B.K. Mehta, J.
1. In order to appreciate the contentions urged on behalf of both the sides for and against the questions referred to us, we set out the relevant facts and circumstances under which this reference has been made.
2. The assessee is a public limited company carrying on the business of manufacture and sale of textiles. The relevant previous year to the assessment year 1971-72 is calendar year ending on December 31, 1970. The assessee follows the mercantile system of accounting. In the course of the assessment proceedings, the assessee claimed deduction of three amounts, namely, (1) Rs. 3,15,674, (2) Rs. 35,193 and (3) Rs. 10,910. The first deduction was claimed in respect of compensation paid by the assessee-company for non-production of controlled variety of coarse cloth as required by the Government under the scheme framed by the Textile Commissioner under the Cotton Textiles (Control) Order, 1948. The Income-tax Officer disallowed this claim without assigning any reasons. The Appellate Assistant Commissioner in appeal against the said disallowance affirmed the order of the Income-tax Officer in view of his earlier order for the assessment year 1969-70, where a similar disallowance was upheld for the reasons stated therein. In further appeal to the Tribunal against the said disallowance, the Tribunal, following its earlier decision in Income-tax Officer v. Rustam Jehangir Vakil Mills Ltd., wherein the Tribunal had an occasion to consider an incidental question, allowed the deduction. In view of that decision, the Tribunal upheld the assessee's claim for the first deduction.
3. The second deduction was on account of the amount paid by the assessee-company for non-fulfilment of its export obligations which were entailed on the assessee-company under the special permission granted by the Textile Commissioner, Bombay, bearing No. 11 (405) 65-MP, dated August 7, 1965, and the bond executed by the assessee-company in favour of the President of India for incorporating automatic looms. The assessee-company was required to pay the said amount of Rs. 35,193 which was stated to be a penalty payable by the assessee-company as a result of shortfall in its export obligations prescribed under the said permit. This special permit was granted by the Textile Commissioner in exercise of his power under clause 12 (6) of the Cotton Textiles (Control) Order, 1948, read with his Notification No. TSCI (11) /60, dated December 14, 1960, permitting the assessee-company to acquire and install 24 automatic looms subject to the conditions mentioned in the said permission. There were six conditions laid down in the special permit subject to which the assessee-company was permitted to import automatic looms. Conditions Nos. 4, 5 and 6 were the important conditions in the sense that they have got a bearing on the questions referred to us. The said conditions read as under :
'4. That the mill agree to export cloth to the extent of 50% of the production equated at 12,500 metres per loom per year for five years.
5. That the mill will maintain export of cloth to the extent of 50% of the average annual exports during the year 1959, 1960, 1961, for five years.
6. That the mill will execute a bond in favour of the President of India to cover the shortfall in exports at the rate of 11 paise per metre in the form and manner prescribed by the Textile Commissioner to the Government of India.'
4. In pursuance of condition No. 6, the assessee-company executed a bond in favour of the President of India on June 17, 1965, agreeing and undertaking to pay Rs. 4,11,401.65 to the Government of India being the amount calculated at the rate of 11 paise per metre on the total quantity of cloth which the assessee was required to export under the special permission granted by the Textile Commissioner and the part payment of the aforesaid amount, viz., Rs. 82,280.33, was further guaranteed by M/s. Narotham Lalbai & Co., a Partnership firm having its main office at Ahmedabad who were the managing agents of the assessee-company at the relevant time. It appears that, according to the special permission, the assessee-company was required in the relevant block of five years, viz., from 1965 to 1969, to export in all 32,94,603 metres of cloth against which the assessee-company actually exported about 29,74,671 metres resulting in a shortfall of 3,19,932 metres as required by the special permission and the bond executed in pursuance thereof. The assessee-company, therefore, at the prescribed rate of 11 paise per metre was required to pay Rs. 35,192.52 to the Government of India to cover the aforesaid shortfall which the assessee-company did pay in the relevant accounting year. It is this amount which the assessee-company has claimed as business expenses before computation of its profits. This claim was negatived by the Income-tax Officer on the ground that the assessee-company by not honouring its export commitments had acted in contravention of its public policy, namely, of earning foreign exchange so as to recoup the expenditure towards foreign exchange incurred earlier by import of the machinery of automatic looms. The Income-tax Officer, therefore, disallowed the claim treating this amount as akin to penalty. In appeal, the Appellate Assistant Commissioner confirmed the view of the Income-tax Officer and disallowed the claim. The assessee-company, therefore, carried the matter in further appeal before the Tribunal. The Tribunal in its detailed order considered the various judicial pronouncements on this point of different High Courts and the Supreme Court and relying on the decision of the Allahabad High Court in Central Trading Agency v. Commissioner of Income-tax : 56ITR561(All) was of the opinion that the assessee-company made the payment of Rs. 35,193 as a result of the contract contained in the bond executed by the assessee-company in favour of the President of India and the right of the Government to take any action for breach of condition was not in any way affected by reason of the fact that the assessee made the requisite payment for non-fulfilment of the export quota. In other words, the Tribunal was of the opinion that the assessee-company could not absolve itself from the legal consequences which might flow or follow from the breach of the relevant provisions. The Tribunal, therefore, allowed the appeal of the assessee-company and accepted the claim for deduction.
