40 A(3) clarification - regarding

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S.RAVICHANDRAN (Querist)
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13 September 2007 Can anyone send me the judgment CIT v. Sundaram Industries Ltd regarding 40 A(3) disallowance for cash payments for a single bill paid on different occasions ?

CMA Gul S

CMA Gul S (Expert)
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13 September 2007 [1999] 240 ITR 335 (MAD.)

HIGH COURT OF MADRAS

Commissioner of Income-tax

v.

Sundaram Industries Ltd.

R. JAYASIMHA BABU AND N.V. BALASUBRAMANIAN, JJ.

TAX CASE NO. 219 OF 1986

APRIL 23, 1999

JUDGMENT

N.V. Balasubramanian, J.—The following questions of law at the instance of the Revenue have been referred to us for our consideration relating to the income of the assessee for the assessment year 1974-75:

"1. Whether, on the facts and in the circumstances of the case, the Appellate Tribunal was right in holding that the sum of Rs. 10,480 spent on the provision of coffee, etc., cannot be viewed as an ‘entertainment expenditure’ and, therefore the disallowance made in this regard was not called for?

2. Whether, on the facts and in the circumstances of the case, the Appellate Tribunal was right in holding that the expenditure incurred on the maintenance of the vehicles owned by the company including the wear and tear thereon, which were provided by the company to its directors should not be treated as a ‘perquisite’ for the purpose of disallowance under section 40A(5) of the Income-tax Act, 1961, and, therefore, the disallowance of the sum of Rs. 10,317 should be deleted?

3. Whether, on the facts and in the circumstances of the case, the Appellate Tribunal was right in holding that the subscriptions paid by the assessee to Rotary Club, Gymkhana Club and the Mylapore Club should be treated as a business expenditure and should accordingly be allowed?

4. Whether, on the facts and in the circumstances of the case, the Appellate Tribunal was right in holding that for the purpose of capital gains arising out of the transfer of shares, the cost of acquisition of original shares should not be disturbed despite the fact that the bonus shares were assigned a value on the basis of spreading the cost of the original shares over the original and the bonus shares taken together and consequently the addition of Rs. 37,366 made under the head ‘Capital gains’ should be deleted?

5. Whether, on the facts and in the circumstances of the case, the Appellate Tribunal was right in holding that for the purpose of arriving at the capital employed under section 80J the value of the machineries awaiting installation and the value of the building under construction should also be taken into account?"

In so far as the first question of law is concerned, it relates to the expenditure of Rs. 10,480 spent on the provision of coffee, tea, etc. The issue that arises is whether such an expenditure can be regarded as entertainment expenditure. The Supreme Court in the case of CIT v. Patel Bros. and Co. Ltd. [1995] 215 ITR 165, held that the hospitality expenditure would not be regarded as entertainment expenditure prior to the insertion of Explanation 2 to section 37(2A) of the Income-tax Act, 1961, by the Finance Act, 1983, with effect from April 1, 1976. Since the assessment year involved is 1974-75, the prior law would apply and following the said decision of the Supreme Court, we answer the first question of law in the affirmative and against the Revenue.

The second question relates to the applicability of section 40A(5) of the Act with reference to the disallowance of Rs. 10,317 being the expenditure incurred by the assessee on the maintenance of vehicles owned by it and provided to its directors. The question that arises is whether the maintenance expenditure can be regarded as perquisite. A similar question was considered by the Supreme Court is C.W.S. (India) Ltd. v. CIT [1994] 208 ITR 649, and the apex court held that the maintenance expenditure incurred by a company for the car provided to the director of the company should be regarded as perquisite subject to the ceiling provided in section 40A(5) of the Act. We are of the opinion, that decision of the apex court would apply to the facts of the case and following the decision of the apex court, we answer the second question of law in the negative and in favour of the Revenue.

We will take up for consideration the third question of law after considering questions Nos. 4 and 5. The fourth question relates to the mode of computation of capital gains in respect of bonus shares. The Supreme Court in Escorts Farms (Ramgarh) Ltd. v. CIT [1996] 222 ITR 509 held that after the issue of bonus shares, the cost of the original shares should be spread over the original shares as well as bonus shares taken together and in view of the decision of the apex court the view of the Tribunal that the cost of acquisition of the original shares should not be distributed or spread over the original shares as well as bonus shares is plainly unsustainable in law. Following the said decision, we answer the fourth question of law in the negative and in favour of the Revenue.

