KOTAK SECURITIES LTD,MUMBAI vs. ADDL CIT RG 4(3), MUMBAI

Order u/s.254(1)of the Income-tax Act,1961(Act) लेखा सद�य,राजे�� के अनुसार लेखा सद�य राजे�� के अनुसार -Per Rajendra,AM: लेखा सद�य लेखा सद�य राजे�� के अनुसार राजे�� के अनुसार Challenging the order dt. 17.03.2010 of CIT(A)-8,Mumbai the assessee has filed the present appeal.Assessee-company,a share broker, filed its return of income on 31.10.2007 declaring its total income of Rs.390.03 crores.The Assessing Officer(AO) completed assessment on 30. 03.2009,determining its income at Rs.401.55 crores.

2.First effective Ground of appeal is about disallowance of bad debts of Rs.32.93 lakhs made by the AO invoking the provisions of section 36(1)(vii)of the Act.Before us,the Authorised Representative(AR) and the Departmental Representative (DR) stated that identical issue was dealt with by the Tribunal in the earlier years, and the Hon'ble Bombay High Court has upheld the order of the Tribunal for AY 2002-03 to 2004-05. We would like to reproduce the relevant portion of the order of the Tribunal,dt.27.7.2011 (ITA.s./ 3272/Mum/06, 1501 and 1052/Mum/2007-AY.s 2002-03 to 2004-05)and it reads as under: “18. The AO had disallowed bad debts amounting to Rs.58,76,826/- which was due from various parties for the secondary market transactions and was claimed by the assessee as bad debts u/s 36(1)(vii) r.w.s. 36(2) of the Act. On appeal, the CIT(A) confirmed the action of the AO by observing as under:- XXXXX

21. After hearing the learned representatives of the parties and perusing the record, we find that the ITAT in asesssee's own case for AY 2001-02, allowed the bad debts claim of the assessee by observing as under:- "7………… We find that the issue is covered in favour of the aeeeesee by the decision of the Special Bench of the Mumbai ITAT in the case of Shreyas S. Morakhia (2010) 40 SOT 440. Respectfully following the decision of the Mumbai Special Bench in the case of Shreyas Morakhia, supra, we allow the entire amount of Rs.34,91,528/- written off by the assessee as a bad debt u/s. 36(1)(vii). Assessee's appeal on this issue is allowed."

22. Since the issue under consideration is identical to that of AY 2001-02, we respectfully follow the decision of ITAT in that year and in the light of that we set aside the order of CIT(A) and allow the bad 3494/M/10(07-08) Kotak Securities Ltd. debts claim of the assessee. Accordingly, the ground raised in all the three years under consideration is allowed. ” The Hon'ble High Court on 03/04/2012 upheld the order of the Tribunal. Respectfully, following the judgment of the Hon'ble High Court,we decide Ground No.1in favour of the assessee. 3.Next effective Ground of appeal (GOA2&3) are about disallowance u/s.14A r.w.r.8D of the Income tax Rules,1962(Rules).It was brought to our notice that in the earlier AY. in & 2028/M/2010 dt.21.05.2012,the Tribunal had restored back the issue to the file of the AO.The assessee also referred to the case of Kotak Mahindra Bank Ltd. (ITA/ 8523/ M/2011);Kotak Mahindra Asset Management Co.Ltd. (ITA/940/M/2010); Tata Consulting Engineers Ltd.(ITA No.265/M/2011). After considering the above,we are of the opinion that matter should be restored back to file of AO for fresh adjudication.He is directed to consider orders of the Tribunal relied by the assessee before us and the directions given by the Tribunal for the earlier year. Ground No.2 &3 stand allowed in favour of the assessee,in part. 4.Fourth Ground is about allowability of depreciation on uninterrupted power supply (UPS). Representatives of both the sides agreed that issue had been deliberated upon by the Tribunal while adjudicating appeals for AY.s 2006-07(supra),and 2010-11(ITA No.2096&1232/M/ 2014).Respectfully,following the above Ground No.5 is decided in favour of the assessee. 