1975 (11) TMI 35 - HC - Income Tax

Auditors' defense costs not deductible under income tax law

The court held that the reimbursement of Rs. 16,854 to the auditors for defending disciplinary proceedings was not an allowable deduction under section ... Capital Expenditure, Capital Or Revenue Expenditure, Same Business Issues Involved:1. Whether the sum of Rs. 16,854 paid to the auditors by the company as reimbursement for defending disciplinary proceedings is an allowable deduction under section 10(2)(xv) of the Indian Income-tax Act, 1922.Issue-wise Detailed Analysis:1. Allowability of Reimbursement as Deduction:The primary issue was whether the reimbursement of Rs. 16,854 paid to the auditors for defending disciplinary proceedings could be considered an allowable deduction under section 10(2)(xv) of the Indian Income-tax Act, 1922. The Tribunal had allowed this claim, reasoning that the dispute between the auditors and the shareholder flowed from the employment of the managing agent, which was necessary for the business, and arose from the manner in which the accounts were prepared for obtaining necessary certificates from the auditors. The Tribunal concluded that the expenditure was incidental to the carrying on of the assessee's business.Analysis of Tribunal's Reasoning:The Tribunal's reasoning was based on the connection between the managing agents' employment and the auditors' preparation of accounts. However, the High Court disagreed, stating that the expenditure must be expended wholly or exclusively for the purpose of the business. The court emphasized that the reimbursement was for defending the auditors in disciplinary proceedings, which was a result of their negligence and imprudence in certifying the profit and loss account. This was deemed personal to the auditors and not connected to the business operations of the company.Legal Precedents and Tests:The court referred to various legal precedents to establish the criteria for allowable deductions:- Strong & Company of Romsey Limited v. Woodifield: Losses connected with trade must be incidental to the trade itself.- Travancore Titanium Products Ltd. v. Commissioner of Income-tax: There must be a direct and intimate connection between the expenditure and the business.- Indian Aluminium Co. Ltd. v. Commissioner of Income-tax: Expenditure incidental to the carrying on of business must be laid out by the assessee as a trader.- Swadeshi Cotton Mills Co. Ltd. v. Commissioner of Income-tax: The intention and motive of the assessee in incurring the expenditure are decisive factors.- Laksmiji Sugar Mills Co. (P.) Ltd. v. Commissioner of Income-tax: Expenditure to protect the good name of the business is allowable.- Commissioner of Income-tax v. Ahmedabad Controlled Iron & Steel Reg. Stockholders Association P. Ltd.: Distinction between expenditure for defending oneself and defending an employee.- Commissioner of Income-tax v. Chaman Lal and Bros.: Expenditure for personal defence is not deductible.- J. N. Singh & Co. (P.) Ltd. v. Commissioner of Income-tax: Expenditure to protect the good name of the business is allowable.Conclusion:The court concluded that the expenditure incurred was purely personal to the auditors and did not affect the company's business or reputation. The payment made under article 196 of the articles of association did not automatically qualify as business expenditure. The court held that the Tribunal erred in allowing the deduction, as the expenditure was not incurred wholly or exclusively for the purpose of the company's business. The reference was answered in the negative and in favor of the revenue, with costs awarded to the revenue.Final Judgment:The reimbursement of Rs. 16,854 to the auditors was not an allowable deduction under section 10(2)(xv) of the Indian Income-tax Act, 1922. The reference was answered in the negative, and costs were awarded to the revenue.