Income from other sources - Deductions
Conditions to be fulfilled - Before section 57 can apply, the following conditions must be fulfilled :
u The expenditure must have been incurred solely and exclusively for the purpose of earning income or making profit.
u The expenditure should not be in the nature of a capital expenditure.
u The amount in question should not be in the nature of personal expenses of the assessee.
u The expenditure should be incurred in the accounting year.
u There must be a clear nexus between the expenditure incurred and the income sought to be earned.
The dominant purpose of the expenditure incurred must be to earn income. The connection between the expenditure and the earning of income need not be direct; even an indirect connection could prove the nexus between the expenditure incurred and the income - Seth R. Dalmia v. CIT  110 ITR 644 (SC).
Relevant tests and basic propositions - On an analysis of the statutory language and principles laid down in the decided cases, the following propositions clearly emerge:
u In order to decide whether an expenditure is a permissible deduction under section 57(iii), the nature of the expenditure must be examined.
u The expenditure must not be in the nature of capital expenditure or personal expenses of the assessee.
u The expenditure must have been laid out or expended wholly and exclusively for the purpose of making or earning income from other sources.
u The purpose of making or earning income must be the sole purpose for which the expenditure must have been incurred, that is to say, the expenditure should not have been incurred for such purpose as also for another purpose, or for a mixed purpose.
u The distinction between purpose and motive must always be borne in mind in this connection, for, what is relevant is the manifest and immediate purpose and not the motive or personal considerations weighing in the mind of the assessee in incurring the expenditure.
u If the assessee has no option except to incur the expenditure in order to make the earning of the income possible, such as when he has to incur legal expenses for preserving and maintaining the source of income, then undoubtedly such expenditure would be an allowable deduction. However, where the assessee has an option and the option which he exercises has no connection with the making or earning of the income and the opinion depends upon personal considerations or motives of the assessee, the expenditure incurred in consequence of the exercise of such option cannot be treated as an allowable deduction.
u It is not necessary, however, that the expenditure incurred must have been obligatory; it is enough to show that the money was expended not of necessity and with a view to an immediate benefit to the assessee but voluntarily and on the ground of commercial expediency and in order indirectly to facilitate the making or earning of the income.
u If therefore it is found on application of the principles of ordinary commercial trading that there is some connection, direct or indirect, but not remote, between the expenditure incurred and the income earned, the expenditure must be treated as an allowable deduction.
u It would not however suffice to establish merely that the expenditure was incurred in order indirectly to facilitate the carrying on of the activity which is the source of income; the nexus must necessarily be between the expenditure incurred and the income earned.
u It is not necessary to show that the expenditure was a profitable one or that in fact income was earned.
u The test is not whether the assessee benefited thereby or whether it was a prudent expenditure which resulted in ultimate gain to the assessee but whether it was incurred legitimately and bona fide for making or earning the income.
u The question whether the expenditure was laid out or expended for making or earning the income must be decided on the facts of each case, the final conclusion being one of law - Smt. Virmati Ramkrishna v. CIT  131 ITR 659 (Guj.).
Income need not have factually been earned - The plain natural construction of the language of section 57(iii) irresistibly leads to the conclusion that to bring a case within that section it is not necessary that any income should in fact have been earned as a result of the expenditure - CIT v. Rajendra Prasad Moody  115 ITR 519 (SC).
Benefit to third party is not relevant factor - The fact that the benefit of deduction goes to a third party is not a ground for denying the benefit of deduction under section 57(iii) - CIT v. P.J. Irani  143 ITR 540 (Mad.).
Deductible items - Illustrations
Interest on call-money - Payment of interest to a company on delayed payment of call-money stands on the same footing as payment of interest to an outside lender when one borrows the amount for payment to the company. Interest so paid to the company cannot be treated as capital expenditure and is allowable as a deduction - Smt. Nirmala M. Doshi v. CIT  82 ITR 648 (Bom.).
Interest on bank loans - Where an assessee has a term deposit in a bank, on the security of which he has taken a loan from the same bank, it is a situation of mutuality and, consequently, the assessee must be assessed on the interest received by him on the term deposit as reduced by the amount of interest paid on loan taken on the security of such deposit - CIT v. Dr. V.P. Gopinathan  90 Taxman 304 (Ker.).
Municipal taxes - Where the assessee had leased out his theatre building together with the equipment, machinery and furniture, and the lease income was assessed as income from other sources, the municipal taxes paid by the assessee on the building were deductible - CIT v. Jagannatha Govindas  45 ITR 61 (Mad.).
Salary to receiver - Salary paid to the receiver appointed by the Court for the management of an estate is an admissible deduction against the income of the estate which is assessable under ‘other sources’ - Sachindra Mohan Ghosh v. CIT 5 ITC 396 (Pat.).
Expenses incurred after discontinuance of business - Where a company discontinued its business but incurred expenditure on keeping itself alive as a company for the profitable disposal of its assets and it had income from other sources, the expenses incurred by it were deductible from such income - CIT v. Rampur Timber & Turnery Co. Ltd.  129 ITR 58 (All.), followed in Nakodar Bus Service (P.) Ltd. v. CIT  179 ITR 506 (Punj. & Har.).
