SRINIVASAN J. - The question that stands referred to us for determination is :
'Whether the aforesaid sums of Rs. 2,35,758 and Rs. 10,303 respectively, paid by way of damages and legal expenses, are allowable in computing the profits and gains of the assessees business under section 10 of the Act ?'
The facts giving rise to this reference are these : The assessee is a public limited company carrying on business in the export of groundnut oil. Export of groundnut oil is governed by notifications issued by the Joint Chief Controller of Exports, Bombay, form time to time. Broadly stated, the policy of the Government in permitting exports of this commodity varies from period to period, and it is generally indicated for every half-year. The Government of India, through the appropriate department, decides upon such policy and decides also as to the total quantity of the commodity which should be permitted to be exported from the country. The established exporters in the line are granted certain export allotments. During the relevant time, there was a public notice issued through the Joint Chief Controller of Exports on the 16th December, 1952, informing all established exporters that a total quantity of 40,000 tons of groundnut oil would be permitted to be exported for the half-year January to June, 1953. This was followed by a further notice which announced that established exporters would be granted export would be permitted to export a certain quantity of groundnut oil during that period against the overall quota of export of 40,000 tons. The assessee, which is an established exporter, was thus allotted an export quota of 1335 tons for that half year. It is common ground that the period during which this quantity could be exported was later extended up to the end of August, 1953. Early in June, 1953, however, a notice was issued by the appropriate authority calling upon the established exporters who had entered into commitments in respect of their export quotas to register with the departments all the sales made by them up to the 2nd of June, 1953. All the exporters were further advised that after that date no fresh sales for export should be contracted for by the exporters. This was notified that only such of the sales as had been contracted prior to the 2nd of June, 1953, and duly registered with the department would be permitted to be exported and that no sale contract entered into after the 2nd June, 1953, would be recognised. This was the position relevant to the export quota that had been granted for the first half-year - January to June, 1953 - in respect of which the period within which the export could be made had later on been extended up to the end of August, 1953.
In September and October, 1953, the assessee entered into four sale contracts with a Belgian company for export of groundnut oil, the dates of shipment being between December, 1953, the February, 1954. It would be noticed that these contracts could have been fulfilled by the company only in the event of an export quota being allotted for the second half-year - July to December, 1953. As usual in all such contracts, there were guarantee clauses therein to which specific reference is not called for. The assessee was unable to fulfil these contracts notwithstanding that the other contracting party extended the time for shipment by two months as provided in one of the clauses of the contract. The principal reason for such failure appears to be the changed policy of the Government with regard to export of groundnut oil as a result of which no quotas for export were at all allotted in the second half-year of 1953. The consequence of the breach of the contract was a demand for damages by the Belgian firm and the matter was referred to arbitration. The arbitrators failing to agree, an umpire, to whom the matter was referred, held that the assessee was liable in damages to the extent of Pounds 17,100. There was an appeal to the committee of the London Oil and Tallow Trades Association in accordance with the rules of arbitration and appeal. As provided by these rules, the Board of Appeal submitted a copy of the award made by it, stated in the form of a special case for the decision of the High Court of Justice, Queens Bench Division. In the meantime, the assessee took legal opinion upon the sustainability of the grounds of his attacks upon the award. The assessees counsel was emphatically of the opinion that there was no prospect of persuading the court to reverse the Appeal Boards decision and that the assessee would be well-advised to abandon further proceedings. The assessee acted upon this advice and decided not to pursue the matter further but to pay the damages and costs awarded against it. These sums amounted to the figures mentioned in the question.