5. The third deduction of Rs. 10,910 was in respect of the expenses incurred by the assessee-company to furnish bank guarantee to the Textile Commissioner for securing the payment to be made by the assessee-company for the shortfall in the company's export obligations for its use of the trademark 'sanforized'. One of the conditions under which the assessee-company was registered as an user of trademark 'sanforized' was that the assessee-company would export such percentage of cloth sanforized by the assessee-company as the Government of India might from time to time determine. The Government of India accordingly determined for the period commencing from July, 1963, to November, 1965, that the assessee-company should export 5 per cent. of the value of the production of the sanforized cloth produced by it during the said period. An agreement was entered into on March 5, 1970, between the President of India and the assessee-company and in accordance with clause 3 of the said agreement if the assessee-company failed in any year to export minimum of 10 per cent. of the production as stipulated in the said agreement, the assessee-company agreed either to pay to the Government a sum at the rate of 10 paise per linear yard for the quantity of cloth falling short of the minimum quantity of sanforized cloth agreed to be exported in accordance with clause (1) of the agreement or to furnish a bond supported by a bank guarantee by 30th June of the following year for payment of the said amount to the Government. The assessee-company furnished a bank guarantee accordingly for which it was required to make payment of the requisite bank guarantee charges. The claim on this count also met the same fate as in the case of the other two deductions before the Income-tax Officer and the Appellate Assistant Commissioner. However, before the Tribunal the assessee-company succeeded as the Tribunal was of the opinion that the said claim should be allowed as a revenue deduction in computing the total income of the assessee. The following three questions have, therefore, been referred to us at the instance of the revenue.
'Whether, on the facts and in the circumstances of the case, the payment of Rs. 3,15,674 made to the Textile Commissioner under the provisions of the Cotton Textiles (Control) Order, 1948, was an allowable business expenditure under section 37 or section 28 of the Act of 1961
(2) Whether, on the facts and in the circumstances of the case, the Tribunal was right in law, in holding that the payment of Rs. 35,193 by the assessee-company was an allowable expenditure under section 37 or section 28 of the Act of 1961
(3) Whether, on the facts and in the circumstances of the case, the Tribunal was right in law, in allowing the deduction of Rs. 10,910 as business expenditure under section 37 or section 28 of the Act of 1961 ?'
6. At the time of hearing of this reference, so far as question No. 1 is concerned, no further contentions have been urged beyond what were stated before a Division Bench of this court in Income-tax Reference No. 14 of 1974 with Income-tax Reference No. 16 of 1974 between the Additional Commissioner of Income-tax v. Rustam Jehangir Vakil Mills Ltd. : 103ITR298(Guj) , where the Division Bench, in respect of a similar claim of the respective assessee-companies before it on account of compensation paid by the said assessee-companies to the Textile Commissioner in failing to produce the prescribed quantity of coarse cloth as required under the scheme framed by the Textile Commissioner in exercise of his power under clause 21(c) of the Cotton Textiles (Control) Order, 1948, had held that such payment of compensation was made under an option under the order of the Cotton Textiles (Control) Order, 1948, and was not one for the breach of law and it was, therefore, allowable as business expenditure under section 37(1). Since this question is concluded, so far as this court is concerned, no further contentions were pressed on behalf of the revenue with the result that question No. 1 is required to be answered in the affirmative and in favour of the assessee.
