PCIT vs. Sushil Gupta Legal Representative of Late Mahabir Prasad Gupta (Bombay High Court)

IN THE HIGH COURT OF JUDICATURE AT BOMBAY
O.O.C.J.
INCOME TAX APPEAL NO. 51 OF 2016
WITH
NOTICE OF MOTION NO. 797 OF 2018
IN
NOTICE OF MOTION NO. 1975 OF 2016
IN
INCOME TAX APPEAL NO. 51 OF 2016
The Principal Commissioner of
Income Tax -17,
Mumbai. .. Appellant
Versus
Sushil Gupta
Legal Representative of Late
Shri. Mahabir Prasad Gupta
A.Y. 1988-99
PAN : AALPG1065E
.. Respondent
……………….
•Mr. Prakash Chandra Chhotaray for the Appellant
•Mr. Vikram Nankani, Senior Counsel with Mr. S.L. Shah i/by M/s.
Shah Legal for the Respondent
……………….
CORAM : AKIL KURESHI &
B.P. COLABAWALLA, JJ.
RESERVED ON : FEBRUARY 13, 2019.
PRONOUNCED ON : FEBRUARY 22, 2019 at
2.45 P.M. IN CHAMBER
ORAL JUDGMENT (Per Akil Kureshi, J.)
1. This appeal was admitted for consideration of following
substantial question of law:-
” Whether on the facts and in the circumstances of the case
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and in law, the Tribunal was justified in holding that the
redemption fine of Rs. 75,00,000/- is allowable as business
expenditure under Section 37 of the Income Tax Act?”
2. The appeal arises in following background:-
2.1 Respondent assessee is an individual. For the
assessment year 1988-89, the assessee had filed return of
income declaring total income of Rs. 1,47,020/-. The return
was accepted without scrutiny. Subsequently, information
was received by the Assessing Officer that the assessee had
made payment of Rs. 75 lacs in two separate installments
towards penalty for import of almonds which import was not
permissible. On the basis of such information, the Assessing
Officer reopened the assessment for the said assessment
year 1988-89 by issuing the notice under Section 148 of the
Income Tax Act, 1961 (“the Act” for short).
2.2 During the course of such assessment proceedings, the
assessee was called upon to provide various details by the
Assessing Officer. The representative of the assessee
remained present before the Assessing Officer and conveyed
that the assessee was using import license of M/s. Rajnikant
Bros. which is an export house. For using the license, the
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assessee would pay service charges equivalent to 25% of CIF
value of the goods. It was further pointed that the
consignment of almond was imported by M/s. Rajnikant Bros.
The assessee had merely acted as an agent in the
transaction. It was pointed out that upon confiscation of the
goods, redemption fine and penalty were imposed by the
Collector of Customs, Madras on M/s. Rajnikant Bros.
Tribunal in the appeal reduced the redemption fine to Rs. 75
Lacs and deleted personal penalty. It was contended that in
any case, the imports were made by M/s. Rajnikant Bros. and
the order was passed against M/s. Rajnikant Bros. and not
against the assessee. It was also contended that the penalty
was paid by M/s. Rajnikant Bros. and not by the assessee.
The assessee, however, could not produce the books of
accounts to establish this averment. The Assessing Officer,
therefore, issued summons to M/s. Rajnikant Bros. asking for
a copy of the agreement dated 14.10.1985 entered between
the assessee and M/s. Rajnikant Bros. for the use of import
licence and other details. In response to the summons, the
accountant of M/s. Rajnikant Bros. appeared before the
Assessing Officer. A copy of the said agreement dated
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14.10.1985 was produced. The procedure attached to the
agreement was also produced. The statement of the
accountant of M/s. Rajnikant Bros. was recorded. Relevant
portion of which reads as under:-
“Q. No. 4 : What is the modus operandi of the transaction
made by Shri. M.P. Gupta regarding the use of
licence?
Ans. : Mr. M.P. Gupta has imported almonds in Madras
Port on 20.12.195 by using the above said licence.
The said material imported in the name of M/s.
Rajnikant Bros. Total consideration of import material
along with duty, fine, foreign payment and clearing
charges etc. are as under:-
Purchases Rs.
i. Foreign payment 55,65,487.23
ii. Duty 56,00,000.00
iii. Redemption Fine (Penalty) 75,00,000.00
(As per Madras Customs Order dt.
27.10.86)
iv. Clearing Charges & Expenses 15,72,487.10
v. Service Charges of M/s. Rajnikant Bros. 12,50,000.00
(As per Agreement dt. 14.10.85) ————————-
Total Rs. 2,14,87,974.33
==============
Q. No. 5 : As stated by you redemption fine of Rs. 75,00,000/-
paid to Madras Customs House. Please state who
has paid the sum:
Answer : Rs. 75,00,000/- paid as custom fine by Mr. M.P.
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Gupta through Rajnikant Bros. from Banoue
Indosuez P. Box 685 A/c No. 11124 201 5301. All
transactions were made by Shri. M.P. Gupta hence, he
is responsible for the above fine. As per agreement,
we are only related for our service charges.”
2.3 The Assessing Officer confronted the assessee
with the factum of payment of penalty of Rs. 75 Lacs. The
assessee in a written response dated 28.2.1997 contended
that he had only made advances to M/s. Rajnikant Bros from
time to time as per the requirements but had not paid
penalty of Rs. 75 Lacs.