5.Last Ground of appeal is about confirming disallowance of Rs.2.62 crores.During the assessment proceedings,the AO found that assessee had paid a sum of Rs. 2,62,90,536/-to various clients in Valsad region on account of is regularities committed by one of its sub brokers.He directed the assessee to explain as to why the said amount should be allowed as revenue expenditure.After considering the submission of the assessee dated 25/03/2009, the AO held that the assessee had entered into a member sub broker agreement with Chetan Dinesh Modi (CDM), proprietor of Modi Financial Services (MFS)that sub broker was solely responsible for any loss or damages arising out of the sub group’s activities/ misappropria - tions,that CDM along with his employee committed fraud by transferring the shares of market on the basis of blank demerit slips given by the clients,that CDM had admitted committing the fraud,that the assessee could not step into the shoes of sub broker and own the liabilities to pay compensation to the clients,that contractually the loss was to be borne by CDM,that business loss claimed by the assessee under section 28 of the Act was not allowable, that mere payment of compensation during the year under consideration would not satisfy the test of wholly and exclusively for the purpose of business, that expenditure 2 3494/M/10(07-08) Kotak Securities Ltd. incurred by the assessee was not allowable as business expenditure as per the provisions of section 37 (1) of the Act that compensation payments were made voluntarily by the assessee, that it was under no obligation to settle the claim of the clients, that voluntary payments, even though made for the purpose of preserving goodwill and reputation, were not allowable under the Act.He further observed that the assessee had recovered a sum of Rs. 25.55 lakhs from CDM, that the assessee had parked the said amount in the liability side of the balance sheet, that the net loss, if at all admissible,was Rs. 2.37 crores only, that it had claimed the full reduction of Rs. 2.62 crores in its profit and loss account.Finally, he made the disallowance of the disputed amount. 5.1.Aggrieved by the order of the AO,the assessee preferred an appeal before the First Appellate Authority(FAA)and made elaborate submissions.He directed the assessee to file copies of the letters obtained from the investors, copy of FIR.After considering the submissions of the assessee and documents produced by the assessee,the FAA held that CDM was affiliated as a broker to the assessee wide agreement dated 25/11/2004, that the sub broker had to assist the clients in buying/selling/dealing in securities through the assessee, that as per the agreement the sub broker had to transfer all the securities sold by the clients in dematerialised form to the assessee’s the demat pool directly from the clients’ the demat accounts, that CDM fraudulently transfer the shares of the clients without their consent and their knowledge, that the clients of MFS suffered losses, that one of the clients filed criminal complaint against CDM and the officials of the assessee, that the assessee negotiator with the clients MFS and settle the account by paying monetary compensation of Rs. 2.62 crores case,that the assessee had submitted detailed working of the payment made to various clients, that it had filed civil suit against CDM in the honorable Bombay High Court. 5.2.After considering the submission of the assessee and the order of the AO,the FAA held that payment for settlement of claim of various clients of its sub broker was not an expenditure but a debt,that it had filed a suit against CDM and had treated the amount as a debt by issue of a debit note, that the settlement was arrived only to ensure that clients would withdraw the name of the assessee and its directors from the police compliant, that CDM was arrested on 25.11.06, that the reputation of the assessee was not at stake that it was well known that the sub broker was involved in the forgery, that as a principle the assessee was not responsible for acts and omissions of its agents, that claim made by the assessee was not allowable u/s. 28 or 37 or 36(1)(vii) of the Act.

