2003 (10) TMI 26 - HC - Income Tax

Compounding fees for illegal extra construction under municipal law held non-deductible business expense u/s37 Explanation

Compounding fees paid to regularize additional construction made in violation of municipal/corporation law were assessed for deductibility under s. 37, IT ... Payment of the compounding fees - claim for exemption u/s 37 - Whether, the Appellate Tribunal is right in law in holding that the payment of the compounding fees is not a penalty for infraction of law and hence allowable? Tribunal is not right in law in holding that the payment of the compounding fees is not a penalty for infraction of law and hence allowable - HELD THAT:- When the Explanation to section 37 of the Act defines that the expenditure incurred for any purpose which is an offence or which is prohibited by law is not entitled for deduction, it is not possible to take the view that the compounding of the offence or violation of the provisions of the Act, for the purpose of saving the offender of the law from the consequences of the commission of such an offence or violation of law should also be given the benefit of section 37 of the Act by permitting the assessee to pay the compounding fee as the fine. When the section is clear and unambiguous, it is not permissible for the courts to stretch the meaning attached to the provision of law to extend the benefit to a person who violates the law or the regulations/rules made by the corporation or the municipal authorities with impunity. Under these circumstances, the expenditure incurred to pay the penalty cannot be treated as loss in business to get the benefit. In our view, the penalty paid has enured to the benefit of the assessee to save the additional construction put up in violation of the provisions of the Act and bye-laws framed thereunder and also the consequences of penal provision provided under the Corporation or the municipal law. Therefore, we are clearly of the opinion that deduction permitted by the Commissioner as well as the Tribunal is totally unsustainable in law. Therefore, in the light of the above conclusion reached by us, the question referred to us by the Tribunal is required to be answered against the assessee and in favour of the Revenue. Accordingly, it is answered and this reference case is disposed of. Issues: Whether the Appellate Tribunal was right in law in holding that payment of compounding fees to regularise unauthorised construction is not a penalty for infraction of law and is therefore allowable as a deduction under section 37 of the Income-tax Act, 1961.Analysis: Section 37 of the Income-tax Act permits deductions for business expenditure but its Explanation declares that any expenditure incurred for any purpose which is an offence or which is prohibited by law shall not be deemed to have been incurred for the purpose of business or profession and no deduction shall be allowed. The Karnataka Municipal Corporation Act makes commencement or completion of construction without sanctioned plans an offence and empowers the Commissioner to compound such offences (including by bye-law 5.6.1 and clause (b) of section 483). Compounding permits regularisation or imposition of a compounding fine but does not erase the fact that an offence or infraction of law was committed. Precedents establish that sums paid because the taxpayer has acted in a manner rendering him liable to penalty or to evade statutory prohibitions are not deductible as commercial losses. The Explanation to section 37 (given retrospective effect) controls the deductibility inquiry and excludes expenditure incurred for offences even where municipal law permits compounding; reliance on pre-amendment decisions that treated regularisation payments as integral to profit-earning is not applicable to the post-Explanation position.Conclusion: The question is answered against the assessee and in favour of the Revenue: the compounding fee paid to regularise unauthorised construction is not an allowable deduction under section 37 of the Income-tax Act, 1961.