Prithvi Raj, J.:— Since the question referred in the two income-tax references is common although the facts and assessment years are different, the two references are being disposed of by this common judgment.

The respondent is a public limited company engaged in the business of manufacture and production of sugar. In Income-tax Reference No. 40 of 1970, the respondent filed return showing a loss of Rs. 3,30,306/- for the assessment years 1959-60 for the accounting period ending on 30th June, 1958. The Income-tax Officer after making certain disallowances and add-backs computed the total income of the company at Rs. 2,97,041/-. The Income-tax Officer dis-allowed a sum of Rs. 1,20,859/- on account of penal interest paid by the assessee on arrears of cess. The U.P Government levied certain cane cess. The assessee disputed its liability to pay the same and as a matter of fact did not pay it. The levy of the cess was challenged by some of the sugar factories in U.P who filed writ petitions alleging that the levy was ultra vires. An application was moved in the writ petition for grant of stay which was granted by the Allahabad High Court as a result of which the factories went on adjusting the cane cess without being required to pay the same. However, the writ petitions were eventually dismissed. The cess became payable on which penal interest was also charged for default to pay the cess in time. In an appeal before the Supreme Court the contention of the Sugar factories was allowed and it was held that the U.P Sugar Cane Cess Act, 1956, was ultra vires of the Constitution and that the recovery of the cess could not be made from the Sugar factories.

The Government issued an Ordinance validating the 1956 Act which was subsequently validated by the U.P Sugar Cess (Validation) Act, 1961. The factories accordingly had to pay arrears of cess along with interest. The Commissioner of Cess appointed by the U.P Government recovered from the assessee the arrears of cess along with interest. The interest payable for the accounting period for the assessment year 1959-60, amounted to Rs. 1,20,859/-. The assessee claimed deduction of the interest paid on the ground that even if it had paid the arrears in time, the assessee would have been able to pay the cess by arranging loans from the market on interest in which event it would have paid interest at a higher rate than what was prescribed in the U.P Sugar Cess Act. That being so the assessee contended that it was cheaper in the business interest of the assessee to pay interest to the Cane Commissioner as provided under the Act. The amount of interest as paid by the assessee was claimed by it as revenue expenditure. The Income-tax Officer disallowed the claim holding that the payment of interest could not be termed as bona-fide business expenses, and that the interest was paid by way of penalty on account of the failure of the assessee to meet its liability within the statutory period.

The Appellate Assistant Commissioner in appeal accepted the contention of the assessee and held that the statutory liability to pay interest under section 3 (3) of the U.P Sugar Cess Act was in no way different from interest paid by a business man and that it represented a bona-fide business expense.

The Revenue feeling aggrieved by the aforesaid order filed an appeal before the Tribunal. The Tribunal agreed with the view of the Appellate Assistant Commissioner stating that it could not be said that the interest was paid for breach of law and allowed the interest holding that the same was bona fide business expenditure.

Similarly for the assessment year 1960-61 for the accounting period ending on 30th June, 1959, the assessee claimed a sum of Rs. 1,83,731/-paid on account of interest as revenue expenditure for its failure to deposit the cess within the statutory period. The Income-tax Officer disallowed this amount for precisely the same reasons as he gave for the assessment year 1959-60. The Appellate Assistant Commissioner as also the Tribunal in appeals allowed the claim of the assessee holding that the expenses were of revenue nature.

On the application of the department, the Tribunal has referred the following common question of law arising out of the orders of the Tribunal in respect of the assessment years 1959-60 and 1960-61.

“Whether on the facts and in the circumstances of the case, the Tribunal was justified in allowing the interest of Rs. 1,20,859/- and Rs. 1,83,731/- paid by the assessee on the arrears of the cess in assessment years 1959-60 and 1960-61 respectively as revenue expenditure?”

