1. This appeal by the assessee is directed against the order of the Commissioner (Appeals) dated 30-12-1978 relating to the assessment year 1974-75.
2. The first issue in this appeal is regarding the sustention of the disallowance of Rs. 1,67,586 made by the ITO on account of loss due to confiscation of woollen rags by the customs department.
3. The factual back-drop relating to this issue is as under : The assessee is a registered firm working under the name and style of International Woollen Mills, Industrial Area, Ludhiana. It maintains its books of account on mercantile system of accounting and its previous year is the financial year, which for the assessment year under appeal ended on 31-3-1974. During the course of assessment proceedings, the ITO found that there was a debit of a sum of Rs. 1,67,586 representing the value of rags which were confiscated by the customs authorities during the year. He, therefore, asked the assessee to justify this claim. It was explained by the assessee that the loss was directly related to the business, that it had been incurred during the commercial transactions ordinarily carried on by the assessee, that the assessee had imported rags on genuine belief that they were covered by the import licence issued by the Government, that the assessee had claimed the loss because the rags had been confiscated by the Collector of Customs and that though the order of the Collector of Customs was not final and the assessee had filed the appeal against the said order which was pending, yet the assessee was entitled to the claim as it had debited the said amount in the books of account maintained on mercantile system of accounting. The ITO rejected this claim on two grounds. He firstly held that the order of the Collector of Customs was not final and secondly, the confiscation order was passed on the infringement of the Customs Act read with Section 3 of the Import and Export Control Act. It was thus in fact a penalty for infringement of law and expenditure will be illegal expenditure. It was disallowed. The learned Commissioner (Appeals) also supported the ITO. In supporting the ITO, the Commissioner relied on the ratio of the Punjab and Haryana High Court judgment in the case of Cineramas v. CIT  110 ITR 762.
4. Before us, the learned counsel for the assessee submitted that even the Assistant Director of Enforcement, vide his order dated 28-2-1980, has held that the Bombay High Court in the Miscellaneous Petition No.92 of 1974 dated 13/15-1-1975 had clarified expression "rags". It was also pointed out in this judgment, it was contended, that said order of the High Court had become final because the customs authorities though earlier decided to go in appeal against the said order of the High Court yet later withdrew the appeal on 26-4-1979. He particularly pointed out to the observations of the said Assistant Director at page 16 that it cannot be stated at present that the parties misutilised the foreign exchange released to them under the relevant import licence.
5. It was contended that the loss was incurred by the assessee in carrying out the ordinary business activity of the assessee. The loss was, therefore, a business loss and the assessee had debited it to the accounts which were maintained on mercantile system because during the accounting period the goods had been confiscated and as such the assessee as a prudent businessman had provided for the loss that had been incurred due to such confiscation. The authorities below, it was contended, erred in not allowing the loss incurred by the assessee in the ordinary conduct of its business.
6. The learned counsel for the assessee further submitted that without conceding and for the sake of argument, it should be noted that if the assessee had incurred the said loss due to infringement of law, even then it was admissible in view of the Supreme Court judgment in the case of CIT v. Piara Singh  3 Taxman 67/ 124 ITR 40.
7. In replying to these arguments, the revenue contended that in so far as the contention of the assessee with regard to the loss by confiscation of goods by the customs authorities is concerned, it may be noted that the reference to the judgment of the Assistant Director under the Enforcement Act does not carry much weight because any judgment by a collateral authority should not affect the judgment of the Collector. In this regard, it was submitted that the infringement of the Customs Act in any case was there by the assessee and it is clearly indicated that the assessee was not entitled to the loss arising out of confiscation in view of the ratio of the Supreme Court judgment in the case of Haji Aziz & Abdulshakoor Bros. v. CIT  41 ITR 350. It was further argued that the alternative argument of the learned counsel for the assessee that he is entitled to the set off of the amount representing the value of confiscated goods can apply only if the assessee concedes that he is carrying on illegal business. Since there is no such concession, the judgment of the Supreme Court in the case of Piara Singh (supra) is not applicable.
