxguru.in/income-tax/understanding-allowability-business-expenditure-section-37-income-tax-act-1961-latest-case-laws.html
[11] Wylie v Eccot, 6 T.C 128(1912).
[12] CIT VS Ras Information Technologies (P) Ltd. 238 CTR 76.
[13] https://www.livelaw.in/news-updates/itat-allows-sec371-deduction-for-harish-salves-foreign-scholarship-as-business-expenses-147174
[14] Vivek P Talwat v. ACIT 8 taxmann.com 268.
[15] DCIT v. Salman Khan
[16] CIT v. United Breweries Ltd 36 DTR 80.
[17] Ibid Note 1.
[18] Ibid Note 1.
Author Bio
Why the expression “for the year ” wa not included in section 37?