In I.T.R 41 of 1970 the assessment year is 1961-62 for the accounting period ending on 30th June, 1961 and the assessee claimed a sum of Rs. 2,00,439/- on account of interest paid by it to U.P Government as revenue expenditure, advancing precisely the same plea as discussed earlier in I.T.R 40 of 1970. The Income-tax Officer disallowed the claim on the ground that it did not represent business expenditure. On appeal the Assistant Appellate Commissioner and the Tribunal upheld the contention of the assessee and allowed the amount of interest as bona fide business expenditure. On the application of the department the Tribunal in this Reference has referred the following question of law to this Court:—

“Whether on the facts and in the circumstances of the case the Tribunal was justified in allowing the interest of Rs. 2,00,439/- paid by the assessee on the arrears of cess as revenue expenditure”.

Mr. G.C Sharma, the learned counsel appearing for the Revenue contended that what has to be seen is as to what was the real object for paying the penal interest. It was not, the learned counsel contended, to bring down the amount of interest as is contended by the assessee that if the cess had been paid in time the assessee would have been able to do so only by arranging loans from the market as the assessee was not possessed of ready cash and in the circumstances the assessee thought that it was beneficial to it not to pay the cess in time and thus the assessee chose to pay interest at a lesser rate than to pay the higher rate of interest by borrowing the money from the market to pay the cess. The learned counsel for the Revenue urged that the cess was not deposited in time not because of the fact that the assessee was not possessed of the ready cash but because of the fact that the assessee challenged the very levy of the cess and all along took the stand that the cess was ultra vires of the Constitution and that the recovery of the cess could not be made from it. It was because of that stand that the assessee had to pay the penal interest. Such an expenditure, goes the argument, could not be termed as bona fide business expenditure and it would be wrong to allow it as revenue expenditure. Mr. G.C Sharma further contended that it was a statutory obligation cast upon the assessee to pay the cess in time and the assessee could not make capital out of the fact that eventually the levy of the cess was declared ultra vires of the Constitution by the Supreme Court as at the time when the cess was required to be deposited presumption of vires was in favour of the law.

The first contention to be considered in this case, therefore, would be whether the amount of interest paid by the assessee could be brought within the term interest paid on borrowed capital.

In V. Ramaswami Ayyanger and another v. Commissioner of Income-tax, Madras, (18 I.T.R 150) (1), the applicants had to pay estate duty to the Ceylon Government. That duty by virtue of section 26 (1) of the Ceylon Ordinance No. 1 of 1938 was to be charged on the estate and under section 46 of the aforesaid Ordinance if the same was not paid within an year of the death of the last owner of the estate, interest at the rate of 4 per cent was chargeable on it. The applicants failed to pay the death duty within the stipulated period. Accordingly, they had to pay interest to the Ceylon Government amounting to Rs. 84,388/-. Exemption under section 10 (2) (iii) or in the alternative under section 10 (2) (xii) which now corresponds to section 10 (2) (xv) of the Income-tax Act, was claimed on the amount of interest paid on the ground that the aforesaid amount should be treated as if it was interest on the capital borrowed or that the amount was expended in the business of the applicants and the interest paid should be treated as an expenditure laid out or spent wholly or exclusively for the purposes of the assessee's business. Satyanarayana Rao, J. with whom Viswanatha Sastri, J. agreed, held that in order to justify the deduction it must be established that there was capital borrowed for the purposes of their business, profession or vocation and that the assessee in order to succeed in his claim must bring himself within one or other of the provisions of the Act recognising his claim as an allowable deduction. It was further held that borrowing implied a consensual act by a debtor receiving money from a creditor and in the said case none of these elements were present. Besides, the Government never advanced any amount as a loan to the assessee. Further, the amount that the assessee was having in his hands was an amount belonging to the Government of Ceylon and in no sense could be described as a borrowing. It was also held that the very fact that the origin of the liability was based on a statute, negatived the conception of borrowing and the conception of consensual act on the part of the assessee and the Government of Ceylon. Further the interest was made payable not under any contract or agreement but under the provisions of the Ordinance which was a statutory liability. In the circumstances it was held that the assessee was not entitled to take advantage of sub-clause (iii) of section 10 (2) as the very requisite of the section, namely, “borrowing of capital”, was absent in that case.

