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Deoria Sugar Mills Ltd. v. Commissioner Of Income Tax
Factual and Procedural Background
This reference arises under Section 66(1) of the Indian Income-tax Act, 1922, relating to the assessment year 1958-59 (previous year ending 31 August 1957). The assessee, a manufacturer and seller of sugar with a mill at Deoria (U.P.) and registered office at Calcutta, claimed a deduction of Rs. 34,355 by letter dated 25 November 1961 as interest paid for arrears of sugarcane cess under the Uttar Pradesh Sugarcane Cess Act, 1956.
The Income-tax Officer disallowed the claim on two grounds: (1) the liability related to the previous accounting year and the assessee had not made any provision for the sum in its accounts for that year despite using mercantile accounting; and (2) the amount was penal in nature, being imposed for nonpayment of the cane cess on the due date.
Before the Appellate Assistant Commissioner the assessee claimed the deduction under either Section 10(1) or Section 10(2)(xv) of the Income-tax Act, 1922, arguing that interest and an additional amount under the Cess Act (though termed "penalty" in the statute) were in substance an additional levy of cess and not a punitive penalty. The Appellate Assistant Commissioner allowed part of the claim and disallowed part: he accepted as deductible interest of Rs. 16,443.68 (interest on arrears from 23 December 1956 to 31 August 1957) but disallowed Rs. 17,911.39, being the sum directed to be paid by way of penalty under Section 3(5) of the U.P. Sugarcane Cess Act, 1956.
The Tribunal affirmed the Appellate Assistant Commissioner, holding that Section 3(5) was intended to penalise the defaulter and that the Rs. 17,911 element could not be allowed as a deduction. The following question was referred to the court:
"Whether, on the facts and in the circumstances of the case, the sum of Rs. 17,911 being the amount paid under Section 3(5) of the U. P. Sugarcane Cess Act, 1956, for default in making the payment of cess in due time was allowable as a deduction either under Section 10(1) or Section 10(2)(xv) of the Indian Income-tax Act, 1922?"
Legal Issues Presented
- Whether the sum of Rs. 17,911, paid under Section 3(5) of the Uttar Pradesh Sugarcane Cess Act, 1956 for default in making payment of cess in due time, was allowable as a deduction either under Section 10(1) or Section 10(2)(xv) of the Indian Income-tax Act, 1922.
Arguments of the Parties
Assessee's Arguments
- The payment under Section 3(5) is not really a penalty for contumacious conduct or violation of law but is in substance an additional interest or levy for delayed payment of cess; thus it should be deductible.
- The assessee asserted inability to pay the cess when due due to insufficient funds and maintained there was no criminal or contumacious conduct; paying the Section 3(5) amount was commercially expedient to enable payment when funds were available.
- Alternatively, under Section 10(1) the assessee argued that expenses incidental to carrying on the business should be allowed as deductions even when not expressly listed in Section 10(2), if they arise out of the carrying on of the business and are incidental to it.
Revenue / Tribunal / Lower Authorities' Position
- The Income-tax Officer contended the liability related to the relevant previous year and was not provided for in the accounts (despite mercantile accounting); and that the amount was penal in nature and therefore not deductible.
- The Appellate Assistant Commissioner held that failure to provide in accounts did not automatically bar deduction if the liability was incurred in the year; he accepted the interest portion (Rs. 16,443.68) as deductible but treated the Rs. 17,911.39 under Section 3(5) as a penalty not incurred for commercial expediency and disallowed it.
- The Tribunal agreed that Section 3(5) imposed a penalty in addition to interest for default and affirmed disallowance of Rs. 17,911.
