Whether a sum of Rs. 1,41,516 paid by way of interest to the Income-tax Department under Section 220(2) of the Income-tax Act is an allowable deduction under Section 37 or 28 in computing the business income of the assessee 2. This question is no longer res integra in view of the two direct decisions of the High Courts on the point, they are CIT v. Oriental Carpet Manufacturers (India) (P.) Ltd.  90 ITR 373 (Punj. & Har.) and National Engineering Industries Ltd. v. CIT  113 ITR 252 (Cal.). But Shri J.P. Shah, learned counsel for the assessee, has taken us through several decisions to convince us that the aforesaid decisions have not been correctly decided in view of the certain observations in the Supreme Court's decisions to which he has referred.
Naturally, therefore, the argument covered a wide gamut. The learned departmental representative also very ably replied the contentions of Shri Shah. However, in order to proceed further it may be necessary to state the facts which are in brief.
3. The assessee is a limited company carrying on business in manufacturing textiles in Ahmedabad. The assessee paid interest under Section 220(2) of the Income-tax Act, 1961 ("the Act") in the assessment year 1977-78 which is the year under appeal (accounting year of the assessee being calendar year). The details of such interest are as follows : DETAILS OF INTEREST PAID TO INCOME- TAX DEPARTMENT UNDER SECTION 220(2)I Assessment year 1973-74 [Order dated 1-11-1976] Rs. Rs. i. On Rs. 12,00,477 from 12-12-1975 to 5-7-1975 79,379 ii. On Rs. 24,254 from 27-2-1975 to 5-7-1975 968 ------- iii. On Rs, 13,951 from 12-12-1974 to 24-5-1976 2,310 82,657II Assessment year 1974-75 [Order dated 1-11-1976) i. On Rs. 5,63,967 from 27-2-1975 to 5-7-1975 22,556 ii. On Rs. 2,59,398 from 27-2-1975 to 24-5-1976 36,303 58,859 ------- ------- The assessee claimed the interest amount of Rs. 1,41,516 as a deduction from income from business. The ITO did not accept the assessee's claim on the ground that the interest payment to the income-tax department is not for the purpose of carrying on the business activity of the assessee but on account of default of non-payment of tax.
4. The assessee carried the matter in appeal. The Commissioner (Appeals) confirmed the disallowance on a cryptic reasoning that there is no provision of law under which the interest can be allowed.
5. In the appeal filed by the assessee there were many grounds and some of them were decided in favour of the assessee. The revenue came up in appeal before the Tribunal against those grounds which were decided against it in IT Appeal No. 1240 (Ahd.) of 1980. The assessee filed cross-objection in that appeal. The appeal was, however, disposed of but the cross-objection has been referred to the Special Bench, as the question with regard to the claim of interest as a deduction is one of the grounds raised in the cross-objection. The bench which heard the cross-objection felt that this matter requires consideration by a larger bench. That is how the cross-objection has come up for hearing before a Special Bench, 6. The first ground raised in the cross-objection relates to claim under Section 35B in respect of the following amounts :7. Dock charges 2,524 --------- Shri Shah fairly stated that the items are covered by the Special Bench decision in the case of J. Hemchand & Co. (supra) but the assessee desires to keep the issue alive. Respectfully following the decision in the case of J. Hemchand & Co., (supra) we hold the claim against the assessee.
7. Coming to the second ground, which is the question actually referred to the Special Bench, Shri Shah at the very outset stated that he is not pressing his claim for deduction of interest under Section 36(1)(m) of the Act, and in our view rightly. He has confined his arguments only on the allowability under Section 28 or 37 of the Act. We have already indicated in the beginning that the question involved in this appeal has already been decided by the two High Courts. The decision of the Punjab and Haryana High Court in the case of Oriental Carpet (supra) directly took into account an identical claim. That was the case dealing with the claim of interest on delayed payment of tax. Their Lordships rejected the assessce's claim and made the following observations: It cannot be said that the interest on payment of delayed tax has any connection with the business of the assessee, within the four corners of the aforesaid test. The assessee paid interest in order to get adjustment from the department to pay the income-tax by instalments, and this has nothing to do with his business activity.
The liability to tax, though arising out of business activity, cannot be said to be in any manner a liability which has anything to do with the business of the assessee. It is merely a consequence of income accruing in such business and nothing more. We do not agree with the observations of the Tribunal that the treatment of interest earned on refund of tax, as income of the taxpayer, has anything to do with interest which an assessee incurs in order to raise money to discharge his income-tax liability. This interest will derive its colour from the principal payment and will partake of it. The interest earned by the department is interest on tax and must be held to be part of the tax. This does not follow when the assessee earns interest on excess payment of tax. The two situations are totally different. (p. 376) Similarly, the Calcutta High Court in the case of National Engg.
