IN THE INCOME TAX APPELLATE TRIBUNAL
DELHI BENCHES : D : NEW DELHI
ITA No.844/Del/2013
Assessment Year : 2009-10
Jai Surgicals Ltd.,New Delhi.
Vs. ACIT,
ORDER
This appeal by the assessee emanates from the order passed by the CIT (A) on 20.11.2012 in relation to the assessment year 2009-10.
2. The only issue raised in this appeal through various grounds is against the confirmation of addition of ` 41,24,129/-. Briefly stated, the facts of the case are that the assessee is engaged in the business of manufacture and export of surgical blades. Note no.6 to the Annual accounts, attached with the return of income, read as under:-
“On an observations by auditor, it was been noticed that the Central government approval of contract for sale, purchase of blades and scalpels and for getting
job work done from M/s Razormed INC. (a partnership concern in which directors of the company are interested as partners) had expired on 01.04.2007 and
the company continued to make transactions their under without renewal approval from Central Government. Subsequent to the closure of financial year the company has got necessary approval from Central Government for the period 06.04.2009 to 31.03.2012 offence relating to the period 01.04.2007 to 05.04.2009 has been compounded by the Company Law Board on an application
made by the Company in this respect.”
3. On the perusal of the Note, the Assessing Officer noticed that the assessee entered into transactions of payment of job work charges to a related party, viz., M/s Razormed Inc. during the financial year relevant to assessment year under consideration without obtaining prior approval of the Central Government in
accordance with the provisions of section 297 of the Companies Act, 1956. On being called upon to explain as to why such job work charges be not disallowed in accordance with the provisions of Explanation to section 37(1) of the Income-tax Act, 1961 (hereinafter also called ‘the Act’), the assessee submitted that the post facto approval for the transactions with the related parties undertaken during the year, was obtained from the Company Law Board on payment of compounding charges for the condonation of delay and hence there was no violation of law.
Not convinced with the assessee’s submissions, the AO opined that the facts of post facto approval and the condonation of delay by the Ministry of Corporate Affairs were not relevant because on the day of payment of such expenditure, there was no prior approval to the job charges paid to M/s Razormed Inc., which
triggered the Explanation to section 37(1) of the Act. This led to the addition of job work charges amounting to ` 41.24 lac and the further disallowance of compounding fee for condonation of delay amounting to ` 6,000/-. The ld. CIT(A) echoed the assessment order on this issue. The assessee is in appeal before us only on the disallowance of job work charges and not on the disallowance of compounding fee for condonation of delay.
4. We have heard the rival submissions and perused the
relevant material on record. It is observed that the disallowance
of ` 41.24 lac under consideration has been made in the light of
the Explanation to section 37(1) of the Act, which came to be
inserted by the Finance (No.2) Act, 1998 with retrospective effect
from 01.04.1962. The disallowance has been made on the
premise that as on the date of making the payment to the related
party, the assessee did not have the approval from the Company
Law Board in accordance with the section 297 of the Companies
Act. Before we embark upon considering the applicability of
Explanation to section 37(1) of the Act, it would be apposite to
consider the relevant parts of section 297 of the Companies Act,
1956, as under:-
‘297. Board's sanction to be required for certain contracts in
which particular directors are interested
(1) Except with the consent of the Board of directors of a
company, a director of the company or his relative, a firm in
which such a director or relative is a partner, any other partner in
such a firm, or a private company of which the director is a
member or director, shall not enter into any contract with the
company-
(a) for the sale, purchase or supply of any goods, material or
services; or
(b) after the commencement of this Act, for underwriting the
subscription of any shares in, or debentures of, the company:
Provided that in the case of a company having a paid-up share
capital of not less than rupees one crore, no such contract shall
be entered into except with the previous approval of the Central
Government.
(2) Nothing contained in clause (a) of sub-section (1) shall affect-
(a) the purchase of goods and materials from the company, or
the sale of goods and materials to the company, by any director,
relative, firm, partner or private company as aforesaid for cash at
prevailing market prices; or
(b) any contract or contracts between the company on one side
and any such director, relative, firm, partner or private company
on the other for sale, purchase or -supply of any goods, materials
and services in which either the company or the director, relative,
firm, partner or private company, as the case may be, regularly
trades or does business.
Provided that such contract or contracts do not relate to goods
and materials the value of which, or services the cost of which,
exceeds five thousand rupees in the aggregate in any year
comprised in the period of the contract or contracts; or
(c) in the case of a banking or insurance company any
transaction in the ordinary course of business of such company
with any director, relative, firm, partner or private company as
aforesaid.