7. The main argument addressed to us on behalf of the revenue in respect of question No. 2 can be summed up as under :
Although the amount of Rs. 35,193 was described as a sum calculated at the rate of 11 paise per metre of the cloth exported short of the quantity specified in conditions Nos. 2 and 3 of the bond executed by the assessee-company in favour of the President of India, it was in reality and substance not liquidated damages but was amounting for all intents and purposes to the payment akin to penalty for infraction of law or in any case committing an act opposed to the public policy adumbrated by the Government of India in the relevant circulars and press notes issued by the Government in the matter of import of automatic looms for expansion of the textile industry in the third plan period by linking up the import of machinery with the export of cloth produced on the machinery so imported as well as the existing machinery. In other words, it was contended that the payment in question is a penalty or one akin to penalty and its very nature segregates it from the expenses of trade inasmuch as the same was not incurred by the assessee-company in its character of trader. The exaction of the amount in question and its consequent payment by the assessee-company under the special permit granted by the Textile Commissioner and the bond executed by the assessee-company in favour of the President of India in pursuance of the said special permit was not a payment of mere damages for breach of contract, though it may not be exactly in the nature of penalty paid under the terms of a statute for contravention of any statutory provisions. None-the-less is was a payment akin to penalty for contravention of public policy enunciated by the Government of India and implemented by the Textile Commissioner in the matter of import of automatic looms by making it obligatory on the importer to export a prescribed quantity of cloth manufactured on the automatic looms so imported and the looms already existing.
The above contention of the revenue were sought to be repelled on behalf of the assessee-company by urging that in the ultimate analysis can this payment be equated to a penalty entailed or imposed for infraction of a statute In the submission of the assessee-company, there is no infraction or breach of any statute or a statutory provision which can be even remotely spelled out in the facts and circumstances of this case. There is no breach of public policy in this case, according to the assessee-company, which will convert this amount of liquidated damages into exaction of payment akin to that of penalty and there is no distinction in principle laid down by this court in Additional Commissioner of Income-tax v. Rustam Jahangir Vakil Mills Ltd. : 103ITR298(Guj) , where this court has held that such payments are incidents of the business of production of cloth by the manufacturer depending upon the exercise of option which he will exercise for reasons of his own production or machinery and they cannot be treated as payments extracted or required for infraction of law.
8. It is in the context of these rival contentions that we have to determine what is the nature of the payments allowed by the Tribunal and referred to us in questions Nos. 2 and 3. We will first deal with question No. 2 since it is on the view which we may take on the second question where the assessee-company has paid the principal amount of Rs. 35,193 to the Government of India to cover its shortfall in export that we will be able to determine consequently what is the nature of the payment referred to us in question No. 3 which the assessee-company incurred for furnishing bank guarantee to the Government of India when it secured the use of the trade mark 'sanforized' by undertaking to export a prescribed quantity of cloth.
9. It should be profitable to shortly refer to a overall scheme under which the assessee-company was permitted to import automatic looms and consequently it agreed and undertook to export the prescribed quota of cloth when the Textile Commissioner permitted the import of automatic looms. The learned advocate for the revenue has furnished us with a small compilation of extracts from the report of the Ahmedabad Millowners' Association of the relevant period so as to give us an idea as to what were the broad features of the scheme for importation of automatic looms. It would not be necessary to refer in detail to the various schemes promulgated by the Government of India in 1956, 1959 and 1963 for importing automatic looms. The entire position has been succinctly summed up in a circular letter of June 26, 1964, addressed to its member-associations by the Indian Cotton Mills' Federation, Bombay. The position regarding export obligations of the mills-companies on automatic looms installed under any of the schemes framed in 1956, 1959 and 1963 has been clarified in the following terms, the gist of which has been set out in the report of the Ahmedabad Millowners' Association for the year 1964 at item No. 70 at page 56 :
'In a circular letter addressed to member-associations on the 26th June, 1964, the Indian Cotton Mills' Federation, Bombay, again clarified the position regarding the export obligation on automatic looms installed under any of the schemes of 1956, 1959, 1963, for installation of such looms for export as under :
(1) 50% of production (i.e., 13,333 yds. per loom per annum) for 5 years if imported automatic looms are installed.
(2) 33 1/3% of production (i.e., 8,888 yds. per loom per annum) for 5 years if indigenous automatic looms are installed.
(3) In addition to the above, mills will be required to export at least 50% of the average quantity of cloth exported by them during the basic years (viz., 1959, 1960 and 1961).'