3494/M/10(07-08) Kotak Securities Ltd. 5.3.During the course of hearing before us,the AR argued that expenditure has to be allowed even it is not arising out of legal obligation, that the expenditure was incurred wholly and exclusively for business purposes and because of commercial expediency,that to decide necessity and the commercial expediency was not the domain of the AO, that assessee had made payment to protect its reputation and its brand name,that it wanted to come out of the adverse publicity given to the incident by the local newspapers, that the payment made by the assessee was not excessive.The AR relied upon the f cases of Nainital Bank Ltd.(62ITR638); F.E.Dinshaw Ltd.(36ITR114);Sales Magnesite Pvt.Ltd. (214 ITR 1),Eastern Investments Ltd. (20ITR1);Sasson J. David and Co. Pvt.Ltd.(118 ITR 261);F.M. Chinoy and Co. Pvt.Ltd. (74 ITR780);Glaxo Laboratories(India)Pvt.Ltd.(114ITR110);Dhanrajgiri Raja Narasingirji (91 ITR 544);Tata sons Ltd.(18 ITR 460);Delhi Safe Deposit Co.Ltd.(133ITR756) and Walchand and Co. Pvt. Ltd.(65ITR381(SC).The DR relied upon the order of the FAA.

5.4.We have heard the rival submissions and perused the material before us.We find that CDM, proprietor of MFS was affiliated as a broker to the assessee vide agreement dated 25/ 11/2004, that the sub broker had to assist the clients in buying/selling/dealing in securities through the assessee,that as per the agreement the sub broker had to transfer all the securities sold by the clients in dematerialised form to the assessee’s the demat pool directly from the clients’ the demat accounts, that CDM fraudulently transferred the shares of the clients without their consent and their knowledge, that the clients of MFS suffered losses, that one of the clients filed criminal complaint against CDM and the officials of the assessee, that the assessee negotiated with the clients MFS and settled the account by paying monetary compensation of Rs. 2.62 corres,that the assessee had submitted detailed working of the payment made to various clients,that it had filed civil suit against CDM in the Hon’ble Bombay High Court,that the FAA had confirmed the disallowance made by the AO. Before proceeding further,we would like to list some of the recognised principles governing allowability of expenditure u/s.37 of the Act. i.An expenditure to be covered by the ambit of section 37 of the Act,should be wholly and exclusively for the purpose of business.The true test for an expenditure, laid out wholly and exclusively for the purpose of business, is that it is incurred by the assessee as incidental to its trade for the purpose of keeping its trade going on and that the expenditure must be incurred by the assessee as a trader and not in any other capacity. The word “wholly” refers to the quantum of expenditure and the word “exclusively” refers to the motive, objective and 3494/M/10(07-08) Kotak Securities Ltd. purpose of the expenditure. The expression “wholly and exclusively” appearing in section 37,does not mean necessarily. ii.An expenditure need not have been incurred with the object of gaining a direct and immediate benefit ; it would be, rather,sufficient even if it was incurred in order to indirectly facilitate the carrying on of the business. iii.An expenditure,incurred for commercial expediency is allowable u/s.37 of the Act.The term commercial expediency would include such purpose as is expected by the assessee to advance its business interest and may include measures taken for preservation, protection or advancement of its business interests. iv.A voluntary payment and not necessarily a payment under an obligation contractual or other -wise could be allowed as a deduction. If the assessee, which carries on a business finds that it is commercially expedient to incur certain expenditure directly or indirectly, it would be open to such an assessee to do so notwithstanding the fact that a formal deed does not precede the incurring of such expenditure. v.In considering the question of commercial expediency it has to be found out as to whether the expenditure was such as would fall within the deductible items in the computation of profits. vi.The commercial expediency would include such purpose as is expected by the assessee to advance its business interest and may include measures taken for preservation, protection or advancement of its business interests. vii.It is not necessary for an assessee to prove the necessity of expenditure.It is also immaterial if a third party also benefits thereby. It is not for the authorities or the court to examine the purpose for which the assessee incurred the expenses for its commercial expediency.What is relevant is whether the amount was advanced as a measure of commercial expediency and not from the point of view whether the amount was advanced for earning profits. Once it is established that there was nexus between the expenditure and the purpose of the business (which need not necessarily be the business of the assessee itself), the Revenue cannot justifiably claim to put itself in the arm-chair of the businessman or in the position of the board of directors and assume the role to decide how much is reasonable expenditure having regard to the circumstances of the case and no businessman can be compelled to maximise his profit.

3494/M/10(07-08) Kotak Securities Ltd.

Now,we would like to take notice of the matter of Nanital Bank(supra).In that case there was a dacoity in one of its branches and ornaments pledged with the bank,by its customers,were stolen by the dacoits.The assessee,in order to preserve the goodwill of its customers and to avoid loss of business reputation, set off the value of the loans against the value of the pledged ornaments and paid to the customers the excess value of the ornaments pledged, and claimed the amounts so paid as a deduction from its business income.Deciding the matter the Hon’ble Court held as under: ……the sums in question were not allowable under section 10(1) of the Income-tax Act as the loss did not arise directly from the carrying on of the business nor was it incidental to it;…….the amounts were, however, allowable as business expenditure under section 10(2)(xv) of the Act as the expenditure was incurred for preserving the confidence of the customers and maintaining the goodwill of the business……Even though there was no legal obligation to incur an expenditure, if it was incurred in the interests of the business, e.g., for preserving the goodwill of the business, it can be allowed as business expenditure. It is also not necessary that expenditure should have been incurred in cash; it may be incurred by setting off amounts due to the assessee against amounts payable by him.” We would also like to refer to the case of Calcutta Landing & Shipping Co. Ltd.(65ITR1).In that matter,the board of directors of the assessee-company, whose employee was murdered while on the company's business, sanctioned payment of pension to his wife at graded rates for a number of years as also passage money and railway fare for her and children to proceed to England as well as other sums. The assessee's claim for deducting the payments under section 10(2)(xv) was negatived by the department and the Tribunal.On a reference,the Hon’ble Calcutta High Court held as under: The expression " commercial expediency " is an expression of wide import and expenditure in commercial expediency includes such expenditure as a prudent man may incur for the purpose of business. Payment made to employees in the expectation of creating impetus or encouraging them to put in selfless work for the employer is a payment made out of commercial considerations and commercial expediency and has to be regarded as an expenditure incurred wholly and exclusively for the purpose of the business. ……the payment of pension to the wife of the deceased employee was an expenditure solely laid out for the purpose of the business and hence allowable.” Coming back to the facts of the case,we find that the assessee had claimed that the payment was made to the clients for preserving its goodwill and reputation.It is a fact that expenditure in question was not incurred for fostering the business of another person.It was also not gratuitous or for some improper or oblique purpose outside the course of the business. Preserving business reputation by an assessee is allowable expenditure under the head commercial expediency. Old business wisdom states that even at the cost of lakhs credit/ reputation/goodwill should be preserved(Jaaye laakh,rahe Saakh).In short,expenditure incurred by the assessee even voluntary and without any legal obligation has to be allowed as it was incurred for preserving the reputation of its business.Alternatively,it is allowable as