Assessee Allowed Foreign Exchange Loss, Club Expenses, and Loss on Closure of Stores

Issue:

Whether a foreign exchange loss arising from a pre-existing liability, where the encashment of the cheque occurred in the relevant year, should be allowed as business expenditure in that year.
Whether club expenses incurred for business purposes by a company’s director should be allowed as business expenditure under Section 37(1) of the Income-tax Act, 1961.
Whether a loss incurred on the closure of business stores, if revenue in nature, is allowable as business expenditure under Section 37(1), and how to treat it if new assets were involved.

Facts:

Foreign Exchange Loss: The assessee, engaged in a car hire business with a US company, incurred losses and subsequently entered into an agreement to terminate a license fee, while still paying royalty. A revised renewal agreement led to a payment, and the exchange rate difference on this expenditure materialized and was debited in the relevant assessment year (2014-15). The Assessing Officer disallowed this claim, stating it pertained to a prior period, despite the cheque’s encashment occurring in the relevant year, leading to the crystallization of the exchange difference.
Club Expenses: For the assessment year 2014-15, the assessee company claimed certain club expenditures. The Assessing Officer disallowed these, but the assessee argued that the expenses were incurred by a director for entertaining guests for business purposes. The Assessing Officer did not provide specific reasons for disallowing the expenditure other than its nomenclature.
Loss on Closure of Stores: The assessee claimed a loss on the closure of some of its stores.

Decision:

Foreign Exchange Loss: The expenditure was held to have crystallized in the relevant year due to the encashment of the cheque and the debiting of the exchange rate difference in that year. Therefore, it was allowed as business expenditure.
Club Expenses: The club expenditure was allowed as business expenditure. The Assessing Officer’s disallowance based solely on the nomenclature of the expenditure, without demonstrating it as non-business related, was deemed unjustified.
Loss on Closure of Stores: The expenditure incurred for the purpose of the assessee’s own business, if revenue in nature and incurred wholly and exclusively for business purposes with no new asset coming into existence, is allowable under Section 37(1). The issue was remanded to the Assessing Officer for verification. If the expenditure was revenue in nature, it was to be allowed. However, if new assets had come into existence and depreciation was claimed in preceding years, the loss should be dealt with through the “Block of Assets (WDV)” by showing the sale value of abandoned assets as NIL and allowing depreciation on the reduced Written Down Value (WDV) as per law.

Key Takeaways:

Crystallization of Expenditure: An expenditure, especially foreign exchange loss, is considered crystallized in the year when it is finally debited and the actual financial transaction (like cheque encashment) occurs, regardless of the underlying liability’s origin in a prior period.
Substantiation of Business Expenditure: To disallow a business expenditure, the Assessing Officer must demonstrate that it is not for business purposes, rather than disallowing it based solely on its nature or nomenclature (e.g., club expenses).
Nature of Business Loss on Closure: Losses incurred due to business closure are allowable as business expenditure under Section 37(1) if they are revenue in nature and no new assets are created. If capital assets are involved, the loss should be adjusted within the block of assets by treating the abandoned assets’ sale value as NIL for depreciation purposes.

IN THE ITAT DELHI BENCH ‘E’

Nijhawan Travel Services (P.) Ltd.

Assistant Commissioner of Income-tax

Challa Nagendra Prasad, Judicial Member
and Avdhesh Kumar Mishra, Accountant Member

IT Appeal No.4296 (Delhi) of 2019
[Assessment Year 2014-15]

APRIL 25, 2025

A.K. Srivastava, CA, for the Appellant. Amit Katoch, Sr. DR, for the Respondent.

ORDER

Avdhesh Kumar Mishra, Accountant Member.- The appeal of the assessee for the Assessment Year (hereinafter, the ‘AY’) 2014-15 is directed against the order dated 20.02.2019 of the Commissioner of Income Tax (Appeals)-6, New Delhi [hereinafter, the ‘CIT(A)’].

2. The assessee has raised following grounds of appeal:

“1. That on the facts and circumstances of the case and in law, the Learned Commissioner of Income Tax (Appeals) grossly erred in confirming the addition of Rs.6,205/- made by the Assessing Officer on account of Club Expenses.

2. That on the facts and circumstances of the case and in law, the Learned Commissioner of Income Tax (Appeals) grossly erred in confirming the addition of Rs.3,92,660/ out of Rs.4,22,752/-made by the Assessing Officer on account of Prior Period Expenses.

