1. These two references under Section 256(1) of the I.T. Act, 1961, made at the instance of the CIT, Lucknow, relate to similar set of facts and may conveniently be disposed of together. The assessment years involved are 1970-71 and 1971-72, the corresponding accounting periods being financial years ending March 31, 1970, and March 31, 1971, respectively. The assessee is a limited company and undertakes contracts for construction of tube-wells and supplying of stores. In the previous year relevant to the assessment year 1970-71, the assessee debited in its books a sum of Rs. 1,29,321 on account of damages and penalty and claimed deduction of the same from the profits and gains of this year. It appears that these amounts were paid by the assessee to the Government departments from whom it had taken certain contracts for breach of the terms of the same and it was claimed by it before the ITO that these payments were not made in violation of any law and as such they were allowable. The ITO, after going into details of the payments made, accepted the claim in respect of a sum of Rs. 4,668 and treated the balance of Rs. 1,25,853 as not deductible and added back that amount to the income of the year.
2. The assessee appealed and before the AAC confined its claim to Rs. 1,13,732, the details of which were as under :
U.P. AgriculturalUniversity, Patna Nagar10,156
Executive Engineer, Tube-wellConstruction Division, Dhariwal (25 T. Wells Dhariwal)59,820
The Executive Engineer,Karnal14,500
3. The AAC analysed each of these items and held that the claim in respect of items Nos. 1, 2 and 5 related to the assessment year 1969-70 and should have been claimed in that year. As for item No. 4, he was of the opinion that this represented penalty levied by the Executive Engineer, Jullundur for delayed tactics adopted by the assessee in executing the contract. As regards the claim at item No. 3, he confirmed the disallowance for the reason that no evidence had been given to show even the date of imposition of that penalty. In the result, he confirmed the disallowance of a total claim of Rs. 1,13,732.
4. The assessee took up the matter in appeal before the Appellate Tribunal and contended that it had been carrying on contract business on artextensive scale and occasional delays in the execution of the contracts were inherent in its work and as such the damages paid were liable to be deducted as business loss. The assessee claimed deduction in this year on the basis of the actual levy of the penalties and payment of the same. The Appellate Tribunal accepted this contention and placed reliance on the decisions of the Orissa High Court in CIT v. Prafulla Kumar Mallick : 73ITR119(Orissa) , that of the Madras High Court in CIT v. Inden Biselers : 91ITR427(Mad) and of this court in Central Trading Agency v. CIT : 56ITR561(All) . The Tribunal hence held that since the penalties were levied and realised during the previous year relevant to the assessment year 1970-71, the assessee was fully justified in claiming deduction of the same in this year and the claim was thus accepted. Now, the following question has been referred for the opinion of this court at the instance of the Commissioner of Income-tax :
'Whether, on the facts and in the circumstances of the case, the Tribunal was right in allowing the assessee's claim for deduction of Rs. 1,13,732 paid by the assessee as penalties and damages ?'
5. In the previous year relevant to the assessment year 1971-72, the assessee had debited a sum of Rs, 8,150 on account of damages and penalties and claimed deduction of the same from the income of this year. The claim was disallowed by the ITO as also on appeal by the AAC, but on further appeal it was accepted by the Appellate Tribunal, following its decision given in the assessee's case for the immediately preceding year. At the instance of the Commissioner, the following question has been referred by the Appellate Tribunal to this court:
'Whether, on the facts and in the circumstances of the case, the Tribunal was right in allowing the assessee's claim for deduction of Rs. 8,150 paid by it as penalties and damages ?'