The learned counsel for the Revenue further drew support from O.RMOM. SP. Firm v. Commissioner of Income-tax, Madras, (52 I.T.R 907) (2). In that case the assessee was a partnership carrying on money lending business. The partners were all brothers. Their father died and on his death estate duty became payable to the Malayan Government. The assessee entered into an agreement with the Malayan Government to pay the dues on that account in monthly instalments with interest. The amount of interest so paid was claimed by the assessee-firm as business expenditure or on account of interest payable on capital borrowed for business purposes. The High Court held that the interest payment on the unpaid estate duty could hardly be brought within the scope of section 10 (2) (iii) as interest on borrowed capital or under section 10 (2) (xv) as estate duty payable was a statutory levy and had no connection with the carrying on of any business and that the duty was payable on the passing of the property on the death of the assessee's father.

In Bombay Steam Navigation Company (1953) Private Limited v. Commissioner of Income-tax, Bombay, (56 I.T.R 52) (3) the assessee company entered into an agreement of amalgamation with an other shipping company and took over the assets of that company. A part of the price was paid by the assessee company while the balance price was treated as loan which was secured by a promissory note. The assessee company also hypothecated all its movable properties. The balance remaining unpaid was also to carry simple interest at 6 per cent. The assessee company claimed deduction on the amount paid by it by way of interest under section 10 (2) (iii) or under section 10 (2) (xv). In the alternative the assessee claimed that in computing true profits of its business under section 10 (1) the amount paid by way of interest was necessarily allowable. Their Lordships of the Supreme Court while considering the contention of the assessee that the interest paid should be treated as interest paid on the “amount borrowed” held that under clause (iii) of section 10 (2) interest to be permissible as an allowance must be paid in respect of the capital borrowed and that interest paid, but not in respect of capital borrowed, cannot be allowed and that the assessee company in truth did not borrow any capital. In this connection their Lordships observed as follows at pages 57 and 58: —

“A loan of money undoubtedly results in a debt, but every debt does not involve a loan. Liability to pay a debt may arise from diverse sources, and a loan is only one of such sources. Every creditor who is entitled to receive a debt cannot be regarded as a lender. If the requisite amount of consideration had been borrowed from a stranger, interest paid thereon for the purpose of carrying on the business would have been regarded as a permissible allowance; but that is wholly irrelevant in considering the applicability of clause (iii) of sub-section (2) to the problem arising in this case. The legislature has under clause (iii) permitted as an allowance interest paid on capital borrowed for the purpose of the business: if interest be paid but not on capital borrowed, clause (iii) will have no application.”

It was accordingly held in the above case that the claim for deduction of the amount of interest under section 10 (2) (iii) was not admissible. The Court, however, held that interest paid by the assessee company was a permissible deduction under section 10 (2) (xv) and that the question had to be viewed for the larger context of business necessity or expediency. Further that if the out-going or the expenditure was so related to the carrying on or conduct of the business, that it may be regarded as a integral part of the profit earning process, the expenditure may be regarded as revenue expenditure. In the circumstances of the case it was held that the transaction of acquisition of assets was closely related to the commencement and carrying on of the business and the amount of interest paid on the amount remaining due must in the normal course be regarded as expended for the purposes of the business which was laid out or expended wholly or exclusively for the purposes of the business.

So far as the latter observations of their Lordships of the Supreme Court in respect of the amount “laid out, or expended wholly or exclusively for the purposes of business” are concerned, the same would be referred to in a subsequent part of this judgment where this aspect of the matter will be noted. For the present it has to be noted that the contention of the assessee that the amount of interest was allowable under clause (iii) of section 10 (2) was negatived by their Lordships of the Supreme Court on the ground that the interest was not interest on capital borrowed.