The fifth question is also covered against the Revenue by a decision of the Supreme Court in the case of CIT v. Alcock Ashdown and Co. Ltd. [1997] 224 ITR 353, wherein the Supreme Court held that for the purpose of determining the deduction under section 80J of the Act, the value of the plant and machinery awaiting installation and the value of the building under construction should be taken into account as a part of the capital employed in the undertaking. Following the decision of the Supreme Court, the Tribunal was correct in holding that while arriving at the capital employed under section 80J of the Act, the value of the machinery installed and the value of the building under construction should be taken into account. Accordingly, we answer the fifth question of law in the affirmative and against the Revenue.

The third question relates to the claim of the assessee of the deduction on the subscription amounts paid to Rotary Club, Gymkhana Club and Mylapore Club as business expenditure. The Income-tax Officer disallowed the claim on the ground that the expenditure paid by way of subscription to the clubs cannot be said to be incurred for the purpose of business of the assessee as a possible advantage to the business of the assessee was remote and not proximate. The Appellate Assistant Commissioner as well as the Appellate Tribunal allowed the claim of the assessee on the ground that the expenditure was incurred by the assessee for the purpose of promoting its business. The reasoning of the Tribunal was that the expenditure was incurred by the company wholly and exclusively for the purpose of promoting its business and, therefore, the expenditure was allowable.

Section 37 of the Act postulates that any expenditure laid out or expended wholly and exclusively for the purpose of the business or profession shall be allowed in computing the income of the assessee. The essential requirement for claiming the deduction of the expenditure is that the expenditure should have been incurred wholly and exclusively for the purpose of business of the assessee. The assessee is a company and it was found by the Appellate Tribunal that the expenditure by way of subscription to the clubs was incurred for the purpose of promoting the business of the company and in view of the finding of the Appellate Tribunal, we hold that the expenditure incurred is an allowable business expenditure. In the case of subscription to clubs, in so far as the assessee is concerned, the expenditure was incurred to promote and foster its business relationship. The object of the assessee was that its directors by remaining as members in some of the city clubs would give them certain social status, and it is obvious that by being members of the club, they would be able to meet various kinds of people in a calm and cool atmosphere of the club and because of the meeting they would develop business relationship, benefiting the assessee. Therefore, it cannot be said that the possible advantage to the assessee is remote and far fetched. No doubt, there may be a personal benefit enjoyed by the director by the various types of amenities afforded at the club. But the personal benefit that goes to the director is incidental to the membership of the club. The question whether a particular expenditure is allowable or not has to be tested from the point of view of the person expending the same and the object with which he incurred the expenditure. The assessee has not spent the money with the object of providing a personal relaxation to the director, but it was incurred to promote its business. In the commercial world, the contact with the right person is vital for an efficient business organisation. The expenditure incurred cannot be regarded as having been incurred for the personal benefit of the director. In our opinion, in each case, it has to be seen whether the object of the expenditure was to promote the business of the assessee. In view of the finding by the Tribunal, the assessee-company, in our view, had incurred the expenditure wholly and exclusively for the purpose of its business and therefore the expenditure incurred by way of subscription to the club is an allowable expenditure.

The Gujarat High Court in the case of Gujarat State Export Corporation Ltd. v. CIT [1994] 209 ITR 649, held that the entrance fee paid to a sports club is an allowable revenue expenditure as the object of the expenditure was entertaining the Indian and foreign customers of the assessee.

The Bombay High Court in the case of Otis Elevator Co. (India) Ltd. v. CIT [1992] 195 ITR 682, held that a payment to the club was made to enable the assessee to increase its business relations and prospects and held that the expenditure is an allowable expenditure. The decisions of the Gujarat and Bombay High Courts make it clear that a club’s subscription is an allowable expenditure as the object in mind. In our view, if the entrance fee paid to become a member is allowable, the subscription paid by the assessee will also stand on the same footing and it is also allowable as a business expenditure.

The decision of the apex court in the case of Sri Venkata Satyanarayana Rice Mills Contractors Co. v. CIT [1997] 223 ITR 101 relied upon by learned counsel for the assessee, wherein the apex court held that the contribution made to a public welfare fund was an allowable expenditure is not quite applicable to the facts of this case and hence it is not necessary to deal with the decision of the Supreme Court. We do not agree with the contention of learned counsel for the Revenue that there is a personal benefit involved in the expenditure and therefore the expenditure should be disallowed as a business expenditure. We hold that in so far as the company is concerned, the company had incurred the expenditure with the object of promoting its business prospects and improve its business relationship and, therefore, the expenditure by way of subscription to the clubs is an allowable expenditure. It is not possible to take a narrow or a rigid view on the question of allowability of business expenditure. Accordingly, we answer the third question of law in the affirmative and against the Revenue.

However, in the circumstances of the case, there will be no order as to costs.