(supra) had occasion to consider the claim for interest on delayed payment of taxes under Section 220(2). There also it was held that the claim is not entertainable.
8. In view, the above decisions which are directly on the point, Shri Shah no doubt had difficulty in convincing us that the decisions should not be followed. His main plank of arguments is based on certain observations of Justice M.H. Beg, as he then was, in the decision rendered by the Supreme Court in the case of Indian Aluminium Co. Ltd. v. CIT  84 ITR 735 and the observations of the Supreme Court in the case of CIT v. Birla Cotton Spg. & Wvg. Mills Ltd.  82 ITR 166. No doubt he has also referred to the observations of the Supreme Court in the cases of Sassoon J. David & Co. (P.) Ltd. v. CIT  118 ITR 261 and Mahalakshmi Sugar Mills Co. v. CIT  123 ITR 429.
The observations of Justice Beg in the case of Indian Aluminium (supra) are referred to for the purpose of accepting Shri Shah's proposition that in the case of a limited company any expenditure incurred is necessarily for the purpose of the business as a company comes into existence only with the object of carrying on business. This argument is advanced for the purpose of distinguishing all those decisions dealing with the claim for payment of interest on the ground that those cases dealt with individual or partnership firms.
It is necessary at this stage to consider the above aspect before we proceed further. We do not think that there can be any such distinction between a corporate body and a non-corporate body in regard to the claim of expenditure under Section 28 or Section 37. The tests laid down in the decided cases are same. Lordship Justice Beg wrote a separate judgment while deciding the Indian Aluminium's case (supra) and this is what his Lordship observed : It is true that wealth-tax is imposed on 'net wealth' of assessees, as defined by Section 2, Sub-section (c), who are all 'persons'.
These persons are both natural and artificial. In the case of an artificial or juristic person like the company before us, it seems very difficult to separate the purpose of the juristic 'persona' which is certainly commercial from the character of the 'persona' itself. Even as regards other traders, that part of tax which falls on what is used exclusively for trade could be really ascribed only to a trading character. To the extent it is a tax on property used for earning profits, it must enter into a computation of profits from trading.(p. 753) These observations have been made, in our opinion, to strengthen the argument as the subsequent sentence clearly show that even in regard to other traders the claim has been considered by his Lordship. We, therefore, do not see any principle in deciding the matter on the status of a person, viz., whether it is a corporate entity or a non-corporate entity.
Secondly, the decisions which dealt with payment of interest on borrowed capital both dealt with corporate and non-corporate bodies. We need not dilate much on those decisions which dealt with the claim of interest paid on money borrowed for the payment of tax, as the claim was made in those cases on the basis of Section 36(1)(iii).
Thirdly, the cases which are directly on the point, as pointed out by us, are both of limited companies.
9. Now comes the consideration of the argument of Shri Shah based on the observations of the Supreme Court in Birla Cotton's case (supra).
Before we deal with this as also the decision of the Supreme Court in the case of Seth R. Dalmia v. CIT  110 ITR 644, we would like to bear in mind certain general principles governing the claim for deduction of expenditure under Section 28 or Section 37 as the case may be.
