M/S.seven Arts Filmsb-9, Brown Stone Apartmentsmahalingapuramchennai v. The Asst. Commissioner Of Income Taxmedia Circle - Iichennai

IN THE HIGH COURT OF JUDICATURE AT MADRAS THE HONOURABLE MR. JUSTICE R.SUDHAKARANDTHE HONOURABLE MS. JUSTICE K.B.K.VASUKI M/s.Seven Arts FilmsB-9, Brown Stone ApartmentsMahalingapuramChennai. .. Appellant - Vs - The Asst. Commissioner of Income TaxMedia Circle - IIChennai. .. Respondent Appeal filed under Section 260-A of the Income Tax Act againstthe order dated 27.05.2014 passed by the Income Tax AppellateTribunal, 'D' Bench, made in ITA No.1291/Mds/2013 against the orderof the Commissioner of Income Tax (Appeals)-VI, made in ITANO.172/11-12 dated 23/01/2013 which was preferred against the Orderof the Joint Commissioner of Income Tax, made in PAN.AAMFS222OC/JCIT-MR/2011-12 dated 22/12/2011 For Appellant: Mr.Suhrith Parthasarathy For Respondents: Mr. M.Swaminathan, assisted by Mr.K.Sureshkumar & Ms.V.Pushpa JUDGMENT (DELIVERED BY R.SUDHAKAR, J.) Aggrieved by the order of the Tribunal in allowing the appealfiled by the Revenue, the assessee is before this Court by filing thepresent appeal raising the following questions of law :- https://hcservices.ecourts.gov.in/hcservices/ "i) Whether the Income Tax Appellate Tribunal haserred in considering the payments made by theappellant to M/s.Pyramid Saimira Entertainment Ltd.,as capital expenditure and therefore incapable ofbeing allowed as deduction under Section 37 of theIncome Tax Act, 1961? ii) Whether the expenditure incurred by theappellant in paying Rs.1,50,00,000/= to M/s.PyramidSaimira Entertainment Ltd., under the SettlementAgreement dated 13.09.2008 is a revenue expendituredeductible under Section 37 of the Income Tax Act,1961? iii) Whether the Income Tax Appellate Tribunal haserred in concluding that the payments made toM/s.Pyramid Saimira Entertainment Ltd., under theSettlement Agreement dated 13.09.2008 is tantamount toa purchase of goodwill? iv) Whether the Income Tax Appellate Tribunal haserred in failing to follow the decisions of thisHon'ble Court in Amarjothi Pictures - CIT (69 ITR 75),CIT - Vs - Gobald Motor Services (100 ITR 240) and CIT- Vs - Associated Electrical Agencies (266 ITR 63)?v) Whether the Income Tax Appellate Tribunal haserred in questioning the genuineness of the payment ofRs.1,50,00,000/= made by the appellant to M/s.PyramidSaimira Entertainment Ltd., under the SettlementAgreement dated 13.09.2008, particularly when the samehas been attested by the Assessing Officer? vi) Whether the Appellate Tribunal's findings areperverse and therefore liable to be set aside?" 2. The facts, in a nutshell, are as hereunder :-The issue relates to print distribution and the subsequentcompensation paid due to the loss incurred by the theater owners inexhibiting the films "Kuselan" and "Kathanayakudu" by theassessee/appellant. 3. The appellant is engaged in the business of production anddistribution of movies/feature films. For the assessment year 2009-2010, the appellant filed its return of income on 30.09.2009admitting a total income of Rs.1,40,59,210/=, which was processedunder Section 143 (1) of the Income Tax Act (for short 'the Act').On 24.3.2011, the appellant filed a revised return admitting a totalincome of Rs.1,33,59,740/=. The case of the appellant was selectedfor scrutiny and notice under Section 143 (2) of the Act was issuedto the appellant. 4. It is the further case of the appellant that during therelevant assessment year, the appellant produced a film 'Kuselan' inTamil and 'Kathanayakudu' in Telugu, which starred Rajinikanth andothers. The rights of both these films were sold outright to https://hcservices.ecourts.gov.in/hcservices/ 4. It is the further case of the appellant that during therelevant assessment year, the appellant produced a film 'Kuselan' inTamil and 'Kathanayakudu' in Telugu, which starred Rajinikanth andothers. The rights of both these films were sold outright to https://hcservices.ecourts.gov.in/hcservices/ M/s.Kavithalaya Productions Pvt. Ltd. (for short 'KPPL') andM/s.Vyjayanthi Movie (for short 'VM') respectively. While the movie'Kuselan' was sold to KPPL for a sum of Rs.25.5 Crores,'Kathanayakudu' was sold to VM for a sum of Rs.14.5 Crores. Thesale, insofar as both the movies, included theatrical rights, audiorights, satellite rights and non-theatrical rights. Both KPPL andVM, in turn, sold their respective rights to one M/s.Pyramid SaimiraEntertainment Ltd., (for short 'PSEL') which, in turn, wasresponsible for disturbing the films through various distributors andexhibitors. 5. It is the further case of the appellant that the Tamil film'Kuselan' unfortunately flopped in the box office and caused a hugeuproar among distributors and exhibitors, who had incurred hugelosses. In order to pacify the distributors and exhibitors,Mr.Rajinikanth offered to compensate them and he brought forthdiscussions between the distributors, exhibitors and producers inorder to arrive at an amicable settlement. Further to the same, anagreement was reached by all the parties, viz., producer, buyers, theactor, Mr.Rajinikanth and the director of the film, Mr.P.Vasu thateach one of them would bring forth a specific amount to be paid ascompensation. Accordingly, the appellant entered into a settlementagreement dated 13.09.2008 with PSEL to whom KPPL had sold the entirerights over the Tamil film 'Kuselan' and VM had sold the rights ofthe Telugu Film 'Kathanayakudu'. It is specifically stated in thesaid agreement that both these films having not been successful atthe box office and the distributors/exhibitors have been makingdemands for compensation, as a gesture of goodwill, the parties,viz., PSEL and the appellant had held negotiations and had mutuallyagreed that an amount of Rs.1,50,00,000/= (Rupees One Crore FiftyLakhs only) would be paid by the appellant to PSEL. It is alsostated in the said agreement that the said amount was paid towardsrefund to compensate the distributors through PSEL for lossesincurred by them from the theatrical release of the two films inTamil Nadu, Andhra Pradesh and Karnataka. 