Kidnappers, extortionists and ransom seekers have a field day in certain areas of Assam, Mizoram and Chattisgarh. Company executives going on tour face the threat of being kidnapped for ransom.

What happens to the payments made to secure their release? Will the payment qualify for deduction as business expenditure in the hands of the company in its income tax assessment?

The Amended Section 37

Section 37 of the Income Tax Act, 1961 provides for deduction of business expenditure incurred wholly and exclusively for the purpose of business. An amendment made by Finance (No.2) Act, 1998 enabled Revenue to disallow payments of an illegal nature.

The amendment declared that no allowance shall be made in respect of expenditure incurred by an assessee for any purpose which is an offence or which is prohibited by law.

The Notes on Clauses explicitly stated that the purpose was to disallow claims made by certain taxpayers with regard to payments on account of protection money extortion, hafta , bribes etc. as business expenditure.

Explanation to Section 37 was given retrospective operation from April 1, 1962 onwards.

The Finance Minister in Para 111 of his Budget speech said, “A controversy has arisen recently regarding the deductibility of payments by way of extortion money. To set the controversy at rest, I propose to explicitly provide retrospectively since the inception of Income Tax Act, 1961 that any money paid by way of extortion will not qualify for deduction as a business expense.”

K. M. Jain case

K.M Jain Tobacco Products (P) Ltd, was manufacturing and selling bidis . One of its directors was looking after purchase, sale and manufacture.

He went to Sagar for buying tendu leaves. He was kidnapped for ransom by a dacoit gang headed by Raju Bhatnakar. Police complaints were given to no effect. After 20 days in captivity, the company paid a ransom money of Rs 5.5 lakh to the dacoits and secured the release of their director.

In its tax assessment, the company claimed deduction of this amount.

The assessing officer disallowed the claim on the ground that payment of ransom to kidnappers cannot be considered as expenditure incidental to business.

The first two appellate authorities allowed the claim and Revenue took up the matter in appeal before the M.P High Court. Revenue argued that the payment, if at all, was personal to the director. It was paid after business hours in a non business place.

The company pointed out that the kidnap, ransom payment, release, the existence of Raj Bhatnagar and his gang were all contemporaneous history available in different news magazines and public records with lot of evidentiary value.

Under the contract with the company, the director was in a position to claim reimbursement of ransom money.

The Ruling

The High Court considered the impact of Explanation to Section 37. It noted that kidnapping for ransom is an offense under Section 364A of the Indian Penal Court. It observed that while demand for ransom is punishable, the law did not say that payment will be an offence if it is meant to save the life of a person. The law did not prohibit payment of ransom. It held that in the absence of such a law, Revenue cannot claim the benefit of Explanation to Section 37(1). It considered the various Rulings of the Supreme Court and other High Courts.

It pointed out that the director concerned was on business tour and was staying at the Government rest house, Sagar from where he was kidnapped. The entire tour of the director was for purchase of tendu leaves of quality.

He was on a business tour. Ransom had to be paid to release him from dacoits. This cannot be treated as an action prohibited under the law.

Arguments based on explanation to Section 37(1) had no substance. The claim for deduction was allowed in full. Controversies have arisen with regard to deductibility of secret commission, speed money, illegal payments to Government officers, money paid for accelerating refunds from Governments, payments allegedly opposed to public policy etc. All these cases require sympathetic handling by both administrative and judicial authorities.

Arguments based on the observations of the FM and the Explanatory Memorandum to the Finance (No.2) Bill of 1998 will be of no avail in considering practical matters of business like the one before the M.P High Court.

The High Court has taken a holistic and correct view of the matter and distinguishes demand for ransom money from its payment.

The demand for ransom is illegal under the IPC, but not payment. If business exigencies require, ransom may have to be paid under duress. Section 37 will not come in the way of the claim for deduction of ransom money 340 ITR 99 (MP).

(The author is a former Chief Commissioner of Income-Tax.)