Brokerage expenses cannot be proportionately disallowed under section 57(iii) if wholly incurred for earning income

The ITAT Mumbai allowed the assessee's appeal regarding disallowance of brokerage expenses under section 57(iii). The AO had proportionately disallowed expenses based on the ratio of principal and interest received from a builder. The tribunal held that once expenditure is established as wholly and exclusively incurred for earning income, it cannot be partly disallowed on estimation basis. The assessee engaged brokers to recover both principal and interest amounts, offering the interest component as income and claiming the entire brokerage expense as deduction. The tribunal emphasized that connection between expenditure and income earning must exist, and the expenditure's purpose should be for earning income, regardless of profitability.

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Issues Involved:
1. Disallowance of brokerage expenses claimed under Section 57(iii) of the Income-tax Act.
2. Proportional allocation of brokerage expenses between principal and interest recovery.
3. Applicability of judicial precedents, particularly the Gujarat High Court decision in Virmati Ramakrishna vs. CIT.

Issue-wise Detailed Analysis:

1. Disallowance of Brokerage Expenses Claimed Under Section 57(iii):
The assessee filed an appeal against the disallowance of Rs. 33,45,313/- out of the total brokerage paid of Rs. 50,00,000/-. The brokerage was incurred to recover the investment principal of Rs. 1,73,12,500 and interest of Rs. 85,63,262/- from a builder. The assessee claimed this brokerage as a deduction under Section 57(iii) of the Income-tax Act, asserting it was an expense incurred wholly and exclusively to earn the said income.

2. Proportional Allocation of Brokerage Expenses Between Principal and Interest Recovery:
The Assessing Officer (AO) acknowledged the brokerage payment but disallowed the portion attributed to the principal recovery. The AO issued a show cause notice and subsequently disallowed Rs. 33,45,313/- of the brokerage, permitting only Rs. 16,54,657/- as deductible against the interest income. The AO's rationale was that the brokerage was paid for both principal and interest recovery, thus only the portion related to interest was deductible under Section 57(iii).

3. Applicability of Judicial Precedents:
The assessee argued that the brokerage was a lump sum payment for recovering the entire amount due from the builder, without bifurcation into principal and interest components. The assessee relied on the Gujarat High Court decision in Virmati Ramakrishna vs. CIT, which laid down principles for claiming deductions under Section 57. The Tribunal noted that the AO's proportional disallowance was not in accordance with these principles. The Tribunal emphasized that the expenditure must be wholly and exclusively for earning the income, and the AO cannot estimate or bifurcate the expenditure without a clear basis.

Tribunal's Findings:
- The Tribunal found that the brokerage payment was genuine and bona fide, and the entire amount was incurred to recover the total dues from the builder, including both principal and interest.
- The Tribunal highlighted that Section 57(iii) does not permit partial disallowance based on proportionality unless explicitly provided by law.
- The Tribunal referred to the Gujarat High Court's principles, emphasizing that the expenditure must be wholly and exclusively for earning the income, and the AO's bifurcation approach was incorrect.
- The Tribunal also cited the Gujarat High Court decision in Atir Textile Industries (P.) Ltd. vs DCIT, which held that the transaction must be considered as a whole and not split into parts for disallowance purposes.

Conclusion:
The Tribunal concluded that the brokerage expense of Rs. 50,00,000/- was incurred wholly and exclusively for recovering the amount due from the builder, including the interest income. Therefore, the entire amount was deductible under Section 57(iii). The appeal of the assessee was allowed, and the disallowance made by the AO was deleted.

Result:
The appeal of the assessee is allowed. The order was pronounced in the open court on 30 August, 2024.

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