Commissioner Of Income Tax vs Microsoft Corporation Of India ...
2008 Latest Caselaw 1413 Del

*           THE HIGH COURT OF DELHI AT NEW DELHI

                                         Judgment reserved on : 08.08.2008
%                                       Judgment delivered on : 21.08.2008

+                              ITA No. 111/2008

COMMISSIONER OF
INCOME TAX,                                                       ..... Appellant

                                     -versus-

MICROSOFT CORPORATION
OF INDIA PVT. LTD                                              ..... Respondent

Advocates who appeared in this case:

For the Appellant              :    Mr R D Jolly with Mr Paras Chaudhry
For the Respondent             :    None

CORAM :-

HON'BLE MR JUSTICE BADAR DURREZ AHMED
HON'BLE MR JUSTICE RAJIV SHAKDHER

1. Whether the Reporters of local papers may be allowed to see the judgment ? Yes

2. To be referred to Reporters or not ? Yes

3. Whether the judgment should be reported in the Digest ? Yes

RAJIV SHAKDHER, J

1. This is an appeal under Section 260A of the Income Tax

Act, 1961 (hereinafter referred to as the Act) against the judgment

dated 31.01.2007 passed by the Income Tax Appellate Tribunal

(hereinafter referred as ITAT). By this judgment the ITAT rejected

the appeal filed by the revenue confirming thereby the order of the

Commissioner of Income Tax (Appeals) allowing the expenses

incurred by the assessee, to the tune of Rs 1,30,60,957/- towards

settlement of a foreseeable liability in respect of premature

termination of an agreement for use of premises entered into with an

entity by the name of, Paharpur Business Centre (hereinafter referred

as to PBC).

1.1 The only issue which arises for our consideration is that

whether settlement expenses paid by the assessee fall within the

provision of Section 37 (1) of the Act. The learned counsel for the

Revenue, Mr R D Jolly contends to the contrary - the basis being,

that since there was no obligation under the contract on the assessee

to pay settlement expenses, it cannot be said that the expenses have

been incurred wholly and exclusively for the purposes of business,

which is a sine qua non for seeking a deduction under Section 37 (1)

of the Act.

2. In order to appreciate the controversy at hand, the

following facts require to be noted :-

2.1 The assessee in respect of the assessment year 2000-01 had

claimed as business expenditure a sum of Rs1,30,60,957/- which it

had paid to PBC as settlement expenses. The Assessing Officer

while scrutinising the return of the assessee under Section 143 (3) of

the Act, issued a questionnaire dated 14.12.2001 whereby, he

sought to know from the assessee the nature and the details of

settlement expenses debited to the profit and loss account shown in

schedule K under the head "Administrative and Other Expenses".

2.2 The assessee vide a reply dated 15.01.2002 and followed by

letters dated 27.11.2003 and 14.01.2003 sought to explain the

transaction. The sum and substance of the explanation given by the

assessee is as follows:-

i) on 01.08.1997, the assessee had entered into an

agreement for use of premises provided by PBC for the

purpose of its office. The said agreement was to end on

30.06.1998;

ii) in 1997, the assessee had also exchanged an Aide-

memoir with PBC whereby, it was understood as

between them, that the use of the premises in issue

would continue for a period of three years, and;

iii) on 01.07.1998 the assessee entered into another

agreement which was to expire on 31.07.1999. The point

to be noted is that as per clause 2 (d) of the agreement

(as noted by the Assessing Officer) the assessee was not

a tenant but was entitled to use the premises only during

office hours. Furthermore, as per clause 2(j), the

assessee was required to give a notice in advance of 180

days in the event it did not require any further use of the

premises.

3. The Assessing Officer also noted that prior to the

assessee‟s exit from the premises, plethora of correspondence was

exchanged by the assessee with the PBC which resulted in the

assessee paying a sum of Rs 1,30,60,957/- to PBC.

4. The Assessing Officer however, by his order dated

31.01.2003 disallowed the claim of the assessee under Section 37 (1)

of the Act for the following reasons :-

"......i) It was a lump sum payments for non user of the premises

rather than for the use of the business premises.

Therefore, it is not for business use.

ii) As per terms of the agreement assessee was not

contractually bound to make payment for settlement. In

other words there was no liability to pay on the assessee.

It has been held in India Garments Ltd 98 ITR 69 that

even payment in excess of the amount that assessee is

liable to pay is not allowable under Section 37 (1) of the

Act. In this case assessee was not bound to pay at all.

Moreover, the agreements are not even registered

including aide-memoir. ......."