6. In addition to the above, in the course of argument, it hasbeen pointed out by the learned counsel for the Revenue and acceptedby the learned counsel for the assessee that VM has also made certainpayment to PSEL, vide agreement dated 8.9.08 in a sum of Rs.75 Lakhsas a goodwill gesture citing commercial expediency. 7. During the course of scrutiny proceedings, the AssessingOfficer called upon the assessee to explain how the amount paid toPSEL in terms of the Settlement Agreement dated 13.9.08 could beclaimed as revenue expenditure in terms of Section 37 of the Act andhe sought to disallow the same as a payment made towards goodwill andthat the said amount has to be treated as expenses, capital innature. The assessee gave a detailed explanation to support the saidpayment as a payment made as goodwill gesture to save its businessand it is a commercial expediency. However, the said explanation was https://hcservices.ecourts.gov.in/hcservices/ was rejected by the Assessing Officer, who disallowed the saidamount, vide adjudication order dated 22.12.2011. 7. During the course of scrutiny proceedings, the AssessingOfficer called upon the assessee to explain how the amount paid toPSEL in terms of the Settlement Agreement dated 13.9.08 could beclaimed as revenue expenditure in terms of Section 37 of the Act andhe sought to disallow the same as a payment made towards goodwill andthat the said amount has to be treated as expenses, capital innature. The assessee gave a detailed explanation to support the saidpayment as a payment made as goodwill gesture to save its businessand it is a commercial expediency. However, the said explanation was https://hcservices.ecourts.gov.in/hcservices/ was rejected by the Assessing Officer, who disallowed the saidamount, vide adjudication order dated 22.12.2011. 8. Aggrieved by the said adjudication order, the assesseepreferred appeal before the CIT (Appeals), who held in favour of theassessee stating that it is a case of sales-return invoking Section 9of the Sale of Goods Act. It was further held by the CIT (Appeals)that the amount was given by way of goodwill gesture and not asgoodwill, as held by the Assessing Officer. For better clarity, therelevant portion of the order is extracted hereinbelow:- "13. Thus it's not that a price of a commodity is aswhat it is determined at the time of sale and it is acommon practice that the price keeps getting reducedby the unfolding of future events. In the event ofthe goods sold being found defective or delivery notin time or not to the satisfaction of the customer,the seller has and has been always willing to reducethe price to keep himself secured in the business andto keep the good customer at his door step. In thiscase, even though the agreement dated 25.4.2008 thePSEL has agreed to a sale consideration of Rs.30Crores for the Kuselan Tamil Film, and 7 Crores forKathanayakudu Talugu film, since both the films havenot done well at the box offices, both the sellersi.e., the assessee company and Mr.C.Aswini Dutt alongwith producer SAF, Mr.Rajinikanth, actor, Mr.P.Vasu,Director of the film have all agreed to compensate thePSEL by specified amounts. Thus it can be said thatthe producer and both the sellers, as parties to therenegotiations, have reduced their sale price by meansof a discount given as the film did not do well at thebox office. It has been very clearly reduced towriting on page 2 of the said Settlement Agreementthat the appellant (being First Part) has agreed toreducing the sale consideration of the film by a sumof Rs.150 lacs. As per Accounting Standard 9 what isreceived on the recognition of a sale has to be takenas revenue. In this case, the assessee even thoughhas received Rs.40 Crores based on the agreement dated25.4.2008 but out of the same, Rs.150 lakhs has beenreturned to PSEL as his share, by virtue of thesubsequent unfolding of events and subsequentagreement dated 17-9-2008. Hence it is not correct tosay that Rs.150 lakhs is a payment of goodwill. Asrightly argued by the AR there is no asset acquired tosay that the asset has come along with goodwill. Infact, the payment made to PSEL of Rs.150 lakhs is onlya reduction in sale consideration, a payment made toprotect the reputation of the assessee and to keepthem in good stead in the business. As rightly urgedby the AR, there is a substantial difference between "Goodwill" and "Goodwill gesture". The goodwillgesture is one which results in goodwill over a longperiod of time whereas a goodwill is a crystalliseditem, price paid in excess of assets over liabilities.Hence a payment made as a goodwill gesture cannot beequated with goodwill, the former is a revenue itemand the latter is a capital item as per the accountingmethods and the Income Tax Act. Since the paymentmade of Rs.150 lakhs on the commercial failure of thefilm is only to compensate the buyer PSEL and also toprotect the reputation of the producer - appellant,the same cannot be held as a 'goodwill but it is onlya sales-return or a discount, as squarely covered byS.9 of the Sale of Goods Act and Accounting Standard9. Moreover, this is not the first time of suchinstances in the film industry, there are precedents.Hence, the AO is directed to delete the addition." 