Commissioner of Income Tax, Tamil Nadu-V vs Lakshmi Mills Co. Ltd.

Balasubrahmanyan, J.—There is an obvious mistake in the question of law sent up by the Tribunal. The question of law, as corrected, reads

as under :

Whether, on the facts and in the circumstances of the case, the payment made by the assessee to the Indian Cotton Mills Federation of Rs.

1,23,500 and Rs. 39,300 in the assessment years 1969-70 and 1970-71, respectively, were proper business expenditure admissible u/s 37 of the

Income Tax Act, 1961 ?

The assessee owns a textile mill in Coimbatore. It is also a member of an association of textile manufactures called the Indian Cotton Mills

Federation, Bombay. The assessee manufactures higher counts of yarn and textiles made of higher counts. These manufactured articles could be

made only from the yarn made out or imported cotton, described in the trade as ""global"" cotton. The Indian Cotton Mills Federation acts as a

canalising agency and as a cartel for the import of foreign cotton. The allotment of import entitlement by the Federation to the member-mills is on

the basis of the number of spindles working on higher counts in each mill. Under the scheme of canalising of imports through the Federation, each

mill has to give a guarantee at the rate of Rs. 100 per bale of cotton for the quantity of foreign cotton which they agreed to obtain by way of

import. As and when import quotas of foreign cotton are announced, they would be distributed to individual mills according to the allotments based

on their spindlage. In the even of any unit rejecting the allotment falling to its share, it would have to forfeit the guarantee amount of Rs. 100 per

bale.

It is quite apparent that the readiness and willingness of the mills to import foreign cotton would depend upon their chances of marketing the

products which are spun and manufactured out of such cotton at an economic price. It would, under certain circumstances, be costlier for a mill to

import foreign cotton utilising the quotas from the Indian Cotton Mill Federation, that to forfeit the guarantee amount of Rs. 100 per bale. That

would depend upon the particular market conditions for higher count textiles and the financial capacity of the mills to utilise and lift the quota of

imported cotton at the prices prevalent.

During the accounting years relevant to the assessment years 1969-70 and 1970-71, the assessee-company did not utilise its right to import

foreign cotton and thereby forfeited the guarantee amounts which it had already deposited with the Indian Cotton Mills Federation. The amounts so

forfeited were Rs. 1,23,500 and Rs. 39,300, respectively, for the two years. The question which arose in the assessment proceedings was whether

the write-off of these amounts by the assessee in its profit and loss account could be allowed in the computation of its profits under the head

Business"". The ITO disallowed the claim. The matter came before the Tribunal in appeal. It was urged before the Tribunal by the department that

the forfeiture of the guarantee amount with the Indian Cotton Mills Federation amounted to a penalty and, in that view, there can be no deduction

in respect of the write-off of the said amount. The Tribunal, however, did not regard the giving up of the guarantee amounts as a penalty. They

took the view that at best it could only be a breach of contract. For coming to this conclusion, the Tribunal relied on an earlier order of theirs in a

different assessee''s case.

At the instance of the department, the Tribunal has now referred the question of law, which we have set out at the beginning of this judgment.

We may observe that another case arising in more or less similar circumstances had been dealt with by a Bench of this court in Commissioner of

Income Tax Vs. Surya Prabha Mills (P.) Ltd., . That also was case of a textile mill which had deposited guarantee money with the Indian Cotton

Mills Federation for obtaining import quota entitlement and which also, in a particular year, had forgone the import and had thereby forfeited the

guarantee amount. While considering the question whether the write-off of the guarantee amount so forfeited can be allowed as a deduction in the

computation of that assessee''s profits, this court expressed the view that the forfeiture can by no means be regarded as a penalty or even as

damages for a breach of contract. The Bench observed that the amount paid by the assessee as a guarantee deposit can be more properly

described as payment made to the Federation as matter of internal arrangement between member-mills. Proceeding further, the Bench held that by

reason of the assessee, which figured in that case, not being in a position to import the allotted quota of cotton, no damage could be said to have

occurred to anyone thereby. In that case, there happened to be a clear finding by the AAC as well as by the Tribunal that it was worth the

assessee''s while to forfeit the guarantee deposit rather than import further cotton bales, since that would avoid a greater loss which would

otherwise have resulted to the assessee. For that as will as other reasons, the Bench upheld the assessee''s claim for deduction, agreeing with the

views expressed by the Tribunal in that case.

In the present case, the Tribunal has not gone into the details of the guarantee deposits made by the assessee with the Indian Cotton Mills

Federation, or the terms subject to which the guarantee deposits were held by the Federation, or the circumstances in which the deposits stood

forfeited. The order of the AAC, however, briefly touches these points in the following passage in his order :

At the material time quite a number of mills were finding it unprofitable to import the quotas of global cotton allotted to them by the Indian Cotton

Mills Federation and they were willing to forfeit to the Federation the premiums paid in respect of such ''quotas'', for, if they had made the imports,

the losses which should have resulted would have been substantially in excess of the forfeited amounts.

The finding of the AAC in this case, with which the Tribunal ultimately agreed, was that the surrender of the guarantee amounts by the assessee

was for the purpose of avoiding possibly higher losses in the assessee''s business which would have entailed in the even of import and utilization of

foreign cotton. In this sense, therefore, the losses were regarded as incidental to the assessee''s business and allowable as such.

There is no controversy in this case as to whether the losses are to be treated on the revenue side, or whether they are to be dealt with as capital

losses. The only question is whether the write-off of the losses is incidental to the assessee''s business. On that question, our answer must be in the

affirmative, both on the findings of the AAC as confirmed by the Tribunal and on the basis of the reasonings rendered by this court in

Commissioner of Income Tax Vs. Surya Prabha Mills (P.) Ltd., . We, accordingly, answer the reference in the assessee''s favour. In the peculiar

circumstances of this case, however, there will be no order as to costs.