Northern India Chemical ... vs Commissioner Of Income-Tax
2000 Latest Caselaw 1113 Del

JUDGMENT

Arijit Pasayat, C.J.

1. On being moved by the assessed for reference under Section 256(1) of the Income-tax Act, 1961 (in short the "Act"), the following question has been referred for the opinion of this court :

"Whether, on the facts and in the circumstances of the case, the Tribunal was correct in law in sustaining the disallowances of Rs. 63,405 and Rs. 2,750 being the amount paid to the State Trading Corporation and legal expenses incurred in connection therewith respectively, claimed as allowable deductions in computing the business profit of the assessed for the assessment year 1972-73 ?"

2. The background facts, as indicated in the statement of the case, are as follows :

The assessed is a public limited company and it maintained its books on the mercantile system of accounting. So far as the assessment year 1972-73 is concerned, the previous year ended on December 31, 1971. The assessed at the relevant point of time, carried on business as an importer of Chemicals. These were not allowed to be imported directly and hence the assessed was acting as a distributor of the Chemicals imported, under the authority of the State Trading Corporation (in short the "Corporation"), since 1962. In 1963, the Central Government decided to permit import of betelnuts. The imports from Malaysia and Ceylon were to be done under the authority of the Corporation. The Northern India Betelnuts and Spices Importers Association (in short the "association") requested the Corporation to release the import quota of betelnuts on its behalf to the assessed. The matter was discussed amongst the parties concerned, i.e., the Corporation, the association and the assessed. Certain terms were settled on August 30, 1963, between the assessed and the association. Subsequently, the assessed entered into an agreement on October 4, 1963, with the Corporation. The board of directors of the assessed's company had adopted a resolution passed on August 22, 1963, under which the assessed had decided to take up the work of import and distribution of betelnuts in Northern India, acting as the corporation's agents having been appointed as a "trading body" of the association. Under the agreement, the assessed was to be in charge of the betelnuts import quota allotted by the corporation and it had to distribute the same in conformity with its agreement with the corporation. According to the assessed, during the assessment years 1963-64 and 1964-65, some of the quota holders did not lift the quotas fixed for them by the corporation. Therefore, there were some unlifted stocks of beteinuts left with the assessed. There was no agreement with the corporation regarding the disposal of such unlifted quota. One A.S. Gupta, who was the director in charge of the operations, was of the opinion that the assessed had the right to dispose of such stocks. A resolution was adopted on January 27, 1964, which permitted disposal of the unlifted stock through the agency, Mam Raj Radhey Shiam Gupta. Incidentally, A.S. Gupta was the proprietor of the said concern. As per the books of account maintained by the assessed on the sales of such unlifted stocks effected by it, there was a net profit, which was taxed. The total quantity imported was 3,85,879.630 kgs. ; the total quantity sold to quota holders was 3,31,583.540, and the quantity sold through Mam Raj Radhey Shiam was 51,073.200 kgs. There was thus a shortage. The value of goods sold through Mam Raj Radhey Shiam was Rs. 3,05,093.60 and the total profits earned from the sale, during the assessment years 1965-66 and 1966-67, was Rs. 64,552.02 in total. When the corporation became aware of the fact that the assessed had disposed of the unlifted stocks, in the manner noted above, it wrote to the assessed on January 31, 1969, pointing out various irregularities. Substantially, there were three charges against the assessed. The assessed furnished its reply dated June 3, 1969. On May 8, 1970, the corporation wrote to the assessed pointing out that a much larger sum from what was indicated in its reply dated June 3, 1969, was recoverable from the assessed. The corporation further stated that the disposal of large quantity of betelnuts was unauthorised and the assessed was responsible. The assessed did not accept the claim of the corporation and stated that it had become the victim of mischief by A.S. Gupta and since it had no reason at all to suspect dishonesty on his part, it would have tried to recover the amount due from him in case the goods had really been sold at prices higher than the prices reported by A.S. Gupta to the assessed. Finally, after exchange of correspondence, the assessed agreed to pay Rs. 63,405.45 in full and final settlement and paid the amount during the relevant assessment year. In the aforesaid background, the assessed claimed the amount as a deduction from the business profits. The Assessing Officer noted that the sum was debited to purchase account and was not shown in the profit and loss account. It was further observed that the assessed had to pay the amount as damages, because one of its directors who was in charge of the work at the relevant period had unauthorisedly and dishonestly sold the goods through its proprietary concern and the liability having arisen because of the deliberate and dishonest violation of the terms of agency, the expenditure was not incidental to the business. A counsel fee of Rs. 2,750, in respect of the transactions, in question was also disallowed. The matter was carried in appeal before the Appellate Assistant Commissioner (in short the "AAC"), who confirmed the views of the Assessing Officers. The matter was carried in further appeal before the Tribunal. After noticing the factual aspects, the Tribunal came to hold that the authorities were justified in disallowing the claim.

3. On being moved by the assessed, reference as aforestated, has been made. There is no appearance on behalf of the assessed when the matter is called. We have heard learned counsel for the Revenue.

4. The only question that needs to be adjudicated is, "whether the expenditure as claimed was incidental to the assessed's business and therefore was an allowable expenditure." The Tribunal with reference to the factual aspects held that A.S. Gupta was not acting sub rosa. The expenditure in question was not made by way of payment of damages for breach of contract. The payment was also not made in settlement of a civil action for damages on the ground of fraud committed in the course of the assessed's business. The situation was one brought on by the assessed's willful departure from ordinary incidents of business conduct and, therefore, falls outside the area of business deductions. According to learned counsel for the Revenue, these conclusions are factual in nature and therefore no question of law is involved.

5. As a general proposition, damages paid for breach of warranty or for failure to perform a trading contract or payment made to procure extension of time for performance of such contract is allowable as business deduction. But where liability for damages is caused by dishonest breach of contract, e.g., payment under a decree passed against the company for misfeasance committed by its directors, the claim is not allowable. A sum paid in settlement of a civil action for damages on the ground of fraud committed in the course of the assessed's business, is to be allowed as a business expenditure. The factual position is different in the present case. The mere fact of a settlement is not a proof of any infraction of law. Thus, the essence of the matter is, where there is a breach of contract and the breach is not dishonest, it can be looked upon as one of the incidents of carrying on the business, and, therefore, damages payable be allowed as a deduction. Where there is no dishonest act on the part of the assesseds in carrying on the business, a loss arising from a breach of warranty or terms of contract, could be a "contemplable loss" to use the expression used in IRC v. Warnes and Co. [1919] 2 KB 444by Rowlatt J. Where the loss, however, is occasioned by a dishonest act on the part of the assessed, it would not be a contemplable one. The Tribunal was, therefore, justified in holding that the claim of Rs. 63,405, as a business expenditure, was not maintainable. So far as legal expenses are concerned, it was noticed by the Tribunal that expenditure was for getting legal advice in connection with the negotiations with the corporation and the claim was dependent on allowability or otherwise of the main claim. Since, we have already held that the claim was not deductible, disallowance of Rs. 2,750 is in order. Our answer to the question, therefore, is in the affirmative, in favor of the Revenue and against the assessed.