N. SUNDARESWARAN VS COMMISSIONER OF INCOME-TAX
1999 P T D 1260
[226 I T R 142]
[Kerala High Court (India)]
Before V. V. Kamat and P. A. Mohammed, JJ
N. SUNDARESWARAN
Versus
COMMISSIONER OF INCOME-TAX
Income-tax Reference No.336 alongwith Income-tax Reference No.337 of 1985, decided on 04/06/1996.
(a) Income-tax---
----Business expenditure---Damages for breach of contract ---Assessee agreeing to supply commodity to foreign buyer ---Assessee unable to supply commodity---Contract providing for arbitration---Foreign buyers claiming damages in letters received in accounting year ending on 31-12-1978-- Damages were un liquidated and, in any event, they were not deductible in assessment year 1978-79---Indian Income Tax Act, 1961, S.37 --- Indian Contract Act, 1872, S.73.
(b) Income-tax---
----Export markets development allowance---Weighted deduction-- Commission paid for obtaining information regarding foreign markets-- Entitled to weighted deduction---Indian Income Tax Act, 1961, S.35-B.
Commission paid in India for gathering information regarding markets outside India is entitled to weighted deduction under S.35-B of the Income Tax Act, 1961.
C.I.T. v. Kerala Nut Food Co. (1991) 192 ITR 585 (Ker.) fol.
When a claim is made for damages for breach of contract, it has to be adjudicated by arbitration or by any process known to law. Only when damages are so determined can they be said to be liquidated damages. A claim for un liquidated damages does not give rise to a debt until the liability is adjudicated and damages assessed by a decree or order of a Court or other adjudicatory Authority. When there is a breach of contract, the party who commits the breach does not eo instanti incur any pecuniary obligation, nor does the party complaining of the breach become entitled to a debt due from the other party. The only right which the party aggrieved by the breach of the contract has is the right to sue for damages. Section 73 of the Contract Act, 1872, provides that where a party suffers a loss or damage in consequence of breach of contract, he is entitled to recover compensation from the party breaking the contract. It is a protection available to the injured party and not to the party who has broken the contract. The assessee who has broken the contract cannot argue that a liability has accrued against it for the reason that the right to recover compensation from the assessee is recognised in the said provision. Therefore, under section 73 of the Contract Act, what is provided is not the accrued liability but the liability to be crystallized in a process known to law.
The assessee entered into contracts with foreign buyers for the supply of cashew kernels. However, the assessee could not fulfil the obligations under the contracts due to the shortage in the supply of raw cashewnuts and consequent rise in prices. the contracts provided for arbitration in case of breach and by letter, dated January 31, 1978, L, a foreign company, referred the case for initiating arbitration proceedings against the assessee. The assessee on receipt of the copy of the reference made by the above foreign company without waiting for the outcome of the arbitration proceedings, made a provision in the accounts for the claim of damages of Rs.10,49,750 being the value of Rs.2,600 cases of kernels. Likewise the assessee claimed deduction of Rs.2,01,875 being the damages arising out of the default made by it in fulfilment of contract of the sale of 950 cases of cashew kernels to I of West Germany. The said foreign company claimed damages for the aforesaid breach of contract as per its letter, dated March 1, 1978. However, the Income-tax Officer observed that the aforesaid claims were inadmissible for the reason that they had not been established. This was upheld by the Tribunal. On a reference:
Held, that in the absence of any material evidencing the finalisation of such proceedings and quantification of damages payable by the assessee, the claim for deduction advanced by the assessee was only for un liquidated damages. The deduction for damages was entered in the account books relating to the accounting year which ended on December 31, 1977, on the basis of two letters, dated January 31, 1978, and March 1, 1978, sent by the foreign companies. Even assuming that the liability to pay the compensation arose on receipt of those letters it could only be during the accounting year ended on December 31, 1978, the relevant assessment year being 1979-80 and not 1978-79.
