SMT. DIVA SINGH, JUDICIAL MEMBER -This is an appeal filed by the assessee against the order dt. 17.12.2010 of CIT(A)-Ghaziabad pertaining to A.Y. 2005-06 on the following grounds.
“1. That the order of ld.CIT(A) is bad in law as well as is against the facts and circumstances of the case, so far as it relates to confirmation of additions of Rs. 1,48,234/- on account of compounding fee paid to GDA.
2. That the ld.CIT(A), erred in not appreciating the fact that the payment of compounding fee was not penal in nature and incurred for business purposes only and also failed to notice the cases relied upon.
It is, therefore prayed that the addition of Rs. 1,48,234/- as upheld by the ld.CIT(A) may kindly be deleted.”
2. The relevant facts of the case are that the assessee is a builder engaged in the construction and sale of flats who returned nil income by way of return dt. 20.3.2006 which after issuance of notice u/s 143(2). resulted in a scrutiny assessment u/s 143(3)wherein the A.O. required the assessee to explain why a sum of Rs. 14,8,234/- which has been debited on account of compounding of plot no.42A on 15.10.2004 as per the account of purchase of plots should not be disallowed as per explanation to S.37(1) of the Income Tax Act, 1961.
2.1 In response to the same the assessee claimed that the compounding fees had been paid merely to regularize the extra construction as per the norms of the authority and permissible under the bye laws of the authority as per which subject to certain conditions extra constructions can be regularized. It was stated that compounding is not in the nature of penalty and as such not disallowable.
2.1.1 It was further contended that compounding fee is a necessary business expenditure in the case of the assessee since the business of the assessee is construction of flats and without regularizing the construction of the flats the same will not be sold.
2.1.2 It was also contended that the sum is compensatory in nature as has been considered in the case of CIT vs. Reliable Water Supply Service of India P.Ltd. (1980) 124 ITR 9 (All.) wherein amount paid to government as penalty and damages for delay in execution of contracts had been allowed. Reliance was also placed on CIT vs. Mandya National Paper Mills Ltd. (1984) 150 ITR 26 (Kar) wherein it had been held in the case of penalty for non payment of sales tax that it is not a penalty in the real sense but only a compensation for delay in payment of the tax due.
2.2. The A.O. added the amount of Rs. 1,48,234/- by way of disallowance rejecting the explanation of the assessee holding as under:-
“The explanation of the assessee is, however, not acceptable in view of explanation to S.37(1) of the IT Act, 1961 inserted with r.e.f. 1.4.1962 by the Finance (No.2) Act, 1998. For the sake of convenience, the same is narrated as under:
“For the removal of doubts, it is hereby declared 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.”
Further, the Hon’ble Karnataka High Court has also held that such expenditure would be hit by the explanation to S.37(1), as held in the case of CIT vs. Mamta Enterprises (2004) 266 ITR 356 (Kar.). In this case ‘the assessee was a builder, and he ;built the 8th floor in an ;apartment without there being any sanctioned plan, in contravention of the provisions of the Municipal Corporation Act. This Act provided for composition of offences, and the assessee paid the compounding fee. The A.O. disallowed the assessee’s claim for deduction of the compounding fee. On appeal, the Karnataka High Court made it clear that the claim for deduction must be considered only under the income tax provisions and not under the provisions of the Municipal Corporation Act, and rejected the contention of the assessee that since the Municipal Corporation Act permitted compounding of the offence, once the violation was compounded, there was no offence committed under the eye of law. The High Court held that compounding of the offence cannot take away the rigor of the aforesaid Explanation to section 37(1) in view of the expression ‘shall not be deemed to have been incurred’ used in that Explanation, and that the assessee’s claim was to be rejected.
In view of the above, a disallowance of Rs. 1,48,234/- is accordingly being made and added back to the income of the firm.’ (Disallowance of Rs. 1,48,234/-).
3. In appeal before the First Appellate authority it was re-agitated that the payment of Rs. 1,48,234/- was made to DDA towards the sanctioning of plan with deviations from the original plan as per norms of the GDA. It was urged that the nature of the payment was not penal and the expenditure incurred was not for any offence nor was it prohibited by law. The same was paid due to normal deviations. The argument put forth with was that the authority itself allows and sanctions the plan of extra construction after receipt of such fees. The payment it was stated was as per the trade practice and is very much for the purpose of business itself. It was further contended on behalf of the assessee that the factum of payment is not in doubt; it is made as per bye-laws of the government authority; payment is merely to allow deviations from the originally sanctioned plan to regularize the extra construction which is not described as an offence under the by-laws of the authority or under any other law; new plan with compounding is duly sanctioned by authority; fees is charged by the authority for allowing normal plan and in case of deviation it charges fee at a higher rate; as such the payment described as a compounding fee is a regular payment; it was a facility to sanction deviations which practically arise. The authority it was urged, does not have the power to allow and charge extra payment for any construction if the construction is against the bye-laws as in such an eventuality it has to be demolished and penalized and the amount recovered are always in the nature of penalty, such construction, on which compounding fee has been paid is duly sold, registered by Registrar and can be transferred subsequently in the normal course and in the instant case there is no dispute over the fact that sale deed of flats on which such compounding fee is paid are duly executed before the Registrar as after compounding there is no distinction of construction with normal fee or with extra fee i.e. compounding fee; government authorities duly issue free hold certificate against such flats, amount incurred is an essential business expenditure beside not penal in nature. The decisions relied upon before the A.O. were relied upon before the CIT(A). The facts of Karnataka High Court relied upon by the A.O. were stated to be distinguishable as in that case it was stated compounding fee paid was on account of extra floor being added where as in the facts of the assessee’s case no floors have been added the deviation is only on the existing floors. Reliance placed upon Explanation added to S.37(1) of the Finance Act with retrospective effect from 1.4.1961 by the Hon’ble Karnataka High Court as being the reason for not agreeing with the other judgements on the issue was stated to be misplaced. It was stated that the said judgement was not applicable as it has been explained in the Explanatory Notes on the amendment moved vide circular no.772 dt. 23.12.1998 para 20 that the amendment has been resorted so as to disallow expenditure which was in the nature of protection money, extortion, hafta, bribes etc. It was argued that accordingly the amendment has not changed the settled legal position as far as the compounding fee is concerned as it is not an offence in the nature of protection money, Hafta, bribe etc. Reliance was placed upon CIT vs. Chemical Constructions (2000) 243 ITR 858 (MP); Lachman Dass Mathura Dass vs CIT (2002) 254 ITR 799 (SC); CIT vs Hero Cycles Ltd. (2009) 178 Taxman 484 (P&H).
