2016 (4) TMI 653 - HC - Income Tax

Revenue's appeal on breach of contract penalty dismissed as compensatory, not penal.

The appeal by the revenue challenging the deletion of a penalty for breach of contract by the Income Tax Appellate Tribunal was dismissed. The Tribunal ... Claim for deduction under section 37(1) - payment to Exide Technologies by way of reimbursement as Exide Technologies was required to pay such amount to Deramic Group on account of the default on the part of the assessee - Held that:- As what the assessee had paid to Exide Technologies was with a view to compensate the holding company for the amount which it was required to pay to Deramic Group on account of the breach committed by the assessee of the conditions of the agreement between Exide Technologies and Deramic Group. The amount paid by the assessee is not penal in nature, but compensatory in nature and hence, the above decision of the Supreme Court in the case of Prakash Cotton Mills P. Ltd. v. Commissioner of Income Tax, (1993 (4) TMI 3 - SUPREME Court], on the contrary, supports the case of the respondent assessee. - Decided in favour of assessee Issues:Challenge to order deleting penalty for breach of contractAnalysis:1. The appellant, the revenue, challenged the order of the Income Tax Appellate Tribunal (ITA) deleting the addition of penalty for breach of contract. The main issue was whether the Tribunal erred in upholding the deletion of the penalty amount of Rs. 65,52,000 added by the Assessing Officer.2. The case involved a contract between Exide Technologies Inc. and Deramic Group for the purchase of battery separators. The respondent assessee, a group company of Exide, purchased batteries from another entity, leading to a penalty imposed by Deramic Group. The Assessing Officer added this penalty amount to the total income of the assessee, which was later deleted by the Commissioner of Income Tax (Appeals) and upheld by the Tribunal.3. The appellant contended that the assessee was not a party to the contract and should not have reimbursed the penalty amount. It was argued that the expenditure was not of a nature a prudent businessman would incur and that the Transfer Pricing Officer's acceptance was irrelevant. The appellant claimed the amount should be added to the total income.4. The Tribunal found that the penalty was a commercial penalty resulting from a breach of contract, compensating Exide Technologies. The expenditure was claimed under section 37 of the Income Tax Act, which allows deductions for expenses laid out wholly and exclusively for business purposes. The Tribunal concluded that the penalty was compensatory, not penal, and therefore deductible.5. Referring to the Supreme Court decision in Prakash Cotton Mills P. Ltd. v. CIT, it was established that statutory imposts claimed as allowable expenditure under section 37(1) should be examined for compensatory or penal nature. In this case, the penalty paid by the assessee to Exide Technologies was compensatory, not penal, as it aimed to compensate for the breach of contract.6. The Tribunal found no legal infirmity in its order, stating that no substantial question of law arose for consideration. Consequently, the appeal by the revenue was dismissed, upholding the Tribunal's decision to delete the penalty amount from the assessee's total income.