Asuma Cashew Co. v. C.I.T. (1990) 182 ITR 175 (Ker.); Calcutta Co. Ltd. v. C.I.T. (1959) 37 ITR 1 (SC) and Union of India v. Raman Iron Foundry AIR 1974 SC 1265 ref.
C. Kochunni Nair for the Assessee.
P. K. R. Menon and N. R. K. Nair for the Commissioner.
JUDGMENT
P. A. MOHAMMED, J. An exporter-firm is the assessee in the above tax references. The assessment is for the year 1978-79, the accounting period for which ended on December 31, 1977. The assessee as well as the Revenue being aggrieved by the order passed by the Commissioner of Income-tax (Appeals), Ernakulam, filed appeals before the Income-tax Appellate Tribunal as I.T.As. Nos.243/(Cock) of 19.82 and 402/(Coch) of 1982. Those appeals were disposed of by the Tribunal by a common order, dated July 16, 1984. These two references arise from the said common order of the Tribunal.
At the instance of the assessee four questions are referred to us for decision. Those questions mainly relate to the claim of deduction of damages occurred during the relevant accounting year. Likewise one question is referred to us for answer at the instance of the Revenue and it relates to the claim of "weighted deduction" under section 35-B of the Income Tax Act, 1961 (hereinafter referred to as "the Act").
The questions referred at the instance of the assessee are the following:
"(1) Whether, on the facts and in the circumstances of the case, the Tribunal was right in law in holding that the claim for deduction of the damages payable by the assessee to foreign companies for breach of contracts was allowable only if the claim had been crystallised during the relevant accounting period?
(2) Whether, on the facts and in the circumstances of the case, the Tribunal was right in holding that the claim for damages will be crystallised only when a claim is actually made by the foreign company and the same is either accepted or determined by negotiation or by arbitration or by suit?
(3) Whether, on the facts and in the circumstances of the case, the Tribunal was right in holding that the claim for damages to the extent of Rs.12,51,625 had not crystallised during the accounting period relevant to the assessment year 1978-79?
(4) Whether, on the facts and in the circumstances of the case, the Tribunal was right in not relying upon the copy of the letter, dated December 16, 1977, from the Richard Franco Agency Incorporated New York, and which was produced by the assessee before the Tribunal for the first time?"
In order to answer the above questions certain basic facts are required. The assessee entered into contracts with foreign buyers for the supply of cashew kernels. However, the assessee could not fulfil the obligations under the contract due to the shortage in the supply of raw cashewnuts and consequent rise in prices. It is said that due to the failure to supply the cashewnuts as per the terms of the contract, there was breach of contract and the assessee, therefore, claimed a deduction of Rs.12,51,625 towards damages payable to the foreign companies. Though this claim was made before the Income-tax Officer, he, however, disallowed it. Therefore, the assessee filed an appeal before the Commissioner of Income-tax (Appeals) and in that appeal the claim was allowed. The revenue filed an appeal against the said order of the Commissioner and in the said appeal the Tribunal disallowed the claim advanced by the assessee-firm.
It is necessary to examine as to how the above claim has been dealt with by the Income-tax Officer in the assessment order passed by him on September 4, 1981. The relevant portion of the assessment order is extracted
below:
Add: Foreign claim ---Rs.12,52,046.
This is made up of 3 items as detailed below:
| | | Rs. P. |
| (1)Richard Franco Agency, New York Contract No. 9957 of 5-11-1978, for 2600 cases, $ 1,33,500 exchange rate Rs.8.85 | | 10,49,750.00 |
| (2)International Emporium, Hamburg. Contract No.2456, dated 27-10-1975 Contract No.2457, dated 27-10-1975 Contract No. 2464, dated 30-6-1976 | 100 c/s 100 750 | |
| | 950c/s | |
| For 950 c/s. $ 23730.00 | | |
| Exchange rate at 8.50 per $ | | 2.01, 875.00 |
| (3) Ve-Sojuzplede import, Moscow, Claim for humidity against Invoice No.76/77 | | 421.19 |
| | Total: | 12.52,046.19" |
Out of the above three items there is no dispute with regard to item No. 3 and we are, in this reference, concerned with Items Nos. l and 2 alone.
