COMMISSIONER (LEGAL DIVISION) LARGE TAXPAYERS UNIT, KARACHI VS BAWANY METALS LTD. KARACHI, 2006 PTD-KARACHI-HIGH-COURT-SINDH 2256 (2005)

(a) Income Tax Ordinance (XXXI of 1979)---

----S. 136---Question already decided by High Court---Not to be entertained again.

(b) Income Tax Ordinance (XXXI of 1979)---

----S. 23---Deductions---Expenditure incurred or extra amount paid on account of infraction of law---Not to be allowed as admissible deduction---Exceptions stated.

Any expenditure on account of infraction of law is not to be allowed. This principle is not to be applied when an extra amount is paid in pursuance of an administrative direction and not in pursuance of infraction of any statute law or rules framed thereunder.

If there is no infringement, transgression, violation or infraction of law and an excess amount has been paid on account of some , executive/administrative orders or in accordance with the terms of a contract between the two private parties and the course adopted is on account of business expediency, the expenditure so made must be treated as wholly and exclusively for the purpose of business. If infringement or violation of any law is such that any commission or omission is not warranted in law at all and the course adopted is not permissible under any provision of law, then any penalty and fine imposed by competent authority shall not be treated as an expenditure incurred wholly and exclusively for the purpose of business and shall not be an admissible expenditure, as infraction of law cannot be held to be for the business purposes. However, if the provision of law itself envisages different courses of action and option is available to a person to adopt any one of the courses, then it would not amount to infraction or violation of law, but would come within the precincts and premises of law. Adoption of any one of the courses open to a person under the law shall be deemed to be a compliance of the law and not the infraction or violation thereof. If any extra amount is paid on account of any delayed payment, such extra amount is in the nature of compensation and not in the nature of penalty or fine. For the purpose of fine or penalty, there should be a separate proceeding initiated and conducted by an authority competent in law. An extra amount paid in ordinary course and automatically without any intervening order passed by competent authority as penalty and fine, shall not be treated on account of infraction of law for the simple reason that the law or administrative act itself provides for payment of extra amount. Likewise any interest/mark-up paid on account of delayed payment of principal amount shall not be treated as fine or penalty. Such extra payment by whatsoever nomenclature charged shall not become a fine or penalty imposed by competent authority for infraction of law, but actually it would be in the nature of compensation, though described differently, and may be loosely termed as penalty or fine. The reason being that mere use of a particular term or a nomenclature is not the final determining factor, but the substance of the matter is to be examined.

The facts and circumstances of each case are to be examined for ascertaining, whether the extra amount paid is in the nature of fine or penalty on account of infringement of provision of law or it was for business expediency and if so, it shall be wholly and exclusively for the purpose of business and shall be treated as admissible deduction. However, if it is not for business consideration, and in fact it is in the nature of penalty or fine, the expenditure is not to be allowed.

If an amount paid is automatic and in contemplation of the parties, then notwithstanding the describing of excess amount as fine or penalty or penal interest or use of any word or nomenclature, shall not change the nature of transaction, which is to be determined and gauged on the basis of the substance of the matter. The reason being that the penalty and fine was not within the contemplation of the parties, but a competent authority on account of infraction of some law imposed it.

1991 PTD 669; Sui Southern Gas Company Ltd. v. Commissioner of Income Tax Companies-V, Karachi PLD 2001 SC 201 and Commissioner of Income Tax Companies-1 Karachi v. Premier Bank Limited 1999 PTD 3005 rel.

(c) Income Tax Ordinance (XXXI of 1979)---

----S. 23---Deductions---Expenditure incurred on account of or in nature of tine or penalty for delayed payment---Kinds of fine or penalty and their admissibility as business expenditure---Principles.

An expenditure incurred on account of fine or penalty or in the nature of fine or penalty is not to be allowed as deduction.

An expenditure, which although has been incurred by an assessee on account of infringement of a provision of a statute, but not in the nature of fine or penalty, can be allowed as admissible deduction, provided it is incurred wholly and exclusively for the purpose of business.

The question, whether any expenditure on account of infringement of any provision of law is for the purpose of business and is an admissible expenditure shall depend on the facts and circumstances of each case.

If any expenditure is claimed on a transaction in flagrant violation of the provisions contained in any law and the transaction, act/omission is liable to the levy of fine or penalty by way of criminal or civil sanction and the competent authority has imposed civil or criminal penalty provided in the law, then expenditure incurred on illegal transaction as well as penalty for indulging in such illegal transaction both shall be inadmissible expenditure.

If there are various provisions in any law providing for automatic enhanced/excess payment on commission of a default or delay and there is a provision for imposition of penalty/tine as well with the discretion of authorities competent under a law and the provisions for imposition of fine or penalty within the discretion of competent authorities have not been invoked and an enhanced/excess amount is charged for any default/delay, such enhanced/excess amount shall be deemed to be part and parcel of original liability and not a fine or penalty.

