KOCHI, DEC 07, 2012: THE issues before the Bench are - Whether deduction can be claimed for an expense incurred for the purpose which constitutes an offence - Whether deduction can be claimed beyond the express provisions of the Act and Whether the expenditure incurred by way of payment of interest in excess of the limit imposed under the State Money Lenders Act, is allowable as business expenditure. And the verdict goes against the assessee.

Facts of the case

Appellant is a financial enterprise engaged in accepting fixed deposits and pays interest. During assessment, AO had made an addition on account of an amount which was claimed as interest paid to the depositors. It was disallowed on the basis that the maximum rate of interest payable under the Kerala Money Lenders Act was 14%. The amount which was disallowed represented the amount paid in excess of the legal limit. On appeal CIT(A) and Tribunal confirmed the AO's order.

On appeal before the HC, appellant's counsel submitted that the Tribunal acted illegally in not giving credit to the amount which was paid to the depositors of the appellant. In the case of CIT, Patiala v. Piara Singh, SC held that the carriage of the currency notes across the border was an essential part of the smuggling operation and detection by the Customs authorities and consequent confiscation was a necessary incident and constituted a normal feature of such an operation. The confiscation of the currency notes was a loss occasioned in pursuing the business of smuggling: it was a loss in much the same way as if the currency notes had been stolen or dropped on the way while carrying on the business. It was a loss which sprang directly from the carrying on of the business and was incidental to it and its deduction had to be allowed u/s 10. Thus, on the basis of above case, it was contended that even where the income was found to be illegal, it was held that loss could be claimed as a deduction. It was also submitted that the payment of excess interest cannot be treated as an offence in an attempt to get over the taboo against deducting the higher interest paid.

On the other hand, the Revenue's counsel pointed out that the Explanation to Section 37 was inserted by the Finance Act No.2/1998 with effect from 01/04/1960. It was also pointed out that there was no similar explanation in regard to Section 10 of the Income-Tax Act, 1922. It was further contended that this was not a case where the business conducted by the appellant could be said to be illegal as such.

Having heard the matter, the High Court held that:

++ we think that there is no merit in the appeal. The AY in question is 1996-97, thus the assessment is to be made under the Income-tax Act, 1961. By virtue of the Finance Act, 1998, Explanation stands inserted in Section 37 with effect from 01/04/1960. This means that a deduction could not be claimed in respect of the year 1996-97, if it is an expenditure incurred by the assessee for a purpose which is an offence or it is prohibited by law. A like provision was not present in Section 10 of the Income Tax Act 1922. Therefore, the decision of the SC relied on by the counsel for the appellant turned on facts present in the said case. The SC had no occasion to consider a provision like Section 37 with the Explanation. As far as the Explanation is concerned as stated above if expenditure is laid out for a purpose which constitutes an offence or if it is prohibited by law, it cannot be treated as an expenditure for which deduction can be claimed;

++ the right of the assessee to claim deduction will depend upon the express provisions of the Act. The terms of the explanation are clear. In the facts of the case, even though the purpose for which the amount was expended may not lead to the commission of an offence, the expenditure by way of payment of interest in excess of the limit imposed under the Kerala Money Lenders Act is prohibited. The grant of interest at the rate an excess of 14% is prohibited. The amount of deduction claimed by the appellant represents money paid as interest in excess of 14%. Therefore, the expenditure is in the grab of the explanation to Section 37 which is the legal provision applicable. We see, therefore, no merit in the appeal and the questions are answered against the appellant.

(See 2012-TIOL-969-HC- KERALA-IT)