Explanation to section 37(1) – Payments to Related Party made without obtaining prior approval of the Central Government in accordance with the provisions of section 297 of the Companies Act, 1956 was merely an irregularity and cannot be disallowed treating the same as an offence or prohibited by law.
Facts:
The assessee is engaged in the business of manufacture and export of surgical blades. The AO noted that the assessee had entered into transactions of payment of job work charges to a related party, viz., M/s. Razormed Inc. during thefinancial year relevant to the assessment year under consideration without obtaining prior approval of the Central Government inaccordance with the provisions of section 297 of the Companies Act, 1956. The assessee submitted that the post facto approval for the said transactions 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. However, the AO opined that the facts of post facto approval and the condonation of delay were not relevant because on the day of payment of such expenditure, there was no prior approval of the job charges paid to M/s. Razormed Inc., which triggered the Explanation to section 37(1) of the Act. He accordingly, added the sum of Rs. 41.24 lakh paid by the assessee towards job work charges. On appeal, the CIT(A) confirmed the order of the AO.
Held:
The Tribunal referred to the provisions of section 297 of the Companies Act, 1956 more particularly s/s. (5) of the said provision. As per the said provisions if the consent is not accorded to any contract under the section, then anythingdone in pursuance of the contract is voidable at the option of the Board of the Company. Thus, according to the Tribunal, if the Board, despite no prior sanction, agrees to go ahead with the contract referred to in s/s. (1) of section 297 of the Companies Act, such contract would be valid. In the case of the assessee, the tribunal noted that the Board had not objected to the contracts between the assessee and Razormed Inc., thus making such contract for doing of job work valid. Thus, there was no violation of section 297 of the Companies Act inasmuch as the so-called violation as per s/s. (1) stood regularised by s/s. (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.
Thus, according to the Tribunal, the payment made by the assessee was neither an offence nor prohibited by law, but it only committed a breach by not obtaining the necessary approval from the Central Government in time.Thus, the payment is otherwise for a lawful purpose. Further, referring to Explanation to section 37(1), the Tribunal observed that in order that the said provisions is applied, it is essential to examine 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. Thus, according to it, if the expenditure is otherwise lawful and neither amounted to offence nor is prohibited by law, but the procedural requirements for incurring it were not complied with, only the irregularity will creep in, but such irregularity would not make the expenditureitself as unlawful so as to be brought within the scope of the Explanation.
