2013 (2) TMI 19 - AT - Income Tax

Disallowance of liquidated damages - CIT(A) held the amount as capital expenditure not allowable u/s 37 - Held that - The assessee company has been incorporated to carry out business of supply of various electrical and optical connectivity equipment and the liquidated damages claimed by the assessee were incurred under contract with the purchasers of these equipments. Thus as per condition no. 0702(a) of the contract, the assessee supplier (seller) company was under obligation to deliver the ordered goods to the Railway company and other public sector undertaking enterprises (purchasers) within the period fixed for delivery in the contract and in case the assessee supplier(seller) company failed to deliver the ordered goods to purchaser enterprise within the period fixed for delivery in the contract, then liquidated damage @2% of the price of stores was to be recovered from the assessee supplier company by the purchaser Railway company. In this condition, it is specifically mentioned that the payment of liquidated damages would not be considered as penalty. Thus respectfully following the judgment of Commissioner of Income Tax, Pune vs R.D. Sharma and Co.(1982 (3) TMI 52 - BOMBAY HIGH COURT) wherein held that the delay in completion of contract is incidental to the business and liability of compensation arising because of delay is an allowable deduction under the Act. In the case in hand, admittedly, the assessee company claimed liquidated damages paid to the Railway department and other government undertaking enterprises as per contract and due to the delay in completion of supply contract. Therefore, this is an allowable expenditure and the authorities below were not justified in disallowing the same - findings of the CIT(A) that the payment of liquidated damages was capital in nature is not sustainable and deserves to be set aside. Thus the claim of the assessee company for liquidated damages is allowable u/s 37(1) of but the calculation of deduction has to be done by the AO because he has observed that the copies of the contract with M/s Bharat Electronics Ltd., Ghaziabad, Panchkula and Bangalore have not been furnished before him and the details furnished by the assessee before the Assessing Officer for the claim of liquidated damages was at much more percentage than prescribed in the contract - thus the claim of assessee on liquidated damages deducted under the agreed condition of the contract as allowable u/s 37(1) subject to the verification of actual claim by the AO - restore the issue of calculation of allowable amount to the file of AO.

Issues Involved:
1. Whether the disallowance of Rs. 32,35,721 on account of liquidated damages by the Assessing Officer was justified.
2. Whether the liquidated damages should be considered as capital expenditure or revenue expenditure under Section 37(1) of the Income Tax Act.
3. Whether the liquidated damages were incurred wholly and exclusively for the purposes of business.
4. Whether the decisions relied upon by the Commissioner of Income Tax(A) were applicable to the facts of the case.
5. Whether the Commissioner of Income Tax(A) erred in not disposing of the ground dealing with levy of interest under section 234B & 234D.

Detailed Analysis:

1. Disallowance of Liquidated Damages:
The assessee filed an appeal against the disallowance of Rs. 32,35,721 on account of liquidated damages made by the Assessing Officer. The Assessing Officer disallowed the claim on the grounds that the liquidated damages were not in accordance with the contract terms, and the details provided by the assessee included entities for which no contract copies were furnished. The Commissioner of Income Tax(A) upheld this disallowance, stating that the liquidated damages were capital in nature.

2. Nature of Liquidated Damages:
The Commissioner of Income Tax(A) held that the liquidated damages were capital expenditure and not allowable under Section 37(1) of the Income Tax Act. The Commissioner relied on the Supreme Court's decision in Swadeshi Cotton Mills Co. Ltd. v Commissioner of Income Tax, which held that damages recovered for late supply of capital assets are capital in nature. However, the Tribunal observed that this case was not applicable as it pertained to the cancellation of contracts for capital assets, whereas the present case involved liquidated damages for delay in delivery of goods, which is a business activity.

3. Purpose of Business:
The Tribunal noted that the liquidated damages were incurred under a contractual obligation for the supply of goods, which is a day-to-day business activity of the assessee. The Tribunal referred to the Supreme Court's decision in Prakash Cotton Mills Ltd. vs Commissioner of Income Tax, which stated that compensatory payments could be allowed as business expenditure under Section 37(1). The Tribunal concluded that the liquidated damages were compensatory and incurred wholly and exclusively for business purposes, thus allowable under Section 37(1).

4. Applicability of Decisions:
The Tribunal found that the Commissioner of Income Tax(A) erroneously relied on decisions that were not applicable to the facts of the case. The Tribunal distinguished the present case from Swadeshi Cotton Mills and other cited cases, noting that the liquidated damages in the present case were related to the supply of goods, not capital assets.

5. Levy of Interest under Section 234B & 234D:
The Tribunal noted that the Commissioner of Income Tax(A) did not dispose of the ground dealing with the levy of interest under section 234B & 234D. However, since the main grounds related to the disallowance of liquidated damages were allowed, this ground became infructuous and was dismissed.

Conclusion:
The Tribunal allowed the appeal, holding that the liquidated damages paid by the assessee were compensatory in nature and incurred wholly and exclusively for business purposes. The Tribunal directed the Assessing Officer to verify the quantum of the claim and allow the deduction accordingly. The appeal was allowed with specific directions for verification of the claim amount by the Assessing Officer.

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