The Supreme Court’s decision in CIT v. Chandulal Keshavlal & Co. (1960) is one of the most influential judgments in the field of income tax law, especially with respect to the principles governing deductibility of business expenditure. This case helped shape the understanding of what qualifies as a legitimate business expense under Section 10(2)(xv) of the Indian Income Tax Act, 1922 (the predecessor to Section 37(1) of the Income Tax Act, 1961).
The judgment is known for laying down the “commercial expediency test”, which courts continue to apply even today when determining whether an expenditure is truly incurred wholly and exclusively for business purposes. The Supreme Court clarified that taxation authorities are not entitled to step into the shoes of a businessman and dictate how business should be conducted. Their role is confined to determining whether the expense is genuine, commercially rational, and tied to business interests.
Background and Facts of the Case
Chandulal Keshavlal & Co. was a managing agent of several companies. The company voluntarily surrendered a portion of its managing agency commission to one of the managed companies due to commercial pressure. Later, when income tax assessment arose, the assessee claimed the surrendered amount as a deductible business expenditure, arguing that reducing the commission was a business decision necessary to maintain long-term business relations and protect its agency rights.
However, the Income Tax Officer disallowed the expense, arguing that the surrendered commission represented income that had already accrued and could not be waived merely by unilateral decision. The matter eventually reached the Supreme Court because authorities differed on whether the surrender constituted:
- a diversion of income at source (which would not be taxable), or
- an application of income after it had already accrued (which would be taxable).
The Supreme Court was also tasked with determining whether the surrendered income could be treated as a “business expenditure” deductible under the law.
Issues Before the Court
1. Whether the surrendered part of the managing agency commission constituted income of the assessee?
The primary issue was whether the amount voluntarily given up by the assessee should still be treated as income accruing to it. If income had already accrued, then giving it up later would be treated as application of income, which cannot reduce taxable income.
2. Whether surrendering part of the commission was a deductible business expenditure?
The second issue was whether such a surrender falls within the meaning of “expenditure incurred wholly and exclusively for the purpose of business,” which is the determining factor under the tax law.
3. Whether tax authorities could question the commercial wisdom behind the assessee’s decision?
This issue touched upon whether authorities could decide what is or is not “commercially prudent,” or whether such decisions fall under the domain of the businessman alone.
Supreme Court’s Observations
The Court began by distinguishing between business expediency and personal motives. It reinforced that the Income Tax Act does not impose a rigid or narrow interpretation on business expenditure. Instead, it requires an assessment of commercial realities.
The Court referred to earlier precedents, including Eastern Investments Ltd. v. CIT and CIT v. Royal Calcutta Turf Club, where the principle that business expenditure must be viewed in the context of business necessity and expediency was recognized.
The Court held that an expense may be incurred to prevent future losses, protect business interests, or maintain commercial relationships—even if there is no immediate monetary return. Such expenditure can still qualify for deduction.
The Supreme Court emphasized that the tax department cannot dictate how much a businessman should earn or how he should manage his affairs. The judgment famously stated that commercial expediency must be judged from the businessman’s point of view, not from the perspective of the tax officer.
Also Read: CIT v. Shoorji Vallabhdas & Co. (1962) – Detailed Case Analysis
Judgment and Ruling
The Supreme Court ruled in favour of the assessee. The key conclusions were:
1. The surrendered commission was deductible business expenditure
The Court held that the commission was given up based on commercial considerations. The assessee had acted in the larger interest of preserving beneficial relations with the managed company, thereby protecting future business prospects.
Thus, the expenditure was “incurred wholly and exclusively for the purposes of business.”
2. The tax authorities cannot question commercial judgment
The Court declared that the department must evaluate expenditure based on real commercial necessity, not hypothetical standards.
3. The surrender was not mere “application of income”
The surrender was treated as an act done in the course of business to protect future earnings. Therefore, it was deductible.
The judgment solidified the approach that even voluntary expenditure, if commercially justified, can be deducted under tax law.
Significance of the Case
1. Birth of the “Commercial Expediency Test”
This case laid down a lasting principle:
- If an expenditure is undertaken for business advantage, necessity, or protection—even indirectly—it is deductible.
2. Impact on Section 37(1) of IT Act, 1961
Even though the case arose under the 1922 Act, its reasoning has been adopted widely in interpreting Section 37(1).
3. Limiting the powers of tax authorities
The Court restricted tax officers from substituting their judgment for that of the businessman, preserving autonomy in commercial decisions.
4. Paved the way for several landmark rulings
Cases such as S.A. Builders (2007), Hero Cycles (2015), and Walfort Share Brokers (2010) rely heavily on this principle.
Tip: “Expenditure is allowable if it is commercially prudent—even if profit does not arise immediately.”
Conclusion
CIT v. Chandulal Keshavlal (1960) stands as a milestone in Indian tax jurisprudence. It clarified that the deductibility of business expenditure must be assessed based on commercial realities, not rigid technical interpretations. By recognizing the importance of preserving business relationships and protecting future earnings, the Court provided a flexible and practical framework for interpreting tax laws. The principle of commercial expediency born from this judgment continues to guide courts, tax practitioners, and businesses across India.
Also Read: How to Choose Between Corporate Law and Litigation in 2025