If the excess amount paid by an assessee in the normal course of business purposes on account of any delay or default is within the contemplation .of the parties and the excess amount paid is automatic, which requires mere calculation, it would be in the nature of compensation paid for delay or default and it shall not be deemed as penalty or fine, or in the nature of penalty/fine or akin to the penalty or fine.

If any excess amount is paid by an assessee for any delay or default in performance of an act and in excess charge is fixed and not in the discretion of any competent authority in law and no separate proceeding is required for charging the excess/enhanced amount and no separate order is required to be made and there is no requirement of framing any charge or confronting the defaulting party and seeking explanation, then the amount so charged would not be deemed to be penalty/fine.

Mere use of word penalty or fine shall not make an amount to be in the nature of penalty or fine, until and unless in substance, the amount charged is penalty or fine or in the nature of penalty or fine.

The payment of only such amount shall be treated as penalty/ fine, which is charged as a result of infraction, transgression or violation, which is imposed by an authority competent in law. An amount paid by an assessee on its own volition/discretion/option available in law for the consideration of business purposes in pursuance of commercial expediency and not with the intention of flouting the mandatory provision of law shall not be deemed to be penalty/fine and shall be deemed to be extension of liability permissible in law and/or compensation for delay/default contemplated by the parties and permissible in law.

The demurrage paid to the Port and Railway authorities, which is in excess of the original liability, likewise surcharge for delayed payment of utility bills such as electricity bill, gas bill, telephone bill, property tax, water tax, municipal taxes, motor vehicle taxes, arms licence fee, late payment fee for examination, late payment fee for renewal of various licences so on and so forth, are not in the nature of penalty or fine, as all of these payments are automatic, without initiation of any separate proceedings and without any separate order and exercise of any discretion by any competent authority on the consideration of facts and circumstances of each case.

1991 PTD 669; Sui Southern Gas Company Ltd. v. Commissioner of Income Tax Companies-V, Karachi PLD 2001 SC 201; Commissioner of Income Tax Companies-1 Karachi v. Premier Bank Limited 1999 PTD 3005; ACIT v. Rustam Jehangir Vakil Mills Ltd 1976 103 ITR 298; Mahalakshmi Sugar Mills Co. v. CIT 1980 123 ITR 429; 1972 85 ITR 320 and CIT Karnataka v. Mandya National Paper Mills Limited 1984 150 ITR 27 Karnataka High Court rel.

(d) Law---

----Connotation---Such expression would include legislative Act, subordinate legislation in nature of Rules and notifications issued under authority of legislative Act---Executive directions issued from time to time would not fall within purview of "law".

Aqeel Ahmed Abbasi for Applicant.

ORDER

MUHAMMAD MUJEEBULLAH SIDDIQUI, J.---This reference application at the instance of Commissioner (Legal Division) Large Taxpayers Unit, Karachi arises out of the following facts.

The assessee/respondent is an Unquoted Public Limited Company deriving income from manufacture and sale of Copper rods. The industrial unit of the company was granted tax holiday from October, 1989 for a period of five years, which expired in September, 1994. From examination of depreciation schedule for the taxable period it was found that respondent has claimed depreciation on the original cost of assets without deducting depreciation allowed during the tax holiday period. The Assessing Officer observed that the treatment given by the assessee was against the instructions of C.B.R. contained in Circular No.23 of 1988 and was also against the provisions of Rule 3A of the 3^rd Schedule which was inserted by Finance Act, 1992, wherein it was provided that during exempt period the normal depreciation shall be deemed to have been allowed and after expiration of the tax holiday period the WDV would be taken after deducting normal depreciation. The Assessing Officer held that while computing allowable depreciation to the assessee on the machineries purchased and used during the' tax holiday period, the normal depreciation for 18 months would be allowed on WDV computed in the manner prescribed by the C.B.R. and 3rd Schedule and the same shall be allocated equally between taxable period and tax holiday period. It is necessary to mention here that the return was filed for 18 months. First 9 months pertained to the tax holiday period and the second 9 months were in respect of taxable period.

The Assessing Officer also disallowed the claim on account of late delivery charges amounting to Rs.36,91,915. The respondent preferred appeal before CIA(A) assailing the above treatment.

In respect of disallowance of the late delivery charges, it was contended before the learned CIT(A) that the assessee had claimed tile payment of liquidated damages/delivery charges to Pioneer Cables Limited, a Public Limited Company on account of delay in supply of contracted goods. These payments were made according to the terms of contract and were not in the nature of penalty for infraction of law and therefore, the treatment given by the Assessing Officer was not sustainable. It was further explained that the amount claimed was deducted from the payments made by Pioneer Cables Limited to the assessee in terms of contract on account of delay in supply of goods. It was further explained that, the amount on account of late delivery was deducted by the Pioneer Cables Limited for the reason that they had also to pay such amount to WAPDA and KESC on account of late delivery of cables supplied to them under the terms of tender and consequently, this expense was incurred wholly and exclusively for the purpose of business and cannot be treated as payment of fine or penalty for infraction of some law.

