2012 (6) TMI 615 - HC - Income Tax

Deduction u/s 37 - Expenditure incurred on account of commercial expediency - illegal gratification - Commission paid to directors for awarding construction contract - Seizure of books of account by the Department Income-tax Officer disallowed the said claim for commission - expression commercial expediency - doctrine or rule of pari delicto - Maxim pari delicto portior est conditio possidentis . HELD THAT - It is a case of return of the advantage which he obtained under the contract to the person who is lawfully entitled to the same. Instead of restoring the advantage to the company which paid him the amount he has repaid the said amount to the directors of the company. The said payment is not made for any services rendered by them. Therefore the said amount cannot be construed as commission or expenditure incurred under section 37 of the Act so as to be eligible for being deducted in arriving at income of the assessee under the head Profits and gains of business or profession because it is not an expenditure laid out or expended fully and exclusively for the purpose of business. Another way of looking at things is there is a clear case of collusion between the directors of the company and the assessee. In the tender which is floated they have submitted prices which are higher than the normal price. Accordingly the payment is made. After awarding the contract they have reduced the price and agreed to receive the difference of price in their name. The assessee has obliged them. It is obvious that it is a kick back or bribe. It is an illegal gratification. It is a scheme adopted to siphon out the money belonging to the company. They want to lend respectability to it by calling it as a commission . Therefore seen from any angle it cannot be construed as an expenditure at all let alone commission. The doctrine or rule of pari delicto is the embodiment of the principle that the courts will refuse to enforce an illegal agreement at the instance of a person who is himself a party to an illegality or fraud. It is a maxim of taw established not for the benefit of either of the parties to the litigation but is founded on the principles of public policy which will not assist a party who has paid over money or handed over property in pursuance of an illegal or immoral contract to recover it back; for the courts will not assist an illegal transaction in any respect . The maxim is therefore intimately connected with the more comprehensive rule of law ex turpi causa non oritur actio on account of which no court will allow itself to be made the instrument of enforcing obligations alleged to arise out of a contract or transaction which is illegal and the maxim may be said to be a branch of that comprehensive rule. If he requires aid from the illegal transaction to establish his case the court will not entertain his claim. Expenditure incurred in such immoral acts cannot be construed as expenditure incurred for the purpose of profits and gains of business or profession and the benefit of deduction or allowance under Parliamentary legislation cannot be extended to such persons or to such expenditure - commission not deductible u/s 37 - appeals are dismissed.

1. ISSUES PRESENTED and CONSIDERED

The core legal question considered in this judgment was whether the expenditure claimed by the assessee as a commission payment was deductible under Section 37 of the Income Tax Act, 1961. Specifically, the court examined whether this expenditure, purportedly paid as a commission to secure a contract, was an allowable deduction or whether it was disallowed as being an expenditure for a purpose that is an offence or prohibited by law.

2. ISSUE-WISE DETAILED ANALYSIS

Relevant Legal Framework and Precedents

The legal framework primarily involved Section 37 of the Income Tax Act, which allows for the deduction of any expenditure laid out or expended wholly and exclusively for the purposes of the business or profession, provided it is not capital expenditure or personal expenses. The Explanation to Section 37 explicitly disallows any expenditure incurred for any purpose which is an offence or prohibited by law.

Precedents considered include judgments from the Supreme Court and various High Courts, which outline the principles for determining the allowability of business expenditures, particularly in relation to expenditures that may be illegal or immoral.

Court's Interpretation and Reasoning

The court interpreted the Explanation to Section 37 to mean that any expenditure incurred for an illegal purpose or which is prohibited by law cannot be allowed as a deduction. The court held that the purported commission payment was not a legitimate business expense but rather an illegal gratification or bribe, which is prohibited by law.

The court also referred to the doctrine of pari delicto, which prevents courts from enforcing illegal agreements. The court emphasized that agreements involving illegal or immoral considerations are void under Section 23 of the Indian Contract Act.

Key Evidence and Findings

The evidence included the revised return filed by the assessee after a search operation revealed that the claimed purchases were fictitious. The assessee admitted that the transactions were havala transactions and that the payments were made as commissions to secure a contract. The court found that these payments were not for any legitimate service rendered but were instead intended to deceive the shareholders of the company awarding the contract.

Application of Law to Facts

The court applied the provisions of Section 37 and the principles of contract law to conclude that the payments were not legitimate business expenditures. Instead, they were kickbacks or bribes, which are not deductible as they are prohibited by law.

Treatment of Competing Arguments

The court considered the assessee's argument that the payments were made for commercial expediency and should be allowed as deductions. However, the court rejected this argument, stating that the payments were not made for any legitimate business purpose but were instead illegal and unethical. The court also dismissed the argument that only payments to public servants constitute an offence, emphasizing that the law prohibits illegal gratifications in general.

Conclusions

The court concluded that the payments were not allowable as deductions under Section 37 of the Income Tax Act, as they were made for purposes that are prohibited by law. The court upheld the disallowance of the claimed expenditure by the Income-tax authorities.

3. SIGNIFICANT HOLDINGS

The court held that any expenditure incurred for a purpose that is an offence or prohibited by law is not deductible under Section 37 of the Income Tax Act. It emphasized that illegal or immoral payments, even if made in the course of business, cannot be allowed as deductions.

Verbatim Quote: "No expense which is paid by way of penalty for a breach of the law can be said to be an amount wholly and exclusively laid for the purpose of the business."

The court established the principle that the doctrine of pari delicto prevents courts from assisting in the enforcement of illegal agreements or transactions.

Final Determination: The appeals were dismissed, and the disallowance of the claimed expenditure was upheld, reinforcing the principle that illegal or immoral expenditures cannot be treated as legitimate business expenses for tax deduction purposes.

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