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TMI Blog2002 (11) TMI 17X X X X Extracts X X X X X X X X Extracts X X X X ..... d 135 of 2001 arise out of the order of the Tribunal in I.T.A. Nos. 295 and 296 of 1993 in respect of the assessment years 1988-89 and 1989-90 in the case of Catholic Syrian Bank Ltd., Thrissur. All these appeals are being disposed of by this judgment since the sole question that arises for consideration in all these cases is as to whether the Tribunal is right in law in holding that the rate of penal interest the assessee has to pay under the relevant banking law is interest only and not penalty. In other words, the question is as to whether the payment of penal interest under the banking laws is for the infraction of law. The respondent-assessees in all these cases are scheduled banks, all having their head offices at Thrissur. In the assessment of the respondent-assessees for the years already mentioned they have claimed deduction of the penal interest paid to the Reserve Bank of India for non-maintenance of cash reserve. The Assessing Officer's concerned had disallowed the same on the ground that the amount represents penal interest. According to the assessees, penal interest is paid to the Reserve Bank of India for non-maintenance of cash reserve as stipulated by the Bank ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... d exclusively for the purposes of the business or profession shall be allowed in computing the income chargeable under the head "Profits and gains of business or profession". In the instant case there is no dispute that the payment of penal interest is not in the nature of a capital expenditure or personal expenses of the assessees. There is also no dispute that the penal interest is paid as an incidence of the banking business of the assessees. In other words, the penal interest paid to the Reserve Bank of India can be treated as laid out or expended wholly and exclusively for the purposes of the business of the assessees' banks. The only question that has to be considered in such circumstances is as to whether the penal interest so paid cannot be allowed as deduction under section 37(1) of the Act. As already noted, according to the department since the payment is penal in character and consequently for infraction of law the same cannot be allowed as a deduction. Section 42 of the Reserve Bank of India Act, 1934, provides for cash reserves of scheduled banks to be kept with the Reserve Bank. The relevant portions read thus: "42. (1) Every bank included in the Second Schedul ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... dertakings) Act, 1980 (40 of 1980); (iv) a banking company as defined in clause (c) of section 5 of the Banking Regulation Act, 1949 (10 of 1949); (v) a co-operative bank; or (vi) any other financial institution notified by the Central Government in this behalf, shall be reduced by the aggregate of the liabilities of all such banks and institutions to the scheduled bank; (e) the aggregate of the 'liabilities' of a scheduled bank which is a State co-operative bank, to,-- (i) the State Bank; (ii) a subsidiary bank as defined in section 2 of the State Bank of India (Subsidiary Banks) Act, 1959 (38 of 1959); (iii) a corresponding new bank constituted by section 3 of the Banking Companies (Acquisition and Transfer of Undertakings) Act, 1970 (5 of 1970); (iiia) a corresponding new bank constituted by section 3 of the Banking Companies (Acquisition and Transfer of Undertakings) Act, 1980 (40 of 1980); (iv) a banking company as defined in clause (c) of section 5 of the Banking Regulation Act, 1949 (10 of 1949); or (v) any other financial institution notified by the Central Government in this behalf; shall be reduced by the aggregate of the liabilities of all such banks ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... hundred rupees for each subsequent fortnight during which the default continues, and (b) the bank may prohibit the scheduled bank from receiving after the said fortnight any fresh deposit, and, if default is made by the scheduled bank in complying with the prohibition referred to in clause (b), every director and officer of the scheduled bank who is knowingly and wilfully a party to such default or who through negligence or otherwise contributes to such default shall in respect of each such default be punishable with fine which may extend to five hundred rupees and with a further fine which may extend to five hundred rupees for each day after the first on which a deposit received in contravention of such prohibition is retained by the scheduled bank.... (5)(a) The penalties imposed by sub-sections (3) and (4) shall be payable within a period of fourteen days from the date on which a notice issued by the bank demanding the payment of the same is served on the scheduled bank, and in the event of failure of the scheduled bank to pay the same within such period, may be levied by a direction of the principal civil court having jurisdiction in the area where an office of the defaultin ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ed to be cash maintained in India. (2A)(a) Notwithstanding anything contained in sub-section (1), or in sub-section (2), after the expiry of two years from the commencement of the Banking Companies (Amendment) Act, 1962 (36 of 1962):-- (i) a scheduled bank, in addition to the average daily balance which it is, or may be, required to maintain under section 42 of the Reserve Bank of India Act, 1934 (2 of 1934), and (ii) every other banking company, in addition to the cash reserve which it is required to maintain under section 18, shall maintain in India,-- (A) in cash, or (B) in gold valued at a price not exceeding the current market , price or in unencumbered approved securities valued at a price determined in accordance with such one or more of, or combination of, the following methods of valuation, namely, valuation with reference to cost price, market price, book value or face value, as may be specified by the Reserve Bank from time to time, an amount which shall not, at the close of business on any day, be less than twenty-five per cent. or such other percentage not exceeding forty per cent. as the Reserve Bank may, from time to time, by notification in the Official Gazet ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... scribed by or under clause (a) of sub-section (2A), such banking company shall be liable to pay to the Reserve Bank in respect of that day's default, penal interest for that day at the rate of three per cent. per annum above the bank rate on the amount by which the amount actually maintained falls short of the prescribed minimum on that day; and (b) if the default occurs again on the next succeeding alternate Friday, or, if such Friday is a public holiday, on the preceding working day, and continues on succeeding alternate Fridays or preceding working days, as the case may be, the rate of penal interest shall be increased to a rate of five per cent. per annum above the bank rate on each such shortfall in respect of that alternate Friday and each succeeding alternate Friday or preceding working day, if such Friday is a public holiday, on which the default continues. (5)(a) Without prejudice to the provisions of sub-section (3), the Reserve Bank may require a banking company to furnish to it a return in the form and manner specified by it showing particulars of its assets maintained in accordance with this section and its demand and time liabilities in India, as at the close of ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ly with the provisions of clause (a) of sub-section (2A), the Reserve Bank may not demand the payment of the penal interest. Explanation.--In this section, the expression 'public holiday' means a day which is a public holiday under the Negotiable Instruments Act, 1881 (26 of 1881)." Before proceeding further with the matter it is necessary to bear in mind the legal principles based on which a payment has to be determined as compensatory or penal in nature. The Andhra Pradesh High Court had occasion to consider the principles regarding the determination of the nature of the levy in CIT v. Hyderabad Allwyn Metal Works Ltd. [1988] 172 ITR 113. The question which arose for consideration was as to whether the interest paid under section 14B of the Employees' Provident Funds and Miscellaneous Provisions Act, 1952, and interest paid on account of the delayed payment of sales tax are allowable deductions under the Income-tax Act, 1961. In that context, the Division Bench observed thus: "The mere nomenclature as interest, penalty or damages in the Act may not be conclusive for the purpose of allowing it as a deduction under the Income-tax Act. Similarly, the circumstance that ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... by an assessee as interest or damages or penalty could be regarded as compensatory (reparatory) in character as would entit1e such assessee to claim it as an allowable expenditure under section 37(1) of the Income-tax Act. Therefore, whenever any statutory impost paid by an assessee by way of damages or penalty or interest is claimed as an allowable expenditure under section 37(1) of the Income-tax Act, the assessing authority is required to examine the scheme of the provisions of the relevant statute providing for payment of such impost notwithstanding the nomenclature of the impost as given by the statute, to find whether it is compensatory or penal in nature. The authority has to allow deduction under section 37(1) of the Income-tax Act, wherever such examination reveals the concerned impost to be purely compensatory in nature. Wherever such impost is found to be of a composite nature, that is, partly of compensatory nature and partly of penal nature, the authorities are obligated to bifurcate the two components of the impost and give deduction to that component which is compensatory in nature and refuse to give deduction to that component which is penal in nature." The Suprem ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... of the law and was an allowable deduction under section 1O(2)(xv) of the Indian Income-tax Act, 1922. The very same question came up for consideration before this court in CIT v. Travancore Electro Chemical Industries Ltd. [1995] 211 ITR 775. The question that arose for consideration was as to whether the interest payable under the Electricity Supply Act is in the nature of penalty which cannot be allowed as a deduction under section 37 of the Income-tax Act. This court relying on the principles laid down by the Andhra Pradesh High Court in CIT v. Hyderabad Allwyn Metal Works Ltd. [1988] 172 ITR 113 and the decision of the Supreme Court in Mahalakshmi Sugar Mills Co. v. CIT [1980] 123 ITR 429 held that the interest liable to be paid by the Kerala State Electricity Board is not penal in nature and therefore the assessee is entitled to claim deduction under section 1O(2)(xv) of the Income-tax Act. Again the very same Division Bench in CIT v. Pachi Philip and Co. [1995] 212 ITR 75 considered the issue with reference to the deductibility of the interest payable under the Abkari Act for delayed payment of kist. Referring to the provisions of the Abkari Act and the Rules and the decisi ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... racter that it has to be regarded as penalty. The Supreme Court in Malwa Vanaspati's case [1997] 225 ITR 383 was concerned with the question, inter alia, with the levy of penalty under section 8 of the Madhya Pradesh General Sales Tax Act, which provides for a penalty in cases where raw materials purchased by a registered dealer are utilised for any purpose other than the purpose specified in sub-section (1) of section 8 of that Act. As per the said section the penalty was to be an amount not less than the difference between the amount of tax leviable under the statute and the amount of tax payable under section 8(1) of the Act and not exceeding 1 1/4th times the amount of tax. Construing the said provision the Supreme Court held that section 8(2) of the Act provides both the elements of compensation and penalty; compensation in so far as payment of tax at the full rate is obligatory, and penalty in so far as something more up to 25 per cent. thereon being payable should the Commissioner so direct. In the light of the Supreme Court decision the Madras High Court held that the amount so recovered though termed penalty is in fact compensatory as the assessee had only been now mad ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... Gazette of