2.4 The Assessing Officer did not accept the said
explanation particularly in view of the failure of the assessee
to produce books of accounts. He was also of the opinion
that the stand of the assessee was in conflict with the
agreement dated 14.10.1985. He did not accept the
assessee/s version of mere advances being made to M/s.
Rajnikant Bros. He, therefore, held as under:-
” All the above facts clearly established that the assessee viz.
Shri. M.P. Gupta, user of the licence standing in the name of M/s.
Rajnikant Bros., has made the custom penalty of Rs. 75,00,000/-. I,
therefore, treat that this expenditure is covered u/S. 69C of the Act
and has been incurred by the assessee from unexplained source of
which the assessee has no explanation about the source nor the
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assessee offered any satisfactory explanation. The penalty
proceedings u/S. 271(1)(c) is being initiated separately.”
2.5 The assessee carried the matter in appeal and
reiterated his stand. In the context of the addition under
Section 69C of the Act, the Commissioner rejected the
assessee’s plea by making following observations:-
” As regards addition u/S. 69C, the appellant has claimed that
payment was made through funds arranged by the assessee through
M/s. Mangla Bros and debited to M/s. Rajnikant & Bros accounts.
The copy of the confirmation filed by M/s. Mangla Bros. as a
Certificate dated 24.11.1997 it states that payments have been made
to Collector of Customs, M.P. Gupta account, M/s. Rajnikant & Bros.
which gives DD No., date, amount and name of the party to whom
payment was arranged. The Certificate does not carry any PAN/GIR
No. of M/s. Mangla Bros. and thus, itself of limited validity. In the
absence of books of account and a valid confirmation the source of
expenditure is not satisfactorily explained and the payment is liable to
be treated as unexplained expenditure u/s 69C of the Act.”
2.6 The assessee had raised additional contention
that when the expenditure was attributed to the assessee,
the same should be considered as business expenditure. In
this context, the question of such expenditure incurred for
any purpose which is an offence or which is prohibited by law
came up for consideration. The assessee had raised
additional contention, though grounds of appeal were
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confined to questioning the additions made by the Assessing
Officer under Section 69C of the Act. The Commissioner of
Income Tax (Appeals) [“the CIT(A) for short], therefore,
considered whether the expenditure was in the nature of
compensatory expenditure or towards fine in contravention
of law. The CIT(A) while rejecting this contention, observed as
under:-
” The appellant’s plea is that the expense is allowable as a cost u/S.
37 in accordance with case laws cited. It is found that after
considering the judgments of the Bombay High Court in (a) CIT Vs.
Pannalal Narottamdas & Co (supra) which laid down that redemption
fine is additional cost for the goods purchased and (b) the judgment
in Rohit Pulp & Paper Mills Vs. CIT (1995) 215 ITR 919/79 Taxman
168 (Bom), where also there was confiscation of goods u/s. 111(d) of
the Customs Act and a fine was paid u/s. 125 of the Customs Act,
and the High Court held that payment was in the nature of penalty,
the ITAT, Mumbai in Dimexon’s case (supra) has held that where the
penalty / fine has to be incurred because of the fault of the assessee
himself, i.e, carrying on of business in an unlawful manner or in
contravention of certain rules and regulations, the penalty / fine paid
cannot be regarded as wholly laid out for the purpose of business.
Thus, in the face of the specific findings of the Custom Tribunal and
Madras High Court, the appellant’s contention is without force.”
2.7 The assessee carried the matter in further appeal
before the Tribunal. In such appeal, the assessee raised both
the contentions. In addition to questioning the very addition
of Rs. 75 Lacs under Section 69C of the Act, he also
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challenged the decision of the CIT(A) not accepting the
contention that in any case, the expenditure was made
wholly and exclusively for the the purpose of business and
therefore, allowable as business expenditure.
2.8 The Tribunal, in the impugned judgment, referred
to the documents under which the import of almond was
held to be unlawful. The Tribunal noted that the Collector of
Customs, Madras had confiscated the goods, imposed
redemption fine 1.20 crore and penalty of Rs. 20 lacs on M/s.
Rajnikant Bros. Ms/. Rajnikant Bros. had filed appeal before
the Customs Tribunal, Madras which had reduced redemption
fine to Rs. 75 Lacs and deleted the penalty. The Tribunal,
while allowing the appeal of the assessee and recognizing
the expenditure as business expenditure came to following
conclusions:-
(i). The assessee and the Export House were under bonafide
belief that the almond in shell was one of the items allowed for
import against additional licence granted;
(ii). That the Customs Tribunal had held that there was no malafide
on the part of the assessee as there was certain amount of
vagueness in the import policy and therefore, redemption fine
was reduced and penalty was deleted;
(iii). The Tribunal noted the decision of the Supreme Court in the
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case of CIT V/s. Ahmedabad Cotton Mfg. Co Ltd.1 and was of
the opinion that the facts of the present case were similar.
The Tribunal noted that in the said case, it was found that the
fault or defect in the REP licence was not attributable to the
assessee. The assessee was not to be blamed,had not
indulged in any offence or incurred any expenditure for the
purpose which is prohibited by law and the assessee had to
pay redemption fine in order to save and protect themselves.”
2.9 Against this judgment, the Revenue has filed this
appeal.
3. Mr. Chhotaray, learned counsel appearing for the
Revenue submitted that the amount of Rs. 75 Lacs paid by
the assessee was towards redemption fine. In terms of
Explanation 1 to Section 37(1) of the Act, such expenditure
was not an allowable deduction. The Tribunal, therefore,
committed serious error in allowing the assessee’s appeal.