In its assessment for the assessment year 1956-57, the assessee claimed that it was entitled to deduct the above sums being the damages and the legal expenses incurred in connection with its business. It may be mentioned that the accounting year of the assessee relevant to the assessment year in question ended on the 31st October, 1955, and the relevant entries in the account books of the assessee were made on the last date of the year. In fact, the decision to abandon the appeal was taken only on 7th November, 1955. The Income-tax rejected the claim of the assessee taking the view that the assessee had entered into unlawful contracts and that an expenditure laid out for the purpose of carrying of the business which would be allowable under section 10(2)(xv) of the Act should be lawful in its nature. On appeal the Appellate Assistant Commissioner took the contrary view. He held that the Imports and Exports Control Act, 1947, does not of itself prohibit a person from entering into a contract. That statute only enabled the Government to take steps for prohibiting or restricting imports or exports by appropriate notifications. Exports under a licence was contemplated under the Act. Agreements to sell goods in future were not so prohibited or restricted. The contracts themselves provided that the exports were to be made only on obtaining licences from the Government of India. It was the view of the Appellate Assistant Commissioner that the contracts were not opposed to public policy and that they were entered into only in the course of the business to earn profits. For these reasons, the appellate Assistant Commissioner held that the amounts in question were proper deductions within the meaning of section 10(2)(xv).
Against the decision of the Appellate Assistant Commissioner, the department carried an appeal to the Appellate Tribunal. It would suffice to state here that the Appellate Assistant Commissioner held that the notifications of the Government amounted to a prohibition against export of groundnut oil and that when the assessee entered into these contracts in disregard of the notifications issued on the basis of a policy governing trade restrictions it could not be said that the assessee incurred an expense connected with the lawful conduct of the assessees business. Though the reason is not precisely stated, that seems to be the substance of the Tribunals rather generalised observations in its appellate order. The Tribunal posed the question thus :
'Can you say as a matter of business common sense that in giving the guarantee in question notwithstanding the legal impediments, the assessee acted as a straight and honest businessman would do in the carrying on of his business in a lawful manne ?',
that is to say, the Tribunal was of the opinion that it was improper on the part of the assessee to have given a guarantee to the other contracting party about its ability to fulfil the contractual obligations and that since the giving of such guarantee cannot be said to be the normal incident of the assessees business, any loss flowing therefrom could not also be regarded as a loss incidental to the business. It, however, expressed its view that the damages was not a penalty paid for the infraction of any specific statutory prohibition.
On the application of the assessee under section 66(1) of the Act, the question set out earlier was referred for the decision of this court.
Our decision of the question must necessarily depend upon a construction of the notifications issued by the Government in the exercise of the powers conferred upon them under the Import and Export Control Act, 1947, and of any notifications issued under the Imports Control Order, 1955, which itself was promulgated under the Imports and Export Control Act, 1947. It has been contended by the learned counsel for the assessee that the entering into the contracts in the present case was the normal and lawful means of furthering the trade of the assessee; that at the time the contracts were entered into there was no prohibition against the export of groundnut oil; that the policy with regard to the export was being announced from time to time and at no point of time could anyone have with reason stated that during the second half-year of 1953 there was any likelihood of prohibition of the export and that at not time could it be stated that engaging in these contracts, which was the only manner in which the trade of the assessee could be carried on, became by reason of any declared policy of the Government or by virtue of any notification issued in this behalf by the Government illegal or opposed to public policy. It is urged that the assessee as a trader was entitled to enter into advance engagements of this kind and, if, owing to circumstances over which he had no control, his failure to fulfil his obligation under the contracts resulted in his having to pay damages, it would not follow that this loss was not an expenditure which was not for the purpose of the business. On the other hand, Mr. Ranganathan, learned counsel for the department, urges that in the light of the notifications which preceded the second half-year of 1953, these were either illegal contracts or contracts which were opposed to public policy and in any event were not such as a prudent businessman would have entered into.
We have no doubt in our minds that the entering into forward contracts for the supply of goods is not in itself an imprudent manner of conducting business. In particular where goods involve export and shipping space has to be obtained it is almost always the normal incident that the contract stipulates for shipping at a future date. In such cases, the seller has to acquire the goods in the open market as and when trade conditions are favourable to him and obtain custody of the goods in sufficient time to enable the export of the commodity. Nor can it be said that the furnishing of a guarantee which is an invariable feature of contracts of this kind is in itself an imprudent act. The Tribunal in comings to the conclusion that it was, while at the same time conceding that the assessee did not infringe any law, relied more upon its inferences about what the future policy of the Government with regard to exports might be upon any fact on the basis of which one could say that the course pursued by the assessee was not the normal trade practice. Since the learned counsel for the department also claimed that a prohibition against exports could be spelt out of the notifications issued by the Government, we called upon him to furnish us with those notifications and we shall now proceed to consider them.