9. On appeal, at the behest of the Department, the Tribunal cameto hold that the assessee/appellant had realised a sum of Rs.39.13Crores from the sale of the two feature films on outright sale toKPPL and VM under agreement dated 16.2.08. Before the Tribunal, thecontention of the assessee was that both the movies did not do willin the theaters and the exhibitors suffered huge losses due to lackof collection from the theaters. Therefore, on the basis of mutualdiscussions between the assessee, distributors, viz., KPPL and VM andthe ultimate distributor, PSEL, it appears a series of agreementswere signed, which we have referred to above, and on the part of theappellant, a sum of Rs.1.5 Crores has been paid to PSEL on 13.9.08.The Tribunal, on the conspectus of these facts, came to hold that theassessee had made the payments to protect his goodwill in the market.The assessee has not shown on the basis of this agreement dated10.2.08, or the supplementary agreement dated 28.7.08 that payment ismade in accordance with the covenants of the agreement. A perusal ofthe records as well as the assessee's admission does not show thatthe payment was made to discharge any legal liability. Accordingly,the Tribunal came to hold that the payment was made eithervoluntarily or out of pressure from market forces, but certainly notdue to business obligation. It also held that the assessee madepayment in the form of compensation to stay afloat in the business.The Tribunal, looking into the various decisions of the High Courtfurther held that the assessee has not been able to show that thepayments were actually received by the persons, who suffered thelosses and, therefore, this casts a shadow over the genuineness ofthe payment. The Tribunal further held that if the payment isbelieved to be genuine, it should be held as capital in nature andcannot be allowed as deduction under Section 37 of the Act. On thispremise, the Tribunal allowed the appeal filed by the Revenue againstwhich this appeal is filed by the appellant/assessee. 10. Mr.Suhrith Parthasarathy, learned counsel appearing for theappellant/assessee relied upon the agreement dated 13.9.08 toestablish the fact that there was a clear statement in the agreementthat those two films have flopped in the box office and PSEL wasunder compulsion from the theater owners to pay up certain amountand, therefore, based on the discussions between the assessee, thedistributors, viz., KPPL and VM and the ultimate distributor, PSEL,the present agreement was signed. For better clarity, the relevantportion of the agreement is extracted hereunder:- 10. Mr.Suhrith Parthasarathy, learned counsel appearing for theappellant/assessee relied upon the agreement dated 13.9.08 toestablish the fact that there was a clear statement in the agreementthat those two films have flopped in the box office and PSEL wasunder compulsion from the theater owners to pay up certain amountand, therefore, based on the discussions between the assessee, thedistributors, viz., KPPL and VM and the ultimate distributor, PSEL,the present agreement was signed. For better clarity, the relevantportion of the agreement is extracted hereunder:- "WHEREAS the party of the First Part represents thatthey have produced the Tamil feature film "Kuselan"with artists Rajinikanth, Pasupathy, Vadivelu, Meena,Nayantara, etc., and directed by P.Vasu and the Telugufilm "Kathanayakudu" with artists Rajinikanth,Jagapathy Babu, Sunil, Meena, Nayantara and sold thedistribution cum marketing rights of Tamil film"Kuselan" to M/s.Kavithalayaa Productions Pvt. Ltd.vide an agreement dated 16/02/08 and the Telugu film"Kathanayakudu" to M/s.Vyjayanthi Movies vide anagreement dated 16/02/2008. WHEREAS the above said M/s.Kavithalayaa ProductionsPvt. Ltd. and M/s.Vyjayanthi Movies have subsequentlysold their respective rights to M/s.Pyramid SaimiraEntertainment Ltd., vide agreements dated 25/04/2008and 10[th] May, 2008 respectively and these saleagreements were confirmed by the party of the secondpart as the producers. Pursuant to the saidagreement, the amount of consideration as agreed tobetween the parties had been duly paid by therespective parties.WHEREAS the film "KUSELAN" and "KATHANAYAKUDU" sincereleased for commercial exhibition and has not beensuccessfulattheboxofficeandthedistributors/exhibitors in the respective states havemade demands for compensation and as a goodwillgesture the parties of the First Part and the SecondPart held negotiations and has mutually agreed thatthe Party of the First Part shall, as producers,reimburse an amount of Rs.1,50,00,000/= (Rupees OneCrore Fifty Lakhs only) to the second party to settlethe issues." 