Compounding fine for unauthorised construction is not deductible as business expenditure where the payment relates to an offence.

Compounding fine paid for unauthorised construction of an additional floor was treated as expenditure incurred for an act that was an offence and prohibited by law. The Karnataka High Court noted that municipal compounding only regularises the violation on payment of a fine and does not change the nature of the payment for income-tax purposes. Applying the Explanation to section 37 of the Income-tax Act, the Court stated that expenses incurred for unlawful conduct cannot be allowed as business deduction, and the contrary pre-amendment authority was inapplicable after the retrospective amendment. The deduction was therefore disallowed.

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Issues: Whether compounding fine paid for unauthorised construction of an additional floor is allowable as business expenditure under section 37 of the Income-tax Act, 1961.

Analysis: The expenditure was incurred because the assessee constructed an eighth floor without a sanctioned plan, an act treated by the municipal law as a violation and an offence. The compounding provision under the municipal statute only permits regularisation of the offence on payment of a fine; it does not alter the character of the payment for income-tax purposes. The Explanation to section 37 of the Income-tax Act, 1961 excludes any expenditure incurred for a purpose which is an offence or prohibited by law from the scope of business deduction. Payments made to compound an offence or to avoid the consequences of unlawful construction therefore cannot be treated as expenditure laid out wholly and exclusively for business. The contrary view based on pre-amendment authority was held inapplicable in view of the retrospective Explanation to section 37.

Conclusion: The compounding fine was not allowable as a deduction; the question was answered against the assessee and in favour of the Revenue.

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