The principle deducible from the above-noted authorities is that only that interest is allowable under clause (iii) of section 10 (2) which is in respect of capital borrowed, as in such an eventuality what comes into existence is the relationship of creditor and debtor as a result of consensual act in which the debtor undertakes to pay interest under a contract or an agreement. We are of the opinion that the interest paid by the assessee in the case before us cannot be brought within the four corners of clause (iii) of section 10 (2) as admittedly no capital was borrowed by the assessee from the Government and no relationship of a creditor and debtor came into existence whereby the assessee undertook to pay interest to the creditor. It may be said in fairness to the learned counsel for the respondent that he did not claim allowance in respect of interest under this clause but primarily sought to bring his case within the provisions of section 10 (1) or in the alternative under section 10 (2) (xv) of the Act.

It was also contended by the learned counsel for the Revenue that in computing the profits or gains of business, profession or vocation carried on by the assessee only such allowances are to be made in favour of the assessee which are enumerated under sub-section (2) of section 10 of the Income-tax Act, 1922. That being so, it was contended, the amount of interest can be allowed only if it could be covered under clause (iii) of sub-section (2) of section 10, i.e, if the amount of interest could be in respect of the capital borrowed for the purposes of business, profession or vocation of the assessee. The learned counsellor the Revenue, therefore, vehemently contended that since the interest had been specifically provided for in section 10 (2) (iii), resort could not be had to clause (xv) of sub-section (2) of section 10. Besides, the amount of interest could not be termed as “any expenditure” laid out or expended wholly or exclusively for the purposes of business, profession or vocation of the assessee, and was not an allowance of the nature described in any of the clauses (i) to (xv) of sub-section (2) of section 10.

In support of his contention that when interest as a deductible allowance was specifically provided for in clause (iii) of section 10 (2), resort could not be made to the provisions of clause (xv) of section 10 (2) to bring the interest within the term “any expenditure”, the learned counsel for the Revenue relied upon N.M Rayaloo Iyer and Sons v. Commissioner of Income-tax/Excess Profits Tax, Madras (26 I.T.R 265) (4) in which the assessee claimed an amount of commission or bonus paid to his employee as deduction under section 10 (2) (x). Satya Narayana Rao, J., while examining the scope of section 10 (2) (x) and section 10 (2) (xv) of the Income-tax Act observed that section 10 (2) (x) was a specific provision which relates to the bonus or commission paid to an employee for services rendered by him while section 10 (2) (xv) deals with any expenditure, not being in the nature of capital expenditure or personal expenses of the assessee laid out or expended wholly and exclusively for the purposes of such business, profession or vocation. The learned Judge further observed that it was an accepted canon of construction of statutes that a specific provision always prevails and excludes a general provision. Mr. Sharma, the learned counsel, therefore, strongly urged that since section 10 (2) (iii) is a specific provision under which interest could be allowed it is not open to the assessee to press into service the provisions of section 10 (2) (xv).

Support was also drawn from Southern Agencies Ltd. v. Commissioner of Income-tax, Madras. (45 I.T.R 602) (5) in which the Madras High Court held that if a claim properly arising under section 10 (2) (xi) cannot be upheld under that sub-section it cannot be brought again under section 10 (2) (xv). In that case the assessee whose one of the objects of business was the promotion of new companies and obtain managing agency of the companies so promoted while exploring the possibility of floating a proposed cement manufacturing company incurred large sums by way of preliminary expenditure. The cement company was, however, never formed. The assessee claimed the amount so expended under section 10 (2) (xi). The claim was not accepted as it was held that in expending the amount no debtor came into existence with a liability to pay the debt and as such it could not be said that the debt was irrecoverable. The assessee in that case in the alternative claimed the amount under section 10 (2) (xv) which claim was also negatived because the Tribunal found that there was absence of adequate business consideration. The learned counsel for the Revenue also relied upon Birla Gwalior Private Ltd. v. Commissioner of Income-tax M.P, (44 I.T.R 847) (6); in which the High Court held that it was well settled that if an allowance was specifically dealt with by any one of the clauses of section 10 (2), then clause (xv) which was a residuary clause could not be resorted to.