11. It is further submitted by the learned counsel for theassessee that the Tribunal failed to adhere to the well settledproposition of law that what constitutes a revenue expenditure oughtto be determined in line with the trade of the assessee. Tobuttress this argument, reliance was placed on the decision in thecase of CIT - Vs - Dhanrajgiriji Raja Narasingirji (91 ITR 544 (SC)).Reliance was also placed on the decisions of this Court in AmarjothiPictures - Vs - CIT (69 ITR 755) and Sanjeevi & Co. - Vs -Commissioner of Income Tax (AIR 1966 Mad 390), to impress upon the fact that the Revenue is confined to decide the reality of theexpenditure as to whether it was factually expended and exclusivelyused for the purpose of business and that the resonableness of theexpenditure could only be gone into for the purpose of determiningwhether the amount was actually spent. 12. It is the further submission of the learned counsel for theassessee that there is a direct nexus between the payments made bythe appellant under the Settlement Agreement to PSEL and the saidamounts were paid purely in the ordinary course of business. Todrive home this point, learned counsel placed reliance on thedecision of this Court in CIT - Vs - Gobald Motor Services P. Ltd.(100 ITR 240 (Mad)). fact that the Revenue is confined to decide the reality of theexpenditure as to whether it was factually expended and exclusivelyused for the purpose of business and that the resonableness of theexpenditure could only be gone into for the purpose of determiningwhether the amount was actually spent. 12. It is the further submission of the learned counsel for theassessee that there is a direct nexus between the payments made bythe appellant under the Settlement Agreement to PSEL and the saidamounts were paid purely in the ordinary course of business. Todrive home this point, learned counsel placed reliance on thedecision of this Court in CIT - Vs - Gobald Motor Services P. Ltd.(100 ITR 240 (Mad)). 13. It is further contended by the learned counsel for theassessee that the payment in this case was made pursuant to theSettlement Agreement with PSEL having regard to the commercialexpediency and in furtherance of the appellant's business. Reliancewas placed on the decision of this Court in CIT - Vs - AssociatedElectrical Agencies (266 ITR 63), wherein this Court held thatpayments made, having regard to commercial expediency need notnecessarily have their origin in contractual obligations. If theassessee, carrying on business, feels that it is commerciallyexpedient to incur certain expenditure directly or indirectly, itwould be open to such an assessee to do so, notwithstanding the factthat a formal deed does not precede the incurring of suchexpenditure. It has also been held in the said decision thatpayments made in commercial exigency need not necessarily arise outof contractual obligations. 14. It is the further stand of the assessee that at no point oftime the genuineness of the payment made to PSEL has been questionedby the Revenue. A finding in this regard is also found in the orderof the Tribunal, which has recorded that the facts have not beendisputed and the only dispute is with relation to the nature of thepayment made to PSEL. 15. It is the further submission of the assessee that it iscommontradepracticeforproducerstocompensateexhibitors/distributors when they suffer losses due to poorperformance of a film. It is the further submission of the learnedcounsel for the assessee that the assessee has right to carry onbusiness and any expenditure made by the assessee during the courseof business for the purposes of removal of any restriction orobstruction or disability would be on revenue account, provided itdoes not result in the acquisition of a capital asset. Reliance wasplaced on the decision of the Supreme Court in the case of BikanerGypsums Ltd. - Vs - CIT (187 ITR 39). Learned counsel vehementlyurged the Court to take into consideration the above submissions, andsubmitted that for the reasons afore-mentioned, the order of theTribunal is liable to be interfered with. 16. On notice, learned standing counsel for the respondentappeared and reiterated the submissions made before the Tribunal,which prompted the Tribunal to interfere with the order of the CIT(Appeals). It was further submitted by Mr.Swaminathan that there wasno necessity for the assessee/appellant to make the payment to PSELas there is no privity of contract. The assessee sold the film toKPPL and VM, who, in turn, sold the same to PSEL and, ultimately, itwas given to the theater owners. There was no legal obligation onthe part of the assessee to make the payment to PSEL. Learnedcounsel tried to justify the stand of the Department that theexpenditure claimed is not revenue in nature, but is capital innature. Therefore, it was vehemently urged that the order of theTribunal warrants no interference in the facts and circumstances ofthe case. 17. Heard the learned counsel appearing for theappellant/assessee and the learned standing counsel appearing for therespondent/Department and perused the materials available on recordas also the decisions relied on by the learned counsel for theappellant/assessee. 18. At the time of hearing, the settlement agreement dated8.9.08, entered into between VM and PSEL was sought to be filedbefore us by the assessee to stress that VM has also paidcompensation to PSEL. However, the said agreement has not been filedbefore the Tribunal. Therefore, we do not propose to look into thatagreement as that document has not been admitted and tested inaccordance with law. Nevertheless, we would like to discuss theissue on the legal plea raised by the learned counsel on either sidein the following manner. 