TMI Blog1963 (1) TMI 57X X X X Extracts X X X X X X X X Extracts X X X X ..... (xv) any expenditure (not being an allowance of the nature described in any of the clauses (i) to (xiv) inclusive, and 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 vocation. The facts are these: The case relates to the assessment year 1955-56 for which the previous year is the calendar year 1954. On May 5, 1954, the opposite party (assessee) entered into an agreement with the Director of Food Supplies on behalf of the Government of Orissa by which the assessee was appointed paddy procuring agent under the Government of Orissa for the purpose of obtaining by purchase or otherwise foodgrains for distribution to such places and at such times as best suits the needs of the people on the terms and conditions of the said agreement, the duration of the agreement commencing from December 11, 1953, and remaining in force up to November, 1954, unless otherwise determined under the provisions thereof. Under the terms of the said agreement the assessee was to supply paddy and rice of a standard quality known as F.A.Q. (fair average quality). Schedule 1 to th ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... gly the deduction claimed should have been allowed. The penalties were imposed not in round figures but in rupees and annas, which show that the penalty in reality was based upon the difference between the price of F.A.Q. standard and the standard of paddy and rice supplied by the assessee to the Government and in effect the assessee got prices lesser than the contractual prices for the supplies he made. There was no dishonest intention on the part of the assessee to make more profits by dishonest methods. In the computation of profit from the business, the penalty should be deducted. The Government had accepted the deliveries although the supply did not conform to the F.A.Q. standard. Having not chosen to refuse the deliveries and having paid the assessee at the contractual rates it is evident that the Government treated the same as a breach of warranty resulting in a claim of damages. The damages were measured in terms of costs. Therefore, the real effect of levy of penalty was to reduce the price of rice and paddy paid or to be paid to the assessee. There is no evidence that the assessee either mixed foreign materials or passed off the inferior quality of paddy and rice to the G ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ingle item but imposed on several occasions which show that it is a case of conducting business not in a negligent manner but in a dishonest manner. In fact, one of the penalty orders (annexure E-24 to the statement of the case) refers to the consistent misbehaviour of the assessee regarding quality factors in matters of rice and paddy. The penalty was thus imposed for infraction of contractual obligations by the assessee. These amounts paid by the assessee by way of penalty could not be said to have been laid out or expended wholly and exclusively for the purpose of his business. The point now is: What is the nature of this penalty imposed under clause 3(d) of the agreement? The penalty is a sum which the assessee conducting the business as paddy procuring agent has had to pay, because in conducting it, he had so acted as to render himself liable to this penalty. It is not a commercial loss. The money which was paid was money paid as penalty, and it does not matter in the least that it is an imposition for breach of the agreement for not conforming to the F.A.Q. standard. It is, in fact, under clause 3(d) of the agreement, a penalty. The penalty in such a case is imposed a ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... he agreement. It was that that the assessee transgressed, when he deliberately persisted in supplying foodgrains not conforming to the F.A.Q. standard. What the assessee had to pay was purposely called penalty in the agreement. Thus the payment was a penalty for committing an act opposed to public policy, a policy that underlay the Essential Supplies (Temporary Powers) Act, 1946, read with the Orissa Foodgrains Control Order, 1951. The Act left to the Government of Orissa to enforce the public policy. The assessee could and should have carried on his business in conformity with the obligations imposed upon him, no doubt, by a contract, but under the authority of the said Act and the Control Order and in furtherance of the policy of control that underlay that Act. The assessee could have carried on the business without infraction of his obligations. That should have been his normal course of conducting his business. The basic principles in the light of which the question is to be decided were initially laid down by Lord Davey in Strong and Co. of Romsey Limited v. Woodifield [1900] A.C. 448, and by Lord Sterndale in Commissioners of Inland Revenue v. Alexander von Glehn Comp ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... uage of the Indian Income-tax Acts which, in pari materia, is substantially the same as of the English Income Tax Acts. In fact, the Indian decisions are mainly based on the principles of the English decisions. After a review of all the relevant cases on the point, their Lordships of the Supreme Court in Haji Aziz and Abdul Shakoor Bros. v. Commissioner of Income-tax [1961] 41 I.T.R. 350 ; [1961] 2 S.C.R. 651 laid down the law as follows: The expenses which are permitted as deductions are such as are made for the purpose of carrying on the business, namely, to enable a person to carry on and earn profit in that business. It is not enough that disbursements are made in the course of, or arise out of, or are concerned with, or made out of, the profits of the business, but they must also be for the purpose of earning the profits of the business. As was pointed out in von Glehn's case [1920] 2 K.B. 553 cited above, an expenditure is not deductible unless it is a commercial loss in trade and a penalty imposed for breach of the law during the course of trade cannot be described as such. If a sum is paid by an assessee conducting his business, because in conducting it he has acted in ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... lly and exclusively for the purpose of the business? In my opinion, such loss or expenditure must, at any rate, amount to something in the nature of loss or expenditure which is contemplable and in the nature of a commercial loss or commercial expense. It is not possible to say that when a punishment-which is what the penalty in the present case amounted to--has been inflicted upon the assessee, it can be said that it involves loss or expenditure laid out or expended wholly and exclusively for the purpose of the business within the meaning of section 10(2)(xv). The assessee was not entitled to supply foodgrains not conforming to the F.A.Q. standard for local