1986 PLP 52 (PTD)

MAMOON KAZI, J.‑The assessee is a private limited company which carries on business of manufacture and sale of tyres and tubes. The company imported certain nylon fabrics for which no licence had been obtained. When the goods arrived the same were confiscated for lack of such licence. However, in order to obtain delivery of such goods the assessee agreed to pay a penalty of Rs. 2,91,

000. After realisation of the goods, the assessee succeeded in obtaining an import licence for the goods and consequently the amount of penalty was reduced to Rs. 1,16,

400. Besides this amount, the assessee had also to pay certain demurrage and duties etc. and alongwith this amount such amounts totaled Rs. 2,06,

823. All these amounts were debited to the trading account by the assessee but disallowed by the Income‑tax Officer for the reason that such expenditure was not incurred wholly and exclusively for the purpose of the assessee's business. On appeal being filed, the Tribunal came to a conclusion that except for the amount of Rs. 1,16,400 incurred on account of penalty imposed by the Customs authorities, the other expenses incurred by the assessee were of admissible nature. When notice of this order was received by the assessee he applied to the Tribunal to refer the following question to this Court which was framed by the assessee as follows:‑ "Whether in the facts and circumstances of the case, the Tribunal was justified in holding that a sum of Rs. 1,16,400‑ representing the amount of penalty paid in lieu of confiscation of goods to the Sea Customs Authorities was not an allowable deduction under the provisions of the Income‑tax Act, 1922." However, the Commissioner of Income‑tax wanted that the question be refrained as follows and the Tribunal agreeing with him has referred the following question for our opinion:‑ "Whether, on the facts and in the circumstances of the case, the Income‑tax Appellate Tribunal was justified in holding that the sum of Rs. 1,16,400 representing the amount of penalty imposed in contravention of the relevant laws of the country for importing goods without obtaining an import licence was not an. allowable deduction under the provisions of the Income‑tax Act, 1922."

2. The relevant provisions of law applicable in this case, on which both the counsel have relied, are contained in clause (xvi) of subsection (2) of section 10 of the Income‑tax Act, 1922, which provides as follows: "10.‑(1) Subject to the provisions of this Act, the tax shall be payable by an assessee under the head profits and gains of business, profession or vacation in respect of the profits or gains of any business, profession or vacation carried on by him. (2) Subject to the provision, of this Act, such profits or gains shall be computed after making the following allowances, namely: (xvi) any expenditure not being in the nature of capital expenditure or personal expenses of the assessee laid out or expended wholly and exclusively for the purpose of such business, profession or vaca tion." The question; therefore, arises whether this amount of Rs. 1,16,400 incurred by the assessee towards payment of penalty is an expenditure incurred wholly and exclusively for the purpose of the business of the assessee.

3. The contention of Mr. Naseem Ahmad Khan the learned counsel appearing for the assesses has been that the amount paid as penalty was paid in connection with the assessee's business and therefore, should have been allowed by the Income‑tax Officer under the relevant clause of sec tion 10(2) of the Income‑tax Act reproduced above. The learned counsel argued that the penalty imposed by the Customs was not of personal nature but it was imposed on goods imported for the purpose of business of the assessee. The learned counsel also referred to the commentary from The law and practice of Income-tax by Kanga and Palkhiwala 7th Edition p. 464, Vol. 1, where the following observations have been made by the Authors:‑ "Expenditure tainted with illegality.‑Revenue expenses incurred by the assessee in his character as a trader and wholly and exclusivel3 for the purpose of his business, stand on a different footing from penalties and fines. Such expenses though tainted with illegality. e.g. infringement of the Companies Act, 1956 are deductible, just as income tainted with illegality is assessable ; even in an illegal business it is the profits, and not the gross receipts, that are taxable." The argument of Mr. Shaikh Haider, the learned counsel for the Commissioner of Income‑tax, on the other hand has been, that deductible expenditure is only that which is incurred wholly and exclusively in connection with a trader's business and if such trader commits an illegality and penalty is imposed on that account, such penalty would not fall within the ambit of clause (xvi) of section 10(2).

