Title not extracted — [1993] 2 S.C.R. 983

The Judgment of the Court was delivered by D VENKATACHALA, J. Two questions are raised for our decision in this appeal. First, whether the appellant was entitled to claim as allowance under Section37(1) of the Income-taxAct, 1961 (the l.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 E

-- under Employees' State Insurance Act, 1947 (the ES! 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 manufac- y ture of textile goods. It is the assessee. In the income-tax return of the F assessee for the Assessment Year 1966-67 (the previous accoiinting year being from 1st July, 1%4 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 G also the sum of Rs.3,865 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 lo the item of expenditure of Rs.3,865, he disallowed Rs.2,500 treating it as el<clusive expenditure incurred on its Directors. Appeals preferred before H

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A the A.A.C. and the Income-taic Appellate Tribunal (Tribunal) questioning the disallowance nf 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 B 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, ques-· tioning the aforesaid orders made by the authorities and the High Court. Reference sought to be obtained from the Tribunal for decision by the - C High Court, was on the following questfons:-

1Copy pinpoint1. Whether the sum of Rs.19,635 debited in the interest account paid by way of interest for delayed payment of sales taic and Employees' State Insurance contribution could be said to have not been incurred, wholly and D exclµsively for the purpose of business?

2Copy pinpoint2. Whether on 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-taic Act, 1961? E

3Copy pinpoint3. 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 allow- - F able under Section 37(2) of the I.T. Act?

4Copy pinpoint4. 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 asses- G see-company?

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

PRAKASH COITON MILLS v. C.!.T. lVENKATACHALA, J.] 987

its opinion under Section 256 of the LT. 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 2'1 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 quelition5 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: c Section 37{1) of the LT. Act corresponds to Section 10{2){XV) of Predecessor Indian Income-Tax Act of 1922 {the LT. Act of 1922), is undisp~ted. · D In Maha/akshmi Sugar Mills Co. v. Commissioner of Income-tax, Delh~ {1980) 123 !TR 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 LT. Act of 1922. ·For deciding that question, this Court examined the E provisions of Sugarcane Cess Act, 1956 which providedfor taking of several

- kinds of action against a person who defaulted in payment of the cess impo,ed 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 F y 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. Oil 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 G 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 l.T. Act of 1922. H

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In Commissioner of Income .Tax v. Hytkrabad All"'Yn Metal WO/kr I..imited, (1988) 172 ITR 113, a Division Bench of the Andhra Pradesh High ., ,

Court had to i!ecide two questions; (i) whether the damages paid by the respondent:assessee 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 B Act, for delayed paymen\ of sales tax thereunder, was an allowable deduc- tion 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

c a passage of his concurring judgment in 0'8ano Chemical Industries v. Union of India, AIR 1979 SC 1803, on the expression 'damages' occurring in Section 14B 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 imposi· D tion 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.148 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 E employers in general not to commit ·a breach of ·the · st<1tutory requirements of section 6, but at the same time it is meant to provide compensation or redress to the

F 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 148 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 G 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 148 must -\ mean 'failure in performance' or 'failure to act'. At the same time, the imposition of damages under section 14B H is to provide reparation for the amount of loss suffered

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by the employees." A

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 fmding, the real distinction that exists between an impost which is compen- B satory 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 relevent provisions of the c law under which it is imposed and the circumstances under which it has been imposed. The mere nomenclature as )nterest, penalty or damages in the Act may not be conclusive for the purpose of allowing it as a deduction under the Income-taJC Act. Similarly, the circumstance that D 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 maJCimum. Such a deter- mination 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 held by the Supreme Court, the said amount comprises both an element of penal levy as well as com- pensatory payment. It will be for the authority under the Income-taJC 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 inter- est." G

1'-- 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 Divi<ion Bench considered the relevant provisions of the BST Act bearing H

990 SUPREME COURT REPORTS (1993] 2 S.C.R. _,

<\_ 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 B of interest for d~layed payment or penal in character. The Act does not provide for automatic payment of interest

c 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 1 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 al- ready indicated while discussing question No.(1), the

F nomenclature of the levy as interest, damages or penalty may not be conclusive."

The decision of this Court, in Mahalakslimi Sugar Mills Company - (supra) and the decision of the Division Bench of the Andhra Pradesh High Court in Hyderabad A//wyn Metal Works Ltd. (supra) with the views of which we are in comple_te 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 G (rcparatory) in character as would entitle such assessee to claim it as an allowable expenditure under Section 37(1) of the l.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 LT. Act, the assessing authority is required to examine the H Scheme of the provisions of the relevant statute providing for payment of

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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 LT. Act, wbereever 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 obligated to bifurcate the two components of the impost and give deduction to that componel)t 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. · C and the Appellate authorities have refused to allow the claims made by the assessee under Section 37(1) of'the LT. Act, without any examination of the Scheme of the provisions of the BST Act, to find whether 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 D 37(1) of the LT. 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 LT- Act. First Question is"answered ·accordingly. E

Second Question:

Miscellaneous expenses claimed by the assessee as <jeductible expen- diture allowable under Section 37(2) of the LT. Act related to a sum of F y Rs.3,865 incurred by the Directors of the assessee-company for entertain- ment at the Diners Club and C.C.L 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 LT. 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 G assessee-company. The A.AC. in dealing with the said claim for deduction in the appeal of the assessec filed before him, held the entire expenses claimed as deductible expenditure under Section 37(2) of the LT. Act could not be regarded as having been laid out or expended wholly and exclusively for the purpose of th~ business of the assessee. He, therefore, H

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A refused to interfere with the order of the l.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 entertairunent expenses of the assessee being a matter to be decided by the fact finding authorities B 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 \heir concurrent finding on considl:ration of the relevant material. Hence, the question under consideration is devoid of merit and

C 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 1.J961 to Income-tax Appellate Tribunal, Bombay 'for being, decided in the light of crur answer to the First Question and decide. the appeaL of the assessee, accordingly. No costs.

l.S.G. Appeal allowed partW