Kalpesh Classes

One of the vexing problems for taxpayers has been the approach of the Assessing Officer to disallow legitimate business expenditure on the ground that such payment is tainted by illegality following​​ the decision of the Supreme Court in the case of Haji Aziz and Abdul Shakoor Bros. v. CIT [1961] 41 ITR 350, where the Supreme Court​​ disallowed a fine paid to avoid confiscation of the goods imported in contravention of import regulations. The ruling was that any payment occasioned by infraction of any law could not be allowed. This decision has often been indiscriminately applied with what is sometimes described as puritanical approach.​​ The issue became complicated and somewhat anomalous, because the Supreme Court itself found its way to allow even illegal expenditure, if the income itself was from an illegal business in CIT v. S. C. Kothari [1971] 82 ITR 794 and CIT v. Piara Singh [1980] 124 ITR 40.​​ The reasoning for this apparent inconsistency was that in​​ the cases of illegal business, the tax collector cannot be heard to say that he will bring the gross receipts to tax.

Our law has wrongly understood that allowance of an illegal expenditure would tantamount to endorsement of such illegality on the part of​​ the courts. The English law, on the other hand, in Minister of Finance v. Smith [1927] AC 193 (PC) took the view that by defining an illegal expenditure admissible as a business expenditure, the court "does not condone or take part in the illegal enterprise".​​ When the Revenue finds that it is entitled to tax profits from an illegal business,  ​​​​ even those businesses in trafficking in drugs, gun running, smuggling, running gambling house, etc., it is odd that there should be hesitancy in allowing penalties or fines in the course of carrying on such business.​​ Some of these contraventions may not be wilful and may have occurred because of the complexities in our laws especially those relating to imports, customs, excise, company law or foreign exchange. Some of​​ these contraventions may not involve any moral turpitude.​​ 

But the present tendency is to relax the rigidities as is apparent from some later Supreme Court decisions. Interest paid for non-payment of cess in time was held allowable by the Supreme Court in​​ Mahalakshmi Sugar Mills Co. Ltd. v. CIT [1980] 123 ITR 429 (SC) reiterated in CIT v. Luxmi Devi Sugar Mills P. Ltd. [1991] 188 ITR 41 (SC). A statutory impost though described as penalty under the Sales Tax Act, or where the payment is for breach of contract, may be allowable to the extent it is compensatory and not punitive as held in Prakash Cotton Mills P. Ltd. v. CIT [1993] 201 ITR 684 (SC) and Standard Batteries Ltd. v. CIT [1995] 211 ITR 444 (SC).Some High Courts also found their way to justify deductions in some cases. A fine for infraction of import restrictions was allowed in CIT v. PC Tangal [1990] 184 ITR 88 (Bom); redemption fine for importing without licence in CIT v. N. M. Parthasarathy [1995] 212 ITR 105 (Mad); demurrage paid to port authorities: Mahalaxmi Sugar Mills Co. Ltd. v. CIT [1986] 157 ITR 683 (Delhi); expenses to regularise after unlicensed imports in CIT v. Maddi Venkataratnam & Co. (Pvt.) Ltd. [1983] 144 ITR 373 (AP) and Apeejay (P) Ltd. v. CIT [1978) 114 ITR 544 (Cal) were all found admissible. Penalty for delayed contribution to provident fund/ESI was an issue remitted by the Calcutta High Court to be decided after consideration whether it was confiscatory or punitive in character in CIT v. General Fibre Dealers Ltd. [1994] 205 ITR 441 reversing their stand Hasimara Industries Ltd. v. CIT [1993] 200 ITR 659 (Cal) following the rationale of the Supreme Court decision under the relevant Acts in Organo Chemical Industries v. Union of India, AIR 1979 SC 1803. The same class of payments​​ was found admissible by other High Courts in New Mahalaxmi Silk Mills P. Ltd. v. CIT [1994] 206 ITR 302 (Bom), CIT v. Hyderabad Allwyn Metal Works Ltd. [1988] 172 ITR 113 (AP) and CIT v. Mysore Electrical Industries Ltd. [1992] 196 ITR 884 (Kar).​​ The amount payable on overdue municipal tax was held allowable as interest,​​ Russel Properties P. Ltd. v. CIT [1982] 137 ITR 358 (Cal), while it was described as penalty and not deductible in CIT v. Dhanraj Mills P. Ltd. [1994] 209 ITR 851 (Bom). The amount of compensation paid to the Government for shortfall of export obligation was held allowable in CIT v. Ahmedabad Cotton Mfg. Co. Ltd. [1994] 205 ITR 163 (SC).​​ ​​ 

The Supreme Court in Sri Venkata Satyanarayana Rice Mill's case [1997] 223 ITR 101 has leaned in favour of the liberal approach. It has approved the the decision of the Full Bench of the Madhya Pradesh High Court in Addl. CIT v. Kuber Singh Bhagwandas [1979] 118 ITR 379,​​ where donations given to the Chief Minister's Drought Relief Fund in the expectation of permit for export of gulabi chana was held deductible on the ground of commercial expediency.​​ It relied upon the decision in Patnaik and Co. Ltd. v. CIT [1986] 161 ITR 365 (SC), where the loss incurred in subscribing to the Government securities merely with a view to sell trucks was held allowable. After adverting to similar other decisions, it reversed the view of the Andhra Pradesh High Court and in the decision in Sri Venkata Satyanarayana Rice Mill's case [1997] 223 ITR 101 held that contributions made to a public welfare fund solely for promotion of assessee's business, whether at the instance of the authorities or otherwise cannot be treated as opposed to public policy.​​ 

Though the decision in the case of Prakash Cotton Mills [1993] 201 ITR 684 (SC) and now the decision in Sri Venkata Satyanarayana Rice Mills' case [1997] 223 ITR 101 do make some advance in resolving such disputes, the basic difference as between the approaches in respect of legal and illegal businesses as exemplified in Haji Aziz and Abdul Shakoor Bros.' case [1961] 41 ITR 350 on the one hand and Piara Singh's case [1980] 124 ITR 40​​ is yet to be reconciled, because the law which puts a smuggler or those in such illegal activities in a better tax position than the one who gets tripped by the multiplicity of our laws, which a businessman has to encounter in the course of his business, is difficult to understand.

Secret commission​​ 

A claim for​​ deduction of secret commission alleged to have been paid to promote sales, in respect of which the assessee refused to furnish names and addresses of payees, is not allowable, since the assessee​​ could not be said to have discharged the burden of proving that the amounts were actually expended - Goodlas Nerolac Paints Ltd. V/s. CIT [1982] 137 ITR 58 (Bom.)

Commission payments​​ 

The mere existence of agreement between the assessee and its selling agents or payment of certain amounts as commission does not bind the ITO to​​ hold that the payments were made exclusively and wholly for the purpose of the assessee’s business. Despite the existence of such agreement/payments, it is open to the ITO to consider the relevant facts and determine for himself whether the commission said​​ to have been paid to the selling agents or any part thereof is properly deductible under section 37(1) - Lachminarayan Madan Lal V/s. CIT [1972] 86 ITR 439 (SC).

Where the selling agents had not only canvassed the sales but had also undertaken the responsibility for the fulfilment of contracts by customers and for the payment of dues by customers to the assessee, the commission paid by the assessee on all sales, whether made through the agents or not, was deductible - Aluminium Corporation of India Ltd. V/s. CIT [1972] 86 ITR 11 (SC).