1. These four references under s. 256(1) of the Income-tax Act, 1961 (hereinafter referred to as 'the Act'), at the instance of the Department, raise the following question of law for the opinion of the court :
'Whether, on the facts and in the circumstances of the case, the Tribunal was legally right in holding that the amount of Rs. 4 lakhs paid by the assessed was not in the nature of penalty for infraction of municipal laws or bye-laws and was thereforee a permissible deduction in arriving at the profits of the business ?'
2. The facts are that in the returns filed for the assessment years 1968-69, 1969-70, 1970-71 and 1971-72, the relevant previous years ending on March 31, 1968, March 31, 1969, March 31, 1970, and March 31, 1971, respectively, the assesseds claimed a deduction of Rs. 4 lakhs having been paid as alleged penalty levied under s 195 of the Punjab Municipal Act, 1911. The assesseds are a partnership firm formed on January 1, 1967, for the purpose of construction of a multi-storeyed building called as 'Himalaya House' at 23, Curzon Road, New Delhi, and for the purpose of selling the major portions of the said building in the form of flats to various customers. The construction of the building was started in June, 1967. According to the plan, sanctioned by the New Delhi Municipal Committee, originally the building was to consist of 13 storeys. According to the bye-laws of the New Delhi Municipal Committee the floor area of the first floor could cover 50% and from 2nd floor upwards only 35%. The assessed, however, exceeded the permissible floor area of the second floor and in place of 35% covered 50%. On March 9, 1970, the assesseds submitted a fresh plan for permission to construct only 12 storeys in place of 13 storeys sanctioned in the original plan on March 24, 1967, in view of the fact that there was excess construction in the second floor. In the revised plan which was submitted on March 9, 1970, the total floor area of 12 storeys amounted to about 1,72,000 sq.ft. which was less than the total floor area of 13 storeys sanctioned in the original plan.
3. The revised plans were laid for consideration before the Plans Sub-Committee of the New Delhi Municipal Committee on March 21, 1970, which by its minutes recorded at Seriall No. 376 recommended to the committee as under :
'The plans Sub-Committee recommends that occupation certificate for 4 months be allowed except for 2nd floor subject to the condition that the party should rectify all the defects as pointed out and also deposit Rs. 2.5 lakhs towards the penalty amount of it and as imposed.'C' form (i.e., completion certificate) be allowed on payment of the amount mentioned above. The case is laid before the Committee for consideration.'
4. The Committee by its resolution No. 7 dated April 3, 1970, approved the minutes of the Plans Sub-Committee and thereby adopted its recommendations. This resolution dated April 3, 1970, of the Committee was communicated to the assessed on the same day. The assessed protested against what they called a heavy fine being imposed. The representation of the assesseds was thereupon placed before the Plans Sub-Committee of the New Delhi Municipal Committee which, in its meeting on April 7, 1970, considered all the aspects, obtained reports of the various departments of the New Delhi Municipal Committee and finally made the following recommendations :
'RECOMMENDATION OF THE PLANS SUB-COMMITTEE
The Plans Sub-Committee considered carefully all the aspects of the case. It was clarified by the C.A. that open (should read even) Though the coverage on second floor, in this case, has been 50% instead of the permissible 35% the total floor area ratio has not been exceeded because the party has eliminated construction of the top floor. That being so, instead of insisting on the demolition of the unauthorised portion (which would naturally affect the whole building) the Committee feels that this may be condoned on payment of an ad hoc penalty by the party. With regard to the structural deviations from the sanction (the word 'plan' or 'construction' seems to be missing) the party has given the estimated cost of Rs. 2,45,565 on which they are liable to pay a penalty of 35%.
The 3rd deficiency in the case is with regard to the construction done after the expiry of the validity period of the plans, i.e., from March 9, 1969, onwards. The party's contention that they made no major construction after that cannot be accepted without a proper check. The only evidence produced by the party is that one N.D.M.C.'s Inspector had reported in July, 1969, that the building was ready except fittings of windows, etc.
Considering all the factors carefully, the Plans Sub-Committee recommends that the irregularities (including the additional coverage on the 2nd floor even though the same (is) within the permissible coverage Floor Area Ratio) be condoned and the revised plans be approved subject to :
(a) payment of an ad hoc penalty of Rs. 4 lakhs;
(b) undertaking from the party that they would not claim any additional Floor Area Ration in lieu of their deletion of the top floor proposed in the original plan.
To this the party has also agreed. The occupation certificate as already been sanctioned by the Plans Sub-Committee in its meeting held on March 21, 1970. The case is laid before the Committee for consideration.'