The CIT(A) accepted the contention and held that the Assessing Officer erred in disallowing the claim of penalty for late delivery of goods which was in accordance with the terms of agreement, as this penalty was not imposed on account of any breach of law, and therefore, shall be treated as expenditure in normal course of business. The CIT(A) further observed that normally all Government contracts and tenders contain penalty clause for the late delivery/late completion of projects etc. Similarly, in the private contracts between the Companies in the normal course of business such penalty clauses are inserted to protect the rights, of parties. This is done to ensure timely and proper compliance of legally binding contracts. He therefore, directed the DCIT to allow claim and delete the addition.

Regarding the second issue pertaining to deduction of normal depreciation during tax holiday period it was contended before the learned CIT(A) that rule (3A) was inserted by Finance Act, 1992 and will not apply to the Companies whose tax holiday period commenced before the insertion of this rule. In this case the company was granted tax holiday from 1989 and therefore, it was not hit by this rule. It was further submitted that the depreciation for the earlier years period to this amendment cannot be deducted for arriving at WDV of the assets.

The learned CIA(A) did not agree with this contention and observed that plain reading of amended rule (3A) of the Third Schedule would show that it is clearly retrospective in nature with the use of word "depreciation admissible shall be deemed to have been allowed." According to learned CIA(A) sub-rule (3A) refers to the entire tax holiday period, the effect whereof is that normal depreciation should be considered to have been allowed for the entire. tax holiday period in arriving at WDV of the assets in respect of the first year of the taxable period. It was further held that depreciation referred to in rule (3A) has to be deducted in full while calculating WDV properly. Th; treatment given by DCIT was upheld.

The assessee as well as department preferred appeals before the learned ITAT. The assessee assailed the direction of the CIT(A) pertaining to the applicability of rule (3A) of the Third Schedule, contending that the written down value of the assets after the tax-holiday period should be adopted without deducting the depreciation prior to assessment year 1992-93 in which sub-rule (3A) was inserted in the Third Schedule of the Income Tax Ordinance, 1979. Reliance in this regard was placed on the earlier judgments of the Tribunal holding that sub-rule (3A) of rule 1 of the Third Schedule of the Income Tax Ordinance, 1979 was not applicable with retrospective effect and will become operative from the assessment year 1992-93. The Tribunal accepted the contention and set-aside the order of CIT(A) and directed the Assessing Officer to calculate the written down value in accordance with law.

The Department assailed the finding of CIA(A) that penalty paid on account of late supply was allowable expenditure. The ITAT upheld the view taken by the CIT(A) and repelled the objection raised on behalf of the department. Reliance in this behalf was placed on an earlier Divsion Bench judgment of the Tribunal reported as 1991 PTD 669, authored by Saiyed Saeed Ashhad, J.M. (as his lordship then was). In the cited case the amount was paid by the assessee to WAPDA on account of late delivery of certain items. The Assessing Officer and CIT(A) had taken view that it was in the nature of fine or penalty and therefore, was not a business expenditure and could not be treated as allowable deduction. It was held by the Tribunal that payment by way of late delivery charges is to be distinguished from payment of amounts by way of penalty or fine. A penalty is levied or a fine is imposed on account of violation of any provision of law, which provides for imposition of fine or levy of penalty. In other words, fine is imposed or penalty is levied in accordance with the provisions of a statute for violation of any provision contained therein. In the cited case late delivery charges were paid by the assessee to WAPDA not on account of violation of any provision of statutory law or any other law but on account of an agreement mutually arrived at between the assessee and WAPDA. Violation of any condition or provision agreed upon mutually by the assessee and WAPDA could neither be treated at par with the violation of any provision of a law nor the payment of late delivery charges by the assessee to WAPDA on account of mutual agreement could be equated with the payment by way of fine or penalty imposed or levied on an assessee for violation of any provision of law. It was further observed that the payment of such amount, was an expenditure wholly and exclusively connected and for the purpose the business of the assessee inasmuch as the non-payment thereof might have result in cancellation or coming to an end of the agreement between the assessee and WAPDA, which was in fact paid by the assessee to save its business and to avoid losses.

The Department still feeling aggrieved submitted reference application under section 136(1) of the Income Tax Ordinance, 1979, proposing the following questions for reference to the High Court.

"(a) Whether on the facts and circumstances of the case, the learned ITAT was justified/correct in accepting the' interpretation that application of sub-rule (3A) of Rule 1 of the Third Schedule to the Income Tax Ordinance, 1979 is not retrospective.

(b) Whether on the facts and circumstances of the case the learned ITAT was justified in treating penalty for late delivery charges as admissible business expenditure."

The learned Tribunal observed that the first question sought to be referred already stands decided by the High Court, and therefore, it is not advisable to refer the same question again. So far the second question is concerned, the Tribunal observed that it was decided merely on consideration of facts and therefore, need not be referred to the High Court.