Table of Precedents Cited
| Precedent | Rule or Principle Cited For | Application by the Court |
|---|---|---|
| Haji Aziz & Abdul Skakoor Bros. v. Commissioner of Income-tax (Supreme Court) | Held that an expense paid by way of penalty for breach of law is not "wholly and exclusively laid out" for business under Section 10(2)(xv) — penalties for infraction of law are not deductible as business expenses. | The court relied on this Supreme Court observation (quoted) to hold that payments imposed as penalties for breach of law cannot be allowed as deductions; this formed central authority for disallowing the Section 3(5) payment. |
| Mahabir Sugar Mills (P.) Ltd. v. Commissioner of Income-tax, [1969] 71 I.T.R. 87 (Allahabad High Court) | Held that a penalty paid under Section 3(5) of the U.P. Sugarcane Cess Act, 1956 for non-payment of arrears of cess is not allowable as business expenditure under Section 10(2)(xv) of the Income-tax Act, 1922. | The court cited this direct authority and expressly agreed with its conclusion that the Section 3(5) payment is not deductible. |
| Badridas Daga v. Commissioner of Income-tax (Supreme Court) | Explains Section 10(1): where a deduction sought is not specifically provided in Section 10(2), admissibility depends on whether, by accepted commercial practice and trading principles, the expense arises out of and is incidental to carrying on the business, provided there is no express or implied prohibition. | The court used this test to consider the assessee's alternative contention under Section 10(1) and concluded that payment under Section 3(5) does not arise out of or is incidental to carrying on the business because an infraction of law is not a normal incident of trade. |
| Central Trading Agency v. Commissioner of Income-tax (Allahabad High Court) — cited by assessee | Relates to contractual penalties (not an infraction of statute) and principles concerning deductibility of certain contractual payments. | The court declined to deal with this judgment for the purposes of the reference because it involved a contractual penalty rather than a penalty for infraction of statute or law; therefore it was not applied to this case. |
Court's Reasoning and Analysis
The court proceeded by (a) identifying the statutory provisions in the U.P. Sugarcane Cess Act, 1956 (notably Section 3(3) — interest on arrears — and Section 3(5) — power to direct recovery of up to 10% by way of penalty for default — and Section 4 which prescribes penalties including imprisonment or fine), (b) considering the character of the sum of Rs. 17,911 paid under Section 3(5), and (c) examining legal authorities on whether penalties or similar payments are deductible under the Income-tax Act.
The court accepted the reasoning of the Supreme Court in Haji Aziz & Abdul Skakoor Bros. that an expense paid by way of penalty for breach of law cannot, on grounds of public policy, be treated as a commercial expense incurred for earning business profits and therefore is not deductible under Section 10(2)(xv). The court regarded that observation as directly applicable.
The court further relied on the Allahabad High Court decision in Mahabir Sugar Mills which held that a payment under Section 3(5) of the U.P. Cess Act is not allowable as business expenditure under Section 10(2)(xv); the court expressly agreed with that view.
Addressing the assessee's alternative submission under Section 10(1) (that even without express statutory provision an expense incidental to business should be allowed), the court applied the Badridas Daga test: a claim not falling within Section 10(2) can be allowed only if, by accepted commercial practice and trading principles, it arises out of and is incidental to carrying on the business and there is no prohibition against it. Applying that test, the court concluded that payments made as a consequence of an infraction of law (i.e., the Section 3(5) payment) could not be regarded as arising out of or incidental to carrying on of the business because an infraction of law is not a normal incident of trade.
The court therefore concluded that the Section 3(5) payment could not be allowed either under Section 10(2)(xv) (as it was a penalty for breach of law) or under Section 10(1) (as it did not meet the test of being incidental to the carrying on of business).
Holding and Implications
Holding: The court's answer to the referred question was negative. In other words, the sum of Rs. 17,911 paid under Section 3(5) of the U.P. Sugarcane Cess Act, 1956 is not allowable as a deduction under Section 10(1) or Section 10(2)(xv) of the Income-tax Act, 1922.
Implications:
- Direct effect: The Rs. 17,911 element paid under Section 3(5) remains disallowed as a deduction in computing the assessee's taxable income for the assessment year in question.
- Costs: The applicant was ordered to pay to the Commissioner the costs of the reference.
- Precedential note: The court expressly relied on and followed existing authorities (Supreme Court and Allahabad High Court decisions) in reaching its conclusion. The decision aligns with the established principle that penalties for breach of statutory law are not deductible as business expenses; the opinion does not purport to create a new departure from those authorities.
Judge: Sabyasachi Mukharji, J. — with concurrence indicated ("I agree").
1. This is a reference under Section 66(1) of the Indian Income-tax Act, 1922. The assessment year is 1958-59. The relevant previous year is the year which ended on the 31st August, 1957. The assessee carried on business in the manufacture and sale of sugar. It had its mill at Deoria, Uttar Pradesh, and its registered office at Calcutta. For the assessment year 1958-59, by its letter dated 25th November, 1961, the assessee claimed a deduction of Rs. 34,355 as interest paid for arrears of sugarcane cess under the Uttar Pradesh Sugarcane Cess Act, 1956.