5. On the same date, i.e. April 7, 1970, the assesseds were informed about the recommendations of the Plans Sub-Committee. The assesseds agreed to pay the composition fee of Rs. 4 lakhs but claimed that they met the President of the New Delhi Municipal Committee and represented to him that they may be permitted to deposit Rs. 2.5 lakhs to start with and the balance of Rs. 1.5 lakhs within one month. A sum of Rs. 2.5 lakhs was deposited by the assesseds with the Committee on April 8, 1970. The recommendations of the Plans Sub-Committee came up for consideration before the New Delhi Municipal Committee on April 10, 1970, when it passed the following resolution :
'Resolved that the minutes of the meeting of the Plans Sub-Committee held on April 7, 1970, be approved.'
'Regarding item No. 57 relating to Himalaya House, 23, Curzon Road, it was pointed out that the party had put in an application asking for payment of the penalty money in Installments over a period of 2 years. To this P.M.C. (President of the Municipal Committee) has not agreed. He, however, was agreeable to accept party's request only to the extent that they pay, in advance Rs. 2,50,000, and for the balance they could be given a time of one month provided a bank guarantee is furnished and wanted the committee to accept it as post dated cheque. To this also the P.M.C. (i.e., President of the Municipal Committee) has not agreed and has asked them to pay the whole amount before the plans are released.
The Committee endorsed the action taken by P.M.C.'
6. The assesseds were informed about this resolution and deposited the balance of Rs. 1.5 lakhs with the committee on April 10, 1970.
7. It would be seen that the revised plans submitted by the assessed were sanctioned and the deviation in the construction of the second floor by the assessed were compounded and condoned by the acceptance of Rs. 4 lakhs. The assesseds, however, received a show-cause notice from the New Delhi Municipal Committee, as to why the resolution dated April 10, 1970, be not rescinded or revoked and withdrawn. Ultimately, despite the representations made by the assesseds, the New Delhi Municipal Committee in its meeting dated May 18, 1970, revoked and rescinded the earlier resolution. The assesseds then filed a writ petition under art. 226 of the Constitution in this court. It was held :
'The responsibility for issuing a completion certificate in accordance with the bye-laws of the New Delhi Municipal Committee is on it. It has nothing to do with the Delhi Development Authority. Vis-a-vis the New Delhi Municipal Committee the plans must be regarded as sanctioned and so it is under a duty to issue completion certificate as well as an occupation certificate. The New Delhi Municipal committee by compounding the deviation has estopped itself from ordering prosecution of the petitioners. A writ must, thereforee, issue restraining them from prosecuting the petitioners in respect of Himalaya House or the deviations therein. With regard to the prayer of the petitioners to issue a similar writ against the Delhi Development Authority, it must be rejected inasmuch as I have already held that the Delhi Development Authority has no power to prosecute in non-development areas.'
8. The New Delhi Municipal Committee's Letters Patent Appeal was dismissed by a Division Bench of this court.
9. The first year's accounts were closed on March 31, 1968. The construction period, thereforee, falls in account years relevant to assessment years 1968-69 to 1971-72. As the work of construction of the building progressed, the assessed received Installments of the agreed price in advance from the customers who had booked their flats. The flats were finally handed over to the customers in the previous year relevant to the assessment year 1971-72. In the returns filed, the assessed claimed a deduction of the sum of Rs. 4 lakhs having been paid as alleged penalty levied under s. 195 of the Punjab Municipal Act, 1911, which was made applicable to the Union Territory of Delhi, as a permissible deduction in arriving at the profits of its business. The building activities in the area within the jurisdiction where the said Act applied are governed by ss. 189 to 195A of the Punjab Municipal Act, 1911. Penalties for contravention of the provisions of the said Act have been set in s. 195. Under this section, a penalty for infringement of building bye-laws can be in three forms :
(i) the N. D. M. C. may require the building to be altered in such manner as it may deem necessary, or
(ii) it may require the building to be demolished, or
(iii) instead of requiring the alteration or demolition of any such building, the Committee may require the payment of such sum as it may deem reasonable.
10. The ITO observed that the assesseds had not constructed the building according to the sanctioned plan and had, thereforee, infringed the provisions of the municipal bye-laws. According to the ITO the principal infringement was in respect of covered 50% of the area instead of permissible limit of 35%.The ITO further observed that there were some other minor infringements, i.e., alterations. In view of these infringements, the New Delhi Municipal Committee could have required the assesseds to demolish the building or to make the requisite alterations. However, after considering all the facts, the N.D.M.C. decided to levy ad hoc penalty of Rs. 4 lakhs for infringement of the relevant bye-laws by its resolution dated April 10, 1970. The ITO was, thereforee, of the opinion that from the above it would be clear that the N. D.M.C. levied penalty of Rs. 4 lakhs on the assesseds for the infringement of the municipal bye-laws. Rejecting the assesseds' contention that this sum of Rs. 4 lakhs was necessary expenditure laid out wholly and exclusively for the purpose of the assesseds' business of construction and sale of flats and it was compounding fee and not penalty, the ITO held that he did not agree with the contention of the assesseds.
