Secretive commission payment not allowable us 37(1). Bribe to procure business is prohibited under explanation to Section 37(1)

Secretive commission payment not allowable us 37(1). It was in the nature of bribe to procure business which is prohibited under explanation to Section 37(1)

ABCAUS Case Law Citation:
ABCAUS 1221 (2017) (04) ITAT

The Grievance:
The appellant assessee was aggrieved by the order passed by the Commissioner of Income Tax (Appeals) in confirming the order of the Assessing Officer (AO) whereby he disallowed the ‘secretive commission” u/s 37(1) of the Income tax Act, 1961 (‘the Act’). 

Assessment Year : 2009-10
Date/Month of Pronouncement: April, 2017

Important Case Laws Cited/relied upon:
Ram Bahadur Thakur vs . CIT
Commissioner of Income Tax. vs Dhanpat Rai And Sons

Brief Facts of the Case:
The appellant assessee was an individual civil contractor, who had taken apartments on lease from their owners and let them out as service apartments. In the assessment made for the relevant year, the AO inter alia disallowed Rs. 53,48,842/-, being the expenses incurred towards business promotion by treating them bribe u/s 37(1).

Aggrieved by the order of the AO, the assessee filed an appeal before the CIT (A) and submitted that the appellant had incurred these expenses by way of commission or incentive to the Executives of the business houses to get the business from the business houses. This payment was made to higher officers in the Human Resources Department to ensure that these people extend the business to the appellant. This amount was incurred wholly and exclusively for the conduct of the business and was not in the nature of bribe to warrant disallowance under explanation to Section 37(1) of the Act.  It was submitted that at best the expenses was a secret commission and not prohibited by any law to constitute a bribe to warrant disallowance u/s 37(1) of the Act and those persons were not employees of any Government or quasi-Government establishments but pure business houses.

The CIT(A) place reliance on the judgment of Hon’ble Kerala High Court wherein to determine that the expenditure falls within the ambit of section 37(1) the following broad principles have been laid down:

• In order to constitute an expenditure falling under section 37(1) of the Act, the six conditions, viz. (i) the expenditure should not be of the nature described in section 30 to 36, (ii) it should have been incurred in the accounting year, (iii) it should be in respect of a business which was carried on by the assessee and the profits of which are to be computed and assessed, (iv) it should not be in the nature of personal expenses of the assessee, (v) it should have been [aid out or expended wholly and exclusively for the: purpose of such business and (vi) it should not be in the nature of capital expenditure should occur.
• Though the expression ‘for the purposes of the business’ is wider in scope than the expression. ‘for the purpose of earning profits’ and may comprehend many acts incidental to the carrying on of a business its limits are implicit in it and the purpose shall be for trhe purpose of the business, that is to say, the expenditure incurred shall be for the carrying on of the business and the assessee shall incur it in his capacity as a person carrying on of the business.
• The expenditure incurred is on the around of commercial expediency and in order, indirectly, to facilitate the carrying on of the business.
• The fact that there was no compelling necessity to incur the expenditure on which deduction is claimed is irrelevant to constitute expenditure under section 37(1) of the Act.
• Even an expenditure incurred by an assessee in the course of his or its business voluntarily and without necessity can be allowed as a deduction if it is incurred for promoting the business and to earn profits even though there was no compelling necessity to incur such expenditure.
• ) If the payment of expenditure is incurred for the purpose of the trade of the assessee it does not matter that the payment may enure to the benefit of a third party also.
• In every case it is a question of act whether the expenditure was incurred wholly and exclusively for the purpose of trade or business of the assessee
• Where an assessee seeks to deduct from his or its business profits certain items of expenditure the onus of proving that such deductions are permissible is on the assessee. This is particularly so when the claims are based on facts which are exclusively within the knowledge of the assessee. Thus, it is for the assessee to plead and prove before the authorities that the expenses are incurred wholly and exclusively for the purpose of the business of the assessee.
• When a claim for deduction of an expenditure under section 37(1) of the Act is made by an assessee the Assessing Officer is bound to conduct an enquiry as to whether the assessee satisfied all the requirements of the section before either allowing or rejecting the claim. The officer cannot mechanically either• allow the deduction or deny the same. It is clear that these are not exhaustive and the application of these principles may vary from case to case and will depend on the facts and circumstances of each case.

CIT(A) opined that as per the decision of the Hon’ble High Court, where an assessee seeks to deduct from his or its business profits certain items of expenditure, the onus of proving that such expenditure is permissible as a deduction is on the assessee. In the instant case, no evidence was in the possession o f the appellant for the deduction claim. The appellant had not furnished the basic information i.e. name and address of the party to whom the alleged commission was paid, date and mode of payments, etc. Accordingly CIT(A) upheld the AO’s order confirming the disallowance.

Observations made by the Tribunal:
The Tribunal observed that the main defence advanced by the assessee was that the payments made was in the nature of secret commission and not prohibited by any law to constitute a bribe to warrant disallowance u/s 37(1) and these persons are not employees of any Government or quasi Government establishments but pure business houses.

The ITAT observed that this suggested that but for Government or quasi-Government establishments, others could indulge in this type of action.

The tribunal noted that  the Explanation appended to Section 37 of the Act by way of Finance (No.2) Act, 1998 which was introduced retrospectively with effect from 1.4.1962 prohibits any expenditure incurred by an assessee for any purpose which is an offence or which is prohibited by law to be considered as incurred for the purpose of business or profession and no deduction or allowance shall be made in respect of such expenditure.

Further The Punjab & Haryana High Court in Dhanpat Rai And Sons case had examine the scope of this provision and held that

“any secret transaction/payment that is made to secure an unfair advantage, would necessarily be repugnant to law. Transaction which is not transparent, offends normal business practice, must suffer scrutiny. Such unexplained and unvouched expenditure, if allowed, is likely to encourage illegal payments, evasion of tax and unscrupulous practices ushering in at both ends. The expenditure incurred on secret commissions would necessarily fall within the mischief of the explanation added to Section 37 of the Act.”

The Tribunal observed that the assessee’s action clearly fell within the mischief of the explanation added to Section 37 of the Act.

Held:
The disallowance under challenge was sustained and the assessee’s appeal was dismissed.