2025 (6) TMI 1145 - HC - Income Tax

Nature of expenses - Allowable business expenditure or not? - Mutual Fund Promotion Expenditure and Initial Public Offer Expenditure - Whether expenses under reference have been incurred by the assessee purely for the purpose of business activities of another person? - ITAT allowed assessee appeal HELD THAT - We agree with the findings of the ITAT. The Assessing Officer has disallowed the assessee s claim on the ground that the assessee was a fund manager for the mutual fund company and there was no need to incur the expenses. In our opinion the AO cannot claim to put himself in the arm chair of the assessee and assume the role to decide whether to incur the expenses and how much is a reasonable expenditure having regard to the circumstances of the case. As decided in Mahindra and Mahindra Ltd 2023 (6) TMI 884 - BOMBAY HIGH COURT since the expenditure was wholly incurred for the purpose of commercial expediency because MMC was a group company of Mahindra and the nexus between Mahindra and MMC was not disputed the AO failed to appreciate the claim in its proper perspective. The expenditure/debts should be treated as having been incurred for the purpose of business and directly relatable to the business of the assessee and thus eligible for deduction as business expenditure/loss in Mahindra s return of business income. Assessee appeal allowed.

Summary

The core legal question considered by the Court was whether the Income-tax Appellate Tribunal (ITAT) was correct in deleting the addition made by the Assessing Officer (AO) relating to Mutual Fund Promotion Expenditure and Initial Public Offer Expenditure incurred by the assessee, where such expenses were incurred by the assessee for the business activities of another person (the mutual fund company) and not directly for its own business.

The primary issues examined include:

• Whether the mutual fund launch and promotion expenses incurred by the assessee, an Asset Management Company (AMC), qualify as business expenditure deductible under section 37(1) of the Income Tax Act, 1961.
• The interpretation of the contractual obligations of the AMC under the tri-partite agreement involving the Settlor, Trustees, and the AMC, particularly concerning the incurrence and reimbursement of such expenses.
• The applicability of SEBI (Mutual Fund) Regulations, 1996, especially Regulation 52, which governs fees and expenses related to mutual fund schemes.
• The legal test for deductibility of expenditure under section 37(1), specifically the meaning of "wholly and exclusively for the purposes of business" and whether expenses incurred voluntarily or for the benefit of another party can qualify.
• The validity of the AO's approach in disallowing expenses on the ground that the AMC, as fund manager, need not have incurred the expenses and that such expenses were for the business of the mutual fund company, not the AMC.
• The relevance and application of judicial precedents concerning business expenditure, commercial expediency, and the scope of section 37(1).

Issue-wise Detailed Analysis

1. Deductibility of Mutual Fund Launch and Promotion Expenses as Business Expenditure

The legal framework centers on section 37(1) of the Income Tax Act, which allows deduction of any expenditure (not being capital expenditure or personal expenses) laid out wholly and exclusively for the purposes of the business. The Court examined whether the expenses incurred by the AMC for mutual fund launch and promotion fall within this ambit.

The AO disallowed the expenses, reasoning that the AMC, as a fund manager, did not need to incur such expenses; these were the mutual fund company's expenses. The CIT(A) upheld this disallowance, emphasizing the absence of any statutory or contractual obligation on the AMC to incur these expenses and concluding that the expenses were incurred for the business of others, not the AMC.

The Court, however, scrutinized the tri-partite agreement dated 18.07.1996, which established the contractual framework among the Settlor, Trustees, and AMC. The agreement explicitly authorized the AMC to manage investments and included provisions for reimbursement of initial issue expenses and promotion expenses from the mutual fund's assets, subject to SEBI regulations. Schedule 2 of the agreement detailed the fees and expenses payable to the AMC by the Trustees on behalf of the mutual fund, including initial issue costs and recurring expenses.

Regulation 52 of the SEBI (Mutual Fund) Regulations, 1996, was pivotal. It sets limits on fees and expenses chargeable to mutual fund schemes, including initial issue expenses capped at 6% of the funds raised, with any excess to be borne by the AMC. The regulation also mandates clear identification and appropriation of expenses to individual schemes and prescribes limits on recurring expenses.