11. In appeal before the AAC, the assesseds contended that the payment of Rs. 4 lakhs was made in the course of or was incidental to the carrying on of assesseds' business and to promote best interest of the business. It was further urged that in April, 1970, when the penalty of Rs. 4 lakhs had to be paid, the building was complete for occupation and the buyers of the flats were pressing hard for handing over of the possession because, the covered area would fetch a monthly rent of Rs. 3 lakhs. The other alternative for the assesseds, it was contended, was to get the entire building demolished because there was an excess floor area of 7,000 sq. ft. on the second floor, according to the original sanctioned plan. If the building had been demolished, the entire business would have been extinguished and instead of earning profits, the assessed would have incurred huge losses in this business and, thereforee, it was in the interest of the assesseds' business to pay Rs. 4 lakhs to avoid this extinction of business and the resultant loss. The AAC was, however, of the opinion that the penalty imposed for breach of any law in the course of the carrying on of any business could not be described as a commercial or trading loss. If any assessed pays any penalty during the course of the carrying on of his business, he has acted in a manner which has rendered him liable to penalty, and hence, it cannot be claimed to be a permissible deduction. According to the AAC, the infringement of law is not a normal incidence of business and, thereforee, any expense incurred towards payment of penalty for breach of law, even though it might not involve any personal liability of the assesseds, cannot be said to be an expenditure wholly and exclusively laid out for the purpose of the business. The AAC rejected the plea of the assesseds and confirmed the disallowance.
12. The assesseds then went up in second appeal before the Income-tax Appellate Tribunal (for short called 'the Tribunal'). The Tribunal recorded several findings of fact. It found that the original plan for construction of the building was communicated to the assesseds on April 15, 1967, and the construction started in July, 1967, and the same was finished by July 25, 1969, but by that time certain finishing touches remained to be given. According to s. 195 of the Punjab Municipal Act, 1911, and the building bye-laws, sanction of plan is valid for two years from the date of the sanction and if the construction is started, then, one year from the date of construction. The Tribunal also found that the validity of the sanction expired on March 24, 1969, and the assesseds could not apply for revalidation before this date, but, on March 9, 1970, revised plans were submitted by the assesseds for revalidation and the New Delhi Municipal Committee was required to pass orders on the same within 60 days i.e., by May 7, 1970. The Tribunal then noticed the resolution passed by the Plans Sub-Committee of the New Delhi Municipal Committee forwarding revised plans and the ultimate resolution of the New Delhi Municipal Committee accepting the recommendations of the Plans Sub-Committee. The Tribunal also took notice of the decision of the learned single judge and a Division Bench of this court in the writ petition filed by the assesseds and the appeal filed by the New Delhi Municipal Committee respectively. The Tribunal then considered the admissibility of the claim of the assessed under s. 28 of the Act. It took the view that the expression used in the proviso to s. 195 of the Punjab Municipal Act, 1911, is compensation and not penalty and, thereforee, it cannot be said that it was penalty for i infraction of law. It further expressed the opinion that the expression 'penalty of Rs. 4 lakhs' used in the resolution of the Plans Sub-Committee of the New Delhi Municipal Committee or any other resolution or communication is a misnomer. It held that the amount of Rs. 4 lakhs was consideration or price for getting the assesseds had to incur during the course of carrying on the business of the assesseds as the business was of constructing buildings and selling of parts of the building flatwise to the purchasers, The Tribunal took the view that the assesseds are entitled to claim deduction of Rs. 4 lakhs as in its view, the payment was made on ground of commercial expediency in the course of the construction activity of the assesseds and with a view to preserve the construction business of the assesseds and there was no question of any infraction of law in the case.
13. At the outset, we may notice the provisions of the Punjab Municipal Act, 1911, as extended to Delhi (hereinafter referred to as 'the Municipal Act') which has been in force in New Delhi since long and governs the building activities falling within the jurisdiction of the New Delhi Municipal Committee (for short called 'the Committee'). The assesseds' building called as 'Himalaya House' falls within the area of the jurisdiction of the committee and its construction is regulated by the provisions of ss. 189 to 195A and of the bye-laws framed by the Committee. Section 189 Prohibits a person from erecting or re-erecting any building without the sanction of the Committee and enjoins upon every person who intends to erect or re-erect a building to give a notice in writing to the Committee of the intention to do so in the prescribed form along with plans of the proposed building. Section 190 gives powers to the Committee to make bye-laws to regulate erection or re-erection of building within its area and provide for the material and method of construction, the height and slope of the building and roof and the ventilation to be provided, the drainage etc., the number of storeys, and all other matters incidental to erecting a building. Section 191 lays down that where no bye-laws have been made in respect of any matter pertaining to a building, the Committee may elicit information about it from the proposed builder. After all this has been done, the Committee is to grant sanction or refuse the same keeping in view its bye-laws. As provided by s. 193, the Committee must sanction or refuse sanction within 60 days of the submission of the plans and if it neglects or omits to do so, sub-section (4) of s. 193 lays down that the plans as submitted would be deemed to have been sanctioned except in so far as the same may contravene any bye-law or any building or town planning scheme which the Committee may make under s. 192. Punishment for erection or re-erection of a building in contravention of a scheme under s. 192 is provided by s. 192A. Every sanction for erection or re-erection of a building which is given by the Committee or is deemed to be given by it is to remain in force for one year from the date of sanction or such longer period as may be provided while granting the sanction and if the erection or re-erection of a building has not been commenced within one year and completed within two years of the sanction, or such longer period as may be indicated by the Committee, such a sanction is deemed to lapse and a fresh sanction for the building is to be obtained by virtue of s. 194 of the Act.