(3) Notwithstanding anything contained in sub-sections (1) and
(2) a director, relative, firm, partner or private company as
aforesaid may, in circumstances of urgent necessity, enter,
without obtaining the consent of the Board, into any contract with
the company for the sale, purchase or supply of any goods,
materials or services even if the value of such goods or cost of
such services exceeds five thousand rupees in the aggregate in
any year comprised in the period of the contract; but in such a
case, the consent of the Board shall be obtained at a meeting
within three months of the date on which the contract was
entered into.
(4) ……………
(5) If consent is not accorded to any contract under this section,
anything done in pursuance of the contract shall be voidable at
the option of the Board.
(6) ……………’.
5. Admittedly, the assessee’s paid up share capital is more than
` 1 crore. As such, the case falls within the purview of the proviso
to sub-section (1), which prescribes that no payment to related
persons etc. can be made except with the previous approval of the
Central Government. However, it is significant to note that subsection
(1) of section 297 of the Companies Act requiring prior
approval of the Board or the Central Government, as the case
may be, in respect of certain contracts in which particular
directors etc. are interested, is not invariably absolute. Such
requirement gets waived in sub-section (2), if the aggregate of
the value of goods or services etc. in a year does not exceed five
thousand rupees. Sub-section (3) further waives pre-sanction in
circumstances of urgent necessity even if the value of such goods
or services exceeds five thousand rupees in the aggregate in any
year. In such cases, the consent of the Board has to be obtained
at a meeting within three months. Then comes sub-section (5) of
section 297, which is quite material. It provides that if the consent
is not accorded to any contract under the section, then, anything
done in pursuance of the contract shall be voidable at the option
of the Board. Clause (i) of section 2 of the Indian Contract Act,
1872 states that : ‘An agreement which is enforceable by law at
the option of one or more of the parties thereto, but not at the
option of the other or others, is a voidable contract.’ The essence
of sub-section (5) is that when there is a violation of sub-section
(1) of section 297 of the Companies Act, the contract does not
automatically become void ab initio, but voidable at the option of
the Board. The expression ‘voidable at the option of the Board’
postulates that if the Board, despite no prior sanction, gives green
signal and agrees to go ahead with the contract referred to in
sub-section (1) of section 297 of the Companies Act, such
contract would be valid. It is only when the Board exercises its
option against validating the contract as per sub-section (1), that
the contract becomes void ab initio. Turning to the facts of the
instant case, it is observed that the Board has not objected to the
contracts between the assessee and Razormed Inc., thus, making
such contract for doing of job work as valid. Viewing from this
perspective, it becomes vivid that there is no violation of section
297 of the Companies Act inasmuch as the so-called violation as
per sub-section (1) stood regularized by sub-section (5) of section
297 to the Companies Act, 1956, thereby making this transaction
of payment of job charges in accordance with the provisions of
the Companies Act.
6. Now we espouse the view point of the Revenue that the case
of the assessee is caught within the mischief of the Explanation to
section 37(1) of the Income-tax Act, 1961. At this juncture, it
would be befitting to note the prescription of the Explanation to
section 37(1), as under : -
‘Explanation.—For the removal of doubts, it is hereby declared
that any expenditure incurred by an assessee for any purpose
which is an offence or which is prohibited by law shall not be
deemed to have been incurred for the purpose of business or
profession and no deduction or allowance shall be made in
respect of such expenditure.’
7. A cursory look at the above Explanation to section 37(1) of
the Act makes it palpable that any expenditure incurred by the
assessee, for any purpose which is an offence or is prohibited by
law, shall not be deemed to have been incurred for the purpose of
business and resultantly no deduction shall be allowed.
8. Reverting to the facts of the extant case, it is noticed that the
authorities below have proceeded to make and uphold the
disallowance in terms of Explanation to section 37(1) of the Act by
observing that since the payment of job work expenses was made
without prior approval from the Central Government, it amounted
to payment in contravention of the Companies Act. Now the
position which is obtaining in the present case is that the
assessee made payment for getting the job work done from its
related concern, which is otherwise neither an offence nor
prohibited by law, but committed a breach by not obtaining the
necessary approval from the Central Government in time. Thus,
on one hand the payment is otherwise for a lawful purpose, but
the legality of the transaction has been shadowed by not
obtaining prior approval from the Central Government. The
pertinent question which arises under the present circumstances
is - Can it be said that the assessee incurred an expenditure for
any purpose which is an offence or which is prohibited by law?
9. Before we deliberate upon this question, it is of paramount
importance to note that we are dealing with a deeming provision.
A deeming provision or a legal fiction as it is commonly called is
one whose mandate does not exist but for such provision.