10. It is well established that the claim for expenditure is allowable if it is wholly and exclusively for the purpose of business. There are several tests laid down as to whether the expenditure is wholly and exclusively incurred for the purpose of business. Commercial expediency is one of the important tests laid down. It is equally well settled that the expression "for the purpose of business" is very much wider than the expression "for the purpose of making or earning income" occurring in Section 57. But it is well known that, however, wide the terms of the expression "for the purpose of business" may be, there are inherent limits which have to be discerned with reference to the facts of each case. The expenditure must be incurred by an assessee as a trader. Recently, the Supreme Court had occasion to consider the claim regarding interest on money borrowed in the case of Madhav Prasad Jatia v. CIT  118 ITR 200. While dealing with the claim under Section 10(2)(xv) of the 1922 Act the Supreme Court referred to various decisions on the point right from the decision of the Bombay High Court in the case of Bai Bhuriben Lallubhai v. CIT  29 ITR 543. It was observed by their Lordships in Jatia's case (supra): Proceeding to consider the claim for deduction made by the assessee under Section 10(2)(iii) or Section 10(2)(iv), we may point out that under Section 10(2)(iii), three conditions are reqdired to be satisfied in order to enable the assessee to claim a deduction in respect of interest on borrowed capital, namely, (a) that money (capital) must have been borrowed by the assessee, (b) that it must have been borrowed for the purpose of business, and (c) that the assessee must have paid interest on the said amount and claimed it as a deduction. As regards the claim for deduction in respect of expenditure under Section 10(2)(xv), the assessee must also satisfy three conditions, namely, (a) it (the expenditures must not be an allowance of the nature described in Clauses (i) to (xiv), (b) it must not be in the nature of capital expenditure or personal expense) of the assessee, and (c) it must have been laid out or expended wholly and exclusively for the purpose of his business. It cannot be disputed that the expression 'for the purpose of business' occurring in Section 10(2)(xv) and also in Section 10(2)(xv) is wider in scope than the expression for the purpose of earning income, profits or gains' occurring in Section 12(2) of the Act, and, therefore, the scope for allowing a deduction under Section 10(2)(iii) or Section 10(2)(xv) would be much wider that the one available under Section 12(2) of the Act. This court in the case of CIT v. Malayalam Plantations Ltd.  53 ITR 140 (SC) has explained that the former expression occurring in Sections 10(2)(iii) and 10(2)(xv), its range being wide, may take in not only the day-to-day running of a business but also the rationalisation of its administration and modernisation of its machinery ; it may include measures for the preservation of the business and for the protection of its assets and property from expropriation, coercive process or assertion of hostile title ; it may also comprehend payment of statutory dues and taxes imposed as a pre-condition to commence or for the carrying on of a business : it may comprehend many other acts incidental to the carrying on of the business but, however wide the meaning of the expression may be, its limits are implicit in it ; the purpose shall be for the purpose of business, that is to say, the expenditure incurred shall be for the carrying on of the business and the assessee shall incur it in his capacity as a person carrying on the business. (p. 208) It is evident from the above that the expenditure in order to be allowed as a deduction must be incurred by an assessee in the capacity as a person carrying on business. Any expenditure incurred not in the capacity as a person carrying on business cannot be allowed as a deduction. It is unnecessary to multiply other decisions on the general principle.
11. In the above background let us consider whether the decisions of the Supreme Court in the case of Birla Cotton (supra) and Dalmia case (supra) lay down any principle by which the claim before us be allowed.
In other words, whether the decisions of the Calcutta High Court in the case of National Engg. (supra) and that of the Punjab and Haryana High Court in the case of Oriental Carpet (supra), disallowing a claim of the nature involved in this case, can be ignored on the ground that they are contrary to the decisions of the Supreme Court.
12. Birla Cotton's case (supra) dealt with the claim for expenditure incurred by an assessee in the proceedings before the Income-tax Investigation Commission. While allowing the assessee's claim, their Lordships observed : The essential test which has to be applied is whether the expenses were incurred for the preservation and protection of the assessee's business from any such process or proceeding which might have resulted in the reduction of its income and profits and whether the same were actually and honestly incurred. It is not possible to understand how the expenditure on the proceedings in respect of the Investigation Commission by the assessee will not fall within the above rule. Even otherwise, the expenditure was incidental to the business and was necessitated or justified by commercial expediency.
It must be remembered that the earning of profits and the payment of taxes are not isolated and independent activities of a business.
These activities are continuous and take place from year to year during the whole period for which the business continues. If the assessee takes any steps for reducing its liability to tax which result in more funds being left for the purpose of carrying on the business there is always a possibility of higher profits. To give an illustration, if an assessee can, by an appropriate proceeding, succeed in getting its tax liability for gains and profits reduced by a sum of Rs. 1,00,000 that amount will essentially become available for the purpose of business with a reasonable expectation of more profits. As was observed by Viscount Simon in Smith's Potato Estates case  AC 508 if the trader considers that the revenue seeks to take too large a share and to leave him with too little the expenditure which the trader incurred in endeavouring to correct this mistake is a disbursement laid out for the purposes of his trade. If he succeeds he will have more money with which to earn profits next year.(p. 171) 13. Shri Shah, for the assessee, laid emphasis on the observation that any step taken for reducing the tax liability which results in more funds for the purpose of carrying on business would be for business. He wants that in this case the same principle would apply inasmuch as the assessee by not paying tax retained the money and thereby reduced its tax liability by claiming the interest as a deduction. We are unable to see any analogy between the case before their Lordships and the case before us. Here, we are concerned with the non-payment of tax, because of which the assessee is statutorily obliged to pay interest to the Government. There is no question of reduction of tax liability. Tax has already been determined. The assessee has not paid the tax. In a way it is committing a default by retaining the Government dues. The statute provides for the payment of compensation by way of interest because the money is not paid. There is no question of reducing the tax liability so far as the assessee's conduct is concerned. We are, accordingly, of the opinion that the principle in the case of Birla Cotton (supra) is totally inapplicable to the case on hand.