10. It should be noted that the corresponding quantity of the cloth manufactured on automatic looms and required to be exported was 12,500 metres = 13,333 yds. and that manufactured on indigenous automatic looms was 8,333 metres = 8,888 yds. It should further be noted that the export obligations of the cloth manufactured on automatic looms as well as on indigenous automatic looms referred to in the circular set out above, held good for the relevant previous year corresponding to the assessment year under reference. It is also common ground that so far as the aforesaid export obligation was concerned, there was a shortfall of 3,19,932 metres which rendered the assessee-company liable to pay to the Government of India a sum of Rs. 35,192.52 at the rate of 11 paise per metre.
11. The short question which, therefore, arises is : What is the nature of this exaction of payment under the bond executed by the assessee-company in favour of the President of India in pursuance of condition No. 6 of the special permit granted by the Textile Commissioner permitting the assessee-company to import 24 automatic looms. Is it possible to spell out from the scheme for import of automatic looms, the permission for which was granted subject to certain conditions which, inter alia, provided for export obligation, that the shortfall in achieving the prescribed export target which entailed obligation on the importer to pay a specific sum agreed between the importer and the Government of India would amount to infraction of law or in any case breach or violation of public policy which will convert the nature of the payment into that of penalty or akin to that of penalty In other words, does the payment under the bond to cover up the shortfall in export target prescribed thereunder amount in reality and substance to penalty or was it for all intents and purposes in the nature of liquidated damages It has been said in the first instance on behalf of the revenue that it is for all purposes a penalty for infraction of law. It is no doubt a settled legal position that expenses in the nature of penalty for infraction of law would not be permissible deduction as the same has been entailed by a trader in the capacity other than that of a trader.
12. In Haji Aziz and Abdul Shakoor Bros. v. Commissioner of Income-tax : 1983ECR1942D(SC) , it has been held as under :
'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. They cannot be deducted if they fall on the assessee in some character other than that of a trader. 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 for an infraction of law, it cannot be claimed as a deductible expense, as it cannot be called a commercial loss incurred in carrying on his business. Infraction of the law is not a normal incident of business.'
13. An attempt has been made on behalf of the revenue to impress upon us that the nature of payment has been described by both the parties to the bond as penalty. We do not think that we can decide the nature of the payment by its mere description by the parties. In order to be a penalty, the payment must in substance amount to penalty. The Supreme Court in Haji Aziz's case : 1983ECR1942D(SC) quoted with approval the statement of law by Lord Sterndale M. R. in Commissioners of Inland Revenue v. Alexander von Glehn & Co. Ltd.  2 KB 553 , which read as under :
'The money that was paid was paid as a penalty and it did not matter if in the information it was called a forfeiture.'
14. We have, therefore, to consider the substance of the transaction. It was strenuously urged on behalf of the revenue that under the special permission granted by the Textile Commissioner to the assessee-company to import automatic looms, the company was enjoined to execute a bond in favour of the President of India to pay a sum calculated at the rate of 11 paise per metre to cover the shortfall in the export target prescribed by the Government in the relevant scheme for import of automatic looms. The special permission was granted by the Textile Commissioner in exercise of his powers under sub-clause (6) of clause 12 of the Cotton Textiles (Control) Order, 1948, issued in exercise of the powers conferred by section 30 of the Essential Supplies (Temporary Powers) Act, 1946, by the Central Government. One of the conditions of this special permit enjoined the assessee-company to execute a bond in the manner and form prescribed. Accordingly, as stated above, the assessee-company executed a bond in favour of the President of India agreeing to export in the block of five years commencing from 1965 to 1969 a total quantity measuring 32,94,603 meters and in default thereof to pay a sum of Rs. 4,11,401.65 to the Government of India. It was, therefore, urged on behalf of the revenue that the liability to pay the amount of Rs. 4,11,401.65 or any other amount under the bond for the default in carrying out the export obligations undertaken therein must be considered as penalty since it is for the infraction of the permit granted by the Textile Commissioner under the statutory order issued by the Central Government in the exercise of the powers under the Essential Supplies (Temporary Powers) Act, 1946 (Act 24 of 1946). We are afraid, we cannot accede to this submission of the revenue for two reasons : in the first instance, there is no provision in the Essential Supplies (Temporary Powers) Act, 1946, entitling