Question of Deductibility of an Expenditure U/s. 57(iii) of Income Tax Act, 1961

Advocate Akhilesh Kumar Sah

Clauses (i), (ia), (ii) & (iia) of section 57 specifically mention to deductions available while computing the income chargeable under the head “Income from other sources”. Clause (iii) to section 57 makes admissible the deduction of any other expenditure (not being in the nature of capital expenditure) laid out or expended wholly and exclusively for the purpose of making or earning such income (income chargeable under the head “income from other sources”). Section 57(iii) of the Act is in line with the section 37(1) of the Act which in general (subject to its Explanation) makes available deduction of any expenditure (not being expenditure of the nature described in sections 30 to 36 of the Act and not being in the nature of capital expenditure or personal expenses of the assessee) laid down or expended wholly and exclusively for the purposes of the business or profession while computing the income chargeable under the head “Profit and gains of business or profession. It may be pertinent to mention the distinction in the language used by the legislature in section 37(1) of the Act and 57(iii) of the Act. Section 37 provides for deduction of expenditure incurred wholly and exclusively “for the purpose of business” whereas section 57(iii) provides for deduction only of expenditure incurred wholly and exclusively “for the purpose of making or earning such income”. “Such income” refers to “income from other sources”. The expression “for the purpose of business” is narrower that the expression “for the purpose of making or earning such income”. In order that an expenditure may be admissible under section 57(iii) it is necessary that the primary motive of incurring it is directly to tern income falling under the head “income from other sources”. That is not so under section 37 which allows deduction of expenditure; incurred wholly and exclusively” for the purpose of the business”. Under section 57(iii), deduction will not be allowed if the expenditure is not incurred for the purpose of earning income falling under the head “income from other sources” CIT vs. Smt. Amirtaben R. Shah (1999) 152 Taxation 721 (Bom.). In CIT vs. Kasturbhai Lalbhai (1968) 70 ITR 267 (Guj.), the assessee were director of A & Co. Ltd., of which K. N. Co. Ltd. was the managing agent. Due to certain mismanagement and change in the directorate of K. N. Co. Ltd., there were difference between the assessees and the other directors of A & Co. Ltd. . The assessees therefore sent out two circulars to the shareholders pointing out the mismanagement. They also collected proxies for a meeting of A & Co. Ltd. requisitioned in the meantime. Before the said meeting could be held, the differences were settled and ultimately the first assessee was elected chairman of the board of directors of A & Co. Ltd. The assessees jointly spent about Rs. 33,299 for sending out the circulars and collecting the proxies and claimed to deduct this amount in their respective assessment both under section 10(2)(xv) and under section 12(2) of I. T. Act, 1922 (which corresponds to section 37(1) & 57 of I. T. Act, 1961, respectively). The departmental authorities negatived this claim, but the Tribunal allowed the expenditure as a permissible deduction under section 12(2). The Tribunal, however, rejected the contention of allowability under section 10(2)(xv). On a reference to the Gujarat High Court, it held as follows:
(i)   as the assessees had incurred the expenditure in issuing the circulars on the ground of commercial expediency in order to indirectly facilitate the earning of the director’s fees, the expenditure relating thereto was an expenditure incurred solely for earning the director’s fees and hence was allowable under sec. 12(2).

(ii)       The expenditure incurred in collecting the proxies from the shareholders cannot be regarded as an expenditure, even indirectly connected with the earning of the director’s fees and, hence, was not allowable under section 12(2).

The plain natural construction of the language of section 57(iii) of the Act, irresistibly leads to the conclusions that to bring a case within that section it is not necessary that any income should in fact have been earned as a result of the expenditure. What section 57(iii) requires is that the expenditure must be laid out or expended wholly and exclusively for the purpose of making or earning income. The section does not require that this purpose must be fulfilled in order to qualify the expenditure for deduction it does not say that the expenditure shall be deductible only if any income is made or earned (CIT vs. Rajendra Prasad Moody (1978), Taxation 51 (3)-52, 115 ITR 519 (SC) : CIT vs. Murli Manohar (1998) IX SITC 673 (All) : CIT vs. Rampur Timber & Turney Co. Ltd. (1981) 129 ITR 58 (All.) : CIT vs. Administrator General of Madras (1998) 142 Taxation 85 (Mad.)).

