Facts of the Case

The assessee, a Public Sector Undertaking, claimed deduction of expenditure incurred towards Corporate Social Responsibility (CSR) under Section 37(1) of the Income Tax Act.

The Assessing Officer (AO) disallowed the deduction on two primary grounds:

  1. The CSR expenditure was capital in nature.
  2. Explanation 2 to Section 37(1) (inserted by Finance Act, 2014) barred such deduction.

The CIT(A) upheld the disallowance, stating that CSR expenditure was not wholly and exclusively for business purposes.

However, the Income Tax Appellate Tribunal (ITAT) allowed the deduction, holding that CSR expenditure was allowable for the relevant assessment year.

The Revenue filed an appeal before the Delhi High Court.

Issues Involved

  1. Whether CSR expenditure is capital or revenue in nature?
  2. Whether CSR expenditure is allowable as deduction under Section 37(1)?
  3. Whether Explanation 2 to Section 37(1) is retrospective or prospective in application?

Petitioner’s Arguments (Revenue)

  • CSR expenditure is not allowable under Section 37(1).
  • The expenditure results in enduring benefits, hence should be treated as capital expenditure.
  • The AO’s findings regarding capital nature were not properly addressed by CIT(A) or ITAT.
  • Explanation 2 to Section 37(1) prohibits deduction of CSR expenses.

Respondent’s Arguments (Assessee)

  • CSR expenditure was incurred in discharge of statutory obligation.
  • The expenditure is not capital in nature, as no asset is created for the assessee.
  • Deductibility cannot depend on how funds are used by the recipient.
  • Explanation 2 (Finance Act, 2014) is prospective, hence not applicable to the relevant year.

Court Findings / Order

  1. CSR Expenditure Not Capital in Nature
    • No evidence that funds resulted in creation of capital assets for the assessee.
    • Mere benefit to society does not make expenditure capital.
  2. Allowability under Section 37(1)
    • CSR expenses incurred in compliance with statutory obligation can be considered wholly and exclusively for business purposes.
  3. Explanation 2 is Prospective
    • Inserted by Finance Act, 2014 with effect from 01.04.2015.
    • Cannot be applied retrospectively.
  4. No Substantial Question of Law
    • Court held that no substantial question of law arises.
    • Appeal dismissed.

Important Clarification

  • Deductibility of CSR expenditure cannot be denied merely because it benefits society.
  • What matters is:
    • Whether the expense is revenue in nature, and
    • Whether it is incurred wholly and exclusively for business purposes.
  • Explanation 2 to Section 37(1) applies only prospectively, i.e., from AY 2015-16 onwards. 

Link to download the order -https://delhihighcourt.nic.in/app/showFileJudgment/RAS06012023ITA32023_114811.pdf

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