TMI Blog1957 (2) TMI 62X X X X Extracts X X X X X X X X Extracts X X X X ..... he export quota was far below the local price. In case of failure to export the coffee so purchased, clause 8 of the contract provided: If the buyer fails to ship the coffee purchased for export to a destination outside India, the Board reserves to itself the right to levy liquidated damages or to restore the status quo in any one of the following ways, at the absolute discretion of the Controller of Coffee : (a) To recover a fixed measure of damages at ₹ 20 per cwt. to be paid to the surplus pool ; (b) to export an equivalent quantity by weight of coffee purchasing the same from pool and to recover the loss incurred in the transactions from the buyer. The decision of the Controller in the matter of price at which such coffee is purchased and sold and in the matter of fixing the loss shall be final; and (c) to call upon the buyer to restore the stock delivered to him at a price less than the purchase price by 2 per cent. of the price for every month after the expiry of the period for export fixed above and the date when the buyer is called upon to restore the stock provided that a period of 15 days and over shall be treated as a month and a period less neglect ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... -45 had been promptly completed, there could have been no claim by the assessee in that year. The assessee never informed the authorities either before 16th August, 1943, or soon after that it had infringed the law and incurred liability by way of damages which had to be paid to the Coffee Controller. Thus, there was no liability incurred at all during the period for which the claim was made. Secondly, it was found that the impugned sum was described as liquidated damages and as such it did not form an addition to the cost of commodity purchased by the assessee. On these two grounds, the Tribunal negatived the assessee's claim and dismissed the appeal. 5. The question of law on which the Tribunal had been directed to state is as follows : Whether on the facts and in the circumstances of the case, the sum of ₹ 1,19,177 paid by the assessee as damages to the Indian Coffee Board for not exporting the coffee seeds outside India under the terms of agreement is allowable as an expenditure under section 10(2)(xv) of the Act in the assessment year 1944-45? S. Swaminathan, for the assessee C. S. Rama Rao Shib, for the Commissioner JUDGMENT The Judgment o ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... him at a price less than the purchase by 2+ per cent. of the price for every month after the expiry of the period for export fixed above and the date when the buyer is called upon to restore the stock provided that a period of fifteen days and over shall be treated as a month and a period less neglected. The fixed damages referred to above shall be deemed as liquidated damages and the buyer shall not be entitled to any reduction thereof in any circumstances. It was apparently the first of these alternatives that it was availed of by the Controller of Coffee, and the damages the assessee was liable to pay for its admitted breach of the contractual obligation was assessed at ₹ 1,19,177 on 1st June, 1946. The assessee paid this amount in instalments in the latter part of its year of account 1945-46. The assessment proceedings for 1944-45 were completed by the Income-tax Officer only on 5th August, 1947. The assessee firm claimed that the sum of ₹ 1,19,177 it had paid as liquidated damages should be deducted to arrive at its assessable profits for the accounting year 1942-43 under section 10(2)(xv) of the Income-tax Act. That claim was disallowed by ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... not have sustained a claim for deduction under section 10(2)(xv) of the Act with reference to the account year 1942-43. It would still have been an unascertained claim for damages for breach of contract. The claim itself was not made in the year of account. That there could be no defence to the claim when it was made did not alter the fact that the claim had yet to be made and the damages yet to be ascertained. It could not be predicated in 1942-43 what would be the claim of the India Coffee Board, the other contracting party entitled to damages under the contract. We have already set out the terms of clause 9 of the contract. It provided for three alternatives, any one of which the India Coffee Board could claim at the discretion of the Controller of Coffee. The quantum of damages could not possibly have been identical under each of these three alternatives open to the India Coffee Board. Which of these three alternatives gave the greatest monetary advantage to the India Coffee Board at any given point of time, with the corresponding monetary liability on the assessee, it was not possible to guess, because no claim even was made by the India Coffee Board in 1942-43. Till the In ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... the assessment proceedings an accountant called in as an expert gave evidence. He stated that the accounts had been prepared in accordance with the principles of sound commercial accounting. He added that, if he had been the auditor of the assessee company, he would not have been prepared to certify the accounts as correct, if the provisions to meet the company's liabilities in respect of equipment shortages had not been made year by year in the manner in which the accounts showed them to have been made. In dealing with the evidence of the accountant, Tucker, L.J., observed: .....they (accounts) might well have been prepared in accordance with the principles of sound commercial accounting without being permissible deductions before arriving at the profits in a particular year. After analysing the terms of the contract in that case Tucker, L.J., observed: The real liability under the contract, so far as the replacement of the utensils goes, was a contingent liability; it was a liability which would not arise until the termination of the contract, and it was contingent upon the inability of the caterers in the meanwhile to replace the