The Gujarat High Court in Padmavati Jaykrishna vs. CIT (1981) 131 ITR 653 has  held that in order to decide whether an expenditure is a permissible deduction under section 57(iii), the nature of the expenditure must be examined. Also the Gujarat High Court in the case of Sarabhai Sons (P) Ltd. vs. CIT (1993) 113 Taxation 407, 201 ITR 464 has held that if the dominate purpose for which the expenditure was incurred not to be earn the income, the expenditure incurred in that behalf would fall outside the purview of section 57(iii) of the Act. Where the dominant purpose of the assessee in taking overdrafts was not to earn income but to meet the personal liability, interest payment on overdrafts was held to be not allowable deduction under section 57(iii) of the Act (H. H. Maharaja Martand Singh Ju Deo Vs. CIT (1989) Taxation 92(3)-199, 174 ITR 515 (MP): Padmavati Jai Krishna Vs. Addl. CIT (1987) Taxation 86(2)-1: 166 ITR 176 (SC)). Connection between the expenditure and earning of income need not be direct and it may be indirect. But, since the expenditure must have been incurred for the purpose of earning that income, there should be some nexus between the expenditure and the earning of the income [Addl. CIT vs. Madras Fertilisers Ltd. (1980) 122 ITR 139 (Mad.) : Vijaya Laxmi Sugar Mills Ltd. vs. CIT (1991) 191 ITR 641 (SC): CIT vs. Dwaraka Chit Funds Pvt. Ltd. (1996) 132 Taxation 109 (Mad.). In CIT vs. K. P. Madan Mohan (1997) 136 Taxation 506 (Mad.), the assessee was an individual. His only activity was going to races at Madras and Bangalore. The A. Y. involved was 1973-74. The assessee joined a syndicate consisting of 13 members and the assessee purchased a ticket for Rs. 25/- and joined this pool which was betting on races. The syndicate winning jackpot an assessee’s share was determined at Rs. 48,669/-. The assessee claimed certain expenses which are disallowed and the entire receipt was taxed by the ITO under the head “other sources”. On appeal the AAC held that it could not be treated as income from undisclosed sources but was a share income from jackpot and the expenditure that would have been incurred for such restricted activity could be allowed. Before the Tribunal, the assessee produced his books as against claim for expenditure in regard to the jackpot at Rs. 16690/- apart from the other expenses such as audit fee, car maintenance, etc. After perusing the account books and following the provisions contained in section 56(2)(i)(b) and section 2(24) (ix) of the Act, the Tribunal allowed Rs. 15,000/- on estimate as a deduction u/s 57 (iii). Being aggrieved, the revenue filed the reference before Madras High Court which held that the expenditure was incurred by the assessee not only towards fare, purchase of race books, tickets, entrance fee, etc. but also towards the loss in the purchase of tickets for betting on horses and food charges. Personal expenditure is not allowable as deduction. So the amount invested for purchasing the ticket cannot be allowed as  deduction since it amounts to investment. Barring these two items of expenditure, the assessee can claim deduction of other expenditure incurred for purchasing the tickets even though the tickets did not yield any income. Considering all these aspects, the Tribunal estimated the expenditure incurred by the assessee in winning the jackpot. The Hon’ble Court thus held that it could not interfere with the order passed by the Tribunal in the matter of allowing the expenditure at Rs. 15,000 on the basis of the estimate.

Conclusion

The provisions of the Income-tax Act relating to allowances disclose  that the expenditure or outgoing sought to be deducted should bear a character which has a connection with or relation to the particular activity which produces the income or constitutes its source. Subject to this broad feature, there are additional limits or qualifications, introduced in order to define as also to circumscribe the scope, character and eligibility of the allowance (CIT vs. S. Devaraj (1969) 73 ITR 1 (Mad.). The expenditure as envisaged by section 57(iii) of the Act should not be in the nature of capital or personal expenditure and it should have been incurred wholly and exclusively for the purpose of making or earning the income which is chargeable under the head “income from other sources”. It is not necessary that income should have been earned as a result of expenditure claimed as deduction under section 57(iii) of the Act. The Gujarat High Court in Virmati Ramkrishna vs. CIT (1981) 131 ITR 659, has observed the following propositions in respect of deduction of an expenditure under sec. 57(iii) of the Act (See also Eastern Investments Ltd. vs. CIT (1951) 20 ITR 1 (SC), Seth R. Dalmia vs. CIT (1977) Taxation 49(3)-57, 110 ITR 644 (SC) :

(1) in order to decide whether an expenditure is a permissible deduction u/s 57(iii), the nature of the expenditure must be examined.

(2) the expenditure must not be in the nature of capital expenditure or personal expenses of the assessee;

(3) the expenditure must have been laid out or expended wholly and exclusively for the purpose of making of earning “income from other sources”;

(4) the purpose of making or earning such income must be the sole purpose for which the expenditure must have been incurred, that is to say, the expenditure should not have been incurred for such purpose as also for another purpose, or for a mixed purpose;

(5) the distinction between purpose and motive must always be borne in mind in this connection, for, what is relevant is the manifest and immediate purpose and not the motive or personal considerations weighing the mind of the assessee in incurring the expenditure;

(6) if the assessee has no option except to incur the expenditure in order to make the earning of the income possible, such as when he has to incur legal expenses for preserving and maintaining the source of income, then undoubtedly, such expenditure would be an allowable deduction; however, where the assessee has an option and the option which he exercises has no connection with the making or earning of the income and the option depends upon personal considerations or motives of the assessee, the expenditure incurred in consequence of the exercise of such option cannot be treated as an allowable deduction;

(7) it is not necessary, however, that the expenditure incurred must have been obligatory; it is enough to show that the money was expended not of necessity and with a view to an immediate benefit to the assessee but voluntarily and on the ground of commercial expediency and in order indirectly to facilitate the making or earning of the income;

(8) if, therefore, it is found on application of the principles of ordinary commercial trading that there is some connection, direct or indirect, but not remote, between the expenditure incurred and the income earned, the expenditure must be treated as an allowable deduction;

(9) it would not, however, suffice to establish merely that the expenditure was incurred in order indirectly to facilitate the carrying on of the activity which is the source of the income; and nexus must necessarily be nexus must necessarily be between the expenditure incurred and the income earned;

(10) it is not necessary to show that the expenditure was a profitable one or that in fact income was earned;

(11) the test is not whether the assessee benefited thereby or whether it was a prudent expenditure which resulted in ultimate gain to the assessee but whether it was incurred legitimately and bonafide for making or earning the income;

(12)  the question whether the expenditure was laid out or expended for making or earning the income must be decided on the facts of each case, the final conclusion being on of law.