2. The Income-tax Officer rejected this claim. His first ground was that the liability related to the assessee's accounting year which ended on the 31st August, 1957, and the assessee had not made any provisions for the said sum in its accounts for that year though the assessee's method of accounting was mercantile. Secondly, he said that the amount in question was not allowable as a deduction since it was penal in nature for nonpayment of the cane cess on the due date.
3. Before the Appellate Assistant Commissioner the assessee based the claim for deduction of the said sum of Rs. 34,355 either under Section 10(1) or under Section 10(2)(xv) of the Act of 1922. The argument was that under the Uttar Pradesh Sugar cane Cess Act, 1956, interest was payable for delayed payment of cess and an additional amount was also payable for non-payment of cess in certain circumstances which though described as penalty in the Act was in effect an additional levy of cess. The Appellate Assistant Commissioner was of opinion that the claim aforesaid could not be rejected merely on the plea that the amount was not provided for in the assessee's books of account in the relevant previous year. And as the liability for the payment of this amount was incurred during the year in question, the deduction should be allowed if otherwise permissible. The Appellate Assistant Commissioner found that the said sum of Rs. 34,355 was made up of two items, namely, (a) Rs. 16,443.68 and (b) Rs. 17,911.39. The first item was interest on arrears of cane cess for the period December 23, 1956, to August 31, 1957. The second item was the amount directed to be paid by way of penalty under Section 3(5) of the Uttar Pradesh Sugarcane Cess Act, 1956. The Appellate Assistant Commissioner held that the second item was inadmissible since it was a levy by way of penalty and this payment could not be said to have been incurred for commercial expediency. He, however, allowed the deduction of the first item, namely, the sum of Rs. 16,443.68.
4. It would be convenient at this stage to set out the provisions of Sections 3 and 4 of the Uttar Pradesh Sugarcane Cess Act, 1956. These provisions are as follows:
"3. (1) The State Government may by notification in the Official Gazette impose a cess not exceeding four annas per maund on the entry of the cane into the premises of a factory for use, consumption or sale therein:
Provided that the State Government may likewise remit in whole or in part such cess in respect of cane used or to be used in a factory for any limited purpose specified in the notification.
Explanation.--If the State Government, in the case of any factory situated outside Uttar Pradesh, so declare, any place in Uttar Pradesh set apart for the purchase of cane intended or required for use, consumption or sale in such factory shall be deemed to be the premises of the factory.
(2) The cess imposed under Sub-section (1) shall be payable by the owner of the factory and shall be paid on such date and at such place as may be prescribed.
(3) Any arrear of cess not paid on the date prescribed under subsection (2) shall carry interest at 6 per cent. per annum from such date to date of payment.
(4) The State Government may, for the purpose of assessment and collection of the cess, appoint officers and authorities and may also prescribe the manner in which the cess shall be assessed and collected.
(5) Where any person is in default in making the payment of the cess, the officer or authority empowered to collect the cess may direct that in addition to the amount of the arrears and interest a sum not exceeding 10 per cent. thereof shall by way of penalty be recovered from the person liable to pay the cess.
(6) The officer or authority empowered to collect the cess may forward to the Collector a certificate under his signature specifying the amount of arrears including interest due from any person, and on receipt of such certificate the Collector shall proceed to recover the amount specified from such person as if it were an arrear of land revenue.
(7) Any sum imposed by way of penalty under Sub-section (5) shall be recoverable in the manner provided in Sub-section (6) for the recovery of the arrears of cess.
4. Penalties.--If any person defaults in the payment of cess imposed under Sub-section (1) of Section 3, or contravenes any provision of any rule made under this Act, he shall, without prejudice to his liability therefor under Sub-section (5) of Section 3, be liable to imprisonment up to six months or to a fine not exceeding rupees five thousand or both and in the case of continuing contravention to a further fine not exceeding rupees one thousand for each day during which the contravention continues."
5. Before the Tribunal the assessee contended that the penalty under the Cess Act was imposed under Section 4 and what was contemplated in Section 3(5) was not penalty but an additional interest charged for non-payment of the cess and interest in due time. The assessee did not dispute the proposition that payment by way of penalty could not be allowed as a deduction provided that this penalty was imposed for contumacious conduct or for violation of any law. The Tribunal held that under Section 3(5), the intention was to penalise the defaulter in addition to the interest charged for non-payment in time while Section 4 provided for imprisonment or fine not only for default of payment of cess but also for contravention of the other provisions of the statute. The Tribunal agreed with the Appellate Assistant Commissioner that the amount of Rs. 17,911 could not be allowed as a deduction and dismissed the appeal.
