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PETITIONER:

PRAKASH COTTON MILLS PVT. LTD.

Vs.

RESPONDENT:

COMMISSIONER OF INCOME TAX (CENTRAL) BOMBAY

DATE OF JUDGMENT06/04/1993

BENCH:

VENKATACHALA N. (J)

BENCH:

VENKATACHALA N. (J)

JEEVAN REDDY, B.P. (J)

CITATION:

1993 AIR 2174 1993 SCR (2) 983

1993 SCC (3) 452 JT 1993 (2) 619

1993 SCALE (2)425

ACT:

Income Tax Act, 1961--A.Y. 1966-67--Allowance under section

37(1) of interest paid by assessee for delayed payment of

Sales Tax under Bombay Sales Tax Act and damages paid for

delayed payment of contribution under Employees State

Insurance Act, 1947

Allowance under section 37 (2) of entertainment expenditure.

HEADNOTE:

The appellant paid Rs.19635 in the accounting year for A.Y.

1966-67, on account of interest, under Bombay Sales Tax Act,

1951, for delay in payment of sales tax, and for damages for

delayed payment of contribution under Employees State

Insurance Act, 1947. The assessee-appellant in the return

of income, claimed the amount as allowance under section

37(1) of I.T. Act. The appellant, also claimed the entire

entertainment expenses, amounting to Rs.3865 as allowance

under section 37(2) of the I.T. Act The Income-tax Officer

treated the payment of Rs.19635 as penal interest and

disallowed it as allowance under section 37(1) of I.T. Act.

Out of the entertainment, expenses, amounting to Rs.3865

incurred by the Directors of the assessee company, for

entertainment at the Diners club and C.C.1, the I.T.O.

regarded Rs.1365 only as permissible deduction under section

37(2) of I.T. Act, taking the view that the remaining sum of

Rs.2500 was attributable to personal expenses of the

Directors of the assessee company and therefore

impermissible deduction under section 37(2) of the I.T. Act.

The Assessee appellant did not succeed in appeals before

the A.A.C. and in the Income Tax Tribunal. Applications

under section 256 (1) of the I.T. Act before the Tribunal

and under section 256 (2) in Bombay High Court were

rejected.

The assessee filed appeal by special leave in Supreme Court.

This Court allowed the appeal partly and,

HELD: 'Mat the authority concerned has to allow deduction

under section 37(1) of the I.T. Act, wherever the concerned

impost is purely 983

984

compensatory in nature. Wherever such impost is found to be

of a composite nature, that is partly compensatory and

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partly penal, the authorities are obligated to bifurcate the

two components of the impost and given deduction to the

component, which is compensatory in nature and refuse the

deduction for the component which is penal in nature.

Therefore, whenever any statutory impost paid by assessee by

way of damages or penalty or interest is claimed, 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. Ibis Court agreed with the view taken

in earlier decisions by this Court and by the Andhra Pradesh

High Court, which settle the law as to when any amount paid

as interest damages or penalty could be regarded as

compensatory (reparatory) as would entitle the assessee to

claim allowance under section 37 (1) of I.T. Act This Court

concluded that the question whether the impost is in essence

compensatory or is by way of penalty, has to be decided

having regard to the relevant provisions of the law under

which it is imposed, the reasons given in the order imposing

and quantifying the damages or penalty. The imposition

though called a penalty may be composite in nature

comprising penalty as well as compensation for delayed

payment. The nomenclature of the levy as interest, damages

or penalty is not conclusive.

[991-B, 990-H, 991-A]

Mahalakshmi Sugar Mills Co. v. Commissioner of Income Tax

Delhi, [1980] 123 I.T.R. 429 S.C.; Commissioner of Income

Tax v. Hyderabad Allwyn Metal Works Ltd., (1988) 172 ITR 113

(H.CA.P.) and Organo Chemical Industries v. Union of India,

A.I.R. 1979 S.C. 1803.