An export trade control circular issued on the 18th November, 1952, related to the period, July to December, 1952, and the trade was informed that the quota of that period was valid for shipment till December 31, 1952. This notification does not impinge upon the matters now in question but is only referred to as the starting point. In another circular dated December 16, 1952, the export policy in respect of the vegetable oil and oil seeds for the half-year January to June, 1953, was published for the information of the trade. It stated that a quota of 40,000 tons had been fixed for export and that allotments against this quota would be made to established shippers and newcomers. It was further notified that the period of shipment of the unshipped balance of the quota of the previous half-year July to December 1952, which would have ended with 31st December, 1952, was extended up to the 31st March, 1953. In a further circular dated 21st December, 1952, the method of allotment of quotas to established shippers of groundnut oil was indicated. It was also laid down that the allotted quota should be so dealt with that not more than 50 per cent. of the quota in excess of 75 tons shall be shipped up to the end of March, 1953. This would appear to indicate that, even though a trader was allotted certain quota, he was not allowed to export the entire quantity in one lot but was excepted to stagger the exports in accordance with directions.
The next circular is dated February 17, 1953. That only dealt with the change of the port of shipment. The next important circular is dated April 6, 1953, which had special reference to the quota allotted for January to June, 1953. It would be recalled that, in an earlier notification, not more than half the quantity allotted was allowed to be exported up to the end of March, 1953. With regard to the balance remaining unexported, this circular extended the period up to the end of August, 1953.
On the 2nd of June, 1953, the Government of India issued a press note calling upon the exporters who had entered into commitments against the quotas of the period, January to June, 1953, to register the sales made by them up to the date of the issue of this press note with the export trade control authorities at the port concerned within one week of the issue of this press note and also advised that, pending further instructions, no fresh sales for export should be made. Obviously, the intention was that all sale contracts in respect of which firm commitments had been entered into by the trades up to the date of the press note should be registered with the authorities and that no further commitments in respect of the non-utilised part of the quota should be entered into. This was reiterated in a trade control circular dated July 2, 1953. It emphasised the position thus :
'As already announced in the press note of the 2nd June, 1953, no fresh sales should be made by the trade against the groundnut quotas. The balance quotas against which no sales have been made will be treated as lapsed.'
The resultant position was that, even if a trader had been allotted a certain quota for export for the period, January to June, 1953, his sales registered with the trade control authorities up to the 2nd of June, 1953, were accepted as coming within the quota and any balance of allotment remaining was treated as lapsed or cancelled.
For the second half-year July to December, 1953, there were no allotments of quotas to established exporters, so that no exporter could have obtained a licence for export of groundnut oil on the basis of any sales effected during that half-year. It is principally this feature, taken along with the circumstances that even in respect of the quota for the first half-year the exporters were prohibited from entering into any further commitments on and after June, 1953, and the further fact that any unutilised part of that quota had lapsed, that has been relied upon by the department in inferring that there was a prohibition against the export in the second half-year of 1953.
