TMI Blog2005 (11) TMI 369X X X X Extracts X X X X X X X X Extracts X X X X ..... t claim for damages. Are integral part of normal underwriting business : ( b )For the reasons stated, there was a genuine dispute between the Issuer Company M/s. Niwas Spinning Mills Ltd. and the appellant as an underwriter. ( c )In terms of legal provisions, particularly section 73 of the Indian Contract Act, payment of compensation for loss or damage caused by breach of contract is wholly legal and permissible and therefore, neither prohibited by law nor an offence. (2) On the facts, in the circumstances of the case and in law, the learned CIT(A)-II, Mumbai erred in holding that : ( a )Not subscribing to devolved security is not normal activity of underwriting business : ( b )The payment of Rs. 36,60,000 by the appellant to the Issuer Company M/s. Niwas Spinning Mills Ltd. was a payment which is prohibited by law and accordingly, in invoking Explanation to section 37(1). ( c )The damages of Rs. 36,60,000 paid as above in terms of the underwriting agreement as well as statutory legal provisions was not a loss arising in the normal course of underwriting business and hence, not allowable under section 29 of the Income-tax Act, 1961. B. Devolvement loss of Rs. ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... blic issue including the assessee. As no mutually agreeable decision was arrived at between the assessee and NSML, NSML referred the matter to the Arbitration committee of BSE by invoking clause 20 of the underwriting agreement. Further, NSML issued several letters to SEBI and various stock exchanges requesting them to initiate appropriate action against all the underwriters including the assessee, who had failed to fulfil its underwriting obligations in respect of the said public issue. A total claim for Rs. 1,96,80,060 was made by NSML against the assessee which included the amount of interest @ 32 per cent for one year on the amount of devolved FCDs and other miscellaneous expenses and it was also mentioned that further interest would be charged on the above from the assessee till the date of actual payment. The assessee-company, pending arbitration proceedings and other legal actions taken by the NSML, entered into a mutual settlement with NSML whereby the assessee paid Rs. 36,60,000 to the NSML as damages and NSML withdrew all proceedings against the assessee. This amount has been claimed as business loss against the income from underwriting commission. The Assessing Officer e ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... e matter with the company. It was therefore, an expenditure for an illegal conduct of not honouring underwriting contract and thus not observing monetary disciple. Hence, it was for a purpose prohibited by the SEBI regulations issued under the authority of the SEBI Act. The amount was therefore, not allowable as deduction by virtue of Explanation below section 37(1). In any case, it was not a loss arising in the normal course of business and hence not allowable under section 29 of the Act. As a corollary, it was not eligible for carry forward and set off against the speculation profit of the future years. This may technically involve enhancement. Hence, an opportunity was given to the appellant vide order sheet entry dated 15-11-2001 to show cause as to why the loss should not be treated as disallowable outright and not as a speculation loss. The reply of the appellant dated 26-11-2001 was duly considered. It is not acceptable for the reasons mentioned above. In view of the above finding that the amount was not allowable by virtue of Explanation below section 37(1) or not allowable under section 29 as a loss arising in the normal course of business, it is not necessary to g ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... obligations and responsibilities and procedure for action in case of default committed by the underwriter. On the basis of the above provisions, the learned counsel contended that it was simply a case of breach of commercial obligation arising under a contract and, therefore, no violation of public policy or any law was involved. It was further pointed out that in the impugned transaction, it was not only the assessee but all the underwriters did not discharge their commitments. The learned counsel further contended that the issue under dispute was squarely covered in favour of the assessee by the decision of the Hon ble Supreme Court in the case of CIT v. Shantilal (P.) Ltd. [1983] 144 ITR 57 wherein it was held that award by an arbitrator on a dispute between parties was allowable as business loss. It was further contended that in the present case there was no award by an arbitrator but there was a mutual settlement between parties in the dispute even then the impugned loss was allowable as damages in view of the decision of the Hon ble jurisdictional High Court in the case of CIT v. Asian Chemical Co. [1992] 197 ITR 634 (Bom.). It was further contended that it was a cas ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... to take subscribe for purchase of FCDs underwritten by the assessee. In the rejoinder, the learned counsel submitted that the amount was paid in June, 1997 to resolve the dispute much after the close of public issue of FCDs and it was settlement of dispute and not of the contract and, therefore, it could not be construed as the transaction of speculative nature within the meaning of section 43(5) of the Act and referred to the decision of the Tribunal in the case of ANZ Grindlays Bank cited supra . It was further contended that breach of contractual obligation was not against public policy in the sense that the decision to not to subscribe was a commercial decision based on business realities and it was permissible as per provisions of underwriting agreement subject to right of the client to claim damages for any loss suffered by him. Finally, it was contended that the penalty was leviable under SEBI Regulation and which was not imposed mainly because of mutual settlement between the assessee and the NSML, therefore, Explanation to section 37(1) was attracted. 7. We have considered the submissions made by both parties, material on record, orders of authorities below and al ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... 