The Department being still dissatisfied has submitted this reference application under section 136(2) of the Income Tax Ordinance, 2001.

We have heard Mr. Aqeel Ahmed Abbasi, learned counsel for the Department and have perused the material placed on record.

Mr. Aqeel Ahmed Abbasi has not denied that the question No.1 already stands decided by this Court against the Department. Thus, we are not inclined to entertain the question No.1, which is a decided issue.

So far the question No.2 is concerned, it is also an issue which already stands decided by the Hon'ble Supreme Court of Pakistan. However, Mr. Aqeel Ahmed Abbasi has submitted that there are two judgments of the Hon'ble Supreme Court, both arising out of the judgments of High Court of Sindh, therefore, the proposition of law may be clarified for the guidance of the departmental officers. In view of the fact that the question No.2 already stands decided by the Hon'ble Supreme Court in the case of Sui-Southern Gas Company Ltd. v. Commissioner of Income Tax, Companies-V, Karachi PLD 2001 SC 201, the question No.2 is not entertained for the purpose of giving opinion. At the request of Mr. Aqeel Ahmed Abbasi, we will merely clarify the legal position for the guidance of departmental officers.

The two judgments of the Hon'ble Supreme Court on which reliance is placed by the Revenue and assessee are:--

(1) The Commissioner of Income Tax Companies-1 Karachi v. Premier Bank Limited 1999 PTD 3005.

(2) Sui Southern Gas Company Ltd. v. Commissioner of Income Tax, Companies-V, Karachi PLD 2001 SC 201.

The relevant facts in the case of Premier Bank Limited (hereinafter referred to as the Bank) were that the Bank having failed to maintain the credit balance levels as required under section 25 of the Banking Companies Ordinance, 1962 and section 36(1) of the State Bank of Pakistan Act, 1956, incurred liabilities to pay penal interest under section 36(4) of the said Act. This amount was claimed as deduction in the relevant assessment year which was disallowed by the Income Tax Officer, for the reason that expenditure was incurred on account of violation of the said provisions of law. The order of the Income Tax Officer was reversed by the Appellate Assistant Commissioner, but on second appeal the Income Tax Appellate Tribunal restored the order of Income Tax Officer reversing the order of the Appellate Assistant Commissioner. The reference was made to the High Court to consider whether such expenditure incurred on account of infraction of statutory provisions can be claimed as admissible allowance. The High Court held that the infractions made by the Bank being connected with their normal business of banking, entitled them to earn more profits against payment of increased interest and hence such payments can be claimed as deductions. Leave was granted by the Hon'ble Supreme Court to consider the question, whether the liabilities incurred by the respondent on account of payment of penal interest can be claimed as deductions in terms of section 10(2)(xvi) of the repealed Income-tax Act, 1922.

It was contended before the Hon'ble Supreme Court on behalf of department that only such expenditure which is incurred in connection with the business of assessee can be claimed by him as an admissible deduction. An amount which was paid as penalty on account of infraction of law was not necessitated by the business of the assessee and therefore, it could not be claimed as an allowable expenditure. Reliance was placed on a D.B. judgment of the High Court of Sindh in Messrs General Tyre and Rubber Co. v. Commissioner of Income Tax, 1986 PTD 52. In this. judgment it was held that an expenditure not laid out wholly or exclusively for the business purpose was not admissible. In the said judgment it was further held that although the penalty paid was not of personal nature but was imposed on import, nevertheless the expenditure was not admissible. Similar view was taken by the Lahore High Court in Commissioner of Income Tax, Lahore Zone, Lahore v. Punjab Oil Expeller Co., Lahore 1979 PTD 437. On behalf of assessee it was contended before Hon'ble Supreme Court, that ,the expenditure was integrally connected with the business of the bank and therefore, it was an allowable deduction. Reliance in this behalf was placed on the judgment of Supreme Court in the case of CIT v. Messrs General Tyre Rubber Company, 1993 PTD 383. After examining various authorities from Pakistan and Indian jurisdiction the Hon'ble Supreme Court laid down the law as follows:--

"Therefore, the view which appears to have generally prevailed with the Courts is that, revenue expenses incurred by the assessee wholly and exclusively for the purpose of his business can legitimately be claimed by him as an allowable deduction under section 10(2)(xvi), but expenditure incurred as penalty or fine paid on account of infraction of law cannot be permitted as expenditure laid out wholly or exclusively for the purpose of the business of assessee. However, in case of expenditure which, although has been incurred by the assessee on account of infringement of provisions of statute, but is not in the nature of penalty, whether such expenditure is admissible under. section 10(2)(xvi), or not, would depend upon the circumstances of each case."

The Hon'ble Supreme Court ultimately held that whether liability is incurred in the form of penalty or in the form of penal interest, the main question, would be whether such payments were closely related to the business of the respondent. It was found that the penal interest paid was not incurred in the normal course of business of assessee and consequently, it was not admissible expenditure.

