1964-VIL-24-ALH-DT

Equivalent Citation: [1965] 56 ITR 561 (ALL.)

ALLAHABAD HIGH COURT

IT Reference No. 40 Of 1959

Dated: 19.03.1964

CENTRAL TRADING AGENCY

Vs

COMMISSIONER OF INCOME-TAX

V.P. Tiwari, B.L. Gupta and A.K. Basu for the Applicant

R.L. Gulati for the Respondent

Bench

M.C. Desai And R.S. Pathak, JJ.

JUDGMENT

R.S. Pathak,

This is a reference at the instance of an assessee under section 66(1) of the Indian Income-tax Act.

The assessee is a registered firm carrying on contract business in the supply of dehydrated vegetable products to the Government. During the course of its business the assessee undertook a contract to supply onions and potatoes to the Government of India. This contract was executed with the Director General of Food, New Delhi, in 1943, for the 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 2 annas per pound on the quantity which it failed to deliver by the due date, unless its failure was due to reasons beyond its control. The assessee was able to supply only about 15 tons of onions by December 31, 1943. As the entire contract was not executed by it within the time stipulated, the Government cancelled the contract and imposed a penalty at the rate of one anna per pound on the balance remaining undelivered. Upon receiving this communication from the Government, the assessee applied to the Government to reconsider its decision and informed it that the required bulk of supplies as well as the facilities for supplying them had already been arranged. Upon this, it appears that the Government recalled its decision and extended the date for delivery of the supplies to August 31, 1944, upon condition, however, that the assessee paid liquidated damages at 2 per cent. These terms were accepted by the assessee, and it paid damages totalling Rs 17,240, of which a sum of Rs 13,517 was paid in the previous year relating to the assessment year 1945-46 and the balance of Rs 3,723 was paid in the previous year relating to the assessment year 1946-47.

In the assessment proceedings for the assessment years 1945-46 and 1946-47, the assessee claimed a deduction of the aforesaid sums of Rs 13,517 and Rs 3,723 respectively under section 10(2)(xv) of the Act. This claim was disallowed by the Income-tax Officer and an appeal filed by the assessee before the Appellate Assistant Commissioner was also unsuccessful. Thereafter, the case was carried to the Income-tax Appellate Tribunal, but the Tribunal took the view that, as the payment was made as a penalty for breach of contract, it did not fall for consideration under section 10(2)(xv).

Accordingly, the following question has been referred by the Tribunal :

"Whether, on the facts and in the circumstances of the case, the sums of Rs 13,517 and Rs 3,723 relating to the assessment years 1945-46 and 1946-47 respectively are permissible deductions under section 10(2)(xv)of the Income-tax Act?"

It is apparent from the facts that the Government had originally cancelled the contract and imposed a penalty for the failure of the assessee to supply the entire bulk of onions by December 31, 1943. Subsequently, however, the Government cancelled this order and by modification of the terms of the original contract enabled the assessee to fulfil the contract within an extended period. The Government stipulated, and the assessee agreed, that liquidated damages would be paid if the original contract was to be kept alive. In our view, 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. Had the Government maintained its original order cancelling the contract and imposing a penalty, it may have been possible legitimately to contend that the payment made on account of such penalty was a payment made on account of a 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 there from upon making the payment which was described as liquidated damages. It is, in our opinion, a payment which is directly connected with the business carried on by the assessee and fully satisfies the test laid down by Lord Davey in Strong and Company of Romsey Ltd. v. Woodifield [1906] 5 Tax Cas. 215, 220. It is a payment made by the assessee as a trader and not in any other capacity. It is a payment made by it for the purpose of carrying on its business and not a payment made for not carrying on the business. It is a payment made, in the words of Lord Davey "for the purpose of enabling a person to carry on and earn profits in the trade..." There can be little doubt that the payment was made by the assessee on the ground of commercial expediency.

The principles laid down by the Supreme Court in Eastern Investments Limited v. Commissioner of Income-tax [1951] 20 ITR 1 ; [1951] SCR 594, which, though a decision in a case under section 12(2), apply equally to a case under section 10(2)(xv), appear to us to cover the case before us. In Commissioner of Income-tax v. Royal Calcutta Turf Club [1961] 41 ITR 414 ; [1961] 2 SCR 729, the Supreme Court held that an expenditure incurred for preventing the extinction of the assessee's business was expenditure wholly and exclusively laid out for the purpose of the business and was a permissible deduction under section 10(2)(xv). In that case the assessee established a school for the training of Indian boys as jockeys so that after the training they may be available for race meetings held under its auspices. This was done for the purpose of keeping available a number of jockeys in the apprehension that, if jockeys were no longer available, the business of the assessee, which was to hold race meetings, would have to close down. The expenditure was incurred in running the school.

Reliance was placed on behalf of the Commissioner on Mask & Co. v. Commissioner of Income-tax [1943] 11 ITR 454 and Commissioner of Income-tax v. Himalaya Rosin-Turpenline Manufacturing Company [1953] 24 ITR 132. In both these cases the claim to deduction was disallowed on the ground that the payment was made as damages for breach of contract. In the former case, it was found that the assessee had acted with palpable dishonesty and the award of damages was not incidental to the trade carried on by it, and in the latter it was held that the payment was made towards a penalty imposed for breach of the rules under which the assessee was extracting rosin.

So also in M.V.G. Baluswamy Iyer v. Commissioner of Income-tax [1955] 28 ITR 235, where part of the claim was disallowed as payment made towards a penalty imposed upon the assessee, and in Senthikumara Nadar & Sons v. Commissioner of Income-tax [1957] 32 ITR 138, where, though the amount 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.

Learned counsel for the Commissioner also referred us to Haji Aziz and Abdul Shakoor Bros. v. Commissioner of Income-tax [1961] 41 ITR 350 ; [1961] 2 SCR 651, where the Supreme Court held that an amount paid by way of penalty for breach of the law was not an amount which could be allowed as a deduction under section 10(2)(xv). Clearly, the facts of the case before the Supreme Court are distinguishable from those in the instant case. The facts in Sree Meenakshi Mills Ltd. v. Commissioner of Income-tax [1963] 49 ITR 156 are also distinguishable, for in that case the payment made was towards expenditure incurred by the assessee in an infructuous attempt to vindicate itself from an offence committed by it.

We are, therefore, of the view that the payments of Rs 13,517 and Rs 3,723 are permissible deductions under section; 10(2)(xv) of the Act. In this view of the matter the question must be answered in the affirmative.

A copy of this judgment under the seal of the court and the signature of the Registrar shall be sent to the Appellate Tribunal. The assessee is entitled to its costs, which we assess at Rs 200. Counsel's fee is also assessed at Rs 200.