Facts of the Case

The respondents/assessees, namely PEC Ltd. and RITES Ltd., claimed deduction of expenditure incurred towards Corporate Social Responsibility (CSR) under Section 37(1) of the Income Tax Act for Assessment Years 2013-14 and 2014-15.

The Assessing Officer disallowed such expenditure on the ground that CSR expenses were not incurred wholly and exclusively for the purpose of business.

The Income Tax Appellate Tribunal (ITAT), however, allowed the deduction holding that Explanation 2 to Section 37(1), which disallows CSR expenditure, is prospective in nature and applicable only from Assessment Year 2015-16 onwards.

Issues Involved

  • Whether CSR expenditure incurred prior to Assessment Year 2015-16 is allowable as deduction under Section 37(1) of the Income Tax Act?
  • Whether Explanation 2 to Section 37(1) is retrospective or prospective in nature?

Petitioner’s Arguments (Revenue)

  • Deduction under Section 37(1) is allowable only if expenditure is incurred wholly and exclusively for business purposes.
  • CSR expenditure constitutes application of income and not business expenditure.
  • Explanation 2 to Section 37(1) is clarificatory and therefore should apply retrospectively to the relevant assessment years.

Respondent’s Arguments (Assessee)

  • CSR expenditure was incurred in the course of business and in furtherance of business interests.
  • Explanation 2 to Section 37(1) is prospective and cannot be applied to earlier assessment years.
  • The expenditure was incurred as per government guidelines and approved by the Board, thus qualifying as business expenditure.

Court’s Findings / Order

  • The High Court upheld the decision of the ITAT.
  • It was held that Explanation 2 to Section 37(1) was inserted with effect from 01.04.2015 and is prospective in nature.
  • The Court relied on:
    • Memorandum to Finance (No.2) Bill, 2014
    • CBDT Circular dated 21.01.2015
  • It was clarified that CSR expenditure incurred prior to AY 2015-16 cannot be disallowed under Explanation 2.
  • Circulars issued by CBDT are binding on the Revenue.

Important Clarification

  • Explanation 2 to Section 37(1) is prospective, not retrospective.
  • CSR expenditure:
    • Disallowed under Section 37(1) only from AY 2015-16 onwards
    • Allowable prior to AY 2015-16 if conditions of Section 37(1) are satisfied
  • CSR expenses may still be allowed under Sections 30 to 36 if they fall within those provisions.

Sections Involved

  • Section 37(1) of the Income Tax Act, 1961
  • Explanation 2 to Section 37(1)
  • Section 135 of the Companies Act, 2013

Link to download the order -https://delhihighcourt.nic.in/app/showFileJudgment/RAS29112022ITA2682022_211737.pdf

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