One-time settlement to contractors is fully deductible under Section 37 as revenue business expenditure

ORDER

Ms. Padmavathy. S, Accountant Member. – These cross appeals by the assessee and revenue are against the order of the Commissioner of Income Tax (Appeals)/National Faceless Appeal Centre (NFAC), Delhi, (in short “CIT(A)”) passed u/s. 250 of the Income Tax Act, 1961 (in short “the Act”) dated 26.02.2025 for Assessment Year (AY) 2017-18. The grounds raised by the assessee and the revenue are as under:

“1. The order of the Learned CIT(A) is contrary to law and facts and is unsustainable. having been passed without properly appreciating the facts, submissions, evidence and binding precedents.

2. The Learned CIT(A) erred in restricting the deduction of \5.43 crores paid as one-time settlement to contractors to 1/5th during the year under consideration and amortising the balance, despite accepting the expenditure as allowable u/s 37(1). The entire amount, being revenue in nature and incurred wholly and exclusively for the purpose of business, ought to have been allowed in full in the year of incurrence.

3. The learned CIT(A), while accepting the allowability of the one-time settlement (OTS) expenditure, erred in directing its amortisation over five years by drawing an analogy with payments made under Voluntary Separation Schemes (VSS). The impugned OTS payments were made to contractors, which fall outside the scope of section 35DDA and Rule 2BA. Consequently, the comparison is misconceived and the direction to spread the deduction over five years is unsustainable in law.

4. The learned CIT(A) further erred in failing to appreciate that amortisation of revenue expenditure, in the absence of a specific enabling provision under the Act, is not permissible and contrary to settled judicial principles.

5. The Learned CIT(A) erred in confirming the disallowance of \1,45,02,961 u/s.14A r.w. Rule 8D over and above the suo motu disallowance of 27,36,398, without appreciating the fact that the appellant had sufficient own funds and no borrowed funds were utilised for the investments. Further, the learned CIT(A) erred in not appreciating that the Assessing Officer had failed to record the requisite satisfaction as mandated under section 14A(2) of the Act before invoking Rule 8D.

6. The additional disallowance sustained by invoking the Rule 8D formula, merely on presumptions of (i) existence of administrative expenses; (ii) size of the investments; and (iii) magnitude of exempt income, is arbitrary, without factual basis and unsustainable in law.

7. Without prejudice to the above, the Ld. CIT(A), erred in considering even the investment from which exempt income was not earned during the year under consideration, while computing the disallowance as per Rule 8D read with Section14A.

8. The Learned CIT(A) failed to duly consider the judicial pronouncements relied upon by the appellant in relation to the allowability of the one-time settlement to contractors and the disallowance under Section 14A.

9. The appellant craves leave to add, alter, amend or withdraw any or all of the grounds at or before the hearing of the appeal.”

1. The Order of the Ld. CIT(A) is contrary to law, facts and circumstances of the case and hence not sustainable.

2. Whether in facts and circumstances in holding of the case, the Ld. CIT(A) has crred that the expenditure of Rs.5.43 Crores incurred towards one time restructuring settlement to long serving contract workers is revenue in nature, without appreciating that the said payment was in connection the with closure of Taratala Unit and not incurred wholly and exclusively for purpose of business.

3. Whether in facts and circumstances of the case, the Ld. CIT(A) has erred in directing amortization of the impugned expenses over five years ignoring that the assessee itself had claimed the entire expenses in one year and that the statute does not provide for such amortization except in specific provisions like Section 35D of the Act.

4. Whether in facts and circumstances of the case, the Ld. CIT(A) has erred in law in not appreciating that no business advantage or enduring benefit accrued to the assessee from the said expenditure as the manufacturing unit at Taratala was closed post restructuring and no further operations were carried out.

5 Whether in facts and circumstances of the case, the Ld. CIT(A) has erred in law in ignoring that as per settled judicial principles, employee compensation/settlement payments connected with retrenchment/closure are not deductible as business expenses u/s 37 of the Act.

