SPECIFIC
PROVISIONS OF
DISALLOWANCES
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Section 14A: Expenditure in relation to earning tax free incomes
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CBDT vide Notification No. S.O. 547(E), dated 24.3.08 has inserted Income
Tax Rule 8D where in method for determining amount of expenditure in
relation to income which does not form part of total income is prescribed.
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ITAT Mumbai Special Bench in the case of ITO v Daga Capital Management
P. Ltd. [2008] 119 TTJ (Mumbai) (SB) 289 has held that no deduction is
allowable, against the income from taxable business, in respect of any
expenditure incurred by the assessee in relation to income which does not
form part of total income.
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Section 14A applies to all heads of income and aims at disallowing
expenditure incurred in relation to income not forming part of total income.
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Example: Interest on capital borrowed for investment in shares has dominant
and immediate connection with dividend income. Even though the shares
may be held as stock in trade, dividend as also profits, if any on sale of
shares are the direct result of such investment. Same is therefore,
disallowable as per provisions of section 14A.
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Section 37(1): Expenditure against public policy not allowed
Section 37(1): Penalty for infraction of law is not allowed.
However the following expense/loss is allowed –
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Compensation paid by the assessee on account of breach of contract,
which did not fall in the category of payment of penalty for breach of
any law. It is a compensation for breach of contractual obligations.
Therefore, forfeiture of security deposits by way of compensation for
not completing the contract within the stipulated period specified in the
agreement constituted an allowable commercial loss. CIT v. S. A.
builders P. Ltd. (2008) 299 ITR 88 (P. & H.)
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Section 37(2B)
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No allowance shall be made of expenditure incurred by an assessee on
advertisement in any souvenir, brochure, tract, pamphlet or the like published by a
political party.
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Section 40 (a)
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Any interest, royalty, fees for technical services or other sum
chargeable under this Act, which is payable (A) outside India or (B) In
India to a Non resident on which tax is deductible at source but has
not been paid during the previous year or in subsequent year before
expiry of time specified in S. 200 (1).
Section 40a(ia): Disallowances of rent, interest, commission, professional
fees, contract payments etc. for non deduction / payment of TDS or payments
made beyond prescribed time limits. This does not apply to TDS on Salary.
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The scheme of disallowance under this section is amended with
retrospective effect from Ay 2005-06 on following lines:
Particulars of
TDS made
Particulars of
TDS payment
Year of deduction in Computing
in computing the business income
April to Feb of previous year
(Say year 1)
Any day up to last day of
previous year (Year 1)
Previous year
(Year 1)
In last month of previous year
(Year 1)
On or before due date Of filing
return of income Specified u/s.
139 (1)
--- do --
April to Feb of previous year
(Say year 1)
After end of PY (Subsequent
previous yr) (Year 2)
Previous year (Year 2)
In which tax is paid
In last month of previous year
(Year 1)
After due date of filing Return
of income
--- do --
Section 40 A(3) :Disallowance in respect of cash payments > Rs.20,000/-
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W.e.f. AY 2009-10 there is amendment in this section.
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a. Substituted sub-section (3) provides that where the assessee
incurs any expenditure in respect of which a payment or aggregate of
payment made to a person in a day, otherwise than by account payee
cheque / draft , exceeds Rs. 20,000/- no deduction shall be allowed.
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b. Substituted sub-section (3A) provides that where an allowance has
been made in assessment of an earlier year and subsequently the
assessee makes payment thereof, otherwise by account payee
cheque / draft exceeding Rs. 20,000/- in a day the payment so made
shall be deemed to Profits or gains of that subsequent year.
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CIT v. Smt. Santosh Jain 159 Taxman 392 (P & H): When income of
assessee is estimated by applying gross profit rate, provision of
section 40A(3) could not be invoked.
S. 41 (1): Profits chargeable to tax:
Remission or cessation of trading liability
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Explanation 1 – Remission or cessation of a liability shall include the remission or cessation
of any liability by a unilateral act by way of writing off such liability in his accounts. ( Inserted
by Finance Act, 1993)
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In the case of Coastal Corporation Ltd. v. JCIT [2008] 307 ITR (AT) 71 (Vishakhapatnam)
the Tribunal held that only trading debts, which were allowed as deduction in earlier years
could be treated as trading liability. Admittedly, the principal portion of the loan amount
waived had not been claimed as deduction in any of the years. Hence waiver of the
principal portion of loan could not be termed as waiver of a trading liability and hence
the second clause of section 41(1) of the Act relating to trading liability, would not apply.
The remission of the principal portion of the loan could not fall in the purview of the
provisions of section 41(1) of the Act.
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It was further held that Section 41(1) of the Act, consists of two main ingredients being “loss
or expenditure” and “trading liability”. The two components of section41(1) of the Act have
to be read separately namely (a) has obtained, whether in cash or in any other manner
whatsoever, any amount in respect of such loss or expenditure; (b) some benefit in respect
of such trading liability by way of remission or cessation thereof. The words “remission or
cessation thereof” shall apply only to trading liability and shall not apply to any loss or
expenditure.
