2025 (7) TMI 1686 - AT - Income Tax

Nature of expenditure - legal and professional expenditure - AO made disallowance u/s 37(1) and found expenditure to be either capital in nature or unrelated to the business activities of the assessee - allowable business expenditure Payment to KPMG - Business Strategy and Restructuring - HELD THAT - This expenditure was clearly aimed at enhancing operational efficiency and exploring avenues for future business and was neither related to nor contingent upon the capital infusion. There is no evidence that the restructuring led to creation of a capital asset or yielded any enduring commercial advantage of the nature contemplated in Ballimal Naval Kishore 1997 (1) TMI 3 - SUPREME COURT - CIT(A) rightly appreciated this position and allowed the deduction. Payment to KPMG India Pvt. Ltd. Preparation of Information Memorandum - The fact that the invoice was raised after the receipt of funds is not determinative. It is trite law that the timing of payment or billing does not ipso facto determine the nature of expenditure. What matters is the underlying purpose. AO s inference that the expenditure is capital in nature merely because it relates temporally to the funding is untenable in the absence of any demonstrable link or benefit of an enduring nature. Information Memorandum did not bring into existence any new asset nor did it alter the fixed capital structure of the assessee. It was an exercise in business facilitation squarely falling within the operational domain. Applying the principles enunciated in Empire Jute Co. Ltd. 1980 (5) TMI 1 - SUPREME COURT we find that the said expenditure is revenue in nature. Accordingly the disallowance deleted. Payment to AZB Partners Transactional Legal Documentation - Legal fees incurred in the course of facilitating investor-mandated compliance particularly when the service provider is dictated by the counterparty cannot be regarded as capital expenditure. The assessee neither acquired any asset nor did the expenditure confer upon it any enduring advantage. The transaction may have resulted in capital receipt but the costs associated with it especially when they are ministerial and documentation-related have been judicially held to be allowable as revenue expenditure. Reference may be drawn by cases Ashima Syntex Ltd. 2000 (8) TMI 22 - GUJARAT HIGH COURT and Shree Capital Services Ltd. 2009 (7) TMI 172 - ITAT CALCUTTA We thus hold that the expenditure was incurred wholly and exclusively for the purposes of business and is allowable u/s 37(1). Payment to Nishith Desai Associates Legal Defence in Post-Investment Dispute - Subsequent to the receipt of investment disputes arose between the assessee and the nominee director of HSBC PI Holdings. The assessee engaged Nishith Desai Associates a leading law firm to defend itself in legal proceedings arising out of those disputes. The services included representation before investigating agencies and rendering legal advice. We find considerable merit in the assessee s submission that these were litigation expenses incurred to protect the interests of the company its management and its reputation. Such expenses have been consistently held to be allowable even where they arise in the context of capital transactions if the object is to defend or protect the existing business. Accordingly the payment made is allowed. Payment to Wadia Ghandy Co. Legal Compliance and Subsidiary Governance - The engagement of Wadia Ghandy Co. was two-fold first to review transaction documents and render legal advice relating to the CCP issue and second to provide legal opinion on the appointment of statutory auditors for the assessee s wholly-owned subsidiary in Dubai - CIT(A) allowed part of this expenditure relating to the latter activity and disallowed the balance - We are of the view that even the legal documentation work carried out by Wadia Ghandy Co. does not result in any acquisition of asset or enduring advantage. It was a standard professional service availed for ensuring legal compliance. The judicial distinction between facilitative expenditure and capital acquisition must be preserved. The review of legal agreements is part of any well-governed business transaction and is not in the nature of capital outlay. Hence we direct that the balance disallowance also be deleted. Thus we hold that none of the components of the impugned expenditure can be said to result in creation of a capital asset nor do they confer any enduring benefit within the meaning attributed by judicial pronouncements. The expenses were incurred in the ordinary course of business either in preparation for expansion to comply with investor-imposed conditions or to defend the company s position in legal proceedings. AO has not demonstrated any nexus between the expenditure and capital creation and has instead proceeded on generalised assumptions unsupported by evidence. It is equally pertinent that the AO disallowed even the service tax components paid to the Government without invoking any of the specific disallowance provisions such as section 40(a) or section 43B. Assessee appeal allowed.

Summary

ISSUES:

Whether legal and professional expenses incurred in connection with capital raising through issuance of Compulsorily Convertible Preference Shares (CCPs) constitute capital expenditure or allowable revenue expenditure under section 37(1) of the Income-tax Act, 1961.Whether consultancy fees paid for business restructuring and preparation of an Information Memorandum aimed at business expansion are capital or revenue expenditures.Whether legal fees incurred for investor-mandated compliance documentation, litigation defense post-investment, and subsidiary governance are allowable as revenue expenditure.Whether the timing of invoicing or proximity of expenditure to capital infusion determines the nature of expenditure.Whether service tax components paid as part of the professional fees can be disallowed under section 37(1) without invoking specific provisions.

RULINGS / HOLDINGS:

The entire legal and professional expenditure of Rs. 1,58,51,240/- is allowable as revenue expenditure under section 37(1) of the Act, as none of the expenses resulted in creation of a capital asset or conferred any enduring benefit. The disallowance on the ground of capital nature is not sustainable.Consultancy fees paid to KPMG for business restructuring aimed at operational efficiency and market expansion are revenue expenditure, not capital, since they do not create or enhance capital structure or assets.Expenditure on preparation of the Information Memorandum by KPMG India Pvt. Ltd. is revenue expenditure, as the document was a general preparatory tool unrelated to any specific capital infusion, and timing of invoice is not determinative of nature of expenditure.Legal fees paid to AZB & Partners for investor-mandated documentation, where the assessee had no discretion in selection and the services were ministerial, are allowable as revenue expenditure under section 37(1).Legal fees incurred for defending post-investment litigation and protecting the company's commercial reputation are allowable as revenue expenditure, notwithstanding their connection to capital transactions.Legal services rendered by Wadia Ghandy & Co. for review of agreements and subsidiary governance are revenue expenditure as they constitute routine compliance and do not result in capital asset creation.Disallowance of service tax components without invoking specific provisions such as section 40(a) or section 43B is untenable.

RATIONALE:

The Court applied the legal framework under section 37(1) of the Income-tax Act, 1961, which allows deduction of any expenditure incurred wholly and exclusively for the purposes of business unless it is capital in nature.Judicial precedents such as Empire Jute Co. Ltd. v. CIT and Ballimal Naval Kishore v. CIT were relied upon to distinguish between capital expenditure and revenue expenditure, emphasizing that expenditure facilitating day-to-day operations or enhancing efficiency without creating capital assets is revenue in nature.The Court rejected the Assessing Officer's approach of inferring capital nature merely based on temporal proximity to capital infusion or the nature of the transaction, holding that the underlying purpose and nexus to business operations are determinative.The Court recognized that legal and professional expenses incurred to comply with investor-imposed conditions, defend litigation, or prepare for business expansion do not necessarily amount to capital expenditure.The decision reflects a doctrinal adherence to the principle that capital expenditure involves acquisition or enhancement of enduring assets or capital structure, whereas expenses incidental to business operations remain revenue in nature.No dissenting or differing opinion was noted.