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TMI Blog2008 (1) TMI 62X X X X Extracts X X X X X X X X Extracts X X X X ..... ) is at issue in this Reference. 2. In the first instance, it deserves to be noticed as to how this controversy has arisen. Before delving on the issue involved, it would be apposite for proper appreciation of the bone of contention between the parties to put a brief look on the factual matrix. A partner of the assesseefirm visited Germany where he entered into a contract for supply of certain goods of a particular value. The agreement so arrived at, however, could not be acted upon by the assessee as it did not have the requisite import licence for the material intended to be imported. The dispute was referred to an arbitrator. In terms of the award of the Arbitration Tribunal, rendered on 29.7.1974, the assessee paid a sum of Rs. 50,000/- to the German-firm, M/s. Duestsche Strahil Metail of Berlin, for failure to perform its part of the contract. Accordingly, the assessee in its return for the assessment year 1975-76, claimed deductions of the aforesaid amount as business expenseson account of damages for breach of contract. 3 . The Assessing Officer had initially allowed the amount of Rs. 50,000/- as deductions out of the total income. But lateron, a notice was issue ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... Tribunal was in consonance with law. He supported the order of the Tribunal. 7 . In the wake of two views on the point, totally contrary to each other it was considered appropriate by the Referral Bench torecommend that the issue deserved to be resolved by a larger Bench. The exact words by which the matter came to be referred are indicated here-in-below just with a view to make explicit on record as to how the question has come up for consideration by the Full Bench. These are: "In our opinion, there is direct conflict between the two decisions of co-ordinate Benches in Indo Switch-Gears (P) Ltd. [1996]222 ITR 772 [P H] and M/s. Baldev Singh Kanwar's case[1997] Indian Taxation Reports 640(P H) which deserves to be resolved by a larger Bench. Accordingly, we direct the Registry to place the papers of this case before Hon'ble the Chief Justice for constituting a larger Bench to decide the controversy arising in this reference." 8. It would be manifest from the above that the spinal issue which arises here is, whether an assessee who pays certain amount by way of damages for breach of contract is entitled to have said expenditure allowed to be deducted from the income. In ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... the touchstone of the provisions of Section 37(1) of the Act. Where an assessee has to pay damages to the other party for the failure to fulfil the contract entered into by him in the ordinary course of his business, the amount of damages so paid is an allowable deduction if it is in the ordinary course of the business, and is not opposed to the public policy. 13. A penalty imposed for breach of any law during the course of trade etc. cannot be described as a commercial loss. If an assessee while conducting his business has acted in an unlawful manner which has rendered him liable to penalty, the sum so paid cannot be claimed as a deductible expense. Infraction of the law is not a normal incident of business and, therefore, no expense which is paid by way of penalty for a breach of law is admissible deduction. In cases where a penalty has to be incurred, for the reason of the assessee having carried on business in an unlawful manner or in contravention of certain rules and regulations, such penalty could not be regarded as 'wholly and exclusively' laid out for the purposes of business as the expense has not been necessitated by the business but by the conduct of the assessee i ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... rically laid down that wherever an amount has been paid by way of damages, the compensatory payment made by the assessee entitles him to claim deduction from the income earned by him and where an element of penal levy is concerned, any such payment made for contravention of law is inadmissible. 17. We may now refer to cases adjudicated by the jurisdictional High Court. In Commissioner of Income Tax, Punjab v. Himalaya Rosin- Turpentine Manufacturing Company, (1953) 24 ITR 132, a Division Bench of this Court was considering the case of an assessee who was carrying the business of extracting rosin from forest leased for that purpose and had entered into an agreement for extracting rosin according to certain terms and conditions and in the eventuality of failure to observe the same, he was liable to pay penalty/fine. The assessee having contravened the terms of the lease was saddled with fine of Rs. 5,000/- which was paid to the State. The said claim was disallowed because it was found that the payment concerned was made towards penalty imposed for breach of the rules under which the assessee was extracting rosin. The aforesaid view was adhered to by another Division Bench of this ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... t year 1977-78, the assessee had to pay an amount of Rs. 4,950/- to the Punjab State Electricity Board on account of late delivery of goods. The question that arose for consideration was, whether the said amount was deductible from the income of the assessee. This Court while interpreting Section 37(1) of the Act concluded that the amount paid was not on account of any infraction of law but was by way of damages for breach of contract and was thus compensatory in nature. It was also concluded that the said amount would entitle the assessee for deduction under Section 37(1) of the Act. This Court after referring Cinaramas's [1977] 110 ITR 762case and Murari Lal Ahuja and sons' case [1989] 177 ITR 228 (p h) observed as under:- ( page 792 of 222 ITR ) "A question about such deductibility also came up for examination before this Court in CIT v. Murari Lal Ahuja and Sons (1989) 177 ITR 228. That was a case where the assessee, who carried on the business of sale of cotton, was unable to fulfil a contract of supplying cotton to the mills and, therefore, settled the dispute by paying them a sum of Rs., 48,158/-. The Income-Tax Officer disallowed the payment holding it to be a speculati ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ivision Bench was regarding payment of damages for breach of contract as the assessee therein had violated the terms of the contract and was held liable for damages. That occurrence because of which the assessee was held liable for damages, being an ordinary incident of business, the amount paid on that account was an allowable expense as a business loss/expenditure. However, by taking the payment of damages for breach of agreement as penalty for infraction of law the same had been disallowed. The Division Bench had therefore, incorrectly decided the issue and we are not in a position to subscribe the said view. Accordingly we over-rule the judgment in M/s. Baldev Singh Kanwar's case (supra) which does not decide the controversy in its right perspective. 24. Having resolved the controversy, we would now take note of the facts of the present case. The facts as disclosed are that the assessee had entered into an agreement with a German firm, on a visit of its partner, for supply of certain goods. The said contract did not fructify as the assessee did not have the requisite import licence for the material intended to be imported. On a dispute being referred to the arbitrator, the ..... X X X X Extracts X X X X X X X X Extracts X X X X
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