TMI Blog1994 (4) TMI 30X X X X Extracts X X X X X X X X Extracts X X X X ..... allowability of legal expenses for conducting the cases before the customs authorities against the levy of redemption of fine ? (4) Whether, on the facts and circumstances of the case, the assessee was entitled to the deduction of the advocate's fees paid in connection with the penalty proceedings before the customs authorities ?" The assessee, an individual, is running a small scale industry at Vellore, in the name of "Electrotechnik". He is manufacturing and selling heat treatment plants and also heat treatment salts to various organisations, including the defence establishment of the Government of India. In September, 1968, he was granted a licence for importing permissible spare parts for construction machinery and spares of machine tools. Misunderstanding the provisions contained in the handbook of Rules and Procedures, 1968, regarding imports of goods it is said, in March, 1970, he imported on the basis of this licence 400 drums of sodium cyanide from Hungary. There was a ready purchaser for it in Messrs. Shantilal Dharamsay of Bombay, who financed him for this purpose. However, as soon as the goods arrived in Bombay Port, the customs authorities noticed that there was ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... authorities. The rationale for such disallowance is reflected as below : " The assessee had an ' import licence ' for importing permissible spare parts for construction machinery and permissible spare parts of machine tools. The sodium cyanide imported by the assessee was not a spare part either of construction machinery or of machine tools. Therefore, the import of sodium cyanide was improper and an offence attracting the punitive provisions of the Customs Act. Any fine or penalty or by whatever name it is called which is imposed for infraction of any law is not an admissible deduction. It is neither a commercial loss nor an expenditure incidental to the business. Vide the decision in Haji Aziz and Abdul Shakoor Bros. v. CIT [1961] 41 ITR 350 . . ." On appeal, the Appellate Assistant Commissioner, accepting the assessee's contention, said thus : "4. In such matters what one has to essentially see is whether these expenses were incurred by an assessee in his character as a trader or rather whether the transaction in respect of which proceedings are taken arose out of and was incidental to his business. This in short may be taken as a guiding principle laid down in the case ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... to the concerned business. Instead, it is my view that in certain cases they could be incidental to the trade. I feel that it is so in the instant case. . . 5. However, the actual amount of fine that came to stay eventually was only Rs. 84,000 and it is but proper that only so much sum is deducted in respect of the sale transaction incorporated in the appellant's accounts of the previous year . . . 6. With regard to the other disallowance or legal charges for Rs. 2,005 for the same reasons, I hold that they are deductible as expenditure incidental to the appellant's business. The disallowance of Rs. 2,005 is not in order. It should be allowed . . . " On the above findings, the Income-tax Officer had been directed to recompute the assessee's total income and tax, by allowing the appeal in part. The Revenue filed an appeal before the Tribunal against the reduction given by the Appellate Assistant Commissioner to the tune of Rs. 1 lakh and Rs. 2,005. The assessee, in turn, filed cross-objections stating that the Appellate Assistant Commissioner should have allowed the actual expenditure of Rs. 1,84,000 incurred during the year, even though it was open to the Department to ass ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... assessee to pay the additional duty and retrieve the goods or to lose the goods as is usually done in normal transactions where in normal transactions where no delivery of goods is taken. In so far as the sum of Rs. 1,84,000 cannot thus be said to have any semblance of penalty embedded in it, it has to be regarded as an expenditure, in this case as an amount laid out in connection with the purchase going to increase the purchase price and be allowed as a deduction in the trading account itself. We, therefore, see no reason to interfere with this part of the Appellate Assistant Commissioner's order. Looked at as above, the reduction of the quantum of Rs. 1,84,000 to Rs. 84,000 is a pure business transaction. In connection with the above assessment, the assessee was claiming that no amount was payable, the maximum amount was put at Rs. 1,84,000, i.e., the amount demanded by the customs authorities. Though negotiation went on, the assessee could either have debited no amount in view of his objecting to the payment by filing an appeal or claimed it based on the actual