the Government or its authorities to exact the payment for infraction of any provision of law. In fact we have not been pointed out any provision in the Essential Supplies (Temporary Powers) Act, 1946, which empowers the Central Government to link up the export obligation with the permission to import machinery from abroad. Consequently, there cannot be any provision in the Cotton Textiles (Control) Order, 1948, issued in pursuance of the powers under the parent Act of 1946. An attempt was, therefore, made to persuade us that when the Textile Commissioner had a power under clause 12 of the aforesaid Order to permit a person to acquire or instal any power-loom, it necessarily implies a power to give a qualified permission as the Textile Commissioner has undoubtedly got a power to grant an absolute permission. We do not think that this attempt of the revenue is well-founded because the Textile Commissioner has merely required the assessee-company to execute a bond in the form and manner prescribed in favour of the President of India to cover the shortfall in export at the rate of 11 paise per metre. On the plain reading of this condition No. 6 in the special permit, we do not find that the liability to pay a sum calculated at 11 paise per metre was in the nature of penalty because it was merely intended to cover the shortfall in export. We do not think, therefore, that the revenue was right when it contended that the nature of the payment under the special permit was that of penalty for infraction of law. We have not been able to find even remotely anything which can be classified as a statutory or a legal provision of export obligation and penalty for its non-compliance either in the Essential Supplies (Temporary Powers) Act, 1946, or in the Cotton Textiles (Control) Order, 1948. By the permit, though it was so laid down, it was legally made enforceable by a contract in the nature of a bond. If it really was a statutory obligation, there was no need to require the importer to enter into such a bond. An incidental argument was advanced in this connection on behalf of the assessee-company that the Textile Commissioner could not have, in exercise of his powers under the Cotton Textiles (Control) Order, 1948, which is issued in exercise of the power under the Essential Supplies (Temporary Powers) Act, 1946, laid down any condition enjoining importers to export a prescribed quantity of cloth manufactured on automatic looms so imported or on the existing looms. We do not think that we should enter this larger question since we have not been able to agree with the contention argued on behalf of the revenue that there is an infraction of the law in the instant case which rendered the assessee-company liable to penalty.
15. The revenue, therefore, made an alternative attempt to persuade us that though the nature of the payment is that of liquidated damages under a contract between the parties, none the less since it amounts to exaction of payment for breach of public policy, it should be treated as one akin to penalty and, therefore, not entitled to deduction. In support of this contention, reliance was sought to be placed on the decision of the Madras High Court in M.S.P. Senthikumara Nadar & Sons v. Commissioner of Income-tax : 32ITR138(Mad) . We do not think that the revenue was justified in drawing support to the proposition urged by it from the decision of the Madras High Court in M.S.P. Senthikumara's case : 32ITR138(Mad) , because the facts and circumstances of that case were peculiar and they cannot be successfully equated with the instant case before us under reference. The fact before the Madras High Court in Senthikumara's case : 32ITR138(Mad) were that the assessee before the Madras High Court was a firm carrying on business in coffee, cardamoms, etc. During the assessment year 1944-45, the assessee under contracts entered into with the India Coffee Board, Delhi, purchased 12,390 cwt. of coffee for export to the Middle East and Australia. In addition, it also purchased from other export licensees 2,303 cwt. of coffee which was intended for export to the said countries. The price of coffee fixed by the India Coffee Board on the export quota was far below the local price. In case of failure to export the coffee so purchased, clause 8 of the contract in that case provided three remedies to the Board, namely, (a) to recover a fixed measure of damages at Rs. 20 per cwt. to be paid to the surplus pool; (b) to export an equivalent by weight of coffee purchasing the same from the pool and to recover the loss incurred in the transactions from the buyer. The decision of the Controller in the matter of price at which such coffee was purchased and sold and in the matter of fixing the loss was final; and (c) to call upon the buyer to restore the stock delivered to him at a price less than the purchase price by 2 1/2 per cent. of the price for every month after the expiry of the period for export fixed above and the date when the buyer was called upon to restore the stock. It was also provided in the contract that the fixed damages referred to above were deemed as liquidated damages and the buyer was not entitled to any reduction thereof in any circumstances. The assessee out of the total quantity of 14,693 cwt. purchased for export, exported only 8,784 cwt. and sold the balance of 5,959 cwt. without the knowledge