3.1. Not convinced with the explanation offered the action of the AO was confirmed by the learned CIT(A) holding as under:-
“6. After having carefully considered all relevant facts and circumstances of the case, my conclusions/observations are as under:
(1) Regarding compounding fee:
The A.O. has correctly relied upon the case law of Mamta Enterprises, which is a case after introduction of explanation to Section 37(1) and which clearly lays down that violation to building laws, may be compounded under Municipal Corporation Act, but penalty levied for such violation would fall under rigours of explanation to Section 37(1).
The appellant has failed to explain as to how appellant’s facts are distinguishable from facts of Mamta Enterprises. The case relied upon by appellant are based on different set of facts.
Thus, addition of Rs. 1,84,234/- is upheld. Most importantly, the compounding order has not been brought on record, so as to establish that violation was merely in respect of slight deviations for original plan. This was onus of assessee!!
On facts on record; this is apparent that compounding charges were in respect of Penal Officer of nature of violation of statues and, hence, same was correctly disallowed by AO.”
4. Aggrieved by this the assessee is in appeal before the Tribunal. Ld.A.R. reiterated the submissions made before the authorities below judgements relied upon before the A.O. and the CIT(A) were reiterated at length. Attention was invited to Circular no.773, copy of which is placed in the paper book filed wherein photocopy of the case law relied upon by the assessee has also been filed. Reliance was also placed upon Sampath Aiyangars Law of Income Tax, 11th Edition, page 4165 so as to contend that the compounding fee is not an offence.
4.1. The Ld.D.R. heavily relied upon the impugned order and the judgement of the Kernataka High Court relied upon by the A.O. and the CIT(A) contended that the addition by way of a disallowance needs to be confirmed and the assessee’s appeal be dismissed in the face of the clear mandate of law and interpretation of the Hon’ble High Court.
5. We have heard the rival contentions and perused the material available on record. On a careful consideration of the same it is seen that the short issue in the present proceedings is whether the compounding fee paid to DGA of Rs. 1,48,234/- is to be allowed as a deduction from business income or not. The issue has to be decided in the light of the Explanation appended to S.37(1) of the Income Tax Act, 1961. The said explanation was inserted by the Finance (No.2) Act, 1998 with retrospective effect from 1.4.1962. The same is reproduced hereunder for ready reference:
“37(1): Any expenditure (not being expenditure of the nature described in sections 30 to 36) and not being in the nature of capital expenditure or personal expenses of the assessee, laid out or expended wholly and exclusively for the purposes of the business or profession shall be allowed in computing the income chargeable under the head ‘Profits and gains of business or profession’.”
Explanation: For the removal of doubts, it is hereby declared 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 the light of the above provision we are called upon to decide whether the CIT(A) was correct in holding that the payment of compounding fee amounts to an infraction of law or not. The A.O. has placed reliance on the judgment of the Karnataka High Court in the case of CIT vs. Mamta Enterprises (Kar) 266 ITR 356 (Kar.), wherein the Hon’ble High Court has held that compounding of the offence cannot take away the rigors of the Explanation to S.37(1) in view of the expression ‘shall not be deemed to have been incurred’ used in that Explanation. The reliance placed upon the various judgements in assessee’s favour by the assessee were held to be not relevant in view of the clear mandate of law. The CIT(A) it is seen has confirmed the action of the A.O. as the assessee could not explain before him how the facts of CIT vs. Mamta Enterprises 266 ITR 356 (Kar.) relied upon by the A.O. were distinguishable. It was also observed by him that the assessee had not discharged its onus by leading any evidence or material on record so much so even the compounding order was not placed on record in support of the claim that there were very slight deviations which did not amount to an offence.
5.1 In the paper book filed before us which as per record was received by post on 15.11.2011, the assessee has filed an extract of undated copy of written submissions filed before the CIT(A) contained at paper book page no. 1 to 5. Along with that copy of letter of DGA appearing map for 3 units is also filed and receipt of compounding fee dated 16.10.2004 'at pages 6 and 7 are enclosed therein along with copy of letter of GDA about compounding (Shaman) with copy of Rule V of the compounding rules shaman placed at pages 8 to 13 have been attached therein and it is certified that no additional evidence is being filed before the Tribunal. The finding arrived at in the impugned order that nothing was brought on record so as to establish that violation was merely in respect of slight deviations from original plan has not been assailed by the assessee as per the procedure mandated by law. In order to decide the issue the Specific Scheme of the Act which empowered the GDA to collect compounding fee necessarily has to be seen. This aim has neither been seen by the CIT(A) and nor has it been placed before us. As such, the issue has to be restored back to the file of the CIT(A).
5.2 While restoring the issue we are of the view that the Ld.CIT(A) shall necessarily have to take into consideration the relevant provisions of the Act, the rules regulations and building bye-laws which created the Ghaziabad Development Authority. A perusal and consideration of the relevant provisions will throw light on the aspect as to considering which provision on what facts the authority empowered to receive payments of compounding fee has received it. The necessity of such an exercise is borne out from a careful reading of the judgments on the issue including the judgement of the Hon’ble Karnataka High Court relied upon by the AO. A perusal of the same would show that the conclusion has been arrived at in the case of CIT vs. Mamta Enterprises, 266 ITR 356 (Kar) after taking into consideration the legal position in the context of the provisions of Karnataka Municipal Corporation Act, 1976 and the building regulations and bye laws thereunder. A perusal of the said judgement shows that their Lordships considering the language employed in Clause (b) of S.483 of the Karnataka Corporation Act which empowered the Commissioner to compound any offence committed in breach of the provisions of the Act, Rules, bye laws or materials which may by rules made by the Government be declared compoundable the Dy. Director of Town Planning who was the delegated authority of the Commission on the request made by the assessee by means of his order dt. 30th September, 1982 permitted the assessee to compound the offence of payment of compounding fee. The said order extracted in the judgement of the Karnataka High Court reads as under.
