1981 PLP (Trib (PTD)

Commissioner of Income‑tax v. Mathura Pursad Hardware (1962) 2 Taxation 377 (Trib.). Commissioner of Income‑tax v. Prafulla Kumar Mallick (1969) 75 I T R

119. Indian Aluminium Co. Ltd. v. Commissioner of Income‑tax, West Bengal (1967) 64 I T R 330.

6. In reply, the learned counsel for the revenue submitted that the cases cited by Mr. M. A. Noorani, the learned counsel for the assessee‑respondent in support of his case are regarding the violation of the terms of agreement or embezzlement etc., whereas the case concerning the infraction of law fall within a different compass.

7. It may also, at this, stage, be mentioned that Mr. Muhammadullah Ansari; the Secretary of the M . . . . C. . . . Bank also addressed us, with our permission, to explain the procedure connected with the control exercise by the Central Bank over the scheduled Banks with specific reference to the provisions of section 36 of the State Bank of Pakistan Act, 1956, regarding the maintenance of cash reserve at not less than 5 % of demand liabilities and 2% of time liabilities at the close of business each day. He emphasised that the power conferred on the State Bank to order the defaulting Bank to pay penal interest is not in lieu of legal punishment but to adopt a disciplinary measure. He submitted that it is the solitary instance where the claim for penal interest has been disallowed. In short, he emphatically urged that the levy of penal interest is beyond the purview or philosophy of penal provisions.

8. Having heard the arguments of the authorised representative of the parties as well as the submission made by Mr. A ... . we are firmly of the view that it was a clear case of infraction of law and the assessee was not entitled to the allowance of deduction of the sum in question in computing the profits as having been laid out wholly and exclusively for the purpose of business. Before proceeding further to consider the submis sions of the parties' representatives at length it seems appropriate if the relevant provisions of section 36 of the State Bank of Pakistan Act, 1956, are reproduced. It runs as under :‑‑‑ "

36. Cash reserve of scheduled Banks to be kept with the Bank.‑(1) Subject to subsection (2) every scheduled Bank shall maintain with the Bank a balance the amount of which shall not at the close of business of any day be less than five per cent of the demand liabilities and two per cent of the time liabilities of such Bank in Pakistan. (2)

(3)

(4) If at the close of business on any day before the day fixed for the next return under the preceding subsection, the balance held at the Bank or any scheduled Bank is below the minimum fixed by sub section (1) or varied under subsection (2), such scheduled Bank may be ordered by the Bank to pay to the Bank in respect of such day penal interest at a rate three per cent above the bank rate on the amount by which the balance with the Bank falls short of the fixed minimum, and if on the day on which the next return is due such balance is still below the fixed minimum as disclosed by this return, the rate of penal interest may be increased to a rate five per cent above the Bank rate in respect of that day and each subsequent day on which the balance held at the Bank at the close of business on that day is below the fixed minimum. (5) When under the provisions of subsection (4) penal interest at the increased rate of five per cent above the bank rate has become payable by a scheduled bank, if thereafter on the day fixed for the next return under subsection (3) the balance held at the Bank is still below the fixed minimum as disclosed by this return. (a) Every Director and officer of the scheduled Bank, who is knowingly and wilfully a party to the default, shall by order of the Bank be punishable with fine which may extend to five hundred rupees for each subsequent day on which the default continue ; and (b) The Bank may prohibit the scheduled Bank from receiving after the Bank in complying with such prohibition, every director and officer on the scheduled Bank who is knowingly and wilfully a party to such default or who through negligence or otherwise contributes to such default shall by order of the Bank be punishable in respect of each default with 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. Explanation.‑In this subsection "officer" included Manager, Secretary, Branch Manager and Branch Secretary. (6) Any Scheduled bank failing to comply with the provisions of subsection (3) shall by order of the Bank be liable to pay to the Bank a penalty of one hundred rupees for each day during which the failure continues. (7) Whoever in any return under this section wilfully or recklessly makes a statement false in any material particular or wilfully or recklessly omits to state a material particular shall by order of the Bank punishable with fine which may extend to one thousand rupees in respect of each such return."

9. It is not dispute before us that the assessee‑Bank was a default under section 36(1) of the State Bank of Pakistan Act, 1956 in respect of maintaining with State Bank of Pakistan the minimum cash reserve and liquidity ratio as required under the State Bank directives. The assessee has claimed the allowance of the sums in question under section 10(2)(xvi) of the Income‑tax Act, 1922, as being an expenditure wholly and exclusively laid out fore the purpose of business. By virtue of section 36 of the State Bank of Pakistan Act, every scheduled bank is under a legal obligation to maintain with the State Bank a balance the amount of which shall not at the close of the business on any day less than 5 % of the demand liabilities and 2 % of the time liabilities of such banking in Pakistan and the con sequences to flow for the failure to comply with this legal requirement are contained in subsections (4), (5), (6) and (8) of section

36. In subsection (8) of section 36, it has been clearly laid down that the penalties imposed under subsections (4), (5), (6) and (7) and shall be payable on demand made by the State Bank of Pakistan.