5. Aggrieved by the order of the Assessing Officer, the

assessee preferred an appeal before the CIT (Appeals). The CIT

(Appeals) by an order dated 17.09.2003 allowed the appeal of the

assessee with respect to the ground in issue. The CIT (Appeals)

noted that the assessee had brought on record sufficient evidence in

the form of correspondence exchanged with the PBC including the

understanding arrived at, as recorded in the aide-memoir, which

suggested that there was a mutual understanding between the

assessee and the PBC that it would continue to use the premises till

July 2000. The CIT (Appeals) further noted that the assessee in

order to avoid protracted litigation, based on the legal advice

received, that the understanding recorded in the aide-memoir, the

assessee could be sued for the specific performance or, in the

alternative for damages; it settled for a lumpsum payment in

furtherance of its business interest. The CIT (Appeals) significantly,

went into the aspect as to whether the settlement expenses was a

camouflage for a payment for purposes other than commercial

reasons. Towards this end, the CIT (Appeals) called for the list of

directors, of the assessee and PBC, in order to ascertain whether

there were any common directors. As a matter of fact the CIT

(Appeals) recorded in his order that the assessee had certified that

there was no other relationship with PBC. The CIT (Appeals) on

the perusal of evidence on record and material in the form of

agreements of August 1997, August 1998, the aide-memoir of 1997,

correspondence and other relevant material came to the conclusion

that in the absence of any suggestion of fraud, the settlement

expenses satisfied the test of commercial expediency. The CIT

(Appeals) also noted that the assessee‟s decision to pay settlement

expenses was a bonafide commercial call made, after considering the

financial implications relating to damages for breach of contract, and

the financial liability that would ensue in the event of litigation, as

also, the monetary gains in securing immediate repayment of

security deposits. Accordingly, the CIT (Appeals) allowed the

assessee to take into account the settlement expenses in the

computation of income chargeable under the head „profit and gains

of business‟ as they were incurred wholly and exclusively for the

purpose of business.

6. The Revenue being aggrieved by the order of the CIT

(Appeals) preferred an appeal to the ITAT. The ITAT after a

detailed discussion and on upon a minute examination of the facts

and the law on the subject dismissed the appeal of the Revenue. In

paragraph no. 15 of the impugned judgment, these facts are noted in

great detail.

7. As stated above, Revenue being aggrieved, has preferred

the present appeal. Before us, at the stage of admission of appeal,

the learned counsel for the Revenue, Mr. R D Jolly, has submitted

that the settlement expenses incurred by the assessee in order to pre-

empt litigation, do not fall within the purview of Section 37 (1) of

the Act. It was the learned counsel‟s contention that the expenses

incurred towards anticipated litigation even before they get

crystalised, cannot be termed as one which are, incurred wholly and

exclusively for the purpose of business.

8. Having heard the learned counsel for the Revenue and

considered the material on record, as also, the findings recorded by

the authorities below, we are of the view that the appeal deserves to

be dismissed in limini for the following reasons:-

8.1 The conditions for all allow-ability of expenses under Section

37 (1) of the Act are :-

(i) the money expended by the assessee is wholly and

exclusively for the purposes of business and;

(ii) the expenditure incurred is not in the nature of a capital

expenses.

8.2 In so far as the second condition is concerned, it has been

fairly conceded, by Mr R D Jolly, the learned counsel for the

Revenue, that, it is not in the nature of a capital expenditure. He

has, as noted, above confined himself to the first condition i.e., the

settlement expenses are not incurred wholly and exclusively for the

purposes of business.

8.3 To determine whether an expense incurred is wholly and

exclusively for the purposes of business - according to us, can be

ascertained only, if it meets the test of commercial expediency, and

that too, from the point of view of the assessee who is engaged in the

business and, not from the point of view of an outsider who is

unaware of the needs of the business.

8.4 There are several judgments of the Supreme Court laying down

principles which, need to be applied in determining whether an

expenditure ought to be allowed under Section 37 (1) of the Act. These

principles have emerged over the years by virtue of judicial

interpretation giving meaning to the words „wholly and exclusively for

purpose of business‟ appearing in Section 37 (1) of the Act. The

principles deducible even though not exhaustive are as follows:-

i) the expression „wholly and exclusively for the purpose of

business‟ is of a wide import - as a matter of fact, is wider

than the expression for the purpose of earning profit;

ii) the expense is allowable under Section 37 (1) of the Act if

it is commercially expedient;

iii) the expense should be commercially expedient from the

perspective of a prudent businessman, and not from the

point of view of the Revenue;

iv) it is not a requisite condition that expense is incurred on

account of compelling necessity, and;

v) last but not the least, the allowability of the expense is not

dependent on the fact that it is incurred to fulfill or

discharge a legal obligation.

See:

(i) Jugal Kishore Baldev Sahai v. CIT : AIR 1967 SC 495;

(ii) Sri Venkata Satyanarayana Rice Mill Contractors Co v.

