Deductibility of Expenditure Incurred for an Unlawful Purpose

Collection of tax collection is an important directive for the government, because money can be generated only through the collection of tax for service delivery. To satisfy the needs of citizens State can collect as much tax as possible. Thus to achieve such an purpose the receiver of revenue extends the scope of income. Taxpayers generate income from various sources, illegal or legal and tax is collected on that income. Moreover the income received by taxpayers is not always meant for them and the activities through which they receive their income are not always legally satisfactory. On the other hand, there is not even a single provision in the Income Tax Act 58 of 1962 that refers to the legality or illegality of income. Tax is paid on income only if such income has been received by the taxpayer. The receiver of revenue would like to make sure that tax is payable on any income received by taxpayers as it is provided in the Income Tax Act. The deductibility of expenditure is main problem generated while paying tax with illegal receipts. In the Income Tax Act of 1962 it is given that spending sustained in the generation of income should be allowed to deduct from taxable income but still expenditure incurred from activities as corruption or bribes or fines are not allowed to deduct from the taxpayers’ income.Section 37 is a residuary provision which talks about general deduction and which provides for the deduction of all expenditure wholly and exclusively laid out or expended for the purpose of the business, where such expenditure is not expressly covered by any other specific provision of the Act. Main resource of disputes between the department and the taxpayer is section 37 of ITA act, 1961. Sections 37 of Income Tax Act 1961 lays down as: Any expenditure (not being expenditure of the nature described in sections 30 to 36 and not being in the nature of capital expenditure or personal expenses of the assessee), laid out or expended wholly and exclusively for the purposes of the business or profession shall be allowed in computing the income chargeable under the head “Profits and gains of business or profession”. Explanation — For the removal of doubts, it is hereby declared that any expenditure incurred by an assessee for any purpose which is an offence or which is prohibited by law shall not be deemed to have been incurred for the purpose of business or profession and no deduction or allowance shall be made in respect of such expenditure. The Explanation was introduced in 1998 and the amendment was made retrospective from 01st April, 1962. For the reason of protection money, extortion, hafta, bribes, etc. this amendment had disallowed the claim which was made by some taxpayers as business expenditure. The disallowance under this Explanation, therefore, rests on the conditions that it should be an expenditure and should have been incurred for any purpose which is an offence.