On the other hand, facts in the case of Sui Southern Gas Company Limited were that the gas company was required to pay the Federal Government, "development surcharge" in relation to gas sold by it under section 3(1) of the Natural Gas (Development Surcharge), Ordinance, 1967. It is provided in section 3(3) of the said Ordinance that interest at the rate of 12 per cent per annum shall be payable in addition to the amount due under section 3(1) if the said amount is not paid within time specified for its payment. The gas company used to purchase raw natural gas from gas supply companies and transmit and sell this gas after purifying, and processing the same under its agreement with the gas supply companies. The gas company was required to pay interest at various rates if the gas price bills were not paid within the stipulated period. The gas company paid an amount of Rs. 34.036 million as interest at 12 per cent per annum on the late payment of gas development surcharge to the Federal Government and Rs.39,916 million was paid by it as, financial charges/interest at an average rate of 14 per cent per annum on the late payment of gas price bills to five gas supply companies. The DCIT, disallowed these claims holding that they were not deductible business expenses as they were in the nature of penalties. The assessee preferred appeal before CIT(A) which was allowed for the reason that there was no infraction of law in business expenditure. The department preferred appeal before the Tribunal which was dismissed. The department then filed the income tax appeal before the High Court which was allowed and the order of Income Tax Appellate Tribunal was set aside. In this case, the Hon'ble Supreme Court framed the following points for consideration:

(1) Whether the interest paid by the petitioner under section 3(3) of the Natural Gas (Development Surcharge) Ordinance, 1967 on late payment of gas surcharge is a tax deductible business expense under Income Tax Ordinance, 1979? and

(2) Whether interest paid by the petitioner on late payment of gas price bins under its agreement with the gas companies is a tax deductible business expense under the Income Tax Ordinance, 1979.

The Hon'ble Supreme Court after considering various judgments ti''1m Indian and Pakistan jurisdiction laid down the law as follows:--

"It may be pertinent to observe that penalty is to be levied or a fine is to be imposed on account of any criminal infraction/ violation of provisions. In the instant case there was no criminal violation of any legal provision. In the instant case, interest/ compensation for delayed payment has been provided in the statute as well as in the agreement, therefore, it may be non-compliance with contractual obligation on the part of the petitioner to make additional payment as interest or compensation for late payment, but It could not be said to be violation or infraction of criminal law therefore, such payment cannot be termed as penalty or penal interest, having regard to the fact that payments were made for the purpose of carrying on business to enable the petitioner to carry on and earn profit in business and if the payment had not have been made, the petitioner could have suffered the losses. These payments and disbursements made by the petitioner were on account of commercial expediency to facilitate the carrying on of business. These were essentially expenses for the purpose of business of petitioner, as such these could not be termed to be penalty or penal interest or fine, hence the petitioner would be entitled to deduction under section 23 as expenditure laid out or expended wholly or exclusively for the purpose of business."

Explaining the ratio laid down by the Hon'ble Supreme Court in the case of Premier Bank it was held that the ratio of the judgment is that every expenditure on account of infringement of statute can not be disallowed. Only such expenditure can be disallowed, which is on account of infringement of provisions of statute, falling within the purview of fine or penalty. Ultimately the judgment of High Court was set aside and the decision of the Appellate Tribunal was restored.

A careful examination of the above two judgments of the Hon'ble Supreme Court shows that the view held by his lordship Saiyed Saeed Ashhad, (as Judicial Member of the Income Tax Appellate Tribunal) in the judgment reported as 1991 PTD (Trib.) 669, has been upheld wherein it was held that the extra payment on account of late delivery charges by way of fine or penalty is admissible expense. In all such cases the litmus-test is whether the expenditure was incurred wholly and exclusively for the purpose of business. The ratio of the judgment of Hon'ble Supreme Court is that the infraction of law entailing penalty can not be termed as expenditure wholly and exclusively for the purpose of business.

Judgment of Hon'ble Supreme Court in the case of Premier Bank Limited, is oftenly misinterpreted. The Hon'ble Supreme Court in the subsequent judgment in the case of Sui Southern Gas Company, has distinguished the ratio of judgment in Premier Bank case which point has already been discussed above. We find that the departmental officers relied on one aspect of the law laid down by the Hon'ble Supreme Court in Premier Bank Ltd., and ignored the other one which is also required to be kept in view in the appropriate cases. The Hon'ble Supreme Court made following observations in the case of Premier Bank Limited:

"However, in the case of expenditure which although has been incurred by the assessee on account of infringement of a provision of statute but is not in the nature of penalty, the question whether such expenditure is admissible under section 10(2)(xvi) or not, would depend upon the circumstances of each case."

