Commissioner Of Income Tax, Dehradun vs. M/s Tehri Steel Ltd

Facts

The assessee, M/s Tehri Steel Ltd., acted as a liaisoning agent for M/s Pharma Ventures International Private Limited to secure a contract from the Ministry of Health for supplying cotton bandages. The assessee was to receive a 28% commission. The assessee, in turn, appointed M/s K.P. Steel Products (P) Ltd. as their liaisoning agent for 13% commission, allegedly to use their contacts in the Ministry to secure the contract. The Ministry awarded contracts to M/s Pharma Ventures, with a total value of Rs. 3,84,40,512/-. The assessee received commission of Rs. 1,07,63,343/- and paid Rs. 49,97,266/- to M/s K.P. Steel Products. The Assessing Officer (AO) disallowed the commission paid to M/s K.P. Steel as an illegal expenditure. The Commissioner (Appeals) and the Income Tax Appellate Tribunal (ITAT) allowed the expenditure as a regular business expense.

Held

The High Court held that the ITAT was correct in its view. The Court noted that while Section 37 of the Income Tax Act, 1961, has an explanation to prevent claims for revenue expenditure prohibited by law, no law was brought to its notice that prohibited the kind of activities the assessee engaged in. The Court found no illegality in the commission paid for liaison work, stating that illegal activity is one prohibited by law, and there was no infraction of any law. The Court reasoned that the payment of commission for liaison work, which ultimately led to securing a contract, cannot be faulted as prohibited by law. Therefore, the expenditure was considered legitimate business expenditure. The substantial question of law was answered against the appellant (Revenue).

Key Issues

1. Whether the ITAT was correct in holding that the payment made by the assessee to M/s K.P. Steel Products was not illegal expenditure and was a regular business expenditure, despite the admitted fact that M/s K.P. Steel used its contacts in the Government to ensure the contract was awarded to the assessee's principal, suggesting unfair means and an unlawful purpose for the commission paid? (Question of law, turning on Section 37 of the Income Tax Act, 1961). Assessee's contention: Not recorded in the judgment. Revenue's contention: The use of 'contacts' to obtain the contract constitutes an illegal activity, and expenses incurred for illegal activities cannot be allowed as a deduction under Section 37 of the Act, particularly in light of the explanation to Section 37 which disallows expenditure prohibited by law.