4. Both the learned counsel have relied upon case‑law on the point, although the cases cited by them are mostly from tile Indian Jurisdiction. However, we first propose to refer to the cases relied upon by Mr. Nasim Ahmed Khan.

5. In Commissioner of Income‑tax, Bombay v. Bannalal Narottamdas & Co. (67 I T R 667), the assessee in that case purchased Bills of Lading and other shipping documents from certain parties in respect of some consignment of goods imported by them from a foreign country. When the goods arrived in India and were sought to be cleared through Customs by the assessee on the basis of the documents purchased by him, it was found that the import was unauthorised and the goods were fable to be confiscated and further liable to imposition of penalty under section 167(8) of the Sea Customs Act. The assessee thereafter paid an amount of Rs. 31,203 by way of penalty for saving the goods from the Customs authorities. It was held, that the actual cost of the goods to the assessee was nut only what it had paid to the importers but in addition thereto what it had to pay by way of penalty in order to save the goods from being confiscated. It was further held that the penalty paid by it 'could, therefore, be regarded as part of the cost of the goods to it and could also be regarded as an amount expended by it, wholly and exclusively for the purpose of the business, because unless the said amount was expended, the goods could not have been saved from confiscation. However, the view taken in Govind Choudhury and Sons v. Commissioner of Income‑tax Bihar and Orissa (79 I T R 493), was different as it was held therein, that penalty would not come within the ambit of section 10(2) (xv) of the Indian Income‑tax Act, 1922 as to entitle the assessee to claim deduction under section 10(2) (xv) as business expenditure but the same would be deductible under section 10(1) of the Act. In that case penalty was imposed on assessee for supplying inferior quality paddy and rice. Reference has also been made to Commissioner of Income‑tax Gujrut v. S. C. Kothari (82 1 T R 794), where the question was, whether the contract in respect of which loss was incurred by the assessee was illegal contract and whether the assessee was entitled to claim set off in respect of such loss. The Supreme Court remitted the matter to the High Court to decide the point whether the profit and loss were incurred in the same business even though that business involved the entering into of contracts some of which were, under the eye of the law, illegal. In another case, reported as Commissioner of Income‑tax, Bombay South v. Pranlal Kesurdas (49 1 T R 931), one of the assessee's constituents incurred loss in connection with certain forward transactions in turmeric with the assessee, which the assessee had put through that constituent was unable to pay the loss suffered by him and tae loss fell on the assessee. Two years later the constituent paid Rs. 4,000 to the assessee in full settlement of his debt and the assessee wrote of the balance remaining unpaid as bad debt. The assessee claimed deduction in the accounting year, when the loss had actually been suffered, but his claim was not allowed by the Appellate Assistant Commissioner woo held that the debt had not become bad in that year but two years later. On reference to the income‑tax Appellate Tribunal the claim of the assessee was allowed by the tribunal. When the matter went before the High Court, it was held that the Tribunal was right in holding that the assessee was entitled to have the amount allowed as deduction as claimed by him. In Commissioner of Income‑tax, Poona v. R. B. Rungta & Co. (50 1 T R 233) the question was, whether debts, which were not enforceable under law could be considered to have become bad and whether such debts were allowable for income‑tax purposes. The Appellate Tribunal took the view that the assessee's claim for deduction of such amount could be allowed under section 10(2) (xi) of the Indian Income‑tax Act, 1922 on general principles governing computation of profits under section 10(t). It was held by tile High Court of Bombay (i) that the appellate tribunal was entitled to grant relief to t to assessee not merely under the head under which the assessee had made its claim but even in the alternative under another head, namely, by way of com mercial losses under section 10(I) of the Act, (ii) that the Appellate Tribunal was right in holding that the assessee was entitled to treat the amounts as revenue loss in computing the profits of its business under section 10(1) inasmuch as the assessee had to make these payments to the association, (iii) that the legal unenforcibility of the assessee's claim did not prevent the amounts from‑ being bad and irrecoverable debts for the purposes of the computation of the taxable income of the assessee and, therefore, the amounts could also be allowed as bad and irreco verable debts under section 10(2) (xi). Another case cited by Mr. Nasim Ahmad Khan, the learned counsel for the assessee, was Commissioner of Income‑tax v. Sree Rajendra Mills Ltd. (93 1 T R 122). In that case the company paid remuneration to its General Manager who was appointed one of its Managing Agents in contravention of the provisions of section 360 of the Companies Act and then claimed the payment as deduction. It was held in that case by the Madras High Court, that even though there was an infringement of section 360 of‑the Companies Act, but since there was an actual payment for actual services rendered, the amount paid will be allowable as deduction under section 10(2) (xv). The learned coups‑l also relied upon a case decided by the Supreme Court of Pakistan and reported as Commissioner of Income‑tax Central Karachi v. Messrs Alpha Insurance Co. Ltd. and another (P L D 1981 S C 293): In that case the assessee had exceeded the ceiling fixed in respect of its expenses by rule 40 of the Insurance Rules. It was held by the Supreme Court that the expenses of management incurred in excess of the limit prescribed under section 40‑C of the Insurance Act 1938 read with rule 40 of the Insurance Rule were not in the nature of penalty, fine or forfeiture for the purpose of their admissibility under section 10 of the Income‑tax Act and therefore allowable.

