Mediwala and Co. (M/s), Jabalpur vs Commissioner of Income Tax, Jabalpur

J.S. Verma, J.—Asa result of the direction of this Court on an application by the assessee u/s 256(2) of the Income Tax Act, 1961, the Tribunal has stated the case and referred to this Court for its decision on the following question of law, namely,--

Whether, on the facts and in the circumstances of the case, the Tribunal was right in-law in disallowing the payment of Rs. 7,365/-made by the assessee to G.C.F. as a ''business expenditure ?

The relevant assessment year is 1967-68. During that period, the assessee claimed a deduction of Rs. 7364/-as a business loss incurred in the supply of goods to the Gun Carriage Factory at Jabalpur, in accordance with the terms of the contract for supply of the goods. One of the terms of the contract was that in case of default in supply of goods according to the stipulation, the buyer could arrange for supply from alternative sources and recover the expenditure so incurred by it from the assessee. Some of the goods supplied by the assessee to the G.C.F. was rejected as not found in accordance with the specification and the G.C.F. obtained the same from alternative sources. The amount of Rs. 7,364/- was recovered by the G.C.F. from the assessee under this term of the contract. The assessee claimed that this was a permissible deduction being a business loss suffered by it. The Income Tax Officer disallowed this claim, taking the view that the amount represented penalty imposed on the assessee for default in supply of goods according to the contract, on account of which it was not an expenditure incidental to the carrying on of the business. The Appellate Assistant Commissioner affirmed that view and dismissed the assessee''s appeal. The assessee''s (sic) her appeal to the Tribunal has also been rejected on the same basis.

Aggrieved by the view taken by the Tribunal, the assessee applied to the Tribunal for referring the aforesaid question of law to this Court u/s 256 (1) of the Act. The Tribunal, having refused to make a reference, the application u/s 2:6 (2) of the Act was made by the assessee in this Court, which has resulted in a reference of the above question in the manner aforesaid.

The view taken by the Tribunal is that the amount of which deduction is claimed by the assessee as business loss was in the nature of penalty imposed on the assessee for default in supply of the goods according to the contract and, therefore, it was not an expenditure incidental to the carrying on of the business. It has been stated that the supply of sub standard goods, giving rise to recovery of the amount from the assessee, could not be said to be in the ordinary course of the assessee''s business. The question is whether on the above facts, the Tribunal has correctly applied the law applicable.

The relevant statutory provisions are contained in S. 23 (i) and 37 (1) of the Income Tax Act, 1961. The effect of these provisions is that any expenditure incurred for the purposes of business or profession shall be allowed in computing the income chargeable under the head ''profits and gains of business or profession''. The test, therefore, is whether the expenditure has been incurred for the purpose of business. After the decision of the Supreme Court in Haji Aziz and Abdul Shakoor Bros. Vs. The Commissioner of Income Tax, Bombay City II, , it is beyond controversy that ''infraction of the law is not a normal incident of business" and, therefore, any expenditure by way of penalty for breach of law cannot be allowed as a business expenditure u/s 37(1) of the 3961 Act, corresponding to section 10(2) (xv)of the 1922 Act. In that very case, the Supreme Court also pointed out that the expenditure in order to be allowed as a deduction must not only be made in the course of or arise out of or be concerned with or made out of the profits of the business, but it must'' also be for the purpose of earning the profits of the business''. In the present case, admittedly the amount was not paid by the assessee as penalty for infraction of any law but was paid under the terms of the contract which was made by the assessee for the purpose of earning profits from that business of supply of goods. In other words, the amount paid by the assessee to the G.C.F. of which deduction is claimed as a business loss, is under a contract itself and not dehorns the contract, the contract having been made for the purpose of earning profits from that business of supply of goods. The test indicated by the Supreme Court is fully satisfied in the present case.

We may now refer to some decisions of other High Courts, which have taken the same view. In Commissioner of Income Tax Vs. Prafulla Kumar Mallik, , it was held by the Orissa High Court that payment of damages as a result of the breach of warranty for supply of certain goods in the course of or as a consequence of earning profits was incidental to the carrying out of the assessee''s business; and it was an unavoidable loss arising as one of the consequences of carrying on such business. It was, therefore, held to be a permissible deduction in computing the profits from the assessee''s business. Similarly, in Govind Choudhury and Sons Vs. Commissioner of Income Tax, the Orissa High Court took the view that the penalty for supply of inferior quality of goods was so integrally connected with the carrying on of the business of supply of the goods that the loss arising out of its payment was a permissible deduction from the assessee''s income. The Allahabad High Court, in Commissioner of Income Tax Vs. Reliable Water Supply Service of India (P.) Ltd., has taken the same view and relied on these decisions of the Orissa High Court as well as some decisions of the Madras High Court and the Delhi High Court, indicating the same view. In the case before the Allahabad High Court, deduction was claimed for the amounts paid as penalty and damages for delay in the execution of the contracts. It was held that the same were permissible deductions, obviously being incidental to the carrying on of the business. The Allahabad High Court applied the test, following the aforesaid Supreme Court decision as well as certain other decisions that the amount to be allowed as permissible deduction ''has to be a commercial loss in trade and also condemnable by the parties; and a payment made'' in fulfillment of the condition agreed to between the parties enabling the assessee to fulfill the contract and earn profits therefrom''. It was held that the payment so made was obviously incidental to the carrying on of the assessee''s business and being a commercial loss in trade, which was clearly in contemplation of the parties to the contract, it must be allowed as a business expenditure. With respect, we are in agreement with this view. As a result of this conclusion, it must be held that the deduction claimed by the assessee in the present case, was also a permissible deduction u/s 37(1) of the Act.

We may also refer to two decisions, which have been relied on by the Tribunal for reaching the contrary conclusion. In our opinion, both these decisions are inapplicable to the facts of the present case. The first decision is MASK AND CO. Vs. COMMISSIONER OF Income Tax, MADRAS., and the other decision is Commr. of Income Tax, Punjab Vs. Himalaya Rosin-Turpentine Manufacturing Co., , in which reference is made to the first decision. The Punjab case is distinguishable on the short ground that the amount claimed as deduction in that case was penalty for breach of the rules, or, in other words, for infraction of law, which is not the case before us. Obviously, the penalty which was recovered for infraction of any law falls in a different category. The earlier Madras decision was based on the ground that the payment was made not for conduct of the business in a negligent manner but for conducting the business in a dishonest manner was not treated as incidental to the business, whereas negligent conduct of business could be treated as incidental. That apart, the subsequent decisions of the Madras High Court, particularly, Hind Mercantile Corporation Ltd. Vs. Commissioner of Income Tax, Madras, and South India Viscose Ltd. Vs. Commissioner of Income Tax, , support the conclusion reached by us. It would therefore, be proper to say that no decision taking a contrary view has been cited before us.

Consequently, the reference is answered in favour of the assessee and against the revenue that the Tribunal was not right in law in disallowing the payment of Rs 7364/- made by the assessee to the G.C.F. and claimed as business expenditure. There will be no order as to costs.