1. In this reference under s. 256(1) of the I.T.Act, 1961 (hereinafter referred to as 'the Act'), the following question has been referred for the decision of the court :
'Whether, on the facts and in the circumstances of the case, the penalty of Rs. 20,095 paid by the assessed under section 3(5) of the U. P. Sugarcane Cess Act, 1956, is allowable as a business expenditure ?'
2. The assessed is M/s. Nawabganj Sugar Mills Co. Ltd. The reference relates to the assessment year 1959-60 and the relevant accounting period is the year ending October 31, 1958. The assessed has a factory at Nawabganj, District Gonda, U. P. The assessed claimed a deduction of Rs. 38,045 as interest and penalty paid for late payment of the cess due under the U. P. Sugarcane Cess Act, 1956 (hereinafter called 'the Cess Act'). In the course of the assessment, the ITO held that the penalty is in the nature of fine and, thereforee, it is not for the propose of business. The amount paid as interest on arrears of cess due under the cess Act was allowed.The amount of penalty of Rs. 20,095 was disallowed. On appeal, the AAC confirmed the order of the ITO. The assessed appealed to the Tribunal. It was argued that the cess could not be paid in time due to business exigencies and the payment of the penalty was incidental business. The Tribunal held that the penalty has been imposed under s. 3(5) of the Cess Act which, unlike the interest, is for an infraction of law which cannot be allowed as business expenditure. The reference is at the instance of the assessed.
3. Mr. Bishamber Lal, the learned counsel for the assessed, contends that the assessed could not pay the cess in time as the funds were otherwise needed or locked up in the business of the assessed. He contends that the interest payable on arrears of cess under s. 3(3) is in reality part and parcel of the liability to pay cess and this has been accepted by the decision of the Supreme Court in Mahalaxmi Sugar Mills Co. v. CIT : 123ITR429(SC) . He then draws the same analogy to the penalty imposed under s. 3(5) of the Cess Act. He contends that the provision for penalty is a civil liability and is not a penalty for a criminal offence. The criminal liability and prosecution is provided in s. 4 of the Cess Act and, thereforee, the default of an assessed is dealt with in two separate provisions. The penalty payable under s. 3(5) of the Cess Act would be incidental to the business of the assessed and is to be allowed as a permissible deduction. In order to appreciate these submissions, it is necessary to refer to the statutory provisions.
4. The Cess Act, as the preamble says, is an Act to amend and consolidate the low relating to imposition of cess of sugarcane intended for use, consumption in or sale to a factory. Section 3 provides for the imposition of cess. The State Government may be notification in the Official Gazette impose a cess not exceeding four annas per maund on the entry of the cane into the premises of a factory for use, consumption or sale therein. The case imposed is payable by the owner of the factory and has to be paid on such date and at such place as may be prescribed. The rules called U. P. Sugarcane Cess Rules, 1956, have been framed in exercise of the powers conferred by s. 10 of the cess Act.It provides for the period during which the cess is to be paid and the manner in which it is to paid. Under sub-s. (3) of section 3 of the Cess Act, if any arrear of cess is not paid on the date prescribed under sub-s. (2), it shall carry interest at 6% per annum for such date to the date of payment. Sub-s. (5) of s. 3 reads as follows :
'Where any person is in default in making the payment of the cess, the officer or authority empowered to collect the cess may direct than in addition to the amount of the arrears and interest, a sum not exceeding 10 percent. Thereof shall by way of penalty be recovered from the person liable to pay the cess.'
5. section 4 reads as under :
'Penalties. - If any person defaults in the payment of cess imposed under sub-section (1) or section 3, or contravenes any provision of any rule made under this Act, he shall without prejudice to his liability thereforee under sub-section (5) of section 3, be liable to imprisonment up to six months or to fine not exceeding rupees five thousand or both and in the case of continuing contravention to a further fine not exceeding rupees one thousand for each day during which the contravention continues.'
6. The manner of the imposition of penalty is provided in rule 8 of the side rules. The Collecting Officer may, after giving an opportunity to the owner of the factory or the gur, rab or khandsari manufacturing unit to show cause why a penalty be not imposed on him under sub-section (5) of s. 3 of the Cess Act and upon being satisfied that there is no sufficient case for non-payment of the cess in time, impose, subject to the provisions of the said sub-section, such penalty as he thinks fit. The penalty of Rs. 20,095 against the assessed has been imposed under sub-s. (5) of s. 3 of the Cess Act after following the procedure laid down in rule 8.
7. The validity of the Cess Act was challenged by sugar manufacturing companies by a petition under article 226 of the Constitution in the Allahabad High Court. The High Court, on final hearing, dismissed the write petition. Subsequently, on appeal the Supreme Court declared the Cess Act ultra virus on the ground that the Cess Act fell beyond the competence of the State Legislature. The judgment was given on December 13, 1960, and is reported as Diamond Sugar Mills Ltd. v. state of Uttar Pradesh : 3SCR242 . Thereafter on January 31, 1961, the President promulgated the U. P. Sugar Cess (Validation) Ordinance of 1961 (1 of 1961). The Ordinance validates the cess imposed assessed or collected by the Government of Uttar Pradesh during the period from January 26, 1950, to the date of the commencement of the Ordinance. The Ordinance was brought into force with effect from February 3, 1961, by notification in the Official Gazette. The Ordinance was replaced by the U. P. Sugarcane Cess (Validation) act, 1961 (for short called 'the Validation Act '). The Validation Act was upheld by the Supreme Court in Jaora Sugar Mills v. State of Madhya Pradesh, : 1SCR523 . The word 'cess' is defined in the Validation Act as meaning the cess payable under any State Act and includes any sums recoverable under such Act by way of interest of penalty. The state Act has further been defined and means, inter alia, the Cess Act. A compendious provisions such as contained in s. 3 of the Validation Act has been made. Their Lordships of the Supreme Court held that the plain meaning of s. 3 is that the material and relevant provisions of State Acts as well as the provisions of notifications, orders and rules issued or made there under are included in s. 3 and shall be deemed to have been included at all material times in it. In other words, what s. 3 provides is that by its orders and force, the respective cesses will be deemed to have been recovered, because the provisions in relation to the recovery of the said cess has been incorporated in the Validation Act itself. The command under which the cess would be deemed to have been recovered would, thereforee, be the command of Parliament, because all the relevant sections, notifications, order and rules have been adopted by the parliamentary statute itself.
