2017 (4) TMI 164 - AT - Income Tax

Disallowance made on account of demurrage charges and penalty charges imposed - Held that - The contractees, Steel Authority of India and Central Coalfields Limited imposed the instant punitive charges on account of breach of contract which does not fall in the category of payment of penalty for breach of any law of the land but is simply a compensation for breach of contractual obligations. In other words, the punitive charges arose out of the failure of the assessee to complete the work within the time frame agreed with the contractees, Steel Authority of India and Central Coalfields Limited. Such types of penalties are usual in this, line of business and the contractees deduct such charges from the payment disbursed by them. The works undertaken as agreed in the contracts entered into were not completed in time and therefore punitive charges under the default clause as laid down therein had to be paid. It is not a penalty for breach of law. Such payment was perforce made to honour the contractual obligation under the agreements executed. This was done in course of carrying on of the business by the assessee. In the instant case, there was a specific requirement to complete the work in time and a clause for imposing punitive charges was included for any default. These rights and obligations arose in course of carrying on of the business of the respondent. Therefore, this payment made under a contractual obligation is to be allowed under section 37(1) of the Act. We find that the payments in the form of punitive charges made by the assessee could under no circumstances be regarded as illegal payments or payments which were opposed to public policy. We find that as long as the payment made is not by way of default on account of infraction of any law and/or opposed to public policy, the same would be allowable as deduction. We hold that in the instant case, the punitive charges paid are only compensatory in nature pursuant to the contractual obligation which is directly connected or intrinsically related with the carrying on of its business which unequivocally qualifies as an allowable deduction under section 37(1) of the Act. - Decided in favour of assessee.

Summary

Issues Involved:
1. Whether the Commissioner of Income-tax (Appeals) was justified in deleting the disallowance of demurrage charges and penalty charges imposed by Steel Authority of India Ltd. (SAIL) and Central Coal Fields Ltd. (CCFL).

Issue-wise Detailed Analysis:

1. Justification for Deleting Disallowance of Demurrage and Penalty Charges:
The core issue in this appeal was whether the Commissioner of Income-tax (Appeals) correctly deleted the disallowance made by the Assessing Officer regarding demurrage charges and penalty charges imposed by SAIL and CCFL. The Assessing Officer had disallowed these expenses, considering them penal in nature and thus not admissible as deductions under the Explanation to section 37(1) of the Income-tax Act, 1961.

2. Nature of Demurrage and Penalty Charges:
The assessee-company, engaged in handling and stevedoring activities, had incurred demurrage and penalty charges due to delays in completing work for SAIL and CCFL. The Tribunal examined whether these charges were penal or compensatory. It was noted that the charges were imposed due to the failure to meet contractual deadlines, not for any infraction of law. The Tribunal emphasized that such charges are usual in this line of business and arise from contractual obligations rather than legal violations.

3. Legal Precedents and Judicial Interpretations:
The Tribunal referred to several judicial precedents to support its decision. It cited the case of CIT v. Jiyajeerao Cotton Mills Ltd., where it was held that payments made under a contractual obligation, even if termed as 'penalty', are allowable as business expenditures if they are compensatory in nature. Similarly, in Nanhoomal Jyoti Prasad v. CIT, demurrage charges were considered compensatory for the delay in clearing goods, not penal. The Tribunal also referenced Mahalaxmi Sugar Mills Co. Ltd. v. CIT, where demurrage was deemed a compensatory charge for the use of facilities beyond the permissible period.

4. Tribunal's Findings and Conclusion:
The Tribunal concluded that the demurrage and penalty charges paid by the assessee were compensatory and arose from contractual obligations, not from any infraction of law. These charges were directly connected to the business operations of the assessee and thus qualified as allowable deductions under section 37(1) of the Act. The Tribunal found no infirmity in the order of the Commissioner of Income-tax (Appeals) and dismissed the Revenue's appeal.

5. Final Decision:
The Tribunal upheld the decision of the Commissioner of Income-tax (Appeals) to delete the disallowance of demurrage and penalty charges, affirming that these expenses were allowable as business deductions under the Income-tax Act.

Outcome:
The appeal by the Revenue was dismissed, and the order of the Commissioner of Income-tax (Appeals) was upheld. The demurrage and penalty charges were deemed allowable deductions, being compensatory in nature and arising from contractual obligations.