MEDIWALA AND COMPANY Vs. COMMISSIONER OF INCOME TAX

JUDGEMENT

(1.) AS a result of the direction of this court on an application by the assessee under Section 256(2) of the Income-tax Act, 1961, the Tribunal has stated the case and referred to this court for its decision, the following question of law, namely :

(2.) THE relevant assessment year is 1967-68. During that period, the assessee claimed a deduction of Rs. 7,364 as a business loss incurred in the supply of goods to the Gun Carriage Factory at Jabalpur, in accordance with the terms of the contract for supply of the goods. One of the terms of the contract was that in case of default in supply of goods according to the stipulation, the buyer could arrange for supply from alternative sources and recover the expenditure so incurred by it from the assessee. Some of the goods supplied by the assessee to the G. C. F. were rejected as not found to be in accordance with the specification and the G. C. F. obtained the same from alternative sources. An amount of Rs. 7,364 was recovered by the G. C. F. from the assessee under this term of the contract. THE assessee claimed that this was a permissible deduction being a business loss suffered by it. THE Income-tax Officer disallowed this claim, taking the view that the amount represented penalty imposed on the assessee for default in supply of goods according to the contract, on account of which it was not an expenditure incidental to the carrying on of the business. THE Appellate Assistant Commissioner affirmed that view and dismissed the assessee's appeal. THE assessee's further appeal to the Tribunal has also been rejected on the same basis.

(3.) THE relevant statutory provisions are contained in Sections 28(1) and 37(1) of the Income-tax Act, 1961. THE effect of these provisions is that any expenditure incurred for the purposes of business or profession shall be allowed in computing the income chargeable under the head "Profits and gains of business or profession". THE test, therefore, is whether the expenditure has been incurred for the purpose of business. After the decision of the Supreme Court in Haji Aziz and Abdul Skakoor Bros. v. CIT [1961] 41 ITR 350, it is beyond controversy that "infraction of the law is not a normal incident of business" and, therefore, any expenditure by way of penalty for breach of law cannot be allowed as a business expenditure under Section 37(1) of the 1961 Act, corresponding to Section 10(2)(xv) of the 1922 Act. In that very case, the Supreme Court also pointed out that the expenditure in order to be allowed as a deduction must not only be made in the course of or arise out of or be concerned with or made out of the profits of the business, but it must "also be for the purpose of earning the profits of the business". In the present case, admittedly, the amount was not paid by the assessee as penalty for infraction of any law but was paid under the terms of the contract which was made by the assessee for the purpose of earning profits from the business in supply of goods. In other words, the amount paid by the assessee to the G. C. F. of which deduction is claimed as a business loss, is under a contract itself and not de hors the contract, the contract having been made for the purpose of earning profits from that business of supply of goods. THE test indicated by the Supreme Court is fully satisfied in the present case.