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TMI Blog1978 (5) TMI 22X X X X Extracts X X X X X X X X Extracts X X X X ..... separately, and it also made independent provisions for their recovery. Interest was not penalty. In carrying on a business an assessee may not be able to discharge his financial commitments in time, and as a result may become liable to pay damages or interest. Such a situation is a normal incident of business, and any loss incurred by an assessee under such circumstances is deductible under s. 37(1). 2. Payment of purchase tax was a statutory exaction and so was interest payable thereon. If the principal (i.e., purchase tax) is a permissible deduction, the interest payable thereon would also be equally permissible, because principal and interest together constitute the assessee's liability, and so interest, like the principal, represented a loss incidental to the carrying on of business and deductible while computing the assessable profits under s. 28(1). The first question which requires consideration is as to the true nature and character of interest and penalty chargeable under the U.P. Sugarcane Purchase Tax Act, 1961. s. 3 of the U.P. Sugarcane Purchase Tax Act, 1961, imposes on every sugar factory a tax on the purchase of sugarcane at the prescribed rates. Under sub-s. ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... Interest as well as penalty is charged for breach thereof, by delaying payment. The charge for delay for the first fifteen days is called interest, while for the subsequent periods it is described as penalty. Interest as well as penalty for delay up to six months is chargeable automatically. It is true that the legislature calls the payment for delay up to 15 days as interest, while for the subsequent period as penalty. It is also true that different sub-sections provide for recovery of interest and penalty, though in the same manner, namely, as arrears of land revenue. But would that make the true nature and character of the two imposts different ? The Supreme Court in CIT v. Bhikaji Dadabhai Co. [1961] 42 ITR 123 at page 128 held: "This court regarded penalty as an additional tax imposed upon a person in view of his dishonest or contumacious conduct. It is true that under the Hyderabad Income-tax Act, distinct provisions are made for recovery of tax due and penalty, but that in our judgment does not alter the true character of penalty imposed under the two Acts." The description or label put on an impost is not decisive of its true character. The correct test appears to ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... r Chapter XXII the revenue will have to prove its case beyond all reasonable doubt, because that is a fundamental principle prevailing in the criminal courts. All these features indicate that prosecutions under Chapter XXII are criminal proceedings, but penalty proceedings constitute a civil sanction. They are revenue in nature, to which article 20 of the Constitution does not apply." Penalty is a civil sanction. So is interest. The object of both is to render evasion or infraction of the law unprofitable, and to secure to the State compensation for damages caused by attempted evasion. Prosecution resulting in fine and/or imprisonment is a criminal sanction. The Sugarcane Purchase Tax Act makes provision for interest, penalty, as well as prosecution. In the premises, it is evident that both interest and penalty are civil sanctions of the same nature and character, provided to deter delay in payment of tax in violation or infraction of the law, and to compensate the Government for damages so caused. In Haji Aziz and Abdul Shakoor Bros. v. CIT [1961] 41 ITR 350, the Supreme Court held that fine paid for contravention of the Sea Customs Act was paid by way of penalty for breach ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ount paid was described as liquidated damages, it was held that the payment was really akin to a penalty for committing an act opposed to public policy, an act which was found not to have been done in the course of the normal trading activities of the assessee. Let us now turn to a different set of authorities, where payment of penalty or liquidated damages or even compounding fee have been held an allowable expense. In Central Trading Agency v. CIT [1965] 56 ITR 561 (All), the assessee entered into a contract with the Government for supply of 100 tons of dehydrated onions by December 31, 1943. The contract contained a clause stipulating that, in the event of the assessee failing to deliver supplies in accordance with the terms of the contract, it would be liable to a penalty of two annas per pound on the quantity which it failed to deliver by the due date. As the assessee defaulted, the Government cancelled the contract and imposed a penalty at the rate of one anna per pound on the undelivered quantity. On the application of the assessee, the Government extended the date of delivery of the supplies to August 31, 1944, upon condition that the assessee paid liquidated damages at ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... n order to save the goods from being confiscated and lost to it. The penalty paid could, therefore, be regarded as part of the cost of the goods to it. It could also be regarded as an amount expended by it wholly and exclusively for purposes of business, because unless the said amount was expended the goods could not have been saved from confiscation. It was observed that this was not a case where a penalty had to be incurred because of the fault of the assessee himself, or, for instance, for the reason of his having carried on the business in an unlawful manner or in contravention of certain rules and regulations. In Govind Choudhury Sons v. CIT [1971] 79 ITR 493 (Orissa), the facts were that the assessee carried on business, inter alia, in paddy. It entered into a contract with the Government for supplying paddy of a particular specification. In the course of the execution of the contract the assessee supplied paddy which was slightly inferior in quality. The authorities levied penalty, which was deducted from the amount payable to the assessee. The Orissa High Court held that this loss arising out of the imposition of penalty was integrally connected with the carrying on of ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... e is prosecuted and a penalty is imposed in respect of the very same transaction or his goods are seized and later on released on compounding then the loss resulting therefrom is not a business loss but arises as a result of the infraction of law by the dealer. In the same transaction is involved breach of warranty as well as breach of law; but different results follow from the different types of loss." Shortly put, the allowable business expense or loss is one which is incurred in carrying on the trade with a view to earn profits, bona fide and in good faith. Carrying on business in an unlawful manner, involving breach or infraction of the law, is not carrying it on in good faith or bona fide. Any expenditure due to infraction of law by the assessee is not a deductible item. 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 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 penalty for infraction of law or viola ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... acter as a trader. It is not a loss incidental to business so as to be deductible while computing the assessable profits of the business under s. 28 of the Act. In my opinion, the law laid down in Kamlapat's case [1976] 104 ITR 783 (All) is not sound. On facts, the position is that the assessee in the present case paid an amount of Rs. 37,783 as interest on arrears of cane purchase tax in the assessment year 1964-65 and an amount of Rs. 1,47,524, in the year 1966-67. It claimed it as a business expenditure. The ITO disallowed the claim. He relied upon Aruna Mills Ltd. v. CIT [1957] 31 ITR 153 (Bom), where interest payable for failure to pay advance tax was held not to be a deductible expense. The AAC as well as the Tribunal affirmed this view-point. They held that violation or infringement of a statutory obligation cannot be said to be a direct incident of business being carried on. At the instance of the assessee, the Tribunal has referred the following questions of law for our opinion: "(1) Whether, on the facts and in the circumstances of the case, the Tribunal was justified in holding that the interest on arrears of cane purchase tax amounting to Rs. 37,783 and Rs. 1,47 ..... X X X X Extracts X X X X X X X X Extracts X X X X
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