Contractual breach payment treated as business loss where liability accrued and was ascertained under mercantile accounting

Payments made for breach of a contractual export-obligation condition attached to trade mark use were treated as business expenditure incidental to the assessee's trade, not as penalties for statutory infraction. Because the liability arose on default during the relevant year, was quantified annually, and had accrued under the mercantile system, it was regarded as an ascertained liability rather than a contingent one. The resulting commercial loss was therefore deductible under section 28(1) of the Income-tax Act, 1961, and the contention that the claim was only contingent was rejected.

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Issues: Whether the amounts paid by the assessee as penalty for shortfall in export obligation under the trade mark conditions were deductible as business loss under section 28(1) of the Income-tax Act, 1961, and whether such liability was contingent or an ascertained liability.

Analysis: The payments were made under the conditions attached to the use of the trade mark and were contemplated by the parties as part of the commercial arrangement. They were not penalties for infraction of any statutory provision and did not involve any illegality or public policy prohibition. The liability arose on default during the relevant year, was quantified annually, and became an accrued and ascertained liability. Since the assessee followed the mercantile system, the loss was deductible when it accrued. The payments were held to be incidental to the carrying on of the business and constituted a commercial loss.

Conclusion: The deduction was allowable under section 28(1) of the Income-tax Act, 1961, and the contention that the liability was merely contingent was rejected.

Ratio Decidendi: A payment made for breach of a contractual business condition, where the breach is contemplated by the commercial arrangement and the liability has accrued and is ascertained, is deductible as a trading loss under section 28(1) if it is incidental to the business and not a penalty for statutory infraction.

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