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Tuesday, 21 March 2017 15:17

It is not the Legal Necessity but Commercial Expediency which guides the Allowability of Expenditure under Section 37(1) of the Act - Mumbai Tribunal

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Allowability of Expenditure u/s 37(1) - Mumbai Tribunal Allowability of Expenditure u/s 37(1) - Mumbai Tribunal Taxpundit.org

Can Revenue prescribe what expenditure should an assessee incur and under what circumstances? - Held No

 

In our considered opinion, it is not the legal necessity to spent the expenditure which is determinative of its allowability; rather, it is the existence or otherwise of commercial expediency which guides the allowability of expenditure under Section 37(1) of the Act. The commercial expediency canvassed by the assessee in the instant case clearly establishes that the impugned expenditure falls within the scope of the expression “wholly and exclusively for the purpose of business or profession” within the meaning of section 37(1) of the Act 

Facts

Shahrukh Khan vs. ACIT1. This appeal pertaining to assessment year 2009-10 is directed against an order passed by CIT(A)-40, Mumbai dated 02/11/2012, which in turn, arises out of an order passed by the Assessing Officer under section 143(3) of the Income Tax Act, 1961 (in short ‘the Act’) dated 30/12/2011

2. In this appeal assessee has raised the following Grounds of appeal :-

“The Grounds of Appeal raised herein are all without prejudice to one another:

The learned CIT(Appeals) was not justified in confirming the action of the learned Asst. CIT in:

1. disallowing an amount of Rs. 10,00,00,000/- being professiona fees returned to Star India P Ltd. The said amount had been incurred by the appellant for the purposes of his profession and on grounds of commercial expediency. The reasons given by both the learned CIT(Appeals) and the learned Asst. CIT in this regard, particularly their reading of the agreement dated 30-3 2007, are incorrect, erroneous and invalid.

2. adding an amount of Rs. 7,00,00,000/ as alleged professional fees. The reasons given by both the learned CIT(Appeals) and the learned Asst. CIT in this regard are incorrect, erroneous and based purely on assumptions, conjectures and surmises.

3. bringing the annual value of the Dubai Villa to tax in India.

4. levying interests u/s 234B and 234C of the Act.”

3. Appellant is an individual who is a Film Actor by profession

4. For the assessment year 2009-10, he filed a return of income declaring a total income of Rs.146,15,23,852/-, which was subject to scrutiny assessment whereby the total income had been assessed at Rs.163,83,39,790/-, after making certain additions/disallowances

5. The assessee had carried the matter in appeal before the CIT(A), who allowed partial relief. Not being satisfied with the order of the CIT(A) assessee is in further appeal before ITAT on the aforesaid Grounds of appeal

6. In so far as the first Ground is concerned, the same arises from the action of the Assessing Officer in disallowing a claim of deduction of Rs.10 crores while computing income from profession

7. During the year under consideration, assessee being an Actor by profession, had declared income from profession based on the cash method of accounting

8. The Assessing Officer noticed that in the Income and Expenditure Account for the year under consideration, assessee had claimed an expenditure of Rs.10 crores under the head ‘Professional fees returned to Star India Private Limited’

9. The said amount represented payment by the assessee to Knight Riders Sports Pvt. Ltd. on behalf of Star India Private Ltd. for grant of sponsorship rights for IPL Season -2

10. On being asked to explain, assessee contended that in terms of an Artist Service Agreement with Star India Pvt. Ltd. dated 30/03/2007 the assessee was liable to act as anchor and host of the programme to be produced by Star India Ltd., namely ‘Kaun Banega Crorepati’ for a total of 104 Episodes, divided into two seasons of 52 Episodes each

11. The total consideration payable was Rs.72 cores, which was received by the assessee in advance and the same was offered for tax in an earlier year on receipt basis

12. It was explained that assessee rendered the services for the first season of 52 Episodes but for second season comprising of the balance 52 Episodes no service was rendered as the programme was discontinued by Star India Pvt. Ltd. for commercial reasons

13. The assessee explained that as the balance Episodes were not delivered, Star India Pvt. Ltd wanted to recover the value of the unutilized amount from the assessee for non-shooting of the 2nd Season and, therefore, in terms of a mutually agreed arrangement dated 20/03/2009, assessee agreed to get for Star India Pvt. Ltd. the following:-

