II. SPECIFIC PROVISIONS OF DISALLOWANCES:
There are certain sections which specifically provides for disallowances of the
Section 14A: Expenditure in relation to earning tax free incomes
CBDT vide Notification No. S.O. 547(E), dated 24.3.08 has inserted Income
Tax Rule 8D where in method for determining amount of expenditure in
relation to income which does not form part of total income is prescribed.
ITAT Mumbai Special Bench in the case of ITO v Daga Capital Management
P. Ltd.  119 TTJ (Mumbai) (SB) 289 has held that no deduction is
allowable, against the income fro taxable business, in respect of any
expenditure incurred by the assessee in relation to income which does not
form part of total income.
Section 14A applies to all heads of income and aims at disallowing
expenditure incurred in relation to income not forming part of total income
even though such expenditure may be allowed under any other provisions
e.g. S. 36 (1)(iii).
Rule 8D inserted in IT Rules, 1962, prescribes the method by which AO has
to determine the disallowance in terms of sub-ss. (2) and (3). Sub s. (1) of
section 14A itself being clarificatory and retrospective, sub ss. (2) and 93)
providing mechanism to give effect to sub-s. (1) can not be construed as
prospective. (Rule 8D though inserted on 24.3.08 applicable retrospectively).
Interest on capital borrowed for investment in shares has dominant and
immediate connection with dividend income. Even though the shares may
be held as stock in trade, dividend as also profits, if any on sale of shares
are the direct result of such investment. Same is therefore, disallowable as
per provisions of section 14A.
Section 37(1): Expenditure against public policy not allowed
Section 37(1): Penalty for infraction of law is not allowed.
Compensation paid by the assessee on account of breach of contract, which
did not fall in the category of payment of penalty for breach of any law. It is a
compensation for breach of contractual obligations. Therefore, forfeiture of
security deposits by way of compensation for not completing the contract
within the stipulated period specified in the agreement constituted an
allowable commercial loss. CIT v. S. A. builders P. Ltd. (2008) 299 ITR 88
(P. & H.)
Section 37(2B): No allowance shall be made of expenditure incurred by an
assessee on advertisement in any souvenir, brochure, tract, pamphlet or the
like published by a political party.
Section 40 (a): Any interest, royalty, fees for technical services or other sum
chargeable under this Act, which is payable (A) outside India or (B) In India to
a Non resident on which tax is deductible at source but has not been paid
during the previous year or in subsequent year before expiry of time specified
in S. 200 (1).
Section 40a(ia): Disallowances of rent, interest, commission, professional
fees, contract payments etc. for non deduction / payment of TDS or payments
made beyond prescribed time limits. This does not apply to TDS on Salary.
The scheme of disallowance under this section is amended with retrospective
effect from Ay 2005-06 on following lines:
Particulars of Particulars of Year of deduction in
TDS made TDS payment Computing business income
April to Feb Any day up to last day Previous year
of previous year of previous year (Year 1)
(Say year 1) (Year 1)
In last month On or before due date --- do --
Of previous year Of filing return of income
(Year 1) Specified u/s. 139 (1)
April to Feb After end of previous yr Previous year (Year 2)
of previous year (Subsequent previous yr) In which tax is paid
(Say year 1) (Year 2)
In last month After due date of filing --- do --
Of previous year Return of income
Disallowance of Transaction fee u/s. 40 (a) (ia) for No TDS u/s. 194J
Transaction fees paid cannot be said to be a fee paid in consideration of the
Stock Exchange rendering any technical services to the assessee company.
Hon. Mumbai Tribunal in the case of Kotak Securities Limited vs. ACIT
(AIT-2008-360- ITAT) 25 SOT 440 (Mum) has upheld these views and have
concluded that provisions of Section 194J are not attracted in the case of
payment of transaction fee to Bombay Stock Exchange.
Disallowance of interconnect charges / telephone lines for No TDS u/s. 194J
Hon. Delhi High court in the case of CIT vs. Bharti Cellular Ltd. (2008) 220
CTR (Del) 258, has held that expression „fees for technical services‟
appearing in Sec. 194J has the same meaning as given to the said
expression in Expln. 2 to Sec. 9(1)(vii). Consequently, the word „technical‟ as
appearing in Expln. 2 has to be construed as involving a human element.