Though not strictly relevant to exports of the second half-year, the subsequent developments with regard to the export of groundnut oil give a clue to the manner in which these exports are sanctioned and quotas are allotted. It appears that a press note was issued on the 29th July, 1954, notifying all established shippers to apply for export allotments subject to a maximum allotment of 400 tons to any one shipper. Exports against such allotments were permitted till the end of October, 1954. The press note itself indicated that the reason for allowing exports in the second half-year of 1954 was due to the steady downward trend of the price of groundnut oil and, in order to stabilise the prices at their present levels, it was decided to allow a small quantity to be exported. It was for this reason that allotments were made to established shippers as stated earlier. A further export instruction issued on the 12th October, 1954, extended the period of shipment till the end of December, 1954. While these press notes and instructions limited the maximum quantity which any one shipper should export to 400 tons, a further export instruction dated November 28, 1954, increased this quantity to 600 tons. It is seen from the above that the export policy of the Government changes even within the period of any one half-year and that more often than not the policy is announced with regard to these exports a considerable time after the commencement of the half-year. This feature relating to the export policy has to be borne in mind in assessing the question whether the assessee, in the present case, in entering into contracts in September and October, 1953, though no export policy had been announced by that date, committed any transgression of the law. It should also be borne in mind that the contract permitted the assessee to ship the goods between December, 1953, and February, 1954, that is, during parts of the second half-year 1953, and the first half-year of 1954. Even if the assessee was unable to obtain any export quota for the second half-year of 1953, in the event of there being an allotment of export quota for the first half-year 1954, the assessee could reasonably have expected that it could fulfil its commitments under the contracts.
No material was placed before us by the department or has been suggested as available to indicate that in entering into contracts in September and October, 1953, which contracts called for fulfilment within the following four months, the assessee was entering into any speculative venture or that mode of doing business was contrary to the usual trade practice. On the other hand, we have already stated that in transactions involving exports to foreign countries, the dealer is of necessity compelled to enter into engagements well in advance of the time stipulated for the fulfilment of the contract, and that, we believe, is the usual practice. But for the fact that there were restrictions upon or prohibitions against the export of this commodity it would be undeniable that had the assessee sustained any loss on account of its engagements, such loss would have been incidental and indeed intimately connected with the course of its business and that such a loss would have been allowable as a deductible item. But what is contended for by the learned counsel for the department is that the notifications that have been referred to, read in the light of the Import and Export Control Act, must lead to the conclusion that there was a prohibition upon export and that if that were so, the assessee, in entering into the sale contract at a time when the prohibition was in force, was engaging itself upon an unlawful activity, or, at any rate, on an activity which was opposed to public policy, in which event it cannot be heard to say that the loss is one sustained in the course of business.
Before we take up the question whether the contracts entered into by the assessee were either illegal or were opposed to public policy, we may refer to a few cases upon which the department relies, in order to appreciate the circumstances in which an illegality can be spelt out. In Senthikumara Nadar & Sons v. Commissioner of Income-tax, it was considered a case of breach of contract rendering the assessee liable in damages. There the assessee firm, which carried on business in coffee, purchased coffee form the Indian Coffee Board at a rate far below the price of coffee to be sold within India, with a contractual obligation to export the whole of the coffee so purchased to places outside India. In addition, the assessee purchased coffee from others out of their export quota which coffee also it was under an obligation to export. The assessee, however, exported only a part of this coffee and sold the balance within India in contravention of its obligations. When the Coffee Board came to know of this contravention and called upon the assessee to explain the assessee admitted its failure to fulfil its obligations and agreed to pay liquidated damages in accordance with the provisions of the contract. Such damages were assessed at Rs. 1,19,177 and paid in the account year 1945-46. The assessee claimed that this amount should be deducted under section 10(2)(xv) of the Act from its profits for the account year 1942-43, in relation to which year it had entered into these obligations. The learned judges held that though the amount paid by the assessee was styled liquidated damages, the payment was in respect of an penalty for committing an act opposed to public policy, a policy which under the Coffee Expansion Act the Coffee Board was competent to enforce. On the question whether the expenditure had been laid out or expended wholly and exclusively for the assessees business, the learned judges held that payments of penalty for infraction of a law fall outside the scope of permissible deductions. A penalty in any such case in imposed as punishment on the offender as a responsible person owing obedience to the law. Its nature severs it from the expense of trade. It is not incurred by him in his character as a trader. A large number of English and Indian cases were considered by the learned judges and they expressed their judges and they expressed their conclusion thus :
'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, for 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.'
