1996 (10) TMI 5 - SC - Income Tax

SC clarifies deductions: only compensatory s.8(2) MPGST payments allowed u/s37(1); s.17(3) penalties fully disallowed

SC held that payments made by the assessee under s. 8(2) of the Madhya Pradesh General Sales Tax Act contain both compensatory and penal elements. Only ... Claim for deduction of expenditure for the purpose of business u/s 37(1) - Whether, the penalty levied under sections 8(2) and 17(5) of the Madhya Pradesh General Sales Tax Act paid by the assessee is allowable expenditure in the computation of total income ? - HELD THAT:- Assessee, should he have used the raw material for a purpose other than that specified in sub-section (1), must pay an amount to be determined as stated in sub-section (2). That amount cannot be less than the difference between the amount of tax on the sale of such raw material at the full rate and the amount at the lesser rate by reason of sub-section (1). That amount also cannot be more than one and one-quarter times the amount of the tax at the full rate. Clearly, sub-section (2) comprises both the elements of compensation and penalty, compensation in so far as payment of tax at the full rate is obligatory, and something more, up to 25 per cent. thereof, is payable should the Commissioner so deem fit, having regard to the circumstances in which the use of the raw material was made : to that extent the amount would partake of the character of a penalty. Now, it does not appear from the record that there had at any stage been a bifurcation, if at all a bifurcation was required, of the amounts paid under the provisions of section 8(2) between the elements of compensation and penalty as aforesaid. This shall now have to be done and the assessee shall be entitled to the deduction under section 37(1) only in so far as the payments under section 8(2) partake of the element of compensation. The amounts payable under the provisions of section 17(3) of the Madhya Pradesh General Sales Tax Act are not allowable expenditure in the computation of total income. The amounts payable under the provisions of section 8(2) thereof are allowable expenditure in the computation of total income only in so far as they are compensatory in character. Appeals are allowed to the extent aforesaid. Issues:- Deductibility of penalty levied under sections of the Madhya Pradesh General Sales Tax Act as business expenditure under section 37(1) of the Income-tax Act, 1961.Analysis:The case involved appeals relating to the assessment years 1971-72, 1972-73, and 1973-74, where the assessee claimed deduction of expenditure for business purposes under section 37(1) of the Income-tax Act, 1961, for amounts paid to the Madhya Pradesh sales tax authorities under specific provisions of the Madhya Pradesh General Sales Tax Act, 1958. The Income-tax Appellate Tribunal initially allowed the deduction claimed by the assessee. However, the matter was referred to the High Court of Madhya Pradesh under section 256 of the Income-tax Act to determine the deductibility of penalties paid under the State statute.The key issue revolved around the interpretation of sections 17(3) and 8(2) of the Madhya Pradesh General Sales Tax Act. Section 17(3) dealt with penalties for non-compliance, empowering the Commissioner to levy penalties on dealers who fail to comply with statutory requirements without sufficient cause. The provision specified penalties not exceeding a certain percentage of the tax assessed or a fixed amount, depending on the circumstances. The court emphasized that Section 17(3) had penal consequences for non-compliance, devoid of any compensatory element, leading to the disallowance of deductions under section 37(1) of the Income-tax Act for penalties paid under this section.On the other hand, Section 8(2) addressed penalties for misuse of raw materials, requiring dealers to pay penalties determined based on the variance between the full tax rate and the rate applicable under sub-section (1). The section allowed penalties up to one and one-quarter times the full tax rate, with the Commissioner having discretion to determine the exact penalty amount based on the circumstances of the misuse. The court noted that Section 8(2) encompassed both compensatory and penal elements, with penalties being applicable in certain situations.The court highlighted the necessity of segregating the amounts paid under Section 8(2) into compensatory and penal components to determine the deductibility under section 37(1) of the Income-tax Act. It was ruled that deductions would be allowed only for the compensatory portion of the payments made under Section 8(2), emphasizing the importance of distinguishing between compensation and penalty components when claiming business expenditure deductions.In conclusion, the court held that amounts payable under Section 17(3) of the Madhya Pradesh General Sales Tax Act were not allowable as business expenditure for tax purposes. However, payments made under Section 8(2) were deemed deductible only to the extent that they represented compensatory payments. The appeals were allowed in part, with no specific order as to costs, thereby providing clarity on the deductibility of penalties under the respective sections of the State statute for income tax assessment purposes.