utensils. In that ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... e company, which carried on business in mining, held their mines on leases which contained the usual covenants for the repair and maintenance of the mines, pits, roads etc. Owing to national stoppage in the coal mining industry, the company was forced to close down their mines from 1st April, 1921, to 2nd July, 1921. The stoppage of work resulted in severe damage to the mines involving considerable amount of expenditure to recondition the mines. The reconditioning work was commenced after 2nd July, 1921. For the period of account from 1st April, 1921, to 30th June, 1921, the assessee debited itself in its accounts with the cost of reconditioning the mines, though no expenditure was made until after the end of the accounting period. It was ultimately held by the House of Lords that the cost of reconditioning was not a proper deduction in computing the results of the assessee company's trade for the accounting period ending 30th June, 1921. Lord Buckmaster observed at page 1048: According to the appellants' contention, however, it is not the actual expenditure that is deducted, but the need for making the expenditure which is to be measured in their favour ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... f liabilities deductible for income-tax purposes. For income-tax purposes it was held that a distinction must be drawn between an actual, i.e., legal liability, which is deductible, and a liability which is future or contingent and for which no deduction can be made. The position under section 10(2)(xv) of the Indian Income-tax Act is the same, as the learned authors pointed out in Kanga and Palkiwala's Income-tax, third edition, at page 500: This clause allows deduction only in respect of expenditure. A contingent liability is not expenditure and therefore cannot be subject of deduction under this clause. Thus the position is that, even had the assessee firm in this case debited itself with the entire amount of ₹ 1,19,177 in the year of account 1942-43, it would have represented only an estimate of its contingent liability and would not have furnished a real basis for a claim to deduct that amount under section 10(2)(xv) of the Act. What the assessee really asked for in this case was that the expenditure actually incurred in its year of account 1945-46 should be related back to the year of account 1942-43 in computing the assessable profits f ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... d wholly and exclusively for the assessee's business. What the Income Tax Act in England does not permit among other things is (1) any disbursements or expenses not being money wholly and exclusively laid out or expended for the purpose of trade (rule 3a) and (2) any loss not connected with or arising out of trade (rule 3e). The interdependence of the two provisions as well as the distinction between them was pointed out by Finlay, J., in Allen v. Farquharson Bros. and Co.**: .....no doubt they do run rather close to each other, but I cannot help thinking that there is a distinction between (a) and (e). Now a case might be put in which it was not very easy to say whether a thing was a disbursement or expense or was a loss. It is conceivablesuch things sometimes happen-that there may be cases in which a thing might fall alternatively-it might be either within (a) or within (e), but, none the less, I do think that there is a distinction to be drawn between the two (a) relates to disbursements; that means something or other which the trader pays out; I think some sort of volition is indicated. He chooses to pay out some disbursement; It is an expense; it is ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... t is made in the course of, or arises out of, or is connected with, the trade, or is made out of the profits of the trade. It must be made for the purposes of earning the profits. The application of these principles has led to the position which may be taken as well settled now, that payments of penalties for infraction of law fall outside the scope of permissible deductions. The penalty in any such case is imposed as a punishment on the offender as a responsible person owing obedience to the law. Its nature severs it from the expense of trade. It is not incurred by him in his character of trader. The principle laid down by Rowlatt, J., in the Commissioner of Inland Revenue v. E.C. Warnes and Co., Ltd. and followed by him in Commissioners of Inland Revenue v. Alexander Von Glehn Co., Ltd. was approved of by the Court of Appeal in Von Glehn's case. In Warnes' case* Rowlatt, J., observed: I may shelter myself behind the authority of Lord Loreburn, who, in his judgment in the House of Lords in Strong Co. v. Woodifield*** said that it is impossible to frame any formula which shall describe what is a loss connected with or arising out of a trade.. ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... its of the trade. The disbursement is made, as I have already said-and the same remark applies to this Rule as to the other-because the individual who is conducting the trade has, not from any moral obliquity, but has unfortunately, been guilty of an infraction of the law. Scrutton, L.J., was of the view that the payment of the penalty in that case was an unfortunate incident that followed after the assessee, Von Glehn, had earned his profits. The principles laid down in Warnes' case and Von Glehn's case** were applied in Cattermole v. Borax and Chemicals Ltd. The law infraction of which was alleged in that case was the law of the United States. The assessee was assessed to tax under the English law. After referring to the dictum of Lord Sterndale in Von Glehn's case, that whether the proceedings in which the penalty was incurred were criminal proceedings or not did not matter, Croom-Johnson, J., observed: I can see no distinction in law as to whether the proceedings were proceedings to recover sums of money of this sort pursued in an American Court or in an English Court. Dealing with the contention that Borax and Chemicals Ltd., paid the mone ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ched