AVITEL POST STUDIOZ LIMITED ,MUMBAI vs. DEPUTY COMMISSIONER OF INCOME TAX , CIRCLE 6(1)(2), MUMBAI

The summary of the findings of the ld. Assessing Officer for giving the disallowance are as under:- (i) During the course of reassessment proceedings, the assessee was called upon to substantiate the claim of legal and professional expenses aggregating to Rs.1,58,51,240/- by furnishing supporting bills, vouchers, and justifications demonstrating that the said expenditures were revenue in nature and incurred wholly and exclusively for the purposes of business. The assessee submitted multiple invoices and engagement letters in support of its claim. However, upon careful examination, the Assessing Officer found the following:

Before the ld. AO, the assessee had relied on various judicial precedents to support its claim. However, the AO noted that the cited decisions dealt with expenditures relating to bonds or convertible instruments, which involved debt financing. In contrast, the assessee’s expenditure pertained to raising equity capital, which constitutes capital expenditure. Thus, the reliance was held to be misplaced.

Thus, the ld. AO held that the entire legal and professional expenditure of Rs.1,58,51,240/- claimed by the assessee was found to be either capital in nature or unrelated to the business Avital Post Studioz Limited activities of the assessee, and accordingly disallowed in full under Section 37(1) of the Income Tax Act, 1961.

To tabulate nature of payment disallowed is as under:-

The ld. CIT (A) has confirmed the addition. By and large, the same reasoning given by the ld. AO qua each of the payment made to the professionals, he held that payment to professional fees are capital in nature and relied upon the judgment of the Hon’ble Supreme Court in the case of Brook bond India Ltd., reported in 225 ITR 798.

KPMG was appointed as a consultancy firm in 2010 to advise the assessee on restructuring its business operations to explore expansion opportunities in the United Kingdom. The services included strategic advice, organisational structuring, and realignment of operational divisions. This was necessitated by the growing international scope of the assessee’s operations, particularly through its wholly-owned subsidiary in Dubai.

Ld. Counsel contended that this was a revenue expenditure incurred in the ordinary course of business and was wholly unconnected to any capital raising activity. The NFAC, in appellate proceedings, accepted the assessee’s submission and allowed the same.

KPMG India was appointed in September 2010 to prepare an Information Memorandum aimed at attracting strategic investments for business expansion. The Memorandum comprised detailed information regarding the Company’s Avital Post Studioz Limited background, key clients, existing contracts, financials, pipeline projects, technology, and future business plans. The assessee has produced the Board Resolution dated 24.01.2010 authorising the appointment and submitted that the assignment was completed in December 2011. It is the assessee’s case that the preparation of this document was unrelated to the subsequent investment by HSBC PI Holdings. The investor had independently exercised its pre-existing rights to subscribe to further capital and the KPMG-prepared document was never utilized for such transaction.

Thus, the expenditure incurred on KPMG India was a preparatory exercise for strategic expansion and does not result in any capital acquisition or enduring benefit. The invoice was raised after the funding merely because the work was completed around that time. He thus submitted that the AO’s inference of capital nexus based solely on the date of invoice is erroneous and lacks evidentiary support.

The assessee states that AZB & Partners were appointed at the insistence of HSBC PI Holdings as a condition precedent for documentation related to issuance of Compulsorily Convertible Preference Shares (CCPs). The investor mandated the engagement of AZB to draft, review, and executes legal documentation on its behalf, at the cost of the assessee.

Following receipt of funds, the assessee faced disputes with the nominee director of the investor entity. Allegations were made, and the assessee engaged Nishith Desai & Associates to defend its position. The legal fees were incurred solely for representation and defense in litigation proceedings before investigating agencies and forums.

He submitted that the expenditure was for protecting its commercial reputation and operational integrity. These were post-investment litigation costs unrelated to capital inflow and clearly fall within the domain of allowable expenditure under section 37(1). The NFAC rightly accepted this contention and allowed the deduction.

Wadia Ghandy & Co. were engaged to provide legal clarity on two aspects:

The Ld. Counsel submitted that both engagements were one- time services of a routine nature. These did not result in creation of any asset or enduring benefit. Legal clarity for subsidiary governance is a standard compliance cost. The NFAC accepted a portion of this expenditure (Rs.3,92,852/-) as revenue in nature, and the balance is contested in this appeal.

Ld. Counsel strongly relied upon the principles laid down in Empire Jute Co. Ltd. v. CIT (124 ITR 1, SC), wherein it was held that even where some advantage may endure, if the expenditure facilitates day-to-day operations or enhances efficiency, it retains the character of revenue expenditure. The test of enduring benefit is not determinative unless it leads to creation or enhancement of a capital structure or asset.

In sum and substance, he submitted that:

Ld. DR relied upon the order of the ld. AO and ld. CIT (A)

We have carefully considered the rival submissions, perused the assessment order, the detailed written submissions filed by the assessee, and the appellate order passed by the Ld. Commissioner (Appeals) under the National Faceless Appeal Centre. The issue that falls for our adjudication is whether the expenditure of Rs.1,58,51,240/- incurred by the assessee towards legal, professional, and consultancy charges is to be treated as revenue expenditure allowable under section 37(1) of the Income-tax Act, 1961, or whether the same deserves to be disallowed as capital expenditure, as held by the Assessing Officer and partly confirmed by the CIT(A).

