TaxTMI 
TaxTMI 
2008 (1) TMI 62
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....l matrix. A partner of the assesseefirm visited Germany where he entered into a contract for supply of certain goods of a particular value. The agreement so arrived at, however, could not be acted upon by the assessee as it did not have the requisite import licence for the material intended to be imported. The dispute was referred to an arbitrator. In terms of the award of the Arbitration Tribunal, rendered on 29.7.1974, the assessee paid a sum of Rs. 50,000/- to the German-firm, M/s. Duestsche Strahil Metail of Berlin, for failure to perform its part of the contract. Accordingly, the assessee in its return for the assessment year 1975-76, claimed deductions of the aforesaid amount as business expenseson account of damages for breach of contract. 3. The Assessing Officer had initially allowed the amount of Rs. 50,000/- as deductions out of the total income. But lateron, a notice was issued to the assessee under Section 148 of the Income Tax Act, 1961 (for short "the Act") on the strength of a plea that the jurisdictional High Court in Cineramas vs. Commissioner of Income Tax, Amritsar-I (1977) 110 ITR 762 had held that infractions of law, including breach....
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....nch. The exact words by which the matter came to be referred are indicated here-in-below just with a view to make explicit on record as to how the question has come up for consideration by the Full Bench. These are: "In our opinion, there is direct conflict between the two decisions of co-ordinate Benches in Indo Switch-Gears (P) Ltd. [1996]222 ITR 772 [P&H] and M/s. Baldev Singh Kanwar's case[1997] Indian Taxation Reports 640(P&H) which deserves to be resolved by a larger Bench. Accordingly, we direct the Registry to place the papers of this case before Hon'ble the Chief Justice for constituting a larger Bench to decide the controversy arising in this reference." 8. It would be manifest from the above that the spinal issue which arises here is, whether an assessee who pays certain amount by way of damages for breach of contract is entitled to have said expenditure allowed to be deducted from the income. In other words, can the aforesaid expenditure be termed as amount expended wholly and exclusively for business purposes within the meaning of Section 37(1) of the Act? 9. With this background, a reference may be made to specific provisions of Section 37(1....
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....deduction if it is in the ordinary course of the business, and is not opposed to the public policy. 13. A penalty imposed for breach of any law during the course of trade etc. cannot be described as a commercial loss. If an assessee while conducting his business has acted in an unlawful manner which has rendered him liable to penalty, the sum so paid cannot be claimed as a deductible expense. Infraction of the law is not a normal incident of business and, therefore, no expense which is paid by way of penalty for a breach of law is admissible deduction. In cases where a penalty has to be incurred, for the reason of the assessee having carried on business in an unlawful manner or in contravention of certain rules and regulations, such penalty could not be regarded as 'wholly and exclusively' laid out for the purposes of business as the expense has not been necessitated by the business but by the conduct of the assessee in trying to carry out the business in an unlawful manner. Under Section 37(1), only that portion of such payment having composite nature which is attributable to its compensatory character for payment as damages is to be allowed as a deduction. The other portion wh....
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....contravention of law is inadmissible. 17. We may now refer to cases adjudicated by the jurisdictional High Court. In Commissioner of Income Tax, Punjab v. Himalaya Rosin- Turpentine Manufacturing Company, (1953) 24 ITR 132, a Division Bench of this Court was considering the case of an assessee who was carrying the business of extracting rosin from forest leased for that purpose and had entered into an agreement for extracting rosin according to certain terms and conditions and in the eventuality of failure to observe the same, he was liable to pay penalty/fine. The assessee having contravened the terms of the lease was saddled with fine of Rs. 5,000/- which was paid to the State. The said claim was disallowed because it was found that the payment concerned was made towards penalty imposed for breach of the rules under which the assessee was extracting rosin. The aforesaid view was adhered to by another Division Bench of this Court in cineramas (1977) 110 ITR 762. 18. In Commissioner of Income-Tax v. Murari Lal Ahuja and sons (1989) 177 ITR 228, while considering the case of damages for breach of contract, this Court held that if the amount is expended as pay....
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....e of the assessee. This Court while interpreting Section 37(1) of the Act concluded that the amount paid was not on account of any infraction of law but was by way of damages for breach of contract and was thus compensatory in nature. It was also concluded that the said amount would entitle the assessee for deduction under Section 37(1) of the Act. This Court after referring Cinaramas's [1977] 110 ITR 762case and Murari Lal Ahuja and sons' case [1989] 177 ITR 228 (p&h) observed as under:- ( page 792 of 222 ITR ) "A question about such deductibility also came up for examination before this Court in CIT v. Murari Lal Ahuja and Sons (1989) 177 ITR 228. That was a case where the assessee, who carried on the business of sale of cotton, was unable to fulfil a contract of supplying cotton to the mills and, therefore, settled the dispute by paying them a sum of Rs., 48,158/-. The Income-Tax Officer disallowed the payment holding it to be a speculative transaction in terms of section 43(5) of the Act. The Tribunal, however, took the view that payment had been made due to abnormal circumstances for the reason that the assessee had flouted the agreement of sale to save himself from a....