By TIOL News Service

HYDERABAD, APR 07, 2015: THE issue before the Bench - Whether contribution to the National Cooperative Union of India out of the net profits is allowable as business expense. NO is the answer.

Facts of the case

The assessee is engaged in the business of banking, corporate agency for insurance and is registered under Multi-State Cooperative Societies Act. Assessee contributed 1% of its net profit to the Cooperative Education Fund maintained by National Cooperative Union and claimed it as revenue deduction. AO held that this is not an expense but is only contribution out of the net profits and therefore, the amount is not allowable as deduction.

The CIT (A) examined Sec. 63 of MSCSA which governs this contribution and held that the very opening line provides that various allocations are to be made out of the "net profits". No contribution was envisaged if there was loss and it is clearly a below the line allocation to be made after payment of taxes. Law is well settled that whereby the obligation income is diverted before it reaches the assessee, it is deductible; but where the income is required to be applied to discharge an obligation after such income reaches the assessee, the same consequence, in law, does not follow. Therefore, contribution is not a business expense u/s 37.

AR submitted that that amount paid u/s 63(1)(b) of MSCSA is paid to third party out of the profits of the year and therefore, it is a charge on the profit and is diversion of income at source. It was submitted that if the funds are for the benefit of the society, then, it is only an appropriation of income and if the funds are utilized for third party, then, it is an outgo from assessee's profits, therefore, an allowable deduction.

After hearing both parties, Tribunal held that,

++ on first principle itself, the amount cannot be allowed as deduction of this year as assessee is not claiming the amount on accrual basis but on payment basis in a later year because contribution is paid at the rate of 1% credit of the profits of the previous year as approved by General Body Meeting;

++ there is a difference between an amount which a person is obliged to apply out of his income and an amount which by the nature of the obligation cannot be said to be a part of the income of the assessee. Where, by the obligation, income is diverted before it, reaches the assessee, it is deductible; but where the income is required to be applied to discharge an obligation after such income reaches the assessee, it is not deductible;

++ that amount contributed is appropriation from the net profits as there is a right to receive the income independent of accrual and receipt of income by the assessee before third party could lay claim to any part of it. Since income reached assessee before it reached to a third party, there is no diversion and is only an appropriation of profit;

++ fact that contribution is payable in respect of year of profit and not in year of loss means that it is only an appropriation of profits earned but not diversion of income. If it was diversion at source by overriding title, then amount was payable whether assessee incurs profits or loss.

(See 2015-TIOL-355-ITAT-HYD)