(a) a key sponsorship association with Kolkota Knight Riders team for calendar year 2009 (IPL Season 2); and,

(b) other accompanying sponsorship rights and deliverables detailed in the arrangement

14. Such accompanying deliverables, inter-alia, included certain ‘Appearances and Promotions’ by the assessee in press conferences in London and Dubai. Notably, the arrangement did not envisage any liability of Star India Pvt. Ltd. in respect of any fee or costs, etc. to be incurred by the assessee or Knight Rider Sports Pvt. Ltd. in relation to the deliverables mentioned and the sponsorship rights

15. It was explained that for procuring the sponsorship rights of Knight Rider Sports Pvt. Ltd. for IPL Season -2, assessee paid Rs.10 crores on behalf of the Star India Pvt. Ltd. to Knight Rider Sports Pvt. Ltd. This amount was claimed as a professional expenditure

16. The Assessing Officer did not accept the plea of the assessee for deduction of the aforesaid amount while computing the taxable income. Firstly as per the Assessing Officer the assessee was under no obligation to refund any amount to Star India Pvt. Ltd. because the non-shooting of the balance 52 Episodes was not for reasons attributable to the assessee. In this context, the Assessing Officer referred to the Artist Service Agreement dated 30/03/2007 between the assessee and Star India Pvt. Ltd to poin out that the assessee was liable to refund the amount only if breach of contract was attributable to the assessee and in the present case the reason for discontinuation was not attributable to the assessee

17. Secondly, the Assessing Officer also observed that during the year under consideration no income of any nature had been received by the assessee from Star India Pvt. Ltd. and, therefore, the expenditure of Rs.10 crores debited under the head ‘ ‘Professional fees returned to Star India Pvt. Ltd.’ does not have any nexus or bearing on any of the professional receipts earned during the year under consideration, and therefore, the impugned expenditure could not be allowed as deduction in the year under consideration

18. Thirdly, the Assessing Officer has also referred to the response of Star India Pvt. Ltd. to certain queries whereby it was clear that the entire amount of Rs.72 crores paid to the assessee has been accounted for as an expenditure in the hands of Star India Pvt. Ltd. As per the Assessing Officer none of the amount comprised in the receipt of Rs.72 crores from Star India Pvt. Ltd. was refundable by the assessee. On the basis of the aforesaid, deduction for the expenditure debited under the head ‘professional fees returned to Start India Pvt. Ltd.’ was denied, which resulted in an addition of Rs.10.00 crores to the returned income

19. In appeal before the CIT(A), assessee reiterated the submissions made before the Assessing Officer and assailed the addition on facts and in law.

20. Before the CIT(A), assessee contended that the Assessing Officer has not appreciated an established business practice, which stresses on maintaining good relationship with customers while evaluating the deductibility of the impugned expenditure

21. CIT(A) has disagreed with the assessee, as according to him, the impugned payment could not be construed as ‘commercially expedient’ since the amount was neither payable nor enforceable in terms of the terms and conditions of the agreement with Star India Pvt. Ltd. As per the CIT(A), the payment was gratuitous in nature and, therefore, on this count also the said amount was not deductible as an expenditure. The CIT(A) noted that as the expenditure related to the income of Rs.72.00 crores which was offered to tax on receipt basis in a preceding year and, thus, such expenditure was not relatable to the incomes of the current year, and was a prior period expenditure in so far as the current year was concerned. For all the above reasons, the CIT(A) sustained the action of the Assessing Officer disallowing the expenditure of Rs.10 cores

Arguments by Assessee

Ld. Representative for the assessee has vehemently pointed out that both the lower authorities have not appreciated the facts in proper perspective inasmuch as assessee had a long-standing professional relationship with Star India Pvt. Ltd. and that the impugned expenditure was incurred on account of commercial expediency. The Ld. Representative for the assessee pointed out that Star India Pvt. Ltd. was a major client of the assessee inasmuch as between assessment years 2007-08 to 2009-10 almost a sum of Rs.132 cores have been earned by the assessee from Star India Pvt. Ltd. and even for the year under consideration, out of the total gross receipts of Rs.150 crores, approximately a sum of Rs.60 cores has been earned from the said concern. 