The assessment order reveals that as per the Contract No.9957, dated November 15, 1978, the assessee entered into contract for the sale of 2,600 cases (320 counts wholes) of cashew kernels to Messrs Los Angeles Nut House, California, through agents Messrs Richard Franco Agency, New York, at $ 1.30 per pound and the assessee defaulted to fulfil the contract for the reason that it could not procure raw nuts as the price of raw nuts has risen considerably. It further discloses that the agreement of contract provided for arbitration in case of breach and by letter, dated January 31,1978, Messrs. Los Angeles Nut House referred to the case for initiating arbitration proceedings against the exporter. It appears that the assessee on receipt of the copy of the reference made by the above foreign company without waiting for the outcome of the arbitration proceedings, made a provision in the accounts for the claim of damages of Rs.10,49,750 being the value of the 2,600 cases of kernels. Likewise the assessee claimed deduction of Rs.2,01,875 being the damages arising out of the default made by it in fulfilment of the contract for sale of 950 cases of cashew kernels to Messrs. International Emporium, West Germany. The said foreign company claimed damages for the aforesaid breach of contract as per its letter, dated March 1, 1978. However, the Income-tax Officer has observed that the aforesaid claims are inadmissible for the reason that they have not been established. The officer further added that those claims are in the nature of "contingent liability" only.
Apart from the above particulars seen in the assessment order, no further details regarding terms and conditions of contracts are made available for scrutiny by this Court. The details regarding the period of contracts, the manner of their performance, quantification of damages, etc., are not specifically brought to our notice. What this Court could positively see is that arbitration proceedings had been referred against the assessee but the damage, if any, had not been crystallised. In this context, it is necessary to examine whether the claim put forth by the assessee is for liquidated damages or unliquidated damages. The Tribunal in its order observed that the claim advanced by the assessee is for unliquidated damages. We think that the above conclusion arrived at by the Tribunal is well-founded. In this case, the assessee admits that it has committed the breach of contracts and, therefore, the damages are payable by it. When a claim is made for damages for breach of contract, it has to be adjudicated by arbitration or by any process known to law. Only when the damage is so determined can there be said to be liquidated damages. In the absence of any material evidencing the finalisation of such proceedings and quantification of damages payable by the assessee we are of the view that the claim of deduction of advanced by the assessee is only for "unliquidated damages".
Even though the Income-tax Officer has made specific reference in the assessment order as to different contracts entered into between the assessee and foreign buyers, copies of those contracts were not made available to this Court for scrutiny. They are also not seen produced before the Tribunal. If the copies of the contracts were made available it would have been possible for us to determine whether the liabilities for compensation had already accrued. When the damage is quantified it may be a case of accrued liability. But in the present case while determining the profits and gains of business of the assessee chargeable to income-tax under section 28 of the Act it claimed deduction of damages to be paid to the foreign companies for breach of contracts treating it as already suffered. Whets such claim is advanced by the assessee it can be allowed only when there is an accrued liability. It cannot be said that when the liability is shown in the accounts it has accrued eo instants.
In channelising the above argument, counsel for the assessee placed reliance on section 73 of the Contract Act. The first paragraph of the said section is thus:
"When a contract has been broken, the party who suffers by such breach is entitled to receive, from the party who has broken the contract, compensation for any loss or damage caused to him thereby, which naturally arose in the usual course of things from such breach, or which tit parties knew, when they made the contract, to be likely to result from the breach of it."
The above provision provides that where a party suffers a loss or damage in consequence of a breach of contract, he is entitled to recover compensation from the party breaking the contract. It is a protection available to the injured party and not to' the party who has broken the contract. The assessee who has broken the contact cannot argue that a liability has accrued against it for the reason that the right to recover compensation from the assessee is recognised in the said provision. Therefore, under section 73 what is provided is not the accrued liability but the liability to be crystallised by a process known to law.