3. That on the facts and circumstances of the case and in law, the Learned Commissioner of Income Tax (Appeals) grossly erred in confirming the addition of Rs. 11,90,861/- being loss on account of closure of a store and renovation on shifting of anoother store made.

4. Without Prejudice to the above aground, the Learned Commissioner of Income Tax Appeals ought to have directed the Asssessing Officer allow Depreciation on the amount disallowed.

5. That on the facts and circumstances of the case and in law, the Learned Commissioner of Income Tax (Appeals) grossly erred in confirming the addition of Rs.8,37,408/-on account of interest on income tax refunds u/s 244A, based on entries in 26AS Statements, which have not been issued to the Appellant.

That the appellant craves leave to add, amend, delete or alter any one or more of the aforesaid grounds of appeal before or at the time of hearing of the appeal.”

3. The relevant facts giving rise to this appeal are that the assessee, engaged in the business of operating retail shops of Adidas, Benetton and other branded goods, leasing of service apartments, sale of properties, travel business, car hiring, etc., filed its Income Tax Return (hereinafter, the ‘ITR’) declaring loss of Rs. (-) 70,20,831/- as per the normal provisions of the Income Tax Act, 1961 (hereinafter, the ‘Act’) and loss of Rs.(-) 41,08328/- under section 115JB of the Act. The case was picked up for scrutiny. Consequentially, the assessment was completed at a loss of Rs. (-) 42,33,447/-by making following disallowances: –

Srl. No.	Disallowances / Additions	Amount (Rs.)
1.	Disallowance on account of contribution of PF	3,24,658/-
2.	Disallowance of club expenses	6,205/-
3.	Disallowance of prior period expenses	4,22,752/-
4.	Disallowance of loss on sale of fixed asset	11,90,861/-
5.	Disallowance taxability of interest receipt on Income Tax refund	8,37,408/-

3.1 Aggrieved, the assessee filed appeal before the ld. CIT(A) and did not get any relief.

4. The Ld. Authorized Representative (hereinafter, the ‘AR’) submitted that the club expenses of Rs.6,205/- incurred for business purposes. The same should be allowed under section 37 of the Act. The Director of the assessee company had entertained certain guests for business purposes only. It was contended that this expenditure was minuscule for a turnover of Rs.45 Crores and there was no element of personal expenditure embedded therein.

4.1 For prior period expenses of Rs.3,92,660/-, the Ld. AR contended that the assessee was engaged in the business of car hire as per the license agreement entered into with Thrifty Rent – a car system, INC, Florida, USA. Under this agreement, the assessee was granted a non-exclusive license to use the licensing system and Marks, as the same were enforced from time to time. As per said agreement, the assessee paid the initial master license fee of US $ 90,000/-. Further, the assessee was also required to pay renewal fees as per the terms & condition of the said agreement. The assessee paid US $ 90,000/-upon signing of the agreement in 2007 (equivalent to Rs.40,51,800/-) and accounted the same as an advance to be written off over the period of license in its books of accounts till 31.03.02012. The assessee had written off Rs.25,32,375/- leaving a balance of Rs.15,19,425/- (page 53,54 of the PB). This balance of Rs.15,19,425/- was claimed as expenditure in the AY 201314, which was disallowed by the Assessing Officer (hereinafter, the ‘AO’). However, the same was restored back to the Assessing officer with certain directions. In pursuance of the said order of the Tribunal, the AO allowed this expenditure of Rs.15,19,425/- after due verification. Since, the car hire business was in loss, therefore, the assessee entered into another agreement on 31^st May, 2012 for termination of the license fee. However, the assessee was making payment of royalty as per pre-determined rate. As per the revised renewal agreement the assessee paid US $ 31,200/- and withholding tax/TDS of US $ 7,800/-. The expenditure of US $ 39,000/- was allowed in the preceding AY as per the claim @ prevailing rate of US $ in that year. However, the said expenditure got finally materialized and debited to the assessee’s bank account on 05.04.2013, therefore, the exchange rate difference of Rs.3,66,911/- on the said expenditure of US $ 39,000/- was claimed in the subsequent/relevant year, which was disallowed holding that the claim pertained to prior period expenditure. The Ld. AR contended that the said claim could not be termed as prior period as the assessee had accounted the same following the principle of mercantile system of accounting. The encashment of cheque was not in hand. Hence, the exchange rate difference of Rs.3,66,911/-, being business expenditure of the relevant year had to be allowed in terms of section 43A and 43AA of the Act.