14. Penalty for disobedience is provided in s. 195 reading as follow :
'Penalty for disobedience. - Should a building be begun or erected or re-erected -
(a) without sanction as required by section 189(1); or
(b) without notice as required by section 189(2); or
(c) when sanction has been refused,
the Committee may be notice delivered to the owner within six months from the completion of the building require the building to be altered or demolished as it may be deem necessary within the period specified in such notice :
and should it be begun or erected
(d) in contravention of the terms of any sanction granted; or
(e) when the sanction has lapsed; or
(f) in contravention of any bye-law made under section 190; or, in the case of a building of which the erection has been deemed to be sanctioned under section 193(4) if it contravenes any scheme sanctioned under section 192;
the Committee may be notice to be delivered to the owner within six months from the completion of the building require the building to be altered in such manner as it may deem necessary, within the period specified in such notice :
Provided that the Committee may, instead of requiring the alteration or demolition of any such building, accept by way of compensation such sum as it may deem reasonable :
Provided also that the Committee shall require a building to be demolished or altered so far as is necessary to avoid contravention of a building scheme drawn up under section 192.'
15. Under s. 195A, it is provided that where a building has been commenced but not completed and contravenes any be-laws or sanctioned plans, the Committee may stop further building operation. A lawful order issued by the Committee under s. 195 or s. 195A, if not obeyed by the person concerned, makes him liable for prosecution under s. 219. Section 221 provides for penalty for obstruction punishable with fine which may extend to five hundred rupees. By virtue of powers conferred by s. 229, the Committee is authorised to compound offences committed under the Municipal Act by accepting a sum of money by way of compensation.
16. It may be noticed that the first part to s. 195 comprising of clauses (a), (b) and (c) which applies to buildings erected without sanction, or without notice under s. 189(2), enables the Committee to have the building altered or demolished. The second part of the section, namely, cls. (d), (e) and (f), relating to the building constructed in contravention of the sanction or of bye-laws or where the period of limitation during which the building could be constructed has run out, empowers the Committee to have the offending structure altered in such manner as the Committee may deem necessary. By the first proviso, the Legislature has, however, softened its rigour by providing that instead of requiring the alteration or demolition of such building, the Committee may accept by way of compensation such sum as it may deem reasonable. Section 195 ensures that the restrictions to be observed by the builders are enforceable either by alteration or by demolition or by accepting sums by way of compensation. It is thus clear that s. 195 does not create any penal offence but only provides for enforcing the statutory restrictions by the Committee against a builder who has the audacity to start construction or construct a building in disregard of statutory provisions.
17. Punishment for erection or-erection of a building in contravention of a building scheme under s. 192 is provided in s. 192A. There is a conviction for the offence and on conviction there is liability to pay fine which may extend to one thousand rupees. Section 199 enables the Committee to add a penalty clause in the bye-laws to be framed and gives teeth to the bye-laws making a breach thereof an offence punishable with fine which may extend to five hundred rupees. Section 219 make the disobedience of any lawful direction or prohibition given by the Committee an offence by statutory fiction if the disobedience or omission is not an offence punishable under any other section and provided for punishment with fine which may extend to five hundred rupees. Section 221 again creates an artificial offence and provides for punishment with fine which may extend to five hundred rupees. Power to compound the offences is conferred by s. 229. There is intrinsic evidence in the Municipal Act, drawing a distinction between the offence (and on its conviction imposition of fines) for which a discretion is vested in the Committee to 'compound an offence' and a disobedience, in which case, the Committee may accept by 'way of compensation' such sum as may seem reasonable.