Because of such provision alone, the given imaginary state of
affairs is taken as reality despite it being at variance with the
scope of the relevant provision of the enactment. It is trite that
the scope of a deeming provision has to be restricted to what is
expressly stated in such a provision. There can be no inference or
intendment as regards such a provision. The Hon’ble Supreme
Court in CIT Vs. Amarchand N. Shroff (1963) 48 ITR 59 (SC)
considered the ambit of a deeming provision and held that the
fiction cannot be extended beyond the object for which it is
enacted. In CIT Vs. Mother India Refrigeration Industries P.Ltd.
(1985) 155 ITR 711 (SC) the same view was reiterated by holding
that the “legal fictions are created only for some definite purpose
and these must be limited to that purpose and should not be
extended beyond their legitimate field.” The Hon’ble Bombay
High Court in CIT Vs. Ace Builders P. Ltd. (2006) 281 ITR 210
(Bom.) considered a case in which the assessee was a partner in a
firm which was dissolved in the year 1984 and the assessee was
allotted a flat towards its credit in the capital account with the
firm. The assessee showed the flat as capital asset in its books of
account and depreciation was claimed and allowed from year to
year. In the previous year relevant to the assessment year 1992-
93 the assessee sold the flat and invested the net sale proceeds
in a scheme eligible u/s.54E of the Act and accordingly declared
Nil income under the head ‘Capital gains’. The Assessing Officer
opined that since the block of building ceased to exist on account
of sale of flat during the year, the written down value of the flat
was liable to taken as cost of acquisition u/s.54E of the Act. He
further held that since the assessee had availed depreciation on
such asset which was otherwise long term capital asset, the
deeming provision u/s.50 would apply and it would be treated as
capital gain on the sale of short term capital asset and resultantly
no benefit u/s.54E could be allowed. When the matter came up
before the Hon’ble Bombay High Court, it noted that sub-sections
(1) and (2) of section 50 contain a deeming provision and such
fiction is restricted only to the mode of computation of capital
gain contained in sections 48 and 49 and hence it did not apply
to other provisions. Consequently the assessee was held to be
eligible for exemption u/s.54E in respect of capital gain arising out
of the capital asset on which depreciation was allowed. On an
appraisal of the above judgments, the legal position which
emerges is that whenever a legal fiction is created by way of a
deeming provision, it is of paramount importance to go strictly by
the express prescription of this provision. Such a deeming
provision cannot be extended beyond what is expressly stated
therein.
10. With this background, when we turn to the language of the
Explanation to sec. 37(1), which is a deeming provision, it is
amply borne out that it talks of disallowing any expenditure
incurred by an assessee for ‘any purpose’ which is either an
offence or prohibited by law. So what is contemplated for
disallowance is an ‘expenditure’ incurred ‘for any purpose which
is either an offence or which is prohibited by law’. When we
consider the mandate of the Explanation in the light of the fact
that it is a deeming provision, there remains no doubt whatsoever
that the inquiry to determine the applicability or otherwise of the
Explanation is restricted to ascertaining the purpose of the
expenditure. In simple words, the investigation should be carried
out to see the object and consideration for the expenditure
incurred. If the purpose of the expenditure is either an offence or
is prohibited by law, then it would suffer disallowance. If,
however, the purpose of the expenditure is neither to commit an
offence nor is prohibited by any law, then there can be no
question of disallowance. It means that the offence or prohibition
under law should be judged with the ‘purpose' of the expenditure
on a standalone basis divorced from the fulfillment or otherwise of
the procedural formalities attached with and necessary for the
incurring of such expenditure. To put it in simple words, if the
expenditure is otherwise lawful and neither amounts to offence
nor is prohibited by law, but the procedural provisions attached
for incurring it are not complied with, no doubt irregularity will
creep in, but such irregularity would not make the expenditure
itself as unlawful so as to be brought within the scope of the
Explanation. At the cost of repetition, we state that the
Explanation, being a deeming provision, is required to be strictly
followed as per its express language and not beyond that. As its
language talks of disallowing any expenditure for any purpose
which is an offence or which is prohibited by law’, we cannot do
violence to the language by expanding its scope to also bring
within its sweep the cases where the purpose of expenditure is
neither an offence nor is prohibited by law, but there is a breach
of some procedural provision necessary for incurring such
otherwise lawful expenditure. What, therefore, turns out is that it
is the expenditure alone which should be tested on the
touchstone of the mandate of Explanation to section 37(1) and
nothing more than that. If the expenditure itself is for a valid and
lawful purpose, then, there can be no question of any
disallowance. The words ‘for any purpose’ set in place by the
legislature with the ‘expenditure’ on the one hand and ‘which is
an offence or which is prohibited by law’ on the other, make it
abundantly clear that if the purpose of expenditure, which is
sought to be disallowed is not an offence or not prohibited by law,
the same cannot be brought within the scope of Explanation to
section 37(1) of the Act. If, on the other hand, the purpose of
expenditure is an offence or is prohibited by law, the same cannot
escape the clutches of the Explanation. The natural corollary
which thus follows is that if the ‘purpose’ of expenditure is not to
commit an offence or is otherwise not prohibited by law, then any
breach of some procedural statutory provision necessary to be
complied with before incurring such expenditure, would not per
se convert the otherwise lawful purpose into an offence or
prohibition under law so as to attract the wrath of the
Explanation. A line of distinction needs to be drawn between the
cases where the purpose of the expenditure incurred itself is
unlawful on one hand and the cases where the purpose of
expenditure is lawful but there is some lapse in complying with
the procedural provisions for incurring such expenditure on the
other. Whereas the disallowance will be called for in terms of the
Explanation to section 37(1) in the first set of cases where the
very ‘purpose’ of the expenditure incurred is unlawful, the second
set of cases will escape the mischief of the Explanation because
the ‘purpose’ of the expenditure is not unlawful. The crux of the
matter is that the ‘purpose’ of the expenditure incurred should be
viewed in isolation unbothered by anything else for determining
whether or not the Explanation is attracted.
