PRAKASH COTTON MILLS (P.) LTD. VS COMMISSIONER OF INCOME-TAX, 1993 PTD-SUPREME-COURT-INDIA 1674 (1993)

(Appeal from the order, dated June 17, 1976 of the Bombay High Court in I.T. Application No. 63 of 1976).

(a) Income-tax-----

----Business expenditure---Statutory impost---Method for allowance---Scheme of statute to be studied to find whether impost is compensatory or penal or composite---Deduction to be allowed where wholly compensatory---When composite only that part which is compensatory to be allowed---Income Tax Act, 1961, S.37(1)---Bombay Sales Tax Act, 1959---Employees' State Insurance Act, 1948.

Whenever any statutory impost paid by an assessee byway of damages or penalty or interest is claimed as an allowable expenditure under section 37(1) of the Income Tax Act, 1961, 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) 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 have to bifurcate the two components of the impost and give deduction of that component which is compensatory in nature and refuse to give deduction of that component which is penal in nature.

Mahalakshmi Sugar Mills Co. v. CPT (1980) 123 ITR 429 (SC) and CPT v. Hyderabad Allwyn Metal Works Ltd. (1988) 172 ITR 113 (AP) fol.

Organo Chemical Industries v. Union of India (1979) 55 FJR 283 and AIR 1979 SC 1803 ref.

[The Supreme Court accordingly remanded the case to the Appellate Tribunal for deciding the claims for deduction (i) of interest for delayed payment of sales tax under the Bombay Sales Tax Act, 1959, and (ii) of damages paid under the Employees' State Insurance Act, 1948, for delayed payment of contribution, after examining the schemes of those Acts.]

(b) Income-tax--

----Business expenditure---Entertainment expenses---Allowance of only part of claim decided on relevant material---No question of law arises---Income Tax Ad, 1961, Ss37(2) & 256.

As to what portion of the miscellaneous expenses claimed by a company, relating to expenses incurred by its directors for entertainment at the Diners Club, is a deductible entertainment expense under section 37(2) of the Income Tax Act, 1961, is a matter to be decided by the fact-fording authorities while assessing the relevant material placed before them; no question of law can arise in this regard, particularly when the fact-finding authorities have recorded their concurrent finding on a consideration of the relevant material

Held, accordingly, that disallowance of Rs. 2,500 out of expenditure incurred by the appellant as entertainment expenses of the Diners Club was justified.

(c) Income-tax---

----Supreme Court---Appeal---Old case seeking reference---Court deciding case on merits.

Mrs. A.K Verma and Mrs. Sayeli P6tak for Appellant.

P.S. Poti, Senior Advocate (R. Satish and Ms. A. Subhashini, Advocates with him) for the Commissioner.

JUDGMENT

N. VENKATACHALA, J.---Two questions are raised for our decision in this appeal. First, whether the appellant wads entitled to claim as allowance under section 37(1) of the Income Tax Act, 1961 ("the I.T. Act"), the interest paid by it for delayed payment of sales tax under the Bombay Sales Tax Act, 1959 ("the BST Act"), and the damages paid by it for delayed payment of contribution under the Employees' State Insurance Act, 1948 ("the ESI Act"). Second, whether the appellant was entitled to claim as allowance under section 37(2) of the Income-tax Act, the entire expenses incurred by it as entertainment expenses.