6. If any help is sought from these cases, then they provide none because, after all a line has to tie drawn between a case where a trader has actually incurred expenses in connection with his business but in violation of some law and a case where penalty has been imposed on him due to trasgression of some law. The cases cited above, fall within the first category, the only exception being the case of Pannalal Narottamdas & Co. referred to above, although the facts of that case are also distinguishable as the assessee in that case had already paid consideration in good faith, for purchase of the documents from the actual importer of the goods. Some support can also be drawn by the assessee from R. B. Rungta & Co.'s case, also referred to above, but there the penalty paid by the assessee was held to be admissible under section 10(1) of the Indian Income‑tax Act. Since the question, whether such expenditure is deductible under section 10(1) or section 10(2) of the Act is not in controversy in the instant case, any further discussion on the point would be futile. II would also be worthwhile to refer to another case here, reported as Raj Woollen Industries v. Commissioner of Income‑tax Simla (43 I T R 36) which has also been cited by Mr. Nasim Ahmed Khan, although the learned counsel very frankly conceded that this case does not support the point now being canvassed by him. In that case, the question before the Punjab High Court was, whether a such of Rs. 6,800 paid by the assessee to achieve what was prohibited by law viz. the export of wool without having the requisite export licence was an admissible expense either under the provisions of section 10(2) (xv) of the Indian Income‑tax Act or otherwise on accepted principles of commercial accountancy under section 10(1) of the said Act. The High Court concluded that it was an amount spent by the assessee to carry out the business unlawfully and the assessee was, therefore, not entitled to deduction of the amount under section 10(2)(xv). 1hn High Court further held, that while determining the profits of a business in accordance with the principles of commercial accountancy under section 10(1), it was not permissible to deduct an item of expenditure laid out or expended for carrying on the business in contravention of the law. It is also noteworthy that no distinction was found between a case where an assessee makes an unlawful expenditure and claims it as a deduction under section 10(2) (xi,) and a case where an assessee incurs expenditure by committing a breach of the law and claims that expenditure under the same provisions of law.