This Court, remitted the matter of the Tribunal concerned,

so far as it related to deduction under section 37(1) of

I.T. Act, regarding impost of interest for delayed payment

of sales tax and impost of damages for delayed contribution

under Employees State Insurance Act, as the I.T.O. and the

appellate authority had refused the allowance without any

examination of the schemes of the provisions of the Bombay

Sales Tax Act and the Provident Fund Act. [991-D]

This Court further held that the question as to what portion

of expenses, claimed, is deductible entertainment

expenditure, has to be

985

decided by the fact finding authorities, while assessing the

relevant materials placed before them. No question of law

arises, particularly when the fact finding authorities had

recorded concurrent findings on consideration of relevant

material. Hence the question was decided against the

assessee appellant [992-B]

JUDGMENT:

CIVIL APPELLATE JURISDICTION : Civil Appeal No. 1279

(NT)/1977.

From the Judgment and Order dated 17.6.1976 of the Bombay

High Court in I.T. Application No.63 of 1976.

Mrs. A.K Verma, Mrs. S.V. Pathak (For J.B. Dadachanji & Co.)

for the Appellant.

P.S. Poti Ms. A Subhashini (NP) and R. Satish for the

Respondent.

The Judgment of the Court was delivered by

VENKATACHALA, J. Two questions are raised for our decision

in this appeal. First, whether the appellant was entitled

to claim as allowance under Section 37(1) of the Income-tax

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Act, 1961 (the I.T. Act) the interest paid by it for delayed

payment of sales tax under the Bombay Sales Tax Act, 1951

(the BST Act) and the damages paid by it for delayed payment

of contribution under Employees' State Insurance Act, 1947

(the ESI Act.) Second, whether the appellant was entitled to

claim as allowance under Section 37(2) of the I.T. Act the

entire expenses incurred by it as entertainment expenses.

The appellant is a company carrying on the business in the

manufacture of textile goods. It is the assessee. In the

income-tax return of the assessee for the Assessment Year

1966-67 (the previous accounting year being from 1st July,

1964 to 30th June, 1965), the interest and, the damages of

Rs. 19,635 paid by if for delayed payment of sales tax under

the BST Act and for delayed payment of contribution under

the ESI Act, was claimed as revenue expenditure, allowable

under Section 37(1) of the I.T. Act. So also the sum of

Rs3,865 paid by it for entertainment expenses was claimed as

revenue expenditure, allowable under Section 37(2) of the

I.T. Act. The I.T.O., 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 exclusive expenditure incurred on its Directors. Appeals

preferred before

986

the A.A.C. and the Income-tax Appellate Tribunal (Tribunal)

questioning the disallowance of claims of the appellant by

the I.T.O., did not succeed. Application made by the

assessee under Section 256(1) of the I.T. 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 I.T.

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 Employees'

State Insurance contribution could be said to

have not been incurred, wholly and exclusively

for the purpose of business?

2. Whether an 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 I.T. Act?

4. Whether there was any evidence or material

before the Tribunal to hold that the

expenditure to the extent of Rs.2,500 at

Diners Club and C.C.I. was not laid wholly and

exclusively for the purposes of business of

the assessee-company'.?

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Questions 1 & 2 are covered by First Question indicated at

the outset. So also, questions 3 & 4 are covered by 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

987

its opinion under Section 256 of the I.T. Act. In the

normal course, we would have done so and left the questions

to be answered by the High Court. But, regard being given

to the fact that the questions relate to a 25 year old case

of the Assessment Year 1966-67 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

question's ourselves and answer them. Such 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:

Section 37(1) of the I.T. Act corresponds to Section

10(2)(XV) of Predecessor Indian Income-Tax Act of 1922 (the

I.T. Act of 1922), is

undisputed.

In Mahalakshmi Sugar Mills Co. v. Commissioner of Income-

tax, Delhi, (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 I.T.

Act of 1922. For deciding that question, this Court

examined the provisions of 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 on delayed payment

of cess was an allowable expenditure under Section 10(2)(XV)

of the I.T. Act of 1922.

