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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