1. This appeal is directed against the order of the Commissioner (Appeals) deleting the disallowance of interest on fixed deposits in computing the total income for the assessment year 1978-79.
2. The admitted facts are that the assessee is a private limited company and that it had borrowed funds by accepting deposits from the public for the purpose of carrying on its business of manufacture and sale of soft drinks. In computing the total income of the previous year ended 31-3-1978 corresponding to the assessment year 1978-79, the assessee had claimed deduction of Rs. 94,889 paid on such deposits. The ITO found the amount borrowed as deposits exceeded the limit prescribed in Rule 3 of the Companies (Acceptance of Deposits) Rules, 1975, read with Section 58A of the Companies Act, 1956. He was of the opinion that the borrowal was, therefore, irregular and illegal and the interest on such borrowal exceeding the limit could not be allowed as a deduction unless the assessee was carrying on an illegal business which was not the case. He, accordingly, disallowed a sum of Rs. 80,120. On appeal, the Commissioner (Appeals) accepted the contention of the assessee that even if the borrowal was irregular, the expenditure incurred for payment of interest on such deposits was allowable as a deduction since it was not specifically prohibited by the Income-tax Act, 1961 ('the Act').
3. In this appeal, the contention of the revenue was that the payment of interest was in contravention of the law and since a contravention of law cannot be part of the business of the assessee, the deduction of that interest was inadmissible. We are unable to accept this contention for more than one reason. Firstly, the interest paid on the deposits exceeding the ceiling imposed under the company legislation is not in the nature of penalty and, therefore, obviously the decision of the Supreme Court in the case of Haji Aziz & Abdul Shakoor Bros. v. CIT  41 ITR 350 has no application. Under Section 58A of the Companies Act, deposits are not to be invited without issuing an advertisement and the deposits have to be received on certain prescribed terms. If the terms are not in accordance with this section then the deposits have to be returned within a month and the company is punishable with a fine for the contravention. Under Rule 3, the deposits shall not exceed the limit prescribed. These rules also require that the excess deposits be returned forthwith and contravention of rules are punishable with fine. We are not concerned with any fine imposed for the contravention of the Act or the rules in this case. We are only concerned with the interest paid on such deposits received in contravention of the Acts and the Rules. There is no direct provision for surcharging the persons managing the company for the payment of such interest and until any person incharge of the affairs of the company is required to reimburse the expenditure incurred, this expenditure has to be treated as the expenditure of the company and admittedly it has been so taken into account in casting audited profit and loss account as required by the Companies Act.
Therefore, the question with which we are really concerned is whether the interest taken into account for ascertaining the profit of the company could still be disregarded only on the ground that the capital borrowed was in contravention of certain regulations in the Companies Act and the Rules.
4. In the case of Haji Aziz & Abdul Shakoor Bros. (supra) it was held that infraction of law was not a normal incident of business carried on by the assessee and any penalty paid for such infraction was held to fall on the assessee in some character other than that of a trader and cannot, therefore, be deducted as an expenditure laid out for the purpose of business. We have a different type of case in CIT v. Piara Singh  124 ITR 40 where distinguishing that case, it was held by the Supreme Court that where an assessee carries on a business inherently unlawful and the income therefrom is being assessed, any penalty, for the infraction of law would constitute a normal incident of that unlawful business and be deductible as an expenditure laid out for the purpose of business. The case of the revenue is that the assessee's business will not fall in the category of unlawful business so as to allow any deduction of payment made illegally. However, we have a third type of case which is in between the two. We cannot shut our eyes to the reality of infraction of law being necessary for carrying on a lawful business also and the question will be whether expenditure incurred illegally or in contravention of any regulation falls on the trader in his capacity as a trader or not. For instance, supposing the assessee has a shop on a street where parking of vehicles is not allowed and the assessee is required by necessity to violate the traffic regulation and park his vehicle for the purpose of transporting his goods, loading and unloading it at his shop, can it be said that infraction of the law was in a capacity other than a trader or that the expenditure incurred because of that infraction falls on him in any other capacity In our mind, such an infraction cannot but be recognised as springing directly from the carrying on of business and incidental to it and the expenditure incurred would be an expenditure laid out for the purpose of business. The vital question is whether the infraction of law was a normal incident of the business of the assessee. From that point of view, the borrowal of funds in excess of the ceiling prescribed is certainly incidental to the business of the assessee since those funds were required for the carrying on of the business. Moreover, with the aid of those funds borrowed in excess of the ceiling prescribed the assessee has undoubtedly earned income and such income is part of the income being assessed to tax. Naturally the interest paid on the funds borrowed with which the income was earned must be a deduction before that income could be assessed to tax. It was suggested that the borrowal of funds beyond the ceiling prescribed amounts to mismanagement and the expenditure incurred by such mismanagement or inefficiency in the running of the business could not be an admissible deduction. This suggestion has to be stated only to be rejected because it is not for the ITO to say, in what manner or how efficiently the assessee should run his business. As long as the expenditure was actually incurred and it was laid out for the purpose of business, it cannot be disallowed as an admissible deduction. The same view has been expressed by the Madras High Court in case of CIT v.Sree Rajendra Mills Ltd.  93 ITR 122 where it was held that merely because there was as infringement of the Companies Act in the payment of remuneration to a manager, that payment could not be disallowed as a deduction since it was not as if no expenditure was incurred by the company or that, that expenditure was not laid out for the purpose of business. In the present case also, the revenue does not dispute the actual payment of interest on the capital borrowed nor the fact that such borrowed capital was utilised in the business. In the circumstances, we do not see how the claim for deduction of such interest in computing the income from such business could be disallowed. We have therefore, no hesitation in confirming the order of the Commissioner (Appeals) allowing the deduction of the interest on borrowed capital even if it be in excess of the ceiling prescribed under the Companies Act.