8. Relying on the Calcutta High Court judgment in the case of Raghubir Pmsad Gupta v. CIT  120 ITR 789, it was contended by the revenue that an amount paid to the customs authorities by way of fines in lieu of confiscation of goods imported without valid licence was held to be expenditure not wholly and exclusively laid out for purposes of the business of an assessee and as such not deductible under Section 37(1) of the Income-tax Act , 1961 by the Calcutta High Court. The same is the case here and, therefore, the loss should be disallowed and the disallowance thereof made should be sustained.
9. Referring to the judgment of the Punjab and Haryana High Court in the case of Cineramas, (supra) referred to by the Commissioner (Appeals), it was contended that commercial expediency is not always a correct or conclusive test to determine whether the expenditure is laid out wholly and exclusively for purposes of the assessee's business. It must be an ordinary or contemplable incident of trade. But, infractions of law, including breaches of obligation are not normal incidents of business. Penalties and damages paid in connection with such infractions and breanches cannot be expenditure laid out or expended wholly and exclusively for the assessee's business. The claim was, therefore, rightly disallowed.
10. We find that the claim of the assessee has been erroneously rejected by the authorities below. The assessee placed orders for import of woollen rags on valid licences. This was done through the State Trading Corporation. In fact, the historical background is that in the year 1967, the Government of India decided to canalise the import of foreign goods through the State Trading Corporation and for this purpose, a notification dated 25-11-1967 was issued. This policy was implemented immediately after the issuance of the notification and it was decided that exporters would be entitled to import goods to the extent of specified percentage of FOB value of the goods exported.
11. On such import entitlements, the licences were issued. The assessee got the import entitlement, transferred to it and also got it nominated for that purpose in respect of 10 import licences, details of which appear at page 37 of the assessee's paper book. These import entitlements were utilised by the assessee for import of two consignments of woollen rags: 204 bales and 23 bales. At page 76 of the assessee's paper book is the photostat copy of the Invoice No. 987 dated 20-6-1972 for import of 23 bales. At page 77 of the assessee's paper book is a copy of Invoice No. 20079 dated 78-3-1973 for 204 bales. A scrutiny of invoice at page 77 would show that the import was against the licences which the assessee had got transferred in its favour as appearing at page 37 already alluded to (supra). The exporters are Shoji & Co. Ltd.. Japan, and the account in which the goods have been dealt with and exported is International Woollen Mills, Ludhiana, account the State Trading Corporation of India, New Delhi.
The exporter has given a certificate in the following terms while exporting 204 bales, what is described as "Old Woolknits Rags" : We hereby certify that merchandise is of Japanese origin. We hereby certify that the goods were dry when packed.
TYPE 'OSAN/S,' - Old Woolknits Rags. Old, unserviceable, torn, mutilated, expected to sort - without guarantee pastels 25 per cent, medium 35 per cent, dark 20 per cent, fancy 20 per cent, shipment of goods commercially all wool.
The import of 23 bales by Invoice No. 987 appearing at page 76 is not so clear as it is a photostat copy.
12. When the goods arrived in India, the customs authorities found that they were not woollen rags as the term was understood by them. To this, the assessee objected. The assessee also suggested that the goods be mutilated so as to render them, even if they were, without conceding that they are serviceable, unserviceable. The assessee also objected to the method adopted by the customs authorities in determining the type and character of the goods whether they were woollen or non-woollen.
The assessee wanted that core-bore method be employed to take the sample and test the goods but this was rejected. The Customs Collector, Bombay, made the order in respect of 204 bales on 2-8-1973 as appearing at pages 4 to 8 of the assessee's paper book. In this order, he relied on the dictionary meaning of woollen rags and rejecting the contention of the assessee that there was no infringement either of import licence or any other law, held that the goods were not of the description for which the import licence had been issued and, therefore, the import contravened Section 111(d) of the Customs Act read with Section 3 of the Import and Export Control Act. The goods were, therefore, confiscated, "absolutely". A similar order was made on 6-8-1973 with regard to 23 bales of the woollen rags imported. In a judgment dated 28-2-1980, the Assistant Director of Enforcement, alluded to the judgment of the Bombay High Court in Miscellaneous Petition No. 92 of 1974 (supra) in the arguments of the learned counsel for the assessee and accepted the contentions in that case that the expression "rags" had wider connotation and should be understood in a common sense known to the trade who usually deal with such items. He has also pointed out that against this judgment, there was an appeal which was later withdrawn. From what is stated above, it becomes clear that there was a genuine difference of opinion as to what a woollen rag is on account of the fact that no definition of the woollen rags had been given in the Customs Act. We have, therefore, to examine as to what part the assessee played in getting the loss incurred so as to see whether there was any contravention of law by the assessee.