He took us extensively through the orders and statements on
record and submitted that the Assessing Officer and CIT(A)
came to the specific conclusion that it was the assessee who
had made the imports and had, therefore, paid the
redemption fine. The Tribunal without any basis came to the
conclusion that the assessee was not connected with the
import of almond which led to imposition of redemption fine.
1 [1994] 205 ITR 163 (SC)
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He submitted that the judgment of the Supreme Court in
case of Ahmedabad Cotton Mfg. Co. Ltd. (supra) was
therefore, wrongly applied by the Tribunal. Learned counsel
heavily relied on the decision of the Supreme Court in the
case of Haji Aziz & Abdul Shakoor Bros. Vs. CIT2.
Learned counsel for the Revenue has also relied on certain
decisions reference to which would be made at proper stage.
4. On the other hand, Mr. Nankani opposed the appeal
contending that the assessee was not an importer. The
imports were made by M/s. Rajnikant Bros. The assessee
had merely entered into an agreement with M/s. Rajnikant
Bros. for purchase of imported almond which in turn would
be sold by the assessee to local consumers / manufacturers
for commission. The sum of Rs. 75 Lacs was thus paid to
prevent the imported consignment being forfeited. The
expenditure was thus made on business considerations.
Sum of Rs. 75 Lacs thus, was an additional cost of purchase
in the hands of the assessee. In the hands of the assessee, it
would not partake the character of penalty. He placed
reliance on the decision of this Court in the case of CIT,
2 41 ITR 350 (SC)
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Bombay Vs. Pannalal Narottamdas & Co3. He also
referred to several other judgments reference to which would
be made at proper stage.
5. Before dealing with the rival contentions, we may
record the genesis of the present dispute. M/s. Rajnikant
Bros. and another who were diamond exporters had applied
for grant of Export House Certificates under the Import Policy
1978-79 which was denied to them on the ground that they
had not diversified their exports. They had, therefore, filed
writ petition before the Bombay High Court claiming that
they were entitled to Export House Certificates. Such
declaration was granted by the Bombay High Court. Special
Leave Petition filed by the Union of India against the
judgment of the Bombay High Court was dismissed directing
the Government of India to issue necessary Export House
Certificates for the year 1978-79 and further providing that :
“Save and except items which are specifically banned under
the prevalent Import Policy at the time of import, the
respondents shall be entitled to import all other items
whether canalized or otherwise in accordance with the
3 (1968) 67 ITR 667 (Bom)
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relevant rules”. Pursuant to such directions, M/s. Rajnikant
Bros. were granted additional licence. It started importing
goods. At that stage, Indo Afghan Chambers of Commerce
who was the association of dealers engaged in the business
of selling dry fruits in North India filed a petition before the
Supreme Court under Article 32 of the Constitution
contending that the goods sought to be imported on the
additional licences included those which were prohibited by
the prevalent import policy. The Supreme Court held that
under the import policy of 1985-88 when the dry fruits were
sought to be imported, they were no longer open to import
under the Open General Licence. Relevant observations of
the Supreme Court read thus:-
“7. We may assume for the purpose of this case that a diamond
exporter is legitimately entitled to obtain an Additional Licence under
the Import Policy 1978-79 for an item which is different from the item
he may have intended to import had the Additional Licences been
rightly granted to him originally. In that event, the diamond exporter
can succeed only if the item could have been imported under the
Import Policy 1978-79 and also under the Import Policy 1985-88 in
accordance with the terms of the order of this Court dated April 18,
1985 as construed by this Court by its judgment dated March 5,
1986.
12. In our opinion the respondents diamond exporters are not
entitled to import dry fruits under the Import Policy 1985-88 under the
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Additional Licences possessed by them. They are also not entitled to
the benefit extended by the judgment of this Court dated March 5,
1986 to those diamond exporters who had imported items under
irrevocable Letters of Credit opened and established before October
18, 1985. It appears from the record before us that the respondents
diamond exporters opened and established the irrevocable Letters of
Credit after that date.
14. The writ petition is allowed and the respondents Nos. 10 and
11, M/s. Rajnikant Brothers and M/s. Everest Gems are restrained
from importing dry fruits during the period 1985-88 under the
Additional Licences granted to them under the Import Policy 1978-79.
In the circumstances there is no order as to costs.”
With this background, we may refer to the facts on
hand. As noted, the Assessing Officer in the order of
assessment after giving ample opportunities to the assessee
came to the conclusion that the assessee M.P. Gupta was the
user of the licence in the name of M/s. Rajnikant Bros. and all
transactions including the payment of penalty had been
carried out by him. He did not accept the version of the
assessee that the assessee had merely advanced the money
to M/s. Rajnikant Bros. in time of its need. It was held that
the assessee had paid the customs fine of Rs. 75 Lacs.
Since, it could not shown the legitimate source of this
amount, the Assessing Officer treated the same as
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assessee’s unexplained expenditure. Before the CIT(A) also,
the assessee failed to persuade the Appellate Authority that
the addition under Section 69C of the Act was wrongly
made by the Assessing Officer. At which time, the petitioner
raised additional contention claiming deduction of the same
amount by way of business expenditure. In response to this,
the CIT(A) held that the penalty or fine had to be incurred
because of the fault of the assessee himself of carrying on
business in unlawful manner or in contravention of the rules
and regulations.