The appellant is a company carrying on business in the manufacture of textile goods. It is an assessee. In the income-tax return of the assessee for the assessment year 1966-67 (the previous accounting year being from July 1, 1964 to tune 30, 1965), the interest and the damages of Rs. 19,635 paid by it for delayed payment of sales tax under the Bombay Sales Tax Act and for delayed payment of contribution under the Employees' State Insurance Act, was claimed as revenue expenditure allowable under section 37(1) of the Income?tax Act. So also the sum of Rs.3,865 paid by it for entertainment expenses was claimed as revenue expenditure, allowable under section 37(2) of the Income?tax Ad. The Income Tax Officer, in his assessment order made on that return, treated the said item of expenditure of Rs. 19,635 as penal interest and disallowed it. As to the item of expenditure of Rs. 3,865, he disallowed Rs.2,500 treating it as exclusively expenditure incurred on its directors. Appeals preferred before the Appellate Assistant Commissioner and the Income-tax Appellate Tribunal ("the Tribunal") questioning the disallowance of claims of the appellant by the Income-tax Officer did not succeed. Application made by the assessee under section 256(1) of the Income-tax Act before the Tribunal to raise the questions covering the said matters and get them referred for decision by the High Court, also did not meet with success. Again, the application made thereafter by the assessee under section 256(2) of the Income-tax Act before the Bombay High Court to obtain a reference on the questions relating to the said matters for its decision was rejected. Hence, the assessee has filed this appeal by special leave, questioning the aforesaid orders made by the authorities and the High Court. Reference sought to be obtained from the Tribunal for decision by the High Court was on the following questions:

"(1)????? Whether the sum of Rs. 19,635 debited in the interest account paid by way of interest for delayed payment of sales tax and the employees' state insurance contribution could not be said to have been incurred wholly and exclusively for the purpose of business?

(2)??????? Whether, on the facts and in the circumstances of the case, the sum of Rs.19,635 claimed by the assessee was an allowable expenditure under the Income Tax Act, 1961?

(3)??????? Whether, on the facts and in the circumstances, the Tribunal was justified in holding that the disallowance of Rs. 2,500 out of expenditure incurred by the assessee at Diners Club and C.C.I. could be disallowed even though the said expenditure was less than the expenditure allowable under section 37(2) of the Income-tax Act?

(4)??????? Whether there was any evidence or material before the Tribunal to hold that the expenditure to the extent of Rs.2,5W at Diners Club and C.C.I. was not laid out wholly and exclusively for the purposes of business of the assessee-company?"

Questions Nos. 1 and 2 are covered by the first question indicated at the outset. So also, questions Nos. 3 and 4 are covered by the second question indicated at the outset. Indeed, after hearing counsel for the parties, we were inclined to think that the said questions ought to be remitted to the High Court for its opinion under section 256 of the Income-tax Act. In the normal course, we would have done so and left the questions to be answered by the High Court. But, regard being had to the fad that the questions relate to a 25-year old case of the assessment year 17 and the fact that they could be considered by us on the facts found in the order of the Tribunal, we consider it most appropriate to deal with the questions ourselves and answer them. Such a course is resorted to by us not merely because of the said peculiar facts and circumstances of this case, but also because of our inclination to remit the first question with our answer thereon for a final decision by the Tribunal.

First question:

That section 37(1) of the Income-tax Act corresponds to section 10(2)(xv) of the predecessor Indian Income-tax Act of 1922 is undisputed.

In Mahalakshmi Sugar Mills Co. v. CIT (1980) 123 ITR 429, this Court had to decide the question whether the interest paid by the appellant? assessee therein under section 3(3) of the U.P. Sugarcane Cess Act, 1956, for delayed payment of cess payable thereunder was an allowable expenditure under section 10(2)(xv) of the Indian Income-tax Act of 1922. For deciding that question, this Court examined the provisions of the Sugarcane Cess Act, 1956, which provided for taking of several kinds of action against a person who defaulted in payment of the cess imposed under that Act. Section 4 was -found to make the defaulter liable to imprisonment or fine or both. Section 3(5) was found to make the defaulter liable for payment of penalty, an amount which far exceeded the amount of cess. Then, section 3(3) was found to make the defaulter liable for payment of interest at 6 per cent. per annum from the date of default till the date of payment. On an analytical examination of the said provisions, this Court took the view that interest paid under section 3(3) by the defaulter for delayed payment of the cess could not be described as a penalty imposed upon him for infringement of the law but ought to be regarded as an amount of compensation paid by him to the Government for delayed payment of the cess levied against him under the Act. In that view of the matter, this Court held that the interest paid by the appellant assessee for delayed payment of cess was an allowable expenditure under section 10(2)(xv) of the Indian Income Tax Act of 1922.