They then proceeded to consider whether there had been any transgression of the law, and came to the conclusion that since the business of the assessee was subject to statutory control and it could carry on the business only within the limits of such control, a violation of the undertaking it had given to export the coffee took the activity outside the normal course of business and the damages incurred by it because for that reason unconnected with a not incidental to the business that it carried on.
This decision of the Madras High Court was approved in Haji Aziz and A. S. Bros. v. Commissioner of Income-tax. That case was one of import. The assessee therein in contravention of certain notifications imported dates from Iraq. The commodity was confiscated by the customs authorities and under section 167(8) of the Sea Customs Act, the assessee had to pay a penalty for getting the goods released. This penalty was claimed by the assessee as a deduction allowable under section 10(2)(xv). It was held that where the liability was incurred as a penalty for infraction of the law and payment was in fact a penalty under a statutory provision, it could not be allowed as a deduction. Their Lordships observed :
'A review of these cases shows that expenses which are permitted as deductions are such as are made for the purpose of carrying on the business, that is, 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 of 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 Glehns case, 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 the 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, it cannot be claimed as a deductible expenses. It must be a commercial loss and in its nature must be contemplable as such. Such penalties which are incurred by an assessee in proceeding launched against him for the infraction of the law cannot be called commercial losses incurred by an assessee in carrying on his business. Infraction of the law is not a normal incident of business and therefore only such disbursements can be deducted as a really incidental to the business itself .....'
Raj Woollen Industries v. Commissioner of Income-tax deals with certain involved aspects of an export transactions. There, the assessee had contracted to sell wool to a party in England at a time when the export of wool to foreign countries could be done only under a licence issued by the Government. Having exhausted its quota under the export licence issued to it, the assessee entered into an arrangement with another company which had the requisite export licence, whereby the assessee sold the wool to that company, and after that company had exported the bales, the assessee repurchased the wool in the course ultimately reached England, that is, the party with whom the assessee had contracted. In the sale and the purchase, the assessee had to pay a sum of Rs. 6,800 to the other company and claimed this amount as a deduction under section 10(2)(xv) of the Act. The question arose whether it was an allowable item of expenditure. The learned judges of the Punjab High Court held that the transaction was so arranged is to evade a lawful prohibition, viz., export of wool without the requisite export licence, that it represented an amount which the assessee spent to enable it to carry on its business unlawfully and it was not therefore entitled to the deduction.
Can it be said in the present case that the assessee entered into an unlawful contract, unlawful in the sense that it was against the declared export policy of the Government or was against any specific restriction or prohibition lawfully notified This question takes us to a construction of the Imports and Exports Control Act. Under section 3 of that Act, the Central Government is empowered by an order to be published in the official gazette to make provisions for prohibiting, restricting or otherwise controlling in all cases or in specified classes of cases and subject to such exceptions, if any, as may be made by or under the order the import, export,...... of goods of any specified description. In the exercise of this power, the Government of India issued the Imports Control Order, 1955, which provided for a system of restriction upon imports and controlling such imports by means of licences. This control order related principally to imports and it is common ground that in the case of exports as well the Government derive their powers only from section 3 of the Act to prohibit or restrict exports. The notifications whereby the Government in the present instance fixed the quotas for export and made allotments in respect of dealers like the present assessee derived their authority only from the Imports and Exports Control Act. Section 3 of the Act itself does not in terms prohibit the export of any commodity. It is only after the Government in the exercise of the powers conferred upon them issue the necessary notification as required in that section that any prohibition or restriction upon export becomes operative. It is however common ground that the general restriction upon the export of any commodity, except under the authority of licence granted under the Imports Control Order, existed during the relevant period, that is to say, the assessee could not have exported the groundnut oil without a licence which would be issued only if a quota for exports had been allotted to him. But it is important to emphasise that there was no prohibition within the meaning of section 3 of the Imports and Exports Control Act altogether placing a ban upon the export of groundnut oil. The notification which we have referred to at some length deal with the first and second half-years of 1953 and the later periods and clearly indicated that the policy of the Government was not one of a total ban upon the exports but that any export should be made only under cover of a licence issued by a lawfully constituted authority, and in the light of an export trade and the incidents of the that trade and the manner of carrying on that trade, viewed against the background of the policy of the Government being declared from time to time and amended from time to time, it has to be decided whether in entering into contracts in September and October, 1953, the assessee was contravening any express or implied prohibition, or whether its act was opposed to any policy which has been declared.