11. At this stage, it will be relevant to note the judgment of the
Hon’ble Punjab & Haryana High Court in CIT vs. Dhanpat Rai &
Sons (2014) 98 DTR (P&H) 209. In that case, the assessee, a
publisher of books claimed deduction of expenditure incurred on
account of secret nature of commission paid to the educational
institutions, teachers and individuals for promotion of sales of
books and supply of specimen copies of books to teachers. The
disallowance made of such secret commission by the AO was
deleted by the CIT (A) as well as the Tribunal. However, the
Hon’ble High Court set aside the tribunal order and remitted the
matter to the Tribunal for deciding the allowability of deduction of
secret commission on the anvil of the Explanation added to
section 37(1) by observing that any secret transaction/payment
made to secure unfair advantage would necessarily be repugnant
to law. The Hon’ble High Court held that such expenditure, if
allowed, is likely to encourage illegal payment, evasion of tax and
unscrupulous practices. From the above judgment, it is patent
that the expenditure in the nature of secret commission aimed at
securing an unfair advantage is against the public policy. As such
a purpose is an offence or prohibited by law, the same is hit by
Explanation to section 37(1).
12. As against that and adverting to the facts of the instant
case, we find that the expenditure which has been instantly
disallowed is a sum of ` 41.24 lac on account of job work charges
paid by the assessee to M/s Razormed Inc. It is not the case of
the Revenue and naturally cannot be that the payment of job
work charges is an offence or is prohibited by law. What the
authorities below have taken into consideration while making the
disallowance is that since there was no prior approval from the
Central Government, the expenditure of job work charges became
disallowable. We fail to understand as to how the payment of job
work charges can by any stretch of imagination be construed as
offence or prohibited by law simply because the necessary
permission from the Central Government was obtained belatedly.
It has been noticed above that the inquiry should stop on
determining the immediate purpose of expenditure, which in the
present case is job work done for the assessee. The first question
to be asked is whether such payment of job charges is an
offence? The answer is obviously in negative. The second
question is whether such payment of job charges is prohibited by
law? Again the answer is in negative because no law prohibits the
payment of job work charges in a manufacturing unit. When the
language of the Explanation is crystal clear and does not
encompass the incurring of expenses for a lawful purpose, such
as the job charges, within its ambit, it is wholly impermissible to
import a further requirement in the language of the Explanation
to make the otherwise lawful purpose as unlawful for lack of the
prior approval of the Central Government. As the ‘purpose’ of
incurring the expenditure of job charges is neither an offence nor
is prohibited by law, we fail to comprehend as to how the
otherwise lawful purpose would become contingent upon
obtaining or not obtaining the prior approval of the Central
Government. Since such expenditure in itself is neither an
offence nor prohibited by any law and there is a valid and lawful
quid pro quo for the same, we are disinclined to uphold the view
canvassed in the impugned order.
13. Viewed from any angle, being the operation of sub-section
(5) of section 297 of the Companies Act or the non-applicability of
Explanation to section 37(1) of the Act, we cannot countenance
the view canvassed by the ld. first appellate authority. It is ergo
held that the ld. CIT(A) erred in sustaining the disallowance of `
41.24 lac incurred on payment of job work charges. The
impugned order is overturned on this issue and the disallowance
is deleted.
14. In the result, the appeal is allowed.
The order pronounced in the open court on 26.06.2014.
Sd/- Sd/-
[C.M. GARG] [R.S. SYAL]
JUDICIAL MEMBER ACCOUNTANT MEMBER
Dated, 26th June, 2014.
dk
Copy forwarded to:
1. Appellant
2. Respondent
3. CIT
4. CIT (A)
5. DR, ITAT
AR, ITAT, NEW DELHI.*
DELHI BENCHES : D : NEW DELHI
ITA No.844/Del/2013
Assessment Year : 2009-10
Jai Surgicals Ltd.,New Delhi.