and concurrence of the India Coffee Board, within India only. The assessee did not inform the Coffee Board at any time that it had contravened the provisions of the licence granted to it to acquire the coffee. In 1946, the Coffee Controller came into possession of certain information which showed that the assessee did not in fact export the coffee acquired by it for that purpose and sold it within the Union territory at higher prices. The Coffee Controller investigated this and by his letter dated 3rd May, 1946, called upon the assessee to show cause why responsibility for selling the coffee, which was intended for export in the Union territory, should not be fixed on it. The assessee in its letter dated 20th May, 1946, admitted not having shipped 5,959 cwt. of coffee and expressing regret for the happening agreed to pay damages in accordance with clause 8 of the contract. The damages were ascertained at Rs. 1,19,177 which sum the assessee paid in four instalments between 3rd May, 1946, and 18th August, 1946. This sum was claimed by the assessee as an admissible deduction from the profits for the assessment year 1944-45. The Tribunal held that there was no liability incurred at all by the assessee during the period in which the claim was made and since the amount to be paid was described as liquidated damages, it did not form an addition to the cost of the commodity purchased by the assessee. The Tribunal on these two grounds negatived the assessee's claim. In the reference, the Madras High Court reviewed the case-law and culled out the relevant tests from the decided cases as under (page 158) :
'As we said, these cases were all virtually decided on the application of the tests laid down in Strong v. Woodifield  AC 448 (HL). It is not enough if the loss sustained or expenditure incurred is in some sense connected with the trade, for it may be only remotely connected with the trade, or it may be connected with something else quite as much or even more than with the trade. Only such losses can be deducted as are connected in the sense that they are really incidental to the trade itself. It is not enough that the disbursement is made in the course of, or arises out of, or is connected with, the trade or is made out of the profits of the trade. It must be made for the purposes of earning the profits.'
16. The Division Bench of the Madras High Court thereafter applied these tests to the facts and circumstances of the case before it. It would be profitable to set out the relevant considerations which prevailed with the Division Bench of the Madras High Court to treat the breach made by the assessee-company before it as a wilful and deliberate violation of its obligation to export the quota of coffee purchased from the India Coffee Board and selling it in the International market as a contravention of the provisions of its licence. This is what the Division Bench of the Madras High Court has considered before arriving at the decision in the case before it that the nature of the payment was one akin to penalty (pages 158, 159) :
'Before we discuss whether these tests have been satisfied by the assessee, we have to verify what the nature of the payment was. No doubt the assessee-firm paid the amount of Rs. 1,19,177 in discharge of the contractual obligation it had entered into with the India Coffee Board to pay an ascertained sum as liquidated damages for breach of contract. The contractual obligation, the performance of which the assessee defaulted, was to export the coffee which had been sold to it at a concessional price, only because it was earmarked for export abroad. The other contracting party, the India Coffee Board, was a statutory body created by the Coffee Market Expansion Act (Act VII of 1942). The control the India Coffee Board exercised over the sales of coffee, whether for ultimate export out of India or for sales within India, had a statutory basis. It is true the Act itself did not in express terms prohibit sale within India of coffee sold by the Board for export. That what was broken by the assessee was a term of the contract and not an express provision of law does not, in the circumstances of this case, make any real difference to the principle to be applied. It was in exercise of the statutory duties imposed on the Board to regulate and control sales of coffee produced in India, in the interests of the national economy of the country, that the Board, through the instrumentality of a contract, virtually laid an embargo on sale within India of coffee that had been sold at a concessional rate for the specified purpose of export. It was that that the assessee transgressed when it deliberately and without any apparent excuse sold the coffee within India. What it had to pay was no doubt called liquidated damages. But the payment was really akin to a penalty for committing an act opposed to public policy, a policy that underlay the Act, which the Act left to the India Coffee Board to enforce. The assessee could and should have carried on its business in coffee in conformity with the obligations imposed upon it, no doubt, by a contract, but under the authority of the Coffee Market Expansion Act and in furtherance of the policy of control that underlay that Act. It could have carried on the business without infraction of its obligations. That should have been its normal course of conducting its business.'
