MR.JUSTICE AKIL KURESHI J- Both the appeals are filed by the Revenue concerning the same assessee. While taking up admission hearing of Tax Appeal No. 647 of 2017 we noticed that Tax Appeal No. 949 of 2013 involving similar issue has been admitted for consideration of following substantial question of law:
“Whether the Appellate Tribunal has substantially erred in law in deleting the disallowance of liquidated damages of Rs. 26,12,269/- by overlooking the fact that the same is contrary to the explanation given to section 37(1) of the Income Tax Act, 1961 and cannot form part of expenditure?”
2. We therefore admit Tax Appeal No. 647 of 2017 for consideration of following question of law proposed by the Revenue:
“Whether the Appellate Tribunal has erred in law and on facts in deleting the disallowance of Rs. 75,36,037/- on account of liquidated damages, without properly appreciating the facts of the case and the material brought on record?” Counsel for the assessee waived notice of admission. We have heard both the tax appeals for final disposal.
3. Issues being identical, we may record facts from Tax Appeal No. 647 of 2017. The respondent-assessee is a company registered under the Companies Act and is engaged in the business of manufacturing and trading of machinery and machinery parts and manufacturing of drink concentrates. For the assessment year 2010-11, the assessee had filed a return of income on 29.09.2010 declaring total income of Rs. 14,53,78,210/-. During the scrutiny assessment, the Assessing Officer noticed that the assessee had claimed business expenditure of Rs. 75,36,037/- by way of liquidated damages in the profit and loss account under the head 'administrative and selling expenses'. The Assessing Officer called for the details of such expenditure in response to which, the assessee stated as under:
“Point No. 17-Liquidated Damages are expenses in the nature of penalty imposed by different parties of the assessee company for delaying delivery or late completiono f terms and conditions of the orders. Thus, this expenditure for liquidated damages is very much a business expense. The assessee company only sells specialized products which are tailir made as per specifications received from the parties. The terms of the purchase order specify that any delay will be charged parties of the assessee company at percentage value of order and hence it is parts of the purchase order. The delay in delivery occurs due to delay in drawing approvals by the customer, delay in inspection and performance test of the equipments by the customer or other authorized inspector. Thus, these are normal features inherent in the business in which assessee deals.”
4. The assessee also pointed out that in earlier years, the Tribunal had granted such claim of the assessee. The Assessing Officer however, was not convinced. He was of the opinion that though the assessee had incurred the loss, the same cannot be considered as business loan and allowed under section 37 of the Act. He was also of the opinion that the assessee had suffered damages which were in the nature of penalty imposed by the various parties for delay in delivering or late completion of the contract. The Assessing Officer referred to judgement of the Income Tax Appellate Tribunal in which, the claim of the assessee therein for loss on account of charges for cancellation of the contract came to be rejected. The Tribunal observed that it is not normal incident of assessee's business to enter into contracts, then cancel contract which led to the cancellation charges. Decision of the Tribunal in case of present the assessee for the earlier years was not followed on the ground that the department had not accepted the position and had filed appeal before the High Court.
5. CIT (Appeals) allowed the assessee's appeal relying on the decision of the Tribunal in case of the assessee in earlier assessment years. The Tribunal in further appeal by the Revenue also relied on its earlier decision in case of this very assessee.
6. Appearing for the Revenue, learned counsel Ms. Bhatt submitted that the expenditure was in the nature of damages suffered by the assessee for breach of the contract. The same was thus in the nature of a penal liability. The expenditure cannot be stated to have been laid out wholly or exclusively for the purpose of business. The assessee, therefore, cannot claim benefit of section 37 of the Act. In support of her contentions, counsel relied on the decision of Division Bench of Kerela High Court in case of Commissioner of Income Tax vs. Bharath Plywood and Timber Products (P.) Ltd. reported in 233 ITR 315.
7. On the other hand, learned counsel Mr Soparkar for the assessee supported the decision of the Tribunal contending that due to various reasons, there would be delay in delivering of the goods or implementation of the contract leading to the liquidated damages paid by the assessee to the customers. This was purely a business loss rightly granted by the Tribunal under section 37 of the Act. The loss was not on account of any penal liability. Counsel relied on certain decisions to which, we would refer at a later stage.