“In your letters cited above, you requested for compounding of the offences of unauthorized construction of eighth floor in two blocks in the above premises. The administrator in his proceedings under subject No.342 dated September 29,1982, as approved the proposal to compound the offence by levying a compounding fine of Rs. 89,960/- (rupees eighty nine thousand nine hundred sixty only).
Please remit the above mentioned compound fine by means of challan for issuing the orders on the compounding of the offence.”
5.3 Considering the language employed in Clause(b) of S.483 which empowered the Commission to “compound the fees” under these circumstances their Lordships held that there cannot be any doubt that offence has been committed by the assessee what has been done is to permit the assessee to compound the offence committed by the assessee by putting up unauthorized construction of 8th floor in the building in question of payment of compounding fee of Rs. 89,960/-. Their Lordships thus held that when the Explanation to S.37 of the Act defines that the expenditure incurred for any purpose which is an offence or which is prohibited by law is not entitled for deduction it is not possible to take the view that the compounding of the offence or violation of the provisions of the Act for the purpose of saving the offender of the law from the consequences of the commission of such an offence or violation of law should also be given the benefit of S.37 of the Act by permitting the assessee to pay the compounding fee as fine. Their Lordships held that the compounding of the offence under the Act could not take away the rigours of the explanation to S.37 of the Act. The claim of deduction according to their Lordships made by the assessee has to be considered in the light of the Explanation given to S.37 of the Act and not with reference to the provisions in the Corporation or the Municipal Law which permits the violator of the provision of the Corporation or the Municipal law to compound the offence either to save the unauthorized or illegal construction put up or to relieve such violation of law from the consequences provided in the corporation or municipal law.
5.4 Their Lordships considering the observations made by Hon’ble Delhi High Court in the case of Loknath (1984) 147 ITR 624 (Delhi) which had been relied upon by ld.A.R. before them as has been relied before us also concluded that the observations made by the Delhi High Court cannot be of any assistance to the assessee as the decision was rendered prior to the Amendment to S.37 of the Act by incorporating the explanation by means of Finance (No.2) of the Act, 1998 made with retrospective effect from 1.4.1962. When the said Section is clear and unambiguous accordingly it was held that it was not permissible for the Courts to stretch the meaning attached to the provision of law to extend the benefit to a person who violates the law or the regulations/rules made by Corporation or Municipal authorities with impunity. Accordingly they held that the expenditure cannot be treated as a loss in the business to get the benefit. It was further held that the penalty paid has ensured to the benefit of the assessee to save the additional construction put up in violation of the provisions of the Act and the bye laws framed thereunder and also the consequences of the penal provision provided under the Corporation or the Municipal law.
5.5 In view of the above categoric discussion on the position of law the relevance and importance of considering the provisions of the Specific Statute which defines the offence propose compounding etc. cannot be over emphasized. The said exercise evidently has not been undertaken. As such, the issue has to be restored for doing the needful back to the CIT(A). While doing so we consider it necessary to address various other issues which have been addressed by the assessee, namely since the payment as per Circular No.772 by virtue of Explanatory Note to the Amendment of section 37 is neither Hafta, protection money nor bribe as such the expenditure is allowable as it is a necessary business expenditure for business purposes as only then a sale after registration can be made and profits posted is not a valid argument as the Explanation specifically prohibits the allowance of expenditure incurred for an offence or which is prohibited by law as such the prohibition is not limited to Hafta, protection money or bribe only and to so hold would be stating a grossly incorrect position of law.
5.6 Similarly the argument of business necessity and resultant consequences of regularizing the construction after payment of fees have no relevance. To the extent the assessee is able to prove on the basis of the wording of the specific statute which created and empowered GDA that the amount so paid is compensatory in nature, the assessee may have a case. In this context attention may be invited to the judgement of the Madras High Court in CIT vs. Chemical Construction 243 ITR 858 (Mad.) wherein their Lordships held that the fact that a levy is termed as a penalty in a statute is not by itself decisive of its true character, as observed by the Supreme Court in Malwa Vanaspati and Chemical Co. v. CIT [1997] 225 ITR 383. "The use of the word 'penalty' in the provision is neither here nor there". It is only when a levy does not have any compensatory character that it has to be regarded as penalty.
5.6.1 In the facts of that case the assessee was a Private Limited Company engaged in the business of constructing buildings. It was held therein that where an assessee used raw material purchased at the lower rate of sales tax specified in section 8(1) of the Madhya Pradeseh General Sales Tax Act, 1958 for a purpose other than that specified in that section, he has to pay an amount to be determined as stated in subsection (2) of that section. That amount cannot be less than the difference between the tax on sale of such raw material at the full rate and the amount at the lower rate by reason of sub-section (1). The amount to be paid by the assessee under section 8(2) comprises both the elements of compensation and penalty; compensation in so far as payment of tax at the full rate is obligatory; and something more up to 25 per cent. thereof as is determined by the Commissioner; to the latter extent the amount would partake of the character of penalty. The amount payable under section 8(2) is allowable as business expenditure under section 37(1) of the Income-tax Act, 1961, to the extent that it is compensatory in nature.
5.6.2 Their Lordships, therein after considering the relevant provisions held that the assessee should he have used the raw material for a purpose other than that specified in sub-section (1), must pay an amount to be determined as stated in sub-section (2). That amount cannot be less than the difference between the amount of tax on the sale of such raw material at the full rate and the amount at the lesser rate by reason of sub-section (1). That amount also cannot be more than one and one quarter times the amount of the tax at the full rate. Whether it should be the aforesaid minimum amount or the aforesaid maximum amount or something in between is for the Commissioner to determine, having regard to the circumstances in which such use was made. As such on a perusal of the specific provision it was held that sub-section (2) comprises both the elements of compensation and penalty. Compensation in so far as payment of tax at the full rate is obligatory, and something more, upto 25 per cent. thereof, is payable should the Commissioner so deem fit, having regard to the circumstances in which the use of raw material was made to that extent the amount would partake of the character of a penalty.
5.6.3 Considering the facts of the case Their Lordships observed that it did not appear from the record that bifurcation had been done at any stage, of the amounts paid under the provisions of section 8(2) between the element of compensation and penalty, which necessarily was required to be done as the assessee would be entitled to the deduction under section 37(1) only in so far as the payments under section 8(2) partake of the element of compensation.
