2023 (11) TMI 858 - AT - Income Tax

Breach of contract damages allowed as business deduction, not treated as legal contravention

ITAT Ahmedabad dismissed revenue's appeal regarding compensation paid for breach of contract. The assessee paid damages to NHAL for failing to meet ... Deductibility of liquidated damages as business expenditure under residuary provision of section 37(1) - Explanation to section 37(1) - expenditure incurred for an offence or prohibited by law - Year of crystallization of expenditure - allowable in the year in which liability crystallizes - Verification of claimed deduction - absence of claim under section 80-IA(7)Deductibility of liquidated damages as business expenditure under residuary provision of section 37(1) - Explanation to section 37(1) - expenditure incurred for an offence or prohibited by law - Year of crystallization of expenditure - allowable in the year in which liability crystallizes - Whether damages paid to NHAL for breach of contract are deductible as business expenditure and whether they relate to an earlier year - HELD THAT: - The Tribunal held that the amounts paid were liquidated damages arising from breach of contractual obligations and were not payments for an offence or for anything prohibited by law; hence they do not fall within Explanation 1 to section 37(1) and are capable of being claimed as business expenditure under section 37. The Court applied the crystallization principle: since the liability for damages crystallized in the year under consideration (as supported by correspondence from NHAL), the expenditure is allowable in that year and is not a prior period expense. Reliance was placed on analogous authority of the Gujarat High Court that liquidated damages are not disallowable under section 37(1). On these grounds the Tribunal found no infirmity in the CIT(A)'s deletion of the addition. [Paras 8, 9]Damages paid to NHAL were deductible as business expenditure in AY 2018-2019; the addition was deleted.Verification of claimed deduction - absence of claim under section 80-IA(7) - Whether any deduction under section 80-IA(7) was claimed by the assessee and whether disallowance was warranted - HELD THAT: - The Tribunal accepted the assessee's submission and the finding of the CIT(A) that no deduction under section 80-IA(7) had been claimed. Consequently, there was no basis for the AO to make any disallowance in respect of section 80-IA(7); the AO was directed to verify records and delete the addition if the contention was found correct. The Revenue did not controvert the CIT(A)'s finding. [Paras 10, 11, 12]No disallowance under section 80-IA(7) was sustained; the ground of appeal was dismissed.Final Conclusion: Both grounds of the Revenue's appeal were dismissed: the Tribunal upheld the CIT(A)'s allowance of the liquidated damages as deductible business expenditure in AY 2018-2019, and accepted that no deduction under section 80-IA(7) had been claimed, leaving no basis for disallowance. Issues:1. Disallowance of damage charges paid to NHAL2. Allowance of deduction under section 80-IA(7) of the ActIssue 1: Disallowance of damage charges paid to NHALThe Revenue appealed against the order of the Learned Commissioner of Income Tax (Appeals) regarding the disallowance of damage charges paid to NHAL. The Assessing Officer disallowed the deduction of the expenditure claimed by the assessee, considering it as penalty and pertaining to an earlier year. However, the Ld. CIT(A) deleted the disallowance, stating that the damages were compensatory in nature, not in violation of law, and allowable as business expenditure. The Ld. CIT(A) relied on Circular No. 722 dated 23/12/1998 and the decision in Kanona Chemicals & Industries Ltd. vs. CIT (1995) to support the allowance of damages crystallized in the current year. The Revenue, being aggrieved by this decision, appealed.The Appellate Tribunal noted that the penalty was paid due to breach of contract, not for an offense or something prohibited by law. Citing the case of PCIT vs. Mazda Ltd., it was held that deduction on account of liquidated damages cannot be disallowed under section 37(1) of the Act. The Tribunal found that the expenditure was incurred for normal business activity and not for any illegal purpose. Additionally, the amount of damage crystallized in the current year, as evidenced by letters from NHAL. Therefore, the Tribunal dismissed the appeal of the Revenue, upholding the order of the Ld. CIT(A) regarding the allowance of the damage charges paid to NHAL.Issue 2: Allowance of deduction under section 80-IA(7) of the ActThe Revenue raised an issue regarding the allowance of deduction under section 80-IA(7) of the Act. The Ld. CIT(A) noted that the appellant had not claimed any deduction under this provision. The Ld. CIT(A) directed the Assessing Officer to verify this claim from records and delete the addition if found correct. The Ld. DR representing the Revenue could not dispute this finding. The Tribunal concurred with the Ld. CIT(A)'s decision, stating that since no deduction was claimed under section 80-IA of the Act, there was no basis for disallowance. Consequently, the Tribunal dismissed the appeal of the Revenue on this issue as well.In conclusion, the Appellate Tribunal upheld the decision of the Ld. CIT(A) regarding both issues raised by the Revenue. The appeal filed by the Revenue was dismissed, and the order was pronounced in the Court on 31/10/2023 at Ahmedabad.