18. The marginal note to s. 195 does mention 'penalty for disobedience' but cannot be construed as providing for an artificial offence. The marginal note cannot be relied upon for interpreting a section unless there is some ambiguity in the section. The marginal note is not decisive of the true intention. The section nowhere in its body uses the word 'penalty' or 'offence' or any 'punishment', or any 'composition' of an offence. The first proviso to the section refers to only 'compensation'. When the language of a section is clear and unequivocal, the word 'penalty' used in the marginal note cannot control the section. In our opinion, there is ambiguity in the section. The compensation here is for the breach of a regulatory procedure in the matter of ex post facto sanction of a building constructed in deviation of a sanctioned plan or when the sanction has lapsed. The ex post facto sanction obtained shows that there is no breach of a provision against public policy. The acceptance by way of compensation of a sum cannot be for any illegal act against public, It is for an act done in disregard of the formulates required to be complied with, The acceptance of Rs. 4 lakhs by the Committee in this case show that there was no breach, no violation or no infringement in the nature of infraction of law on which penalty is imposable. The statutory provision is s. 195 envisages the disobedience of statutory restriction, an offer by the assesseds and the acceptance by the Committee of a sum by way of compensation. The mandate of the Legislature is that on the acceptance of the compensation there is condensation of the disobedience of procedural requirement. This compensation is not a penalty payment to save the assesseds from criminal liability or criminal prosecution or to compound any offence committed by the assesseds.
19. Shri K. K. Wadhera, the learned counsel or the Department, urges that the assesseds in conducting their business have acted in a manner which has rendered them liable to penalty for infraction of the law. The penalty imposed upon the assesseds for a breach of law whcih they have committed in their business cannot be claimed as a deductible expense. A penalty imposed for breach of law during the course of trade cannot be described as a commercial loss. Infraction of law is not a normal incident of business, and for this reason no expense whcih is paid by way of penalty for a breach of the law can be said to be an amount wholly and exclusively laid out for the purpose of the business. The counsel urges that if during the course of business activities any assessed infringes any law and there upon was penalised, the payment of that penalty is not allowable either under s. 28 or s. 37 of the Act. Reliance is heavily placed on Haji Aziz and Abdul shakoor Bros. V. CIT : 1983ECR1942D(SC) , wherein it was held (at. p. 359) :
'A review of these cases shows that expenses which are permitted as deductions are such as 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 assessed 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 contemplable as such. Such penalties which are incurred by an assessed in proceedings launched against him for an infraction of the law cannot be called commercial losses incurred by an assessed in carrying on his business. Infraction of the law is not a normal incident of business and, thereforee, only such disbursements can be deducted as are really incidental to the business itself, They cannot be deducted if they fall on the assessed in some character other than that of a trader. thereforee, 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 assessed as a trader, the lest 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.'
20. It would be seen from the ratio extracted above that if an expenditure has been incurred for the purpose of carrying on the business, i.e., to enable a person to carry on and earn profit in that business, it would be treated as a permissible deduction. However, a penalty imposed for breach of law during the course of trade cannot be regarded as an allowable expenditure. The emphasis by the counsel for the Department, while relying upon a number of cases, is on the penalty imposed because of an infraction of law. We are noticing all these cases hereinafter with a short observation in each case. All these cases deal with either offences under the statutory provision or penalty paid for composition of those offences or for saving the assessed from criminal prosecution or payment of fine under the statutory provisions or breach of statutory provisions against a public policy. They clearly stand on a different footing from the compensation contemplated under s. 195 of the Municipal Act.
21. Reference is made by the counsel for the Department to Gabdulal Tulsiram, In re  21 ITR 330 (All) in which case a composition money was paid for understatement of stock insurable under the War Risks (Goods) Insurance Ordinance, 1940. That was a case where the amount was paid to the Central Government to compound the offence as is clear from the report. The next case relied upon is CIT V. Himalaya Rosin turpentine Mfg. Co , wherein an amount was paid under the lease of forest lands for illegal extraction of rosin and selling it. That was a case where the sum or Rs. 5,000 was not an item which was expended for the purpose of enabling the assessed to earn profits in the trade but was imposed as a penalty for the breach of the rules which had been made by the Durbar and which they had under the contract undertaken to observe. The next case is Juggilal Kamlapt Cotton Spg. and Wvg. Co. Ltd. V. CIT : 28ITR78(All) in which composition money was paid in respect of a proposal for prosecution for returning much less income in the return. In that case, the assessed paid the sum to compound the offence and the Inspecting Assistant Commissioner under s. 53(2) of the 1922 Act agreed to the offence being compounded on payment of the amount. The next case is CIT v. Prafulla Kumar Mallik : 51ITR65(Orissa) in which the supply of the paddy was not up to the specified standard and the Government levied penalty. In that case, the payment was a penalty for committing an act opposed to public policy, a policy that underlay the Essential Supplies (Temporary Prices) Act, 1946, read with the Orissa Foodgrains Control Order, 1951, and the Act left to the Government to enforce public policy. The next case is CIT v. Mathura Prasad Hardwar Prasad Deoria : 55ITR476(All) , wherein the penalty was imposed for wrongful import of goods. In that case, Pakistan had prohibited import of molasses into Pakistan from India. In spite of prohibition the assessed there imported molasses into Pakistan, but the goods were sized. The release of the goods were only against payment of penalty under Pakistan laws, though the exact provisions are not quoted in the report. It was for infraction of a law in force in Pakistan.
