Fact that payment is used for ‘illegal’ purpose does not attract Expl to s. 37(1)

The assessee exported tea to Iraq under the ‘Oil for Food Program’, as sanctioned by the United Nations. It paid commission of Rs 1.28 crores to one Alia Transportation, a Jordanian company. The Volcker Committee, which was set up to expose the ‘Oil for Food scam’ found that this company was a front company for the Iraqi regime, meant to receive illegal kickbacks, and did not render any services. The AO, acting on the report, held that the commission paid by the assessee was “illegal” and not allowable under the Explanation to s. 37(1).

This was reversed by the CIT (A). On appeal by the department, the Tribunal (72 DTR 425) upheld the stand of the assessee on the ground that even if the amounts paid to Alia were actually kickbacks to Iraqi regime, that fact per se would not attract Explanation to s. 37(1). It was pointed out that while the transactions between Alia and the Iraqi regime may be contrary to the UN sanctions, the transactions between the assessee and Alia were not hit by the UN sanctions and that there was no specific violation of law by the assessee. It was emphasized that what the recipient of the payment does is not important because the assessee has no control over the matter. The onus of demonstrating that the assessee was aware that the payments were intended for kickbacks is on the AO which has not been discharged. It was held that the “purpose” of the expenditure has to be seen and if the payment is for bonafide business purposes, the fact that they end up being used as illegal kickbacks, will not attract Explanation to s. 37(1). On appeal by the department to the High Court, HELD dismissing the appeal:

The department could not satisfy us as to why were the findings recorded by the CIT(A) and the Tribunal are incorrect either on fact or in law. There is, as such, no reason why the appeal should be entertained. The appeal is, therefore, dismissed.