Company expenses for subsidiary maintenance during winding-up allowed as deduction under sections 28 and 37

The HC allowed the appeal in favor of the assessee company regarding deduction of expenses under sections 28 and 37. The court held that expenditure incurred by the assessee to maintain its subsidiary company MMC during winding-up was deductible as commercial expediency, citing SC precedent in Delhi Safe Deposit Co. Ltd. The assessee held 27% equity in MMC and acted as managing agent until 1974. To protect goodwill and reputation, the board approved expenditure for MMC's maintenance, which was permissible as deduction. Regarding book profit computation under section 115J, the court ruled the Assessing Officer cannot probe accounts beyond statutory provisions, following SC precedent in Malayala Manorama Company Limited.

---

---

1. ISSUES PRESENTED and CONSIDERED

The core legal questions considered by the Court in this appeal under Section 260A of the Income Tax Act, 1961, for Assessment Year 1990-91, are as follows:

(i) Whether the Tribunal was correct in disallowing the write-off of deposits and interest thereon as a business loss under Section 28 of the Act, amounting to Rs. 200.47 lakhs, incurred by the appellant company in the course of its business.

(ii) Whether the Assessing Officer (AO), while determining the book profit under Section 115J of the Act, can question the correctness of the profit and loss account prepared and certified by the statutory auditors of the appellant company as having been prepared in accordance with Parts II and III of Schedule VI to the Companies Act, 1956.

(iii) Whether the Tribunal erred in not allowing miscellaneous expenses of Rs. 49,18,786 incurred by the appellant for Machinery Manufacturers Corporation Ltd. (MMC) under Section 37 of the Act on grounds of commercial expediency and preservation of the reputation of the assessee's estate and business.

2. ISSUE-WISE DETAILED ANALYSIS

Issue (i) and (iii): Deductibility of write-off of deposits, interest, and miscellaneous expenses under Sections 28 and 37 of the Income Tax Act

Relevant Legal Framework and Precedents: The Court examined Section 28 of the Income Tax Act, which pertains to profits and gains of business or profession, and Section 37(1), 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 Supreme Court's decision in CIT vs. Delhi Safe Deposit Co. Ltd. (1982) was a key precedent, where it was held that expenditure incurred on commercial expediency, even if voluntary, may be deductible if it is wholly and exclusively for the purpose of business.

Court's Interpretation and Reasoning: The Court found that MMC was a subsidiary and group company of the appellant, with the appellant holding 27% equity capital and acting as managing agent until 1974. MMC was undergoing financial distress and was ordered to be wound up. The appellant incurred expenses and wrote off deposits and interest due from MMC as part of efforts to preserve MMC's business and goodwill, which was integral to the appellant's commercial interests.

The Court relied heavily on a recent Division Bench judgment of the same High Court in the appellant's own case for the preceding assessment year (MAHINDRA & MAHINDRA LTD. VS. COMMISSIONER OF INCOME TAX), where similar claims were allowed. The Division Bench had held that the expenditure and write-offs were incurred for commercial expediency and were directly relatable to the business of the appellant. It further emphasized that the amounts were not gratuitous but were incurred to protect the business reputation and preserve the value of goodwill.

Key Evidence and Findings: The BIFR (Board for Industrial and Financial Reconstruction) orders and records showed that MMC was part of the appellant's group and that the appellant had invested substantial amounts to revive MMC. The appellant's Board of Directors had approved the expenditure and write-offs. The appellant's role as managing agent and the nexus between the two companies were undisputed.

Application of Law to Facts: The Court applied the principle from Delhi Safe Deposit Co. that commercial expediency justifies the deduction of such expenses. The nexus between the appellant and MMC, the nature of the losses as business losses, and the commercial rationale behind the expenditure supported the claim. The Court held that these expenses and write-offs should be treated as incurred wholly and exclusively for the purpose of business and thus deductible under Sections 28 and 37.

Treatment of Competing Arguments: The revenue contended that the loss was capital in nature, not business loss, and that the expenses were not incurred to carry on the appellant's business. The revenue also relied on the fact that the amounts were debited below the line in the profit and loss account and that the Tribunal had confirmed disallowance based on precedent for the previous year. The Court rejected these contentions, holding that the precedent was overruled by the Division Bench decision and that the commercial expediency principle applied. The concept of "below the line" was held to be irrelevant as Schedule VI does not prescribe such a classification.