8. As already noticed, the Supreme Court had the occasion to consider the question of interest payable on an arrear of cess under s. 3(3) of the Cess Act in Mahalakshmi sugar Mills Co.'s case : 123ITR429(SC) . Their Lordships expressed that the interest payable on an arrear of cess under s.3(3)is in reality part and parcel of the liability to pay cess and it is an accretion to the cess. The enlargement of the cess liability is automatic under s. 3(3) of the Cess Act no specific order is necessary in order that obligation to pay interest should accrue. It was then held (pp. 433 and 434) :
' It is not a penalty, for which provision has been separately made by s. 3(5). Nor is it a penalty within the meaning of s. 4 which provides for a criminal liability and criminal prosecution. The penalty payable under s. 3(5) lies in the discretion of the collecting officer or authority. In the case of the penalty under s. 4, no prosecution can be instituted unless, under s. 5(1), a complaint is made by or under the authority of the Cane Commissioner or the Direct Magistrate. There is another consideration distinguishing the interest payable under s. 3(3) from the penalty imposed under s. 3(5). Section 3(6) provides that the officer or authority empowered to collect the cess may forward to the Collector a certificates under his signature specifying the amount of arrears including interest due from any person, and on receipt of such certificate the Collector is required to proceed to recover the amount specified from such person as if it were an arrear of land revenue. The words used in s. 3(6) are ' specifying the amount of arrears including interest', that is to say, that the interest is part of the arrear cess. In the case of penalty imposed under s. 3(5), a separate provision for recovery has been made under s. 3(5),a separate prevision for recovery has been made under s.3(7). Although the manner of recovery provided by s. 3(6) of the arrears of cess, the Legislature dealt with it is as something distinct from the recovery of the arrears of cess including interest. In truth the interest provided for under s. 3(3) is in the nature of compensation paid to the Government for delay in the payment of cess. It is not be way of penalty. The provision for penalty as a civil liability has been made under s. 3(5) and for penalty as a criminal offence under s. 4'.
9. 'Cess', 'interest' and 'penalty' are separate and distinct under the Cess Act at all material times. The liability to pay interest or penalty arises under the cess act only when payment of the cess is not made on the due date. The definition of cess in the Validation Act does not advance the case of the assessed, as contended, that the cess includes interest or penalty. The definition of cess given in the Validation Act is only for the purpose of the Validation Act and for the purpose of the Cess Act. By s. 3 of the Validation Act, Parliament validated the imposition and collection of cesses under the State Act during a certain period and for that reason the expended meaning was given to the cess, meaning the cess payable under any state Act any includes any sums recoverable under any such Act by way of interest or penalty. The State Government went on imposing, assessing and collecting cess from various sugarcane factory owners under the Cess Act. Some of them did not pay the amount of cess and, thereforee, become liable to pay interest and also penalty. The penalties were imposed, assessed and collected. The Cess Act was declared as ultra virus with the result that the entire amount of cess, interest and penalty that had been collected by the State Government become am illegal recovery under a void statue and, thereforee, had to be refunded. The effect of the Validation Act is that the cess including interest or penalty imposed, assessed or collected became valid by a deeming fiction of the Validation Act. In s. 3, however, the Legislature used the word ' cess ' only and defined the same in s. 2(a). The definition of the word ' cess' was with a different purpose and not giving an extended meaning to cess as used in the Cess Act. We are fortified in this view by a Division Bench of his court in CIT v. Upper Doab Sugar Mills Ltd. : 85ITR489(Delhi) .
10. There is a catena of authorities right from Haji Aziz and Abdul Shakoor Bros. v. CIT : 1983ECR1942D(SC) , that infraction of law is not normal incident of business. The expenses which are permitted as deductions are such as are made for the purpose of the carrying on of the business. An expenditure is not deductible unless it is a commercial loss in trade. A penalty imposed for breach of law cannot be said to be an expenditure wholly and exclusively laid out for the purpose of business. The penalty of Rs. 20,095 paid by the assessed is because, in conducting its business, it has acted in a manner which has made it liable to penalty. The liability to pay penalty is not automatic. The liability to pay arises as a result of default in making the payment of the cess, but quantified only after following the procedure laid down in rule 8. It ultimately arises as a result of the imposition of the penalty by the officer or authority empowered to collect the cess when it is discovered that the assessed has committed a breach of the provisions of s.3 of the Cess Act. In this case, there is even a finding by the Tribunal that there is no evidence in support of the submission that the assessed could not pay the cess in time as the funds were otherwise needed or locked up in the business. The payment of the penalty, thereforee, could not be incidental to the business. Such expenses incurred on account of the penalties levied fro a breach of the law cannot be said to be laid out for the purpose of the business of the assessed. We are of the opinion that the case is also covered against the assessed by the observations of the Supreme Court in Mahalaxmi Sugar Mills Co. : 123ITR429(SC) .
11. For the above reasons, we answer the question in the negative, i.e., against the assessed and in favor of the Department. We make no order as to costs.