1. This appeal had been filed by the assessee and the first ground taken is that the Commissioner (Appeals) was not justified in upholding the disallowance of a sum of Rs. 2,23,650 being the penalty imposed by the Enforcement Directorate.
2. The assessee is a registered firm which was engaged in the exhibition of films in a cinema house known as 'Kamal Talkies'. On 2-10-1970 the assessee started a new venture under the name and style of International Ice Holiday. The said business was commenced after obtaining due approval of the concerned authorities and was set up in the plot owned by the LIC outside Connaught Circus, New Delhi. After running the show for a short period between 2-10-1970 to 9-11-1970, it had to be stopped under the orders of the Ministry of Home Affairs. The foreign artists employed by the assessee in running the venture were departed by the Government and proceedings under the Foreign Exchange Regulation Act, 1973 (FERA) were also initiated by the Directorate of Enforcement. The assessee entered into litigation with the Government for the closure of the business and had to incur large amount of litigation expenses. On 15-10-1973 the Special Additional Director, Enforcement Directorate, New Delhi, imposed a penalty of Rs. 2,23,650 on the assessee for violation of the FERA. The assessee claimed deduction of the said penalty during the assessment year 1974-75 as, according to it, the liability in respect of the penalty had accrued during the accounting period relevant for the assessment year 1974-75.
Before the ITO, the assessee submitted that the penalty imposed by the Enforcement Directorate was expenditure incurred during the course of its business and, hence, was incidental to the carrying on of the business and should be allowed as a deduction. The ITO did not accept the assessee's contention and held that the penalty so imposed on the assessee could not be regarded as an expenditure wholly laid down for the purpose of the business. In taking the above view, he relied on the decision of the Gujarat High Court in CIT v. Mihir Textiles Ltd.  104 ITR 167 and did not place any reliance on the decision of the Bombay High Court in CIT v. Pannalal Narottamdas & Co.  67 ITR 667 cited by the assessee.
3. The assessee went in appeal and before the Commissioner (Appeals), a reference was made to the order of the Tribunal relating to the assessment year 1971-72 wherein the Tribunal allowed the assessee's claim of expenditure incurred on litigation by holding that the said expenditure was incurred by the assessee in trying to preserve its business and, hence, was incidental to the carrying on of the said business. The Tribunal also held that the business carried on by the assessee was a lawful business and continued to be so till it was closed by the Government. The assessee also referred to the decision of the Gujarat High Court in Mihir Textiles Ltd.'s case (supra) and also the decision of the Supreme Court in CIT v. Piara Singh  124 TTR 40 and submitted that even if there was an infraction of law, the expenditure incurred on payment of penalties was an allowable deduction. The Commissioner (Appeals) also did not accept the assessee's contention and relying on the decision of the Supreme Court in Haji Aziz & Abdul Shakoor Bros. v. CIT  41 ITR 350, came to the conclusion that the violation of the FERA was not and could not be regarded as an essential part of the business carried on by the assessee-firm and, hence, the expenditure incurred on payment of penalty imposed for the infraction of law could not be allowed as a deduction. Aggrieved by the findings of the Commissioner (Appeals), the assessee has come up in the present appeal.
4. Before us, the learned counsel of the assessee submitted that if the business carried on by the assessee was treated as a lawful business by the Tribunal, any expenditure arising out of the said business was also allowable as a deduction. It. was pleaded that there was no infraction of law and the assessee has challenged the order of the Enforcement Directorate before the Delhi High Court and the matter is still pending. It was submitted that even if there was an infraction of law the business was done lawfully and, hence, the amount of penalty imposed is an admissible deduction. In pressing home his point of view, he relied on the decision of the Supreme Court in Piara Singh's case (supra) and some other decisions, namely, Pannalal Narottamdas & Co.'s case (supra), CIT v. Ahmedabad Controlled Iron & Steels Reg.
Stockholders Association (P.) Ltd.  99 ITR 567 (Guj.), Nanhoomal Jyoti Prasad v. CIT  123 ITR 269 (All.) and CWT v. S.C. Kothari  82 ITR 794 (SC). The learned representative of the department, on the other hand, has relied on the decision of the Commissioner (Appeals).
5. We have carefully considered the rival contentions and in our opinion, the order of the Commissioner (Appeals) does not call for any interference. The law on the subject has been clearly laid down by the Hon'ble Supreme Court in Haji Aziz & Abdul Shakoor Bros.'s case (supra) wherein the Hon'ble Supreme Court has observed as under : A review of these cases shows that expenses which are permitted as deductions are such as are made for the purpose of carrying on the business, i.e., to enable a person to carry on and earn profit in that business. It is not enough that the disbursements are made in the course of or arise out of or are concerned with or made out of the profits of the business but they must also be for the purpose of earning the profits of the business. As was pointed out in Von Glehn's case  2 KB 553 an expenditure is not deductible unless it is a commercial loss in trade and a penalty imposed for breach of the law during the course of trade cannot be described as such. 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. It must be a commercial loss and in its nature must be con-templable as such.