Commercial Expediency

For all the above reasons, the plea of the assessee is that there was sufficient commercial expediency for incurring the impugned expenditure and that it has to be examined from the point of view of a businessman and the Assessing Officer has misdirected himself. In the course of his arguments, the Ld. Representative referred to the propositions laid down in the following judgments in support of the case of the assessee :-

(i) Sassoon J. David & Co. Pvt. Ltd. vs. CIT, 118 ITR 261(SC)

(ii) S.A Builders vs. CIT, 288 ITR 1(SC)

(iii) CIT vs. Dhanrajgiri Raja Narasingiriji, 91 ITR 544 (SC)

Arguments by Revenue

As per the Ld. Departmental Representative, there was no breach of agreement by the assessee and, therefore, he was under no obligation to either refund the fees for the non-produced Episodes or spend the amount of Rs.10 crores for grant of sponsorship of Kolkata Knight Riders Cricket Team to Star India Pvt. Ltd. It was therefore, argued that the expenditure in question was not borne out of any business necessity and was, rather, gratuitous in nature. It was also pointed out that the entire fee was received by the assessee upfront and offered for tax in earlier assessment year on receipt basis and therefore, even if the impugned expenditure is in relation to the income from Star India Pvt. Ltd., it cannot be allowed while deducting current year’s income as it is in the nature of prior period expenditure. In sum-andsubstance, the Ld. Departmental Representative has defended the action of the lower authorities by placing reliance on the respective orders.

Also Read : Capital or Revenue?E-Connectivity Charges - Ruling in UBC India Private Ltd vs. Addl. CIT

Adjudication

We have carefully considered the rival submissions. Evidently, the dispute in this Ground revolves around the import of the provisions of section 37(1) of the Act. Section 37(1) of the Act, inter-alia, relates to deduction of an expenditure laid out or extended wholly and exclusively fo the purpose of business or profession while computing the income chargeable under the head “profits and gains of business or profession”. Precisely put, the controversy before us is as to whether the expenditure of Rs.10 crores incurred by the assessee by way of payment to Knight Riders Sports Pvt. Ltd. for obtaining sponsorship rights in favour of Star India Pvt. Ltd. would constitute an expenditure expended whol y and exclusively for the purpose of asessee’s business or profession so a to be deductible in terms of section 37(1) of the Act.

The fact-situation lies in a narrow compass and has already been noted by us in sufficient detail in the earlier part of this order. Be that as it may, it would suffice to note that assessee, who is an Actor by profession, entered into an Artist Service Agreement on 30/03/2007 with Star India Pvt. Ltd. for acting as anchor and host of a programme – “Kaun Banega Crorepati”, which was to be produced by Star India Ltd. The agreement was for a total of 104 Episodes divided into two seasons of 52 Episodes each. The total consideration payable was Rs.72 crores, which was received by the assessee in advance and the same has also been offered to tax in an earlier assessment year on receipt basis. It transpires that after production of 52 Episodes in the first season, the Star India Pvt. Ltd. decided not to produce the balance 52 Episodes for commercial reasons.

It further emerges that since the balance Episodes were not produced, Star India Pvt. Ltd. wanted to recover the value of the unutilized amount from the assessee for non-shooting of the second season. In terms of a mutually agreed arrangement, assessee, inter-alia, agreed to secure for Star India Pvt. Ltd. a sponsorship association with Kolkata Knight Riders Cricket Team for IPL Season -2. For securing such sponsorship, assessee paid Rs.10 crores to Knight Riders Sports Pvt. Ltd. and in return sponsorship rights were awarded to Star India Pvt. Ltd. The said expenditure has been claimed as deductible while computing the income chargeable under the head “profits and gains of business or profes