Facility provided by MTNL / other companies for interconnection / port access
is one which is provided automatically by machines. Thus, MTNL / other
companies which provide such facilities are not rendering any technical
services, therefore, payments made by the assessee to MTNL / other
companies for the services provided through interconnect / port / access / toll
are not liable to TDS under Sec. 194J.
Section 40 A(3) :Disallowance in respect of cash payments > Rs.20,000/-
W.e.f. AY 2009-10 there is amendment in this section.
a. Substituted sub-section (3) provides that where the assessee incurs any
expenditure in respect of which a payment or aggregate of payment made to
a person in a day, otherwise than by account payee cheque / draft , exceeds
Rs. 20,000/- no deduction shall be allowed.
b. Substituted sub-section (3A) provides that where an allowance has been
made in assessment of an earlier year and subsequently the assessee makes
payment thereof, otherwise by account payee cheque / draft exceeding Rs.
20,000/- in a day the payment so made shall be deemed to Profits or gains of
that subsequent year.
CIT v. Smt. Santosh Jain 159 Taxman 392 (P & H): When income of
assessee is estimated by applying gross profit rate, provision of section
40A(3) could not be invoked.
S. 41 (1): Profits chargeable to tax: Remission or cessation of trading
Explanation 1 – Remission or cessation of a liability shall include the
remission or cessation of any liability by a unilateral act by way of writing off
such liability in his accounts. ( Inserted by Finance Act, 1993)
In the case of Coastal Corporation Ltd. v. JCIT  307 ITR (AT) 71
(Vishakhapatnam) the Tribunal held that only trading debts, which were
allowed as deduction in earlier years could be treated as trading liability.
Admittedly, the principal portion of the loan amount waived had not been
claimed as deduction in any of the years. Hence waiver of the principal
portion of loan could not be termed as waiver of a trading liability and
hence the second clause of section 41(1) of the Act relating to trading liability,
would not apply. The remission of the principal portion of the loan could not
fall in the purview of the provisions of section 41(1) of the Act.
It was further held that Section 41(1) of the Act, consists of two main
ingredients being “loss or expenditure” and “trading liability”. The two
components of section41(1) of the Act have to be read separately namely (a)
has obtained, whether in cash or in any other manner whatsoever, any
amount in respect of such loss or expenditure; (b) some benefit in respect of
such trading liability by way of remission or cessation thereof. The words
“remission or cessation thereof” shall apply only to trading liability and shall
not apply to any loss or expenditure.
Section 43B: Employer’s Contribution to PF (amendment for allowance if
paid before due date of filing return to be considered retrospectively)
As per Section 43B in the case of welfare dues, the delayed payment beyond
the due date during the year of accrual was to lose the benefit of deduction all
together. It was only an amendment by the Finance Act 2003 w.e.f 1.4.2004
that the deduction of welfare dues was allowed if paid on or before filling
return of income or due date of filling of return, whichever is earlier. This
amendment is considered as curative in nature and as such is applicable
retrospectively CIT vs. Vinay Cement Ltd  213 CTR 268 (SC).
S. 43B Deduction for tax, duty etc. is allowable under section 43B on
payment basis before incurring the liability to pay such amounts.
In the case of DCIT vs. Glaxo Smithkline Consumer Healthcare Ltd. 
299 ITR (AT) 1 (Chandigarh) (SB) Special bench of Chandigarh held that
Advance payment of Central excise duty, satisfied the character of
exaction made by the sovereign under authority of law and were to be
treated as actual payment of duty for the purpose of deduction u/s. 43B.
It is not necessary that the assessee must prove incurring of a specific liability
under any statute referred to in different clauses of section 43B. The
expression “a deduction otherwise allowable” reflects deduction on account of
general liability fastened to the assessee‟s business on account of duties,
taxes etc. The expression does not mean any specific liability which is
required to be incurred.
However, unexpired modvat credit could not be treated a advance payment of
excise duty, as there is no question of set off on the last day of the previous
year and therefore no occasion to treat the unexpired credit as equivalent to
the tax paid.
CIT vs. Raj and San Deeps Ltd.  293 ITR 12 (P&H): Excise duty
payable as soon as goods are manufactured. Amount kept in “Account
Current” for payment of excise duty cannot be disallowed. Section 43B.
In the case of CIT v. Kerala Solvent Extractions Ltd.  306 ITR 54
(Ker) Kerala High court has held that payment towards advance sales tax
not entitled to claim deduction u/s. 43B. Assessee conceding liability was
of next year.