Conclusions: The Court answered the first and additional substantial questions of law in favour of the appellant, allowing the deduction of Rs. 49,18,786 and Rs. 200.47 lakhs as business expenses and losses incurred in the course of business.

Issue (ii): Whether the Assessing Officer can question the correctness of the profit and loss account certified by statutory auditors under Section 115J of the Income Tax Act

Relevant Legal Framework and Precedents: Section 115J mandates that companies prepare their profit and loss accounts in accordance with Parts II and III of Schedule VI to the Companies Act, 1956, for the purpose of computing book profits for minimum alternate tax (MAT). The Supreme Court decisions in Apollo Tyres Ltd. vs. CIT (2002), Malayala Manorama Company Ltd. vs. CIT (2008), and Khaitan Chemicals and Fertilizers Ltd. vs. CIT (2008) were pivotal. These cases held that the Assessing Officer's powers under Section 115J are limited to verifying whether the accounts are prepared according to the Companies Act and certified by statutory auditors, and do not extend to re-assessing or questioning the correctness of the profit and loss account entries.

Court's Interpretation and Reasoning: The Court reiterated that Section 115J(1A) requires preparation of accounts as per Schedule VI, and the net profit so computed forms the basis for book profit. The provision does not empower the AO to probe beyond the statutory certification or to re-examine the correctness of the accounts. The Court observed that if the legislature intended to allow such reassessment, it would have explicitly stated so in the statute.

Key Evidence and Findings: The appellant's profit and loss account was certified by statutory auditors as prepared in accordance with Schedule VI. The revenue's contention that the amounts were debited below the line was found irrelevant since Schedule VI does not recognize the concept of "below the line."

Application of Law to Facts: The Court applied the above principles to hold that the AO could not question the correctness of the profit and loss account entries, including the disputed expenses and write-offs, for the purpose of computing book profit under Section 115J.

Treatment of Competing Arguments: The revenue relied on a Supreme Court decision in Principal Commissioner of Income Tax-6 vs. Khyati Realtors Pvt. Ltd. (2022) to argue that the AO could interfere with the accounts. The Court distinguished this case and held that the AO's powers remain circumscribed under Section 115J and the accounts certified by auditors cannot be disturbed.

Conclusions: The Court answered the second substantial question of law in favour of the appellant, holding that the AO cannot question the correctness of the profit and loss account prepared and certified under the Companies Act for the purpose of computing book profit under Section 115J.

3. SIGNIFICANT HOLDINGS

The Court made the following crucial legal determinations and established core principles:

"The expenditure incurred was a deductible expenditure. The solution to a question of this nature sometimes is difficult to arrive at. But, however difficult the task may be, a decision on that question should be given having regard to the decisions bearing on the question and ordinary principles of commercial trading and of commercial expediency." (CIT vs. Delhi Safe Deposit Co. Ltd.)

"Whether to treat the debt as bad debt or as business loss/deduction under Section 28 of the Act is a commercial or business decision of the assessee based on the relevant material in possession of the assessee. Once the assessee records the amounts as business loss/deductions in his books of account that would prima facie establish that it was not recoverable loss unless the Assessing Officer for good reasons holds otherwise." (Division Bench judgment in appellant's own case)

"Section 115J(1A) mandates the company to maintain its accounts in accordance with the requirements of the Companies Act and is bodily lifted from the Companies Act into the Act of 1961 for the limited purpose of making the said account so maintained as a basis for computing the company's income for levy of income-tax. It does not empower the authority under the Act to probe into the account accepted by the authorities under the Companies Act." (Apollo Tyres Ltd. vs. CIT)

Final determinations:

• The write-off of deposits and interest amounting to Rs. 200.47 lakhs and the miscellaneous expenses of Rs. 49,18,786 incurred for MMC are deductible as business expenses/losses under Sections 28 and 37 of the Income Tax Act, being incurred for commercial expediency and preservation of business goodwill.
• The Assessing Officer cannot question the correctness of the profit and loss account prepared and certified by statutory auditors under the Companies Act for the purpose of computing book profits under Section 115J of the Income Tax Act.
• The Tribunal's order disallowing these claims is set aside, and the appeal is allowed accordingly.

---