19. The primary plea raised by the learned counsel for theappellant is on the premise that due to failure of those two moviesin the box office, there was great pressure from the theater ownersand distributors, which fact is not dispute, the assessee, in orderto sustain its goodwill in the market, as a goodwill gesture, hadentered into the agreement. All the authorities unanimously recordthat there was no legal obligation on the part of theappellant/assessee to pay this amount. On the contrary, it is thefinding of the Tribunal that the payment is in the nature of goodwillgesture, but at the same time, the Tribunal also gives a finding thatthe assessee made payment in the form of compensation to stay afloatin the business. This, according to the learned counsel for theappellant, establish a case of business expediency and to buttressthis argument he relied on the following decisions :-1) AIR 1966 SC 1053 :: 1966 (60) ITR 52 (SC); 2) AIR 1967 SC 453 :: 1966 (62) ITR 638 (SC); 3) AIR 1982 SC 757 :: 1982 (133) ITR 756 (SC); 4) 2004 (266) ITR 170 (Mad.); 5) 2004 (266) ITR 63 (Mad.) ; 6) 2007 (288) ITR 1 (SC). 20. Before proceeding to analyse the merits of the casethreadbare to decide the nature of the expenditure made by theappellant, it would be expedient to refer to the decisions relied onby the learned counsel for the assessee as to the law on the subject. 21. In India Cements Ltd. - Vs - Commissioner of Income Tax,Madras (AIR 1966 SC 1053 :: 1966 (60) ITR 52 (SC)), the Supreme Courtdealt with a case where the appellant therein had obtained loan andhad utilised the same for obtaining assets. The High Court, in thesaid case, held the said amount to be capital in nature on the groundthat the expenditure was incurred to obtain assets of enduringbenefit and, therefore, the appellant could not claim the same asdeduction under Section 10 (2). However, on appeal, the SupremeCourt observed that loan is not an asset or advantage of enduringbenefit and that the expenditure is incurred wholly and exclusivelyfor the purpose of business and, therefore, the said expenditureshould be regarded as revenue expenditure for the purpose ofdeduction under Section 10 (2). The Supreme Court specifically dealtwith the expression 'for the purpose of the business' and in the saidcontext, held as hereunder :- "25. The last contention of Mr. Desai is that evenif it is revenue expenditure, it was not laid outwholly and exclusively for the purpose of business.Subba Rao J. reviewed the case law in Commissioner ofIncome-tax v. Malayalam Plantations and observed asfollows:"The expression 'for the purpose of thebusiness' is wider in scope than the expression'for the purpose of earning profits'. Its range iswide: it may take in not only the day-to-dayrunning of a business but also the rationalisationof its administration and modernization of itsmachinery; it may include measures for thepreservation of the business and for theprotection of its assets and property fromexpropriation, coercive process or assertion ofhostile title; it may also comprehend payment ofstatutory dues and taxes imposed as a preconditionto commence or for carrying on of a business: itmay comprehend many other acts incidental to thecarrying on of a business."(Emphasis supplied) Accordingly, the Supreme Court went on to hold that expensesincurred wholly and exclusively for the improvement of the businessand protection of the business is not in the nature of capitalexpenditure. 22. In Commissioner of Income Tax, U.P. - Vs - Nainital Bank Ltd.AIR 1967 SC 453 :: 1966 (62) ITR 638 (SC), the Supreme Court https://hcservices.ecourts.gov.in/hcservices/ considered the status of the amount credited to the account of theborrower by the bank against loss of the pledged jewels and theamount paid by way of compensation. The Supreme Court, in the saidcase, held that the compensation given by the bank to the borrower isfor the purpose of maintaining its goodwill and the same was laid outfor the purpose of business within the meaning of Section 10 (2) (xv)of the Act. For better appreciation, the relevant portion isextracted hereinbelow :- 22. In Commissioner of Income Tax, U.P. - Vs - Nainital Bank Ltd.AIR 1967 SC 453 :: 1966 (62) ITR 638 (SC), the Supreme Court https://hcservices.ecourts.gov.in/hcservices/ considered the status of the amount credited to the account of theborrower by the bank against loss of the pledged jewels and theamount paid by way of compensation. The Supreme Court, in the saidcase, held that the compensation given by the bank to the borrower isfor the purpose of maintaining its goodwill and the same was laid outfor the purpose of business within the meaning of Section 10 (2) (xv)of the Act. For better appreciation, the relevant portion isextracted hereinbelow :- "7. It was urged by the Commissioner that the bankwas under no legal liability to pay to theconstituents the value of the jewellery pledged withit. It was said that the bank was, as a pledgee, abailee of the jewellery and was in law required totake as much care of the pledged jewellery as a personof ordinary prudence would take under similarcircumstances of his own jewellery of the same bulk,quantity and value, and the bank having provided anadequate number of watchmen, it was not liable for theloss of the property pledged. Granting that, on proofthat it had taken as much care of the jewellerypledged with it as it would have taken if it belongedto it, the bank could enforce its rights and recoverthe full amount due from the constituents, thequestion still remains whether in admitting liabilityfor the value of the jewellery pledged, the