6. Whether in facts and circumstances of the case, the Ld. CIT(A) has erred in law in relying upon the judgement in the case of S.A. Builders v. CIT (288 ITR1) (SC) without appreciating that the said ratio applies only where expenses are incurred out of commercial expediency in furtherance of business, whereas in the instant case no business purpose was served.

7. For these and other grounds that may be adduced at the time of hearing, it is prayed that the order of the learned CIT(A) may be set aside and that of the Assessing Officer restored.”

2. The assessee is a company engaged in the business of manufacture of welding electrodes and components. The assessee filed a return of income for AY 2017-18 on 21.11.2022 declaring total income of Rs.32,64,25,800/-. The case was selected for scrutiny and the statutory notices were duly served on the assessee. The A.O completed the assessment by making the following additions:

3. Aggrieved, the assessee filed further appeal before the CIT(A). The CIT(A) gave partial relief to the assessee towards disallowance of one time settlement to contractors to the extent of Rs. 1,08,60,000/-. Both the assessee and the revenue are in appeal against the order of the CIT(A).

4. The A.O during the course of assessment noticed that the assessee has made payment to the extent of Rs. 5.43 Cr. towards one time settlement to contractors and called on the assessee to substantiate the claim along with evidences. The assessee submitted that the amount paid is towards one time settlement to contractors on account of restructuring of operations at Taratala, Kolkata and that the payment is incurred in the normal course of operation. Accordingly, the assessee submitted that the same is allowable u/s. 37 of the Act. The A.O did not accept submissions of the assessee stating that there is no employer employee relationship between the assessee and the workers of those contractors and that the onetime settlement does not result in any corresponding revenue to the assessee. Accordingly, the A.O disallowed the entire expenditure by holding it as capital in nature. On further appeal, the CIT(A) accepted the submissions of the assessee that the expenditure is revenue in nature and that the same is incurred for the purpose of business. However, the CIT(A) held that since the assessee has claimed only 1/5^th of payments made towards one time settlement of the employees, to bring parity the one time settlement to workers of contractors also need to be allowed only to the extent of 1/5^th. Accordingly, the CIT(A) allowed the deduction to the extent of Rs. 1.08 Crores.

5. The Ld. Authorized Representative (AR) of the assessee submitted that the CIT(A) has accepted the fact that the expenditure is incurred for the purpose of business and therefore there is no reason for the CIT(A) to allow only 1/5^th of the expenditure. The Ld. AR further submitted that the onetime settlements are in the nature of contract payments on which the assessee has deducted tax at source u/s. 194C of the Act. The Ld. AR in order of substantiate the fact that the expenditure incurred towards one time settlement are for the purpose of business drew our attention to the agreement entered into with the contractors and also to the internal correspondence (additional evidence), where it is stated that the contract workers are unhappy with the restructuring of business which prompted the assessee to make one time settlement in order to ensure smooth running of business. Accordingly, the Ld. AR argued that when the expenditure is incurred for the purpose of business the entire expenditure needs to be allowed as a deduction.

6. The Ld. Departmental Representative (DR), on the other hand, argued that when there is employer and employee relationship, the claim of the assessee that the onetime settlement is to buy peace cannot be accepted since it is responsibility of the contractor to settle in case of retrenchment of workers. The Ld. DR therefore supported the order of the A.O stating that the A.O has correctly treated the expenditure as not revenue in nature. The ld. DR also argued that the CIT(A) without considering the nature of relationship erred in allowing the 1/5^th of the expenditure.

