Legal Expenses Allowed As Business Expenditure under Section 37 of IT Act

Nikhil Mogha

24 May, 2024

The Chennai Income Tax appellate tribunal in the case of Kalaignar TV (P.) Ltd. v. Assistant Commissioner of Income-tax 2022 has remanded the matter back to the assessing officer for fresh adjudication. In the said matter, the assessee (Kalaignar TV (P.) Ltd.) has filed an appeal for claiming the legal expenses as business expenditure under Section 37 of the IT Act. It is further alleged by the assessee that the legal expenses allowed as business expenditure under Section 37 of IT act as the director and shareholders of the company have undertaken the transaction as a part of the conduct of the business. The assessing officer rejected this contention of the assessee and was further upheld by CIT (A). Henceforth, being aggrieved by the dismissal, the assessee filed an appeal before the Chennai tribunal, which is discussed in detail below.

Facts of the case

The facts of the case are:

1. The Assessee (Kalaignar TV (P.) Ltd.) has claimed legal expenses allowed as business expenditure under Section 37 of IT act for a certain amount incurred in respect of the ongoing case in CBI.

2. The assessing officer has rejected the assessee’s claim and states that the expenditure was not incurred “wholly or exclusively” for the business purpose. The officer further alleges that legal charges are framed against the director and shareholders of the company for their misconduct & not that of the company, as the company is a mere recipient and it does not involve itself in the process of receiving the funds. Henceforth, the legal expenses allowed as business expenditure under Section 37 of the act are not maintainable.

3. Being aggrieved by the order of the assessing officer, the assessee filed an appeal at CIT (A). The CIT (A) also dismissed the assessee’s appeal and upheld the assessing officer’s contentions while stating that the legal expenses were incurred in respect of a case pending in CBI in which the directors of the assessee company were accused. Moreover, the appeal is also dismissed as the assessee could not prove how the legal expenses incurred were for profit-making capability and enhancing its business activity.

4. Being aggrieved by the order of dismissal by CIT (A), the assessee filed an appeal at the Chennai appellate tribunal.

Issue of the Case

Whether the legal expenses are allowed to be debited under the head “other Expenses” as business expenditure under section 37(1) of the Income Tax Act, 1961?

Grounds of Appeal

1. The order of the CIT (A) that has discredited the assessee’s contentions for legal expenses allowed as business expenditure under Section 37 of the act is erroneous, illegal and without any basis.
2. The order of the CIT (A) is erroneous as it has simply upheld the assessing officer’s findings without considering the other legal and factual parameters.
3. The expenses incurred by the assessee company is eligible for deduction as it is incurred to protect the goodwill or reputation of the business.
4. There is a wrong assumption that the legal expenses are incurred for the personal needs of the directors & shareholders. The AO /CIT (A) has failed to evaluate whether the expenses incurred have a direct connection with the business.

Submissions of the Appellant

It was submitted by the appellant that:

• The disallowance of legal expenses allowed as business expenditure by the AO /CIT (A) on the ground that the legal expenses incurred was in respect of the case in CBI and, therefore, it is not wholly for business purposes is not correct.
• The order of CBI has acquitted all the accused, and therefore the legal expenses are incurred in respect of business purposes only, and it is to be allowed under Section 37 of the act.
• The CIT (A) has passed the order without considering the order of CBI.
• The receipt of Rs 200 crore is for the utilisation for the purpose of business and is, therefore, a business transaction. Hence, the expenditure on defending the promoters, shareholders & directors in a legal case is allowed as business expenditure under Section 37.
• The company operate through its directors, and the directors undertake the transaction of Rs 200 crore for the company. Therefore, the onus of the directors is the one who will prove that the transaction is genuine in the CBI case.
• The expenditure on the legal proceedings before CBI is necessary to protect the company’s commercial loss, reputation and goodwill. Therefore, it is necessary to defend the directors of the assessee company who are working under their instructions.

Submissions of the Respondent

It was submitted by respondent that:

• According to Section 37 of the act, the expenditure need not be in the nature of capital expenditure or personal expenditure and must be wholly or exclusively for the purpose of business. Henceforth, the same has to be verified before claiming legal expenses.
• The CBI case is related to the involvement of the director and shareholder of the assessee company in their individual capacity. Therefore, the legal expenditure allowed as business expenditure by way of reimbursing the director’s legal expenses before the CBI court cannot be regarded as the expenditure for business purposes; hence, the same is not allowed for claiming the deduction.

Observations of the Tribunal

The tribunal observes that at the time of assessment proceedings, the order of CBI had not been passed; hence the assessing officer could not take such an order into account. Henceforth, there was no chance available to the officer to examine the decision of the CBI court and consider whether the legal expanse allowed as business expenditure under Section 37 of IT act is maintainable or not. Moreover, the CIT (A) has also passed the order after the order of CBI and the CIT (A), without considering the same, passed the order of dismissal of the appeal.        

Therefore, it is noted by the tribunal that both authorities have failed to consider the decision of the CBI and, therefore, observed that whether disallowing legal expenses allowed as business expenditure under Section 37 of the act is a matter of fact which needs to be decided rationally.

Decision of the Tribunal              

The tribunal in the case has set aside the order of the CIT (A) and remitted the matter back to the adjudicating officer for the fresh adjudication of the matter after examining the decision of the CBI case.

Conclusion

The tribunal in the case has upheld the grounds of appeal of the assessee raised in the appeal. The tribunal, on the point of law, whether legal expenses are allowed as business expenditure under section 37 of IT act, has stated that for claiming deduction of legal expenses as business expenditure, the assessee needs to prove that the expenditure incurred is wholly and exclusively for the purpose of business.

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