5.6.4 In these circumstances it was held that the question referred to the High Court must be answered thus: the amounts payable under the provisions of section 17(3) of the Madhya Pradesh General Sales Tax Act are not allowable expenditure in the computation of total income. The amounts payable under the provisions of section 8(2) thereof are allowable expenditure in the computation of total income only in so far as they are compensatory in character. It is only when a levy does not have any compensatory character that it has to be regard as penalty.
5.7 However, the minute the payment is tainted with illegality then as being against public policy itself even if the specific statute permits the payment to regularize the sale, the payment being tainted with illegality is not allowable as a deduction by virtue of Explanation attached to sec. 37(1) of the Income-tax Act. A perusal of the settled legal position which we shall subsequently address brings out the above principle.
5.8 Accordingly the arguments on behalf of the assessee dehors the facts and without considering the relevant provisions that the judgement of the Hon’ble Karnataka High Court in the case of Mamta Enterprises is not relevant as therein the Hon’ble High Court was seized of a major violation as there was a construction of an extra floor is of no relevance. The emphasis that the deciding factor therein which differentiated from the facts of the present case was that the act of putting up 8th floor in the apartment would not be a correct approach. No doubt therein extra floor was constructed without there being a sanctioned plan, the deciding factor/crucial factor was that such an act was defined as an offence within the meaning of section 436 of the Karnataka Municipal Corporation Act. The assessee was held to have put up the construction in violation of the building bye laws as such he was held to have committed infraction of law u/s 436 of the Karnataka Municipal Corporation Act wherein the language employed in clause (b) of section 483 of the Corporation Act empowered the Commissioner to compound the offence. Under these circumstances even though the statute permitted the assessee to compound the offence committed by it, their Lordships were of the view that Explanation to section 37 defines that the expenditure incurred for any purpose which is an offence or which is prohibited by law is not entitled to deduction. On these facts considering the specific provision it was considered that it is not possible to take a view that the provisions under the Karnataka Municipal Corporation Act allowing the compounding of an offence for the purposes of saving the offender of the law from the consequences of the commission of such an offence or violation of law should also be given the benefit of section 37(1) by permitting the assessee to pay the compounding fee as the fine. For the said reason it was held that the compounding of the offence under the Karnataka Municipal Corporation Act cannot take away the rigour of Explanation to sec. 37(1). Accordingly, their Lordships held that the claim for deduction made by the assessee had to be considered in the light of the Explanation given to sec. 37 and not with reference to the provision of the Corporation or the Municipal Law which permits the violator of the provisions of the corporation or the Municipal law to compound the offence either to save the unauthorized or illegal construction put up or to relieve such violator of law from the consequences provided in such municipal or corporation law.
5.9 For the said purpose the wording of the relevant provision of the specific statute empowering the GDA to collect compounding fee qua the nature and extent of violation committed by the assessee necessarily need to be taken into consideration.
5.10 Another argument which has been advanced before the CIT(A) as well as reiterated before us is that it is an expense in normal trade activity in the case of a person engaged in building and construction as violations invariably occur may not have any relevance. 5.11 This principle was made clear by the judgment of the Apex Court rendered by three Judges in the case of Haji Aziz & Abdul Shakoor Brothers (1961) 41 ITR 350 (SC) relied upon by the Hon’ble Karnataka High Court in Mamta Enterprises.
5.11.1 Their Lordships of the Supreme Court held therein that infraction of law is not a normal incident of business thus, proceedings launched against an assessee for an infraction of law cannot be called a commercial loss.
5.11.2 A perusal of the said judgment would show that their Lordships on facts were called upon to decide the allowability of an expenditure in the context of S.10(2)(xv) of the Income Tax Act, 1922 which read as under:-
Section 10(2)(xv) : "any expenditure (not being in the nature of capital expenditure of personal expenses of the assessee) laid out or expended wholly and exclusively for the purpose of such business, profession or vocation."
5.11.3 The said provision which corresponds to S.37(1) of the Act wherein evidently the benefit of explanation to S.37(1) was not available to the Revenue or in contrast the hurdle posed by the said Explanation to the claim of the assessee was not in existence. Their Lordships by the said judgement rendered by three judges held that the amount of fine could not be said to have been paid for salvaging goods but was paid as a penalty in consequence of an illegal act on the part of the assessee and therefore was not an allowable item u/s 10 to 15.
5.11.4 The relevant facts of the case were that the assessee firm was doing the business of importing dates from abroad and selling them in India. During the relevant Accounting Year the assessee imported dates from Iraq. At the relevant time the import of dates by steamers was prohibited by two notifications dt. 12.12.1946 and 4.6.1947 but they were permitted to be brought by country craft. Goods which had been ordered by the assessee were received partly by steamers and partly by country craft. Consignments which were imported by steamers were confiscated by Customs Authorities. However the assessee was given an option to pay fine and get released the confiscated goods. The assessee paid fine and got released the goods. In its return the assessee claimed the amount of fine as a deduction on the ground that same came under the ordinary principles of commercial accounting. The argument put forth on behalf of the assessee that it had specifically instructed the shippers to send the goods by country craft relying upon certain correspondence was held to be not of any help in the income tax proceedings for the assessee. The arguments that the order of confiscation as a consequence of which the amount was paid to get the goods released was an order in rem against the stock in trade of the assessee firm as such there was no infraction by the appellant firm or on the person of the partners was also not accepted. On a perusal of S.167 items of sea Customs Act the said argument was found to be not correct.
5.11.5 It was observed that option is given in cases governed by this section under section 183 which provided that "Whenever confiscation is authorised by this Act, the officer adjudging it shall give the owner of the goods an option to pay in lieu of confiscation such fine as the officer thinks fit."
5.11.6 Enforcement of the payment of penalty it was observed was provided in section 193, the second clause of which was considered relevant to the case and the same read as under:- "When an officer of Customs who has adjudged a penalty or increased rate of duty against any person under this Act is unable to realize the unpaid amount thereof from such goods, such officer may notify in writing to any Magistrate within the local limits of whose jurisdiction such person or any goods belonging to him may be the name and residence of the said person and the amount of penalty or increased rate of duty unrecovered and such Magistrate shall thereupon proceed to enforce payment of the said amount in like manner as if such penalty or increased rate had been a fine inflicted by himself."