22. Next case is CIT v. Pannalal Narottamdas and Co. : 67ITR667(Bom) , in which case the assessed purchased bills of lading without knowledge that it import was unauthorised and later paid penalty to avoid confiscation. This case does not advance the case of the Department. In that case, on the facts and circumstances, it was held, that the actual cost of the goods to the assessed was not only what it had paid to the importers but in addition thereto what it had to pay by way of penalty in order to save the goods from being confiscated and lost to it. The penalty paid by it could, thereforee, be regarded as part of the cost of the goods to it. It can also be regarded as an amount expended by it wholly and exclusively for the purposes of the business, because unless the said amount was expended, the goods could not have been saved from confiscation. Other obiter observation are only on hypothetical basis. Next case is CIT v. Bhiwandiwalla & Co, : 79ITR467(Bom) , where litigation expenses were not allowed as a business expenditure, Thus case does not deal with penalty. In that case, it was found as a fact that the litigation expenses were incurred not for the promotion of the business, not for the purpose of continuing its existence so as to enable the assessed to earn profits, not for the purpose of avoiding a threat to its destruction. The object of the litigation was to recover by way of damages what the assessed had been made to lose by the stoppage of its business. Consequently, the litigation expenses were not allowed as a revenue expenditure incurred in the assessed's business. Next case is Lakshmi Narayan Gouri Shankar v. CIT : 100ITR143(Patna) , where the penalty was imposed under the Sea Customs Act, In that case, the assessed incurred a loss by reason of penalty for release of confiscated goods and personal penalty for infraction of the Sea Customs Act. Next case is Cineramas v. CIT where the amount paid by the assessed by way of penalty to the East Punjab Motion Picture Association was not allowed as revenue expenditure. In that case, a member failing to carry out the directions of the association would be suspended from the membership and would be eligible to be reinstated on payment of a specified amount of penalty in addition to reinstatement charges. It was opinion there that the breaches of the obligations are skin to infraction of law and damages paid in connection with such infraction and breaches are not expenditure laid out or expended wholly and exclusively for the assessed's business. Next case is Raghubir Prasad Gupta v. CIT : 120ITR789(Cal) , wherein an amount paid to the Customs authorities by way of fine in lieu of confiscation of goods imported without license was disallowed. In that case, it was imposed because of an infraction of law entailing a penal consequence by way of payment of fine either for the release of the confiscated goods or for the personal penalty imposed upon the assessed. Next case relied upon is CIT v. Malwa Vanaspati and Chemical Co. Ltd. : 135ITR221(MP) wherein the penalty was levied and paid under the M. P. General Sales Tax Act but not allowed as expenditure. In that case, a penalty was imposed under s. 8(2) of the M. P. General Sales Tax Act, 1958, where any raw material purchased under s. 8(1) is utilised for a purpose other than a purpose specified in s. 8(1). Liability to penalty under s. 8(2) is not automatic and arises as a result of imposition of the penalty when it is discovered that the assessed has committed a breach of the provision of s. 8(1). Similarly, the liability to penalty under s. 17(3) is also not automatic and arises as a result of imposition. It is penalty for breach of statutory provision against public policy and would be imposed for infraction of law. Next case is CIT v. Upper Doab Sugar Mills Ltd. : 85ITR489(Delhi) , wherein it was held that the interest and penalty paid under the U. P. Sugar Cane Cess Act, 1956, was not an allowable deduction. We may point out that this decision has been revered by the Supreme Court in Mahalakhsmi Sugar Mills C. v. CIT : 123ITR429(SC) , wherein it was held that interest payable on arrears is an allowable business expenditure. It was held as not a penalty, for which provision has been separately made nor it is a penalty which provides for criminal liability and criminal prosecution.
23. The question whether the amount of Rs. 4 lakhs paid by the assessed was or was not in the nature of penalty for infraction of municipal laws and bye-laws has to be answered in favor of the assesseds. Expenses which are permitted as deductions are such as are made for the purpose of carrying on business. They are for the purpose of keeping the business going and of making it pay; they are to enable a person to carry on and earn profit in that business. Any expenditure laid out or expended wholly and exclusively for the purpose of business is an allowable deduction in computing the income. What is money wholly and exclusively laid out for the purpose of trade is a question which has to be determined upon the principles of ordinary commercial trading or on the grounds of commercial expediency. The payment of Rs. 4 lakhs was made in the course of the assessed business of the assesseds, inasmuch as without paying this amount the assessed could not have completed the building, according to the plans, lawfully. The payment was vital for the assesseds ' business which consisted in the construction of the building and its sale flat-wise. The expenditure was for saving of the losses of the alteration of the closing stock of the assessed. The expenses incurred were to preserve or in other words to save it from extinction.