The Supreme Court in Calcutta Co. Ltd. v. C.I.T. (1959) 37 ITR 1 observed to the following effect (headnote):
"That undertaking imported a liability on the appellant which accrued on the dates of the deeds of sale, though that liability was to be discharged at a future date. It was thus an accrued liability and the estimated expenditure which would be incurred in discharging the same could be deducted from the profits and gains of the business, and the amount to be expended could be debited in accounts maintained in the mercantile system of accounting before it was actually disbursed. The difficulty in the estimation thereof did not convert the accrued liability into a conditional one, because it was always open to the income-tax authorities concerned to arrive at a proper estimate thereof having regard to all the circumstances of the case."
The facts of the above case are dissimilar to the facts in the present case under discussion. There the estimated expenditure had to be incurred to discharge an existing and definite obligation enforceable against the assessee in praesenti and, therefore, the Court held it to be a permissible deduction in the computation of income. It has to be seen in that case that as per the terms of the sale the assessee had undertaken an unconditional obligation which was enforceable against it. Thus, it was a case of liability incurred and not one which required to be adjudicated. The Supreme Court in Union of India v. Raman Iron Foundry AIR 1974 SC 1265, emphatically observed (page 1273): '
"Now, the law is well-settled that a claim for unliquidated damages does not give rise to a debt until the liability is adjudicated and damages assessed .by a decree or order of a Court or other adjudicatory authority. When there is a breach of contract, the party who commits the breach does not eo instanti incur any pecuniary obligation, nor does the party complaining of the breach become entitled to a debt due from the other party. The only right which the party aggrieved by the breach of the contract has is the right to sue for damages.
It is further observed (page 1273):
"But, and this is most important to note, he does not get damages or compensation by reason of any existing obligation on the part of the person who hays committed the breach. He gets compensation as a result of the fiat of the Court. Therefore, no pecuniary liability arises till the Court has determined that the party complaining of thebreach is entitled to damages."
The Division Bench of this Court while considering exactly a similar claim by an exporter-assessee observed in Asuma Cashew Co. v. C.I.T. (1990) 182 ITR 175 thus (page 179):
"On these facts, the Tribunal held that the liability of the assessee to pay compensation will arise or be crystallised only when the liability to pay damages is adjudicated and the liability itself is determined and accepted by private negotiation or is determined by an arbitrator or by a Court. In other words, it was held that an enforceable liability will spring into existence only when it was determined and fixed by the arbitrators and not when the breach occurred as contended by the assessee. We see no error in the said reasoning and conclusion of the Tribunal."
In view of the above decisions, it is arduous for this Court to countenance the contention of the assessee that there is an incurred liability in this case. The said contention is, therefore, rejected.
As pointed out earlier, the assessee did not wait for the outcome of the arbitration proceeding. In order to claim damages, it has produced two letters, evidenced by Annexures "D" and "D-1 " and they are, dated December 16, 1977, and August 29, ,1978, respectively. These letters were not produced before the Income-tax Officer even though the assessment order was passed only on September 4, 1981. From the dates mentioned in the above letters it would clearly indicate that those letters were in the possession of the assessee at the time of finalisation of assessment proceedings. It is not known why they were not produced before the Income-tax Officer or the Commissioner of Income-tax (Appeals). Those letters were produced for the first time before the Tribunal. In this context, it is pertinent to note that the deduction for damages is seen entered in the account books relating to the accounting year which ended on December 31, 1977, on the basis of two letters, dated January 31, 1978 and March 1, 1978, sent by the foreign companies as referred to hereinbefore. Even assuming that the liability to pay the compensation arose on receipt of those letters it can only be during the accounting year ended on December 31, 1978, the relevant assessment year being 1979-80 and not 1978-79.
