Issue for Consideration An expenditure laid out or expended wholly and exclusively for the purposes of business or profession is allowed as a deduction, u/s. 37, in computing the income chargeable under the head ‘Profits and Gains of Business or Profession’, provided such an expenditure is not in the nature of a capital expenditure or a personal expenditure of the assessee and is not of the nature covered by section 30 to 36 of the Act.
The expenditure, though incurred for the purposes of business, shall be deemed to have not been incurred for the purposes of business, where the expenditure is incurred for a purpose which is an offence or which is prohibited by law. No deduction or allowance, therefore can be made in respect of such an expenditure by virtue of Explanation 1 to section 37(1) of the Act.
It is not uncommon for a businessman to make certain payments in the course of his business, the payment of which might be an offence or prohibited by law. Several cases of payments of fines and penalties for violation of law are the examples that immediately come to mind. Such payments largely would be the cases of expenditure that would be hit by the Explanation 1 to section 37(1) and would stand to be disallowed in computing the Total Income.
Cases often arise wherein a businessman, for the purposes of his safety or for safeguarding his business, is required to make certain payments to either the police or security guards or to the gangsters or even to the kidnappers. Such payments, when made to the police or security guards are known as “Security Charges”, when made to gangsters are known as “Protection Money” and as “Ransom” when paid to kidnappers.
Issue arises in the context of Allowance or Deduction when such payment, i.e., security charges or protection money or ransom is made. Whether such payments, though made for business purposes, would be liable for disallowance on the ground of it being construed as an expenditure incurred for a purpose which is an offence or is prohibited by law. Conflicting views of the High Courts highlight the controversial nature of the issue under consideration.
M. S. Swam inathan’s case
Before the Karnataka High Court in the case of CIT vs. M. S. Swaminathan, 236 CTR 559, the Revenue had raised the following question for consideration of the high court in an appeal filed by it – “ whether the payment made to local police and local rowdies can be an allowable expenditure as a business expenditure ?
“In the said case, a sum of Rs. 86,000 was claimed as expenditure for money paid to local police and local goons towards the maintenance of the two theatres run by the assessee, viz., Vinayaka Touring Talkies and Sri Krishna Theatre. The expenditure of Rs. 86,000 claimed was disallowed by the AO. The CIT(A), in an appeal filed by the assessee, concurred with the view expressed by the AO and dismissed his appeal. Aggrieved by the same, the assessee filed the second appeal before the tribunal, which allowed the appeal in part, by allowing deduction of Rs. 50,000 as against Rs. 86,000 claimed. Being aggrieved by the same, the appeal was filed by the Revenue before the High Court.
On hearing the rival contentions, the Karnataka High Court allowed the appeal of the Revenue for disallowing the claim of the expenditure by holding as under;
“If any payment is made towards the security, towards the business of the assessee, such amount is an allowable deduction, as the amount spent for the maintenance of peace and law and order in the business premises of the assessee as he was running two cinema theatres. But the amount spent in the instant case claimed by the assessee is towards payment made to the police and rowdies. If any payment is made to the police illegally, it amounts to bribe and such illegal gratification cannot be considered as an allowable deduction and similarly, if any amount is paid to a rowdy as a precautionary measure to see that he shall not cause any disturbance in the theatre run by the assessee, the same is also an amount paid illegally for which no deduction can be allowed by the Department. If the assessee had spent the money for the purpose of security, we would have to concur with the view of the Tribunal. However, in the instant case, the payment has been made to the police and rowdies to keep them away from the business premises which payment be held as illegal and such illegal payment cannot be an allowable deduction.”
Khemchand Motilal Jain, Tobacco Products (P.) Ltd.’s case
The issue arose in the case of CIT vs. Khemchand Motilal Jain, Tobacco Products (P.) Ltd. 340 ITR 99 (MP) before the Madhya Pradesh High Court. In that case, the assessee company was engaged in manufacturing and sale of bidis. One Mr. Sukhnandan Jain was a whole-time director of the assessee-company and was looking after the purchase, sales and manufacturing of bidis. During his business tour in August 1987 to Sagar for purchase of tendu leaves, he was kidnapped for ransom by a dacoit gang headed by Raju Bhatnagar. Immediately, a complaint and FIR were lodged with Sagar Police. The assessee company awaited the action of the police but the police was unsuccessful in getting Mr. Sukhnandan Jain released from the clutches of the dacoit. Ultimately after 20 days, a sum of Rs. 5,50,000 was paid by way of ransom for the release of Mr. Sukhnandan Jain. On the same day of payment of the ransom, Mr. Sukhnandan Jain was released by the dacoits.