Section 43B: Employer’s Contribution to PF (amendment for
allowance if paid before due date of filing return to be considered
retrospectively)
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As per Section 43B in the case of welfare dues, the delayed payment beyond
the due date during the year of accrual was to lose the benefit of deduction all
together.
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It was only an amendment by the Finance Act 2003 w.e.f 1.4.2004 that the
deduction of welfare dues was allowed if paid on or before filling return of
income or due date of filling of return, whichever is earlier. This amendment is
considered as curative in nature and as such is applicable retrospectively CIT
vs. Vinay Cement Ltd [2007] 213 CTR 268 (SC).
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S. 43B Deduction for tax, duty etc is allowable under section 43B
on payment basis before incurring the liability to pay such amounts.
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It is not necessary that the assessee must prove incurring of a specific liability under any statute
referred to in different clauses of section 43B.
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The expression “a deduction otherwise allowable” reflects deduction on account of general liability fastened to
the assessee’s business on account of duties, taxes etc. The expression does not mean any specific liability
which is required to be incurred.
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However, unexpired modvat credit could not be treated a advance payment of excise duty, as there is no
question of set off on the last day of the previous year and therefore no occasion to treat the unexpired credit
as equivalent to the tax paid.
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CIT vs. Raj and San Deeps Ltd. [2007] 293 ITR 12 (P&H): Excise duty payable as soon as goods are
manufactured. Amount kept in “Account Current” for payment of excise duty cannot be disallowed. Section
43B.
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In the case of CIT v. Kerala Solvent Extractions Ltd. [2008] 306 ITR 54 (Ker) Kerala High court has held that
payment towards advance sales tax not entitled to claim deduction u/s. 43B. Assessee conceding liability was
of next year. The scheme of payment of sales tax under the Sales Tax Act is to remit tax due for every month
on or before the tenth day of the succeeding month. On the other hand, it will be carried as an amount of tax
paid in advance for the next year and if the assessee carries on business and incurs liability in the next year,
the amount will be adjusted towards the tax liability for that year. On the other hand, if the assessee does not
continue the business, it is entitled to get refund of the tax paid in the previous year. Held, section 43B by
itself would not help the assessee to claim deduction as it was only an additional conditions for allowing
deduction which was otherwise admissible under the provisions of the Act.
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The opening words of section 43B show that the section deals with deductions otherwise allowable under the
provisions of the Act. Therefore, section 43B is only supplementary to section 145 of the Act and it is only an
additional conditions for allowance of deductions otherwise allowable under the other provisions of the Act.
43B(f): Allowance of leave encashment only on actual payment:
Constitutionally not valid : struck down
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Exide Industries Ltd. vs. Union of India & Ors. [2007] 292 ITR 470 (Cal):
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Leave encashment is neither a statutory liability nor a contingent
liability. It is a provision for entitlement of an employee n a
particular financial year. An employer is otherwise entitled for
deduction of such amount by showing the same as a provisional
expenditure in its accounts.
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Enactment is not consistent with the original provision of S. 43B,
same is struck down being arbitrary and unconscionable and de
hors the apex court decision.
EXPENDITURE ALLOWED
UNDER SPECIFIC PROVISIONS
There are certain sections which specifically provides for allowances of certain
specified expenditures. They are covered in section 30 to 37.
Section 31:
Repairs and insurance of machinery, plant and furniture
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Explanation – For the removal of doubts, it is hereby declared that the
amount paid on account of current repairs shall not include any expenditure
in the nature of current repairs. (inserted by Finance Act 2003)
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CIT vs. Saravana Spinning Mills P Ltd. [2007] 293 ITR 201 (SC):
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Replacement of a machine in textile mills may not fall in the connotation of
the words “current repairs” under section 31(1).
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It can not be said that the textile mills constitute one plant. It can not be said
that the manufacturing process in the textile mills is one continuous
integrated process. Each machine including ring frame is an independent
and separate machine and therefore expenditure incurred of replacement of
ring frames cannot come within the meaning of words “current repairs” in
section 31 (1).
Section 35 (1) (iia) :
Expenditure on Scientific research
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Amendment wef AY 2009 -10:
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Weighted deduction for payment to a Co. for Scientific Research
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A weighted deduction of 125% is allowed in respect of expenditure by way
of payment for scientific research, made to a company registered in India,
whose main object is scientific research and development and which is
approved by the prescribed authority and fulfills specified conditions. Earlier
such deduction was available only for payments made to scientific research
associations or to universities or college or institutions.
Section 35D: Amortisation of Preliminary Expenses
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Amendment wef AY 2009 -10: Amortisation of certain expenses for non industrial entities
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Earlier expenditure on increase of capital, public issue expenses, feasibility / project
reports etc. in the context of extension of exiting business was allowed to be amortised
over a period of 5 years only if such expenses were in connection with the extension of an
industrial undertaking or in connection with setting up a new industrial unit.
