Compensatory settlement payment for civil patent claims was deductible as business expenditure, not hit by the prohibition on offence-related .

A payment made under a bona fide out-of-court settlement of civil patent infringement claims was treated as compensatory, not penal, and therefore was allowable as business expenditure under section 37(1) of the Income-tax Act, 1961. The settlement was entered into to avoid the expense and uncertainty of foreign litigation, and the compromise merely recorded resolution of civil disputes without any finding that the assessee had committed an offence or violated patent law. Because the nature of the payment, not its label, governs deductibility, and patent remedies are civil in character, the expenditure was not hit by the Explanation to section 37(1).

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Issues: Whether payment made under an out-of-court settlement for alleged patent infringement was hit by the Explanation to section 37(1) of the Income-tax Act, 1961 and whether such payment was deductible as business expenditure.

Analysis: The settlement was entered into to avoid the expense and uncertainty of foreign litigation and the agreement itself showed that the payment was made to resolve civil claims and terminate disputes. No court had recorded a finding that the assessee had committed an offence or violated patent law. The payment was treated as compensatory rather than penal in character. In matters of patent infringement, even the statutory remedies are civil in nature and provide for damages or account of profits, not penal consequences. Applying the principle that the nature of the impost, and not its label, determines deductibility, the payment was held to be purely compensatory and commercially motivated. A compromise decree merely records the parties' settlement and does not amount to a judicial finding of wrongdoing.

Conclusion: The expenditure was not for any purpose that was an offence or prohibited by law and was allowable as business expenditure under section 37(1) of the Income-tax Act, 1961.

Ratio Decidendi: A payment made in bona fide settlement of civil patent claims, being compensatory and commercially expedient and not established as penal or for an offence prohibited by law, is deductible under section 37(1) of the Income-tax Act, 1961.

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