2016 (8) TMI 511 - HC - Income Tax

Court allows business expenditure for compensatory payment under Income Tax Act

M/s. SHYAM SEL LTD Versus DEPUTY COMMISSIONER OF INCOME TAX, CC XIII, KOLKATA

The court ruled in favor of the assessee, holding that the payment of Rs. 12,50,000/- was compensatory and, therefore, an allowable business expenditure ... Disallowance u/s 37 - compensating the damage to the environment - Held that:- The payment of the sum of ₹ 12,50,000/- would not be deductible if the same had been made for the purpose of achieving an illegal object or for an illegal purpose. Such payment is opposed to public policy which presumably is the reason why the same is not deductible. The payment in this case was for the purpose of compensating the damage to the environment and this compensation has been recovered on the “polluter pays principle” adopted by the Organization for Economic Cooperation and Development which has been recognized in M.C. Mehta Vs. Kamal Nath and Others [1996 (12) TMI 352 - SUPREME COURT] It is nobody’s case that the business pursued by the assessee was illegal. The compensation was paid because the assessee had failed to install the pollution control device within the time prescribed. Therefore, payment of the sum of ₹ 12,50,000/- is not hit by explanation-1 to Section 37 of the Income Tax Act. The payment is undoubtedly for the purpose of business or is in consequence of business carried on by the assessee and is thus covered by section 37. For the aforesaid reasons, the order passed by the learned Tribunal is set aside. - Decided in favour of assessee. Issues Involved:1. Disallowance of expenditure of Rs. 12,50,000/- incurred by the petitioner on account of payment of penalty.2. Interpretation of Section 37 of the Income Tax Act, 1961 concerning the disallowed expenditure.Detailed Analysis:Issue 1: Disallowance of Expenditure of Rs. 12,50,000/-The primary issue was whether the expenditure of Rs. 12,50,000/- incurred by the assessee due to the invocation of a bank guarantee by the West Bengal Pollution Control Board (WBPCB) should be considered an allowable expenditure. The assessing officer disallowed this expenditure, categorizing it as a penalty for non-installation of pollution control equipment, thus inadmissible. The CIT(A) reversed this decision, stating that the payment was made in response to a government order, not as a penalty. However, the Tribunal reinstated the assessing officer's decision, emphasizing that the amount was a penalty for failing to meet statutory obligations.Issue 2: Interpretation of Section 37 of the Income Tax Act, 1961The court had to determine if the expenditure fell under the purview of Section 37, which allows deductions for expenses incurred wholly and exclusively for business purposes, excluding those incurred for purposes that are an offense or prohibited by law. The Tribunal viewed the payment as a penalty, thus non-deductible under Section 37. However, the assessee argued that the payment was compensatory, not punitive, and hence deductible.Court’s Findings:- Nature of Payment:The court analyzed whether the payment was compensatory or punitive. The assessee contended that the payment was compensation for failing to install pollution control equipment on time, as per the performance guarantee, and not a penalty for an offense. The court referred to the Supreme Court judgment in M.C. Mehta Vs. Kamal Nath, which distinguished between fines (punitive) and damages (compensatory).- Legal Precedents:The court also considered a judgment from the National Green Tribunal, which highlighted that payments made under bank guarantees for compliance with environmental norms are compensatory, not punitive. This distinction is crucial as punitive payments are non-deductible under Section 37, whereas compensatory payments are deductible.- Application of Section 37:The court noted that under Section 37, expenses incurred for business purposes are deductible unless they are for an offense or prohibited by law. The court concluded that the payment in question was compensatory, aimed at addressing environmental damage, and thus did not fall under the exclusions of Section 37.Conclusion:The court set aside the Tribunal's order, ruling that the payment of Rs. 12,50,000/- was compensatory and, therefore, an allowable business expenditure under Section 37. The question formulated by the court was answered in the affirmative, favoring the assessee, and the appeal was allowed.