8. Material on record would suggest that the assessee, who was in the business of manufacturing and trading of machinery, machinery parts and manufacturing of drink concentrates would sometimes fall behind the time schedule for execution of the contracts. Before the Assessing Officer, the assessee pointed out that the assessee sales specialized products which are tailor made as per the specifications given by the customers. The agreement would envisage that any delay in delivery would be charged to the assessee at a prescribed percentage of the value of the order. The assessee pointed out that such terms were part of the purchase orders. Typically delay in delivery would arise due to delay in approval of the drawings by the customer, delay in inspection and performance tests of the equipments by the customer or authorized inspector. These are normal features inherent to the business in which the assessee was engaged.
9. No contrary facts are brought on record by the Revenue. What therefore emerges from the unopposed averments of the assessee is that the assessee would provide customized product or a machinery. The purchase order would specify the date of delivery of the machinery or execution of the contract. The purchase order itself would specify that in cases of delay, the assessee would be charged at a certain percentage of the value of the order. The delay would occur due to multiple reasons such as delay in approval of the drawings, delay in inspection and performance test of the equipments by the customer or the authorized inspector or such like. It can thus be seen that in the nature of the business that the assessee was doing, such unintended delay and resultant liability of the assessee to pay damages was inbuilt feature and inherent part of the business and cannot be dissect or disassociate from the assesse's normal business activities.
10. Section 37 of the Act is the residuary provision granting deduction of an expenditure not being expenditure of the nature of capital expenditure or personal expenses of the assessee, which is laid out or expended wholly and exclusively for the purposes of business or profession and not specified in the preceding sections 30 to 36 of the Act. Explanation to section 37(1) would clarify that any expenditure incurred by an assessee for any purpose which is an offence or which is prohibited by law shall not be deemed to have been incurred for the purpose of business or profession and no deduction or allowance shall be made in respect of such expenditure.
11. As noted, the expenditure in question was purely in relation to the assessee's normal business activity and was inherent part of its business transactions. The expenditure was certainly not incurred for any purpose which is an offence or which is prohibited by law. The Tribunal therefore was perfectly justified in granting such expenditure.
12. The decision in case of Keralal High Court in case of Bharath Plywood and Timber Products (P.) Ltd. relied upon by the counsel for the Revenue concerned the deduction claimed by the assessee of a penalty paid for delay in remitting employees' State Insurance and Provident Fund contributions. The Court was of the opinion that as per the statute, delay in depositing the contribution would result into penal liability. Such are not the facts in the present case.
13. The Calcutta High Court in case of Mundial Export Import Finance (P) Ltd vs. Commissioner of Income Tax, Kolkata-IV reported in [2016] 67 taxmann.com 31 considered a case where the assessee had taken a lease on a plot of land from Calcutta Port Trust. It was found that the assessee had encroached on some portion of the land belonging to the Port Trust who asked the assessee to pay compensation due to such unauthorized occupation of land in excess of what was granted under the lease. The assessee paid such amount and claimed it as a business expenditure. The Court held that:
“10. We have already indicated that the payment was made to compensate the loss suffered by CPT due to occupation of land in excess of what was demised to the assessee. Therefore, the payment did not partake the character of penalty. The payment could not partake the character of a capital expenditure because contention of the CPT was that the prayer for lease of the land unauthorisedly occupied could not be examined before payment of the compensation. Therefore, the payment was altogether compensatory for the benefit already received by the assessee by user of the land which had or could have nothing to do with a grant of lease in future.”
14. Full Bench of Punjab and Haryana High Court in case of Jamna Auto Industries vs. Commissioner of Income Tax reported in 299 ITR 92 highlighted the difference between the penalty for infraction of law and damages for breach of contract in the context of deduction under section 37(1) of the Act. The Court held that whenever damages are to be paid by an assessee for a breach of contract, such damages are treated to be normal expenses of business. It was further held that where an assessee has to pay damages to other party to fulfill the contract entered into by him in the ordinary course of his business, the amount of damages to be paid is allowable deduction if it is in the ordinary course of business and is not opposed to public policy.
15. In the result, both the questions are answered in favour of the assessee and against the Revenue. Tax appeals are dismissed.