17. In other words, the Madras High Court spelt out from the scheme contained in the Coffee Market Expansion Act (Act VII of 1942) that there was a statutory basis for the control by the India Coffee Board over the sales of coffee whether for ultimate export out of India or for sale within India. The India Coffee Board was empowered to regulate and control sales of coffee produced in India in the interest of the national economy of the country. In order to effectuate that policy, the Board was empowered to control and regulate the sales of coffee produced in India. According to section 14 of the Coffee Act, 1942, every owner of land planted with coffee plants was required to be registered as an owner in respect of such estate owned by him, and by section 17 no registered owner was entitled to sell or contract to sell in the Indian market coffee from any registered estate if by such sale the internal sale quota allotted to that estate is exceeded. By section 20 the Board was empowered to grant authorisation to export coffee from India in the prescribed manner and in the prescribed cases. By section 22 the Board was empowered, with the previous sanction of the Central Government, to allot to such registered estate an internal sale quota for the year. By section 25 all coffee produced by a registered estate in excess of the amount specified in the internal sale quota allotted to the estate was required to be delivered to the Board for inclusion in the surplus pool by the owner of the estate or by the curing establishment receiving the coffee from the estate. By section 36 contravention of sections 16, 17, 18 and 19 by any registered owner was made punishable with fine which may extend to one thousand rupees.
18. It is in the context of the above scheme contained in the Coffee Act, 1942, that the India Coffee Board entered into the contract with the assessee-company before the Madras High Court and by that contract virtually laid an embargo on sale at a concessional rate for the specified purpose of export through the assessee-company. It was when the assessee deliberately and without apparent excuse sold the coffee earmarked for export in the international market contrary to the provisions of its licence and when it suppressed this fact from the Board that the Controller of Coffee Board on finding out this deliberate default held the assessee liable and tried to exact the payment in the nature of fixed damages at the rate of Rs. 20 per cwt. In that context of the particular scheme contained in the Coffee Market Expansion Act (Act VII of 1942) and in the facts and circumstances of the case where the assessee-company contravened the provisions of its licence and committed breach of the contract entered into with the India Coffee Board that the court found that the nature of the payment was more akin to a penalty, though described as liquidated damages, because in the opinion of the Division Bench of the Madras High Court the act of the assessee for disposing of a part of the quota of coffee earmarked for export was opposed to the public policy underlying the said Act. We do not think, therefore, that the said decision of the Madras High Court in Senthikumara's case : 32ITR138(Mad) can be of any assistance to the revenue. The learned advocate appearing on behalf of the revenue heavily relied on this decision in support of his contention that in so far as the assessee-company before us failed to achieve the export target, it committed a breach of the public policy of the Government of India to recoup the foreign exchange, which it has spent while permitting the assessee-company to import machinery from abroad. We do not think that this reliance is justified because in the first place there was no public policy of compulsory export for all the mill-companies. The schemes of import of automatic looms in 1956, 1959 and 1963, clearly indicate that the Government of India wanted to encourage a voluntary effort by the mill-companies intending to rationalise their manufacturing activities by importing and installing automatic looms to export the cloth manufactured on such looms as well as the existing looms. It is only with a view to encouraging the voluntary efforts in that direction that while permitting the import of automatic looms from abroad, the Textile Commissioner laid down certain conditions enjoining the export of a prescribed quantity of cloth manufactured by the importing textile mills and also prescribing a certain amount of damages in case of default in achieving the target so prescribed. We are afraid we cannot compare this scheme before us in the present reference with the scheme which we find in the Coffee Market Expansion Act (Act VII of 1942). As a matter of fact, the damages agreed to be paid was something which was contemplated by the assessee as well as by the Government. In Commissioner of Inland Revenue v. E. C. Warnes and Co.  12 TC 227 Rowlatt J. observed :
'I may shelter myself behind the authority of Lord Loreburn, who, in his judgment in the House of Lords in Strong & Co. v. Woodifield  AC 448; 5 TC 215 , said that it is impossible to frame any formula which shall describe what is a loss connected with or arising out of a trade ...... but it seems to me that a penal liability of this kind cannot be regarded as a loss connected with or arising out of a trade. I think that a loss connected with or arising out of a trade must, at any rate, amount to something in the nature of a loss which is contemplable, and in the nature of a commercial loss. I do not intend that to be an exhaustive definition, but I do not think it is possible to say that when a fine, which is what it comes to, has been inflicted upon a trading body, it can be said that that is 'a loss connected with or arising out of' the trade.'