5.11.7 Their Lordships considering these sections of the Sea Customs Act concluded that these sections show the punishments provided for the breach of the prohibitions in regard to importation or exportation of goods under sections 18 and 19 ; the power of the customs authorities to give an option to pay in lieu of confiscation and how the penalties are to be imposed. Therefore, when the appellants incurred the liability they did so as a penalty for an infraction of the law; but it cannot he said that the money which they had to pay was not paid as a penalty and in fact under section 167(8) it was a penalty. Relying upon various English decisions and some High Court Judgments incorporating the principle of “against the public policy”, the claim of the assessee was rejected.
5.12 We may at the juncture refer to certain land mark judgments which need a mention. The words " for the purpose of such business " have been construed in Inland Revenue Commissioners v. Anglo Brewing Co. Ltd. (1925) 12 Tax Laws 803, 813 to mean " for the purpose of keeping the trade going and of making it pay ". The essential condition of allowance is that the expenditure should have been laid out or expended wholly and exclusively for the purpose of such business.
5.13 Similarly a mention has necessarily to be made of the decision in Commissioners of Inland Revenue v. Warnes & Co. (1919) 2 KB 444 therein the assessees who carried on the business of oil exporters were sued for a penalty on an information exhibited by the Attorney General under the Sea Customs Consolidation Act for breach of orders and proclamations. The matter was settled by consent on the assessee agreeing to pay a mitigated penalty of 2,000 pounds. All imputations on the moral culpability of the assessees were withdrawn. The provisions of the Act under which this information was lodged and penalty paid were similar to the provisions of the Indian Sea Customs Act. This amount was held not to be a proper deduction because in order to be within the provision similar to section 10(2)(xv) of the Indian Act of 1922 the loss had to be something within commercial contemplation and in the nature of a commercial loss for a situation to be covered by commercial loss reliance was placed on the observation of Lord Loreburn, L. C., in Strong & Co. v. Woodifield (1906) which had been relied upon by Rowlatt J which held :
"but it seems to me that a penal liability of this kind cannot be regarded as a loss connected with or arising out of a trade. I think that a loss connected with or arising out of a trade must, at any rate, amount to something in the nature of a loss which is contemplable and in the nature of a commercial loss. I do not intend that to be an exhaustive definition, but I do not think it is possible to say that when a fine which is what the penalty in the present case amounted to has been inflicted upon a trading body, it can be said that that is a loss connected with or arising out of' the trade within the meaning of this rule."
5.14 The sum and substance of these judgements would show that a deduction could be allowed only of that amount which was within commercial contemplation and not in the nature of a commercial loss.
5.15 The principle of law as culled out in the above observation was approved subsequently in Commissioners of Inland Revenue v. Alexander von Glehn & Co. Ltd. (1920) 2 KB 553 where also in similar circumstances by consent of the assessee penalty of 3,000 poundsid and the penalty plus the costs were claimed as deduction in arriving at the profits. The Special Commissioners had found that the penalty and costs were incurred by the assessee in the course of carrying on their trade and so incidental thereto and were admissible deductions. Rowlatt, J., on a reference held it to be a non deductible item. This judgment was affirmed on appeal by the Court of Appeal. Lord Sterndale, M. R., was of the opinion that it was immaterial whether technically the proceedings were criminal or not. The money that was paid was paid as a penalty and it did not matter if in the information it was called a forfeiture.
5.16 The argument that there was no moral obliquity was attributed to them and that it did not matter whether the expenditure was incurred in consequence to an infraction of law or whether it was a penalty for doing an illegal was held to be not relevant. In the words of Lord Sterndale in the said judgement at page 65 the following observation was made:-
" Now what is the position here ? This business could perfectly well be carried on without any infraction of the law. This penalty was imposed because of an infraction of the law, and that does not seem to me to be, any more than the expense which had to be paid in Strong & Co. v. Woodifield appeared to Lord Davey to be, a disbursement or expense which was laid out or expended for the purpose of such trade. 5.17 In the very same judgement, Warrington Lord Justice at page 569 held as under:-
"It is a sum which the persons, conducting the trade have had to pay because in conducting it they have so acted as to render themselves liable to this penalty. It is not a commercial loss, and I think when the Act speaks of a loss connected with or arising out of such trade it means a commercial loss connected with or arising out of the trade."
5.18 Reference may also be made to the judgement in Spofforth and Prince vs Golder (1945) 26 Tax Cas 310 wherein the assessee was a firm of chartered accountants, who claimed a deduction for certain legal costs paid in connection with a successful defence of one of the partners in a Police Court. The assessee firm also sought legal advice in regard to matters connected with some proceedings. Summons were issued against the assessee firm but were eventually dismissed. The assessee contended that the whole of the costs incurred in connection with the proceedings were " wholly and exclusively " laid out or expended for the appellant's profession and were, therefore, allowable deductions. The Special Commissioner had held the issue against the assessee which was upheld by the court. The test laid down by Lord Davey in Strong & Co. v. Woodifield (1906) AC 498 was applied and applying that test it was held that except the expenses for obtaining legal advice the other expenses were not admissible.
5.19 We may also refer to the English Law by Lord Sterndale in the case of Alexander Von Glehn and Co.Ltd. (1920) 12 TC 232 (CA), it was laid down that it was not enough that the disbursal was made in the course of trade it must be for the purpose of the trade and the purpose must be lawful purpose.
Moreover, it will be against public policy to allow the benefit of deduction under one statute, of any expenditure incurred in violation of the provisions of another statute or any penalty imposed under another statute. In the instant case, if the deductions claimed are allowed, the penal provisions of the FERA will become meaningless. It has also to be borne in mind that evasion of law cannot be a trade pursuit. The expenditure in this case cannot, in any way, be allowed as wholly and exclusively laid out for the purpose of the assessee’s business.
5.20 In the Indian context reference may be made to Mask & Co. vs CIT (1943) 11 ITR 454, the assessee in breach of his contract sold crackers at a lower rate and a decree was passed against him for damages for breach of contract which he claimed as an allowable deduction. It was held that as the assessee had disregarded the undertaking given and his conduct was palpably dishonest it did not constitute an allowable expenditure. Sir Lionel Leach, C.J. after ;referring to Warnes case and von Glehn’s case held that the amount did not constitute an expenditure falling within section 10(2)(xii).
