Explanation 2 To S. 37(1) of Income Tax Act, Which Bars Deduction of CSR Expenses, Is Prospective In Nature: Delhi High Court

The bench of Justices Rajiv Shakdher and Tara Vitasta Ganju remarked that deductibility of CSR expenses under Section 37(1), prior to its amendment by the Finance Act, cannot depend upon how the funds are spent by the recipient.

The assessee/ respondent, Steel Authority of India, claimed certain expenses incurred towards Corporate Social Responsibility (CSR) as deduction under Section 37(1) of the Income Tax Act. The Assessing Officer (AO) denied the deduction. Taking into account the purposes for which the recipient utilized the funds, the AO opined that the said expenses were in the nature of capital expenditure. Further, the AO held that in view of Explanation 2 to Section 37(1) of Income Tax Act, as inserted by the Finance Act, 2014, the assessee was not eligible to claim deduction.

Section 37(1) of the Income Tax Act provides that any expenditure, not being in the nature of capital expenditure/ personal expenses of the assessee or falling under Sections 30 to 36 of the Act, which are incurred wholly and exclusively for the purposes of business or profession shall be allowed as deduction while computing the income under the head “Profits and gains of business or profession”.

As per Explanation 2 to Section 37(1), expenditure incurred on CSR shall not be deemed to be an expenditure incurred for the purposes of business or profession.

Against the order of the AO, the assessee/ Steel Authority of India filed an appeal before the Commissioner of Income Tax (Appeals) (CIT(A)), who upheld the order of the AO. The CIT(A) concluded that the CSR expenses were not incurred wholly and exclusively for the purpose of business.

The assessee filed an appeal before the ITAT.

The ITAT ruled that prior to the amendment to Section 37(1), CSR expenses were allowed as deduction as there was no specific bar contained either under Section 37(1) or under any other provision of the Income Tax Act. A specific bar for claiming the said deduction under Section 37(1) was brought by the Finance Act, 2014, with effect from 01.04.2014.

Since the said amendment only applied prospectively, the ITAT concluded that the CSR expenses incurred by the assessee were allowable as deduction under Section 37(1).

Against this, the revenue department filed an appeal before the Delhi High Court.

Dealing with the department’s contention that the CSR expenses were in the nature of capital expenditure in view of the purposes for which the recipient utilized the funds, the High Court ruled that deductibility under Section 37 cannot depend upon how the funds are spent by the recipient.

The Court added that it cannot be said that the assessee’s obligation to incur expenses towards CSR was not connected wholly and exclusively with its business.

“The capital asset in which funds are funnelled by the recipient is not the asset of the payer i.e., the assessee. The assessee provided funds in discharge of its obligation as mandated by law on the advise of the Department of Public Enterprises. It cannot be said that an obligation placed on the assessee by law was not connected wholly and exclusively to its business,” the Court said.

The bench added: “…there is nothing on record, which would show that the respondent/assessee had directed investment of funds, which were offered in fulfilment of discharge of its legal obligation, in a capital asset.”

Enumerating the conditions for allowing deduction under Section 37, the bench stated that the expenditure must not be in the nature of capital expenditure and it must be laid out or expended wholly and exclusively for the purposes of the business or profession. Further, the deduction with respect to the expenditure incurred must not be of the nature specified under Sections 30 to 36 of the Income Tax Act.

Dismissing the contention of the revenue department that the amendment to Section 37(1) is retrospective in nature, the Court reckoned that the said Explanation was inserted by the Finance Act, 2014 with effect from 01.04.2015.

“That the Explanation appended to Section 37(1) of the Act is prospective has been held by this Court in order dated 29.11.2022 passed in a bunch of appeals, the lead matter being ITA 268/2022, titled PR. COMMISSIONER OF INCOME TAX -7 Vs. PEC LTD,” the Court concluded.

The Court thus upheld the order of the ITAT and dismissed the appeal.

Case Title: Pr. Commissioner of Income Tax versus M/s Steel Authority of India Ltd.

Citation: 2023 LiveLaw (Del) 95

Dated: 06.01.2023

Counsel for the Appellant: Mr Puneet Rai, Sr. Standing Counsel

Counsel for the Respondent: Ms Vidhi Gupta and Ms Shweta Kumar, Advocates for Mr Alakh Kumar, Advocate

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