Such penalties which are incurred by an assessee in proceedings launched against him for an infraction of the law cannot be called commercial losses incurred by an assessee in carrying on his business. Infraction of the law is not a normal incident of business and, therefore, only such disbursements can be deducted as are really incidental to the business itself. 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. (p. 359) The learned counsel of the assessee, during the course of arguments, has placed a lot of stress on the fact that the Tribunal vide its order dated 25-9-1978 has clearly held that the business carried on by the assessee was perfectly legal and, hence, the expenditure incurred by the assessee in trying to preserve his business was incidental to the carrying on of the said business. We do not dispute the findings of the Tribunal recorded in connection with the assessment year 1971-72 when the assessee claimed certain litigation expenses and other incidental expenses and the same were allowed by the Tribunal, but where a business is carried on lawfully by an assessee, it is not an incidence of business to commit infraction of the law and, hence, any expenditure incurred for violating the law committed in the carrying on of a lawful business could not be allowed as an admissible deduction. Although the learned counsel of the assessee had heavily relied on the decision of the Supreme Court in Piara Singh's case (supra) but in our opinion, the said decision is of no assistance to the assessee. In this connection, it would be pertinent to reproduce below the following observations made by theirs Lordships : Reliance was placed by the revenue on Haji Aziz and Abdul Shakoor Bros. v. CIT  41 ITR 350 (SC). In that case, however, the assessee carried on the lawful business of importing dates from abroad and selling them in India. The import of dates by steamer was prohibited. Nonetheless he imported dates from Iraq by steamer and the consignments were confiscated by the customs authorities. But the dates were released subsequently on payment of fine. The assessee's claim to deduction under Section 10(2)(xy) of the Indian Income-tax Act, 1922, was rejected on the ground that the amount was paid by way of penalty for a breach of the law. An infraction of the law as not a normal incident of business carried on by the assessee and the penalty was rightly held to fall on the assessee in some character other than that of a trader. Reference was made by the revenue to Soni Hinduji Kushalji & Co. v. CIT  89 ITR 112 (AP). The assessee's claim to the deduction of the value of gold confiscated by the customs authorities was found unsustainable by the Court. The decision in that case can be explained on the ground that the assessee was carrying on a lawful business in gold, silver and jewellery and committed an infraction of the law in smuggling gold into the country. Our attention has also been invited to J.S. Parkar v. V.B. Palekar  94 ITR 616 (Bom.), where on a difference of opinion between two learned judges of the Bombay High Court, a third learned judge agreed with the view that the value of gold confiscated by the customs authorities in smuggling operations was not entitled to deduction against the estimated and assessed income from an undisclosed source. It was observed that the loss arose by reason of an infraction of the law and as it had not fallen on the assessee as a trader or businessman a deduction could not be allowed. Apparently, the true significance of the distinction between an infraction of the law committed in the carrying on of a lawful business and an infraction of the law committed in a business inherently unlawful and constituting a normal incident of it was not pointedly placed before the High Court in that case. (p. 43) From the above passage, it is obvious that the Supreme Court has explained the earlier decision in Haji Azjiz & Abdul Shakoor Bros.'s case (supra) and have clearly held that an infraction of law committed in the carrying on of a lawful business cannot be treated as a normal incidence and, hence, a penalty imposed for the infraction of the law cannot be allowed as a deduction. In this connection, we may also refer to the decision of the Allahabad High Court in Saraya Sugar Mills (P.) Ltd. v. CIT  116 ITR 387 (FB). In the above decision their Lordships held that carrying on business in an unlawful manner involving breach or infraction of the law is not carrying it on in good faith or bona fide and any expenditure due to infraction of law by the assessee is not a deductible item. In view of the ratio laid down in the above decisions of the Hon'ble Supreme Court and of the Allahabad High Court, we are clear that the Commissioner (Appeals) was fully justified in upholding the disallowance of the penalty of Rs. 2,23,650 imposed by the Enforcement Directorate for violation of the FERA by the assessee. We have also gone through the other decisions cited by the learned counsel of the assessee but they do not advance the case of the assessee.
6. The next ground taken by the assessee in this appeal is against the disallowance of Rs. 5,000 being the penalty levied by the Delhi Development Authority (DDA) for the infrigenent of building by-laws.
The above penalty was levied by the DDA since the cinema building, which was meant for the purpose of exhibition of films, was let out by the assessee on rent. In our opinion, since the penalty was imposed on the assessee for infringement of the by-laws of the local authority, the said expenditure cannot be treated as incidental to the carrying on of the assessee's business and, hence, was rightly disallowed by the authorities below. We decline to interfere.
7 to 10. [These paras are not reproduced here as they involve minor issues.]