Expression “purposes of business” is wider than “purpose of earning profits” – ITAT

Commercial expediency – Expression “for the purposes of the business” is wider than “for the purpose of earning profits” – ITAT

In a recent judgment, Ahmedabad ITAT has allowed an expenses u/s 37(1) considering Commercial expediency holding that the expression given in section 37 “for the purposes of the business” is wider in scope than the expression “for the purpose of earning profits

ABCAUS Case Law Citation:
ABCAUS 4145 (2024) (07) ITAT

In the instant case, the assessee had challenged the order passed by the CIT(A) in confirming the disallowance under section 37(1) of the Income Tax Act, 1961 (the Act) in respect of expenses claimed towards forfeiture of bank guarantee.

The appellant assessee was a company engaged in the business of construction and gas pipeline projects. During the year the company had entered In the instant appeal, the assessee had challenged the order of CIT(A) in confirming a MoU to form a consortium with another company and jointly given a bank guarantee in a tender bidding. Due to certain disqualifications, the consortium was unable to meet the tender requirements, resulting in the forfeiture of the bank guarantee. The Assessee Company paid its ½ share towards the forfeiture.

The company has claimed a deduction claim towards the said forfeiture as selling expenses as business expenses under Section 37(1) of the Act being incurred wholly and exclusively for the purpose of carrying on its business.

However, the Assessing Officer (AO) disallowed the said expenses on the ground that these expenses were not incurred for the business purposes of the Company and hence not allowable under Section 37(1) of the Act.

Before the Tribunal the assessee contended that the CIT(A) failed to appreciate the standard industry practices and the sequence of events leading to the incurrence of these expenses. The expenses were genuine business expenses aimed at securing additional business and should be allowed as a deduction under Section 37(1) of the Act.

The Revenue contended that the consortium formed represented an “Association of Person” (AOP), i.e. a separate entity and thus expenses belonged to the AOP and not that of assessee.

The Tribunal opined that based on the detailed examination of the facts and legal provisions, the CIT(A)’s assumption regarding the existence of an AOP was not substantiated. The appellant’s submission and the facts on record indicated that the tender was applied for by the Consortium, not as a legally separate AOP. The Memorandum of Understanding (Consortium

Agreement) also supports that the consortium was formed solely for the purpose of tender application and execution.

The Tribunal further observed that the CBDT Circular No. 7/2016 dated 07.03.2016 provides clarity on the taxability of consortium members, specifically in the context of EPC/Turnkey contracts. The circular also lists attributes that may prevent a consortium from being treated as an AOP.

The Tribunal in the light of the said circular opined that the Consortium under consideration operated more as a joint working arrangement rather than a unified entity with common control and management, which are essential elements of an AOP. Therefore, considering the nature of the consortium agreement, the operational structure and the legal precedents, it is evident that the said consortium does not constitute an AOP for taxation purposes. The CIT(A)’s assumption of the existence of an AOP was therefore incorrect, as the consortium lacked the essential characteristics of an AOP as defined under the Income Tax Act and clarified by the CBDT.

The Tribunal opined that the evidence provided by the assessee, including the MOU and the sequence of events, clearly showed that the expenses were incurred wholly and exclusively for the purpose of carrying on the business An expense is deductible if it is laid out or expended wholly and exclusively for the purposes of the business or profession. It is important that the expenditure should be for the business and not for any other purpose. Therefore, the expenditure incurred by a taxpayer in the course of its business must be allowed if it is for commercial expediency.

The Tribunal stated that the test is not the necessity but the commercial expediency of the expenditure. The expression given in section 37 of the Act – “for the purposes of the business” is wider in scope than the expression “for the purpose of earning profits”. Therefore, expenditure incurred voluntarily and on the grounds of commercial expediency is allowable.

The Tribunal held that thus, disallowance of selling expenses by the AO and the upholding of such disallowance by the CIT(A) was not justified. The expenses incurred by the assessee were allowable under Section 37(1) of the Act as they were laid out wholly and exclusively for the purpose of the business.

Accordingly, the AO was directed to delete the addition made on account of disallowance of selling expenses. 

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