6. In our opinion, the Tribunal without adverting to the
relevant facts and materials on record granted benefit to the
assessee on the lines followed by this Court in the case of
Pannalal (supra). The Tribunal without discussing the
relevant materials compared the case of the assessee with
the facts arising in the judgment of the Supreme Court in the
case of Ahmedabad Cotton Mfg Co Ltd (supra) in which it was
recorded that the fault or defect in the REP licence was not
attributable to the assessee and therefore, the assessee was
not to be blamed for indulging in any offence or having
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incurred any expenditure for the purpose which was
prohibited by the law. In the present case, the Assessing
Officer had held that it was the assessee who had imported
the goods. The CIT(A) also largely concurred with this
finding. The Tribunal did not advert to the materials on
record to give a different conclusion. The Tribunal totally
ignored the statement of the representative of M/s. Rajnikant
Bros., relevant portion of which is reproduced earlier in which
he attributed the entire transaction of import and payment or
fine to the assessee. The Tribunal merely referred to the
terms of the agreement overlooking the ground realities.
The entire consideration of the Tribunal, therefore, has been
vitiated on account of this vital error. Even otherwise, the
facts on record would suggest that it was the assessee who
had imported the goods by utilizing the advance licence of
said M/s. Rajnikant Bros. M/s. Rajnikant Bros. merely
received payment computed in terms of percentage of CIF
value of the imports. For the purpose of making declarations
and filing bill of entries, M/s. Rajnikant Bros. may be the
correct entity and therefore, the Customs Authorities might
have offered redemption fine and imposed penalty on M/s.
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Rajnikant Bros and the Tribunal in the appeal may have
reduced the redemption fine and deleted the penalty in the
hands of M/s. Rajnikant Bros, but in the context of income tax
liability, we cannot ignore the hard facts that the imports
were made by the assessee himself. M/s. Rajnikant Bros. had
merely allowed the licence to be used for such purpose. In
essence,therefore, whatever the fault, defect or error of law
in such import, would attach to the assessee. In the context
of considering whether the expenditure incurred in the
process of importing the goods could be claimed by way of
expenditure regard being had to the first explanation to subsection
(1) of Section 37, would therefore have to be decided
on the anvil of this conclusion.
7. Once this much is clear, everything else would fall in
line. There is a clear line of distinction between two lines of
authorities, one led by the judgment of the Supreme Court in
the case of Hazi Aziz (supra) and the other adopted by this
Court in the case of Pannalal (supra) as pointed out by
learned counsel for the assessee.
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8. In case of Hazi Aziz (supra), the facts were that the
assessee was a firm doing the business of importing dates
from abroad and selling them in India. During the accounting
year under consideration, the assessee had imported dates
from Iraq. At the relevant time, import of dates by steamer
was prohibited but permitted to be brought by country craft.
The goods ordered by the assessee were received partly by
steamer and partly by country craft. Consignments imported
by steamer were confiscated by the Customs Authorities and
the assessee was given an option to pay fine for redemption
of goods, upon payment of which the dates were released.
The assessee claimed the redemption fine amount by way of
deduction while computing profit arising out of sale of the
goods. In this background, the issue reached the Supreme
Court. The Supreme Court held that the expenditure was in
the nature of penalty for infraction of law and therefore, not
a deductible expenditure. It was observed as under:-
” A review of these cases shows that expenses which are permitted
as deductions are such as are made for the purpose of carrying on
the business, i.e., to enable a person to carry on and earn profit in
that business. It is not enough that the disbursements are made in
the course of or arise out of or are concerned with or made out of the
profits of the business but they must also be for the purpose of
earning the profits of the business. As was pointed out in Von
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Glehn’s case [1920] 2 K.B. 553 an expenditure is not deductible
unless it is a commercial loss in trade and a penalty imposed for
breach of the law during the course of trade cannot be described as
such. If a sum is paid by an assessee conducting his business,
because in conducting it he has acted in a manner, which has
rendered him liable to penalty, it cannot be claimed as a deductible
expense. It must be a commercial loss and in its nature must be
contemplable as such. Such penalties which are incurred by an
assessee in proceedings launched against him for an infraction of the
law cannot be called commercial losses incurred by an assessee in
carrying on his business. Infraction of the law is not a normal incident
of business and, therefore, only such disbursements can be
deducted as are really incidental to the business itself. They cannot
be deducted if they fall on the assessee in some character other than
that of a trader. Therefore where a penalty is incurred for the
contravention of any specific statutory provision, it cannot be said to
be a commercial loss falling on the assessee as a trader the test
being that the expenses which are for the purpose of enabling a
person to carry on trade for making profits in the business are
permitted but not if they are merely connected with the business.
It was argued that unless the penalty is of a nature which is
personal to the assessee and if it is merely ordered against the
goods imported it is an allowable deduction. That, in our opinion, is
an erroneous distinction because disbursement is deductible only if it
falls within 10(2)(iv) of the Income-tax Act and no such deduction can
be made unless it falls within the test laid down in the cases
discussed above and it can be said to be expenditure wholly and
exclusively laid for the purpose of the business. Can it be said that a
penalty paid for an infraction of the law, even though it may involve
no personal liability in the sense of a fine imposed for an offence
committed, is wholly and exclusively laid for the business in the
sense as those words are used in the cases that have been
discussed above. In our opinion, no expense which is paid by way of
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penalty for a breach of the law can be said to be an amount wholly
and exclusively laid for the purpose of the business. The distinction
sought to be drawn between a personal liability and a liability of the
kind now before us is not sustainable because anything done which
is an infraction of the law and is visited with a penalty cannot on
grounds of public policy be said to be a commercial expense for the
purpose of a business or a disbursement made for the purposes of
earning the profits of such business.