Vs. ACIT,
ORDER
This appeal by the assessee emanates from the order passed by the CIT (A) on 20.11.2012 in relation to the assessment year 2009-10.
2. The only issue raised in this appeal through various grounds is against the confirmation of addition of ` 41,24,129/-. Briefly stated, the facts of the case are that the assessee is engaged in the business of manufacture and export of surgical blades. Note no.6 to the Annual accounts, attached with the return of income, read as under:-
“On an observations by auditor, it was been noticed that the Central government approval of contract for sale, purchase of blades and scalpels and for getting
job work done from M/s Razormed INC. (a partnership concern in which directors of the company are interested as partners) had expired on 01.04.2007 and
the company continued to make transactions their under without renewal approval from Central Government. Subsequent to the closure of financial year the company has got necessary approval from Central Government for the period 06.04.2009 to 31.03.2012 offence relating to the period 01.04.2007 to 05.04.2009 has been compounded by the Company Law Board on an application
made by the Company in this respect.”
3. On the perusal of the Note, the Assessing Officer noticed that the assessee entered into transactions of payment of job work charges to a related party, viz., M/s Razormed Inc. during the financial year relevant to assessment year under consideration without obtaining prior approval of the Central Government in
accordance with the provisions of section 297 of the Companies Act, 1956. On being called upon to explain as to why such job work charges be not disallowed in accordance with the provisions of Explanation to section 37(1) of the Income-tax Act, 1961 (hereinafter also called ‘the Act’), the assessee submitted that the post facto approval for the transactions with the related parties undertaken during the year, was obtained from the Company Law Board on payment of compounding charges for the condonation of delay and hence there was no violation of law.
Not convinced with the assessee’s submissions, the AO opined that the facts of post facto approval and the condonation of delay by the Ministry of Corporate Affairs were not relevant because on the day of payment of such expenditure, there was no prior approval to the job charges paid to M/s Razormed Inc., which
triggered the Explanation to section 37(1) of the Act. This led to the addition of job work charges amounting to ` 41.24 lac and the further disallowance of compounding fee for condonation of delay amounting to ` 6,000/-. The ld. CIT(A) echoed the assessment order on this issue. The assessee is in appeal before us only on the disallowance of job work charges and not on the disallowance of compounding fee for condonation of delay.
4. We have heard the rival submissions and perused the
relevant material on record. It is observed that the disallowance
of ` 41.24 lac under consideration has been made in the light of
the Explanation to section 37(1) of the Act, which came to be
inserted by the Finance (No.2) Act, 1998 with retrospective effect
from 01.04.1962. The disallowance has been made on the
premise that as on the date of making the payment to the related
party, the assessee did not have the approval from the Company
Law Board in accordance with the section 297 of the Companies
Act. Before we embark upon considering the applicability of
Explanation to section 37(1) of the Act, it would be apposite to
consider the relevant parts of section 297 of the Companies Act,
1956, as under:-
‘297. Board's sanction to be required for certain contracts in
which particular directors are interested
(1) Except with the consent of the Board of directors of a
company, a director of the company or his relative, a firm in
which such a director or relative is a partner, any other partner in
such a firm, or a private company of which the director is a
member or director, shall not enter into any contract with the
company-
(a) for the sale, purchase or supply of any goods, material or
services; or
(b) after the commencement of this Act, for underwriting the
subscription of any shares in, or debentures of, the company:
Provided that in the case of a company having a paid-up share
capital of not less than rupees one crore, no such contract shall
be entered into except with the previous approval of the Central
Government.
(2) Nothing contained in clause (a) of sub-section (1) shall affect-
(a) the purchase of goods and materials from the company, or
the sale of goods and materials to the company, by any director,
relative, firm, partner or private company as aforesaid for cash at
prevailing market prices; or
(b) any contract or contracts between the company on one side
and any such director, relative, firm, partner or private company
on the other for sale, purchase or -supply of any goods, materials
and services in which either the company or the director, relative,
firm, partner or private company, as the case may be, regularly
trades or does business.
Provided that such contract or contracts do not relate to goods
and materials the value of which, or services the cost of which,
exceeds five thousand rupees in the aggregate in any year
comprised in the period of the contract or contracts; or
(c) in the case of a banking or insurance company any
transaction in the ordinary course of business of such company
with any director, relative, firm, partner or private company as
aforesaid.