A point which is lost sight of is that the Hon'ble Supreme Court has held in the case of Premier Bank Ltd., that any expenditure on account of infraction of law is not to be allowed. This principle is not to be applied when an extra amount is paid in pursuance of an administrative direction and not in pursuance of infraction of any statute law or rules framed thereunder. Secondly, the expression "Law" used by the Hon'ble Supreme Court is to be confined to the legislative Act, subordinate legislation in the nature of rules and the notification issued under the authority of the legislative Act. The executive directions issued from time to time do not fall within the purview of law. Thirdly, if there is no infringement, transgression, violation or infraction of law and an excess amount has been paid on account of some executive/ administrative orders or in accordance with the terms of a contract between the two private parties and the course adopted is on account of business expediency the expenditure so made must be treated as wholly and exclusively for the purpose of business. It is also to be kept in view that if infringement or violation of any law is such that any commission or omission is not warranted in law at all and the course adopted is not permissible under any provision of law, then any penalty and fine imposed by competent authority shall not be treated as an expenditure incurred wholly and exclusively for the purpose of business and shall not be an admissible expenditure, as infraction of law cannot be held to be for the business purposes. However, if the provision of any law itself envisages different courses of action and option is available to a person to adopt any one of the courses, then it would not amount to infraction or violation of law but would come within the precincts and premises of law. Adoption of any one of the courses open to a person under the law shall be deemed to a compliance of the law and not the infraction or violation thereof. It is also to be kept in view that if any extra amount is paid on account of any delayed payment, such extra payment is in the nature of compensation and not in the nature of penalty or fine. For the purpose of penalty or fine there should be a separate proceeding initiated and conducted by an authority competent in law. An extra amount paid in ordinary course and automatically without any intervening order passed by competent authority as penalty and fine shall not be treated on account of infraction of law for the simple reason that the law or administrative act itself provides for payment of extra amount. Likewise any interest/markup paid on account of delayed payment of the principal amount shall not be treated as fine or penalty. Such extra payment by whatsoever, nomenclature charged, shall not become a fine or penalty imposed by competent authority for infraction of law but actually it would be in the nature of compensation, though described differently, and may be loosely termed as penalty or fine. The reason being that mere use of a particular term or a nomenclature is not the final determining factor but the substance of the matter is to be examined.

In order to apply ratio of judgment of Hon'ble Supreme Court in Premier Bank Ltd., the facts and circumstances of each case are to be examined for ascertaining whether the extra amount paid is in the nature of fine or penalty on account of infringement of provision of law or it was for business expediency and if so, it shall be wholly and exclusively for the purpose of business and shall be treated as admissible deduction. However, if it is not for business consideration, and in fact it is in the nature of penalty or fine the expenditure is not to be allowed.

We would like to lay emphasis that if an amount paid is automatic and in contemplation of the parties then notwithstanding the describing of excess amount as fin,. or penalty or penal interest or use of any words or nomenclature shall not change the nature of transaction which is to be determined and gauged on the basis of the substance of the matter. The reason being that the penalty and fine is not within the contemplation of the parties but it is imposed by a competent authority on account of infraction of some law. It would be appropriate to consider some judgments from Indian jurisdiction also which have bearing on the issue under consideration.

"In the case of ACIT v. Rustam Jehangir Vakil Mills Limited (1976 103 ITR 298) (Gujrat High Court), the assessee was a Limited Company manufacturing cotton textile. The Textile Commissioner under the provisions of the Cotton Textile (Control order) directed the assessee to produce certain types of cloth in the quantity set out in the direction. The assessee did not manufacture that type of cloth and, therefore, under clause 21-C(i)(b) the assessee was called upon to pay different amounts from time to time. The assessee paid the amount to Textile Commissioner and claimed this amount as allowable expenditure on the ground that it was expenditure wholly and exclusively for the purpose of business. The ITO did not allow the deduction. The Appellate Assistant Commissioner allowed the claim. The Revenue took the matter in further appeal to Tribunal. The Tribunal confirmed the decision of AAC. The Revenue filed reference in Gujarat High Court. The Gujarat High Court held that under the law the assessee has option to make payment in lieu of manufacturing of minimum quantity of cloth and, therefore, the payment was not in the nature of infraction of law and the amount paid was neither penalty nor akin to penalty. Similar view was taken in the judgments reported as 1979 120 ITR 321, and 1981 123 ITR 269. It' has been held by Allahabad High Court that the, demurrage charged by Port Authority is compensation for the delay in clearance of goods in godown from the Port Authorities and is a business expenditure which is admissible. It has been further held that the commercial expediency dictated and required the assessee to take delivery of the goods from the Port Authorities after paying compensation to them for use of their dock facility beyond the free period allowed under the rules. The demurrage paid by the assessee was not fine for infraction of any law and, therefore, it was an admissible expenditure.

In the case of Mahalakshmi Sugar Mills Co. v. CIT (1980 123 ITR 429) (S.C.), the facts were that the assessee was engaged in the business of manufacture and sale of sugar. A claim of deduction was made on account of interest paid on arrears of Cess due under the U.P. Sugar Cane Cess Act, 1956. The ITO disallowed the claim but the AAC held that it was a permissible deduction and the Income Tax Appellate Tribunal affirmed the view. The reference was preferred in Dehli High Court. The Delhi High Court vide judgment reported as 1972 85 ITR 320 held that the amount was paid by way of penalty for an infringement of the Act and, therefore, the claim was not admissible. The assessee preferred appeal before the Supreme Court of India.