In our opinion the High Court rightly held that the amount
claimed was not deductible and we therefore dismiss this appeal with
costs.”
9. In case of Maddi Venkataraman & Co P Ltd Vs. CIT4
, the facts were that the assessee company had remitted to a
party in Singapore certain amounts in violation of law. The
proceedings were undertaken against the assessee for
infringement of the relevant provisions of Foreign Exchange
Regulation Act which ultimately resulted into penalty being
imposed against the assessee. The Supreme Court held and
observed as under:-
“20. The case of Haji Aziz Abdul Shakoor Bros. (supra) is important
for another reason. It was categorically held in this case that no
distinction can be made in this regard between a personal liability
and a liability of any other kind. So long as the payment has to made
for infraction of law, it cannot be said that it was made in course of
carrying out of the trade.
4 (1998) 2 SCC 95
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23. In the instant case, the assessee had indulged in transactions
in violation of the provision of Foreign Exchange (Regulation) Act. The
assessee’s plea is that unless it entered into such a transaction, it
would have been unable to dispose of the unsold stock of inferior
quality of tobacco. Another words, the assessee would have incurred
a loss. Spur of loss cannot be a justification for contravention of law.
The assessee was engaged in tobacco business. The assessee was
expected to carry on the business in accordance with law. If the
assessee contravenes the provision of FERA to cut down its losses
or to make larger profits while carrying on the business, it was only to
be expected that proceedings will be taken against the assessee for
violation of the Act. The expenditure incurred for evading the
provisions of the Act and also the penalty levied for such evasion
cannot be allowed as deduction. As was laid down by Lord Sterndale
in the case of Alexander Von Glehn (supra) that it was not enough
that the disbursement was made in the course of trade. It must be for
the purpose of the trade. The purpose must be a lawful purpose.
24. Moreover, it will be against public policy to allow the benefit of
deduction under one statute of any expenditure incurred in violation
of the provisions another stature or any penalty imposed under
another statute. In the instant case, if the deductions claimed are
allowed, the penal provisions of FERA will become meaningless. It
has also to be borne in mind that evasion of law cannot be a trade
pursuit. The expenditure in this case cannot, in any way, be allowed
as wholly in this case cannot, in any, way be allowed as wholly and
exclusively laid out for the purpose of assessee’s business.”
10. In case of Rohit Pulp and Paper Mills Ltd Vs. C.I.T.5,
the assessee had imported goods which were found by
Customs Authorities not covered by a valid licence. The
5 [1995] 215 ITR 919 (Bom)
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Deputy Collector of Customs ordered confiscation of the
goods and offered redemption on payment of fine. This
amount was claimed by the assessee as a deduction.
Rejecting such a claim, the High Court observed as under:-
” We do not find that the above amount paid by the
assessee is anything else than a penalty. It is, therefore, not
allowable as a deduction under the Income Tax Act. The
Income Tax Officer and other authorities were justified in not
allowing any deduction under Section 37 of the Income Tax
Act on account of the same. The third question is, therefore,
answered in the negative and in favour of the Revenue.”
11. In case of M.S.P. Senthikumara Nadar & Sons Vs
C.I.T. Madras6, Division Bench of Madras High Court
considered a case where the assessee firm which was
carrying on the business in coffee had entered into contract
with India Coffee Board and purchased coffee at a rate far
below the price of coffee to be sold within India with the
contractual obligation to export the whole of the coffee so
purchased to the places outside India. The assessee,
however, exported part of it and sold the rest within India.
The Coffee Board, in terms of the agreement levied damages
from the assessee for breach of the contract. This amount
6 [1957] 32 ITR 138 (Madras)
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was paid by the assessee and and claimed by way of
expenditure. The High Court referred to various judgments
on the issue and observed as under:-
“From what we have said above it should be clear that it was not a
case of a payment of damages for a mere breach of contract with
nothing more. It was not of course a case of penalty paid under the
terms of a statute for contravention of any specific statutory provision.
In the circumstances of this case, the liquidated damages claimed
and paid was, however, more akin to a penalty than the damages
suffered for breach of contract in the course of normal trading
activities, whether or not that breach of a contract was also
dishonest. That is why we said that it may not be necessary to rest
our decision in this case on the rule laid down in Masks case [1943]
11 ITR 454. In our opinion it is the principle laid down in Von Glehns
case [1920] 12 Tas Cas. 232 that should be extended and applied to
negative the claim of the assessee in this case. To adopt the words
of Sterndale, M. R., in Von Glehns case (supra) the assessee’s
business could perfectly well be carried on without any infraction of
the obligations laid on the assessee by the India Coffee Board,
entrusted with the statutory duty of controlling and regulating sales of
coffee. A penalty was imposed because of an infraction of these
obligations and the money was not expended or laid out for purposes
of the trade which the assessee carried on. Or in the words of
Scrutton, L.J :
“Were these fines made or paid for the purpose of earning the
profit ? The answer seems to me obvious, that they were not, they
were unfortunate incidents which followed after the profits had been
earned.”
