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 contractual deadlines. AO disallowed the deduction treating it as contravention of law and prior period expense. ITAT held that breach of contract damages cannot be equated with legal offences, citing Gujarat HC precedent in PCIT vs. Mazda Ltd. The damages crystallized in the assessment year, not being prior period expenses. ITAT also dismissed revenue's appeal on section 80-IA(7) disallowance since no deduction was claimed by assessee.

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Issues:
1. Disallowance of damage charges paid to NHAL
2. Allowance of deduction under section 80-IA(7) of the Act

Issue 1: Disallowance of damage charges paid to NHAL

The 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 Act

The 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.

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