5.21 The Madras High Court in Snethikumara Nadrar & Sons vs CIT (1957) 33 ITR 138 held that payments of penalty for an infraction of law fell outside the scope of permissible deductions u/s 10(2)(xv). In that case the assessee had to pay liquidated damages which was akin to penalty incurred for an act opposed to public policy, a policy underlying the Coffee Market Expansion Act, 1942, and which was left to the Coffee Board to enforce.
5.22 Reference may also be made to the judgement of Apex Court in the case of CIT vs. Hirjee (1953) 23 ITR 427 (S.C.) which was rendered by four Judges.
5.22.1 The facts of that case would show that the assessee was prosecuted under the Hoarding and Profiteering Ordinance and was finally acquitted. The expenses spent on defending himself were claimed u/s10(2)(xv) in his assessment. It was held that the distinction between the legal expenses on a successful and unsuccessful defense was not sound and that the deductibility of such expenses under section 10(2)(xv) must depend on the nature and purpose of the legal proceedings in relation to the business whose profits are in computation and are unaffected by the final outcome of the proceedings.
5.22.2 In the facts of that case the assessee was carrying on the business as selling agent of a company who was prosecuted. Under section 13 of the Hoarding and Profiteering Ordinance, 1943, on a charge of selling the goods at prices higher than a reasonable price in contravention of the provisions of section 6 of the Act. A part of the stock of goods was seized and taken away. The prosecution, however, ended in acquittal. The assessee claimed deduction of a sum of money spent in defending the case.
5.22.3 The Income tax Appellate Tribunal found that the expenditure was incurred solely for the purpose of maintaining the assessee’s name as a good businessman and to save his stock from being undersold if the court held that the prices charged by him were unreasonable.
5.22.4 The High Court rejected the reference application on the ground that the decision of the Tribunal was based on findings of fact.
5.22.5 On appeal, the Apex Court held that the findings of the Tribunal were vitiated by its failure to consider the possibility of the criminal proceedings terminating in the conviction and imprisonment of the assessee. It was held that the deductibility of such expenses must depend upon the purpose and nature of legal proceedings and could not be affected by the final outcome of the proceedings. It was also pointed out that the income tax assessment had to be made for every year and could not be held up until the final result of the legal proceedings which pass through several courts was announced.
5.23 Penalties which are incurred by an assessee in proceedings launched against him for an infraction of the law, it has been repeatedly held, cannot be called commercial losses incurred by an assessee in carrying on his business. The Courts are very clear that infraction of the law is not a normal incident of business and, therefore, only such disbursements can be deducted as are legally incidental to the business itself. The Courts have held that they cannot be deducted if they fall on the assessee in some character other than that of a trader. Therefore, where a penalty is incurred for the contravention of any specific statutory provision, it cannot be said to be a commercial loss falling on the assessee as a trader the test being that the expenses which are for the purpose of enabling a person to carry on trade for making profits in the business are permitted but not if they are merely connected with the business.
5.24 In the judgment of the Apex Court rendered by Three Judges in the case of Abdul Aziz Shakout Brothers referred to earlier the argument was advanced that unless the penalty is of a nature which is personal to the assessee, it may be disallowed but where it is merely ordered against the goods imported it is an allowable deduction was held by their Lordships as an erroneous distinction because disbursement it was held could be deductible only if it falls within section 10(2)(xv) of the Income tax Act. Expenses which are permitted as deductions are such as are made for the purpose of carrying on the business and if a sum is paid by an assessee conducting his business because in conducting it he has acted in a manner which has rendered him liable to penalty, it cannot be claimed as a deductible expense. Their Lordships were of the view that unless it falls within the test laid down in the cases discussed by them as such they were categorically of the view that it cannot be said to be expenditure wholly and exclusively laid for the purpose of the business. Their Lordships observed that: Can it be said that a penalty paid for an infraction of the law, even though it may involve no personal liability in the sense of a fine imposed for an offence committed, is wholly and exclusively laid for the business in the sense as those words are used in the cases that have been discussed. In answer to the said query they held that in their opinion, no expense which is paid by way of penalty for a breach of the law can be said to be an amount wholly and exclusively laid for the purpose of the business. The distinction sought to be drawn between a personal liability and a liability of the kind, with which they were seized with their Lordships held the argument was not sustainable because anything done which is an infraction of the law and is visited with a penalty cannot on grounds of public policy be said to be a commercial expense for the purpose of a business or a disbursement made for the purposes of earning the profits of such business.
5.24.1 Attention may be invited to the judgement of Madras High Court in CIT vs. Chemical Construction 243 ITR 858 (Mad.) wherein their Lordships held that the fact that a levy is termed as a penalty in a statute is not by itself decisive of its true character, as observed by the Supreme Court in Malwa Vanaspati and Chemical Co. v. CIT [1997] 225 ITR 383. "The use of the word 'penalty' in the provision is neither here nor there". It is only when a levy does not have any compensatory character that it has to be regarded as penalty.
5.25 Reference also may be made to the judgement of Apex Court in the case of Maddi Venkataraman & Co. (P) Ltd. Vs. CIT, 229 ITR 535 (S.C.) which has also been relied upon by the Hon’ble Karnataka High Court in Mamta Enterprises.
5.25.1 In the facts of that case the assessee company carried on the business of exporting tobacco. Deduction as a business expenditure/loss was claimed on account of accumulating sub standard quality of tobacco since the said stock could not be exported it was sold at the floor price fixed by the Govt. of India. It was claimed by the assessee that it had no alternative but to sell tobacco at 20% discount. On paper the full sale price was paid by the Singapore party without any discount. The 20% of the price paid by the party was remitted back to the assessee through one Mr.S. In pursuance of the agreement the assessee received the full floor price from the Singapore party and paid a sum of Rs. 2,88,000/- to Mr.S who remitted the equivalent amount in Singapore Currency to the Singapore party.