amount finally paid, namely, Rs. 84,000. In this view of the matter, the Appellate Assistant Commissioner is also corre ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... aid to advocates for defending the penalty proceedings before the customs authorities. Haji Aziz and Abdul Shakoor Bros. v. CIT [1961] 41 ITR 350 (SC) was the earliest case, wherein the apex court of this country had the occasion to consider the question as to whether the expenses incurred by way of penalty for breach of the law, even though it might involve no personal liability, could be construed as an allowable deduction under section 10(2)(xv) of the Income-tax Act (old), the equivalent of which, in the present new Income-tax Act, is section 37. For understanding the principles evolved therein, we feel it is better to pen down the facts therein in a crisp fashion. (a) The assessee, which carried on the business of importing dates from abroad and selling them in India, imported dates from Iraq partly by steamer and partly by country craft, at a time when import of dates by steamer was prohibited. The dates, valued at Rs. 5 lakhs, which were imported by steamer, were confiscated by the customs authorities under section 167 (item 8) of the Sea Customs Act and the assessee, having given an option under section 183 of the said Act to pay fines, aggregating to Rs. 1,63,950, whic ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ut 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 IRC v. Alexander Von Glehn and Co. Ltd. [1920] 2 KB 553 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 a manner which has rendered him liable to penalty, it cannot be claimed as a deductible expense. It must be a commercial loss and in its nature must be contemplable as such. Such penalties which are incurred by an assessee in proceedings launched against him for an infraction of the law cannot be called commercial losses incurred by an assessee in carrying on his business. Infraction of the law is not a normal incident of business and, therefore, only such disbursements can be deducted as are really incidental to the business itself. They cannot be deducted if they fall on the assessee in some character other than that of a trader. Therefore, where a penalty is incurred for the contravention o ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... 1) of the Income-tax Act, the assessing authority is required to examine the scheme of the provisions of the relevant statute providing for payment of such impost notwithstanding the nomenclature of the impost as given by the statute, to find whether it is compensatory or penal in nature. The authority has to allow deduction under section 37(1) of the Income-tax Act wherever such examination reveals the concerned impost to be purely compensatory in nature. Wherever such impost is found to be of a composite nature, that is, partly of compensatory nature and partly of penal nature, the authorities are obligated to bifurcate the two components of the impost and give deduction to that component which is compensatory in nature and refuse to give deduction to that component which is penal in nature.." Useful reference, we feel in this connection, may also be made to the case of CIT v. Ahmedabad Cotton Mfg. Co. Ltd. [1994] 205 ITR 163 (SC). During the accounting period relevant to the assessment year 1972-73, the respondent-company, which ran a textile mill, instead of producing and packing the minimum quantity of specified type of cloth as required by the Textile Commissioner in direct ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... stion whether the payment could be regarded as one made as a measure of business expediency, for it cannot ignore the fact that the law or the statutory scheme enables incurring of such expenditure in the course of the assessee's business." On the face of the decision in the cases of Prakash Cotton Mills P. Ltd. v. CIT [1993] 201 ITR 684 (SC) and CIT v. Ahmedabad Cotton Mfg. Co. Ltd. [1994] 205 ITR 163 (SC), the rule laid down in the case of Haji Aziz and Abdul Shakoor Bros. v. CIT [1961] 41 ITR 350 (SC) cannot at all be stated to have laid down an inflexible rule of law to be followed in all eventualities and situations. The aforesaid two latest rulings of the apex court, we rather feel, give a wider scope to consider the question in a broad spectrum analysis, in examining the scheme of the provisions of the relevant statute, providing for payment of such imposts notwithstanding the nomenclature of the impost as given by the statute, to find out whether it is compensatory or penal in nature. The authority has to allow deduction under section 37(1) of the Income-tax Act, whenever such examination reveals the concerned impost to be purely compensatory in nature. Whenever such im ..... X X X X Extracts X X X X X X X X Extracts X X X X
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