Disallowance u/s 37 for legal fee paid in excess of damages received in the relevant case deleted. Profit in immediate proximity not a basis of disallowance – High Court
ABCAUS Case Law Citation:
ABCAUS 2019 (2017) (08) HC
The Grievance:
The appellant revenue had filed the instant appeal being aggrieved by the judgment of the Income Tax Appellate Tribunal (ITAT) sustaining the order of Commissioner of Income Tax (Appeals) [CIT(A)] deleted the disallowance u/s 37 of the Income Tax Act, 1961 (the Act) made by the Assessing Officer (AO).
Assessment Year : 2006-07
Important Case Laws Cited/relied upon by the parties:
Sassoon J. David & Co. (P) Ltd., V. CIT, (1979) 118 ITR 261
Brief Facts of the Case:
the Assessee was a limited company and had paid a sum of Rs. 1,93,90,452/- towards legal fees along with a sum of Rs. 1,81,327.50 towards Professional Indemnity Insurance to its legal adviser, in U.K.
According to the Assessing Officer, the Assessee could not have claimed deduction for the aforementioned payments, under Section 37 of the Act. The reasons according to by the Assessing Officer was that the legal fees was exorbitant and far in excess to the compensation received in the matter fought with the entity, which had infringed assessee’s rights in the registered software qua which, advice was received from its aforementioned legal adviser based in U.K.
Regarding the claim for deduction towards payment on Professional Indemnity Insurance, the Assessing Officer took the view that insurance, under the U.K. law, had to be taken out by the legal adviser, and, therefore, the deduction claimed could not be allowed.
The assessee carried the matter in appeal to the CIT(A). Before the CIT(A), the Revenue took an additional ground that the payment of legal fee, in the first instance, had been made by the Director of the Assessee company via his personal account. However, affirmed with the genuineness of the transaction CIT(A) rejected it holding that the “modus operandi” of payment was not relevant. The CIT(A) reversed the view taken by the Assessing Officer and allowed the expenses incurred, both towards legal fee and Professional Indemnity Insurance, under Section 37(1) of the Act.
The Revenue, being aggrieved, carried the matter in appeal to the Tribunal. The Tribunal, in turn, sustained the view of the CIT(A).
Observations made by the High Court:
The High Court observed that Revenue lost site of the fact that the assessee company was protecting its rights in a registered software. The registered software was a property of the Assessee Company, which, one would assume, could earn the Assessee, revenue from time to time, as and when, it licenced its use by third parties. Therefore, to compare the value of compensation paid by the infringer of the right with the expenses incurred on legal fees, would be fallacious.
The High Court concurred with the views of the CIT(A) in that the Revenue, if, at all, ought to have compared the fees paid to legal adviser, with the fees demanded by a professional working out of U.K., qua a similar kind of work.
The High Court also noted that the amount paid towards Professional Indemnity Insurance, by the Assessee was also in order, as even though, the Legal adviser was required to take out an insurance under the U.K. law, the legal adviser was entitled to recover the same from his client, i.e., the Assessee.
Before concluding, the High Court went on to indicate that the test to be employed for examining as to whether or not a particular expenditure incurred by an Assessee, be allowed, is that, which is, provided in Section 37 itself. Therefore, what is required to be ascertained is, whether or not, the expenditure in issue is laid out or incurred wholly and exclusively for the purpose of business, and that, it is not an expenditure, which is described under Sections 30 to 36 of the Act, or an expenditure in the nature of capital expenditure or, if, an Assessee is an individual, it involves defrayment of personal expenses.
In ascertaining as to whether the expenditure has been laid out or expended wholly and exclusively for the purpose of business, what is to be borne in mind, is that, it is incurred on account of commercial expediency of the Assessee. The fact that the expenditure incurred by an Assesseee is not propelled on account of any legal obligation, or that, it benefits a third party, would not come in the way of it being allowed, as long as it is incurred due to commercial expediency.
As to what is commercial expediency is to be looked at by Income Tax Authorities by placing themselves in the shoes of a prudent business person.
The High Court explained that the fact that a particular expense does result in a profit for the Assessee in the immediate proximity cannot form the basis of its disallowance. In incurring an expense, a business person could have a short and a long term perspective. The fact that in the short term the expense incurred does lead to a profit, cannot rule out the possibility of accretions of profits to the Assessee in the long run. These are business decisions best left to the wisdom of those who run and manage the business.
Held:
Accordingly, the High Court held that notwithstanding the fact that the legal fee paid was more than the compensation received by the assessee, the same, was amenable for deduction under Section 37 of the Act. Likewise, the expense incurred towards Provisional Indemnity Insurance could not have been disallowed, merely, by reason of the fact that adviser in U.K. was required to take out the insurance.
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