INTEREST PAID BY ASSESSEE ON DELAYED PAYMENT OF SALE TAX IS NOT A PENALTY

[Mr. M. GOVINDARAJAN]

Sec. 37(1) of the Income Tax Act, 1961 ('Act' for short) provides that any expenditure (not being expenditure of the nature described in Section 30 to 36 and not being in the nature of capital expenditure or personal expenses of the assessee), laid out or expended wholly and exclusively for the purposes of the business or profession shall be allowed in computing the income chargeable under the head 'Profits and gains of business or profession'. A bare perusal of Section 37 of the Act shows that when an expenditure is laid out wholly and exclusively for the purpose of business it can be deducted in computing the income under the head of profits and gains business. However expenditure incurred by the assessee for any purpose, which is an offence or prohibited by law is not deemed to be included for the purpose of business. The general principle is that portion of interest paid on delayed payment which is compensatory in nature is allowed to be deducted and that portion which is penal cannot be deducted.

In 'Mahalakshmi Sugar Mills Co., V. Commissioner of Income Tax' - 2008 -TMI - 5833 - Supreme Court the Apex Court was dealing with section 10(2)(xv) of the Indian Income Tax Act, 1961, which is identical to section 37 of the Income Tax Act. In the said case, the assessee had been held liable to pay interest under the U.P. Sugarcane Cess Act because of delayed payment of cess. The U.P. Act also provided that penalty could also be levied under such circumstances. The Apex Court, in this case, held that the interest payable on an arrear of cess under section 3(3) is in reality part and parcel of the liability to pay cess. It is an accretion to the cess. The arrear of cess carries interest; if the cess is not paid within the prescribed period a larger sum will become payable as cess. The enlargement of the cess liability is automatic under section 3(3). No specific order is necessary in order that the obligation to pay interest should accrue. The liability to pay interest is certain as the liability to pay cess. As soon as the prescribed date is crossed without payment of cess, interest begins to accrue. It is not a penalty for which provision has been separately made by section 3(5). Nor is it a penalty within the meaning of section 4, which provides for a criminal liability and a criminal prosecution. The penalty payable under section 3(5) lies in the discretion of the collection officer or authority. In the result it was held that the interest paid for the delayed payment of the cess is an expenditure laid out wholly for the purpose of business and hence deductible.

In 'Triveni Engineering Works Limited V. Commissioner of Income Tax' - 2008 -TMI - 28540 - Allahabad High Court, a Full Bench of the Allahabad High Court held that the interest payable on arrears of sugarcane purchase tax is part and parcel of the liability of tax and hence deductible.

In 'Prakash Cotton Mills P. Ltd., V. Commissioner of Income Tax' 2008 -TMI - 5409 - Supreme Court, the Apex Court held that whenever any statutory impost paid by an assessee by way of damages or penalty or interest is claimed as an allowable expenditure under Sec. 37(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 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.

In 'Lachmandas Mathuradas V. Commissioner of Income Tax' - 2008 -TMI - 6074 - Supreme Court the question before the apex court was whether interest paid on arrears of sales tax is penal or compensatory. The apex court held that the said amount was an allowable deduction since it was compensatory in nature.

The Apex Court in 'Swadeshi Cotton Mills Co. Ltd., V. Commissioner of Income Tax' 2008 -TMI - 5683 - Supreme Court was dealing with the question as to whether damages paid for delayed payment of employees contribution to employees' provident fund was compensatory or penal. The court following the judgment in 'Prakash Cotton Mills Ltd.,' - 2008 -TMI - 5409 - Supreme Court remitted the matter to the High Court for reconsideration in the light of the observation made therein.

In 'Commissioner of Income Tax V. H.P. State Forest Corporation' - 2009 (9) TMI 524 - HIMACHAL PRADESH HIGH COURT the assessee is an undertaking of H.P. Government. The main business of the assessee is to extract timber and sell the same. The trees to be felled are handed over by the Forest Department to the Forest Corporation. The Corporation pays royalty to the State Government at rates which are finalized by the Pricing Committee constituted by the State Government. The Corporation is liable to pay interest on belated payment of royalty and other amounts payable to the corporation. The Forest Department is liable to pay sales tax on royalty but in actual fact this amount is actually deposited by the Forest Corporation on behalf of the Forest Department. A lease is executed by the Forest Department in favour of the Corporation. The assessee claimed deduction of the amounts paid as interest on royalty, sales tax etc., The Assessing Officer rejected the claim of the assessee which was also upheld by the commissioner of Income Tax (Appeals). The Tribunal allowed the appeal and hence the Revenue filed this present appeals before the High Court.

The Court framed the question whether the deduction is permissible or not. Both sides have referred to a number of decisions. The Revenue contended that clause 18G of the lease deed clearly lays down that in case the corporation does not pay the sale tax on the due date it shall be liable to pay the penalty at 18% per annum. Since in the agreement the payment is described as penalty the same cannot be held to be compensatory in nature and must be held to be penal in nature. The Tribunal is not agreeable to the contentions of the Revenue. It relied on the judgment of Supreme Court in 'Prakash Cotton Mills P. Ltd.,' (supra) in which the Apex Court held that the Assessing Officer must determine whether the same is compensatory or penal in nature. It further held that taxing statutes normally have two impost for delayed payment. One is the imposition of interest, which is automatic and the second is the imposition of penalty for which not only notice is automatic for the delayed period, the imposition is compensator in nature. In the present case no doubt the word 'penalty' has been used in clause 18G but if the entire lease deed is read and the provisions of the HP General Sales Tax Act together, it is apparent that the parties to the lease deed decided that though the sales tax in fact was to be deposited by the State it would be deposited on its behalf by the assessee. If the same was not paid the dealer became liable to pay simple interest at 12% per annum for the delay of one month and thereafter 18% per annum till the default continues.

The Tribunal held that it is more than obvious that this interest was not payable by way of penalty but by way of compensation to compensate the State for the interest which it would have been liable to pay under Section17A.