consumption and export, that is to say, except within the limits imposed by the restrictions. Yet, in fact, the assessee did so and failed to observe the restrictions imposed. The only business which the assessee had a right to carry on was a business within the limits imposed by municipal law. The assessee cannot carry on his business as he pleases. If a person were to carry on his business in defiance of the law against adulteration and in consequence incurred a penalty, it could not be held that he would be entitled to attri ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... that statutory control that the assessee had to carry on his business. Transgression of that control was not a normal incident of that business, though it was in one sense connected with his business. If he had not been a paddy procuring agent, he could not have been in a position to supply foodgrains not conforming to the F.A.Q. standard. But this connection is not enough to sustain the claim, that what the assessee had to pay the Government of Orissa by way of penalty was inextricably mixed up with his normal line of business. The breach of his contractual obligation to the Government was not in the normal course of business, and the liability the assessee had to discharge for such a breach was not incidental to the business itself that he carried on. It is thus clear that it was not a case of payment of damages for a mere breach of contract with nothing more. The Income-tax Appellate Tribunal was not correct in taking the view that the Government treated the supply not conforming to the F.A.Q. standard as a breach of warranty resulting in a claim for damages, that the damages were measured in terms of costs, and that therefore the real effect of levy of penalty was to reduce ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... admissible deduction. We answer the question referred to us in the negative and against the assessee. Since the assessee has failed, the assessee will pay the costs of this reference. Hearing fee ₹ 250. NARASIMHAM C.J.-- I agree. The material facts have been fully set out in the judgment of my learned brother. The main question for decision is whether the penalty imposed by the Collector on the assessee for supply of inferior quality rice and paddy in contravention of the terms of the contract is a permissible deduction under section 10(2)(xv) of the Income-tax Act, 1922. One of the main objectives of the Essential Supplies (Temporary Powers) Act, 1946, was to maintain supplies of essential commodities and to secure their equitable distribution and availability at fair prices-see section 3 of that Act. It was in pursuance of this objective that the Orissa Foodgrains Control Order, 1951, was made by the Government of Orissa by which extensive control was imposed on the purchase, sale and storage of foodgrains including rice and paddy and their transport. The policy of the Government of Orissa was to purchase foodgrains through agents known as purchasing agents and ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ca, mud, husk, etc. If this percentage was exceeded, the paddy supplied also ceased to be of the F.A.Q. standard. The learned Income-tax Tribunal incorporated along with the statement of the case, copies of penalty orders and statements of penalties imposed by the Collector against the assessee for the year in question. These show that on the basis of refraction reports of samples of rice and paddy supplied by the assessee to Government, the Collector was of opinion that the rice and paddy supplied was below the F.A.Q. standard, and hence levied penalties of varying amounts. The levy of penalty was made, not in respect of a few isolated instances but in several instances of supply spread over a period of some months. In the penalty statement for the months of July, August, November and December, 1953 (annexure E-24 ) (which was also incorporated in the statement of the case), the Collector while quantifying the penalties, observed that the levy of penalty was made because of consistent misbehaviour regarding quality factors in the matters of rice and paddy. On these materials the Appellate Assistant Commissioner of Income-tax held that it was not a case of the assessee con ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... il. If the action of the assessee be held to be dishonest, then this case would come within the principles laid down in Mask Co. v. Commissioner of Income-tax [1943] 11 I.T.R. 454. In that case it was held that where an assessee conducted his business in a dishonest manner, in consequence of which he was directed to pay damages to a party against whom he committed breach of contract, the damages could not be deducted as a permissible deduction under section 10(2)(xii) of the Income-tax Act. Their Lordships of the Supreme Court also cited the aforesaid decision, with approval, in Haji Aziz and Abdul Shakoor Bros. v. Commissioner of Income-tax [1961] 41 I.T.R. 350 ; [1961] 2 S.C.R. 631. Here the Tribunal's finding to the effect that there was no dishonest intention on the part of the assessee is obviously based on a misreading of the various penalty orders. The correctness of the levy of penalty by the Collector was not challenged at any stage. Hence it must be held that the paddy and rice supplied by the assessee were not of the standard prescribed in the schedule attached to the agreement. In other words, the paddy supplied must be held to have contained more than the perm ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... t be interfered with by this court, however gross and inexcusable the error may be, nevertheless, I think the principle laid down in Senthikumara Nadar Sons v. Commissioner of Income-tax [1957] 32 I.T.R. 138 would apply. That case is very similar to the present case. There also, there was a statute known as the Coffee Market Expansion Act, 1942, which was primarily intended to control the export of coffee. The India Coffee Board was constituted under that Act and the assessee entered into a contract with the board undertaking to export certain quantity of coffee outside India. In view of that undertaking, he was given a specific quota and the coffee was also sold to him by the Board at a concessional rate. But, in breach of the undertaking, he sold the coffee in India at a very high price and made handsome profits. Under the terms of the contract, the Coffee Board assessed him to damages for breach of contract. The learned judges of the Madras High Court held that such damages would not constitute permissible deductions. Their decision did not rest on the view that the action of the assessed was dishonest--in which case the principle of Mask's case [1943] 11 I.T.R. 454 woul ..... X X X X Extracts X X X X X X X X Extracts X X X X
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