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Issues Involved:
1. Whether the penalty paid by the assessee to the Government of Orissa is an admissible deduction under section 10(2)(xv) of the Indian Income-tax Act, 1922. Issue-Wise Detailed Analysis: 1. Admissibility of Penalty as Deduction under Section 10(2)(xv): Facts and Background: The case pertains to the assessment year 1955-56. The assessee entered into an agreement with the Government of Orissa as a paddy procuring agent. The agreement required the supply of paddy and rice conforming to the Fair Average Quality (F.A.Q.) standard. Clause 3(d) of the agreement allowed the Government to levy penalties for non-conformance to the F.A.Q. standard. The assessee was penalized Rs. 25,700 for supplying substandard foodgrains and sought to deduct this amount as business expenditure under section 10(2)(xv). Assessee's Contentions: The assessee argued that the penalty was effectively a reduction in the sale price due to the substandard quality of the supplied foodgrains. The penalties were not imposed in round figures, indicating they were based on the difference between the F.A.Q. price and the actual quality supplied. The assessee claimed no dishonest intention and contended that the penalties should be deducted to accurately compute business profits. Revenue's Contentions: The Income-tax Officer and the Appellate Assistant Commissioner disallowed the deduction, asserting that the penalties were for supplying substandard foodgrains and thus constituted a breach of contractual obligations. They argued that such penalties could not be considered as expenditure wholly and exclusively for business purposes under section 10(2)(xv). Legal Analysis: The judgment emphasized that the penalty was not a commercial loss but a punitive measure for non-compliance with the F.A.Q. standard, which was a contractual and statutory obligation. The penalty was seen as a consequence of the assessee's failure to adhere to quality standards, thus not qualifying as an allowable business expenditure. The court referred to principles laid down in English cases, emphasizing that disbursements must be made for the purpose of earning profits, not merely arising out of business activities. The penalty was deemed a result of infraction of law, not a commercial expense. The Indian Supreme Court's decision in Haji Aziz and Abdul Shakoor Bros. v. Commissioner of Income-tax was cited, reinforcing that penalties for legal infractions are not deductible as business expenses. Conclusion: The court concluded that the penalty paid by the assessee was not an admissible deduction under section 10(2)(xv) as it was not incurred wholly and exclusively for business purposes. The penalty was a punitive measure for non-compliance with statutory and contractual obligations, thus not qualifying as a business expenditure. Separate Judgment: Narasimham C.J. concurred, emphasizing the public policy underlying the Essential Supplies (Temporary Powers) Act, 1946, and the Orissa Foodgrains Control Order, 1951. He noted that the penalties were for systematic breaches of contract affecting equitable distribution of essential commodities, thus not deductible as business expenses. Final Decision: The court answered the question in the negative, ruling against the assessee. The penalty paid to the Government of Orissa was not an admissible deduction, and the assessee was ordered to pay the costs of the reference.
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