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12. In case of Agra Leatheries Ltd Vs. CIT7, the Division
Bench of Allahabad High Court considered the case where
the assessee had obtained licence for import under which
the assessee had imported plastic sponges. The Customs
Authorities held that under the licence, the assessee could
have imported only natural sponges and not plastic sponges
and the import of plastic sponges was thus illegal. The
assessee claimed penalty for infraction of law by way of
expenditure. The Allahabad High Court relied on the decision
of the Supreme Court in the case of Hazi Aziz (supra), ruled
against the assessee by making following observations:-
” The question whether penalty levied for infraction of law is a
permissible deduction is not res integra. In Haji Aziz and Abdul
Shakoor Bros. v. CIT [1961] 41 ITR 350, the Supreme Court held that
in a case where the penalty has to be incurred because of the fault of
the assessee himself, as for instance for the reason of his having
carried on his business in an unlawful manner or in contravention of
certain rules and regulations, the penalty paid by the assessee for
such conduct could not be regarded as wholly laid out for the
purpose of the business, because the incurring of the said expenses
has not been necessitated by the business but by the conduct of the
assessee in trying to carry on the business in unlawful manner. We,
therefore, do not see any legal infirmity in the view taken by the
Tribunal.”
7 [1993] 200 ITR 792 (Allahabad)
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The decision of this Court in the case of Pannalal
(supra) was cited before the Court which was distinguished.
13. This Court in a decision in the case of T. Khemchand
Tejoomal Vs. CIT8 considered a case where the assessee
was a registered firm doing business mainly in cloth. The
assessee had acquired a licence for importing automobile
spare parts. The assessee then entered into a contract for
import and sale of capacitors to one Bipin Automobiles. The
purchaser would bear all expenses including customs duty.
Pursuant to the agreement, the assessee placed an order of
capacitors and the goods were imported. However, it was
found that the goods did not conform to some of the
specifications in the licence and the Customs Authorities
confiscated the goods and offered the option to pay penalty
for clearance of goods. The assessee paid the penalty and
claimed it as business expenditure. Before the High Court, it
was argued that the assessee was a mere nominal licence
holder and the penalty was really levied on Bipin
Automobiles to whom the goods have been sold and
therefore, the assessee should be allowed to claim the
8 161 ITR 492 (Bom)
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expenditure as business expenditure. The Court held and
observed as under:
” The submission of Mrs. Jagtiani, learned counsel for the
assessee, is that in this case, on the facts found, the assessee must
be regarded as a mere nominal licence-holder and the penalty was
really levied on M/s. Bipin Automobiles to whom the goods had been
sold as aforesaid. It was argued by her that, in these circumstances,
the assessee should be allowed to claim the amount of penalty paid
by the assessee as a deduction in the computation of profits under
section 28 of the Income Tax Act, 1961. She placed strong reliance
on the decision of a Division Bench of this court in CIT v. Pannalal
Narottamdas & Co. : [1968] 67 ITR 667(Bom) . We shall deal with this
case after setting out our own views. In the present case, the facts
found by the Tribunal clearly show that it was the assessee who had
got the import licence. It was the assessee who imported the goods
in question, and it was the fault of the assessee if the goods in
question imported did not conform to the specifications of the licence.
In these circumstances, there is no escaping the conclusion that the
penalty was levied on the assessee for the default of the assessee
itself and not on the ground of any other person’s default. Nor is this
a case in which the assessee can be regarded in any sense as a
nominal licence-holder. It is not as if the assessee gave its licence to
M/s. Bipin Automobiles for importing the goods in question and M/s.
Bipin Automobiles imported the goods. The licence was utilized by
the assesses-firm itself and that fact cannot be altered by the
circumstance that they had agreed to sell the goods to be imported
by them to M/s. Bipin Automobiles. It is well settled that if an
assessee has to pay a penalty to the customs authorities in respect
of goods imported by the assessee on account of its own default, the
amount of that penalty cannot be deducted in the computation of
taxable profits of the assessee.
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Coming to the case of Pannalal Narottamdas & Co. (supra)
cited by Mrs. Jagtiani, the facts in that case were altogether different.
In that case, in the course of its business, the assessee had
purchased bills of lading and other shipping documents from certain
parties in respect of some consignments of goods imported by them
from a foreign country. When the goods arrived in India and were
sought to be cleared through the customs by the assessee on the
basis of the documents purchased by it, it was found that the imports
were unauthorized and the goods were liable to be confiscated and a
penalty was liable to be imposed under section 167(8) of the Sea
Customs Act, 1878. The assessee paid the penalty for saving the
goods from being confiscated. The Tribunal took the view that the
assessee was entitled to plead that it had purchased the documents
of title in good faith and had paid consideration thereon, and,
thereafter, it had to pay the penalties in order not to lose the goods
which had become its property and, in these circumstances, the
penalty could be legitimately regarded as part of the cost of the
goods. It was held by the Division Bench that, on the facts and
circumstances, the actual cost of the goods to the assessee was not
only what it had paid to the importers but in addition thereto what it
had to pay by way of penalty in order to save the goods from being
confiscated and lost to it. It is significant that the observations of the
Division Bench set out at page 672 of the aforesaid report show that
the Division Bench clearly took the view that in cases where penalty
had to be incurred because of the fault of the assessee himself, as
for instance, by reason of his having carried on his business in an
unlawful manner or in contravention of certain rules and regulations,
the penalty paid by the assessee for such conduct thereof could not
be regarded as wholly laid out for the purpose of the business, and,
in support of this conclusion, the decision of the Supreme Court in
Haji Aziz & Abdul Shakoor Bros. v. CIT : [1961] 41 ITR 350 was cited.
This decision, in our view, does not advance the argument of Mrs.