Salary to residual staff after take-over of business - Where, after take-over of its business by the Government, the assessee retained some employees for earning interest, income is assessable under ‘other sources’, and the salary paid to those employees is to be allowed as a deduction, there would be no justification to deny the claim of the assessee regarding deduction of gratuity payment made by it to two employees. The gratuity paid was also allowable as a deduction - CIT v. Sijua (Jheria) Electrical Supply Co. Ltd.  242 ITR 404 (Cal.).
Litigation expenses - Litigation expenses incurred by a landlord for ejecting a tenant from its premises leased out to the tenant are deductible - CIT v. East India Development Co. (P.) Ltd.  120 ITR 655 (Cal.).
Expenses of company in liquidation - The actual expenditure incurred towards salary and wages of the staff and rent for office premises would be deductible in the case of a company in liquidation as expenditure incurred wholly and exclusively for purpose of earning the income assessable under ‘other sources’ - CIT v. Benares Electric Light & Power Co. Ltd.  204 ITR 804 (Cal.).
u Where the assessee-company has gone into liquidation, the entire expenses on salaries, audit fees, miscellaneous expenses and bank charges cannot be deducted out of income earned by way of interest on fixed deposits; only the proportionate expenses incurred for earning that income can be deducted - Shahdara (Delhi) Saharanpur Light Railway Co. Ltd. v. CIT  208 ITR 882 (Cal.).
Non-deductible items - Illustrations
Interest on borrowals for tax payments - Interest paid on amounts borrowed for meeting tax liabilities is not deductible, since the liability to pay income-tax and wealth-tax is a personal one - Smt. Padmavati Jaikrishna v. Addl. CIT  166 ITR 176 (SC).
Interest on interest - The assessee is entitled to only the interest payable on the principal amount, but not the additional interest on the overdue interest - Jaswantrai P. Mehta v. CIT  192 ITR 577 (Guj.).
When interest income is capitalised, no deduction can arise - Where certain interest income is directed to be capitalised so as to reduce the cost of asset, the question of deduction of any expenditure incurred on earning such income from such interest income would not arise - Karnal Co-op. Sugar Mills Ltd. v. CIT  233 ITR 531 (Punj. & Har.).
Borrowals for acquiring controlling interest - Where the assessee utilised the borrowals on purchase of shares of a company in order to acquire controlling interest in that company, interest paid on such borrowals was not deductible, since the expenditure could not be said to have been incurred for the purpose of earning dividend income - CIT v. Smt. Amritaben R. Shah  106 Taxman 134 (Bom.).
Pre-commencement expenses - Office or establishment expenses incurred before the company starts carrying on business are not deductible from the interest income earned during pre-commencement period - Traco Cable Co. Ltd. v. CIT  72 ITR 503 (Ker.)/ CIT v. Bihar Spg. & Wvg. Mills Ltd.  24 ITR 108 (Cal.).
Litigation expenses - Where no connection or relationship is established between the litigation expenses and dividend income, the expenses are not deductible - CIT v. S. Devraj  73 ITR 1 (Mad.).
u Where a holding company incurred legal expenses for removal of directors of its subsidiary, the expenses were not deductible under section 57(iii) - United Breweries Ltd. v. CIT  162 ITR 527 (Kar.).
Expenses after take-over of business - Where, after take-over of its business by the Government, a company derived income only by way of interest on investments and compensation due from Government, and the assessee incurred administrative expenses, the entire expenditure was not deductible against interest income since the expenditure in its entirety was not incurred for earning interest income; estimation of allowable expenses made at 10 per cent of the expenditure was reasonable - South Arcot Electricity Distribution Co. Ltd. v. CIT  94 ITR 469 (Mad.).
Development Officers of LIC - The LIC agents, working for the LIC on commission basis, are not the employees of the LIC, whereas the Development Officers working in the LIC are the employees of the LIC, and it is on account of this relationship that the Development Officer is rewarded in the form of incentive bonus for the extra labour he puts in for procuring the business. Therefore, the ad hoc deduction allowed to LIC Agents under CBDT Circular No. F 8/2/68-IT(A-I), dated 18-10-1968 cannot apply in the case of Development Officers - CIT v. Shiv Raj Bhatia  133 CTR (Raj.) 379.
Taxes - Where an assessee had given one of its buildings to the bank as security for an overdraft taken by its associate concern, and received guarantee commission from that concern for standing security, the municipal taxes paid by the assessee on that building were not deductible from the guarantee commission, since the taxes were paid by the assessee in its capacity as the owner of the building, and not as a trader to earn the guarantee commission - CIT v. Nawn Estates (P.) Ltd.  70 ITR 784 (Cal.).
Interest on borrowals for agricultural purposes - Where the assessee-company engaged in plantation business borrowed funds on payment of interest for business purposes, interest so paid cannot be deducted from its interest income earned from fixed deposits, since the borrowal has been utilised for agricultural purposes - CIT v. Vaikundam Rubber Co. Ltd.  241 ITR 50 (Ker.).