The Court observed that the AMC was under a contractual obligation to incur these expenses and that the expenses were incurred in accordance with SEBI regulations. The AO's reasoning that the AMC "need not have incurred" the expenses was rejected as impermissible interference with the business judgment of the AMC. The Court held that the expression "wholly and exclusively" in section 37(1) does not mean "necessarily," and expenditure incurred voluntarily but for promoting the business is deductible.

2. Interpretation of "Wholly and Exclusively" for Business Purposes

The Court relied extensively on the Supreme Court's decision in Sassoon J. David & Co. P. Ltd. v. CIT, which clarified that "wholly and exclusively" does not require necessity but only that the expenditure be for the purpose of the business. The legislative history showed that the word "necessarily" was deliberately omitted from section 37(1) due to public protest.

The Court further referred to authoritative commentary by N.A. Palkhivala, explaining that "for the purpose of the business" is a wider expression than "for the purpose of earning profits" and may include expenditures incidental to carrying on the business, rationalization, preservation, and protection of business assets.

Other precedents cited include Indian Aluminium Co. Ltd. v. CIT, where incidental expenditure was held deductible, and S.A. Builders Ltd. v. CIT(A), which emphasized that the AO cannot substitute his own judgment for that of the assessee in determining the reasonableness of expenditure if the nexus with business purpose is established.

3. Application of Law to Facts and Treatment of Competing Arguments

The AO and CIT(A) argued that the AMC was only a fund manager and that the mutual fund company should bear launch and promotion expenses. The Court rejected this, emphasizing the contractual obligations of the AMC and the SEBI regulatory framework, which envisaged such expenses being incurred by the AMC and reimbursed by the mutual fund within prescribed limits.

The Court underscored that the AO cannot sit in the "arm-chair" of the assessee to decide whether to incur an expense or its quantum. The voluntary incurrence of expenses for business promotion is permissible. The expenses were held to be wholly and exclusively for the purpose of the AMC's business of managing mutual funds.

4. Reliance on Precedents Supporting Deductibility of Expenditure Incurred for Business of Another

The Court referred to several Tribunal decisions where similar expenses incurred by AMCs were allowed as deductions. It also relied on a recent Division Bench decision of the Bombay High Court in Mahindra and Mahindra Ltd. v. Commissioner of Income Tax, where expenses incurred by a promoter company on behalf of its group company were held deductible on the ground of commercial expediency and business nexus.

In Mahindra and Mahindra, the Court elaborated that expenditure incurred voluntarily but for preserving goodwill, reputation, or business interests, even if benefiting another entity, qualifies as deductible if there is a nexus with the assessee's business. The Court quoted extensively from this decision, emphasizing that the true test is whether the expenditure is incidental to the trade and for keeping the trade going.

5. Conclusion on the Substantial Question of Law

The Court answered the substantial question of law in the affirmative, holding that the ITAT was correct in deleting the addition made by the AO. The expenses incurred by the AMC on mutual fund launch and promotion were held to be incurred wholly and exclusively for the purposes of its business and thus deductible under section 37(1).

Significant Holdings and Core Principles

The Court preserved the following crucial legal reasoning verbatim:

"The AO cannot claim to put himself in the arm-chair of the assessee and assume the role to decide whether to incur an expenditure and how much is reasonable expenditure having regard to the circumstances of the case."

"The expression 'wholly and exclusively' used in section 37(1) of the I.T.Act 1961, does not mean 'necessarily'. Even an expenditure incurred 'voluntarily' without any 'necessity', would be permissible for deduction u/s. 37(1) if it was incurred for promoting the assessee's business."

"The fact that somebody other than the assessee was also benefited by the expenditure should not come in the way of an expenditure being allowed by way of deduction under section 37(1) of the Act, if it satisfied otherwise the tests laid down by law."

"The true test of an expenditure laid out wholly and exclusively for the purposes of trade or business is that it is incurred by the assessee as incidental to his trade for the purpose of keeping the trade going and of making it pay and not in any other capacity than that of a trader."

The Court established the principle that contractual obligations and regulatory frameworks governing business activities must be respected in determining deductibility of expenses, and that voluntary expenditure incurred for commercial expediency and business promotion, even if benefiting another entity, can qualify as deductible business expenditure.

Accordingly, the final determination was that the mutual fund launch and promotion expenses incurred by the AMC were deductible under section 37(1) as they were incurred wholly and exclusively for the purposes of the AMC's business, and the ITAT's deletion of the addition was upheld.