5.25.2 The claim of the assessee that it had no alternative but to enter into such a transaction with a firm to dispose of the said unsold stock of inferior quality tobacco an amount of Rs. 2,88,000/- was paid to Mr.S was claimed as a business expenditure was not accepted by the AO. 5.25.3 However the Tribunal allowed it. Hon’ble High Court was of the view that the amount had not been repatriated in a straight forward manner but had been sent to Singapore through an illegal channel as such it was concluded that the agreement being illegal and contradictory to law could not be recognized by a Court of law and could not be treated as a transaction to be a normal incidence of carrying on the business.
5.25.4 The Apex Court held that the assessee had involved in transactions in violation of provisions of Foreign Exchange Regulate Act (‘FERA’ for short) as such the claim of the assessee that it would have incurred a loss was held to be not a valid justification for contravention of law.
5.25.5 The assessee being engaged in tobacco business, their Lordships held, was expected to carry on the business in accordance with law and if the assessee contravenes the provisions of FERA to cut down its losses or to make larger profits while carrying on the business it was only to be expected that proceedings would be taken against the assessee for violation of that Act.
5.25.6 The expenditure incurred for evading the provisions of the Act and also the penalty levied for such evasion it was held could not be allowed as a deduction as it would be against the public policy to allow the benefit of deduction under one Statute, of any expenditure incurred in violation of provision of another Statute or any penalty imposed under another Statute. Their Lordships held that if the deductions claimed by the assessee it was held were allowed, the penal provisions of the FERA would become meaningless.
5.25.7 Their Lordships also held that the spur of loss cannot be a justification for contravention of the law.
5.25.8 The assessee according to their Lordships was expected to carry on the business in accordance with law. If the assessee contravenes the provisions of law to cut down the losses or to make larger profits while carrying on the business it was only to be expected that proceedings will be taken against the assesse for violation of the Act.
5.25.9 Their Lordships further held that it is also to be borne in mind that evasion of law cannot be a trade pursuit. The expenditure in this case could not be allowed as wholly and exclusively laid out for the purpose of assessee’s business.
5.26 The settled legal proposition laid down in the above judgement have been discussed specifically in response to a claim of the assessee before the authorities that the payment is as per the trade practice and without making the payment the assessee could not regularize its extra construction and could not make any sale of the property may not be a valid argument for deciding the issue what is relevant is the wording of the specific Act the Rules and Regulations and building bye-laws of the Specific Act which denote the penalty as an infraction of law for deciding whether it is a penal offence or merely compensatory. As such the mode of recovery laid down in the Specific Act which empowered the GDA receive compounding fee would be a relevant and necessary area of consideration. The legal position for payment of an amount be it termed as compounding fee or penalty is very clear, if it is an offence under the Specific Statute then the mode of regularizing the same may be held to be valid for the purpose of sale of that property but by virtue of being termed as an offence under the Income Tax Act deduction thereof cannot be claimed and if claimed cannot be allowed. The payment of compounding fee of an offence cannot be incidental to the business but if it is not an offence and is compensatory then the claim has to be allowed. In the facts of the present case this enquiry has not been done.
5.27 We may also refer to the judgment of the Apex Court in the case of Lachman Dass Mathura Dass V. CIT, 254 ITR 799 (SC) which has been heavily relied upon by the assessee wherein the decision of the Allahabad High Court in CIT vs. Lachman Dass Mathura Dass, 124 ITR 411 (Alld.) was reversed which had relied upon Saraya Sugar Mills vs CIT 116 ITR 387 (Alld.) as the said judgment had been reversed by a larger Bench of the Allahabad High Court in the case of Triveni Engineering Works Ltd. Vs. CIT 144 ITR 372 (Alld.).
5.27.1 In all these judgments Explanation to S.37(1) was not taken into consideration as the judgment of the Apex Court referred to above was delivered on 16th Jan. 1997 and the Explanation to sec. 37(1) was inserted by Finance (No.2) Act, 1998 w.r.e.f. 1.4. 1962.
5.28 In the facts of the present case the learned AR of the assessee has also advanced arguments that the facts of Mamta Enterprises and the present case are distinguishable as there was a major violation and in the facts of the present case there was only normal deviation which occur in particularly all cases. Not only this fact has not been demonstrated and has to be considered in the context of the Specific Act empowering GDA, it also needs mention that similar argument was advanced before the Hon’ble Karnataka High Court in Millennia Develops (P) Ltd. Vs DCIT (2010) 188 Taxman 388 (Kar.) wherein the said argument was moved on behalf of the assessee who was carrying on the business activity as developer and builder who had claimed that the amounts had been paid by way of regularization fee for the deviations.
5.28.1 For ready reference we reproduce the arguments advanced before the Hon’ble High Court:-
“5. Appearing on behalf of the appellant/assessee, Mr. Dinesh, learned counsel would submit that in the first instance, the amount could not be taken as a penalty, as it was an amount in the nature of regularisation fee even in terms of bye-law 6.0 of Bangalore Mahanagara Palike Building Bye-Laws, which reads as under : -
"6.0. Deviations during construction— (i) Wherever any construction is in violation/deviation of the sanctioned plan, the Commissioner may, if he considers that the violations/deviations are within 5 per cent of (1) the set-back to be provided around the building, (2) plot coverage (3) floor area ratio and (4) height of the building and that the demolition under Chapter XV of the Act is not feasible without affecting structural stability, he may regularize such violations/deviations after recording detailed reasons for the same.
(ii) Violation/deviation as at 6.0(i) above may be regularized only after sanctioning the modified plan recording thereon the violations/deviations and after the levy of fee prescribed by the corporation from time to time."
6. Therefore, the learned counsel submits that the authorities below have committed an error in law in understanding that the payment was in the nature of a penalty. The further submission is that, the ruling of this Court rendered in the case of Mamta Enterprises (supra) is not attracted to the present case for the reason that in the case of Mamta Enterprises (supra), on facts it was found that the builder/assessee had put up 8th floor of the building without obtaining any approved plan at all. Whereas in the present case the assessee had put up construction on obtaining an approved plan from the municipal authorities and compounding fee was paid only in respect of deviations within the permissible limits upto 5 per cent of the sanctioned plan. In the light of enabling provisions of regularising such deviations had paid regularisation fee, applying the said ruling to the present facts of the case was not called for and therefore the authorities below have committed an error in law in holding that ruling covers this case also.”
