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TMI Blog1980 (1) TMI 79X X X X Extracts X X X X X X X X Extracts X X X X ..... conditions laid down for the use of the aforesaid trade mark was the export of a certain percentage of sanforized fabrics manufactured by the companies using that trade mark and such percentage was to be determined by the Government of India. It was five per cent. during the period July, 1963 to 1965. Thereafter, when the trade mark registration was revalidated for a further period of seven years to extend up to 1972, the quantum of export obligation was raised to 10 per cent. and that was by letter dated 30th April, 1966. In the event of non-fulfilment of the export obligation, the mills were to pay certain penalty. Clause (v) of that letter reads as under : " (v) Mills failing to fulfil the export obligation shall pay a penalty at the rate of 10 p. per linear yard to the extent of the annual shortfall, while mills will be permitted to discharge their export obligation reckoned in the manner prescribed above cumulatively during the period 1966-72, the performance of each mill in relation to its obligation shall be reviewed annually (in February of the year following the one to which the export obligation relates) and an amount shall be deposited in Government account by the def ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... the assessee's normal trading activities and further that it was not a contingent liability because in case at some future date the assessee obtained refund of those amounts or any part thereof, such amount could be brought to tax as income of the year of receipt. Two submissions were made before us on behalf of the revenue by Sri R. K. Gulati, advocate. Firstly, that the obligation of the assessee to export a certain percentage of sanforized cloth produced by it was on the basis of an order made by a statutory authority and business carried on in breach of such order would be on the same footing as business carried on in contravention of a statutory provision and hence the action of the assessee was against public policy. According to Sri Gulati, this obligation was not on the basis of any agreement because no agreement had been entered into by the assessee as required by art. 299 of the Constitution. The second submission made was that the disputed claim was only in the nature of a contingent liability because the assessee could make good the shortfall in the subsequent years. Reliance was placed on certain decisions in support of these contentions. After hearing counsel for th ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... rtain particulars required to be furnished with such an application. Sub-s. (3) gives power to the Central Govt. to direct the Registrar to accept the application either absolutely or subject to any conditions, restrictions or limitations which the Central Government may think proper to impose. The Registrar is required to dispose of the application in accordance with the direction so issued by the Central Govt. According to Sri Gulati, the Central Govt., in the instant case, did impose certain conditions in regard to the use of this trade mark and, hence, carrying on of the business in breach of such a condition would tantamount to not carrying on business according to law and the decision of the Supreme Court in Haji Aziz and Abdul Shakoor Bros. v. CIT [1961] 41 ITR 350 would be applicable. We do not find any substance in this submission either because breach of a condition imposed by the Central Govt. has not been made an offence under this Act. Chapter X of this Act has made provision for offences, penalties and procedure. In none of the sections occurring in this Chapter it has been provided that the breach of a condition imposed by the Central Govt. under s. 49(3) would be an ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... as a permissible deduction. In other words, to be an expenditure and qualify for deduction it has to be a commercial loss in trade and also contemplable by the parties. However, a penalty imposed for breach of the law during the course of trade cannot be regarded as an allowable expenditure. Therefore, it has to be seen whether the disputed amounts paid by the assessee for the two years under consideration were in the nature of a commercial loss in trade and were contemplable by the parties or were in the nature of penalty for breach of law during the course of trade. We have already indicated above that these payments were not in the nature of a penalty incurred for the contravention of any statutory provision. These payments were made because of the breach of certain conditions of the agreement and such breach was in the contemplation of the parties as would be clear from para. (V) of letter dated 30th April, 1966, quoted above. For the shortfall in the export of sanforized cloth in any year of the six year period damages were to be deposited at a certain rate by the defaulting company and on a final review of the cumulative export performance against its total obligation necess ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... scertaining profits taxable under s. 10(1) and that if there was any loss which, from the commercial point of view, can be considered as trading loss that loss is to be deducted under s. 10(1) before the true profits of the business are ascertained. Reference may be made to the decision of the Supreme Court in Calcutta Co. Ltd. v. CIT [1959] 37 ITR 1, wherein their Lordships held that the expression " profits and gains " in s. 10(1) of the 1922 Act has to be understood in its commercial sense and there can be no computation of such profits and gains until the expenditure which is necessary for the purposes of earning receipts is deducted therefrom. in Badridas Daga v. CIT [1958] 34 ITR 10 (SC), this is what the Supreme Court had to say in this behalf : " The result is that when a claim is made for deduction for which there is no specific provision in section 10(2), whether it is admissible or not will depend on whether, having regard to accepted commercial practice and trading principles, it can be said to arise out of the carrying on of the business and to be incidental to it. If that is established, then the deduction must be allowed, provided of course there is no prohibition ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... amages for breach of contract, but it was found that the assessee's conduct was palpably dishonest and the award of damages was not incidental to the trade carried on by it. This case is distinguishable as in the present case it has been found by the Appellate Tribunal: " The assessee's contention that these amounts were payable by it in the normal course of its trade appears to be correct. The assessee did not export because it was unprofitable to do so and paid the penalties. The payment was, therefore, in the course of the assessee's business. " The Tribunal rejected the