2013 (7) TMI 851 - HC - Income Tax

Business expenditure u/s 37(1) - Encashment of bank guarantee - compensation for non performance - whether in the nature of penalty - Held that - ONGC encashed the bank guarantee, which was furnished by the assessee (performance guarantee) due to the non-fulfillment of the contract by the assessee. It can be said to be compensatory in nature and not penal in nature, the ITAT has rightly held that the assessee would be entitled to the deduction of the same as business expenditure under section 37(1) - Following decision of Prakash Cotton Mills P.Ltd. vs. Commissioner of Income-Tax 1993 (4) TMI 3 - SUPREME Court - Decided against Revenue.

Summary

Issues:
1. Allowance of encashment of bank guarantee as business expenditure under section 37(1) of the Income Tax Act.

Analysis:
The case involves an appeal by the Revenue challenging a judgment passed by the Income Tax Appellate Tribunal (ITAT) regarding the allowance of encashment of a bank guarantee as business expenditure under section 37(1) of the Income Tax Act. The facts reveal that the assessee, engaged in construction and erection work, incurred expenses due to non-performance of a contract with ONGC, resulting in the encashment of a bank guarantee. The Assessing Officer disallowed the expenditure, which was later partly allowed by the CIT(Appeals). The ITAT allowed the appeal, stating that the encashment was compensatory in nature and thus deductible under section 37(1) of the Act.

The Revenue, dissatisfied with the ITAT's decision, raised the question of law regarding the allowance of the encashment as business expenditure. The High Court noted that the encashment occurred due to the assessee's decision not to proceed with the contract after providing a performance guarantee to ONGC. Relying on precedents, including a decision by the Punjab and Haryana High Court, the High Court affirmed that damages for breach of contract can be considered allowable business expenditure if not incurred for contravention of any law.

Further referencing a Supreme Court decision, the High Court emphasized that deductions under section 37(1) can be allowed when found to be wholly compensatory. The Court reiterated that the nature of the payment, whether compensatory or penal, must be examined. In line with the principles established by the Supreme Court and the Punjab and Haryana High Court, the High Court concluded that the encashment of the bank guarantee was compensatory in nature, making it eligible for deduction under section 37(1) of the Income Tax Act.

Ultimately, the High Court found no substantial question of law to interfere with the ITAT's decision. Consequently, the High Court dismissed the Tax Appeal, upholding the ITAT's ruling in favor of allowing the encashment of the bank guarantee as business expenditure under section 37(1) of the Income Tax Act.