10. When the assessee‑bank incurred the liabilities, it did so obviously as a penalty for an infraction of the law. It has been clearly enunciated by the Bombay High Court in the case reported as (1961) 41 I T R 350 (as well as in certain other authorities cited at the bar and to which we shall make a reference later on) that a penalty for breach of the law during the Course of Trade cannot be described as commercial loss in trade. In that cass, the assessee had; in violation of law, imported dates by steamer, which were confiscated by the Custom authorities but these were later on released to the assessee on payment of fine. The assessee claimed the amount of penalty on ordinary principle of commercial accounting. The Income‑tax Officer disallowed the claim and the Appellate Assistant Commissioner confirmed it. But the Tribunal allowed it. The High Court held that infraction of law is not a normal incident of business and no expense which was paid by way of penalty for a breach of the law could be said to be an amount wholly and exclusively laid for the purpose of business. As per Wharton's Law Lexicon, 14th Edition, penalty means "a sum recoverable by action from a person infringing a statute". It may here be pointed out that in subsection (4) of section 36 the expression "penal interest" has been used, but in subsection (8) of the said section, a already pointed out, it has been clearly referred to and described as a penalty. The penal interest, therefore, is nothing but a penalty and has to understood and interpreted as such while considering its allowability or otherwise as an expenditure under section 10(2)(xvi) of the Act. In the facts of the instant case it is definitely not possible for us to hold that liabilities in question were in the nature of expenditure incurred on the ground of commercial expediency or with a view to indirectly facilitate the carrying on the assessee's business. Even at the cost of repetition it may be added that the payments of the liabilities in question cannot be characterised or treated as incidental to the assessee's business notwithstanding the fact that it may have some connection with its business. It is, however, evidently borne out from the facts, narrated above, that the assessee's liabilities arose directly from non‑compliance of the mandatory provisions of law to maintain a balance of not less than 5 % of its demand liabilities and 2 % of its time liabilities in Pakistan. It cannot by any process of reasoning be said to be incidental to the assessee's business. It is clearly a case of infraction of law and the breach of statutory obligation which has, consequently, resulted in the imposition of penalty. It is as already stated, a well established proposition of law by authorities that no deduction for and in respect of penalty followed the infraction of law, can be allowed as an admissible expenditure. Wherever the assessee disregards or violates the statutory provision of law and as a result thereof any penalty is imposed upon the assessee, it cannot be construed as a business expense and be allowed as a deduction within the purview of section 10(2(xvi) of the Act. Nor can it be treated or held to be an expense wholly and exclusively laid out for the purpose of the business. Having reached this conclusion, we fell persuaded to reverse the order of the learned Appellate Assistant Commissioner who, as already stated without examining the issue in detail, has decided this issue in favour of the assessee.

11. Before parting with the case, we may briefly refer to some of the authorities cited at the bar and which directly illustrate the point in issue. The case of Atta Hussain Khan Limited has no bearing on the facts of the instant case. In that case the Court was concerned with the allowance of remuneration of the Managing Director under section 10(2)(xvi) of the Income‑tax Act, as an expenditure having been incurred "wholly and exclusively for the purpose" of the business of the company. The second case, relied upon by Mr. Mansoor Ahmad reported as (1972) 85 I T R 489, is a decision of Delhi High Court. There the assessee‑Company was subjected to a penalty of Rs. 97,028 under the U. P. Sugarcane Cess Act, on delayed payment of cess and tax. That Act was later struck down by the Supreme Court and the U. P. Legislature passed the U. I'. Sugar Cess Act (Validation) Act,. 1961, validating the levy under the Act, 1956. The question involved therein was whether the penalty paid by the assessee was an allowable deduction in computing its profits. The High Court held that the penalty paid was not an allowable deduction. The imposition of penalty was on account of failure on the past of the assessee to comply with the statutory obligation and as such any payment made by the assessee was not incidental to its business nor was there any commercial expediency for its payment. The Lahore High Court in the judgment reported as (1979) 40 Taxation 55, while dealing with the question whether an amount forfeited by M. B. R. 81 Committee of out of surrendered high denomination notes for committing violation of law was allowable as legitimate business held that it could not be described as an admissible business expenditure within the meaning of clause (xvi) of subsection (2) of section 10 of the Income‑tax Act. Paras. 10 and 11 of the judgment which are relevant for our purposes are extracted below :‑ "(10) In order that the assessee may be found entitled to deduction of any amount from his "total income" he has got to prove that a particular amount of expenditure was incurred by the assessee that expenditure was laid out or expended "wholly and exclusively" for the purpose of business, profession or vocation. (11) It is no part of the business of an assessee to commit violation of law and thus any liability arising from the infraction of law would not be regarded as an expenditure incurred wholly, exclusively and necessarily for the purposes of business."