7. Mr. Shaik Haider, the learned Advocate appearing on behalf of the Commissioner has placed reliance on the following case: Indian aluminium Co. Ltd. v. Commissioner of Income‑tax, West Bengal‑I (79 I T R 514), Ccrtnmis5iuner of Income‑tax, Gujrat v. Mihir Textiles Ltd. (104 I T R 167) and Haji Aziz and Abdul Shakoor Bros, v. Commissioner of Income‑tax, Bombay City II (41 I T R 350). In Indian Aluminium Company's case, the principal business of the assessee‑company consisted of manufacturing aluminium ingots, sheets and other aluminium products. A company in Montreal (Canada) provided the assessee with technical knowhow, engineering services, etc. The agreement between the two companies provided for an annual retainer fee. There was no condition or stipulation that the fee would be payable by the assessee without deduction of tax under the provisions of the Indian Income‑tax Act, 1922. The assessee had credited a total fee of Rs, 2,50,000 in favour of the Montreal Company for a period of seven years. In 1951 the income‑tax Officer treated the assessee as being in default under section 18(7) of the Act in respect of the amount of tax liable to be deducted from the payments made to the Montreal Company under section 18(38). The assessee paid the sum of Rs. 1,24,199 towards such tax and asked the Montreal Com pany for reimbursement. The Montreal Company refused to reimburse the amount on the ground that it was bound neither morally nor contractually to meet the obligations of the Indian tax liability. The assessee wrote off the amount during the accounting year ending December 31, 1954, and the ques tion was, whether the sum was deductible either as a bad debt or as business expenditure. It was held by the Supreme Court of India that the payment made under a statutory obligation because the assessee was in default could not constitute expenditure laid out for the purpose of the assessee's business within the meaning of section 10(2) (xv). In Haji Abdul Aziz and Abdul Shakoor Bros. v. Commissioner of Income‑tax, Bombay City, II, certain dates were imported from Iraq partly by steamer and partly by country draft at a time when import of dates by steamer was prohibited. As a result of that the dates, which were imported by steamer were confiscated by the Customs authorities and the assessee being given .an option to pay a fine paid the fine and got the imparted goods released. In computing its profits, the assessee sought to deduct the amount paid as allowable expenditure under section 10(2) (xv) of the Indian Income‑tax Act. It was held by the Supreme Court of India, that no expense which was paid by way of penalty for a breach of the law even though it might involve no personal liability could be said to be an amount wholly and exclusively laid for the purpose of the business of the assessee within the meaning of section 10(2) (xv) of the Income‑tax Act and the fine paid by the assessee was not an allowable deduction under that section. In the Commissioner of Income‑tax, Gujrat v. Mihir Textiles Ltd., cited above, it was held by the Gujrat High Court that an amount would be deductible as expenditure only if it is an expenditure connected with or arising out of trade and is something in the nature of a commercial loss. It was further held that infraction of law is not a normal incident of business and an amount paid by way of penalty in lieu of confiscation of goods by the Customs authorities cannot, therefore be claimed as a deduction under section 28(i) or section 37(2) of the Income‑tax Act, 1961.

8. In the instant case, as already pointed out above, the question is, as to the payment of penalty by the assessee due to default committed by him, notwithstanding the fact that the same may be of a technical nature. The words used by the legislature in clause (xvi) of subsection (2) of section 10 of the Income‑tax Act, 1922 are "expenditure laid out or expended wholly and exclusively for the purpose of such business

" Therefore, there is a clear emphasis on the words "wholly" and "exclusively" in clause (xvi). The penalty paid by the assessee, no doubt, was not of a personal nature and was imposed on goods which were imported in connection with and for the purpose of the assessee's business but we are still of the view that payment of such penalty cannot come within the purview of clause (xvi) of section 10(2) of the Income‑tax Act because such expenditure cannot be treated as expenditure incurred wholly and exclusively for the purpose of the business. The incurring of the expenditure, in the instant case, was not necessitated by the business of tire assessee but by his conduct in importing the goods without a valid import licence. In this respect we think, that the cases reported as Raj Woollen Industries v. Commissioner of Income‑tax, Simila, Haji Abdul Aziz and Abdul Shakoor Bros. v. Commis sioner Income‑tax, Bom, ay City II and Commissioner of Income‑tax, Gujrat v. Mihir Textiles Ltd., provide a sufficient answer to the point referred to us. Even in the case decided by the Supreme Court of Pakistan and already referred to above the following observations of the Supreme Court are noteworthy and we quote with respect: "The expenses of management incurred in excess of the limit prescribed under section 40‑C of the Insurance Act and rule 40 of the Insurance Rules are not in the nature of penalty, fine or forfeiture for the purpose of their admissibility for deduction as business expenses under section 10 of the Income‑tax Act:" Although the point in issue before the Supreme Court was different, the observations made by it do support the Commissioner's case, though indirectly.

9. In the result we would answer the question referred to us in the affirmative. In view of the nature of the points involved there will be no order as to costs. M. B. A. Question answered in affirmative.