8-5-1998, wherein the penalty recommended by the enquiry officer was set aside. In this background the question before us is whether it was a settlement of contract or a settlement of dispute arising out of breach of contract between the parties. If it is a case of settlement of dispute between the parties then it would not amount to speculative transaction but if it is a settlement of contract and then it would be speculative transaction . Before dwelling upon this issue we would like to mention that FCDs are "commodities within the meaning of section 43(5) of the Act", and therefore, the contention of the assessee that FCDs are not commodities stands rejected. Once it is held that FCDs are commodities then the nature of transaction requires determination. The Revenue has placed reliance on the decision of Comfund Financial Services (I) Ltd. in support of its contention that compensation paid for breach of the contract is speculative loss. We are afraid that this proposition is not applicable to the case on hand because in the case relied by the Revenue these observations were made with reference to the termination of transactions on the due date by way of settlement of contrac ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... he case of Shantilal (P.) Ltd. ( supra ) relied by the assessee upheld the decision of Hon ble Calcutta High Court in the case of Pioneer Trading Co. (P.) Ltd. ( supra ). In the instant case undisputedly there is non-performance by the assessee which resulted into dispute between the two parties and subsequently it was settled mutually although the arbitration proceedings had also been initiated by the aggrieved party, (NSML). The ld. D.R. had contended that in this case there was no award by an Arbitration Tribunal, therefore, the decision of the Hon ble Apex Court in the case of Shantilal (P.) Ltd. ( supra ) was not applicable, while the ld. Counsel appearing on behalf of the assessee relied on the two decisions of the Hon ble jurisdictional High Court in the cases of Asian Chemical Co. ( supra ) and Jaydwar Textiles ( supra ), wherein the compensation paid for settlement of breach of contract was held as the transaction of non-speculative character. In our considered opinion the Hon ble Apex Court on the facts of the case referred to arbitration award and did not restrict the deductibility of claim of damages only to such cases for the reason that the Hon ble Apex Co ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... what is intended to be dealt with is a case of performance of contract and not non-performance : Held that, in the instant case, there was breach of contract and, therefore, damages had to be paid. When a contract is broken there can be no cause of action founded on a contract itself which can be said to be capable of settlement. Hence, the Tribunal was correct in allowing the deductions in the computation of the assessee s income from business." Thus, on the basis of above discussion it emerges that there is clear distinction between the "settlement of contract" and "settlement of dispute arising out of contract" and non-performance cannot be termed as settlement of contract and present case is of non-performance, therefore it is a case of settlement of dispute arising as consequence of breach of contract and accordingly, the loss arising on account of settlement of dispute is allowable as business loss. Before parting with the issue we would like to deal with the contention of the revenue that underwriting activity was more or less that of a speculator, therefore, the underwriting business was speculation business and any loss arising therefrom was to be treated as specula ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ard Ld. Counsel appearing on behalf of the assessee drew our attention to the model underwriting agreement devised by SEBI which envisages a situation of failure on the part of the underwriter and contended that the agreement between the assessee and NSML was based upon the same and therefore, the breach of contract by way of failure on the part of the underwriter to subscribe to the devolved FCDs could not be termed as an act prohibited under the law. The consequence which the assessee, at the most could have been burdened with was in the form of cancellation/suspension of the licence to act as an underwriter and that too would have happened only if the assessee would have been found guilty in accordance with the SEBI Regulations. We are of the considered opinion that the non-performance of commercial agreement cannot be termed as an act prohibited under any law particularly in view of the provisions of Indian Contract Act, 1872 which deals such situations. Even if it is assumed that it was a dishonest breach of contract by the assessee even then it would make no difference so long it is established that the damages paid by the assessee were incidental to the assessee s trade. The ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... able. It was further contended that this section is applicable to dealing in the purchase and sale of shares and not on debentures and in support of his contention, relied on the decision of the Hon ble Supreme Court in the matter of Appollo Tyres Ltd. v. CIT [2002] 255 ITR 273 wherein the Hon ble Apex Court held that "Units of UTI were not shares" within the meaning Explanation to section 73 of the Act. 10. The learned Departmental Representative, on the other hand, strongly supported the order of learned CIT(A). 11. We have considered the submissions made by both sides, material on record, orders of the authorities below and also applicable legal provi-sions. Admittedly, the loss of Rs. 1,04,000 is on account of diminution in value of stock of shares resulting from the valuation of the same on the basis of cost or market price which ever is lower. It is also an admitted fact that the assessee has not purchased or sold shares during the year. This is a notional loss which has been provided in the books of account on the basis of accounting principles/policy. To put it differently it is only a book entry. There is no trading transaction, because there is no transfer ..... X X X X Extracts X X X X X X X X Extracts X X X X
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