bank laidout expenditure for the purpose of the business. Thequestion is not about the strict enforcement of thelegal rights and obligations between the bank and itsconstituents. The sole question is whether the bankin incurring the expenditure acted in the interest ofand for the purpose of its business. The bank iscarrying on banking business and advances loans on thesecurity of jewellery. The credit of a bankingbusiness is very sensitive: it largely thrives uponthe confidence which its constituents have in itsmanagement. To maintain that confidence the managementhas often to make concessions and thereby to preservethe goodwill of the business and its relations withthe clientele. The bank could have, if so advised,taken its stand strictly on its legal obligations, andcould have recovered the amounts due by theconstituents at the same time denying liability tomake any compensation for the loss of jewellerypledged with it. But such a stand might very well haveruined its business, especially in the rural areas inwhich it operated. The bank had evidently two coursesopen: to enforce its rights strictly according to law,and thereby to lose the goodwill it had built up amongthe constituents, or to compensate the constituentsfor loss of their jewellery, and maintain its businessconnections and goodwill. In choosing the second alternative, in our judgment, the bank laid outexpenditure for the purpose of its business. Paying tothe constituents the price of the jewellery stolen ina robbery or a burglary was therefore expenditure forthe purpose of the business. There can be no doubtthat the expenditure was wholly and exclusively in theinterest of the business. The expenditure was laidout for no other purpose. 8. We hold accordingly that the settlements with theconstituents and the consequent posting of entries inthe books of account cannot be regarded as forbearanceto enforce the claim of the bank to recover the loansadvanced. The settlement consisted of two constituentelements--paying by the bank of the value of thejewellery pledged with it against receipt from theconstituent the amount which was recoverable by thebank. The first element of the transaction wouldappropriately be deemed expenditure and suchexpenditure having been laid out for protecting andfurthering the business of the bank was properlyadmissible under section 10(2)(xv) of the Income-taxAct, 1922." 8. We hold accordingly that the settlements with theconstituents and the consequent posting of entries inthe books of account cannot be regarded as forbearanceto enforce the claim of the bank to recover the loansadvanced. The settlement consisted of two constituentelements--paying by the bank of the value of thejewellery pledged with it against receipt from theconstituent the amount which was recoverable by thebank. The first element of the transaction wouldappropriately be deemed expenditure and suchexpenditure having been laid out for protecting andfurthering the business of the bank was properlyadmissible under section 10(2)(xv) of the Income-taxAct, 1922." 23. In Commissioner of Income Tax, Delhi - Vs - Delhi SafeDeposit Company Ltd. (AIR 1982 SC 757 :: 1982 (133) ITR 756 (SC)),dealing with the expenditure incurred for the purpose of preservingthe name of the firm, the Supreme Court held as under :- "..... In British Insulated and Helsby Cables Ltd. v. Atherton [1926] AC 205 ; [1925] 10 TC 155, 193 (HL), Lord Cave observed :"It was made clear in the above cited cases ofUsher's Wiltshire Brewery v. Bruce [1915] AC 433(HL) and Smith v. Incorporate d Council of LawReporting for England and Wales [1914] 3 KB 674(KB), that a sum of money expended, not ofnecessity and with a view to a direct andimmediate benefit to the trade, but voluntarilyand on the grounds of commercial expediency, andin order indirectly to facilitate the carrying onof the business, may yet be expended wholly andexclusively for the purposes of the trade;......"Rowlatt J. in Mitchell v. B. W. Noble Ltd. [1927] 1KB 719 ; II TC 372, held that the money spent ongetting rid of a director and saving the company fromscandal was deductible. Affirming the above view, theCourt of Appeal (whose judgment appears at p. 731)held that as the payment was not made to secure anactual asset so as effectually to increase thecapital of the company but was made in order toenable the directors to carry on the business of thecompany as they had done in the past unfettered by the presence of the retiring director, which mighthave had a bad effect on the credit of the company,it must be treated as revenue and not as capitalexpenditure and was deductible as such for income-taxpurposes. 8. The true test of an expenditure laid out whollyand exclusively for the purposes of trade or businessis that it is incurred by the assessee as incidentalto his trade for the purpose of keeping the tradegoing and of making it pay and not in any othercapacity than that of a trader. In CIT v. MalayalamPlantations Ltd. [1964] 7 SCR 693 ; 53 ITR 140, 150,Subba Rao J. (as he then was) summarised the legalposition, at p. 705, thus : "The aforesaid discussion leads to, thefollowing result : The expression 'for the purposeof the business' is wider in scope than theexpression " for the purpose of earning profits'.Its range is wide : it may take in not only theday to day running of a business but also therationalization of its administration andmodernization of its machinery; it may includemeasures for the preservation of the business andfor the protection of its assets and property fromexpropriation, coercive process or assertion ofhostile title ; it may also comprehend payment ofstatutory dues and taxes imposed as a pre-condition to commence or for carrying on of abusiness; it may comprehend many other actsincidental to the carrying on of a business.However wide the meaning of the expression may be,its limits are implicit in it. The purpose shallbe for the purpose of the business, that is tosay, the expenditure incurred shall be for thecarrying on of the business and the assessee shallincur it in his capacity as a person carrying onthe business." 