The Supreme Court of India observed that under section 3(2) the payment of cess is to be made on the date prescribed under the rules. Rule 4 of the UP Sugar Cane Cess Rules, 1956 provides that the cess due on the sugarcane entering into the premises during the first fortnight of each calendar year must be deposited in the Government treasury by the 22nd day of that month and the cess due for the remainder of the month must be deposited before the seventh day of the next following months. If the cess is not paid by the specified date, then by virtue of section 3(3) the arrears of cess will carry interest at the rate of 6% per annum from the specified date to the date of payment. The Supreme Court of India further observed that under subsection (5) of section 3 additional sum was recoverable by way of penalty from a person who defaults in making payment of cess. The Supreme Court of India held that the entire interest and arrears of cess under section 3(3) is in reality part and parcel of the liability to pay cess. It is an accretion to cess. It was observed as follows:

"The arrears of cess `carries'

interest; if the cess is not paid within the prescribed period, a larger sum will become payable as cess. The enlargement of the cess liability is automatic under section 3(3). No specific order is necessary in order that the obligation to pay interest should accrue.

The liability to pay interest is as certain as the liability to pay cess. As soon as the prescribed date is crossed without payment of the cess, interest begins to accrue. It is not a penalty, for which provision has been separately made by section 3(5). Nor it is a penalty within the meaning of section 4, which provides for a criminal liability and a criminal prosecution. The penalty payable under section 3(5) lies in the discretion of the collecting officer or authority. In the case of the penalty under section 4 no prosecution can be instituted unless, under section 5(1), a complaint is made by or under the authority of the Cane Commissioner or the District Magistrate. There is another consideration distinguishing the interest payable under section 3(3) from the penalty imposed under section 3(5). Section 3(6) provides that the officer or authority empowered to collect the cess may forward to the Collector a certificate under his signature specifying the amount of arrears including interest due from any person, and on receipt of such certificate the Collector is required to proceed to recover the amount specified from such person as if it were an arrear of land revenue. The words used in section 3(6) are, specifying the amount of arrears including interest, that is to say that the interest is part of the arrears of cess. In the case of a penalty imposed under section 3(5), a separate provision for recovery has been made under section 3(7) which is not the same as the manner for recovery provided by section 3(6) of. the arrears of cess. The legislature has dealt with it, as something distinct from the recovery of the arrears of cess including interest. In truth, the interest provided for under section 3(3) is in the nature of compensation paid to the Government for delay in the payment of cess. It is not by way of penalty. The provision for penalty as a civil liability has been made under section 3(5) and for penalty as a criminal offence under section 4. The Delhi High Court proceeded entirely on the basis that the interest bore the character of a penalty. It was, according to the learned Judges `penal interest". The learned Judges failed to notice section 3(5) and other provisions of the Cess Act.

In our opinion the interest paid under section 3(3) of the Cess Act cannot be described as penalty for an infringement of the law."

In the case of CIT, Karnatka v. Mandya National Paper Mills Limited (1984 150 ITR 27 Karnataka High Court), a reference was made, if the amount paid by an assessee as penalty for non-payment of sales-tax is an allowable deduction. The relevant facts were that the assessee committed default in payment of tax under the Karantaka Sales Tax Act, 1957. Consequently it had to pay penalty under section 13(2) of the said Act. The said amount was claimed as allowable deduction and the Assessing Officer disallowed the claim holding that it was not a business expenditure. It was urged before the Tribunal that the penalty collected under section 13(2) of the said Act should not be construed as penalty levied for any infraction of law, as it represented only damages paid to the Government for the belated payment of tax due. The contention was accepted and the addition was deleted. It was held by the Karnataka High Court that the amount payable by the assessee was a statutory liability and it was not for the infraction of any law. It was further held that the Act gives a discretion to the Authorities to waive or reduce the penalty. Obligation is cast on the defaulting assessee to make payment of the penalty computed in the manner provided by section 13(2). Reliance was placed on the judgment of Supreme Court of India in the case of Mahalakshmi (1980 123 ITR 429) wherein it was held that the interest paid on arrears of cess under section 3(3) of the U.P. Sugar Cane Cess Act, 1956 was accretion to the cess and not a penalty payable for infringement of any law. Ultimately it was held that the penalty paid under section 13(2) of the Karnataka Sales Tax Act, 1957 was not a penalty in the real sense of the term and it was only a compensation for delay in payment of the tax due. It was thus.held as an allowable deduction.

On careful examination of the ratio of judgment of Hon'ble Supreme Court in the case of Premier Bank Ltd. (supra) and Sui Southern Gas Company Ltd., (supra) as well as other judgments from the Indian jurisdiction the following conclusions are drawn:--

??????????? (1) An expenditure incurred on account of fine or penalty or in the nature of ????? fine or penalty is not to be allowed as deduction.