It is not necessary to deal with this aspect of the case as the contention of the learned counsel for the assessee is that the assessee is entitled to claim allowance for the amount of interest because according to him, it was an expenditure laid out or expended wholly and exclusively for the purposes of business, profession or vocation of the assessee and not on account of interest on borrowed capital.

The contention to be considered, therefore, is whether the amount paid by the assessee by way of interest can be said to be “any expenditure” laid out or expended wholly or exclusively for the purposes of the assessee's business, profession or vocation as envisaged by clause (xv) of section 10 (2). This aspect of the matter was considered by their Lordships of the Supreme Court in Badridas Daga v. Commissioner of Income-tax (34 I.T.R 10) (7). In that case the assessee carried on business as money lenders, dealers in shares and bullion and commission agents. The assessee's agents at Bombay held a power-of-attorney conferring on him large powers of management including authority to operate on bank accounts. The said agent withdrew from the firm's bank account sums aggregating to Rs. 2,30,636-4-0 and applied them in satisfaction of his personal debts incurred in speculative transactions. The assessee filed a suit for the recovery of the said amount against the agent which was decreed. Only a sum of Rs. 28,000/- was recovered from the agent which was adjusted towards the decree and the balance of Rs. 2,02,442-13-9 was written off at the end of the accounting year as irrecoverable. The assessee claimed that amount as an admissible deduction under section 10 (1) or under the general principle of determining the profit and loss of the assessee or on the ground that the amount was deductible under section 10 (2) (xv). The Tribunal held that the amount was not a trading loss and did not allow it. The High Court also negatived the contention of the assessee. In appeal on leave granted to the assessee, under Article 136, their Lordships of the Supreme Court held that the moneys which were withdrawn by the employee out of the business till without authority and in fraud of the employer could in no sense be said to be an “expenditure laid out or expended wholly or exclusively” for the purpose of the business. It was then considered whether the amounts lost through embezzlement by an employee were a trading loss which could be deducted in computing the profits of a business under section 10 (1). In this connection their Lordships of the Supreme Court observed as follows at page 15: —

“. . When a claim is made for a deduction for which there is no specific provision in section 10 (2), whether it is admissible or not will depend on whether, having regard to accepted commercial practice and trading principles, it can be said to arise out of the carrying on of the business and to be incidental to it. If that is established, then the deduction must be allowed, provided of course there is no prohibition against it, express or implied, in the Act”.

On the facts of that case the Court held that the loss arising from misappropriation by an agent whose employment was incidental to the carrying on of business must be held to arise out of the carrying on of business and to be incidental to it. The court, however, pointed out that the loss for which a deduction could be made under section 10 (1) must be one that springs directly in the carrying on of business and was incidental to it and not any loss sustained by the assessee even if it had some connection with his business.

Applying the principle laid down by their Lordships of the Supreme Court only such expenditure is allowable which is laid out or expended wholly and exclusively for the purpose of business, profession or vocation and which expenditure is incidental to the carrying on of the business of the assessee and which must be incidental to the business. The question, therefore, is whether it can be said in the present case that the amount of interest paid by the assessee was an expenditure which sprang directly from the carrying on of the business and was in any manner incidental to it. The assessee in the present case had to pay the interest because of his failure to deposit the cess. In other words, the assessee failed to fulfil his statutory obligation. That being so, it cannot be said that the amount of interest paid was in any manner incidental to the carrying on of the business; rather it was paid for avoiding a statutory obligation. The interest, therefore, was de horse to the carrying on of the business or trade of the assessee and was not incidental to it.

