The Hindu Business Line : Liaisoning can be taxing

Any expenditure incurred by an assessee for any purpose which is an offence, or which is prohibited by law, is deemed not to have been incurred for the purpose of business.

THE RECENT exposures in the Volcker report in which many Indian companies have been named will open up a vista of litigation for which the Tax Department seems to be geared. In this context, it is important to note that under the Explanation to Section 37(1) of the Income-Tax Act, 1961, which was introduced retrospectively from April 1, 1962, any expenditure incurred by an assessee for any purpose which is an offence, or which is prohibited by law, is deemed not to have been incurred for the purpose of business. Therefore, no deduction of such expense, and no loss arising from such transaction, would be allowed.

In a recent decision the Kerala High Court took a strict view in respect of expenditure on liaisoning work. The facts of C.I.T. v. Premier Breweries Ltd. (279 I.T.R. 51) were that the assessee was involved in the business of manufacturing and sale of beer. It filed a return of income for the assessment year 1990-91 declaring a total income of Rs 56,14,990. On going through the accounts, the Assessing Officer noticed that the assessee had claimed Rs 59,85,644 as marketing expenses and service charges.

At the same time expenditure claimed under the same head for the period relevant to the assessment year 1989-90 was Rs 60,750. The claim included Rs 7,75,602 on account of liaison work and Rs 22,72,192 on account of corporate management charges. The Assessing Officer took cognisance of circulars issued by the Kerala State Beverages Corporation Ltd. prohibiting liaison on the part of the manufacturers for canvassing their brands and, if such canvassing was resorted to, the Kerala State Beverages Corporation Ltd. was free to withhold the orders and blacklist companies. The managing director of the company informed the Assessing Officer that no liaisoning work was done by R. J. Associates with the Corporation. The amount of Rs 7,75,602 was disallowed.

The High Court, even without referring to the aforesaid Explanation to Section 37(1), held that the assessee must satisfy the Assessing Officer the main purpose for which an amount is spent, though generally the assessing authorities are not entitled to go into the reasonableness of the expenditure. The mere fact that the payment has been made under a contract or agreement is not conclusive that the expenditure has been incurred wholly and exclusively for the purpose of the business.

According to the assessee, payments were made by account-payee cheques and R. J. Associates had acknowledged the payment and offered the same as income in their assessment. On the marketing and service charges paid to Golden Enterprises, the assessee contended that the same was also made under an agreement for rendering services to the assessee. The Assessing Officer noted that the circular issued by KSBC Limited, dated August 3, 1984, prohibited any liaison activity on the part of the representatives of the manufacturers for canvassing their brands by approaching its bonded warehouses and wholesale shops, and if such canvassing was resorted to, KSBC Limited was free to withhold the orders.

It was noted that by another circular canvassing of business by any of the representatives of the manufacturers by approaching the Corporation's bonded warehouses and wholesale shops would invite stringent action including withholding of orders and blacklisting of companies. Further, the managing director had informed the Assessing Officer that no liaisoning work was done by the R. J. Associates with the Corporation. According to the Court, since liaisoning work with the Corporation had been banned, the assessee could not claim that it had spent money for the purpose of the activity which was not permitted. Further, it had also been established that R. J. Associates had two women partners who in their sworn statements stated that they had absolutely no knowledge about the marketing of any product and that they were not at all involved with the business activities of the firm which were being looked after by their husbands.

According to the Kerala High Court, mere existence of an agreement did not give rise to a claim for payment of commission and the income-tax authorities could go into the question whether the commission paid was properly deductible under Section 37 of the IT Act. Further, on going through the income-tax returns filed by R. J. Associates, it was found that the net profit returned by that firm was very meagre compared to the commission received by them from the assessee-company.

The assessee had also claimed that it had entered into an agreement with Golden Enterprises, Madras, in respect of supplies effected to TASMAC Ltd., Madras. The agreement indicated that Golden Enterprises was a proprietary business. The Assessing Officer had doubts about the genuineness of the documents and consequently made thorough enquiries. Summons were issued under Section 131 to the managing director of TASMAC Ltd., Madras, who stated that Golden Enterprises had not done any liaison work with TASMAC.

The Assessing Officer had also issued summons to Golden Enterprises and visited its premises and recorded the statements of a director of the Balaji group companies whose head office was located on the premises of Golden Enterprises. He was unaware of the existence of the firm Golden Enterprises.

The Assessing Officer recorded the statement of the wholetime director of the company and ultimately came to the conclusion that Golden Enterprises was not involved directly in the marketing and distribution arrangements. The Assessing Officer had doubted the existence of the firm Golden Enterprises and therefore concluded that the so called payment to Golden Enterprises was made for the purpose of diversion of profits to the assessee-company and payment was not made on grounds of commercial expediency. Thus, it was not an allowable deduction under Section 37 of the Act.

The Court emphasised that the burden is entirely on the assessee to prove genuineness of transactions. The agreement entered into between R. J. Associates and Golden Enterprises by itself did not advance the case of the assessee.

In Lachminarayan Madan Lal v. C.I.T. (86 I.T.R. 439), the Supreme Court held that the mere existence of an agreement between the assessee and its selling agents or payment of certain amounts as commission, assuming there was such payment, does not bind the Assessing Officer to hold that the payment was made wholly for the purpose of the assessee's business. Although there may be such an agreement in existence and the payments might actually have been made, it is still open to the Assessing Officer to consider the relevant facts and determine for himself whether the commission paid to the selling agents or any part thereof is properly deductible under Section 37 of the Act.

If any expenditure is incurred by the assessee for purposes which are prohibited, the assessee cannot claim any deduction of the amount alleged to have been spent for such purposes. In C.I.T. v. Sauser Liquor Traders (222 I.T.R. 33), the Madhya Pradesh High Court held that though illegal transactions might have resulted in profits which are taxable, no deduction for the amount paid by the assessee for illegal purposes can be allowed under Section 37.

The aforesaid decisions throw considerable light on the question as to what constitutes legitimate business expenditure. The Volcker report has now provided a cutting edge to this vexatious issue.

If commission has been paid for liaisoning and procuring orders and such payments are illegal or against public policy, as in case of bribes and kickbacks, the expenditure would not be allowable even if such payment is made under an enforceable agreement.

(The author, a Mumbai-based advocate specialising in tax laws, can be contacted at ranina@bom2.vsnl.net.in)