In CIT v. Hyderabad Allwyn Metal Works Ltd, (1988) 172 ITR 113, a Division Bench of the Andhra Pradesh High Court had to decide two questions (1) whether the damages paid by the respondent-assessee under section 14-B of the Employees' Provident Funds and Miscellaneous Provisions Ad, 1952, was an allowable deduction under section 37(1) of the Income-tax Act and (ii) whether the interest paid under the Bombay Sales Tax Act for delayed payment of sales tax thereunder was an allowable deduction under section 37(1) of the Income-tax Ad. For deciding question (i) the Division Bench referred to the view of A.P. Sen, J. of this Court found in a passage of his concurring judgment in Organo Chemical Industries v. Union of India, AIR 1979 SC 1803; (1979) 55 FJR 283, 304, on the expression "damages" occurring in section 14-B of the Central Act of 1952, which reads thus (at page 118 of 172 ITR):

"The expression `damages' occurring in section 14-B is in substance, a penalty imposed on the employer for the breach of the statutory obligation. The object of imposition of penalty under section 14-B is not merely `to provide compensation for the employees'. We are clearly of the opinion that the imposition of damages under section 14-B serves both the purposes. It is meant to penalise defaulting employers as also to provide reparation for the amount of loss suffered by the employees. It is not only a warning to employees in general not to commit a breach of the statutory requirements of section 6, but at the same time it is meant to provide compensation or redress to the beneficiaries, i.e., to recompense the employees for the loss sustained by them. There is nothing in the section to show that the damages must bear relationship to the loss, which is caused to the beneficiaries under the Scheme. The word `damages' in section 14-B is related to the word `default'. The words used in section 14-B are `default in the payment of contribution' and, therefore, the word `default' must be construed in the light of para. 38 of the Scheme

The Division Bench, having regard to the said view of the expression "damages" occurring in section 14-B of the Provident Funds Act, found that such damages paid by the concerned assessee-respondent could not have been treated by the Tribunal as purely compensatory. While recording such finding, the real distinction that exists between an impost which is compensatory and an impost which is a penalty, is pointed out, thus (at page 119 of 172 ITR):

"The question whether any such impost is in essence compensatory or is by way of penalty will have to be decided having regard to the relevant provisions of the law under which it is imposed and the circumstances under which it has been imposed. The mere nomenclature as interest, penalty or damages in the Act may not be conclusive for the purpose of allowing it as a deduction under the Income-tax Act. Similarly, the circumstance that a fixed rate of interest has to be paid also may not be conclusive. Section 14-B of the Ad provides for levy

of damages for delayed payment as a percentage of the amount due up to a prescribed maximum. Such a determination is to be done by the appropriate authority after giving an opportunity to the employer. Thus, the levy will be by a speaking order of the authority 'fixing quantum of damages. As held by the Supreme Court, the said amount comprises both an element of penal levy as well as compensatory payment. It will be for the authority under the Income?tax Ad to decide with reference to the provisions of the Employees' Provident Funds Act and the reasons given in the order imposing and quantifying the damages to determine what proportion should be treated as penal and what proportion as compensatory. The entire sum can neither by considered as mere penalty nor as mere interest."

