2021 (7) TMI 1168 - AT - Income Tax

Disallowance u/s 37(1) - security deposit encashment claim - AO observed that encashment of bank guarantee being penal in nature on account of nonperformance of contract at assessee s behest - as per AR impugned encashment of bank guarantee is outcome of failure to perform its contractual obligation only without involving any offence or penal component u/s.37(1) - HELD THAT - Faced with this issue, we find that a catena of case law (GUJARAT STATE FINANCIAL CORPORATION 2013 (8) TMI 78 - GUJARAT HIGH COURT , NEO STRUCTO CONSTRUCTION LTD. 2013 (7) TMI 851 - GUJARAT HIGH COURT , REGALIA APPARELS (P.) LTD. 2013 (7) TMI 114 - BOMBAY HIGH COURT , Jamna Auto Industries 2008 (1) TMI 62 - PUNJAB HARYANA HIGH COURT and Green Delhi BQS Ltd. 2018 (5) TMI 632 - ITAT DELHI holds that such an encashment of bank guarantee is incurred in the normal course of business than involving any penalty element at all. We adopt the very reasoning herein as well and direct the Assessing Officer to delete the impugned disallowance/addition in issue - Decided in favour of assessee.

Summary

Issues Involved:
1. Disallowance of security deposit encashment claim treated as penal in nature.
2. Applicability of Section 37(1) of the Income Tax Act, 1961.
3. Nature of the expenditure—whether compensatory or penal.

Detailed Analysis:

1. Disallowance of Security Deposit Encashment Claim Treated as Penal in Nature:
The core issue in this case is the disallowance of the assessee's claim of ?1,10,61,051/- as a business expenditure, which was treated as penal in nature by the lower authorities. The CIT(A) upheld the Assessing Officer's decision, stating that the encashment of the bank guarantee was a penalty for the assessee's failure to execute a turnkey project with the High Explosive Factory, Pune. The assessee argued that the loss incurred was due to uncontrollable circumstances and should be considered a business expenditure.

2. Applicability of Section 37(1) of the Income Tax Act, 1961:
The assessee contended that the expenditure was compensatory and not penal, hence allowable under Section 37(1) of the Act. Section 37(1) allows deductions for any expenditure (not described in Sections 30 to 36) that is not capital or personal in nature and is expended wholly and exclusively for business purposes. The explanation to Section 37(1) disallows expenditures incurred for any purpose that is an offense or prohibited by law.

3. Nature of the Expenditure—Whether Compensatory or Penal:
The assessee argued that the encashment of the bank guarantee was compensatory, as it was a consequence of the failure to perform contractual obligations, not a penalty for an offense. The assessee cited several judicial precedents to support this claim, including judgments from the Income Tax Appellate Tribunal, High Courts of Bombay, Gujarat, Jammu & Kashmir, and Punjab-Haryana, which have held that such expenditures are compensatory and allowable under Section 37(1).

Judgment:
The tribunal considered the rival pleadings and the case law cited. It found that the encashment of the bank guarantee was incurred in the normal course of business and did not involve any penalty element under Section 37(1) of the Act. The tribunal cited several judgments, including CIT Vs. Neo Structo Construction Ltd., CIT Vs. Regalia Apparels P. Ltd., and Jamna Auto Industries Vs. CIT, which supported the view that such expenditures are compensatory and allowable as business expenditures.

Conclusion:
The tribunal directed the Assessing Officer to delete the impugned disallowance/addition, allowing the assessee's appeal. The order was pronounced in the open court on 6th May 2021.