(3) Notwithstanding anything contained in sub-sections (1) and
(2) a director, relative, firm, partner or private company as
aforesaid may, in circumstances of urgent necessity, enter,
without obtaining the consent of the Board, into any contract with
the company for the sale, purchase or supply of any goods,
materials or services even if the value of such goods or cost of
such services exceeds five thousand rupees in the aggregate in
any year comprised in the period of the contract; but in such a
case, the consent of the Board shall be obtained at a meeting
within three months of the date on which the contract was
entered into.
(4) ……………
(5) If consent is not accorded to any contract under this section,
anything done in pursuance of the contract shall be voidable at
the option of the Board.
(6) ……………’.
5. Admittedly, the assessee’s paid up share capital is more than
` 1 crore. As such, the case falls within the purview of the proviso
to sub-section (1), which prescribes that no payment to related
persons etc. can be made except with the previous approval of the
Central Government. However, it is significant to note that subsection
(1) of section 297 of the Companies Act requiring prior
approval of the Board or the Central Government, as the case
may be, in respect of certain contracts in which particular
directors etc. are interested, is not invariably absolute. Such
requirement gets waived in sub-section (2), if the aggregate of
the value of goods or services etc. in a year does not exceed five
thousand rupees. Sub-section (3) further waives pre-sanction in
circumstances of urgent necessity even if the value of such goods
or services exceeds five thousand rupees in the aggregate in any
year. In such cases, the consent of the Board has to be obtained
at a meeting within three months. Then comes sub-section (5) of
section 297, which is quite material. It provides that if the consent
is not accorded to any contract under the section, then, anything
done in pursuance of the contract shall be voidable at the option
of the Board. Clause (i) of section 2 of the Indian Contract Act,
1872 states that : ‘An agreement which is enforceable by law at
the option of one or more of the parties thereto, but not at the
option of the other or others, is a voidable contract.’ The essence
of sub-section (5) is that when there is a violation of sub-section
(1) of section 297 of the Companies Act, the contract does not
automatically become void ab initio, but voidable at the option of
the Board. The expression ‘voidable at the option of the Board’
postulates that if the Board, despite no prior sanction, gives green
signal and agrees to go ahead with the contract referred to in
sub-section (1) of section 297 of the Companies Act, such
contract would be valid. It is only when the Board exercises its
option against validating the contract as per sub-section (1), that
the contract becomes void ab initio. Turning to the facts of the
instant case, it is observed that the Board has not objected to the
contracts between the assessee and Razormed Inc., thus, making
such contract for doing of job work as valid. Viewing from this
perspective, it becomes vivid that there is no violation of section
297 of the Companies Act inasmuch as the so-called violation as
per sub-section (1) stood regularized by sub-section (5) of section
297 to the Companies Act, 1956, thereby making this transaction
of payment of job charges in accordance with the provisions of
the Companies Act.
6. Now we espouse the view point of the Revenue that the case
of the assessee is caught within the mischief of the Explanation to
section 37(1) of the Income-tax Act, 1961. At this juncture, it
would be befitting to note the prescription of the Explanation to
section 37(1), as under : -
‘Explanation.—For the removal of doubts, it is hereby declared
that any expenditure incurred by an assessee for any purpose
which is an offence or which is prohibited by law shall not be
deemed to have been incurred for the purpose of business or
profession and no deduction or allowance shall be made in
respect of such expenditure.’
7. A cursory look at the above Explanation to section 37(1) of
the Act makes it palpable that any expenditure incurred by the
assessee, for any purpose which is an offence or is prohibited by
law, shall not be deemed to have been incurred for the purpose of
business and resultantly no deduction shall be allowed.
8. Reverting to the facts of the extant case, it is noticed that the
authorities below have proceeded to make and uphold the
disallowance in terms of Explanation to section 37(1) of the Act by
observing that since the payment of job work expenses was made
without prior approval from the Central Government, it amounted
to payment in contravention of the Companies Act. Now the
position which is obtaining in the present case is that the
assessee made payment for getting the job work done from its
related concern, which is otherwise neither an offence nor
prohibited by law, but committed a breach by not obtaining the
necessary approval from the Central Government in time. Thus,
on one hand the payment is otherwise for a lawful purpose, but
the legality of the transaction has been shadowed by not
obtaining prior approval from the Central Government. The
pertinent question which arises under the present circumstances
is - Can it be said that the assessee incurred an expenditure for
any purpose which is an offence or which is prohibited by law?
9. Before we deliberate upon this question, it is of paramount
importance to note that we are dealing with a deeming provision.
A deeming provision or a legal fiction as it is commonly called is
one whose mandate does not exist but for such provision.
Because of such provision alone, the given imaginary state of
affairs is taken as reality despite it being at variance with the
scope of the relevant provision of the enactment. It is trite that
the scope of a deeming provision has to be restricted to what is
expressly stated in such a provision. There can be no inference or
intendment as regards such a provision. The Hon’ble Supreme
Court in CIT Vs. Amarchand N. Shroff (1963) 48 ITR 59 (SC)
considered the ambit of a deeming provision and held that the
fiction cannot be extended beyond the object for which it is
enacted. In CIT Vs. Mother India Refrigeration Industries P.Ltd.
