Background :
The Supreme Court in Punjab Industrial Development Corporation Ltd v. CIT, (1997) 225 ITR 792 held that the amount paid to the Registrar of Companies as filing fee for enhancement of capital constitutes capital expenditure. Relying on this decision, the Supreme Court in Brooke Bond India Ltd. v. CIT, (1997) 225 ITR 798 held that expenditure incurred in connection with issuing shares for increasing capital by a company is capital expenditure. Since then one is a witness to these two decisions being mechanically applied by tax authorities as a ground for disallowing any and every expenditure associated with share capital. These include expenses not only directly related but also incidentally connected to capital expansion. The question for consideration is whether any and every expenditure relatable to capital expansion is capital expenditure? Whether the above-mentioned decisions of the Supreme Court are all-pervasive? To put it differently, could there be occasions when these Supreme Court decisions become distinguishable? This write-up discusses one such occasion — in two parts. The first part outlines the law applicable for allowing any expenditure as business expenditure under the head income from business or profession. The second part would cover why the ratio of above-mentioned decisions of the Supreme Court cannot be regarded as all-pervasive as also other connected matters.
Assumed facts:
ABC Limited is a public company (hereinafter referred to as ‘ABCL’ for brevity) engaged in the business of manufacture and sale of pharmaceuticals products. ABCL has presence in various countries across the globe. The success of the business of ABCL is dependent upon marketing of its products. During financial year 2010-11, ABCL undertook certain strategic initiatives (including organisational restructuring) to re-align its business activities for entering into European, African and Asia-pacific countries. The objective was to capture trading opportunities available in such countries. ABCL was thus in need of funds for various business purposes viz., working capital for carrying out business, funds for securing distribution rights, licences, brands.
In view of the above, ABCL engaged the services of a commercial bank (say, XY bank) which assisted it in raising funds through foreign investors. With assistance from XY bank, ABCL managed to raise funds by issuing preference shares to three foreign investors. The funds raised by ABCL were utilised for the above purposes. In consideration of all the services provided, ABCL paid a consolidated fee to XY bank. The question for consideration is whether fees or any portion thereof paid to XY bank would be deductible as business expenditure under the provisions of the Income-tax Act, 1961 (‘Act’ for short hereinafter).
Applicable law — Introduction:
Chapter IV-D contains provisions relating to computation of ‘Profits and gains from business or profession’. Section 28 is the charging section. Section 29 enjoins that profits and gains referred to in section 28 shall be computed in accordance with the provisions contained in sections 30 to 43D. Sections 30 to 36 and 38 outline the law relating to specific deductions. Section 37 deals with expenditure which is general in nature and not covered within sections 30 to 36.
The payment by XY bank would not qualify for deduction under sections 30 to 36. Even section 35D would not have relevance. This is for the reason that the section would apply when expenses are incurred under specified heads prior to incorporation or after incorporation in connection with the extension of the industrial undertaking. The expenses under consideration are not pre-incorporation expenses. No extension of any existing undertaking is involved. Section 35D therefore would not be relevant. The deductibility of the said expenditure under section 37(1) of the Act remains for consideration.
Deductibility under section 37(1):
Section 37(1) of the Act enables a general or residual deduction while computing profits and gains of business or profession. Section 37(1) reads as under: “(1) Any expenditure (not being expenditure of the nature described in sections 30 to 36 and not being in the nature of capital expenditure or personal expenses of the assessee), laid out or expended wholly and exclusively for the purposes of the business or profession shall be allowed in computing the income chargeable under the head ‘Profits and gains of business or profession’.
(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.)
In order to be eligible for an allowance under section 37, the following conditions should be cumulatively satisfied:
(i) The impugned payment must constitute an expenditure;
(ii) The expenditure must not be governed by the provisions of sections 30 to 36;
(iii) The expenditure must not be personal in nature;
(iv) The expenditure must have been laid out or expended wholly and exclusively for the purposes of the business of the assessee; and
(v) The expenditure must not be capital in nature.
(i) The payment must constitute an expenditure:
The first and foremost requirement of section 37 is that there should be an expenditure. The term expenditure is not defined in the Act. The Supreme Court in Indian Molasses Company (P) Ltd. v. CIT, (1959) 37 ITR 66 (SC) defined it in the following manner:
“ ‘Expenditure’ is equal to ‘expense’ and ‘expense’ is money laid out by calculation and intention though in many uses of the word this element may not be present, as when we speak of a joke at another’s expense. But the idea of ‘spending’ in the sense of ‘paying out or away’ money is the primary meaning and it is with that meaning that we are concerned. ‘Expenditure’ is thus what is ‘paid out or away’ and is something which is gone irretrievably.”
A definition to a similar effect is found in section 2(h) of the Expenditure Act, 1957. This definition reads as : “Expenditure : Any sum of money or money’s worth spent or disbursed or for the spending or disbursing of which a liability has been incurred by an assessee. The term includes any amount which, under the provision of the Expenditure Act is required to be included in the taxable expenditure.”
In CIT v. Nainital Bank Ltd., (1966) 62 ITR 638, the Supreme Court held : “In its normal meaning, the expression ‘expenditure’ denotes ‘spending’ or ‘paying out or away’, i.e., something that goes out of the coffers of the assessee. A mere liability to satisfy an obligation by an assessee is undoubtedly not ‘expenditure’ : it is only when he satisfies the obligation by delivery of cash or property or by settlement of accounts, there is expenditure.”
Expenditure for the purposes of section 37 includes amounts which the assessee has actually expended or which the assessee has provided for or laid out in respect of an accrued liability. In the case under discussion, ABCL has paid fees to XY bank as consideration for services. The amount paid to XY bank constitutes ‘expenditure’ for the purpose of section 37(1) of the Act.
(ii) The expenditure must not be governed by the provisions of sections 30 to 36:
As already stated, the payment under discussion viz., fees paid to XY bank is not covered by any of the provisions of sections 30 to 36 of the Act. The payment would also not qualify for deduction under section 35D as the same has not been incurred prior to incorporation of business of ABCL or in connection with extension of the undertaking or setting up a new u