Reliance was then placed on Commissioner of Income-tax v. Rohtas Industries Ltd., (67 I.T.R 783) (8) in which case the assessee acquired a piece of land through Government under the Land Acquisition Act. The possession of the land was taken before the total amount of compensation money payable was determined and the assessee had to pay and paid a sum of Rs. 22,438/- as interest, required to be paid under section 34 of the Land Acquisition Act. The assessee claimed deduction of the interest amount under section 10 (2) (iii) or alternatively under section 10 (2) (xv). It was held by the Patna High Court that the deduction was not permissible under section 10 (2) (iii) since no interest was paid on capital borrowed for the purposes of the assessee's business. However, the interest was allowed under section 10 (2) (xv) on the ground that the land was acquired for the assessee by the Government under the Land Acquisition Act and, therefore, it could be presumed that the land was acquired for the purposes of the business of the company. In that view of the matter, the Court held that the payment of interest was in relation to the business of the Company as the land was used for the purposes of the business of the Company and that the question had to be viewed in the larger context of business necessity or expediency.

However, the facts of the above-cited case are distinguishable from the facts of the case before us. In the above case interest was payable under the provisions of the statute while in the instant case interest had to be paid because the assessee infringed the provisions of the law and as such interest in the instant case cannot claimed as expenditure allowable under section 10 (2) (xv) of the Income Tax Act, 1922.

The learned counsel for the assessee relied on Commissioner of Income-tax, West Bengal v. Hindustan Motors Ltd., (68 I.T.R 301) (9). In that case the assessee-company was engaged in the business of manufacturing motor cars. Its factory was situated within the territorial limits of Kotrang Municipality, at a little distance away from the G.T Road. An approach road connecting the factory with the G.T Road which belonged to the Government had fallen into disrepair and thus caused difficulty to the assessee in transport of manufactured motor cars from the factory premises to the place of their sale. The Government undertook to repair the approach road on the assessee's contributing in advance a sum of Rs. 39,770/- to meet the costs of the repair to be carried. The company paid the aforesaid sum to the Government and claimed the amount as expenditure, allowable under section 10 (2) (xv) of the Income-tax Act, 1922. The Income-tax officer and the Appellate Assistant Commissioner held that the expenditure was of a capital nature. On appeal the Tribunal allowed the appeal stating that the expenditure was laid out for the purpose of facilitating carrying on of its business and that the enduring benefit went to the owner of the road and not to the assessee. On the asking of the department the question “whether, on the facts and in the circumstances of the case, the sum of Rs. 39,770/- was an allowable expense within the meaning of section 10 (2) (xv) of the Indian Income-tax Act, 1922” was referred to the High Court. While dealing with the question the High Court observed as follows at pages 308 and 309: —

“The motive behind the payment was to do away with the inconvenience of a disrepair road, which should have been kept in repair by the Government as part of civilised administration. The money was spent not so much to bring about any asset or advantage of enduring benefit to itself but to run the business efficiently and conveniently, that is to say, by not being hampered by slow and possibly dangerous locomation of cars, produced in the factory, while moving on a disrepaired and ill-conditioned road. As a matter of business prudence, there was justification on the part of the assessee to expend this amount so as to induce the Government to repair the road, which it could not itself, repair, not being the owner of the road. The expenditure ought thus to be treated as wholly and exclusively spent for the assessee's business within the meaning of section 10 (2) (xv) .”

Drawing support from the above-cited case the learned counsel contended that interest paid was covered by the term “any expenditure” as the same was paid in the business necessity or expediency of the business of the assessee. The learned counsel also relied upon State of Madras v. G.J Coelho (53 I.T.R 186) (10) in support of his contention that the interest was allowable under section 10 (2) (xv). In that case the respondent-assesses purchased an estate consisting of tea, coffee, and rubber plantations for a sum of Rs. 3,10,000/-. The assessee was not possessed of the full price and borrowed Rs. 2,90,000/- on interest and claimed deduction on the amount of interest paid under section 5 (k) of the Madras Plantations Agricultural Income-tax Act, the provisions of which section are word for word a reproduction of the provisions of section 10 (2) (xv) of the Indian Income-tax Act, 1922. The question for consideration in that case was whether the payment of interest was in the nature of capital expenditure or not. The Court held that in ordinary commercial practice payment of interest would not be termed as capital expenditure as no new asset was acquired with it and neither any enduring benefit was made. It was further held that the payment of interest on the amount borrowed for the purchase of plantation when the whole transaction of purchase and the working of plantation was viewed as an integrated whole, was so closely related to the plantation that the expenditure could be said to be laid out or expended wholly or exclusively for the purpose of plantation and from the agricultural receipts must be deducted all expenses which in ordinary commercial accounting must be debited against the receipts.

