Legal expenses to defend writ filed to quash mining lease of the company are revenue expenditure not capital expenditure and deduction is allowable u/s 37 of the Income Tax Act, 1961 – High Court
ABCAUS Case Law Citation:
ABCAUS 2021 (2017) (08) HC
The Substantial Question of Law framed for determination:
Whether, in the facts and circumstances of the case, the tribunal is justified in holding that the legal expenditure incurred by the assessee to defend the writ petition filed to quash the government notification and lease deed, is capital expenditure and is a deduction allowable within the meaning of section 37 of the Income tax Act?
Assessment Year : 2008-09 and 2009-10
Important Case Laws Cited/relied upon by the parties:
Dalmia Jain & Co., Ltd., vs. CIT [81 ITR 754 (SC)]
Sree Meenakshi Mills Ltd., vs. CIT [63 ITR 207 (SC)]
V.Jaganmohan Rao and Others vs. Commissioner of Income Tax
Excess Profits Tax, Andhra Pradesh [(1970) 75 ITR 373 (SC)]
M/s.Mangalore Ganesh Beedi Works vs. Commissioner of Income Tax, Mysore and Another [2015-TIOL-241-SC-IT],
Commissioner of Income Tax vs. M/s.ITC Hotels Ltd.
Atherton vs. British Insulated and Helsby Cables Ltd.  A.C. 205
M/s.Assam Bengal Cement Co. Ltd., vs. Commr. of Income-tax, West Bengal [AIR 1955 SC 89]
Brief Facts of the Case:
One of the business activities of the respondent assessee was mining of iron ore by taking lands on lease from the State Government. Ccertain lands were leased out to assessee for the purpose of mining iron ore by the Department of Mines and Geology. The assessee was working on the said lease as a lessee of the State Government.
The grant of lease to the assessee was challenged by two companies in writ petitions before the High Court. The assessee, for the relevant assessment years had debited certain legal expenditure incurred while defending the said writ petitions filed which were seeking quashing of Government notifications granting mining lease to the assessee.
The Assessing Officer sought to disallow the claim of legal expenditure on the ground that it was a capital expenditure. But the assessee maintained that the mining lease was granted by the Department of Mines and Geology to the assessee, which was assailed in the writ petitions filed by two parties. The expenditure incurred was to protect the lease that was granted by the Government to the assessee, who was defending a claim made by third parties and not for the purpose of perfecting a mining lease.
The Assessing Officer not being satisfied with the contention of the assessee, held that the expenditure had to be construed to be capital expenditure, as it was an expenditure having nexus to earning of profits in business. Accordingly, the claim was disallowed.
The assessee filed an appeal before the Commissioner of Income Tax, Appeals (CIT-A), which allowed the claim of the assessee.
As against the order of the Appellate Commissioner, the Department filed appeals before the Income-tax Appellate Tribunal (ITAT). The Tribunal held that the CIT-A had not looked into the aspect as to whether the expenditure incurred long back could be allowed on piecemeal basis in subsequent years and that the approach of the Appellate Commissioner in deciding the matter was not proper. Therefore, the appeals were remanded for reconsideration by the CIT-A.
Being aggrieved by the order of Tribunal, the Revenue had preferred an appeal to High Court which is the subject matter of the present judgment.
Contention of the Respondent Revenue:
It was contended that where money is paid to perfect a title or as consideration for getting rid of a defect in the title or a threat of litigation, the payment would be capital payment and not revenue payment.
Contentions of the Respondent Assessee:
It was submitted that the said expenditure was incurred in order to defend a claim made by third parties in respect of a mining lease granted to the assessee. That the purpose of incurring the aforesaid expenditure towards litigation was for defending grant of mining lease and not merely a business expenditure or expenditure arising during the course of business. Such an expenditure cannot be treated as revenue expenditure, but it is a capital expenditure. Therefore, the expenditure cannot be treated wholly and exclusively incurred to protect the interest of business or for the purpose of business within the meaning of Section 34 of the Act.
Observations made by the High Court:
The Hon’ble High court observed that the assessee was made a respondent in the writ petitions filed. It was in order to defend and sustain the said lease that the assessee had to incur expenditure towards legal fee and other allied expenditure. The assessee was dragged into litigation before the High Court by writ petitions filed by third parties. The assessee had to resist the writ petitions in order to protect his mining rights in respect of the contentious lease. Therefore, the expenditure incurred towards legal fee and other litigation charges was to protect its business interests in relation to the mining lease. The expenditure was not incurred to acquire the mining lease or to get rid of a defect in the title. While resisting the writ petitions, the assessee did not bring into existence any asset or create any capital asset. Therefore, the question, is, whether, the expenditure has to be attributed to be revenue expenditure or capital expenditure.