14. Coming to Dalmia's case (supra), the question that arose there is different. But Mr. Shah drew our pointed attention that the Supreme Court approved the decision of the Bombay High Court in the case of CIT v. H.H. Maharani Vijaykuverba Saheb of Morvi  100 ITR 67. Though, according to Shah, those cases dealt with deduction from out of income from other sources under Section 57, the decision is very pertinent so far as this case before us is concerned. This leads us to the consideration of the decision of the Bombay High Court. There the question that arose was whether the expenditure in the form of interest paid on borrowings for the purpose of payment of estate duty, on the death of the owner, by the trustees under Section 12(2) of the 1922 Act is allowable or not. Their Lordships held that on the facts of that case, the borrowings were made by the trustees for the purpose of meeting the estate duty liability, which is attached to the property which was the subject-matter of the trust and that too for the purpose of maintaining or preserving the erstwhile income that was being received from the corpus of the trust. Accordingly, the expenditure was held to be a permissible deduction. We are not able to see how the decision of the Bombay High Court can at all be applied to the facts of the case before us. In this case, we are concerned with the claim of interest for non-payment of tax. The tax is determined after the profits are computed. It is not connected, either directly or indirectly, with the earning of profits. It is like sharing of the profits between the assessee and the Government. In the Bombay High Court case, the very property that produced that income was in jeopardy and in order to preserve that property, the expenditure was incurred.
It is like incurring the expenditure in connection with a business asset. This approach is in line with the decision of the Supreme Court in the case of Indian Aluminium (supra) where their Lordships held that wealth-tax is an allowable deduction from out of the business income.
It is true that the Legislature amended the law by specifically mentioning that wealth-tax is not deductible. Incidentally, we may note here that Section 40 of the Act specifically debars the deduction of income-tax. Even otherwise, income-tax was never allowable as a deduction inasmuch as it arises after the profits are earned. It is like giving a share out of the profits to the State. Thus, we find that none of the decisions cited by Mr. Shah ran contrary to what has been held by us above and particularly the decision of the Punjab and Haryana High Court in the case of Oriental Carpet (supra) and Calcutta High Court in the case of National Engg. (supra), dealing directly with the question involved in the present appeal. Before we conclude, we would like to mention one more aspect, since Mr. Shah laid great stress on the fact that because of non-payment of taxes by the assessee, more funds were available, which were utilised in the business. The availability of the funds with the assessee arose as a consequence of non-payment of taxes by it. The assessee merely kept the funds with it without payment of taxes. In order to claim expenditure from the business income, any benefit which results in consequence of the expenditure must be taken to be simply a by-product and not its purpose. This principle is well recognised in law and we may refer to the decision of the House of Lords in the case of IRC v. Korner  74 ITR 584. Lord Donovan in his speech made the pertinent observations to the above effect. What we want to bring to light is that as a consequence of the assessee's default in not paying the taxes, the assessee was, no doubt, left with more funds. There is no positive step taken by the assessee by which it can be held that an expenditure was incurred which has direct or indirect connection with its business.
15. There were some arguments as to whether the interest charged under Section 220(2) is penal in character and so, it cannot be claimed as deduction. The Gujarat High Court, no doubt, held that it is not penal in character but it is only compensation for the retention of the money- Bharat Textiles Works v. ITO  114 ITR 28 and Chandrakant Damodardas v. ITO  123 ITR 748. It is unnecessary for us to deal with this aspect further in view of the reasons given by us.
16. The learned departmental representative also raised a ground that the liability did not accrue this year as the payment of interest relates to earlier periods. This argument has no merit. The liability to pay interest arose only on the passing of the order. It did not arise earlier. Unless, the ITO applies his mind and passes an order demanding interest, no liability accrues. Admittedly, the ITO passed orders demanding interest on 1-11-1976 and, therefore, the liability accrued only on that date.
17. In the result answer to the question referred to the Special Bench is against the assessee. Since other grounds raised by the assessee also fail, the cross-objection is dismissed.