12. The last case cited by the learned counsel reported as (1961) 41 I T R 350, has already been referred to and discussed in the earlier part of this order. We shall now proceed to consider the cases relied upon by the learned counsel for the assessee‑respondent.

13. The first case relied upon by the counsel has no relevancy to the instant case and hence we do not consider it necessary to examine it. The case reported as (1961) 41 1 T R 350 was cited by the learned counsel for the appellant as well and we have already narrated the relevant facts and the Law enunciated by the Bombay High Court in that case. It clearly lends support to the case of appellant. Another case (1957) 32 I T R 138 has been referred to in this decision wherein it has been expliatly hold that "the payment of penalty for an infraction of law fell outside the scope of permis sible deductions under section 10 (2)(xv) of the Indian Income‑tax Act, 1922", which is parallel 4o 10(2) (xvi) of our Act. In (1966) 13 Taxation 279 the Allahabad High Court found that the import of molasses into Pakistan was prohibited by Pakistan from India. In spite of this prohibition of the assessee exported molasses to Pakistan through boars. Pakistan Custom Authorities seized the goods but, later on, having been approached by the Government of India allowed its entry into Pakistan on payment of penalties by the assessee. The assessee claimed deduction of penalties paid by it from profits for the purpose of Income‑tax. The Income‑tax Officer disallowed the claim and held that the payment of penalties could not be said to be necessary for the purpose of its business. On appeal, the Appellate Assistant Commissioner reversed the order of the Income‑tax Officer and held that the deductions were allowable because the penalties were paid for the purposes of carrying on business in molasses in East Pakistan and the payment of penalty was in much obligatory as the payment of Custom Duty, but disallowed the deductions because the assessee had not proved the amounts of penalties paid by them. On further appeal the Tribunal allowed the deductions upon assessee's producing evidence of penalties paid by it. Upon reference, the High Court held that the penalties paid by the assessee to the Pakistan Government for its allowing the molasses to be imported to Pakistan cannot be said to be an expenditure of the nature mentioned in section 10(2)(xv). The High Court referred to the case of Commissioner of Inland Revenue v. Warnes & Co. Ltd. ((1912) 2 K B 444=12 Tax. Cas. 227). Where it was held that a penalty paid by an assessee on account of irregularities committed by him in the course of business of exporting, the expenditure was not deductable from his profits in the assessment of Income‑tax Rowlatt, J. held, "that a penal liability of this kind cannot be regarded as connected with or arising out of a trade and that a loss connected with or arising out of a. trade must amount to something in the nature of a loss which is contemplatable and in the nature of a commercial loss." It is further pointed out in judgment that this case was approved by the Supreme Court in Haji Aziz Abdul Shakoor Bothers v. Commissioner of Income‑tax ((1966) 41 I T R 350).

14. The next case cited by him is (1960) 2 Taxation

377. It was a case of recovery of extra amount for late supplies, and it was held to be of a nature of compensation and not a penalty. The Tribunal held that such as expenditure was incidental to business. It has also therefore, no relevancy to the facts of the instant case.

15. The case reported as (1969) 73 I T R 119 has also of no direct bearing on the facts of this case. On the facts of that case, the finding of the Tribunal was that the real nature of the transaction was a breach of warranty resulting in a claim of damages. It was in consideration of this finding that the Orissa High Court held that, "In determining the question whether payment of penalty by way of damages was incidental to the business itself. One has to consider the degree of connection between the trade and business carried on and the cause of the liability for damages".

16. The only other case on which Mr. Noorani placed reliance was (1967) 64 1 T R

330. This case, in our opinion, actually goes against the assessee. The relevant facts were that the assessee paid certain amount of fee to a non‑resident without deducting tax and thereby contravened section 18(38) of the Income‑tax Act, 1922. The Income‑tax Officer treated the assessee as a defaulter under section 18(7), in respect of the sum which it ought to have deducted. The non‑resident Company refused to re‑imburse this amount to the assessee. The assessee wrote off this amount and claimed a deduction of this amount from its profits, as business expenditure or as a bad debt. The Income‑tax Officer disallowed the claim but the Appellate Assistant Commissioner held it to be an allowable and admissible deduction. On further appeal, the Tribunal held that the expenditure was either Incidental to the business, much less wholly and exclusively laid out for the purpose, nor was it claimable as a bad debt, in view of the fact that it was not a trade debt in the course of the business. There upon the case came up before the Calcutta High Court in reference. The High Court agreed with the conclusion of the Tribunal and held; "The liability has arisen out of an in-faction of the statutory provision that accordingly is not deductable from the profits and gains of the business under section 10(1) or under section 10(2)(xv) of the Act. It is neither incidental to the business, such less wholly and exclusively laid out for the business".

17. In the result, the Departmental appeals succeed ; the order of the Appellate Assistant Commissioner is vacated and those of the Income‑tax officer restored. Appeals allowed.