Giving the matter our careful consideration, we are satisfied that the assessee did not contravene any express or implied prohibition. Nor was the policy relating to exports such an inflexible one that the assessee should have known that he could not obtain any licence for the export of the commodity either in the second half of the year 1953 or in the first half of the year 1954. We have already expressed our view that the manner in which the assessee entered into these contracts or the stipulations that figured in the terms of the contract were the normal features of the conduct of an export trade in a commodity of this kind. When so much has been found in favour of the assessee, it must necessarily follow that the loss incurred in the course of the business was incidental to and intimately connected with the conduct of the business and for the purpose of earning profits for the business. It should follow in the light of the decided cases to which brief reference has been made that the expenditure is an allowable item.
Mr. Ranganathan, learned counsel for the department, did not attempt to support the view taken by the Tribunal that the particular contractual obligations undertaken by the assessee were of such a kind that a straight and honest businessman doing business in a lawful manner would not have furnished such guarantees. We are frankly unable to understand how the guarantee given by the assessee in the present case brought into the contract a term which was either of an unusual nature or meant that the assessee was shouldering hazards of a more than normal kind. What particular guarantee the Tribunal had in the mind we are unable to understand. The guarantee clause is clause 15 of the contract and the relevant portion reads :
'Should shipment be delayed by fire, strike, etc., prohibition of exports or any executive of legislative act done by or on behalf of the Government of the territory where the port or ports of shipment named herein is or are situate, or any cause comprehended in the term force majeure...... the time of shipment shall be extended by two months.'
This seems to be a normal term in any contract covering transactions of this kind. What apparently the Tribunal thought was that the assessee should not have undertaken shipment in any case where there was a prohibition of exports. What this clause stipulated was only that the time of shipment should be extended by two months should the shipment be delayed by prohibition of exports. The Tribunal seems to have thought that the position with regard to exports was of so definite a nature that the assessee should have inferred that there would be not only a restriction but an absolute prohibition upon the export of the commodity. The clause purports to indicate on the other hand that the assessee expected that, even if there was a prohibition, it would be only of a temporary duration, so that an extension of the time of shipment by two months would perhaps be sufficient to enable him to export after the prohibition was withdrawn. The Tribunal appears to have been induced to believe that the assessee should not have given such a guarantee was somewhat out of the ordinary. We are unable to accept this interpretation. The assessee was perfectly justified to our minds in believing that there would not be an absolute prohibition against the export of groundnut oil and that, as had been happening in the past, it would be allotted some quantity for export though perhaps less than the quantity which was allotted to it in the first half-year of 1953. Its anticipation was a reasonable one and is entering into contracts in advance of the declaration of the policy of the Government with regard to the export was not so opposed to trade practice that it can be labelled as not in the course of business.
In the light of the above discussion, we are of the view that the Tribunal had no material before it to warrant the conclusion that there was either an infraction of the law or a business activity which ran outside the sphere of a lawful activity. We accordingly answer the question in the affirmative and in favour of the assessee.
We indicated earlier that the account year of the assessee, the previous year relevant to the assessment year, ended on the 31st October, 1955. We stated also -records show it to be so - that the assessee abandoned the appeal in the English High Court only on 7th November, 1955. Mr. Ranganathan, for the department, argued that in any event the allowance could not be claimed for the assessment year 1956-57, as the liability could not arise so long as the matter was pending adjudication in a court of law. We notice however that this aspect of the question was not put in issue before the Tribunal, nor did the Tribunal deal with it. It cannot, therefore, be said to arise out of the order of the Tribunal and we express no opinion on this contention.
The assessee will be entitled to its costs. Counsels fee Rs. 250.
Question answered in the affirmative.