7. We have heard the parties, and perused the material available on record. The assessee during the year under consideration has stopped the manufacturing activity in its Kolkata operations. The assessee made onetime payment of Rs.5.43 Crores to its contractors to settle to workers. The assessee also made similar payments to its employees under Voluntary Suppression Scheme. The assessee in the return of income claimed 1/5^th of the expenditure towards payment made its employees u/s.35DDA. The assessee claimed the entire deduction towards one time settlement of contractor u/s.37 of the Act. The A.O while allowing the amount claimed towards employees disallowed the payment made to contract workers stating that it is not revenue in nature and where there exists no employer employee relationship the deduction cannot be allowed. The CIT(A) though held that the amount paid by the assessee is wholly and exclusively for the purpose of business and is revenue in nature allowed only 1/5^th stating that the allowance should be in par with the amount claimed towards payment to employees. From the perusal of the agreements entered into by the assessee with the contractors towards one time settlement, we notice that the payments are made to the contractors after deducting tax at source u/s. 194C of the Act and the responsibility of making the final settlement to the workers was fixed on the contractors. The additional evidences now produced go the root of the issue and for a proper adjudication of the issue and for substantial cause, the additional evidence is admitted and taken on record. From the perusal of the additional evidence submitted by the assessee we notice that the payment is made to avoid trouble to the day to day running of the business and to buy peace with the contract workers who were threatening to cause disruption to the smooth running of business. Accordingly, we see merit in the submissions of Ld. AR that the payments towards one time settlement are made wholly and exclusively for the purpose of business of the assessee. From the perusal of the finding of the CIT(A) we notice that the CIT(A) has allowed only 1/5^th stating that since the assessee had claimed only 1/5^th of the payments made to employees to strengthen to principle of the equitable amortization only 1/5^th of the payments made to the contractors should be allowed. We notice that the onetime settlement to the employees of the assessee is done under Voluntary Suppression Scheme which as per Section 35DDA of the Act is entitled for 1/5^th of the deduction. However, the onetime settlement to the contractors does not fall within the purview of section 35DDA of the Act and therefore the said payment need to be examined in the light of the provisions of Section 37 of the Act. We have already held that the impugned payment is incurred by the assessee wholly and exclusively for the purpose of business and accordingly we are of view that allowing only 1/5^th merely for the reason that there should be equitable amortization cannot be sustained. Accordingly we direct the A.O to delete the disallowance made towards 4/5^th of the expenditure incurred towards one time settlement to contractors.

8. The assessee during the year under consideration has earned dividend income of Rs. 6,53,00,000/-which was claimed as exempt. The assessee has made a suo motu disallowance to the tune of Rs. 7,36,398/- towards the exempt income u/s. 14A of the Act. The A.O held that the assessee has not made any disallowance towards earning exempt income and therefore computed a disallowance of Rs.1,52,39,359/-. The CIT(A) confirmed the disallowance stating that the suo motu disallowance made by the assessee is not sufficient and the A.O has correctly made the disallowance.

9. The Ld. AR submitted that the A.O while computing the disallowance u/s. 14A r/w. Rule 8D has made an incorrect observation that the assessee has not made any suo motu disallowance. The Ld. AR further submitted that on the basis of such incorrect understanding, the A.O did not record any satisfaction before proceeding to compute the disallowance u/s. 14A of the Act. The Ld. AR also submitted that the assessee has disallowed the salary of the employee engaged in treasury operations and has followed a scientific method for the purpose of disallowance. The Ld. AR argued that the A.O in the notice issued u/s. 142(1) of the Act called for the assessee to explain the applicability of section 14A to which the assessee had made submissions (page 118, 123 to 125 of paper book). The Ld. AR further argued that the A.O did not issue any show cause notice with respect to the disallowance to be made u/s. 14A of the Act and therefore the assessee was under a bona fide belief that the submissions made in response to notice u/s. 142(1) of the Act have been accepted by the A.O. The Ld. AR also argued that the assessee came to know of the disallowance u/s. 14A of the Act only from the assessment order and therefore there is a violation of natural justice with regard to the impugned disallowance.

10. The Ld. DR, on the other hand, submitted that the assessee did not bring to the notice of the A.O any details with regard to the suo motu disallowance and the computation made in this regard. The Ld. DR drew our attention to the findings of the A.O in para 4.4 of the assessment order to submit that the A.O has rightly made the observation that to handle such voluminous investment to claim that there is no involvement of top management is not acceptable. The Ld. DR further submitted that the A.O has recorded satisfaction by making observations with regard to the assessee not making any disallowance towards indirect expenses and therefore, the contention is that no satisfaction is recorded is not tenable.