6. The following question has been referred to this court:
" Whether, on the facts and in the circumstances of the case, the sum of Rs. 17,911 being the amount paid under Section 3(5) of the U. P. Sugarcane Cess Act, 1956, for default in making the payment of cess in due time was allowable as a deduction either under Section 10(1) or Section 10(2)(xv) of the Indian Income-tax Act, 1922 ?"
7. On behalf of the assessee it has again been argued before us that the payment which is made under Section 3(5) of the Uttar Pradesh Sugarcane Cess Act, 1956, is not really a penalty imposed for contumacious conduct or violation of any law. It is in the nature of additional interest charged for non-payment of cess in due time.
8. Learned counsel for the assessee draws our attention to the assessee's submission before the Tribunal that the assessee was unable to pay the cess as it had not sufficient funds at its disposal and it should not be said that the assessee was guilty of any crime or any violation of law for which he was subjected to any penal provision under the law. Learned counsel then says that it was, therefore, found to be commercially expedient to pay the additional amount under Section 3(5) to enable the assessee to make payment when sufficient funds were available. Counsel for the assessee submits that the Tribunal misdirected itself in law by not taking into account these important factors.
9. Alternatively, Mr. Debi Pal, learned counsel for the assessee, urged that in computing commercial profit under Section 10(1) expenses incidental to the carrying on of the assessee's business should be allowed as deductions even though no express provisions therefor had been made under Section 10(2).
10. Reliance was placed on a judgment of the Allahabad High Court in Central Trading Agency v. Commissioner of Income-tax, [1965] 56 I.T.R. 561 (All.). We do not propose to deal with this judgment in this reference as it was not a case of penalty for infraction of statute or violation of law but a case of contractual penalty.
11. In Haji AZIZ & Abdul Skakoor Bros. v. Commissioner of Income-tax, the assessee carried on the business of importing dates from abroad and selling them in India. It imported dates from Iraq partly by steamers and partly by country craft. These imports were made when import of dates by steamer was prohibited. The customs authorities confiscated the dates under Section 167 of the Sea Customs Act (item 8). The assessee was given an option under section 183 of that act to pay a fine. The assessee paid the fine and had the dates released. In its computation of profits the assessee sought to deduct the amount paid as fine as an allowable expenditure under Section 10(2)(xv) of the Act of 1922. The Supreme Court has held, inter alia, that no expense which was paid by way of penalty for a breach of the law, even though it might involve no personal liability, could be said to be an amount wholly and exclusively laid out for the purpose of the business of the assessee within the meaning of Section 10(2)(xv) of the Income-tax Act. At page 360 their Lordships of the Supreme Court observed :
" The distinction sought to be drawn between a personal liability and a liability of the kind now before us is not sustainable because anything done which is an infraction of the law and is visited with a penalty cannot on grounds of public policy be said to be a commercial expense for the purpose of a business or a disbursement made for the purposes of earning the profits of such business."
12. To our mind the case before us has to be decided in the light of these observations of the Supreme Court. In fact, there is a direct authority of the Allahabad High Court on this point. In Mahabir Sugar Mills (P.) Ltd. v. Commissioner of Income-tax, [1969] 71 I.T.R. 87 (All.) it has been held that penalty paid under Section 3(5) of the U. P. Sugarcane Cess Act, 1956, for non-payment of arrears of sugarcane cess levied under the said Act, is not allowable as business expenditure under Section 10(2)(xv) of the Act of 1922. We respectfully agree with this view.
13. We may now cite another judgment of the Supreme Court on Section 10(1) as the alternative argument of the assessee's counsel herein was based on that sub-section. In Badridas Daga v. Commissioner of Income-tax, Venkatarama Iyer J., speaking for the Supreme Court, has said :
" .........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."
14. When we apply these principles to the facts before us, we cannot uphold the assessee's claim for deduction on the basis of Section 10(1). Any payment made under Section 3(5) of the Uttar Pradesh Sugarcane Cess Act, 1956, cannot be said to arise out of the carrying on of the business of the assessee or to be incidental to it. An infraction of law is not a normal incident of trade.
15. In the premises aforesaid, the answer to the question referred to us is in the negative. The applicant will pay to the Commissioner the costs of this reference.
Sabyasachi Mukharji, J.
I agree.
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