COMMISSIONER OF INCOME TAX vs JIYAJEERAO COTTON MILLS LTD.

SUHAS CHANDRA SEN, J. :

The following questions of law have been referred to this Court by the Tribunal under s. 256(1) of the IT Act, 1961.

"(1) Whether, on the facts and in the circumstances of the case, the amount of Rs. 6,91,066 and Rs. 49,67,643 being the gratuity liability are allowable ?

(2) Whether, on the facts and in the circumstances of the case, the amount of Rs. 19,165 representing the expenditure incurred on the guests and selling agents is allowable ?

(3) Whether, on the facts and in the circumstances of the case, the Tribunal was right in holding that the amount of Rs. 14,385 representing the difference paid on the cancellation was allowable as a deduction in computation the profits and gains of the assessees business for asst. yr. 1972-73 ?

(4) Whether, on the facts and in the circumstances of the case, the amount of Rs. 47,393 paid for non-delivery of export cloth in time is allowable as a deduction ?"

The year of assessment in this reference is the asst. yr. 1972-73, for which the relevant period of account is the year ending on 31st March, 1972.

Question No. 1 is concluded in the case of Commissioner of Income Tax (Central-I) Vs. Eastern Spinning Mills Ltd., . Following the principles laid down in that case question No. 1 must be answered in the affirmative and in favour of the assessee.

The second question is about the allowability of expenditure incurred on account of guests and selling agents. In view of the law as it stood at the material time the expenditure on this account having been incurred in course of carrying of business this has to be allowed as deduction from business profits. So the question No. 2 must also be answered in the affirmative and in favour of the assessee.

Question No. 3 is about the amount paid for cancellation of a contract. The case of the Department is that this was a speculation loss. No delivery of goods had taken place and the transaction could not be treated as business transaction. It has been recorded by the Tribunal that the assessee had contracted with M/s. Oriental Importers & Exporters for supply of certain quantities staples yard. The Tribunal held as follows :

"We have taken into account the rival contentions of both the sides alongwith various authorities relied on by them. It is seen that the company contracted with M/s. Oriental Importers and Exporters for supply of 15,000 kgs. of specified single yarn. The assessee, however, could supply only 10,205 kgs. of yarn and the balance of 4,795 kgs. was not supplied because of the assessees own consumption of the said commodity had gone up due to the increased manufacture of synthetic fabrics by the assessee and that in the meanwhile the rates or prices of yarn had also increased. The amount paid by the assessee in the instant case was for the difference of the rates claimed by the above party from the assessee by way of damages. After we have given our careful consideration of the facts of the case, we are of the view that the claim of the assessee was justified and that the above payment should have been allowed as deduction by the authorities below. In this view of the matter, the claim of the assessee is allowed and the orders of the authorities below on this point stand set aside."

It would appear from the order of the Tribunal that the assessee entered into a contract with M/s. Oriental Importers & Exporters for supply of 15,000 kgs. of yarn and the major part of the obligation under the contract was fulfilled by supplying 10,205 kgs. of yarn. The balance quantity of 4,795 kgs. could not be supplied partly because the assessees own requirements had gone up and partly because the rates of yarn had also been increased. Therefore, the assessee decided to pay the difference to the firm to get out of its legal obligation to deliver the balance quantity of yarn. This payment was made because of the business exigency. Having regard to the fact that the assessee had entered into a contract for supply of 15,000 kgs. of single yarn, out of which 10,205 kgs. had actually been supplied, we are of the view that this transaction was not a speculative transaction. The contract was substantially carried out. It is not case where the assessee does not deliver goods pursuant to a contract but settles it otherwise.

Therefore, the question No. 3 must also be answered in the affirmative and in favour of the assessee.

Question No. 4 relates to an amount paid for non-delivery of goods in time in terms of the contract. The amount had been paid pursuant to a default clause contained in the contract itself. The ITO disallowed the claim of the assessee in the following words :

"Compensation on export cloth on non-delivery of goods in time is claimed at Rs. 47,393. It is penalty paid to the parties in terms of cl. 12 of the contract with them. This is evidenced from the copy of the contract filed. Penalty is not an allowable item. Hence, disallowed."

The AAC went into this question at length and observed as under :

"In the instant case the facts have to be interpreted on the basis of terms of the contract. Clause 12 of the contract provides that the seller shall, on the buyer abandoning his other right under the contract in so far as they relate to deliveries, pay to the buyer penalty at the rate of 1-1/2% on the value of goods the delivery of which has not been given within the due date. The first part of this cl. 12 is that the buyer will pay godown rent and insurance in case of taking delivery after the due date. In my opinion the payment of penalty in lieu of abandonment of other right under the contract assumes the nature of payment of damages. Though the facts of the instant case are different from the case laws cited above, the amount of Rs. 47,393 appears to be allowable deduction in the computations of income. The ITO is directed to delete the disallowance of Rs. 47,393."

Before the Tribunal it was contended on behalf of the Revenue that there was no justification for the AAC to allow the claim of the assessee particularly in view of the decision of the Madras High Court in the case of MASK AND CO. Vs. COMMISSIONER OF Income Tax, MADRAS., . It was submitted that the AAC had not brought out any facts but had dealt with the matter theoretically.

On behalf of the assessee it was contended that the payment was not in the nature of penalty but it was paid of the business carried on by the assessee. It was further submitted that as per cl. 12 of the contract, the assessee had to pay the amount when the goods were not delivered in time as stipulated in the contract.

After considering the submissions of the parties, the Tribunal held as under :

"We have given our consideration to the various contentions and submissions of both the parties. We have perused the provision of cl. 12 of the contract made between the assessee and the parties concerned. Having regard to the materials and other papers placed before us alongwith the various submissions of the parties, we are of the opinion that the expenditure of the assessee should be considered to have been incurred for the purpose of his business and that the payment was not for violation of any law or statutory provision. The order of the AAC is, therefore, confirmed."

From the facts noted by the IT authorities and the Tribunal, it appears that the goods were not delivered in time and as because the goods were not delivered in time a penalty under the default clause the aforesaid sum of Rs. 47,393 had to be paid by way of penalty. It is not a penalty for breach of any law. The payment was made on account of the contractual obligation under cl. 12 of the agreement. When the goods were not delivered within the stipulated period, an extra amount, designated penalty had to be paid. This was done in course of carrying on the business by the assessee Usually time is not of the essence of the contract but the parties are entitled to make is so by inserting a specific clause in the contract. The parties are entitled to fix the time within which the goods must be delivered and to stipulate that if there is any failure to deliver the goods within the contracted period, extra money will have to be paid to compensate the buyer for non-delivery of the goods in time.

In the instant case, there was specific requirement to deliver the goods in time and a penalty clause for default. These rights and obligations arose in course of carrying on of the business of buying and selling, goods. I fail to see how this payment made under a contractual obligations cannot be allowed as business expenditure.

The question No. 4, therefore must also be answered in the affirmative and in favour of the assessee.

In view of the above, all the four questions are answered in the affirmative and in favour of the assessee.

There will be no order as to cost.

BHAGABATI PRASAD BANERJEE, J. :

I agree.