The company claimed a deduction of the ransom amount as business expenditure. The AO disallowed the claim of the assessee company on the ground that the ransom money paid to the kidnappers was not an expenditure incidental to business. On appeal, the CIT (Appeals) allowed the claim of the assessee. The Tribunal confirmed the finding of the CIT (Appeals). On appeal, the Revenue contended that the amount of ransom could not have been claimed by way of expenditure as the Explanation to sub-section (1) of section 37 prohibits such expenditure. The Tribunal referred the following question to the Court :“Whether on the facts and in the circumstances of the case, the Tribunal was justified in law in holding that the amount of Rs. 5,50,000 paid as ransom money to the kidnappers of one of the Directors was an allowable deduction under section 37(1) of the Income-tax Act,1961?”
Before the High Court, the Revenue submitted that the amount of ransom could not have been claimed by way of expenditure as the Explanation of sub-section (1) of section 37 of the Income-tax Act, 1961 prohibited allowance of such an expenditure. It was submitted that the payment of any amount which was prohibited by law was not a business expenditure and it could not be allowed as an expenditure.
The amicus curiae, and the assessee company supported the orders passed by the appellate authorities and submitted that the payment of ransom was an allowable expenditure. It was pleaded that the amount was paid to the dacoits to get Mr. Sukhnandan Jain, who was on business tour and who was working as the director of the company, released from the dacoit. It was contended that the aforesaid amount was rightly claimed as an expenditure of business. It was insisted that at the relevant time, Mr. Sukhnandan Jain was on a business tour and was staying at a Government Rest House at Sagar, from where he was kidnapped.
The assessee company, in support of its claim, relied upon the judgments in cases of Sassoon J. David & Co. (P.) Ltd. vs. CIT, Bombay 118 ITR 261 and CIT West Bengal, Calcutta vs. Karam Chand Thapar and Brothers (P.) Ltd, 157 ITR 212(Cal.) and Addl. CIT vs. Kuber Singh Bhagwandas, 118 ITR 379(MP).
The madhya Pradesh high Court extensively quoted with approval the findings of the appellate authorities in respect of the contribution of Mr. Sukhnandan Jain to the business of the company, his need to travel for the purposes of business, the business exigency for payment of ransom money and the compulsion thereof. The court noted that from the perusal of the facts, it was apparent that Sukhnandan jain was conducting business tour for the company and was staying at a government rest house and the visit was to meet one Bihari Lal for the procurement of quality tendu leaves and it was during the business tour, that he was kidnapped. The court further noted that for a period of near about 20 days after lodging a report to the police, when all the efforts of the police were unsuccessful, the company made payment of ransom amount of Rs. 5,50,000 to the kidnappers and ultimately on the same day, Sukhnandan jain was released from the clutches of the dacoits and that both the appellate authorities had found that it was a business expenditure while allowing the claim.
The court referred to the provisions of explanation of sub-section (1) of section 37, for determining whether the expenditure could have been disallowed under that provision of the act. It also examined the provisions of section 364a of the indian Penal Code which provided that kidnapping a person for a ransom was a criminal offence. It noted that the aforesaid section 364A provided that kidnapping a person for ransom was an offence and any person doing so or compelling to pay, was liable for punishment as provided in the section, but nowhere it was provided that to save a life of the person if a ransom was paid, it would amount to an offence. No provision was brought to the notice of the court that the payment of ransom was prohibited by any law and in absence of it, the Explanation of sub-section (1) of section 37 was not applicable in the case of the assessee company.
The madhya Pradesh high Court, after analysing the decisions cited by the assessee company, observed that in the case before the court, Mr. Sukhnandan Jain was on business tour and was staying at a government rest house from where he was kidnapped and to get him released, the amount was paid to the dacoits as ransom money. It thereafter held as under; “If the respondents to save his life paid the aforesaid amount, then the aforesaid amount cannot be treated as an action which was prohibited under the law. No provision could be brought to our notice that payment of ransom is an offence. In absence of which, the contention of the petitioner that it is prohibited under Explanation of section 37(1) of the Income-tax Act has no substance. The entire tour of Sukhnandan Jain was for purchase of tendu leaves of quality and for this purpose he was on business tour and during his business tour, he was kidnapped and for his release the aforesaid amount was paid.”
The high Court accordingly held that the ransom amount was an allowable business expenditure.