CIT, AP-II: (1996) 6 SCC 611;

(iii) CIT v. Walchand & Co. Pvt. Ltd : AIR 1967 SC 1435 = 65 ITR 381;

(iv) M/s Sassoon J. David & Co. Pvt Ltd v. CIT Bombay :

1979 (3) SCC 524;

(v) The CIT, West Bengal v. Birla Cotton Spinning & Weaving Mills & Another : (1971) 3 SCC 344

(vi) SA Builders Ltd v. CIT ; 2007 (1) SCC 781.

8.5 Keeping in mind the aforesaid test, let us examine the facts of

the present case.

8.6 The assessee had entered into an agreement for use of the

premises of PBC by an agreement dated 01.08.1997. In 1997, the

assessee and the PBC had recorded that the assessee would use the

premises of PBC for a period three years. The relevant extract of the

aide-memoir is as follows :

".......... AIDE-MEMOIR"

The understanding is for a period of 3 years. The schedule of charges for Office Facilities are valid from August 1, 1997 to July 31, 1999, subject to the modifications provided hereunder:

1. The facilities charges will be increased by 10% for Unit 2A w.e.f. August 1 every year on the last Office Facilities charges paid as on July 31 of the current year. Unit 1A & 1B shall be billed using the prevailing area rate for Unit 2A w.e.f. August 5, 1998.

2. Fresh Documents containing the terms and conditions contained :-

a) Membership Application Form.

b) Agreement dated August 1, 1997.

c) Letter dated August 1, 1997.

Which will be signed before August 1 every year. The Security Deposit will be increased by 10% calculated on 24 times. The difference in Security Deposit would be payable on August1, every year. ................"

8.7 The aide-memoir was signed on behalf of the assessee by one

Shri Rajiv Nayar on 21.08.1997.

8.8 In August 1998, the assessee entered into another agreement

by virtue of which it could continue the use of the premises till

31.07.1999.

8.9 In the interregnum, in March 1999, the assessee acquired a

new premises, and evidently, entered into a contract with respect to

the same with M/s Great Eastern Shipping Company Private

Limited. The charges payable for the new premises were Rs

20,56,416/- as against Rs 30,87,827/- per month with respect to the

use of the premises of PBC.

8.10 By a communication dated 22.03.1999, the assessee informed

the PBC of its intention to dis-continue the use of the premises with

effect from 31.08.1999, and consequently, demanded return of its

interest free security amounting to Rs 7,46,07,848/-.

8.11 This communiqué triggered correspondence between the

assessee and PBC on the specific issue of early termination of the

understanding which required continued use of the premises till July,

2000.

8.12 In this background, the assessee sought legal advice. The

assessee was advised that there was a possibility of litigation

ensuing, in respect of, its early exit from the premises. It was

advised that it could be sued for damages for breach of contract and /

or for specific performance, keeping in mind the contents of the

aide-memoir based on the doctrine of promissory estoppel. The

legal advisers of the assessee referred to various judgments of

Supreme Court and the High Court in this regard.

8.13 The assessee keeping in mind the legal advice rendered to it,

as also, the following the factors which directly impinged upon its

business, took a decision to pay the settlement expenses to the tune

of Rs 1,30,60,957/- The factors which compelled the assessee to take

a decision to pay the settlement expenses were as follows :-

(i) the assessee could avoid payment of Rs 3,70,53,924/- as user

charges for the unexpired period between August 1999 to July 2000;

(ii) it would get immediate return of its interest free security

deposit lying with PBC in the sum of Rs 6,15,81,997/- after netting

off the settlement expenses to the tune of Rs 1,60,30,957/- on which

it could earn a return, in the form of interest, or otherwise;

(iii) it would avoid the payment of discount charges of Rs

1,26,35,881/- as demanded by the PBC for immediate payment of

interest free security deposit;

(iv) it would save moneys towards payment of rent not only for

two premises, but would, also save an amount of not less than Rs

10.00 lacs per month by shifting to the new premises offered by

Great Eastern Shipping Company Private Limited and;

(v) last but not the least, it would avoid not only expenditure in

the form of litigation costs, but would also, avoid the attendant

expenses in the form of productive time spent by its officers/

executives looking after the litigation.

9. In our view, the aforementioned factors which the

assessee took into account while taking its decision to pay PBC

settlement expenses for an early exit from PBC‟s premises falls

squarely within the meaning of expression "commercial expediency"

when, seen from the perspective of the assessee‟s business.

10. In the aforesaid circumstances, we are of the view that

the findings recorded by the authority below are the findings of fact

based on appreciation of evidence placed before them. There is no

demonstrable perversity in the order of the Tribunal. No substantial

question of law, much less a question of law, arises in the instant

case for our consideration.

11. In the result, the appeal is dismissed.

RAJIV SHAKDHER, J

BADAR DURREZ AHMED, J

August 21, 2008 mk