??????????? (2) An expenditure which although has been incurred by an assessee on account ?????????? of infringement of a provision of a statute but not in the nature of fine or penalty ?????? can be allowed as admissible deduction provided it is incurred wholly and ????? exclusively for the purpose of business.

??????????? (3) The question whether any expenditure on account of infringement of any ????? provision of law is for the purpose of business and is an admissible expenditure ???? shall depend on the facts and circumstances of each case.

??????????? (4) If any expenditure is claimed on a transaction in flagrant violation of the ??????? provisions contained in any law and the transaction, act/omission is liable to the ?????? levy of fine or penalty by way of criminal or civil sanction and the competent ??????????? authority has imposed civil or criminal penalty provided in the law then ? expenditure incurred on illegal transaction as well as penalty for indulging in such ?????? illegal transaction both shall be inadmissible expenditure.

??????????? (5) If there are various provisions in any law providing for automatic ???? enhanced/excess payment on commission of a default or delay and there is a ??????????? provision for imposition of penalty/ fine as well, within the discretion of ? authorities competent under a law and the provisions for imposition of fine or ???????? penalty within the discretion of competent authorities have not been invoked and ?????? an enhanced/excess amount is charged for any default/delay, such ???????? enhanced/excess amount shall be deemed to be part and parcel of the original ???? liability and not a fine or penalty.

??????????? (6) If the excess amount paid by an assessee in the normal course of business and ???????? wholly and exclusively for business purposes on account of any delay or default is within the contemplation of the parties and the excess amount paid is automatic ???????? which requires mere calculation, it would be in the nature of compensation paid for delay or default and it shall not be deemed as penalty or fine, or in the nature ? of penalty/fine or akin to the penalty or fine.

??????????? (7) If any excess amount is paid by an assessee for any delay or default in ???????? performance of an act and the excess charge is fixed and not in the discretion of ????????? any competent authority in law and no separate proceeding is required for ???? charging the excess/enhanced amount and no separate order is required to be ?? made and there is no requirement of framing any charge or confronting the ???? defaulting party and seeking explanation then the amount so charged would not be ?? deemed to be penalty/fine.

??????????? (8) Mere use of word penalty or fine shall not make an amount to be in the nature ???????? of penalty or fine until and unless in the substance the amount charged is penalty ??? or fine or in the nature of penalty or fine.

??????????? (9) The payment of only such amount shall be treated as penalty/fine which is ??? charged as a result of infraction, transgression or violation which is imposed by an ????????? authority competent in law. An amount paid by an assessee on its own ???? volition/discretion/option available in law for the consideration of business ???????? purposes in pursuance of commercial expediency and not with the intention of ???? flouting the mandatory provision of law shall not be deemed to be penalty/fine ????? and shall be deemed to be extention of liability permissible in law and/or ??????????? compensation for delay/default contemplated by the parties and permissible in ????? law.

??????????? (10) The demurrage paid to the Port and Railway Authorities which is in excess of ??????? the original liability, likewise surcharge for delayed payment of utility bills such ????????? as, electricity bill, gas bill, telephone bill, property tax, water tax, municipal taxes, ?????????? motor vehicle taxes, arms licence fee, late payment fee for examination, late ????? payment fee for renewal of various licences so on and so froth are not in the ????? nature of penalty or fine, as all of these payments are automatic without initiation ?????? of any separate proceedings and without any separate order and exercise of any ??????????? discretion by any competent authority on the consideration of facts and circumstances of each case.

??????????? (11) In the case of Mahalakshmi (Supra) the Supreme Court of India has dealt with the issue elaborately. Under section 3(3) of the Sugar Cane Cess Act, 1956 ??????????? the payment of interest at 6% was automatic for which no separate or specific ??????? order was required and the obligation to pay interest was to accrue automatically ????????? and, therefore, payment of such amount was held to be part of the original liability ??????? and not penalty or fine. The excess amount was held to be compensatory in ? nature. Under subsection (5) of section 3 of the same Act the officer or authority ?????????? empowered to collect the cess may direct for payment of additional tax and such ???? amount was held to be penalty as it was not automatic or a mere matter of ?? calculation without discretion. In the case of Premier Bank Limited the Hon'ble Supreme Court of Pakistan has held that the payment of penal interest under ?????? subsection (4) of section 36 of the State Bank Act, 1956 is in the nature of fine. A ? perusal of subsection (4) of section 36 of the State Bank Act, 1956 shows that the ??????????? penal interest was to be made by order of the bank. It was not automatic. The ? words used in subsection (4) of section 36 are, "schedule bank may be ordered by ?????? the Bank to pay to the Bank". Thus it was within the competence and discretion of ????????? the State Bank of Pakistan to order for the payment by scheduled bank. Once it is ??????? provided that a separate and specific order is to be made then it will not make any ?????????? difference if the rate of penalty interest is fixed."

S.A.K./C-17/K??????????????????????????????????????????????????????????????????????????????????? Order accordingl