24. The courts have considered claims for deduction, whether allowable or not, in several cases cited at the Bar. In CIT v. Prafulla Kumar Mallick : 73ITR119(Orissa) , the questions arose before the Orissa High Court as to whether penalties levied for supply of foodgrains not conforming to contract quality was a permissible deduction under s. 10(1) of the 1922 Act. It was held that it was an inevitable consequence of the assessed's business as a paddy procuring agent that as a result of the goods delivered not being of contract quality, breach of guarantee, with the risk of liability to pay damages, should at times be committed and payment of such damages to pay damages, should at times be committed and payment of such damages as a result of the breach of guarantee in the course of or as a consequence earning profits and gains was incidental to the carrying on of the assessed's business. It was ruled that it was an unavoidable loss arising as one of the consequences of carrying on of such business and the sum paid by the assessed by way of penalty to the Government was an admissible deduction in computing the profits under s.10 (1)of the 1922 Act. Again in Govind Choudhury & Sons. v. CIT : 79ITR493(Orissa) , the Orissa High Court held that payment of similar penalty was integrally connected. In CIT v. J. K. Cotton Spg, & Wvg. MIlls Co. : 123ITR911(All) , the case came up before the Allahabad High Court, where the assessed which was engaged in the manufacture of cloth, was recognised as registered user of a trade mark and one of the conditions laid down for the use of the trade mark and one of the conditions laid down for the use for the trade mark was the export of certain percentage of fabrics manufactured under the trade mark. In the event of non-fulfilling of the export obligation, the assessed was to deposit in Government account a penalty of 10% per liner yard of the annual shortfall of the annual export. At the end of the seven year-period a final review of the cumulative performance of the assessed was to be made and where admissible a refund of the deposit was to be made. The assessed paid the amount for the shortfall in export and claimed deduction of the amount paid by it as a penalty. It was held that the payment was not made for infraction of law. It was on account of a contractual obligation imposed by the Government and the breach was in the contemplation of the parties amounting to a risk in the carrying on of business and was a commercial loss. In CIT v. Reliable water Supply Service of India (p.) Ltd. : 124ITR199(All) , the question arose before the Allahabad High Court in the case of an assessed company who undertook contracts for construction of tubewells and supplying of stores. The assessed paid an amount to the Government Departments form whom it had taken certain contracts as penalty and damages for delay in the execution of the contracts. It was held that the delay was inherent in the nature of business carried on by the assessed and the payments were incidental to the carrying on of the business and thus the amount was deductible in computing the assessed's profits. In CIT v. R. D. Sharma & Co. : 137ITR333(Bom) , the penalty was levied for non-completion of contract within the stipulated time. The Bombay High Court held that since the assessed carried on the business of building contracts, it was not unusual that in the performance of such contracts, delay might occur for several reasons and if delay occurred there was a breach of the conditions relating to the completion of the contract work within the stipulated time and such failure if it occurred, was clearly incidental to the business of the assessed. It was observed that though the amount of deduction was described as a penalty, yet, in fact, it was really a compensation payable by the assessed to the Government and the nature thereof was wholly different form a penalty which arose from a breach of a statutory provision. The assessed was held entitled to the deduction of the amount paid to the Government.
25. In CIT v. Vasantha MIlls Ltd. : 120ITR321(Mad) , the assessed there, a textile mill, was directed under clause 21A(1) of the Cotton Textiles (Control) Order, 1948, to produce a particular variety of cloth but it did not comply with those directions but paid a sum of Rs. 30,872 in lieu there of as provided in clause 21A(1)(b) of the said Order. The Tribunal took the view that as the assessed was given an option either to produce cloth or to make the payment, there was nothing wrong in the assessed's thinking that it was advantageous to make the payment rather than produce the cloth and suffer a loss and hence the payment will not cease to be made wholly and exclusively for the purpose of the business. The view of the Tribunal was upheld by the Madras High Court by holding that the payment was business expenditure within the meaning of s. 37(1) of the 1961 Act. A similar view on similar facts was held by the Madras High Court in CIT v, Rajkumar Mills Ltd. : 135ITR811(MP) and the Bombay High Court in CIT v. Chemicals and Fibres of India Ltd. : 142ITR413(Bom) .