The Tribunal after evaluating the materials on record came to the conclusion that the assessee has failed to establish that the claim for damages had crystallised during the accounting period. The Tribunal has also observed that the claim cannot be allowed merely because the breach of the contract was committed in the accounting period. It cannot be said that from the aforesaid findings of the Tribunal the questions of law framed at the instance of the assessee do not arise for consideration. Questions Nos. l and 2 directly arise for decision and the third question is found to be consequential in nature. The fourth question relates to the refusal by the Tribunal to rely on a letter, dated December 16, 1977, from a foreign company in order to substantiate the claim of the assessee for deduction of damages. The Tribunal is legally justified in not relying upon the said letter for the reason that it was produced before it for the first time. The Tribunal in this connection has also observed that the copy of the letter by which the assessee remitted the claim before the close of the previous year has not also been made available.
Counsel for the Revenue points out that there is a factual error in so far as the payment of compensation to the foreign company is concerned in the order of the Tribunal and hence is liable to be clarified. What the Tribunal observed in the order is this: "He took note of the fact that the amount has not been actually paid and that it was adjusted against amounts receivable against subsequent shipments. " Counsel for the Revenue submits that what the Tribunal observed above is a mistake and the correct position is stated by the Commissioner of Income-tax thus: "The compensation has not been paid yet because according to learned counsel trade with the U.S.A. is slack and no export has taken place subsequently. He points out that the claim will be adjusted against the amount receivable by the appellant in respect of the subsequent shipments." Therefore, it is clear that the Tribunal has misunderstood the statements contained in the order of the Commissioner. Thus, it is crystalline that the compensation claimed by the foreign companies has not been paid by the assessee.
In view of the discussion hereinabove, we answer questions Nos. l to 4 referred to us at the instance of the assessee in the affirmative and in, favour of the Revenue end against the assessee.
We will now advert to the question referred to us at the instance of the Revenue. The said question is as follows:
"Whether, on the facts and in the circumstances of the case, the Tribunal was right in holding that the assessee was entitled to weighted deduction under section 35-B of the Income Tax Act, 1961, on the commission paid in India to Nut Meat Trading Co. Ltd., Bombay?"
The assessee claimed "weighted deduction" of Rs.66,747 under section 35-B(1)(b) of the Act. It represents the commission paid to Nut Meat Trading Co. Ltd., Bombay, in respect of the export of goods of the assessee to foreign countries. This claim was disallowed by the Income-tax Officer on the ground that the said expenses were incurred within India. However, it was allowed by the Commissioner of Income-tax in appeal on the ground that the expenditure incurred for gathering information regarding markets outside India is an allowable weighted deduction. The Tribunal also took the view that the weighted deduction can be allowed oz commission paid in India. if it otherwise qualifies under one or the other clauses of section 35-B(l)(b). The Tribunal has also observed that the assessee had received the information about the foreign markets through the agents in India. The Division Bench of this Court in C.I.T. v. Kerala Nut Food Co. (1991) 192 ITR 585 held (page 597):
"The services are incidental to the formation of the contract falling under sub-clauses (i) and (ii) of clause (b) of section 35-B(1) of the Income-tax Act. It is evident that the agents render positive and specific services for the marketing of the goods in which the assessee deals in the course of his business. The commission agents obtained information regarding the markets outside India regarding the goods for export. They render services to the exporters by obtaining information regarding markets outside India for the assessee's goods and they actually give advertisement and publicity outside India in respect of the goods of the assessee and also obtain information regarding markets outside India for the goods exported by the assessee. The commission payments will certainly qualify for weighted deduction under section 35-B(1)(i) and (ii) of the Income tax Act."
In view of the settled position emerging from the above decision, the question referred to us at the instance of the Revenue can only be answered in favour of the assessee. Accordingly, the said question is answered in the affirmative and against the Revenue and in favour of the assessee. The references are disposed of as above.
A copy of this judgment under the seal of this Court and the signature of the Registrar shall be forwarded to the Income-tax Appellate Tribunal, Cochin Bench.
M.B.A./1889/FCReference answered.