2017 (9) TMI 1038 - HC - Income Tax

Disallowance of liquidated damage - allowable business expenditure u/s 37 - nature of expenses - Held that - Section 37 of the Act is the residuary provision granting deduction of an expenditure not being expenditure of the nature of capital expenditure or personal expenses of the assessee, which is laid out or expended wholly and exclusively for the purposes of business or profession and not specified in the preceding sections 30 to 36 of the Act. Explanation to section 37(1) would clarify that any expenditure incurred by an assessee for any purpose which is an offence or which is prohibited by law shall not be deemed to have been incurred for the purpose of business or profession and no deduction or allowance shall be made in respect of such expenditure. Where an assessee has to pay damages to other party to fulfill the contract entered into by him in the ordinary course of his business, the amount of damages to be paid is allowable deduction if it is in the ordinary course of business and is not opposed to public policy. See Jamna Auto Industries vs. Commissioner of Income Tax reported 2008 (1) TMI 62 - PUNJAB & HARYANA HIGH COURT As noted, the expenditure in question was purely in relation to the assessee s normal business activity and was inherent part of its business transactions. The expenditure was certainly not incurred for any purpose which is an offence or which is prohibited by law. The Tribunal therefore was perfectly justified in granting such expenditure. - Decided in favour of the assessee

Summary

Issues:
1. Whether the Appellate Tribunal erred in deleting the disallowance of liquidated damages?
2. Whether the liquidated damages claimed by the assessee are allowable under section 37 of the Income Tax Act, 1961?

Analysis:
Issue 1:
The High Court admitted the Tax Appeal for consideration of whether the Appellate Tribunal erred in deleting the disallowance of liquidated damages. The assessee, engaged in manufacturing and trading, claimed liquidated damages as business expenditure. The Assessing Officer disallowed the claim, considering it a penal liability. However, the CIT (Appeals) and the Tribunal allowed the claim based on the business nature of the expenditure.

Issue 2:
The key question was whether the liquidated damages were allowable under section 37 of the Act. The Revenue argued that the damages were penal in nature and not laid out wholly for business purposes. The assessee contended that the delays leading to damages were inherent in their business, making it a business loss. The Court analyzed the nature of the expenditure, emphasizing that it was part of normal business activities and not prohibited by law.

The Court referred to precedents to support its decision. It distinguished cases involving penal liabilities, such as delay in remitting statutory contributions, from the present case where damages were a result of breach of contract. The Court highlighted that damages for breach of contract are considered normal business expenses and allowable deductions under section 37(1) of the Act.

In conclusion, the Court ruled in favor of the assessee, upholding the Tribunal's decision to allow the liquidated damages claimed. The Tax Appeals filed by the Revenue were dismissed, affirming that the liquidated damages were a legitimate business expense and eligible for deduction under section 37 of the Income Tax Act, 1961.