In India, the `profit and gains of business or profession` category stands as the primary source of government revenue. The Income Tax Act, 1961, in its Section 37, offers deductions for business expenditure, provided certain conditions are met. This article aims to analyze the statutory interpretation of Section 37 of the Income Tax Act, examine the meaning and scope of the term "expenditure" through case laws, and distinguish personal expenditure from business expenditure.
The Statutory Understanding of Section 37
Section 37 of the Income Tax Act outlines several prerequisites for an expense to be considered business-related:
The expenditure should not fall under sections 30 to 36 (Expenses allowable under other sections not allowed u/s 37) .
It should not be of a capital nature (should be of revenue nature).
It should be incurred during the previous year (prior period expenses not allowable).
It should not be of a personal nature.
It must be incurred wholly or exclusively for the purpose of the business or profession.
The business should have commenced.
The courts have clarified that business expenditure need not be exclusively for profit generation; it can include administrative, managerial, operational costs, and statutory expenses. However, contingent expenditure falls outside the scope of Section 37. For instance, in the C.I.T v. Nainital Bank Ltd case  9 TAXLOK.COM (IT) 611 (SC), an expense related to maintaining goodwill among customers was accepted as business expenditure, even though it did not result in a direct profit.
Understanding the Scope of Business Expenditure vs. Personal Expenditure
To claim a deduction, it is crucial to differentiate personal expenses from business expenses. Courts have consistently excluded personal expenses from the scope of business expenditure, even if other conditions are met.
The courts have reaffirmed the concept of personal expenditure through various cases. Medical expenses incurred due to illnesses resulting from professional activities are considered personal and not deductible. However, expenses related to the education of a student engaged in the taxpayer`s business can be claimed under Section 37(1), even if the student is the managing director`s child.
Courts often rely on commercial expediency to determine the nature of expenditure. Expenses related to foreign education for a partner were disallowed as business expenses, while a recent ruling by the Income Tax Appellate Tribunal accepted a claim for foreign scholarships as a valid business expense.
In the case of legal expenses, the courts evaluate their relation to business operations. Expenses for legal proceedings directly impacting profit computation are deductible. Still, those for defending criminal proceedings unrelated to the taxpayer`s profession are considered personal and not allowed against business income.
The line between personal and business expenditure is not always clear, and courts examine each case individually. Expenses indirectly related to the business, such as increased hotel rates for business-related activities, are sometimes contentious. Despite being spent on personal needs, they indirectly benefit the business.
Section 37 of the Income Tax Act, 1961, allows a broader interpretation of "for the purposes of business" than simply "for earning profits." It encompasses various actions incidental to business operations. However, for an expense to qualify as "for the purposes of business," there must be a direct nexus between the expenditure and the taxpayer`s business character. Deciding whether an expense is wholly and exclusively for business is a mixed question of fact and law, with the final deduction depending on legal provisions.
CA Pranay Jain is a young and aspiring Chartered Accountant. He qualified Chartered Accountancy Course in 2021 and has a well-established practice in various fields of taxation and auditing, with his core area of practice being in the field of litigation i.e., handling assessment and appeal-related matters and representing assesses before various tax departments.
He is also socially active on LinkedIn at linkedin.com/in/capranayjain
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