2026 (2) TMI 423 - HC - Income Tax

Allowable expenditure for compensation paid for exchange rate loss upheld as business deduction after commercial expediency test favours taxpayer.

Whether compensation paid for exchange rate fluctuations qualifies as an allowable business expenditure under the Income Tax Act was contested. The AO ... Allowable expenditure u/s 37 - business loss as an allowable expenditure or not? - compensation amount paid by the assessee - interpretation of contract clauses for tax deductibility - commercial expediency test for allowance of expenditure - ITAT held that the deduction/ expenditure claimed by the assessee to SMTPL towards the loss suffered due to fluctuation in exchange rates is absent in the agreement, and in the absence of any written covenant with regard to the same, it cannot be construed that, either parties is liable to compensate for the loss on account of fluctuation in the exchange rates. Thus, concluded that the said amount cannot be held to be an allowable expenses in the hands of the Assessee. HELD THAT:- As in the absence of any dispute on the actual payment of the said amount by the assessee to the SMTPL, the disallowance of the said amount by the Assessing Officer cannot be said to be in accordance with law, unless the Assessing Officer comes to the conclusion that the same is an expenditure of the nature prescribed in Sections 30 to 36 of the Act, 1961 and does not fall within the scope and ambit of Section 37 of the Act, 1961. As seen from the assessment order as well as the order passed by the learned Appellate Tribunal, there is nothing to indicate that the said expenditure incurred by the appellant would fall either under Sections 30 to 36 or to say that the same does not fall under Section 37 of the Income Tax Act, 1961, except saying that the same is not covered by agreement. When the CIT(A) had considered the matter elaborately and furnished detailed reasons for his conclusion, the learned Tribunal with not even finding fault with the order of CIT(A) passed a cryptic order simply referring to Clauses (g) and (j) of the Agreement. In the order of assessment, there is a finding that the expenditure has been incurred in the financial year ending 31.03.2006. This finding is arrived at on the basis of the fact that FMTPL had not accounted for the said expenditure either in years ending 31.03.2004 or 31.03.2005. It was only in year ending 31.03.2006, relevant to AY 2006-07, that a ledger of SMTPL was produced, accounting for compensation received from the assessee. This payment was pursuant to a Board Resolution, that was communicated to SMTPL by the assessee on 14.09.2005. Based on the above, the Assessing Authority concludes that the expenditure would be relevant only to AY 2006-07 and disallows the same for AY 2004-05, being the subject assessment year. It is relevant to note that he has not questioned the genuinity of the expenditure incurred. The Commissioner of Income Tax (Appeals) has accepted the assessee’s challenge to the disallowance on the ground of commercial expediency, being of the view that the disallowance of the expenditure must be tested from the view point of a business man. He does not go into the year of claim. The Tribunal reverses the order of the Commissioner of Income Tax (Appeals) on the ground that the agreement did not contain a clause for compensation. The Tribunal too, does not refer to the year of claim. We have, in the paragraphs supra, found that the contract contained a categoric clause providing for the payment of compensation. As we have noted earlier, genuinity of the expenses is not in question, as the Assessing Authority has not doubted either the need or the incurrence of the same. Thus, Appellate Tribunal is not right in interfering with the well-considered order passed by the Commissioner of Income Tax (Appeals) insofar as the disallowance is concerned. Decided in favour of assessee. Issues: Whether the amount paid by the assessee towards loss on account of exchange rate fluctuation (Rs.45,67,071) pursuant to a mutual agreement is an allowable business expenditure under Section 37 of the Income-tax Act, 1961 and, if so, whether the liability crystallised in the earlier year such that the assessment for the relevant assessment year must be revised.Analysis: The agreement between the parties contains clauses governing invoicing, credit period and compensation for services rendered; the claimed payment was contemporaneously recorded in notes to accounts and accepted as paid. The Assessing Officer disallowed the deduction on the ground that no explicit clause in the agreement provided for compensation for exchange fluctuation; the Tribunal affirmed that view by reference only to clauses concerning six months' credit and premature termination. The First Appellate Authority examined the commercial context, the quantification and acceptance of the claim by mutual agreement and the timing when liability crystallised. The question of whether an expenditure is allowable under Section 37 is to be tested by commercial expediency and by whether the liability is genuine and has crystallised in the year claimed, subject to exclusions under Sections 30-36. The payment here was mutually agreed, quantified prior to the end of the earlier year and not shown to fall within Sections 30-36; the absence of an express clause authorising a specific head of compensation does not, by itself, render a genuine commercial payment non-allowable where it falls within the contract's scope and is commercially expedient.Conclusion: The payment of Rs.45,67,071 towards exchange fluctuation loss is an allowable business expenditure under Section 37 in favour of the assessee; the liability crystallised in the earlier year and the assessment for the subsequent year shall be revised accordingly.Ratio Decidendi: A genuine commercial liability, mutually agreed and quantified before the end of the relevant previous year and not falling within the exclusions in Sections 30-36, is allowable as a business expenditure under Section 37 even if the agreement does not contain an express clause using the exact terminology for that specific head of compensation; commercial expediency and crystallisation of liability determine the relevant assessment year.