13. As pointed out above, the assessee placed orders with the Japanese exporters. According to the exporters, the goods were woolknit rags.
The purpose of the assessee was to import woollen rags for purposes of utilisation in its business. At no stage there has been any evidence collected by the revenue to show that when the assessee placed the order, it had ordered something else than what was authorised to be imported under the import licence, which the assessee had with it when the orders were placed. Further, it is a very important to note that the exporters in Japan had not kept only the assessee in view but apparently the debit was made to the State Trading Corporation of India, New Delhi, and the said account with the firm of Shoji & Co.
Ltd. (page 77 of the assessee's paper book) show that the account is of International Woollen Mills, Ludhiana, account the State Trading Corporation of India, New Delhi. Therefore, it could not be said that the assessee in coalition or in collaboration with the State Trading Corporation subverted the licences which were issued for import of woollen rags to import something which was not permitted under the licences. The assessee, therefore, could not be said to have infringed any law so as to invite such penalty that could be said to be in violation of law and inadmissible as business expenditure. The role played by the assessee was that of simple importer who on the basis of genuine import licences ordered goods from exporters in Japan and on their arrival in India, these were found to be not conforming with the idea of woollen rags that was prevalent with the authorities, who had to interpret its connotation under the Customs Act. We are, therefore, of the considered opinion that the assessee did not infringe any law so as to be visited with any penalty or fine. The question, however, remains of confiscation of goods of the assessee by the customs authorities 14. This confiscation took place on two days. 204 bales were confiscated on 2-8-1973 by order of the Collector of Customs. 23 bales were confiscated on 6-8-1973 by order of the Collector of Customs. The previous year of the assessee relevant to the assessment year under appeal is financial year 1973-74. Therefore, the confiscation of the goods was during the course of the previous year relevant to the assessment year under appeal.
15. The assessee is maintaining books of account on mercantile system of accounting. Since confiscation had taken place during the previous year and the goods had physically gone out of the possession and control of the assessee, the assessee was in August 1973 neither physically possessed all the goods nor legally entitled to them, the further appeal to the Central Board against the Customs Collector's order notwithstanding. At this point of time, the issue was whether the assessee was entitled to give to the value of the confiscated goods the treatment that it gave in its books of account or not.
16. In a system of accounting which is mercantile, profit or loss account for the year under appeal could not have been drawn up without taking into consideration the value of the confiscated goods as going out of the coffers of the assessee. It is also settled in Kedarnath Jute Mfg. Co. Ltd. v. CIT  82 ITR 363 (SC) that liability did not cease to be a liability because the assessee had taken proceedings before the higher authorities for getting it reduced or wiped out so long as the contention of the assessee did not prevail. Therefore, the assessee was entitled to incorporate the loss in its books of account as it did at the material time. Question now remains whether the assessee is entitled to it as revenue loss.
17. The assessee is a manufacturer and in the course of its activities needed woollen rags. The assessee purchased import entitlements and placed orders through lawful agencies with the exporters in the foreign countries. The account of the assessee is along with State Trading Corporation of India and all the further transactions and actions that took place were in furtherance of this transaction. The only flaw in all the transactions is that the goods were considered as not according to the description under which they could be imported. The assessee had done all this in the ordinary course of business. The loss has arisen in its ordinary course of business without any infringement of law which should be considered as penal in nature. The venial breach of law should not stand in the way of the assessee to make claim with regard to the impugned sum as revenue expenditure as it in fact has gone and would have otherwise been stock-in-trade of the assessee. The expenditure is revenue in nature and is admissible. It is directed to be allowed. In coming to this conclusion, we have carefully considered the authorities cited by both the sides and if we do not refer to them in particular in extenso, we do not consider it necessary.
18 to 20. [Paras 18 to 20 are not printed here as they involve minor issues.]