the principle which we referred to earlier, that a payment by way of penalty for an infraction of law will not come within the scope of section 10(2)(xv) which requires that the expenditure should have been incurred wholly and exclusively for the assessee's business. The next class of cases to which we shall refer decided again on an application of the principles laid down in Strong v. Woodifield(1) dealt with payments by way of damages or compensation. In Income-tax Appellate Tribunal, Bombay v. Chhaganmal Mangilal(4) after considering the scope of the principles laid down in Warnes' case(5) and Von Glehn's case(6) and in Strong v. Woodifield(1) the learned Judges applied the principle laid down by the Court of Appeal in Scammel and Nephew Ltd. v. Rowles(7) and observed at page 215: The assessee Seth Chhaganmal Mangilal was not convicted for infringement of the trade mark. The suit against him was not decided on merits. An appeal was filed against an interlocutory order in a pending suit. The compromise of the claim did not amount to an admission that he had committed an infringement of the trade mark. Instead of carrying on an expensive and uncertain li ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... (Suppl.) 41 the finding was that that test was satisfied. The decision in Herald and Weekly Times Ltd. v. Federal Commissioner of Taxation was the one on which the learned counsel for the assessee relied to a considerable extent. In that case the appellant assessee, which was the proprietor and publisher of an evening newspaper, claimed to deduct from its assessable income moneys paid by way of compensation, either before or after judgment, for damages in respect of defamatory matter published in that paper, and amounts incurred by way of costs in contesting the claims of persons defamed and in obtaining advice in regard thereto. The Court by a majority held that the monies so disbursed were wholly and exclusively laid out or expended for the production of assessable income. That decision of the majority was based on the application of tests laid down in Strong v. Woodifield*. Gavan Duffy, C.J., and Dixon, J., pointed out that the distinction between the case before them and Strong v. Woodifield* lay in the degree of connection between the trade or business carried on and the cause of the liability for damages. At page 119 the learned Judges pointed out: ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... wed did not constitute an expenditure falling within section 10(2)(xii). It was not incidental to the trade. The learned Chief Justice further observed: This is not a case of conducting a business in a negligent manner; it is a case of conducting a business in a dishonest manner. In Baluswamy Iyer v. Commissioner of Income-tax, Madras*** we had occasion to refer to the decision in Mask Co. v. Commissioner of Income- tax, Madras#, when the correctness of that decision was not challenged. The learned counsel for the assessee invited us to differ from the principles laid down in Mask's case#. It may not be necessary to examine in this case the full implications of the decision in Mask's case# or the correctness of the extension of the principles of the English decisions which it might involve. In any event we do not understand the learned Chief Justice to have laid down that, where a wilful breach of contract has been established, that is sufficient proof of dishonesty which would disentitle the assessee from preferring any claim under section 10(2)(xv) of the Act for damages paid for breach of contract. As we shall presently show, it is not necessar ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... or expenditure incurred is in some sense connected with the trade, for it may be only remotely connected with the trade, or it may be connected with something else quite as much or even more than with the trade. Only such losses can be deducted as are connected in the sense that they are really incidental to the trade itself. It is not enough that the disbursement is made in the course of, or arises out of, or is connected with, the trade or is made out of the profits of the trade. It must be made for the purposes of earning the profits. Before we discuss whether these tests have been satisfied by the assessee, we have to verify what the nature of the payment was. No doubt the assessee firm paid the amount of ₹ 1,19,177 in discharge of the contractual obligation it had entered into with the India Coffee Board to pay an ascertained sum as liquidated damages for breach of contract. The contractual obligation, the performance of which the assessee defaulted, was to export the coffee which had been sold to it at a concessional price, only because it was earmarked for export abroad. The other contracting party, the India Coffee Board, was a statutory body created by the Coffee ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... export it would not have been in a position to sell that coffee within India. But that connection is not enough to sustain the claim, that what the assessee had to pay the India Coffee Board was inextricably mixed up with its normal line of business. The breach of its contractual obligation to the Board 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 trade itself that it carried on. From what we have said above it should be clear that it was not a case of a payment of damages for a mere breach of contract with nothing more. It was not of course a case of penalty paid under the terms of a statute for contravention of any specific statutory provision. In the circumstances of this case, the liquidated damages claimed and paid was, however, more akin to a penalty than the damages suffered for breach of contract in the course of normal trading activities, whether or not that breach of a contract was also dishonest. That is why we said that it may not be necessary to rest our decision in this case on the rule laid down in Mask's case. In our opinion it is the principle laid down in Von Glehn' ..... X X X X Extracts X X X X X X X X Extracts X X X X
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