(1985) 155 ITR 711 (SC) the same view was reiterated by holding
that the “legal fictions are created only for some definite purpose
and these must be limited to that purpose and should not be
extended beyond their legitimate field.” The Hon’ble Bombay
High Court in CIT Vs. Ace Builders P. Ltd. (2006) 281 ITR 210
(Bom.) considered a case in which the assessee was a partner in a
firm which was dissolved in the year 1984 and the assessee was
allotted a flat towards its credit in the capital account with the
firm. The assessee showed the flat as capital asset in its books of
account and depreciation was claimed and allowed from year to
year. In the previous year relevant to the assessment year 1992-
93 the assessee sold the flat and invested the net sale proceeds
in a scheme eligible u/s.54E of the Act and accordingly declared
Nil income under the head ‘Capital gains’. The Assessing Officer
opined that since the block of building ceased to exist on account
of sale of flat during the year, the written down value of the flat
was liable to taken as cost of acquisition u/s.54E of the Act. He
further held that since the assessee had availed depreciation on
such asset which was otherwise long term capital asset, the
deeming provision u/s.50 would apply and it would be treated as
capital gain on the sale of short term capital asset and resultantly
no benefit u/s.54E could be allowed. When the matter came up
before the Hon’ble Bombay High Court, it noted that sub-sections
(1) and (2) of section 50 contain a deeming provision and such
fiction is restricted only to the mode of computation of capital
gain contained in sections 48 and 49 and hence it did not apply
to other provisions. Consequently the assessee was held to be
eligible for exemption u/s.54E in respect of capital gain arising out
of the capital asset on which depreciation was allowed. On an
appraisal of the above judgments, the legal position which
emerges is that whenever a legal fiction is created by way of a
deeming provision, it is of paramount importance to go strictly by
the express prescription of this provision. Such a deeming
provision cannot be extended beyond what is expressly stated
therein.
10. With this background, when we turn to the language of the
Explanation to sec. 37(1), which is a deeming provision, it is
amply borne out that it talks of disallowing any expenditure
incurred by an assessee for ‘any purpose’ which is either an
offence or prohibited by law. So what is contemplated for
disallowance is an ‘expenditure’ incurred ‘for any purpose which
is either an offence or which is prohibited by law’. When we
consider the mandate of the Explanation in the light of the fact
that it is a deeming provision, there remains no doubt whatsoever
that the inquiry to determine the applicability or otherwise of the
Explanation is restricted to ascertaining the purpose of the
expenditure. In simple words, the investigation should be carried
out to see the object and consideration for the expenditure
incurred. If the purpose of the expenditure is either an offence or
is prohibited by law, then it would suffer disallowance. If,
however, the purpose of the expenditure is neither to commit an
offence nor is prohibited by any law, then there can be no
question of disallowance. It means that the offence or prohibition
under law should be judged with the ‘purpose' of the expenditure
on a standalone basis divorced from the fulfillment or otherwise of
the procedural formalities attached with and necessary for the
incurring of such expenditure. To put it in simple words, if the
expenditure is otherwise lawful and neither amounts to offence
nor is prohibited by law, but the procedural provisions attached
for incurring it are not complied with, no doubt irregularity will
creep in, but such irregularity would not make the expenditure
itself as unlawful so as to be brought within the scope of the
Explanation. At the cost of repetition, we state that the
Explanation, being a deeming provision, is required to be strictly
followed as per its express language and not beyond that. As its
language talks of disallowing any expenditure for any purpose
which is an offence or which is prohibited by law’, we cannot do
violence to the language by expanding its scope to also bring
within its sweep the cases where the purpose of expenditure is
neither an offence nor is prohibited by law, but there is a breach
of some procedural provision necessary for incurring such
otherwise lawful expenditure. What, therefore, turns out is that it
is the expenditure alone which should be tested on the
touchstone of the mandate of Explanation to section 37(1) and
nothing more than that. If the expenditure itself is for a valid and
lawful purpose, then, there can be no question of any
disallowance. The words ‘for any purpose’ set in place by the
legislature with the ‘expenditure’ on the one hand and ‘which is
an offence or which is prohibited by law’ on the other, make it
abundantly clear that if the purpose of expenditure, which is
sought to be disallowed is not an offence or not prohibited by law,
the same cannot be brought within the scope of Explanation to
section 37(1) of the Act. If, on the other hand, the purpose of
expenditure is an offence or is prohibited by law, the same cannot
escape the clutches of the Explanation. The natural corollary
which thus follows is that if the ‘purpose’ of expenditure is not to
commit an offence or is otherwise not prohibited by law, then any
breach of some procedural statutory provision necessary to be
complied with before incurring such expenditure, would not per
se convert the otherwise lawful purpose into an offence or
prohibition under law so as to attract the wrath of the
Explanation. A line of distinction needs to be drawn between the
cases where the purpose of the expenditure incurred itself is
unlawful on one hand and the cases where the purpose of
expenditure is lawful but there is some lapse in complying with
the procedural provisions for incurring such expenditure on the
other. Whereas the disallowance will be called for in terms of the
Explanation to section 37(1) in the first set of cases where the
very ‘purpose’ of the expenditure incurred is unlawful, the second
set of cases will escape the mischief of the Explanation because
the ‘purpose’ of the expenditure is not unlawful. The crux of the
matter is that the ‘purpose’ of the expenditure incurred should be
viewed in isolation unbothered by anything else for determining
whether or not the Explanation is attracted.