5.28.2 Rejecting the argument their Lordships decided the issue against the assessee on the following reasoning:-
7. We have bestowed our consideration to the submissions made at the Bar and perused the orders of the assessing authority, first and second appellate authority.
8. The appeal is sought for admission on the following questions of law :
"(i) Whether in law, the Tribunal was justified in upholding the disallowance of payment of Rs. 4,40,500 for regularization of the deviations which were within the permissible limits, holding it as penalty and thus not liable to be allowed under s. 37(1) of the Act ?
(ii) Whether in law under the KMC Act the payment made for regularization of the deviations in the plan within the permissible margin could be held to be penalty for the purpose of disallowance under s. 37(1) of the Act especially when the appellant had contracted and sold the properties in accordance with the regularized plan, the profit from which had been offered for taxation ?"
9. On the overall examination of the facts and legal position, we find that the authorities below have not committed any error in law, warranting a correction by this Court in exercise of appellate jurisdiction under s. 260A of the Act. We say so, for the reason that the so-called regularisation fee in terms of bye-law 6.0 of the Bangalore Mahanagara Palike Bye-Laws is a provision made for regularising the deviations/violations as enabled under s. 483(b) of the Karnataka Municipal Corporation Act, 1976 which reads as under : "483. Provisions respecting institution, etc., of civil and criminal actions and obtaining legal advice—The Commr. may—
(a) .........
(b) compound any offence against this Act, the rules, bye-laws or regulations which may be rules made by theGovernment be declared compoundable."
10. The language of s. 483(b) leaves us with no doubt as to the nature of the expenditure as it is only an amount paid for compounding an offence. The amount paid for compounding an offence is inevitably a penalty in terms of s.483 itself and the mere fact that it has been described as compounding fee cannot, in any way, alter the character of the payment which payment is in the nature of penalty.
11. As it is in the nature of penalty, the law too is wellsettled to hold that it can never be an amount in the nature of expenditure which can qualify for deduction under s. 37 of the IT Act and it is for this reason, we have to dismiss this appeal. If an answer is warranted in respect of the questions referred above, we answer the same against the assessee and in favour of the Revenue.
12. The appeal is dismissed.”
5.29. In the facts of the present case it is pleaded that there is a slight deviation from the original plan. The evidence in regard thereto needs verification along with the provisions of the Specific Act which empowered the Ghaziabad Development Authority to compun the offence.
5.30 Before parting we deem it necessary to mention that the above case law has been referred so as to address its applicability and relevance in the present proceedings. It is seen that the assessee has placed reliance before the authorities below and also before us on the judgements of the Delhi High Court in CIT vs Loknath Co. 146 ITR 624 (Delhi) stating that it is the judgement of the Jurisdictional High Court as such binding on us. On consideration it is seen that in view of the fact that the assessee is situated at Ghaziabad, the Jurisdictional Court would be the Hon’ble Allahabad High Court and not the Hon’ble Delhi High Court. Apart from that the said judgment was prior to the insertion of Explanation to section 37 as such to observation therein would even otherwise have no relevance as settled by the Apex Court in CIT vs. Sun Engineering Pvt. Ltd. 198 ITR 297 (SC), which already mandates that the judgment must be read as a whole and the observations from the judgment have to be considered in the light of questions which were before the Court. It is neither desirable nor permissible to pick out a word or a sentence from the judgment divorced from the context of the question under consideration and treat it to be complete law declared by the court.
5.31 The AO and the CIT(A) have relied upon CIT vs. Mamta Enterprises cited supra which has relied upon Maddi Venktaraman P.Ltd. vs CIT 229 ITR 534 wherein their Lordships observed that this was a case where there was violation of FERA. The principle of being against public policy was invoked and there was no question of compensatory element being part of such penalty as was the position in the case of Swadeshi Cotton Mills Co.Ltd. vs CIT 233 ITR 199 wherein their Lordships held that: “On the facts of that case there was ‘nothing on the record to show that the amount of penalty had a compensatory element in it.’ It is clear from the observation that the compensatory element in a levy termed as penalty is eligible for being regarded as business expenditure. It is only that part, which is purely penal that has to be excluded.
5.32 While so holding reference may be made to two well known legal principles, namely, “ratio decidendi” and the doctrine of stare decisis “Stare decisis et non quieta movere”, it means to adhere to precedent and not to unsettle things which are settled. However, the scope is limited to litigated facts and necessarily decided questions. Apart from Article 141 of the Constitution of India, the policy of courts is to stand by precedent and not to disturb a settled point. When Court has once laid down a principle of law as applicable to certain state of facts, it will adhere to the principle, and apply it to all future cases where facts are substantially the same. In the facts of the present case the specific provisions of the Specific Act which empowers the G.D.A. to receive compounding fee necessarily needs to be taken into consideration as such the principle laid down by the consistent judgements of the Hon’ble Karnataka High Court in the light of the provisions of KM Corporation Act need to be considered in the light of the Specific Act applicable to G.D.A. A decision is an authority for what it decides and no more. The words in a judgement are not used after weighing the pros and cons of all conceivable situations that may arise. They constitute just the reasoning of the Judges in a particular case, tailored to a given set of facts and circumstances. What is made relevant and binding is only the ratio decidendi. One may doubt the wisdom of attempting to trace a common ratio decidendi from divergent views expressed by different judges in support of a conclusion but it seems equally illogical to altogether ignore a clear conclusion arrived at by the majority of judges only because they arrived at that conclusion by different processes of reasoning. One would rather have though that a conclusion stands more fortified when it can be supported not on one but on several lines of reasoning. At least for an identical problem, the final answer should be the same [Ramesh Birch v. Union of India, AIR 1990 SC 560, 5821]. Similarly the argument that judgement of the Karnataka High Court should be ignored also on the ground that it is of a nonjurisdictional High Court to our minds cannot be accepted as judicial discipline demands that a judgment of a High Court being a superior forum qua the Tribunal necessarily needs to be followed and cannot be ignored.
6. Accordingly for the detailed reasons given hereinabove on facts and in law the issue has to be restored to the learned CIT(A) with the directions to decide the same in accordance with law requiring him to call for and examine the provisions of the Specific Scheme which empowered the GDA to collect the compounding fee. Needless to say that the assessee shall be given a reasonable opportunity of being heard.
In the result, the appeal is allowed for statistical purposes.