6. In this reference nobody appeared before us on behalf of the respondents and so we had not the advantage of hearing its counsel. After hearing learned counsel for the Commissioner, we are of the opinion that the view taken by the Appellate Tribunal is absolutely correct. As noted above, the Appellate Tribunal has recorded a finding of fact that, in the nature of the assessee's business, delay in the execution of the contracts was rather inherent. The law in this behalf almost stands settled. The ratio laid down by the Supreme Court in Haji Aziz and Abdul Shakoor Bros. v. CIT : 1983ECR1942D(SC) is that if an expenditure has been incurred for the purpose of carrying on the business, that is, to enable a person to carry on and earn profit in that business, it would be treated as a permissible deduction. It has to be a commercial loss in trade and also contemplable by the parties. However, a penalty imposed for breach of any law during thecourse of trade cannot be regarded as an allowable expenditure. In the present case, the assessee had to pay damages not for breach of any provision of any law but for breach of contractual obligation and in that behalf it has to be seen as to whether these payments were made to enable the assessee to carry on its business and further whether such payments were contemplable by the parties. The question whether the loss is incidental to the operation of a business is a question of fact to be decided on the facts of each case, having regard to the nature of the operations carried on and the nature of the risk involved in carrying them out: See CIT v. Nainital Bank Ltd. : 55ITR707(SC) and Badridas Daga v. CIT : 34ITR10(SC) . Reference may also be made to Calcutta Co. Ltd. v. CIT : 37ITR1(SC) .
7. It would be seen that the Appellate Tribunal, on the facts of the case, has found that the disputed payments were incidental to the carrying on of its business by the assessee because the delay in the execution of the contracts was inherent in the nature of the business itself.
8. The proposition that under Section 10(1) of the 1922 Act, corresponding to Section 28(1) of the Act of 1961, deduction should be allowed in respect of a loss arising from forfeiture of security deposit or imposition of any damages as a result of non-performance of a trade contract admits of no doubt. This court had occasion to decide a similar question in Central Trading Agency v. CIT : 56ITR561(All) . In that case, the assessee, a registered firm, carrying on a contract business in the supply of dehydrated vegetables to the Government, entered into a contract in 1943 for the supply of 100 tons of dehydrated onions to the Government by December 31, 1943. It was provided in the contract itself that in the event of the assessee's failure to deliver supplies as contracted, it would be liable to pay a penalty of 2 annas per pound on the quantity which it failed to deliver by the due date unless its failure was due to reasons beyond its control. By December 31, 1943, the assessee could supply only 15 tons of onion and hence the Government cancelled the contract and imposed a penalty. It, however, on the application of the assessee, extended the date of delivery to August 31,1944, but upon the condition that the assessee paid a certain amount as liquidated damages. The assessee paid that amount in the previous years relevant to the assessment years 1945-46 and 1946-47 and claimed deduction of the same as business expenditure. The claim was disallowed by the revenue authorities as also by the Appellate Tribunal, but on reference it was accepted by this court. The view taken was that the payment under consideration was made not as a penalty or damages for breach of contract, but merely in fulfilment of the condition agreed to between the parties enabling the assessee to fulfil the contract and earn profits therefrom upon making the payment which was described as liquidated damages.
9. Similarly in CIT v. Prafulla Kumar Mallick : 73ITR119(Orissa) the assessee, a paddy procuring agent, failed to supply foodgrains of the quality contracted for to the Government of Orissa and under the terms of the agreement certain penalties were imposed on it and they were realised by deductions from the bills. The assessee claimed deduction of those amounts under Section 10(1) of the 1922 Act, The claim was accepted by the Orissa High Court on the view that it was an inevitable consequence of the assessee's business as a paddy procuring agent, that as a result of the goods delivered not being of the contracted quality, breach of warranty, with the risk of liability to pay damages, should at times be committed. Hence it was held that payment of such damages as a result of breach of warranty was incidental to the carrying on of the assessee's business and the claim was an admissible deduction in computing the profits under Section 10(1) of the Act. There is another decision of that very High Court on almost similar facts in Govind Choudhury and Sons v. CIT : 79ITR493(Orissa) . In this behalf reference may also be made to a decision of the Madras High Court in Hind Mercantile Corporation Ltd. v. CIT : 49ITR23(Mad) and of the Delhi High Court in R. C. Jain v. CIT : 91ITR557(Delhi) .
10. We are in respectful agreement with the aforesaid decisions and on the facts found by the Appellate Tribunal we agree with the view taken by it. Hence, for both these years the questions referred are answered in the affirmative, against the department and in favour of the assessee. There shall, however, be no order as to costs.