The opening words of section 43B show that the section deals with
deductions otherwise allowable under the provisions of the Act. Therefore,
section 43B is only supplementary to section 145 of the Act and it is only an
additional conditions for allowance of deductions otherwise allowable under
the other provisions of the Act.
The scheme of payment of sales tax under the Sales Tax Act is to remit tax
due for every month on or before the tenth day of the succeeding month. On
the other hand, it will be carried as an amount of tax paid in advance for the
next year and if the assessee carries on business and incurs liability in the
next year, the amount will be adjusted towards the tax liability for that year.
On the other hand, if the assessee does not continue the business, it is
entitled to get refund of the tax paid in the previous year.
Held, section 43B by itself would not help the assessee to claim deduction as
it was only an additional conditions for allowing deduction which was
otherwise admissible under the provisions of the Act.
43B(f): Allowance of leave encashment only on actual payment:
Constitutionally not valid : struck down
Exide Industries Ltd. vs. Union of India & Ors.  292 ITR 470 (Cal):
Leave encashment is neither a statutory liability nor a contingent liability. It is
a provision for entitlement of an employee n a particular financial year. An
employer is otherwise entitled for deduction of such amount by showing the
same as a provisional expenditure in its accounts. Enactment is not consistent
with the original provision of S. 43B, same is struck down being arbitrary and
unconscionable and de hors the apex court decision.
III EXPENDITURE ALLOWED UNDER SPECIFIC PROVISIONS:
There are certain sections which specifically provides for allowances of
certain specified expenditures. They are covered in section 30 to 37 of the
Income Tax Act, 1961.
Section 31: Repairs and insurance of machinery, plant and furniture
Explanation – For the removal of doubts, it is hereby declared that the
amount paid on account of current repairs shall not include any expenditure
in the nature of current repairs. (inserted by Finance Act 2003)
CIT vs. Saravana Spinning Mills P Ltd.  293 ITR 201 (SC):
Replacement of a machine in textile mills may not fall in the connotation of
the words “current repairs” under section 31(1). It can not be said that the
textile mills constitute one plant. It can not be said that the manufacturing
process in the textile mills is one continuous integrated process. Each
machine including ring frame is an independent and separate machine and
therefore expenditure incurred of replacement of ring frames cannot come
within the meaning of words “current repairs” in section 31 (1).
Section 35 (1) (iia) : Expenditure on Scientific research
Amendment wef AY 2009 -10: Weighted deduction for payment to a Co.
for Scientific Research
A weighted deduction of 125% is allowed in respect of expenditure by way
of payment for scientific research, made to a company registered in India,
whose main object is scientific research and development and which is
approved by the prescribed authority and fulfills specified conditions.
Earlier such deduction was available only for payments made to scientific
research associations or to universities or college or institutions.
Section 35D: Amortisation of Preliminary Expenses
Amendment wef AY 2009 -10: Amortisation of certain expenses for non
Earlier expenditure on increase of capital, public issue expenses,
feasibility / project reports etc. in the context of extension of exiting
business was allowed to be amortised over a period of 5 years only if such
expenses were in connection with the extension of an industrial
undertaking or in connection with setting up a new industrial unit.
The benefit of such amortisation is now being extended to cases of
extension of any undertaking, or setting up of any new unit. Therefore
all entities including trading, finance and service companies would now be
entitled to avail of the benefit of such amortization and claim deduction u/s.
In the case of CIT v. Neha Proteins Ltd.  306 ITR 102 (Raj)
Rajsthan High court has held that Interest received on share application
money can be set off against public issue expenses. Interest accrued
is not taxable.
The amount of interest, accruing on the share application money, could
not be used by the assessee for any purpose whatever, other than those
mentioned in section 73(3) and (3A) of the Companies Act, 1956, and on
the allotment of shares, the assessee was to take stock of things, about
the expenditure incurred by it, being the public issue expenses, and the
interest accrued did reduce that expenditure and it was rightly required to
be adjusted against the expenditure.
Interest accrued on the share application money lying with the bank under
the mandate of section 73 of the Companies Act was not taxable as
“Income from other sources”. And it was nobody‟s case that this was to be
taxed as income from “Profits and gains of business or profession”.
Section 36(1) (vii): Bad Debts : CIT v. M/s. Star Chemicals (Bombay) P. Ltd.
(Bom.) ITAL No. 1915 of 2007 dt. 27.2.2008 In this case Hon. Bombay High
Court has held that after amendment w.e.f. 1.4.89 writing off of bad debt in
account is sufficient for allowing deduction. It is not necessary to prove that
debt has become bad.