department's contention and held that the liability for the payment of these amounts arose in the normal course of the trading activities of the assessee. Cineramas v. CIT [1977] 110 ITR 762 (Punj) is another case of payment of penalty for breach of a contractual obligation. In that case, the assessee who carried on business in exhibition of films was a member of the East Punjab Motion Picture Association. Under the bye-laws of the association a member is obliged to carry out the " award and directives " of the association arising out of all disputes between members or upon complaints received by the assoc ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... at 2 per cent. The assessee accepted those terms and the damages totalling Rs. 17,240 and claimed that amount as business expenditure in its assessment for the assessment years 1945-46 and 1946-47. This claim was disallowed by the ITO as also by the AAC And the Income-tax Appellate Tribunal on appeals. On a reference this court held that the amount paid by way of liquidated damages was merely an amount paid by the assessee for the purpose of keeping the contract alive and was in reality a payment made for the purpose of enabling the assessee to completely execute the contract. " It is not, as contended on behalf of the Commissioner, a payment made as damages for breach of contract ...... But it seems to us plain that the payment under consideration was made not as a penalty or as damages for breach of contract, but merely in fulfilment of the condition agreed to between the parties enabling the assessee to fulfil the contract and earn profits therefrom upon making the payment which was described as liquidated damages." It was thus held that it was payment made by the assessee as a trader and not in any other capacity and the purpose was to enable it to carry on its business. In ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... e previous years relevant to the assessment years 1969-70 to 1971-72, from the Textile Commissioner whereby they were required to pack minimum of the particular types of cloth mentioned therein. That was not done and hence by different orders the Textile Commissioner directed the assessees to pay certain amounts in respect of the relevant assessment years under cl. 21C(1)(b) of the Cotton Textiles (Control) Order, 1948, and the amounts were so paid by the assessees. They claimed those amounts in the relevant assessment years as deductible expenses. Their claim was accepted by the Appellate Tribunal as a legitimate deduction under s. 28 of the Act. On a reference the view taken by the Gujarat High Court was that by failing to produce the whole or part of the minimum quantity of cloth specified in the directions issued by the Textile, Commissioner, that particular manufacturer did not commit any infraction of law. The words used in cl. 21C, namely, that " producer may, in lieu of packing the whole or part of the minimum quantity ...... make payment " go to indicate that the option has been given to the producer to decide whether he would produce any part of the minimum quantity speci ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... um calculated at the rate of 11 paise per metre to cover the shortfall. The assessee exported rag cloth amounting to 90% of the target and paid a sum of Rs. 35,193 towards the shortfall and claimed that amount as a business loss under s 28 or business expenditure under s. 37. The view taken by the Gujarat High Court in reference was that the aforesaid payment was not in the nature of penalty for infraction of law or violation of public policy but was a loss connected with and arising out of trade. The decision in Rustam Jehangir Vakil Mills [1976] 103 ITR 298 (Guj) was followed. In Sarays Sugar Mills (P.) Ltd. v. CIT [1979] 116 ITR 387 (All) (FB), when the case of Addl. CIT v. Arvind Mills Ltd. [1977] 109 ITR 212 (Guj) was cited before the Full Bench of our court, this is what the court observed about it : " Learned counsel for the assessee placed reliance on Addl. CIT v. Arvind Mills Ltd. [1977] 109 ITR 212 (Guj). In that case, the assessee paid a sum of money to cover the shortfall in the export of the agreed quantity of cloth. It was held by the Gujarat High Court that the payment was to cover the shortfall which was contemplated by the parties. It was not in the nature of p ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... e word used in the scheme for the sum to be paid in default of fulfilling the export obligation had been described as " penalty " but in the ultimate analysis it is the substance of transaction between the parties to be considered for the purpose of determining what is the nature and import of the scheme and the bond executed in pursuance thereof. The view taken was that in the interest of business and such other things the textile manufacturers could apt for payment of compensation or damages to cover up the shortfall in the export obligation. In our opinion, this decision squarely applies to the present case and we are inclined to take the same view. The only difference in facts is that there a bond had also been executed by that textile mill in favour of the President of India, while no such bond had been executed by the present assessee. That, however, does not make much difference because the export obligation arose from the condition imposed by the Central Government for the use of this trade mark. A breach of that condition, as already discussed, would not amount to an infraction of the law. There is also a decision of the Madras High Court in the case of Hind Mercantile C ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... e good the shortfall in the subsequent years. We do not find any substance in this submission either. Clause (v) of the letter dated 30th April, 1966, clearly provided that the performance of each mill in relation to its export obligation shall be reviewed annually and in the event of default in discharging the export obligation, the defaulting mill would have to deposit a certain amount in the Government account. Thus, as soon as any of the mills concerned made the default, a liability arose in praesenti and it was also an ascertained liability. The mere fact that the defaulting mill could make good the shortfall in the subsequent years would not change the nature of this liability and render it a contingent liability. We need hardly emphasise that the computation of the net profit is to be made on the basis of the method of accounting followed by an assessee. If he follows the mercantile system, the loss becomes deductible at the time when it accrues. All that is necessary in this behalf, therefore, is to see that the loss or the liability accrued in the relevant previous year and, secondly, that it was an ascertained liability. In our opinion, there can be no doubt whatsoever th ..... X X X X Extracts X X X X X X X X Extracts X X X X
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