Ruling by Mumbai Tribunal

Factually speaking, there is no dispute that assessee and Star India Pvt. Ltd. share a business relationship, inasmuch as, the assessee has earned substantial professional receipts from Start India Pvt. Ltd. not only in this year but also in the past years. At this point, we may observe that the Assessing Officer has wrongly noted that assessee has not received any professional receipt from the said concern in the instant assessment year. On the contrary, the details on record reveal that assessee has earned a sum of Rs.60 crores from Star India Pvt. Ltd., which is a part of the total professional receipts for the year under consideration. In fact, the Ld. Representative for the assessee submitted that the amount of Rs.60 crores received from Star India Pvt. Ltd. during the year under consideration constituted almost 40% of the total receipts. Be that as it may, what we are trying to emphasize is that there is a subsisting professional relationship between assessee and Star India Pvt. Ltd.and the impugned arrangement has to be viewed from the prism of a Principal – client relationship. In terms of the Artist Service Agreement dated 30/03/2007, assessee was to shoot for 104 Episodes but no shooting took place for 52 Episodes on account of a decision of Star India Pvt. Ltd., whereas the consideration for the entire Episodes was paid to the assessee in advance.

In such a situation, intention of Star India Pvt. Ltd to obtain or recover the value of the unutilized amount from assessee for non-shooting of the balance 52 Episodes is quite plausible. As per the Revenue, the Artist Service Agreement dated 30/03/2007 did not obligate the assessee to refund the unutilized amount because the non-shooting on a decision taken by Star India Pvt. Ltd. No doubt, the point made by the Revenue may be correct in the context of the terms and conditions of the Artist Service Agreement dated 30/03/2007 but the allowability of the impugned expenditure has to be examined in the context of its commercial expediency. The assessee entered into an arrangement with Star India Pvt. Ltd. on a mutually agreed basis whereby the loss suffered by Star India Pvt. Ltd. was sought to be recouped with the earnings from the sponsorship of Kolkata Knight Riders Cricket Team for which assessee incurred Rs.10 crores on behalf of Star India Pvt. Ltd. In our considered opinion, it is not the legal necessity to spent the expenditure which is determinative of its allowability; rather, it is the existence or otherwise of commercial expediency which guides the allowability of expenditure under Section 37(1) of the Act.

From the point of view of commercial expediency, it is abundantly clearly that assessee had a long-standing professional relationship with Star India Pvt. Ltd. and there is a nexus between the impugned expenditure and the purpose of business. The Ld. Representative for the assessee has rightly relied upon the judgment of Dhanrajgiri Raja Narasingiriji (supra) to contend that it was not for the Revenue to prescribe what expenditure should an assessee incur and under what circumstances. In the present case, there is no challenge to the bonafides of the expenditure incurred and, in our view, the same can be understood to have been incurred wholly and exclusively for the purposes of business within the meaning of section 37(1) of the Act.

In fact, the Hon'ble Supreme Court in the case of Sassoon J. David (supra) has held that the expression “wholly and exclusively” used in section10(2)(xv) of the Income Tax Act, 1922 ( which is pari-materia to section 37(1) of the Act ) does not mean that expenditure has to be “necessarily” incurred. As per Hon'ble Supreme Court, an expenditure incurred voluntarily and without any necessity would be allowable so long as it has been incurred for promoting the business of the assessee. In our considered opinion, the commercial expediency canvassed by the assessee in the instant case clearly establishes that the impugned expenditure falls within the scope of the expression “wholly and exclusively for the purpose of business or profession” within the meaning of section 37(1) of the Act. Therefore, on this aspect, assessee has to succeed. Accordingly, the order of the CIT(A) is set-aside and the Assessing Officer is directed to delete the addition of Rs.10 crores. Thus, assessee succeeds on this Ground.

Cases Referred to

1. Sassoon J. David & Co. Pvt. Ltd. vs. CIT, 118 ITR 261(SC)

2. S.A Builders vs. CIT, 288 ITR 1(SC)

3. CIT vs. Dhanrajgiri Raja Narasingiriji, 91 ITR 544 (SC)

4. Shoorji Vallabhdas and Co., 46 ITR 144 (SC)

5. Godhra Electricity Co. Ltd., 225 ITR 746 (SC)

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Read 4564 times Last modified on Monday, 03 April 2017 13:35
Deepak Kumar

A Post Graduate and Chartered Accountant Deepak Sinha is a member of Taxpundit's core team. An analytical, result oriented professional with more than 10 years of combined experience in industry and consultancy.

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