S. 36 (1) (iii): Interest On Borrowed Capital In The Case Where Loans
And Advances Are Given To Associates / Subsidiaries Free Of Interest
Where the assessee lends money without interest, notional income based on
reasonable interest, which the assessee might have charged for lending to
relatives or sister concerns can not be taxed. But then in such case there may
be a disallowance of a proportionate part of interest on such borrowed capital,
if any, to the extent that the borrowed funds are utilized for interest – free
advances, on the ground, that it is not incurred for purpose of business.
Hon. Supreme Court in the case of S.A Builders Ltd. v. CIT appeals 
288 ITR 1 has held no businessman need be compelled to maximise the
profit. The authorities should put themselves in the shoes of the assessee and
consider what a prudent businessman would do. Such advance should be
taken as prompted by commercial expediency, so as to be deductible under
section 37, if not under section 36(1) (iii) of the Act.
It was argued on behalf of the assessee, that the advance had been made out
of a bank account, wherein, both its own and borrowed funds were mixed up,
so that there was no direct nexus between borrowing and the advances. It
was further argued and accepted by the Supreme Court that the loan to a
sister company, in which this case was a subsidiary of the assessee company
is one, which should be treated as prompted by commercial expediency, so
that the amount was even otherwise allowable.
The expression “commercial expediency” is one of wide import and includes
such expenditure as a prudent business- man incurs for the purpose of
business. The expenditure may not have been incurred under any legal
obligation, but yet it is allowed as business expenditure if incurred on ground
of commercial expediency
“For the purpose of business” includes expenditure voluntarily incurred for
commercial expediency, and it is immaterial if a third party also benefits
thereby. The expression “for the purpose of business” is wider in scope than
the expression “for the purpose of earning profits”.
The authorities and the courts should examine the purpose for which the
assessee advanced the money and what the sister concern did with the
money. That the borrowed amount is not utilized by the assessee in its own
business but had been advanced as interest free loan to its sister concern is
not relevant. What is relevant is whether the amount was advanced as a
measure of commercial expediency and not from the point of view whether
the amount was advanced for earning profits. Once it is established that there
is nexus between the expenditure and purpose of the business (which need
not necessarily be the business of the assessee itself) the same needs to be
S. 36(1)(xiii): Banking Cash Transaction tax paid is allowed as deduction.
Section 36 (1)(xv) & 36(1)(xvi) : STT (Securities transaction tax) and CTT
(Commodities transaction tax) now considered as business expense
STT paid in is now allowed as business expenditure instead of being allowed
earlier as rebate u/s 88E against the tax payable. Rebate u/s. 88E was
allowed to the extent of tax payable on income from such securities. Now
even if the securities transaction has resulted in a loss, STT paid on such
transaction will be deductible in computing the taxable income.
Similar to STT now a new tax known as CTT (Commodities transaction tax) is
introduced. CTT paid is also allowed as business expenditure against the
income arising from such taxable commodities transactions.
S. 37(1): Residual section: Expenditure should have been laid wholly
and exclusively for the purpose of business or profession
The main requirement of the provision of section 37(1) is that expenditure
should have been laid out wholly and exclusively for the purpose of the
business. The nexus between the expenditure and the business, in
connection with which expenditure has been incurred, has to be established
before the assessee gets entitled to deduction under section 38(1).
Commercial Expediency- If a payment or expenditure is incurred for the
purpose of the trade of the assessee, it is deductible even if it may bring a
benefit to a third party.
Reasonableness of the expenditure has to be adjudged from the point of view
of businessman and not of the revenue. The rule that increased remuneration
can only be justified if there be corresponding increase in the profits of the
employer is erroneous.
There is no ceiling of any expenditure for business but it has to be genuine,
incurred for business.
However, the reasonableness of the expenditure applies under the restrictions
u/s. 40A(2). These are payments made to specified persons such as relative
of an individual, director, partner, persons having substantial interest, their
relatives associate / sister concerns etc.
There are no arithmetic formulas of expenses to revenue receipt. It is best
judgement with fairness expected by assessing officer. It is prudent to
establish the genuineness of expenditure and the reasonableness of the
quantum of such expenditure sought to be claim.
The burden of proof is on the assessee to produce the cogent evidence to
establish the claim of expenses; otherwise assessing officer may use his best
judgement to consider reasonable allowable expenses.