4.2 The Ld. AR further submitted that the assessee had closed down certain stores of Adidas, Benetton and other products being non-economically viable during the relevant year, which resulted loss of Rs. (-) 11,90,861/- on account of plant machinery and other assets installed in the rented premises. The said loss of Rs. (-) 11,90,861/- was claimed as business expenditure during the relevant year. But the same was disallowed by the AO. It was contended that this issue was decided in the assessee’s favour in AY 2013-14 by the Ld. CIT(A) following the decision of the Tribunal in the case of Xerox India Ltd. in the ITA No.5389/Del/2011, order dated 12.12.2014. Hence, the Ld. AR prayed for allowance of this expenditure.

4.3 The last issue is in respect of taxability of interest of Rs.8,37,408/- on the income tax refund. The Ld. AR prayed for remitting this matter back to the AO for verification and doing needful.

5. The Ld. Sr. DR, placing emphasis on the finding of the lower authorities, argued the case vehemently and prayed for dismissal of the appeal.

6. We have heard both parties and perused the material available on record. We find merit in the submissions/arguments/contentions of the Ld. AR. The AO had not demonstrated the club expenditure as non-business expenditure. It seemed that the AO had disallowed this expenditure of Rs.6,205/- by nomenclature of the expenditure only. We do not see any justification therein. Therefore, the same is allowed as business expenditure.

7. As far as the disallowance of exchange rate difference of Rs.3,66,911/-is concerned, we find merit in the submissions/arguments/contentions of the Ld. AR that the said expenditure was not crystalized in the preceding year as the encashment of said cheque happened in the relevant year. The exchange rate fluctuation resulting foreign exchange gains or losses typically arise from cross border transactions which are denominated in foreign currencies. Such import and export transactions may be capital and revenue in nature; goods and services, acquisition and disposal of assets as well as loans. For accounting purposes, no distinction is made in the Profit & Loss account regarding exchange differences that are capital or revenue in nature. The tax treatment of foreign exchange gains or losses differs from its accounting treatment. For tax purposes, the revenue transactions resulting foreign exchange gains/losses are taxable/deductible being revenue in nature. Here, in the present case, the expenditure of US $ 39,000/- was allowed in the preceding AY as per the claim but not the exchange rate fluctuation in the relevant year though the same was crystalized/materialized in the relevant year. The AO has not raised any doubt on the claim of expenditure of US $ 39,000/- in the preceding year. However, the encashment of said cheque, which happened in the relevant year resulting further expenditure due to the exchange rate difference of Rs.3,66,911/- was not allowed on the reasoning that it pertained to the prior period. In view of the facts as mentioned above, we are of the considered view that this expenditure is held to have crystalized in the relevant year and thus, it has to be allowed as business expenditure.

We therefore, delete the disallowance of Rs.3,66,911/- on this score.

8. The next issue is in respect of the loss of Rs. (-) 11,90,861/- on closure of the stores. This issue has been dealt in detail by the Bombay High Court in the cases of Rediff.com India Ltd. [2021 (10) TMI 174 and Idea Cellular Ltd. [2016 (10) TMI 181], wherein it has been held that the expenditure incurred for the purpose of the assessee’s own business undisputedly abandoned by the assessee, if revenue in nature and incurred wholly and exclusively for the purpose of assessee’s business is allowable under section 37(1) of the Act if no new asset has come into existence. The only requirement which has to be seen is that the expenditure is of revenue nature and not capital nature. There are series of decisions wherein the Hon’ble High Courts and Hon’ble Supreme Court that has laid down the principle that if an expenditure is incurred for doing the business in a more convenient and profitable manner and has not resulted in brining any new asset into existence then such expenditure is allowable business expenditure. It is also pertinent to note that in the case in hand, the expenditure has been incurred; prima-facie, for assets in respect of the existing business and are capital in nature. However, this issue is restored back to the AO for verification and doing needful. If the expenditure is of revenue in nature, then the same has to be allowed as business expenditure under section 37(1) of the Act and if new assets have come into existence on which depreciation have been claimed in preceding year(s), then this loss has to be dealt through the Block of assets (WDV) showing sale value of the abandoned assets as NIL and allowing depreciation on the reduced WDV as per the law. In view of the above observations, the issue is being remitted to the AO for deciding it afresh as per the law.

9. The last issue is in respect of taxability of interest of Rs.8,37,408/- on the income tax refund. The dispute before us is confined to the quantum of interest and not the taxability of it per se. Therefore, this issue is remitted back to the AO for verification and taxing the actual amount of interest paid by the income tax Department on the refund under section 244A of the Act during the relevant year.

10. In the result, the appeal of the assessee is partly allowed as above.