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2023 (12) TMI 452 - AT - Income TaxDisallowance of expenditure - compensation paid to principal for non-fulfilment of contractual obligation - allowable business expenditure or not? - according to the assessee, the amount of rubber required to be used for production of one item was short and, therefore, the factory was shut down - how a business expenditure incurred by an assessee would be categorised as penal in nature with the application of Explanation 1 to Section 37? - HELD THAT - In the present case, the assessee entered into with an agreement with M/s. JK Tyre Industries Limited for carrying out the manufacturing activity of J.K. Tyres on job work basis. It failed to produce the end product qualitatively according to the parameters of J.K. Tyres and dispute arose between the parties. In order to resolve the dispute, the assessee has to pay something to M/s. JK Tyre Industries Limited so that it can continue to work on behalf of M/s. JK Tyre Industries Limited for job work basis. Therefore, the expenditure was not incurred for any infringement of law rather, it is a by- product of commercial activity. For example, the assessee was required to manufacture a tyre by using 10Kg. of rubber, but it had used 11 Kg. or 9 Kg., tyre will not be to the specification of the principal and that would spoil the market of the principal and users will raise complaint. The principal would have to replace them that would lead to some expenditure as well as bad name in the market, so the compensation given by the assessee was on account of these commercial transactions. Therefore, both the authorities are incorrect in categorizing the expenditure as hit by Explanation 1 to Section 37. We delete the addition and allow the appeal of the assessee.
Issues Involved:
The issue in this case revolves around the addition of Rs. 1,00,00,000/- made by the Assessing Officer by disallowing an expenditure paid to M/s. JK Tyre & Industries Limited. Summary: The assessee, a company engaged in manufacturing automotive rubber tubes, filed its return of income declaring a loss. During scrutiny, it was found that the company paid Rs. 1 crore as compensation to a principal for contractual non-fulfillment. The Assessing Officer disallowed this expenditure, citing Explanation 1 to Section 37. The company contended that the payment was a result of technical shortcomings leading to a dispute with the principal, not an offense or prohibited act. The CIT(A) upheld the disallowance. The Tribunal, after considering the provisions of Section 37 and Explanation 1, concluded that the expenditure was a by-product of commercial activity, not a penal offense. Therefore, the addition was deleted, and the appeal of the assessee was allowed. In conclusion, the Tribunal ruled in favor of the assessee, allowing the appeal and deleting the addition made by the Assessing Officer.
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