988

In Commissioner of Income. Tax v. Hyderabad Allwyn Metal

Works Limited, (1988) 172 ITR 113, a Division Bench of the

Andhra Pradesh High Court had to decide two questions; (i)

whether the damages paid by the respondent-asseswe under

Section 14B of the Employees' Provident Funds and

Miscellaneous Provisions Act, 1952, was an allowable

deduction under Section 37(1) of I.T. Act and (ii) whether

the interest paid under the BST Act, for delayed payment of

sales tax thereunder, was an allowable deduction under

Section 37(1) of the I.T. Act. 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, on the expression 'damages' occurring in Section 14B

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of Central Act of 1952, which read thus:-

"The expression 'damages' occurring in section

14B is, in substance, a penalty imposed on the

employer for the breach of the statutory

obligation. The object of imposition of

penalty under s. 14B is not merely 'to provide

compensation for the employees'. We are

clearly of the opinion that the imposition of

damages under s.14B 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 employers 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 14B is

related to the word 'default'. The words used

in section 14B are 'default in the payment of

contribution' and, therefore, the word

,default' must be construed in the light of

para.38 of the Scheme which provides that the

payment of contribution has got to be made by

the 15th of the following month and,

therefore, the word 'default' in section 14B

must mean 'failure in performance' or 'failure

to act'. At the same time, the imposition of

damages under section 14B is to provide

reparation for the amount of loss suffered

989

by the employees."

The Division Bench, having regard to the said view of the

expression damages occurring in section 14B of Provident

Fund 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:-

"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 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 14B of the Act 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 hel

d

by the Supreme Court, the said amount

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comprises both an element of penal levy as

well as compensatory payment. It will be for

the authority under the Income-tax Act 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

be considered as mere penalty nor as mere

interest."

Then, dealing with question (ii) relating to interest paid

by the concerned respondent assessee under the BST Act which

the Tribunal had treated as an allowable deduction under

Section 37(1) of the I.T. Act, the Division Bench considered

the relevant provisions of the BST Act bearing

990

on the question and held, thus:-

'From a reading of the aforesaid provision and in the

background of the various sections 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 sub-section (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. Sub-section (5)

of Section 36, which is extracted above, indicates that

after the levy of this amount under sub-section (3),

immunity is granted from prosecution on the same facts.

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

Company (supra) and the decision of the Division Bench of

the Andhra Pradesh High Court in Hyderabad AIN" Metal Works

Ltd. (supra) 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 regarded as

compensatory (reparatory) in character as would entitle

'such assessee to claim it as an allowable expenditure under

Section 37(1) of the I.T. 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(1) of the I.T. Act, the assessing authority

is required to examine the Scheme of the provisions of the

relevant statute providing for payment of

991

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 I.T. Act, whereever such

examination reveals the concerned impost to be purely

compensatory in nature. Whereever such impost is found to

be of a composite nature, that is, partly of compensatory

nature and partly of penal nature, the authorities are

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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 I.T.O. and the Appellate authorities have refused to

allow the claims made by the assessee under Section 37(1) of

the I.T. Act, without any examination of the Scheme of the

provisions of the BST Act, to find whet her 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 I.T. Act. The same is

the position as regards the impost of damages paid by the

assessee under the Provident Fund Act 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 I.T. Act. First Question is

answered accordingly.

Second Question:

Miscellaneous expenses claimed by the assessee as deductible

expenditure allowable under Section 37(2) of the I.T. 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 I.T.O. regarded a sum of Rs.1,365 out of the

said sum of Rs.3,865 as permissible deduction under Section

37(2) of the I.T. Act, while he regarded the remaining sum

of Rs.2,500 as impermissible deduction under Section 37(2)

of the I.T. Act taking the view that the same was

attributable to personal expenses of the Directors of the

assessee-company. The A.A.C. in dealing with the said claim

for deduction in the appeal of the assessee filed before

him, held the entire expenses claimed as deductible

expenditure under Section 37(2) of the I.T. Act 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,

992

refused to interfere with the order of the I.T.O. made in

that regard. The Tribunal which considered the matter in

the appeal of the assessee before it, affirmed the view of

the A.A.C. in the matter. As to what portion of the

miscellaneous expenses claimed, is a deductible

entertainment expenses of the assessee being a matter to be

decided by the fact finding authorities while assessing the

relevant materials 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 that appeal partly and remit the

case relating to appellant-assessee's claim for deduction

under Section 37(1) of the Income-tax Act, 1961 to 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.

I.S.G.

Appeal allowed partly.

993