The Hon’ble High court noted the observations made in various judgments of the High Courts as under:
Dalmia Jain & Co., Ltd
“The question for decision is whether the litigation expenses incurred by the assessee were for the purpose of creating, curing or completing the assessee’s title to capital or whether it was for the purpose of protecting its business. If it is the former then the expenses incurred must be considered as capital expenditure. But, on the other hand, if it is held that the expenses were incurred to protect the business of the assessee, then it must be considered as a business loss. The principle which has to be deduced from decided cases is that, where the expenditure laid out for the acquisition or improvement of a fixed capital asset is attributable to capital, it is a capital expenditure but if it is incurred to protect the trade or business of the assessee then it is a revenue expenditure. In deciding whether the particular expenditure is capital or revenue in nature, what the courts have to see is whether the expenditure in question was incurred to create any new asset or was incurred for maintaining the business of the company. If it is the former it is the capital expenditure; if it is the latter, it is the revenue expenditure.”
The Hon’ble High court observed in the case of Dalmia Jain, the High Court relied upon Shree Meenakshi Mills and held that “Deductibility of expenditure incurred in prosecuting a civil proceeding depends upon the nature and purpose of the legal proceeding in relation to the assessee’s business and the same cannot be affected by the final outcome of that proceeding. However wrong-headed, ill advised, unduly optimistic or overconfident in his conviction the assessee might appear in the light of the ultimate decision; expenditure in starting and prosecuting a civil proceeding cannot be denied as a permissible deduction in computing the taxable income merely because the proceeding had failed, if otherwise the expenditure was laid out for the purpose of the business wholly and exclusively, that is, reasonably and honestly incurred to promote the interest of the business. Persistence of the assessee in launching the proceeding and carrying it from Court to Court and incurring expenditure is not a ground for disallowing the claim.”
It had been held, it is well established that where money is paid to perfect a title or as consideration for getting rid of a defect in the title or a threat of litigation the payment would be capital payment and not revenue payment. What is essential to be seen is whether the amount was paid for bringing into existence a right or an asset of an enduring nature. In other words, if the asset which is acquired is in its character a capital asset, then any sum paid to acquire it must surely be capital outlay. Money paid in consideration of the acquisition of a source of profit of income is capital expenditure.
M/s.Mangalore Ganesh Beedi Works
It was observed that on a consideration of the issues placed before the Tribunal, including the decision of High Court in Dalmia Jain, it was held that the expenses incurred by the Assesee were honest and reasonable and were incurred for the purpose of protecting the business of the firm as a going concern.
M/s. ITC Hotels Ltd
It had been observed that on a consideration of the facts in detail, the Tribunal has recorded a finding that the litigation expenses were incurred not to protect the lease hold rights or to protect its title, but were incurred to defend its right to carry on business of a hotel and therefore, the expenses are revenue in nature and it is purely a finding of fact and does not involve any question of law.
M/s.Assam Bengal Cement Co. Ltd
It had been held that the question as to whether any expenditure is capital or revenue in nature has all along been considered to be a question of fact to be determined by the Income-tax Authorities on an application of the broad principles laid down and the courts of law would not ordinarily interfere with such findings of fact if they have been arrived at on a proper application of those principles. It has also been held in the said decision that the aim and object of the expenditure would determine the character of the expenditure whether it is a capital expenditure or a revenue expenditure. The source or the manner of the payment would then be of no consequence.
The Hon’ble High court opined that in B.Jaganmohan Rao, facts were that payment of money made by the assessee therein was in order to perfect his title to the capital asset. It was a lump sum payment for acquisition of a capital asset and therefore, the Hon’ble Supreme Court held that the amount should be treated as capital payment and the assessee was not entitled to exclude from the income sought to be assessed in his hands any portion of that amount. But having regard to the facts in the present case and by applying the decisions in the aforementioned judgments, he Hon’ble High court held that the Tribunal was justified in holding in favour of the assessee and thereby, dismissing Department’s appeal.
The legal expenditure incurred by the assessee to defend the writ petitions filed to quash the Government notification and lease deed was not a capital expenditure and deduction was allowable within the meaning of Section 37 of the Act, as it was revenue expenditure.