Jagtiani, and, in fact, the aforesaid observations pointed out by us
lend considerable support to the view which we have taken.”
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It can, thus, be seen that consistently various High
Courts following the decision of the Supreme Court in the
case of Hazi Aziz (supra) have held that fine or penalty for
redemption of goods ordered to be confiscated for breach of
import conditions is not an allowable deduction. The case of
the assessee squarely falls in this category.
14. We may now refer to the decisions cited by Mr. Nankani,
the learned counsel for the respondent. The decision in the
case of Pannalal (supra) would require close examination. It
was the case in which the assessee, a registered firm was
dealing inter alia in gum. In the course of its business, the
assessee purchased bills of lading and other shipping
documents from certain parties in respect of some
consignments of gum imported by them from Africa. When
the goods arrived in India, the assessee sought to clear them
on the basis of the documents purchased by it. It was found
that the imports were unauthorized and the goods were
liable to be confiscated and penalty liable to be imposed.
The assessee paid an amount of Rs. 31,302/- by way of
penalty for saving the goods being confiscated. This
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amount the assessee claimed by way of allowable
deduction. The assessee had argued that the amount must
be regarded as a part of purchase price of the gum. It was
argued that the assessee had purchased the consignments
of gum in good faith and was not aware of any faults
committed by the importers in such importation. It was only
when the goods arrived in India that the assessee found that
the imports were unauthorized. The parties from whom the
assessee had purchased the goods declined to pay the
penalties. It was further argued that in the circumstances,
the penalty amount which the assessee had to bear was in
the nature of additional cost of the goods in the hands of the
assessee. The Revenue Authorities rejected such contention.
The Income Tax Appellate Tribunal, however, had taken a
view that the assessee was correct in contending that it had
purchased the documents of title in good faith and
therefore, it had to pay the additional cost not to loose goods
which had become its property. In this context, a reference
was made to the High Court on following substantial question
of law:-
“Whether the penalties totaling Rs. 31,302/- paid in breach of
the Sea Customs Act in respect of imports of stock-in-trade, but
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on bills of lading, purchased in good faith, is a proper deduction
under Section 10(1) of the Income Tax Act?”
The Department objected to the framing of the
question and insisted that the following question be reframed
by the High Court:-
“Whether, on the facts and in the circumstance of the case, the
penalty of Rs. 31,302 paid by the assessee to the customs authorities
for infringement of Import Control Regulations constitutes an
allowable deduction under Section 10 of the Income-tax Act?”
The High Court first rejected any modification to the
question as desired by the Revenue observing that the
Tribunal had concluded that what was paid as penalties by
the assessee was to be regarded as cost of the goods, which
was based on its acceptance of the contention of the
assessee. In other words, the conclusion of the Tribunal was
based on its acceptance of the assessee’s case that its
purchase of bills of lading was in good faith. Having thus
accepted the Tribunal’s conclusion on facts, the Court
proceeded to answer the question referred in favour of the
assessee by making following observations:-
“7. Coming now to the question as framed, we think that it must
be answered in the affirmative and in favour of the assessee. Under
section 10(1) of the Indian Income Tax Act, tax is made payable in
respect of the profits or gains of business. Profits or gains of
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business would be the excess of the sale price over the cost price
and in determining the profits or gains, therefore, the cost has to be
deducted from the proceeds realized on sale of the goods. On the
facts and circumstances of the present case, the actual cost of the
goods to the assessee was not only what it had paid to the importers,
but in addition thereto what it had to pay by way of penalty, in order to
save the goods from being confiscated and lost to it. The penalty paid
by it could, therefore, be regarded as part of the cost of the goods to
it. It can also be regarded as an amount expended by it wholly and
exclusively for the purposes of the business, because unless the said
amount was expended, the goods could not have been saved from
confiscation. It may be pointed out that, in cases where the penalty
has to be incurred be incurred because of the fault of the assessee
himself, as for instance, for the reason of his having carried on his
business in an unlawful manner or in contravention of certain rules
and regulation, the penalty paid by the assessee for such conduct
thereof, could not be regarded as wholly laid out for the purpose of
the business, because the incurring of the said expenses has not
been necessitated by the business,but but by the conduct of the
assessee in trying to carry out the business in an unlawful manner
(see Haji Aziz and Abdul Shakoor Bros. v. Commissioner of Incometax
[supra]). In the present case, however, on the finding of the
Tribunal the penalty has been imposed not for the fault of the
assessee but he had to bear the same for the purpose of getting his
goods released from the customs authorities. In the present case,
therefore, the expenses incurred by the assessee could be regarded
as wholly and exclusively incurred for the purpose of his business. In
our opinion, therefore, the conclusion arrived at by the Tribunal that
the sum of Rs. 31,302 was allowable to the assessee as proper
deduction is correct and the deduction is capable of being allowed
under section 10(1) of the Income Tax Act as held by the Tribunal or
even under section 10(2)(xv) of the Act.”
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This case, thus, is clearly distinguishable. On facts, the
Tribunal had held that the assessee was not responsible for
the breach of law, a finding on the basis of which the High
Court proceeded. It was in this background that the Court
upheld the Tribunal’s decision allowing deduction of the
amount in question as an expenditure emphasizing that
such amount in the hands of the assessee was not penalty
but an additional cost for purchase of goods.