26. The Supreme Court had also occasion to consider in several cases the scope of the expression for the purpose of the business. In CIT v. Malayalam Plantations Ltd. : 53ITR140(SC) , it was expressed that the expression 'for the purpose of the business' is wider in scope than the expression 'for the purpose of earning profit.' Its range is wide, it may take in not only the day to day running of the 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 protection of its assets and property from misappropriation, 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 carrying on of a business; it may comprehend many other acts incidental to carrying on of business. The purpose shall be for the purpose of the business, that is to say, the expenditure incurred shall be for the carrying on of a business and the assessed shall incur in its capacity as a person carrying on its business. Again in Bombay Steam Navigation Co. (1953) P, Ltd. v. CIT , their Lordships expressed that in considering whether expenditure is revenue expenditure, the court has to consider the nature and the ordinary course of business and the objects for which the expenditure is incurred. The question whether a particular expenditure is a revenue expenditure incurred for the purpose of business must be viewed in the larger context of business necessity or expediency. If the outgoing or expenditure is so related to the carrying on or conduct of the business that it may be regarded as an integral part of the profit earning process and not for acquisition of an asset or a right of permanent character, the possession of which is a condition of carrying on of a business, the expenditure may be regarded as a revenue expenditure. In India Cements Ltd v. CIT : 60ITR52(SC) , the assessed obtained a a loan of Rs. 40 lakhs from the Industrial Finance Corporation secured by a charge on its fixed assets and in that connection it spent a sum of Rs. 84,633 towards,, stamp duty, registration fee, lawyer's fee, etc., and claimed this amount as business expenditure. The act of borrowing money was incidental to the carrying on of business, the loan obtained was not an asset or advantage of enduring nature and thus the expenditure made for securing the use of money for a certain period is deductiable from the receipts of the business to ascertain the taxable income. It was an outgoing by means of which the assessed procured the use of a thing by which he makes a profit. In Sree Meenakshi Mills Ltd. v. CIT : 63ITR207(SC) , it was held that the deductibility of the expenditure incurred in prosecuting a civil proceeding depends upon the nature and cannot be affected by the final outcome of that proceeding. However wrong headed, ill-advised, unduly optimistic or over confident in his conviction the assessed might appear in the light of the ultimate decision, expenditure in starting and prosecuting a civil proceeding cannot be denied as a permissible deduction in computing the taxable income merely because the proceeding had failed,, if otherwise the expenditure was laid out for the purpose of business wholly and exclusively, i.e., reasonably and honestly incurred to promote the interest of the business. In CIT v. Dhanrajgirji Raja Narasingirji : 91ITR544(SC) , the question was whether the amount spent by the assessed for criminal litigation was whether the amount expenditure under s. 10(2)(XY) of the 1922 Act. The Tribunal found that the criminal case was instrumental in bringing about the compromise and that the expenditure was bona fide incurred by the assessed for the purpose of his business. The Lordships of the Supreme Court held that the assessed had incurred the expenditure for the purpose of his business. It was for the assessed to decide how best to protect his own interest. It was the duty of the assessed to see that the prosecution was properly conducted. The fact that he did not leave the carriage of the case in the hands of the prosecuting agency of the Government was no ground to disallow the expenditure and it was not open to the Department to prescribe what expenditure an assessed should incur and in what circumstances he should incur that expenditure.
27. The charge is not on gross receipts but on profits and gains property so called. The profits to be assessed are real profits and they must be ascertained on ordinary principles of commercial expediency. The partnership was formed for the purpose of construction of a multi-storeyed building called as Himalaya House and for the purpose of selling the major portions of the said building in the form of flats to various customers. The assessed got the original building plans sanctioned and commenced the constructions. The assessed had no right to make deviations from the sanctioned plan or to continue the construction after the sanction had lapsed. Any constructions thus made would be deemed to have been erected without a proper sanction. The Committee, however, has the power to sanction revised plans so as to regularise the deviations or give ex post facto sanction for the constructions made after the sanction had lapsed by accepting by way of compensation such as it may deem reasonable. It is at that stage that the assesseds had to consider the question of payment on the principles of ordinary commercial trading or on grounds of commercial expediency. Seen in the light of the law noticed above, the assessed had the desire to preserve the building and to save a part of it from demolition. The expenditure was for saving of the loss on the alteration of the closing stock of the assessed. Such an expenditure has to be permitted as a deduction made for the purpose of carrying on of business. The question whether a particular expenditure is a revenue expenditure incurred for the purpose of business must be viewed in the larger context of the assesseds' business, necessity or expediency. The expenditure of payment of compensation incurred by the assesseds has to be regarded as an integral part of the profit-earning process of the assesseds. The portion of the buildings thus saved from alteration of demolition remained as a business stock available for sale flat-wise. The assessed by this outgoing of Rs. 4 lakhs procured the portion of the building by which the assesseds made profit. The payment is not in the nature of penalty for infraction of law and is a right in holding that it is a permissible deduction in arriving at the profit of business of construction and sale of building, the outgoing being allowed in one assessment year.
28. We answer the reference against the Department and in favor of the assesseds with costs. Counsel's fee Rs. 500.
29. Reference answered in the affirmative.