Sec Industries Private Limited vs. DCIT - (Income Tax Appellate Tribunal) (11 Jan 2024)

Where an assessee has to pay damages to other party to fulfil the contract in the ordinary course of his business, the amount of damages paid is allowable deduction

MANU/IH/0005/2024

Direct Taxation

Assessee is a private limited company engaged in the business of manufacturing and supply of components, engineering systems to various Defence units and other customers. For the assessment year 2016-17, it filed the returns declaring total income of Rs. 17,34,20,620 under normal provisions of the Income Tax Act, 1961 (IT Act) and admitted an income of Rs. 17,58,28,654 under Section 115JB of the Act under MAT provisions. Assessment was completed by disallowing a total sum of Rs. 1,22,49,634, making addition on account of Consultancy charges paid to the tune of Rs. 1,12,50,000, liquidated damages of Rs. 5,54,406 and other expenses Rs. 4,45,228.

Aggrieved, assessee preferred appeal before the learned CIT(A).Learned CIT(A), however, while deleting the other additions, confirmed the addition of Rs.5,54,406 towards liquidated damages, but did not assign any reasons. Hence the assessee preferred this appeal.

It is the settled principle of law that, Section 37 of the Act is the residuary provision, granting deduction of an expenditure not being expenditure of the nature of capital expenditure or personal expenses of the assessee, which is laid out or expended wholly and exclusively for the purposes of business or profession and not specified in sections 30 to 36 of the Act. Explanation to section 37(1) clarifies that any expenditure incurred by an assessee for any purpose which is an offence, or which is prohibited by law shall not be deemed to have been incurred for the purpose of business or profession and no deduction or allowance shall be made in respect of such expenditure.

The impugned expenditure in this case was purely in relation to the assessee's normal business activity and was inherent part of its business transactions. Even according to the Revenue, the expenditure was certainly not incurred for any purpose which is an offence, or which is prohibited by law.

In the decision reported in the case of Jamna Auto Industriesvs. CIT, the Punjab and Haryana High Court considered this issue and while highlighting the difference between the penalty for infraction of law and damages for breach of contract in the context of deduction under Section 37(1) of the Act, held that whenever damages are to be paid by an assessee for a breach of contract, such damages are treated to be normal expenses of business. High Court further held that, where an assessee has to pay damages to other party to fulfil the contract entered into by him in the ordinary course of his business, the amount of damages paid is allowable deduction if it is in the ordinary course of business and is not opposed to public policy.

This decision is applicable to the facts of the present case on all fours and while respectfully following the same, present Court hold the issue in favour of the assessee and direct the learned Assessing Officer to delete the addition so made. Appeal allowed.

Tags : ASSESSMENT ADDITION LEGALITY