15. In case of CIT, Gujarat V/s. Ahmedabad Cotton
Mfg. Co Ltd & Ors.9, the assessee company had to pay to
the Textile Commissioner an amount in view of the non
production and non packing of the minimum quantity of
specified types of cloth. It was, in this background, that the
payment was held to be allowable expenditure. The Court
held that the decision in the case of Hazi Aziz (supra) would
not apply.
16. The Supreme Court in the case of Prakash Cotton
Mills Pvt Ltd. Vs. CIT10 had emphasized on the nature of
9 (1994) 1 SCC 632
10 (1993) 201 ITR 684
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statutory imposts paid by the assessee, be it in the nature of
damages or penalty or interest in the context of assessee’s
claim of expenditure under Section 37(1) of the Act. The test
laid down was whether such payment was compensatory or
penal in nature.
17. In the case of CIT Vs. N.M. Parthasarathy11 , the
Madras High Court considered the case where the assessee,
an individual running a small scale industry was granted a
licence for importing permissible spare parts for construction
machinery and spare of machine tools. On the basis of such
licence, the assessee imported 400 drums of sodium cyanide
from Hungary. When the goods arrived, the Customs
Authorities noticed that there was no valid licence covering
the consignment and that the provisions of Customs Act,
1962 were violated. This resulted into confiscation of the
goods and imposition of redemption fine in lieu of
confiscation. The assessee claimed the amount of
redemption fine of Rs. 1,84,000/- by way of business
expenditure which was disallowed by the Revenue
Authorities. The High Court noticed the decision of the
11 (1995) 212 ITR 105 (Mad)
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Supreme Court in the case of Hazi Aziz (supra) and the ratio
laid down therein but observed that in view of later
decisions in the case of Prakash Cottom Mills (supra) and
Ahmedabad Cotton Mfg Co Ltd (supra), the ratio laid down in
the case of Hazi Aziz (supra) cannot be stated to have laid
down an inflexible rule of law to be followed in all
eventualities and situations.
18. In our opinion, the ratio laid down by the Supreme
Court in the case of Hazi Aziz (supra) continues to hold the
field even post decisions in the case of Prakah Cotton Mills
(supra) and Ahmedabad Cotton Mfg Co Ltd (supra). In
neither of these two decisions, the ratio laid down in the
decision in case of Hazi Aziz (supra) which was a decision of
Bench of three Judges can be seen to have been diluted. In
other words, what the facts of the case are materially similar
as the facts before the Supreme Court in the case of Hazi
Aziz, the ratio laid down therein would squarely apply. The
later decision cited by the learned counsel for the assessee
emphasizes that not the nomenclature of fine or penalty, but
the true character of payment must be taken into
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consideration. If the payment is compensatory in nature, it
would be allowable deduction. Judgment of this Court in
Pannalal (supra) proceeded on the basis that the infraction of
law for which penalty was imposed, was by the importer and
not the assessee who had purchased the goods, though the
fine was borne by the assessee. It was in this background,
the Court had held that the payment in question was in the
nature of additional cost of the goods for the assessee.
19. Reliance was also placed on the decision of Punjab &
Haryana High Court dated 9.12.2008 in the case of
Commissioner of Income Tax Vs. Hero Cycles Ltd.
However, this decision does not lay down any ratio which can
be applied in the present case. The observations in the
judgment that: “there is no doubt that payments made in the
nature of penalty or fine for any wrongful act cannot be
allowed as permissible deductions but mere label of the
payment is not conclusive. Certain payments may be
incidental to the business and have to be allowed on the
test of ‘commercial expediency’, if no violation of law or
public policy is involved. Where penalty is not for deliberate
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violation of law.” can at best be seen as passing remarks,
obiter dicta but not ratio.
20. In the present case, the Tribunal, without proper
justification or detailed examination of material on record,
followed the line of logic adopted by this Court in the case of
Pannalal (supra) whereas the facts as we have noticed
squarely fall within the parameters of the decision of the
Supreme Court in the case of Hazi Aziz (supra). The
Assessing Officer had summoned the import licence holder
M/s. Rajnikant Brothers whose representative had stated
before the Assessing Officer that M.P. Gupta, the present
assessee had imported almond by using the licence and that
redemption fine of Rs. 75 lacs paid to the Madras Custom
House was done by M.P. Gupta. All transactions were made
by him and he was responsible for the fine. He stated clearly
that as per the agreement, M/s. Rajnikant Brothers were only
entitled to the service charges. Thus, there was ample
evidence on record suggesting that the assessee had made
imports through his direct involvement by using the import
licence of M/s. Rajnikant Brothers and that M/s. Rajnikant
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Brothers merely received an agreed commission. The
assessee cannot disassociate or divest himself from the
irregularities or illegalities committed in the process of
importing the goods. Thus, the penalty was for the infraction
of law committed by the assessee. Under these
circumstances, the question is answered in the negative i.e
in favour of the Revenue and against the assessee. The
impugned judgment of the Tribunal is set aside. Accordingly,
the appeal is disposed of.
21. In view of the Revenue’s appeal being allowed, the
question of releasing a sum of Rs. 1,90,50,000/- in favour of
the respondent assessee would not arise. However, the very
dispute with respect to the source of this amount is pending
in Suit No. 445 of 2002 before the learned Single Judge. It
will be open for the Revenue to file appropriate Motion before
appropriate forum as may be advised for withdrawal of the
amount.
22. In view of disposal of appeal, nothing survives in the
Notice of Motion. The same is disposed of accordingly.
[ B.P. COLABAWALLA, J. ] [ AKIL KURESHI, J ]
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