Then, dealing with question (ii) relating to interest paid by the concerned respondent assessee under the Bombay Sales Tax Act which the Tribunal had treated as an allowable deduction under section 37(1) of the Income-tax Ad, the Division Bench considered the relevant provisions of the Bombay Sales Tax Act bearing on the question and held, thus (at page 121 of 172 ITR):

"From a reading of the aforesaid provision and in the background of the various sections a mentioned above, it cannot be said that the levy under section 36(3), though called a penalty, is merely compensatory or in the shape of interest for delayed payment or penal in character. The Act does not provide for automatic payment of interest due to delay in payment. The levy under subsection (3) of section 36 is to be made after giving notice to the dealer and after recording reasons for it where the tax has not been paid within the time contemplated for payment by the Act. The commissioner has also the power to remit the whole or any part of the interest calculated in the manner mentioned in it which can be only on relevant grounds. Subsection (5) of section 36, which is extracted above, indicates that after the levy of this amount under subsection (3), immunity is granted from prosecution on the same fads. These indicate that the imposition, though called a penalty, is a composite one comprising both a penalty and a compensation for delayed payment. The Tribunal, therefore, was not right in treating the entire payment as merely interest for delayed payment. As already indicated while discussing question No.(1), the nomenclature, of the levy as interest, damages or penalty may not be conclusive."

The decision of this Court in Mahalakshmi Sugar Mills Co. (1980) 123 ITR 429) and the decision of the Division Bench of the Andhra Pradesh High Court in Hyderabad Allwyn Metal Works Ltd. (1988) 172 ITR 113 with the views of which we are in complete agreement, are in our opinion, decisions which settle the law on the question as to when an amount paid by an assessee as interest or damages or penalty could be regarded as compensatory (reparatory) in character as would entitle such assessee to claim it as an allowable expenditure under section 37(1) of the Income-tax Act. 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(l) 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.

??????????? The facts of the case under our consideration disclose that the Income-tax Officer and the appellate authorities have refused to allow the claims made by the assessee under section 37(1) of the Income-tax Act, without any examination of the Scheme of the provisions of the Bombay Sales Tax Ad, to find whether impost of the interest paid by the assessee for delayed payment of sales tax was compensatory in nature as would entitle it for deduction under section 37(1) of the Income-tax Ad. The same is the position as regards the impost of damages paid by the assessee under the Employees' State Insurance Ad, 1948, for delayed payment of contribution thereunder. Hence, we consider it necessary to remit the question to the concerned Tribunal for deciding the assessee's claims for deduction of interest and damages under section 37(1) of the Income-tax Act. The first question is answered accordingly.

Second Question:

Miscellaneous expenses claimed by the assessee as deductible expenditure allowable under section 37(2) of the Income-tax Act related to a sum of Rs. 3,865 incurred by the directors of the assessee-company for entertainment at the Diners Club and C.C.I. The Income Tax Officer regarded a sum of Rs.1,365 out of the said sum of Rs3,865 as a permissible deduction under section 37(2) of the Income-tax Act, while he regarded the remaining sum of Rs. 2,500 as impermissible deduction under section 37(2) of the Income Tax Act taking the view that the same was attributable to personal expenses of the directors of the assessee-company. The Appellate Assistant Commissioner, in dealing with the said claim for deduction in the appeal of the assessee filed before him, held that the entire expenses claimed as deductible expenditure under section 37(2) of the Income-tax Ad could not be regarded as having been laid out or expended wholly and exclusively for the purpose of the business of the assessee. He, therefore, refused to interfere with the order of the Income-tax Officer made in that regard. The Tribunal, which considered the matter in the appeal of the assessee before it, affirmed the view of the Appellate Assistant Commissioner in the matter. As to what portion of the miscellaneous expenses claimed is a deductible entertainment expense of the assessee being a matter to be decided by the fact-finding authorities while assessing the relevant material placed before them, no question of law could arise in that regard, particularly, when the fact-finding authorities have recorded their concurrent finding on consideration of the relevant material. Hence, the question under consideration is devoid of merit and is answered against the assessee.

In the result, we allow this appeal partly and remit the case relating to the appellant-assessee's claim for deduction under section 37(1) of the Income Tax Act, 1961, to the Income Tax Appellate, Tribunal, Bombay for being decided in the light of our answer to the first question and decide the appeal of the assessee accordingly. No costs.

M.B.A./2458/T??????????????????????????????????????????????????????????? Appeal partly allowed.