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The benefit of such amortisation is now being extended to cases of extension of any
undertaking, or setting up of any new unit. Therefore all entities including trading, finance
and service companies would now be entitled to avail of the benefit of such amortization
and claim deduction u/s. 35D.
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In the case of CIT v. Neha Proteins Ltd. [2008] 306 ITR 102 (Raj) Rajsthan High court has
held that Interest received on share application money can be set off against public issue
expenses. Interest accrued is not taxable.
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The amount of interest, accruing on the share application money, could not be used by the
assessee for any purpose whatever, other than those mentioned in section 73(3) and (3A)
of the Companies Act, 1956, and on the allotment of shares, the assessee was to take stock
of things, about the expenditure incurred by it, being the public issue expenses, and the
interest accrued did reduce that expenditure and it was rightly required to be adjusted
against the expenditure.
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Interest accrued on the share application money lying with the bank under the mandate of
section 73 of the Companies Act was not taxable as “Income from other sources”. And it
was nobody’s case that this was to be taxed as income from “Profits and gains of business
or profession”.
Section 36(1) (vii)
Bad Debts
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CIT v. M/s. Star Chemicals (Bombay) P. Ltd. (Bom.) ITAL No. 1915
of 2007 dt. 27.2.2008 In this case Hon. Bombay High Court has
held that after amendment w.e.f. 1.4.89 writing off of bad debt in
account is sufficient for allowing deduction. It is not necessary to
prove that debt has become bad.
S. 36 (1) (iii): Interest On Borrowed Capital In The Case Where Loans And Advances Are
Given To Associates / Subsidiaries Free Of Interest
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Where the assessee lends money without interest, notional income based on reasonable interest, which the
assessee might have charged for lending to relatives or sister concerns can not be taxed. But then in such
case there may be a disallowance of a proportionate part of interest on such borrowed capital, if any, to the
extent that the borrowed funds are utilized for interest – free advances, on the ground, that it is not incurred
for purpose of business.
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Hon. Supreme Court in the case of S.A Builders Ltd. v. CIT appeals [2007] 288 ITR 1 has held no
businessman need be compelled to maximise the profit. The authorities should put themselves in the shoes of
the assessee and consider what a prudent businessman would do. Such advance should be taken as
prompted by commercial expediency, so as to be deductible under section 37, if not under section 36(1) (iii) of
the Act.
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It was argued on behalf of the assessee, that the advance had been made out of a bank account, wherein,
both its own and borrowed funds were mixed up, so that there was no direct nexus between borrowing and
the advances. It was further argued and accepted by the Supreme Court that the loan to a sister company, in
which this case was a subsidiary of the assessee company is one, which should be treated as prompted by
commercial expediency, so that the amount was even otherwise allowable.
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The expression “commercial expediency” is one of wide import and includes such expenditure as a prudent
business- man incurs for the purpose of business. The expenditure may not have been incurred under any
legal obligation, but yet it is allowed as business expenditure if incurred on ground of commercial expediency
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“For the purpose of business” includes expenditure voluntarily incurred for commercial expediency, and it is
immaterial if a third party also benefits thereby. The expression “for the purpose of business” is wider in scope
than the expression “for the purpose of earning profits”.
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The authorities and the courts should examine the purpose for which the assessee advanced the money and
what the sister concern did with the money. That the borrowed amount is not utilized by the assessee in its
own business but had been advanced as interest free loan to its sister concern is not relevant. What is
relevant is whether the amount was advanced as a measure of commercial expediency and not from the point
of view whether the amount was advanced for earning profits. Once it is established that there is nexus
between the expenditure and purpose of the business (which need not necessarily be the business of the
assessee itself) the same needs to be allowed.
S. 37(1): Residual section: Expenditure should have been laid wholly and exclusively for the
purpose of business or profession
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The main requirement of the provision of section 37(1) is that expenditure should have been laid
out wholly and exclusively for the purpose of the business. The nexus between the expenditure
and the business, in connection with which expenditure has been incurred, has to be established
before the assessee gets entitled to deduction under section 38(1).
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Commercial Expediency- If a payment or expenditure is incurred for the purpose of the trade of
the assessee, it is deductible even if it may bring a benefit to a third party.
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Reasonableness of the expenditure has to be adjudged from the point of view of businessman
and not of the revenue. The rule that increased remuneration can only be justified if there be
corresponding increase in the profits of the employer is erroneous.
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There is no ceiling of any expenditure for business but it has to be genuine, incurred for business.
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However, the reasonableness of the expenditure applies under the restrictions u/s. 40A(2). These
are payments made to specified persons such as relative of an individual, director, partner,
persons having substantial interest, their relatives associate / sister concerns etc.
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There are no arithmetic formulas of expenses to revenue receipt. It is best judgement with
fairness expected by assessing officer. It is prudent to establish the genuineness of expenditure
and the reasonableness of the quantum of such expenditure sought to be claim.
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The burden of proof is on the assessee to produce the cogent evidence to establish the claim of
expenses; otherwise assessing officer may use his best judgement to consider reasonable
allowable expenses.