India, direct that every scheduled bank shall, with effect from such date as may be specified in the notification, maintain with the bank, in addition to the balance prescribed by or under sub-section (1), an additional average daily balance the amount of which shall not be less than the rate specified in the notification, such additional balance being calculated with reference to the excess of the total of the demand and time liabilities of the bank as shown in the return referred to in sub-section (2) over the total of its demand and time liabilities at the close of business on the date specified in the notification as shown by such return so however, that the additional balance shall, in no case, be more than such excess. Sub-section (3) provides that if the average daily balance held at the bank by a scheduled bank during any fortnight is below the minimum prescribed by or under sub-section (1) or sub-section (1A), such scheduled bank shall be liable to pay to the bank in respect of that fortnight penal interest at a rate of three per cent., above the bank rate on the amount by which such balance with the bank falls short of the prescribed minimum, and if during th ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... lting bank is situated, such direction to be made only upon an application made in this behalf to the court by the bank and under clause (b) when the court makes a direction under clause (a), it shall issue a certificate specifying the sum payable by the scheduled bank and every such certificate shall be enforceable in the same manner as if it were a decree made by the court in a suit. Clause (c) of sub-section (5) provides that notwithstanding anything contained in this section, if the bank is satisfied that the defaulting bank had sufficient cause for its failure to comply with the provisions of subsection (1), (1A) or (2), it may not demand the payment of the penal interest or the penalty, as the case may be. Sub-section (7) provides that the bank may, for such period and subject to such conditions as may be specified, grant to any scheduled bank such exemptions from the provisions of this section as it thinks fit with reference to all or any of its offices or with reference to the whole or any part of its assets and liabilities. Similarly sub-section (1) of section 24 of the Banking Regulation Act provides that after the expiry of two years from the commencement of this Act, e ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... to which it relates, furnish to the Reserve Bank in the prescribed form and manner a monthly return showing particulars of its assets maintained in accordance with this section, and its demand and time liabilities in India at the close of business on each alternate Friday during the month, or if any such Friday is a public holiday, at the close of business on the preceding working day. Sub-section (4)(a) provides that if on any alternate Friday or, if such Friday is a public holiday, on the preceding working day, the amount maintained by a banking company at the close of business on that day falls below the minimum prescribed by or under clause (a) of sub-section (2A), such banking company shall be liable to pay to the Reserve Bank in respect of that day's default, penal interest for that day at the rate of three per cent. per annum above the bank rate on the amount by which the amount actually maintained falls short of the prescribed minimum of that day; and (b) if the default occurs again on the next succeeding alternate Friday, or, if such Friday is a public holiday, on the preceding working day, and continues on succeeding alternate Fridays or preceding working days, as the ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... by the defaulting banking company that the banking company had sufficient cause for its failure to comply with the provisions of clause (a) of sub-section (2A), the Reserve Bank may not demand the payment of the penal interest. From the aforesaid provisions of the two enactments it would appear that those two sections contain provisions of compensatory nature as well as penal interest. We draw the said conclusion particularly with reference to sub-section (3A) of section 42, clause (c) of sub-section (5) and sub-section (7) of section 42 of the Reserve Bank of India Act as well as sub-sections (7) and (8) of section 24 of the Banking Regulation Act, 1949, in regard to maintaining the requirement of sub-section (1) and the provisions of sub-section (3) of section 42 of the Reserve Bank of India Act providing for levy of penal interest. Under sub-section (3A) of section 42 of the said Act the payment of penal interest for not maintaining the said requirement on the first occasion cannot be treated as penal in character as is evident from the fact that the consequence of not maintaining the requirement is provided only in a case where such default is repeated for the second time. Tha ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... rest is being paid for infraction of law there is no question of waiving the penal interest at all. Sub-section (8) of section 24 of the Banking Regulation Act and sub-section (7) of section 42 of the Reserve Bank of India Act gives power to the Reserve Bank to exempt a bank from the requirement regarding the compliance with sections 24 and 42(1), respectively, of the said Acts. Thus, on a consideration of the relevant provisions of the aforesaid two enactments we are of the view that if the payment of penal interest relates to the first default of non-compliance of the provisions of section 42(1) of the Reserve Bank of India Act or the non-compliance of the provisions of section 24(1) of the Banking Regulation Act such payment cannot be treated as penalty for infraction of law. However, if the payment is by way of penal interest for the second default under the provisions of the aforesaid two enactments, in view of the fact that consequence by way of punishing the director, secretary, etc., are provided the payment of penal interest for the second default will have to be treated as penalty for infraction of law. This is so with regard to various other penalties under the other pr ..... X X X X Extracts X X X X X X X X Extracts X X X X
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