19. In Commissioners of Inland Revenue v. Anglo Brewing Co. Ltd.  12 TC 803 the words 'for the purpose of such business' have been construed to mean 'for the purpose of keeping the trade going and making it pay'. The question, therefore, is whether this loss or for that matter the expenses were something which were contemplable by the parties when they entered into the contract. The very fact that the parties contemplated a particular maximum sum to be calculated at a fixed rate to cover the shortfall in achieving the target clearly indicates that the expenses or the loss on that count was contemplable by both the parties. It is an admitted position that the amount of Rs. 4,11,401.65 agreed to be paid by the assessee-company in the bond executed by it in favour of the President of India was on the basis of the default of the assessee-company in exporting the entire quantity agreed to be exported under the scheme and the bond. It should not be lost sight of that the sum required to be paid was with a view to cover up the shortfall and not for any breach of the public policy or for infraction of law. We do not think that the damages which entailed upon the assessee-company in this case before us was in the character other than that of a trader. The parties to the contract contemplated clearly that there may be various factors responsible for the shortfall in achieving the export target the fulfilment of which depended on the competition in the international market, the quality of the goods to be exported, the reputation and standing of the manufacuring unit, so on and so forth. The parties did contemplate when they ascertained and fixed the maximum sum to be paid in case of the default of carrying out the entire obligation of export commitment that the said amount was the loss to which the assessee-company would be exposed in case of its default. We should also emphasise the fact that the assessee-company had achieved 90% of its target and out of the total obligation of exporting 32 lakhs and odd metres of cloth it had in fact exported actually 29 lakhs and odd metres of cloth. We do not think, therefore, that the revenue was right when it contended that since there is violation of the public policy of the Government of India to recoup itself in the foreign exchange, the exaction of the payment, though under the bond, should be considered as one akin to a penalty. The second question, which has been referred to us, therefore, should be answered in the affirmative and in favour of the assessee-company.
20. That takes us to the third question about the expenses entailed by the assessee-company for furnishing the bank guarantee for securing payment to be made in case of default in fulfilling the export target prescribed under the agreement between the assessee-company and the President of India in consideration of the permission granted by the Government to use 'sanforized' trade mark. The United Commercial Bank has agreed to stand as a guarantor and joined the execution of the bond as confirming party as guarantor between the assessee-company and the President of India on 26th June, 1961. The assessee-company by the bond agreed to export cloth or ready-made garments to the extent of 5% and 10% of its production of sanforized cloth during the periods of July, 1963, to December, 1965, and January, 1966, to December, 1967, respectively, or to pay a sum calculated at the rate of 11 paise per linear yard to cover up the shortfall of 38,33,431 yards in exports in the aforesaid periods, the assessee undertook the export by 30th September, 1971, the said shortfall in the quantity of export of sanforized cloth for the period up to 31st December, 1969, in addition to the mills export obligation in respect of sanforized cloth for the years 1970 and 1971 in accordance with the agreement dated 5th March, 1970, entered into by the assessee-company with the Government; or, in the alternative, to pay to the Government the aforesaid sum of Rs. 3,83,343.10 or such lesser sum at the rate of 10 paise per linear yard in respect of the actual shortfall in the export obligation outstanding as on 30th September, 1971. To secure this payment, the assessee-company furnished a bank guarantee of the United Commercial Bank for which the assessee-company was required to make the payment of bank charges. It cannot be assailed that the finding of the Tribunal was wrong in law when it permitted deduction claimed on that count for the obvious reason that in order to carry on the business and earn sufficient profits, the cloth produced must be durable and non-shrinking so as to survive in the test of the competitive market, national as well as international. The assessee-company, therefore, must secure the use of sanforized mark and instal sanforizing machinery. It had to undertake export obligation and had to enter into the necessary bond undertaking to export the agreed quantity for the permission for the use of the trade mark 'sanforized', and in course of that trade it was required to furnish bank guarantee to the Government securing payment which the assessee-company would be required to make to cover the shortfall in the export target agreed between the parties for the permission for the use of trade mark 'sanforized'. It was really for the purpose of carrying on the business of foreign trade in order to fulfil the export target that the assessee-company was required to furnish bank guarantee. As the Supreme Court observed in Haji Aziz & Abdul Shakoor Bros.' case : 1983ECR1942D(SC) the expenses were laid out for the purpose of carrying on business and earning profits. The entire reasoning which we have indicated above while answering question No. 2 applies a fortiori in the determination of question No. 3 about the expenses incurred for furnishing bank guarantee Unless the assessee-company could furnish a bank guarantee securing payment to be made by it for its default to fulfil the export commitments, it could not carry on the trade of export of cloth. In that view of the matter, therefore, we think that we must answer question No. 3 in the affirmative and in favour of the assessee.
21. In the result all the three questions are, therefore, answered in the affirmative and in favour of the assessee. The Commissioner shall pay costs of this reference to the assessee.