Observations
The bitter reality of the day is that people do have to regularly cough up money, against their will, for securing the safety of their business or lives or both. in some cases. the payments are made to ensure continuity of the business. In many cases, the payments are not only involuntary but may not be authorised by the law, as well. Such payments are forced by the goons or the guardians of the law and at times by the framers of the law. Barring a very limited section of the society, no one cherishes such payments but are seen, nonetheless to be acquiescing to such extortions in the interest of survival. Cases are available wherein a citizen has to resort to imaginary ways to meet such demands by generating cash from one’s accounted funds. In most of the cases, even approaching the authorities, entrusted with the task of protecting and ensuring the safety of the citizens, involves an extra and additional cost. Therefore, it brings additional pains where such expenditure incurred against one’s will is not allowed as a deduction in computing the total income. On disallowance of the claim, it becomes a case of a double whammy for the businessman.
The Government, instead of ensuring that its citizens are not extorted to pay money against their will by securing their safety, by booking the extortionists, has, to add insult to the injury, legislated the said Explanation to section 37(1) for providing that such an expenditure is disallowable.
Section 37 of the income-tax act provides for allowance of an expenditure that has been wholly and exclusively incurred for the purposes of the business of the assessee. It is a settled position in law that the expression “wholly and exclusively” does not mean “necessarily”. An expenditure maybe incurred by than assessee without there being a dire necessity for incurring such an expenditure and such an expenditure will not be disallowed once it is shown that the same has been incurred for the purposes of business of the assessee. It is for the assessee to decide whether any expenditure should be incurred in the course of his business or not. Such an expenditure may be incurred voluntarily and without any necessity. Once an expenditure is incurred for promoting the business and to earn profits, the assessee can claim deduction even though there is no compelling necessity to incur such expenditure.
In order to decide whether a payment of money or incurring of expenditure is for the purpose of the business and is an allowable expenditure or not, the test to be applied is that of ‘commercial expediency’. If the payment or expenditure is incurred to facilitate the carrying on of the business of the assessee and is supported by commercial expediency, it does not matter that the payment is voluntary or that it also enures to the benefit of a third party.
An expenditure otherwise allowable u/s. 37, in terms of the tests discussed above, would still be disallowed if the same is incurred for a purpose which is an offence or is prohibited by law, in which event the expenditure so incurred shall be deemed to be not for the purposes of business or profession. The purpose behind an expenditure assumes a great importance; where the purpose is an offence, the disallowance would take place.
An offence, as per the dictionary, in the context, is an illegal act; a transgression or misdemeanour. accordingly, an expenditure incurred for the purpose which is illegal cannot be allowed under the act. Similarly, an expenditure incurred for achieving a purpose that is prohibited by law would not be allowed a deduction. It appears that there is very little difference between a purpose which is an offence and a purpose which is prohibited by law. In the context of explanation to section37 (1), one is therefore required to examine whether the payment is being made for a purpose which is prohibited by law.
Ensuring security of the business or of the business personnel, is an essential function of any business and therefore, payment of security charges would neither be an offence nor prohibited by law. We are afraid that the objective of the payee or his purpose behind demanding, collecting or receiving the payment is an irrelevant factor while applying the test of explanation 1 to section 37(1), the application of which is qua the payer and is limited to his purpose, as long as the purpose behind his expenditure is not an offence or prohibited by law.
Taking this understanding to the second level of payment of protection money, to a gangster, such a payment should not be disallowed as long as paying such an amount is not an offence under the indian Penal Code or any other law. It is true that for a gangster, demanding protection money or extorting money for not causing any damage, is an offence that is punishable under the indian Penal Code. His offence, however, need not necessarily be the offence of the payer assessee. The objectives and the purposes are different and cannot be equated.
Likewise, payment of ransom for securing the release to a kidnapper is not an offence or is not prohibited under any law. So, however, demanding a ransom is a serious crime that is punishable in law. Accordingly, the payment of ransom shall not be liable for any disallowance, simply on application of explanation 1 to section 37(1).
At the same time, it is significant to note that a payment to a police officer is an offence and is also prohibited by law if the same amounts to bribing him. however, an official payment to the Police Department, for security, is not an offence and is not liable for disallowance. In Swaminathan’s case (supra), it is not clear that what was the nature of payment to the police. Was it a bribe? if yes, it was liable for disallowance.
Many years back, the mumbai tribunal in the case of Pranav Construction Company, 61 T1TJ 45, held that payments made by a builder of “protection money” to tapories and hawkers was allowable as deduction on being satisfied about the genuineness of the expenditure. The tribunal held that the builders engaged in construction activities were vulnerable to danger such as extortion, haftas, etc. and unless, they obliged, it would be impossible for them to conduct business.
The view of the madhya Pradesh high Court, in the case of Khemchand Motilal Jain’s case (supra), that payment of ransom for securing the release of the director was not an expenditure for a purpose that was an offence or was prohibited by law and was therefore not hit by the explanation 1 to section 37(1) is the correct view in law.
