TMI Blog2011 (7) TMI 581X X X X Extracts X X X X X X X X Extracts X X X X ..... of goodwill and damages to its capital and for terminating of case US Courts" as is clearly mentioned in clause (3) of the Agreement. No finding is given by any Court that the assessee had violated the patent right of SEMCO. The Agreement is applicable within the area defined as "territory". This territory mentions some specific countries in Europe as well as Japan, Australia and Korea. There is no mention of 'India' at all. That clearly implies that SEMCO has no objection if the assessee continues to manufacture the goods in the same manner using same patent which it has been using and marketing it in India or any other countries, which are not stipulated in the 'territory' with respect to which only restraint is provided in the agreement - in favour of assessee. - IT APPEAL NO. 572 OF 2011 - - - Dated:- 11-7-2011 - A.K. SIKRI AND M.L. MEHTA, JJ. Sanjeev Sabharwal for the Appellant. Ms. Shashi M. Kapila and Ms. Charu Kapoor for the Respondent. JUDGMENT A.K. Sikri, J. Before we reproduce the substantial questions of law, which are to be answered, we deem it appropriate to state the facts and circumstances under which these questions of law arise for c ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... to infringement of SEMCO's United States Patent bearing No. 4769053 caused by the assessee company and its customers for manufacturing and marketing the Energy Recovery Wheel products. Further, SEMCO had sued VENMAR in the same Court for infringement of SEMCO's patent by selling the assessee company's product in their patented territory and in those proceedings, the VENMAR had acknowledged that the patent held by SEMCO was valid and enforceable and thus, agreed not to sell the products that would infringe the patent of SEMCO and accordingly compensated SEMCO for such infringement. In these circumstances, according to the Assessing Officer, the amount paid by the assessee to SEMCO was nothing but a "penalty" or as something akin to penalty and the payment was made only due to infringement which would, in any way, resulted into a compensation. The Assessing Officer, further, observed that violation of the patents/trademark, etc. is always prohibited by law and therefore, in view of the provisions contained in Explanation to section 37(1) of the Income-tax Act (hereinafter referred to as 'the Act'), the expenditure so incurred by the assessee was not allowable. The Assessing Officer ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... iduary provision, allows the expenditure as deductable while computing the income on the satisfaction of the following conditions: "(a) Expenditure must not be governed by the provisions of sections 30 to 36 of the Act; (b) The expenditure must have been laid out wholly and exclusively for the purposes of the business of the assessee: (c) The expenditure must not be personal in nature; and (d) The expenditure must not be capital in nature." 6. The Explanation to sub-section (1) of section 37 of the Act has been inserted by the Finance (No. 2) Act, 1988 with full retrospective effect from 1-4-1962 and provides: "For removal of doubts, it is hereby declared that any expenditure incurred by an assessee for any purposes, which is an offence or which is prohibited by law, shall not be deemed to have been incurred for the purpose of business or profession and no deduction or allowance shall be made in respect of such expenditure." 7. The dispute revolves around the issue as to whether the aforesaid expenditure incurred by the assessee was for a purpose which would be treated as an "offence" or which is prohibited by law. If this be so, the expenditure is not allowab ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... would be a clear case where the payment was made for a purpose which is prohibited by law. Thus, the Explanation was fully applicable and expenses could not be treated as having been incurred for the purpose of business and no deduction is to be allowed on such expenses in the nature of penalty. 11. Learned counsel also took support from the reasons given by the Assessing Officer as well as the CIT(A) in their respective orders. He pointed out that the CIT(A) had clearly held that it was a case where there was an infringement of United States Patent Law by the assessee. The goods were manufactured and sold by the assessee to VENMAR for sale in US and Canada markets and as a manufacturer, the assessee could not escape the primary responsibility by stating that it was not directly involved in infringement. Further, for making a disallowance under section 37 in respect of penalty, etc. finding by a competent Court was not a condition precedent to attract the Explanation to section 37(1). According to the CIT(A), the Explanation simply states that if expenditure is incurred for any purpose, which is an offence, or which is prohibited by law, such expenditure will not be deeded to hav ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ime being in force" in India. Obviously it has no reference to any law of other countries of the world." 14. According to her, similarly, the expression "prohibited by law" can only mean prohibited by law in force in India. The expression "prohibited by law" as used in the Explanation to section 37(1) has the same contextual import as the expression "forbidden by law" as used in section 23 of the Indian Contract Act, 1872. This came up for the consideration of the Full Bench in the case of Abdul Hameed v. Mohd. Ishaq AIR 1975 All. 166 wherein the Allahabad High Court observed as under: "12. The expression 'law' has not been defined in the Contract Act, nor in the U. P. General Clauses Act, 1904, but in the Central General Clauses Act, 1897, 'Indian Law' is defined in section 3(29) as below: "'Indian law' shall mean any Act, Ordinance, Regulation, rule, order, bye-law or other instrument which before the commencement of the Constitution had the force of law in any Province of India or part thereof, or thereafter has the force of law in any Part A State or Part C State or part thereof, but does not include any Act of Parliament of the United Kingdom or any Order in Council, ru ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ns in US Courts, which is costly. She argued that no damages had been paid under the Indian Patent Act or under the US Patent Laws and there was no evidence to show the infringement. She also argued that in absence of any violation of the provisions of Indian Patent Act, the payment under settlement with SEMCO does not fall within the meaning and scope of expression 'offence' and 'prohibited by law' used in Explanation to section 37(1) of the Act. The assessee still manufactures the energy saving wheel using the impugned desiccant and sells it in India as well as exports it to other countries without any restrictions and no suit has been filed by SEMCO for infringement of its patent in India. However, exports to USA and Canada, past settlement is as per the Settlement Agreement. 16. Ms. Kapila further submitted that even if it is presumed that the payment was made for infringement of patent, that entails only civil damages, which are compensatory in nature and it cannot be said that the payment made was in the nature of penalty. She pointed out that the averments in the plaint filed by SEMCO as per which the only civil damages were claimed and criminal suit was scored out in the ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... greements, promises, damages, judgments, awards, executions, claims and demands whatsoever in law or in equity, and any and all claims for damages (and attorneys' fees and costs) based upon the violation of a federal, state or other statute, regulation or law or arising out of any conduct, contract, employments, action, event or circumstance, under the law of any and all nations, whether known or unknown, which occurred at any time up to an including the date of the execution of this Agreement, except obligations created by this Agreement, any associated licence Agreement and/or by the Consent Judgment to be filed in accordance with this Agreement." 19. It would be pertinent to highlight that the Agreement is applicable within the area defined as "territory". This territory mentions some specific countries in Europe as well as Japan, Australia and Korea. There is no mention of 'India' at all. That clearly implies that SEMCO has no objection if the assessee continues to manufacture the goods in the same manner using same patent which it has been using and marketing it in India or any other countries, which are not stipulated in the 'territory' with respect to which only restraint ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... supra), where the Apex Court observed as under: " Therefore, whenever any statutory impost paid by an assessee by way of damages or penalty or interest is claimed as an allowable expenditure under section 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 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." 23. It was an expenditure which was motivated purely by commercial purpose and would be allowable under section 37(1) of the Act as held by the Apex Court in the case of Sri Venkata ..... X X X X Extracts X X X X X X X X Extracts X X X X
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