9. In the instant case, the assessee incurred theexpenditure in question to avoid any adverse effecton its reputation, to protect the managing agencywhich was an income earning apparatus and forretaining it with the reconstituted firm in which theinterest of the assessee was the same as before. Itwas likely that but for the expenditure, the fairname of the assessee would have been tarnished orrendered suspicious and the managing agency wouldhave been terminated. The expenditure incurred on thepreservation of a profit earning asset of a businesshas always been held to be a deductible expenditureby courts. In the circumstances, it is difficult tohold that the expenditure incurred by the assessee was either gratuitous or one incurred outside thetrading activities of the assessee. The expenditurewas, therefore, rightly held to be deductible unders. 37. We, therefore, reject the contention of therevenue that the amount in question could not beclaimed as a deduction under s. 37 of the Act." 24. In Commissioner of Income Tax - Vs - Madras Refineries Ltd.(2004 (266) ITR 170 (Mad.)), the assessee, to maintain its goodwill,had incurred expenditure, which expenditure was not for the purposeof earning the income and, therefore, the said expenditure wasdisallowed. On appeal, this Court held that the monies spent for thepurpose of earning the goodwill cannot be considered as being whollyoutside the ambit of business concern, as the business can succeed ina greater measure with the aid of such goodwill. In the saidcontext, this Court held as under :- "5. The concept of business is not static. It hasevolved over a period of time to include within itsfold the concrete expression of care and concern forthe society at large and the people of the locality inwhich the business is located in particular. Beingknown as a good corporate citizen brings goodwill ofthe local community, as also with the regulatoryagencies and the society at large, thereby creating anatmosphere in which the business can succeed in agreater measure with the aid of such goodwill. Moniesspent for bringing drinking water as also forestablishing or improving the school meant for theresidents of the locality in which the business issituated cannot be regarded as being wholly outsidethe ambit of the business concerns of the assessee,especially where the undertaking owned by the assesseeis one which is to some extent a polluting industry." 25. In Commissioner of Income Tax - Vs - Associated ElectricalAgencies & Anr. (2004 (266) ITR 63 (Mad.)), while dealing with anexpense shared by the assessee under a contractual obligation, thisCourt held that the payment made in regard to commercial expediencyneed not have their origin in contractual obligations and once it isaccepted and acted in accordance with letter and the payments havingbeen made, the assessee cannot be faulted. In the saidcircumstances, this Court observed as hereunder :- "10. The Tribunal ultimately held that on applyingthe test as to whether the expenditure had beenincurred wholly or partly or exclusively for thepurpose of the assessee’s business it was necessaryto find out as to whether the assessees were actingreasonably in the interest of their own business. TheTribunal accepted the assessees’ case that they wereindeed acting in the interest of the business, astheir business was primarily that of acting as "10. The Tribunal ultimately held that on applyingthe test as to whether the expenditure had beenincurred wholly or partly or exclusively for thepurpose of the assessee’s business it was necessaryto find out as to whether the assessees were actingreasonably in the interest of their own business. TheTribunal accepted the assessees’ case that they wereindeed acting in the interest of the business, astheir business was primarily that of acting as agents for the sale of the products manufactured bythe company, and by agreeing to share any sum of theexpenditure which was necessary for the company toincur for promoting the products manufactured by itand marketed by the assessees they were in effectadvancing the cause of their own business. It alsoaccepted theassessees’ claim that the expenditureincurred was commercially expedient for theassessees. It also accepted the assessees' case thatthe expenditure in fact had been incurred asnecessary entries had been made in the books ofaccount. 11. The Tribunal also took note of the fact thatthese amounts had been shown in the books of accountof the company and that there had been nodisallowance of expenditure by the Assessing Officer.The Tribunal concluded with the finding that theexpenses as claimed by the assessees were allowableas they were incurred indirectly to facilitate thecarrying on of the business or to preserve theirexisting source of income with a view to safeguardingthe business and also increasing their profits infuture.