Introduction
The Telangana High Court (‘HC’), in a landmark decision, has upheld the disallowance for expenditure incurred by Subsidiary Company for overseeing Holding Company’s projects. This significant ruling was made in the case of Pipelic Energy Software India Pvt Ltd (‘Assessee’) vs Deputy Commissioner of Income Tax, Hyderabad (‘DCIT’) dated 28 June 2024. The HC underscored that deductions are permissible only when expenses are incidental or directly related to the Assessee’s own business activities. Emphasizing the separate legal identities of the Holding and Subsidiary companies, the HC ruled that the expenditure pertaining to one entity cannot be claimed or allowed in the hands of the other entity. Given that the Assessee solely supervised and executed contracts for its Holding Company without engaging in independent business activities, the HC concluded that these expenses were not incurred for its own business purposes and thus disallowed them.
Facts of the case
- The Assessee specializes in consulting on industrial computer software systems for sectors such as oil, gas, and water pipelines.
- For the Assessment Year (‘AY’) 1999-2000, the Assessee filed the Income tax return reporting a loss of INR 55,68,141. Initially issued a refund of INR 4,194, the case was subsequently considered for Scrutiny under the Income Tax Act, 1961 (‘the Act’).
- During assessment, the Assessing Officer (‘AO’) disputed certain expenditures claimed as business losses, particularly those related to support services for the Assessee’s Holding company, resulting in their disallowance in the assessment order.
- Subsequently, the Assessee appealed to the Commissioner of Income Tax (Appeals) (‘CIT(A)’), who recognized the Assessee’s legitimate role as advisor and consultant to its Parent company based on its Memorandum and Articles of Association.
- Disagreeing with the AO, the CIT(A) allowed the appeal, directing acceptance of the claimed expenses as revenue expenditure.
- The AO subsequently appealed to the Income Tax Appellate Tribunal, Hyderabad (‘ITAT’), which overturned the CIT(A)’s decision. The ITAT emphasized the distinct legal identities of the Holding and Subsidiary Companies, hence ruling that the expenses incurred by one entity cannot be claimed by another.
- Aggrieved by the ITAT’s decision, the Assessee filed the instant appeal in the Telangana HC.
Assessee’s Contention
- The Assesse contended that the ITAT’s order was erroneous and unjust, asserting that it failed to consider the evidence and explanations presented to the CIT(A).
- The Assessee emphasized that the Tribunal incorrectly concluded that the Assessee was not engaged in business, resulting in the complete disallowance of claimed expenditures without proper assessment and allocation.
- The Assessee further contended that the expenditures incurred were business-related expenses for projects assigned by the Holding Company, aligning with its objectives stated in the Memorandum of Association.
- The Assessee argued that the Tribunal should have acknowledged the AO’s failure to verify the Assessee’s contributions to its Holding company, which resulted in substantial incomes in subsequent years. Ultimately, they urged the Tribunal to grant the appeal.
AO’s Contention
- The AO contended that the appeal filed by the Assessee lacks merit and fails to raise any legal questions for consideration.
- The AO emphasized that the Tribunal correctly upheld the Department’s appeal, noting that the Holding Company and Subsidiary Company are distinct entities, and expenses cannot be interchanged between them for the purposes of claiming allowance under the Act.
- Additionally, the AO highlighted the ITAT’s findings that the expenses were not mere administrative costs or intended for income generation, emphasizing that the Assessee’s engineers were deployed at their own cost to fulfil the contractual obligations of the Holding Company.
- Consequently, the expenses incurred by the Assessee are deemed ineligible for allowance under the Act.
References made:
- Sri Venkata Satyanarayana Rice Mill Contractors Co. Vs. Commissioner of Income Tax, A.P.II
- Commissioner of Income Tax vs. Samsung India Electronics Ltd.
- Commissioner of Income Tax, West Bengal vs. Royal Calcutta Turf Club
- Mira Kulkarni vs. Assistant Commissioner of Income Tax
- Crescent Organics (P.) Ltd., v. Deputy Commissioner of Income-tax Range-8(1), Mumbai
- P. Amarnath Reddy v. Assistant Commissioner of Income Tax, Central Circle-III(3), Chennai
- Commissioner of Income Tax vs. Electron India
- Commissioner of Income Tax vs. Chandulal Keshavlal & Co.
Issue raised before the HC
- Whether the expenditure incurred by the Assessee for projects related to its Holding Company is eligible for allowance under the Act?
Decision of the HC
- The HC emphasized that a business is considered commenced once it is ready to serve clients, which requires necessary expenses.
- In the instant case, the Holding Company received orders and inquiries, and the Assessee incurred expenses to oversee and execute these contracts. However, these expenses incurred by the Assessee were not incurred in connection with its own business or incidental to its business, but rather to oversee the projects of the holding company, making these expenses unrelated to its own business.
- For expenses to be deductible under Section 37 of the Act, they must be incurred for the business carried on by the Assessee and spent exclusively for it.
- The HC observed that the Assessee’s expenses were for supporting the Holding Company’s projects, not its own business, and thus do not qualify as deductible business losses.
- Consequently, the HC upheld the Tribunal’s decision, dismissing the appeal and ruling that the Assessee’s expenses are not eligible for deduction under the Act.
Conclusion
In this significant ruling, the HC upheld that expenses incurred for supporting a Holding Company’s projects are not related to the Assessee’s business and are thus not eligible for claiming deduction under the Act. Such expenses, even within the same corporate group, do not qualify as business losses for the Assessee. The HC reaffirmed that deductible expenses must be directly connected to the Assessee’s own business activities. This ruling underscores the necessity for businesses to ensure that expenses claimed for deductions are directly in connection to their own business or incidental to their business, and not merely incurred for the benefit of their associated entities.
