2020 (5) TMI 478 - AT - Income Tax

Disallowance of contract benevolent fund (CBF) expenses expenditure allowable u/s 37(1) - Whether CBF is mandatory deduction by State Government and not voluntary in nature - CIT(A) confirmed the order of AO holding that the contribution made by the assessee was purely out of benevolence and not for the purpose of business of the assessee - HELD THAT - ITAT, Bangalore Bench in the case of Shri S.Basavaraja Vs ACIT in 2018 (7) TMI 2115 - ITAT BENGALURU was dealing with a case of individual who was also a Civil Contractor and whose case also contribution to CBF was disallowed by the revenue authorities. Tribunal held that the contribution to CBF was for the purpose of business of the assessee and was of revenue in nature and had to be allowed as deduction subject to verification whether the contribution was made in accordance with notification issued by the Government of Karnataka whereby several contractors were obligated to contribute CBF. We are of the view that the deduction claimed has to be allowed subject to verification as mentioned in the order of the Tribunal referred to above. The relevant ground is treated as allowed. Disallowance of Reserve for NOC was purely on business expenditure allowable u/s 37(1) - HELD THAT - With reference to a specific query as to under what provision in the Contract or any other statutory provision, the assessee is obliged to contribute towards Reserve for NOC , the ld. Cousel for the assessee submitted that such obligations are part of the Contract entered into with the State Government. Another query was raised by the Bench as to whether the sum contributed towards Reserve for NOC will be refunded to the assessee in the event of third party certification of execution of good work being given. Assessee expressed his inability to give an answer to this query. In the circumstance, we are of the view that this issue should be remanded to the AO for fresh consideration and the assessee should demonstrate before the AO that the contribution towards Reserve for NOC is based on contract between parties or is a contribution which is payable under statute or is a matter of practice while executing the Civil work for State Government. The assessee shall also establish that the sum so contributed will not be refunded to the assessee at any point of time or as to how the sum so refunded would be offered to tax as income as and when the same is received. Penalties paid for non-performance of contract in time was in the nature of compensatory damages and was purely business expenditure u/s 37(1) - HELD THAT - It is not possible to link the penalties levied under various bills by the PWD as a payment made by way of damages for dealy in execution of contract. The assessee was not able to link the penalty reflected in the bills as penalty for delayed implementation or delayed execution of the contract. This aspect needs detailed verification and the assessee is directed to establish this fact before the AO and for this purpose the issue is remanded to the AO for consideration fresh after due opportunity to the assessee. If the payment is established as for payment for breach of contract and then the same cannot be said to be a payment falling within the ambit of Explanation to Sec.37(1). In this regard, assessee has placed reliance on the decision in the case of Prakash Cotton Mills (P)Ltd. Vs CIT 1993 (4) TMI 3 - SUPREME COURT and the aforesaid decision clearly lays down the proposition that when a payment by way of impost or by way of penalty or interest is purely compensatory and not penal in nature, the same should be allowed as expenditure u/s 37(1) - A payment of compensation for breach of contract can by no stretch of imagination be termed as penalty for infraction of law

Summary

Issues Involved:
1. Disallowance of Contract Benevolent Fund (CBF) expenses.
2. Disallowance of Reserve for NOC.
3. Disallowance of penalties paid for non-performance of contract in time.

Issue-wise Detailed Analysis:

1. Disallowance of Contract Benevolent Fund (CBF) Expenses:
The assessee contended that the disallowance of CBF expenses amounting to ?2,51,397/- should be allowed under Section 37(1) of the Income Tax Act, 1961. The authorities, including the CIT(A), held that the contribution was out of benevolence and not for the business purpose, thus not allowable as a deduction. The Tribunal referenced a similar case (Shri S. Basavaraja Vs ACIT) where it was held that the contribution to CBF was for business purposes and of revenue nature, subject to verification. The Tribunal remanded the matter back to the AO for verification to ensure the contribution was made in accordance with the Government of Karnataka's notification. If verified, the deduction should be allowed.

2. Disallowance of Reserve for NOC:
The assessee claimed a deduction of ?6,09,351/- under 'Reserve for NOC', which the AO disallowed, considering it a reserve and not an accrued liability. The CIT(A) upheld this view. The assessee explained that this reserve was a mandatory deduction by the State Government and related to third-party inspection charges. The Tribunal noted the lack of clarity on whether this sum would be refunded or retained and remanded the issue back to the AO. The assessee must demonstrate that the contribution is contractually or statutorily mandated and clarify the refundability and tax treatment of any refunded amounts.

3. Disallowance of Penalties Paid for Non-Performance of Contract in Time:
The assessee claimed a deduction of ?7,25,299/- under 'penalty and charges', which the AO disallowed, citing it as penal expenditure under Explanation 1 to Section 37(1) of the Act. The CIT(A) confirmed this, viewing the expenditure as penal. The assessee argued that the penalties were compensatory for non-fulfillment of contractual obligations. The Tribunal required detailed verification to establish if the penalties were indeed compensatory and linked to delayed execution of contracts. Relying on the Supreme Court's decision in Prakash Cotton Mills (P) Ltd. Vs CIT, the Tribunal noted that compensatory payments for contract breaches should be allowed under Section 37(1). The matter was remanded to the AO for fresh consideration, directing the assessee to establish the nature of the penalties.

Conclusion:
The Tribunal allowed the appeal for statistical purposes, remanding the issues back to the AO for detailed verification and fresh consideration, ensuring the deductions align with the legal provisions and established practices. The order was pronounced in the open court on 11-03-2020.