11. At this stage, it will be relevant to note the judgment of the
Hon’ble Punjab & Haryana High Court in CIT vs. Dhanpat Rai &
Sons (2014) 98 DTR (P&H) 209. In that case, the assessee, a
publisher of books claimed deduction of expenditure incurred on
account of secret nature of commission paid to the educational
institutions, teachers and individuals for promotion of sales of
books and supply of specimen copies of books to teachers. The
disallowance made of such secret commission by the AO was
deleted by the CIT (A) as well as the Tribunal. However, the
Hon’ble High Court set aside the tribunal order and remitted the
matter to the Tribunal for deciding the allowability of deduction of
secret commission on the anvil of the Explanation added to
section 37(1) by observing that any secret transaction/payment
made to secure unfair advantage would necessarily be repugnant
to law. The Hon’ble High Court held that such expenditure, if
allowed, is likely to encourage illegal payment, evasion of tax and
unscrupulous practices. From the above judgment, it is patent
that the expenditure in the nature of secret commission aimed at
securing an unfair advantage is against the public policy. As such
a purpose is an offence or prohibited by law, the same is hit by
Explanation to section 37(1).
12. As against that and adverting to the facts of the instant
case, we find that the expenditure which has been instantly
disallowed is a sum of ` 41.24 lac on account of job work charges
paid by the assessee to M/s Razormed Inc. It is not the case of
the Revenue and naturally cannot be that the payment of job
work charges is an offence or is prohibited by law. What the
authorities below have taken into consideration while making the
disallowance is that since there was no prior approval from the
Central Government, the expenditure of job work charges became
disallowable. We fail to understand as to how the payment of job
work charges can by any stretch of imagination be construed as
offence or prohibited by law simply because the necessary
permission from the Central Government was obtained belatedly.
It has been noticed above that the inquiry should stop on
determining the immediate purpose of expenditure, which in the
present case is job work done for the assessee. The first question
to be asked is whether such payment of job charges is an
offence? The answer is obviously in negative. The second
question is whether such payment of job charges is prohibited by
law? Again the answer is in negative because no law prohibits the
payment of job work charges in a manufacturing unit. When the
language of the Explanation is crystal clear and does not
encompass the incurring of expenses for a lawful purpose, such
as the job charges, within its ambit, it is wholly impermissible to
import a further requirement in the language of the Explanation
to make the otherwise lawful purpose as unlawful for lack of the
prior approval of the Central Government. As the ‘purpose’ of
incurring the expenditure of job charges is neither an offence nor
is prohibited by law, we fail to comprehend as to how the
otherwise lawful purpose would become contingent upon
obtaining or not obtaining the prior approval of the Central
Government. Since such expenditure in itself is neither an
offence nor prohibited by any law and there is a valid and lawful
quid pro quo for the same, we are disinclined to uphold the view
canvassed in the impugned order.
13. Viewed from any angle, being the operation of sub-section
(5) of section 297 of the Companies Act or the non-applicability of
Explanation to section 37(1) of the Act, we cannot countenance
the view canvassed by the ld. first appellate authority. It is ergo
held that the ld. CIT(A) erred in sustaining the disallowance of `
41.24 lac incurred on payment of job work charges. The
impugned order is overturned on this issue and the disallowance
is deleted.
14. In the result, the appeal is allowed.
The order pronounced in the open court on 26.06.2014.
Sd/- Sd/-
[C.M. GARG] [R.S. SYAL]
JUDICIAL MEMBER ACCOUNTANT MEMBER
Dated, 26th June, 2014.
dk
Copy forwarded to:
1. Appellant
2. Respondent
3. CIT
4. CIT (A)
5. DR, ITAT
AR, ITAT, NEW DELHI.*
No comments:
Post a Comment