*********15. The reasons given by the Tribunal, for takingthe view that it did, cannot be said to be arbitraryor irrational, having regard to the facts availableon record. It was not the case of the Revenue thatany part of the monies agreed to be paid by theassessees to the company and for which sums credithad been given in the books of the assessees havesubsequently come back to the assessees in any othermanner. While it is no doubt true that there was nolegal compulsion on the assessee to agree to pay thesums which are mentioned in the letter of themanaging director of the company, there was also nolegal bar to their agreeing to pay a higher price forsupplies already received if they felt that it was intheir long term interest to pay such a higher price.It was also open to them to agree to bear a part ofthe advertising and marketing costs as those costswere incurred with a view to enlarge the market andto improve the sales. Sales effected of the company’sproduct resulted in benefits to the assessees as theywere the selling agents for the company.*********18. Payments made, having regard to the commercialexpediency, need not necessarily have their origin incontractual obligations. If the assessee, whichcarries on a business finds that it is commerciallyexpedient to incur certain expenditure directly or https://hcservices.ecourts.gov.in/hcservices/ indirectly, it would be open to such an assessee todo so notwithstanding the fact that a formal deeddoes not precede the incurring of such expenditure.While the company in this case may have haddifficultyin compelling the assessee to makepayments solely on the basis of that letter of March20, 1992, once the assessees accepted and acted inaccordance with what was set out in that letter, theassessees cannot be faulted for having agreed tosomething which had been set out as a record of aprior agreement, in a letter written to them by thecompany." https://hcservices.ecourts.gov.in/hcservices/ indirectly, it would be open to such an assessee todo so notwithstanding the fact that a formal deeddoes not precede the incurring of such expenditure.While the company in this case may have haddifficultyin compelling the assessee to makepayments solely on the basis of that letter of March20, 1992, once the assessees accepted and acted inaccordance with what was set out in that letter, theassessees cannot be faulted for having agreed tosomething which had been set out as a record of aprior agreement, in a letter written to them by thecompany." 26. In S.A. Builders Ltd. - Vs - CIT (Appeals) & Anr. (2007 (288)ITR 1 (SC)), the Supreme Court had occasion to consider a case wherethe assessee borrowed certain amount, which was not utilised by theassessee for any business, but advanced the same as interest freeloan to its sister concern and that was claimed as revenueexpenditure citing commercial expediency. The Supreme Court, whileconstruing the scope and ambit of the expressions "commercialexpediency" and "for the purpose of business", had occasion toconsider several earlier decisions of the Supreme Court,particularly, Madhav Prasad Jatia - Vs - CIT (1979 (118) ITR 200(SC)), CIT - Vs - Malayalam Plantations Ltd. (1964 (53) ITR 140(SC)), CIT - Vs - Birla Cotton Spinning & Weaving Mills Ltd. (1971(82) ITR 166 (SC)). The terms "commercial expediency" and "for thepurpose of business" were considered in-depth and the Supreme Courtcame to hold that if the assessee was able to prove that there was acase of commercial expediency, it did not matter whether theexpenditure has been incurred for any legal obligation or contractualobligation. If there is an element of commercial expediencyestablished in such a claim, assessee is entitled to claim such adeduction. In the said decision, reliance was also placed on thedecision of the House of Lords in Atherton (H.M. Inspector of Taxes)- Vs - British Insulated & Helsby Cables Ltd. (1925 (10) TC 155 (HL))wherein the House of Lords pointed out that even voluntary payment onthe ground of commercial expediency and in order to indirectlyfacilitate doing of business could be considered as a claim fordeduction. That principle has been approved by the Supreme Court inthe case of Eastern Investments Ltd. - Vs - CIT (1951 (20) ITR 1) andChandulal Keshavlal & Co. (1960 (38) ITR 601). For better clarity,the said portion is quoted hereunder :- "21. In Madhav Prasad Jatia v. CIT [1979] 118 ITR200 (SC) ; AIR 1979 SC 1291, this court held that theexpression " for the purpose of business" occurringunder the provision is wider in scope than theexpression " for the purpose of earning income,profits or gains", and this has been the consistentview of this court. 22. In our opinion, the High Court in the impugnedjudgment, as well as the Tribunal and the Income-tax https://hcservices.ecourts.gov.in/hcservices/ authorities have approached the matter from anerroneous angle. In the present case, the assesseeborrowed the fund from the bank and lent some of itto its sister concern (a subsidiary) as interest freeloan. The test, in our opinion, in such a case isreally whether this was done as a measure ofcommercial expediency. 22. In our opinion, the High Court in the impugnedjudgment, as well as the Tribunal and the Income-tax https://hcservices.ecourts.gov.in/hcservices/ authorities have approached the matter from anerroneous angle. In the present case, the assesseeborrowed the fund from the bank and lent some of itto its