The M P High Court in 278ITR345 held that to be an allowable expenditure within the provisions of section 37(1) the money paid out or away expenditure incurred must be a) wholly and exclusively for the purpose of business or profession and further (b) must not be (i) capital expenditure, (ii) personal expenses or (iii) an allowance of the character described in sections 30-36. Beyond this, the A.O. cannot probe into the question as to whether such expenditure was legitimate or necessary. Any such inquiry will be illegitimate hence not called for or contemplated under the law. This decision also holds good for the proposition that the business expenditure is allowable even if business set up and not carried.
The Gujarat High Court in 282ITR224 also held that section 37 requires one to consider the purpose for which and not the motive with which, the expenditure is incurred, because the purpose is different from motive. It requires that the expenditure should be ‘ wholly and exclusively’ laid out or expanded for the purpose of the business, but not that it should necessarily be laid out or expanded for such purpose. In other words, even it the outlay is found to be unnecessary or unnecessarily large or benefits a third party such outlay cannot be disallowed in the absence of a specific provision prohibiting the outlay or restricting it like in section 40A (2).
The Court further held that a claim for a deduction for which there is no specific provision under the Act would still be admissible under section 28 having regard to the accepted commercial practice and trading principles if it can be said to have been incurred for the purpose of business or in the course of carrying on the business and it is incidental to it. In this case, the assessee society was to pay a certain price increase to its members who have supplied milk, which was calculated and also paid on the last day of the previous year. The A. O. thus defined it as in the nature of the distribution of profits and even argued that the assessee held discretion as to the payment of such additional price both of which arguments failed on facts and under the law. On the contrary, the Tribunal in its third member decision held that the payment was an additional purchase price and if it is regarded as adjustment of profit at a pre-determined level, the nature of the payment would not change and cannot be termed as distribution of profits.