11. We have heard the parties, and perused the material available on record. The A.O from the return of income filed by the assessee noticed that there has not been any disallowance towards exempt income and called on the assessee by issue of notice u/s. 142(1) of the Act to justify the applicability of disallowance u/s. 14A of the Act. From the perusal of the reply filed by the assessee, we notice that the assessee has given submissions with regard to the applicability of disallowance u/s. 14A of the Act to its case by placing reliance on certain decisions. However, it is noticed that the assessee has not made any submissions with regard to the suo motu disallowance made by the assessee and the relevant workings. We also notice from the findings of the A.O that the A.O proceeded to consider the disallowance u/s. 14A on the premise that the assessee has not made any suo motu disallowance without considering that the computation of income contains the details with regard to the suo motu disallowance. It is also relevant to note here that the A.O further to the notice issued u/s. 142(1) of the Act did not issue any show cause notice specifically for the purpose of disallowance u/s.14A of the Act. Considering the overall facts and circumstances with regard to the impugned issue, we are of the view that the A.O has not examined the disallowance properly considering the suo motu disallowance and that the assessee on its part did not submit full details with regard to the suo motu disallowance. Therefore, we are of the view that the impugned issue needs to be re-examined and accordingly we remit the same back to A.O for fresh consideration. The A.O is directed to consider the suo motu disallowance made by the assessee while re-examining and decide the issue in accordance with law. The assessee is directed to furnish the details pertaining to the computation of suo motu disallowance and any other details as may be called for by the A.O. It is ordered accordingly.

12. The additional grounds raised are pure legal issue, which does not require investigation of new facts. Hence, placing reliance on the judgment of the Hon’ble Apex Court in the case of National Thermal Power Co. Ltd. v. CIT 229 ITR 383 (SC), we admit the additional grounds.

13. Before the CIT(A), the assessee raised an additional ground towards denial of benefits of provisions of Direct Taxes Avoidance Agreement (DTAA) over the Dividend Distribution Tax (DDT) paid u/s. 115O of the Act. The assessee during the year under consideration has paid dividends to non-resident shareholders from jurisdictions such as United Kingdom and Netherlands. The assessee had paid DDT @ 20.36% on such payments. The claim of the assessee is that as per the applicable DTAA, the dividend income is taxable at 10% and 5% respectively, which should have been considered for the purpose of section 115O of the Act. The CIT(A) however did not accept the submissions of the assessee and dismissed the additional grounds raised in this regard.

14. We heard the parties and perused the material on record. The Ld. AR submitted that the impugned issue stands covered by the decision of the Hon’ble Bombay High Court in the case of Colorcon Asia Pvt. Ltd. v. Jt. CIT [2026] 486 ITR 476 (Bombay)dated 28.11.2025, where it has been held that DDT though paid by the company, in effect is a tax on the dividend income of the shareholder and therefore if the shareholder is a non-resident, the rates prescribed under the relevant Article of applicable DTAA need to be considered for the purpose of tax rates. However, we notice that the Hon’ble Supreme Court in the appeal filed by the revenue against the above order of the Hon’ble High Court Jt. CIT v. Colorcon Asia (P.) Ltd. (SC)/(SLP No7546/2026 dated 13.05.2026) has stayed the further proceedings of the matter involving the impugned issue. We further notice that Hon’ble High Court has directed the listing of the matter on 12.08.2026 giving time for any intervention application to be made by 15.07.2026. Considering this development subsequent to the decision of the Hon’ble Bombay High Court and considering that the lower authorities have not considered the contentions of the assessee with regard to the impugned issue we deem it fit to remit the issue back to the AO with a direction to decide the same based on the final decision of the Hon’ble Supreme Court on the said issue. Needless to say that the assessee be given a reasonable opportunity of being heard. It is ordered accordingly.

15. In result the appeal of the assessee is allowed for statistical purposes and the appeal of the Revenue is dismissed.