Madras High Court
Commissioner Of Income-Tax vs Surya Prabha Mills (P.) Ltd. on 11 October, 1979
Equivalent citations: [1980]123ITR654(MAD)
JUDGMENT Sethuraman, J.
1. The Appellate Tribunal has referred the following question at the instance of the Commissioner of Income-tax under Section 256(1) of the I.T. Act, 1961 :
"Whether, on the facts and in the circumstances of the case, the Appellate Tribunal was right in law in holding that the sum of Rs. 34,100 paid by the assessee to the Indian Cotton Mills Federation is a business expenditure and should be allowed while computing the income of the assessee ?"
2. The assessee is a limited company running a textile mill at Coimbatore. The Indian Cotton Mills Federation, of which the assessee is a member, makes allotment of foreign cotton to the member mills spinning higher yarn counts. The allotment is on the basis of the number of spindles working on higher counts. The mills have to give a guarantee at the rate of Rs. 100 per bale of the quantity of cotton which they agreed to accept. As and when quotas of foreign cotton are announced, the cotton would be distributed to individual mills in the proportion of the shares they had agreed to accept based on the spindleage of higher counts. The units which rejected the allotment falling to their share would have to forfeit their quota guarantees. They would also become ineligible to receive any foreign cotton for the succeeding year.
3. For the year under reference (1969-70), the assessee was given a quota of 715 bales of cotton. As against this, the assessee imported only 374 bales. Since it did not comply with the terms of the arrangement with the Indian Cotton Mills Federation it had to pay a sum of Rs. 34,100 to the Federation for the non-import of the remaining bales of allotted cotton under what is called the guarantee clause. The assessee claimed this amount as deduction in its assessment for the said year. But the ITO disallowed it on the ground that what was paid to the Federation was only "penalty" for infringement of its obligation. On appeal, the AAC pointed out that the assessee omitted to fulfil its part of the contractual obligation of importing allotted' number of bales only with a view to avoid greater loss and that its action was motivated by business prudence and that there was no question of infringement of any law. In these circumstances, the amount was clearly held to be admissible as a deduction. The order was taken on appeal to the Tribunal by the ITO and the Tribunal, agreeing with the AAC, confirmed his view that there was no element of penalty involved in this payment. The result was that the allowance of the amount was upheld. This order of the Tribunal is challenged in the present reference.
4. In the present case, as would be clear from the statement of facts given above, there was a kind of pooling arrangement on the part of the Indian Cotton Mills Federation to distribute the foreign cotton, or what is called global cotton, in proportion to the spindleage utilised for spinning higher counts of yarn. The distributed quota of cotton has to be imported by the respective mills. Wherever any mill was not in a position to import the allotted quota, it had to pay to the Federation a fixed sum per bale. Thus, the whole arrangement is a contractual arrangement between the assessee and the Federation. The ITO has considered the amount paid to the Federation as a "penalty". The word "penalty" does not appear to occur in any correspondence that passed between the assessee and the Federation. The word "penalty" would ordinarily involve the concept of some violation of statute or public policy. There is no question of any such violation in the present case as the whole arrangement was only contractual and was only between the cotton mills and the Federation. The amount paid in the present case can be more appropriately described as payment made to the Federation as a matter of internal arrangement and not as a penalty or even as damages for any breach. There was no damage or loss to anyone by reason of the assessee not being in a position to import the allotted quota of cotton. The finding of the AAC as well as the Tribunal is clear to the effect that if the assessee had imported further cotton bales than it actually did, it would have sustained a greater loss. Thus, the action of the assessee in paying the amount to the Federation was only motivated by business prudence and commercial expediency. The question is whether such payment could be disallowed.
5. The learned standing counsel referred to a decision of the Punjab and Haryana High Court in Cineramas v. CIT [1977] 110 ITR 762. The assessee in that case who carried on business in exhibition of films was a member of the East Punjab Motion Pictures Association. A member failing to carry out the directive of the association could be suspended from membership and would be eligible to be reinstated on payment of a specified sum as "penalty" and other charges. During the relevant accounting year, the assessee paid a sum of Rs. 4,300 by way of "penalty" to the association for being reinstated as a member and claimed it as business expenditure. The Tribunal disallowed the expenditure and on reference it was held that the amount paid was not allowable as revenue expenditure. The amount in that case was paid for the purpose of reinstatement and not for any breach of any obligation incurred during the relevant year. In dealing with such a situation, several cases have been noticed and at page 764, the learned judges observed :
" We do not think that commercial expediency is always a correct or conclusive test to determine whether expenditure is laid out wholly and exclusively for the assessee's business.........We think it is perhaps wiser to leave the words of the statute as they are than to put a gloss upon them. All that is necessary for us to say is that the expenditure must, in some way, be connected with trade, it must be an ordinary or contemplable incident of trade. There must be a discernible nexus between the expenditure and the trade. There must be something commercial about it. We are of the view that infractions of law, including breaches of obligations, are not normal incidents of business and penalties and damages paid in connection with such infractions and breaches are not expenditure 'laid out or expended wholly and exclusively for the assessee's business'."
6. In so far as it has been stated that there must be discernible nexus between the expenditure and the trade and there must be something commercial about it, no exception can be taken to it. Applying this test, the amount was clearly deductible here. But, we are, with great respect, unable to agree that commercial expediency is not always the correct or conclusive test to determine whether expenditure is laid out wholly and exclusively for the assessee's business. Excepting cases where infractions of law or public policy or statutes are involved, the assessee would be free to do his business in a manner beneficial to him and the I.T. Act cannot be a vehicle for enforcing morality or discipline as conceived by the ITO on the assessee. He could do business in his own way and in his best interest and this is what the assessee did here.
7. The well-known principle, both in India and abroad, which has been invariably applied, has been set out in Atherton v. British Insulated and Helsby Cables Limited [1925] 10 TC 155 at 191 (HL) as follows :
" .......a sum of money expended, not of necessity and with a view to a direct and immediate benefit to the trade, but voluntarily and on the grounds of commercial expediency and in order indirectly to facilitate the carrying on of the business, may yet be expended wholly and exclusively for the purposes of the trade."
8. Considered in the light of this principle, in the present case, the amount having been paid only to avoid further loss, could only be treated as an expenditure laid out wholly and exclusively for the purpose of the business. There is no element of any penalty ; there is no infraction of law or offence against public policy. In these circumstances, the amount was rightly allowed as deduction by the Tribunal. In a similar case, the same view has also been taken by us in CIT v. Vasantha Mills Ltd. (T.C. Nos. 614 of 1975 and 26 of 1976) in the judgment dated 7th August, 1979 [since ]. The question referred is, accordingly, answered in the affirmative and in favour of the assessee. The assessee will be entitled to his costs. Counsel's fee Rs. 500.