Business loss from contractual penalty for defective supply is allowable in computing profits, not as deduction expenditure.

A penalty recovered for supplying paddy not according to specification was treated as a business loss because it arose directly from performance of the assessee's contractual trading activity and was integrally connected with the carrying on of the business. The proper inquiry was under section 10(1) in computing business profits, not as a deduction under section 10(2)(xv). The amount was therefore allowable in business income, even though it was not deductible as expenditure under section 10(2)(xv).

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Issues: Whether the amount recovered by the Government as penalty for supply of paddy not according to specification was deductible in computing business income, and whether the claim fell for consideration under section 10(1) rather than as a deduction under section 10(2)(xv) of the Income-tax Act, 1922.

Analysis: The penalty arose directly from the assessee's business of supplying paddy under a contractual obligation to supply goods of a specified quality. The loss resulted from performance of the business contract and was therefore integrally connected with the carrying on of the business. The proper approach was not to treat the amount as a deductible expenditure under section 10(2)(xv), but to determine whether it was to be excluded in computing business profits under section 10(1). The payment was not a loss divorced from the business activity, but one arising in the course of that activity.

Conclusion: The amount was allowable as a business loss under section 10(1) and the assessee succeeded, though not on the footing of deduction under section 10(2)(xv).

Ratio Decidendi: A loss or penalty incurred in direct and integral connection with the carrying on of business is to be considered in computing business profits under section 10(1), even if it is not deductible as an expenditure under section 10(2)(xv).

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