At the outset, it is pertinent to observe that there is no dispute either with respect to the genuineness of the payments or the identity of the service providers. The disallowance is solely premised on the alleged capital nature of the expenditure, said to be linked to the infusion of capital in the form of Compulsorily Convertible Preference Shares (CCPs) by HSBC PI Holdings (Mauritius) Ltd., formerly known as HPEIF Holdings 1 Ltd. Avital Post Studioz Limited 27. To appreciate the nature of the expenditure, it becomes imperative to briefly revisit the factual canvas. The assessee, an established player in the post-production space, with expanding operations in the Middle East through its wholly-owned subsidiary in Dubai, was contemplating further expansion in the United Kingdom. In pursuit of this goal, it undertook a restructuring exercise and appointed renowned professional firms—KPMG, KPMG India Pvt. Ltd., AZB & Partners, Nishith Desai & Associates, and Wadia Ghandy & Co. at various points in time, for services spanning business restructuring, preparation of investor-facing material, transaction documentation, legal compliance, and post-funding representation.

Now we will deal with each component of the impugned expenditure in detail, in the context of judicially settled principles and the factual substratum.

The first limb of the disallowance pertains to the payment made to KPMG for consultancy services rendered in relation to restructuring the assessee’s business with a view to entering the United Kingdom market. The engagement was initiated in the year 2010, substantially prior to any negotiations with the eventual investor, HSBC PI Holdings. The services rendered involved analysis of the assessee’s international structure, formulation of strategy, and internal realignment of functions.

KPMG India was engaged through a board-approved resolution dated 24.01.2010 for the purpose of preparing an Information Memorandum, a comprehensive document aimed at facilitating discussions with potential strategic or financial investors. The material placed before us, including the timeline of engagement and the scope of work, unequivocally establishes that this document was a general preparatory tool and was not tailored for HSBC PI Holdings. Indeed, the said investor subsequently exercised its contractual right of first refusal, rendering the memorandum otiose for that transaction.

The fact that the invoice was raised after the receipt of funds is not determinative. It is trite law that the timing of payment or billing does not ipso facto determine the nature of expenditure. What matters is the underlying purpose. The AO’s inference that the expenditure is capital in nature merely because it relates

The Information Memorandum did not bring into existence any new asset, nor did it alter the fixed capital structure of the assessee. It was an exercise in business facilitation, squarely falling within the operational domain. Applying the principles enunciated by the Hon’ble Supreme Court in Empire Jute Co. Ltd. v. CIT [124 ITR 1 (SC)], we find that the said expenditure is revenue in nature. Accordingly, the disallowance of Rs.1,00,37,300 is directed to be deleted.

AZB & Partners were engaged by the assessee to handle legal documentation in relation to the issuance of CCPs to HSBC PI Holdings. However, what emerges clearly from the record is that the appointment of the said law firm was not at the volition of the assessee but was a mandatory pre-condition imposed by the investor. The assessee had no discretion in the matter; the role of AZB & Partners was confined to documentation and compliance.

In our considered view, legal fees incurred in the course of facilitating investor-mandated compliance, particularly when the service provider is dictated by the counterparty, cannot be regarded as capital expenditure. The assessee neither acquired any asset nor did the expenditure confer upon it any enduring advantage. The transaction may have resulted in capital receipt, Avital Post Studioz Limited but the costs associated with it, especially when they are ministerial and documentation-related, have been judicially held to be allowable as revenue expenditure. Reference may be drawn to CIT v. Ashima Syntex Ltd. (251 ITR 133) (Guj.) and CIT v. Shree Capital Services Ltd. (310 ITR 420) (Cal.).

We thus hold that the expenditure of Rs.25,35,803 was incurred wholly and exclusively for the purposes of business and is allowable under section 37(1).

Subsequent to the receipt of investment, disputes arose between the assessee and the nominee director of HSBC PI Holdings. The assessee engaged Nishith Desai & Associates, a leading law firm, to defend itself in legal proceedings arising out of those disputes. The services included representation before investigating agencies and rendering legal advice.

We find considerable merit in the assessee’s submission that these were litigation expenses incurred to protect the interests of the company, its management, and its reputation. Such expenses have been consistently held to be allowable, even where they arise in the context of capital transactions, if the object is to defend or protect the existing business. Accordingly, the payment made is allowed.

We are of the view that even the legal documentation work carried out by Wadia Ghandy & Co. does not result in any acquisition of asset or enduring advantage. It was a standard professional service availed for ensuring legal compliance. The judicial distinction between facilitative expenditure and capital acquisition must be preserved. The review of legal agreements is part of any well-governed business transaction and is not in the nature of capital outlay.

Hence, we direct that the balance disallowance of Rs.10,50,056/- also be deleted.

Thus, we hold that none of the components of the impugned expenditure can be said to result in creation of a capital asset, nor do they confer any enduring benefit within the meaning attributed by judicial pronouncements. The expenses were incurred in the ordinary course of business, either in preparation for expansion, to comply with investor-imposed conditions, or to defend the company’s position in legal proceedings.

In light of the foregoing discussion, and applying the principles laid down by the Hon’ble Supreme Court and various High Courts, we hold that the entire expenditure of Rs.1,58,51,240/- is allowable as revenue expenditure under section 37(1) of the Act.

The appeal of the assessee is accordingly allowed.