But in the case before us what is to be seen is whether the assessee by infringing the provisions of the statute and not depositing the cess in time whereby penal interest was imposed on him could claim that the amount deposited by way of penal interest was in any manner closely related to the assessee's business as a result whereof the expenditure incurred by way of penal interest could be said to be laid out or expended wholly or exclusively for the purpose of assessee's business. We are unable to answer the question in favour of the assessee as the origin of the liability flows from a statute and in meeting his liability of depositing the penal interest it cannot be said that the assessee was laying out or expending the amount wholly and exclusively for the purpose of his business.

Lastly in this respect the learned counsel for the assessee relied upon Central Trading Agency v. Commissioner of Income-tax, U.P (56 I.T.R 561) (11). In that case the assessee undertook under a contract to make certain supplies to the Government. One of the conditions of contract was that if the assessee failed to make supply within the stipulated period it was liable to penalty of 2 annas per pound unless its failure was due to reasons beyond its control. The assesse failed to complete the supply within time and penalties were imposed on it by the Government, The assessee claimed a deduction for penalties paid by it as a business expenditure under section 10 (2) (xv). Before the Tribunal a further contention was raised to the effect that in the nature of the business carried on by the assessee, the risk of penalty was inherent in such a business and that the penalty should be treated as an admissible business expenditure. The facts of that case were that the Government cancelled the contract for the assessee's failure to supply the goods within time. Subsequently the Government revoked the order and allowed the assessee to complete the supply by extending the time and the assessee agreed to pay the liquidated damages to keep the original contract alive. In that view of the matter the High Court held that the amount of liquidated damages paid was not by way of penalty imposed or as damages for breach of contract; rather the payment by the assessee was for the purpose of carrying on its business and not a payment made for not carrying on its business and the payment made was for “commercial expediency”. The Court also observed that the payment was made with a view to enable the assessee to fulfil the contract and earn profits therefrom.

We do not think that the assessee can derive any help from this authority as the facts of the said case stood entirely on different footing than the facts in the case before us. In that case as already discussed the assessee agreed to pay the penalty or liquidated damages in the interest of business expediency as it was on its undertaking to pay such an amount that the Government revoked the order canceling the contract as a result whereof the assessee was able to complete the supply under the contract and earn profits therefrom but in the instant case the interest was paid by way of penalty by the assessee for having breached the provisions of a statute.

Lastly the learned counsel for the assessee contended that if interest paid by the assessee was not allowable under section 10 (2) (xv) the assessee was certainly entitled to the same under section 10 (1) of the Act as tax has to be paid in respect of profits or gains of the business, profession or vocation carried on by the assessee and for computing the profits and gains of business, profession or vocation all relevant and legitimate expenses incurred by the assessee during the course of the business, profession or vocation have to be allowed. The learned counsel contended that when the amount of cess paid was itself an allowable deduction it does not stand to reason why interest paid on it should not be allowable. Besides, it was contended that nature of the amount paid by way of interest was nothing but additional tax paid. In other words, the interest paid amounted to an increase in tax and has to be allowed under section 10 (1) and that both logical and commonsense view of the aforesaid section would be that interest paid by the assessee was by way of augmentation of the tax. We are unable to sustain this contention. Penal interest was paid not on account of increase in tax or by way of additional tax but as penalty for the omission on the part of the assessee to deposit the cess in time and the amount so paid cannot be termed as legitimate business expenses as cess may be allowable under section 10 (1).

