Contractual sharing of service tax held deductible as business expenditure where liability under law rested on the recipient.

A contractual sharing of service tax borne by an assessee as part of commission-linked insurance auxiliary services was held allowable as business expenditure under section 37 of the Income-tax Act, 1961. The payment was made to secure and retain business, and the statutory service tax liability lay on the recipient under reverse charge, not on the assessee. Explanation 1 did not apply because there was no legal prohibition on the contractual arrangement itself. The recipient's failure to deposit the tax with the Government did not alter the character of the assessee's expenditure, as any default was attributable to the recipient.

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Issues: Whether the amount borne by the assessee under a contractual arrangement with an insurance company, described as its share of service tax liability, was allowable as a deduction under section 37 of the Income-tax Act, 1961, or was hit by Explanation 1 to that section as an expenditure for an offence or one prohibited by law.

Analysis: The amount was paid pursuant to a contractual arrangement under which the assessee agreed to bear 50% of the service tax component linked to commission income from insurance auxiliary services. The underlying statutory liability for service tax rested on the recipient under the reverse charge mechanism, and the assessee was not itself the person on whom the tax liability was cast by law. The payment was found to be incurred to secure and retain business and to earn commission income, and there was no specific legal prohibition against such a contractual sharing arrangement. The fact that the recipient had not deposited the tax with the Government did not change the character of the assessee's expenditure, since any default in that regard was attributable to the recipient and not to the assessee.

Conclusion: The disallowance was unsustainable. The amount was allowable as business expenditure under section 37 of the Income-tax Act, 1961, and the assessee succeeded.

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