In support of his contention the learned counsel drew support from Govind Choudhury and Sons v. Commissioner of Income-tax, Bihar and Orissa, (79 I.T.R 493) (12). In that case the assessee claimed deduction for a certain sum paid as penalty to the Government of Orissa for supplying inferior quality of paddy and rice. The claim was rejected by the Income-tax Officer who held that it was not an admissible deduction in the hands of the assessee as the penalty imposed on the assessee was for violation of the terms of the contract by it. In appeal the Appellate Assistant Commissioner negatived the contention of the assessee on the ground that the payment of the penalty amount had to be made due to the breach of the contract on the part of the assessee and the payment could hardly be called “legitimate business expenditure”. In further appeal before the Tribunal the payment of the amount of penalty was claimed as deductible under section 10 (2) (xv) of the Act. The Tribunal holding that the penalty was imposed as the assessee failed to supply paddy and rice according to specification, did not sustain the contention of the assessee. The High Court in the Reference made to it observed that the question to be examined in the case was whether the penalty was so integrally connected with the carrying on of the business of supplying paddy; that the loss arising out of its failure would be deductible from the income itself. The High Court further observed that the answer to the question must be in the affirmative as the loss arising out of the imposition of penalty was integrally connected with the carrying on of the business of paddy supply. That view proceeded on the ground that the action of the assessee was not contrary to law but was in violation of terms of agreement under which the business was carried on and that the real question that required to be answered was whether the deduction claimed could come under section 10 (1) of the Indian Income-tax Act, 1922 and the High Court observed that the assessee was entitled to relief under section 10 (1) of the Act and not by way of deduction under section 10 (2) (xv).

We do not think that any help can be drawn by the assessee from the above-cited case. Non-payment of Government dues cannot be said to be an act integrally connected with the business of the assessee because such an act is contrary to law and if penalty had to be paid, it cannot be urged that it was a legitimate business expenditure allowable under section 10 (1).

Support was also drawn from Calcutta Company Limited v. Commissioner of Income-tax, West Bengal (37 I.T.R 1) (13) in which their Lordships of the Supreme Court observed that the words “profits and gains” have to be understood in their commercial sense and there can be no computation of profits and gains until the expenditure which was necessary for the purpose of earning profit was deducted therefrom — whether the expenditure was actually incurred or the liability in respect thereof had accrued even though it may have to be discharged at some future date.

Now the point to be considered is whether the amount of penal interest paid was on account of the expenditure which was necessary for the purpose of earning the receipts of the assessee and hence deductible therefrom with a view to arrive at “profits and gains” of the assessee. As already observed in an earlier part of this judgment penal interest was paid for having violated the provisions of law, and it is not open to the assessee to say that its act of infringing the law and not paying the cess in time was in any manner integrally connected with the business of the assessee. In this view of the matter it cannot be said by any stretch of imagination that the penal interest paid would be covered under the head “expenditure necessary for the purposes of earning receipts” and the penal interest cannot be termed as legitimate business expenditure. There is no warrant in law that in carrying on a business an assessee may at its sweetwill infringe the law and if in answer to a charge for infringement the assessee had to incur some expenses or deposit some amount by way of penal interest, the assessee can with justification assert that the amount so spent or penal interest so deposited was legitimate business expenditure. Further the plain language of section 10 (1) cannot be strained to hold that the penal interest deposited by the assessee was in any way a legitimate expenditure for earning profits and was integrally connected with the carrying on of the assessee's business. There is another aspect required to be considered and that is that the assessee did not deposit the cess as the assessee took the stand that the cess was violative of the Constitution and the assessee, therefore, deliberately chose not to deposit it within time. It is not, therefore, open to the assessee to suddenly turn round and say that the penal interest has in any manner become legitimate business expenditure; more so when the penal interest had to be paid for an infringement of law committed by the assessee.

For the reasons stated above the question has to be answered in the negative. The assessee shall pay Rs. 300/- (Rupees three hundred) as costs to the Revenue in both the References.

Reference answered accordingly.