O. Chinnappa Reddy, J.:— The assessee who carries on business in exhibition of films is a member of East Punjab Motion Pictures Association. Under the Byelaws of the Association, a member is obliged to carry out the “award and directives” of the Association arising out of all disputes between members or upon complaints received by the Association. A member failing to carry out the directive of the Association would be suspended from membership of the Association and would be eligible to be reinstated on payment of a specified sum of penalty in addition to “reinstatement circulation charges”. The assesses had to pay a sum of Rs. 4300/- by may of penalty to the Association during the Accounting Year relevant to the Assessment year 1970–1971. The assessee claimed that the sum of Rs. 4300/- paid by way of penalty to the Association was a sum ‘laid out wholly and exclusively for the purposes of the assessee's business’ and was, therefore, allowable expenditure under section 37 of the Income-tax Act, 1961. The Tribunal held that branches of contractual obligations were not incidents of business and, therefore, the amount paid by the assessee as penalty was not allowable expenditure.
2. At the instance of the assessee, the following question has been referred to us for our opinion:—
“Whether on the facts and in the circumstances of the case, the Tribunal was justified in holding that the sum of Rs. 4,300/- paid by the assessee by way of penalty to the East Punjab Motion Pictures Association was not deductible as a business expenditure under the Income-tax Act, 1961?
3. The learned counsel for the assessee invited our attention to Paragraph 16(a) of the Rules and Regulations of the East Punjab Motion Pictures Association which prohibits every distributor-member of the Association from supplying films to a non-member exhibitor and vice-versa, and, argued that in order to survive in the business of an exhibitor of films, the assessee was bound to seek reinstatement of membership by paying the penalty. The payment of penalty was essential to enable the assessee to continue to carry on the trade and so it must be held to have been laid out wholly and exclusively for the purposes of the assessee's business. The learned counsel argues that breaches of contractual obligations were often commercially expedient and that they should not be treated on a par with ‘infractions of law.’
4. We do not agree with the sub-missions of the learned counsel. We are unable to hold that damage paid for committing breaches of obligation can any more be said to be expenditure laid out wholly and exclusively for the assessee's business than a penalty paid for an infraction of the law. Infractions of law may be as commercially expedient as breaches of obligation. For a smuggler or a bootlegger, infraction of law is the very breath of his business but he cannot claim the ‘hush money’ that he may pay to corrupt officials as expenditure incurred wholly and exclusively for his business on the ground that it is commercially expedient to pay ‘hush money’, otherwise he will be out of business. We do not think that commercial expedience is always a correct on conclusive test to determine whether expenditure is laid out wholly and exclusively for the assessee's business. We think it is impossible and in expedient to define the expression “wholly and exclusively for the assessee's business”. (This is a difficulty which was also expressed by Rowlatt, J. and Lord Sterndale. M.R, whose observations we will presently quote). We think it is perhaps wiser to leave the words of the statute as they are than to put a gloss upon them. All that is necessary for us to is say is that the expenditure must, in someway, Reconnected with trade, it must be an ordinary or contemplable incident of trade. There must be a discernible nexus between the expenditure and the trade. There must be something commercial about it. We are of the view that infractions of law including breaches of obligations, are not normal incidents of business and penalties and damages paid in connection with such infractions and breaches are not expenditure “laid out or expended wholly and exclusively for the assessee's business”.
5. In Mask & Co. v. Commissioner of Income-tax 11 ITR 454, the assessee committed a breach of contract and in a suit filed by the other party, he was obliged to pay a sum of Rs. 500/- by way of damages. The amount was claimed by the assessee as expenditure “laid out or expended wholly and exclusively for purpose of assessee's business”. Negativing the assessee's claim, leach C.J and Lakshmana Rao, J. after refining to Inland Revenue Commissioners v. Waren & Co. and Inland Revenue Commissioners v. Von Glehn and Co., said:—
“In the present case, the assessee was not fined for breach of law but was made to pay damages for a breach of the contract entered into. The assessee's action in disregarding the undertaking given was palpably dishonest we are of the opinion that the award of damages which followed did not constitute an expenditure falling within section 10(2)(xii). It was not incidental to the trade.”
6. The decision in Mask and Company's case was quoted with implicit approval by the Supreme Court in Haji Aziz & Abdul Shakoor Brothers v. Commissioner of Income-tax.
7. In Inland Revenue Commissioners v. E.C Warnes & Co. . 12 Tax Cases 227., a mitigated penalty of Rs. 2000/- was levied for breaches of certain orders and procl imations under the Customs (War Powers) Act, 1915. The amount was claimed as business expenditure, Rowalatt, J., said:—
“But the question, really, is whether, within the meaning of this Rule, it is a loss connected with or arising out of their trade. I may shelter myself behind the authority of Lord Lreburn, who in his Judgment in the House of Lords in Strong & Co. v. Wood field said that it is impossible to frame any formula which shall describe what is a loss connected with or arising out of a trade. That statement I adopt, and I am no sure that I gain very much by going through a number of analogies; but it seems to me that a penal liability of this kind cannot be regaided as a loss connected with or arising out of a trade. I think that a loss connected with or arising out of a trade must, at any rate, amount to something in the nature of loss which is cantemplaihe, and in the nature of a commercial loss. I do not intend that to be an exhaustive definition, but I do not think it is possible to say that when a fine, which is what it comes to, has been inflicted upon a trading body, it can be said that is “a loss connected with or arising out of the trade within the meaning of this Rue. As I say, it is impossible to say what is such a “loss”, but I have a clear view that this is not, and I can say no more than that.”
8. The decision of Rowlatt, J. was approved by the Court of Appeal in Inland Revenue Commissioners v. Von Glehn and Co. . 12 Tax Cases 232.. After referring to Rule 1 in which was used the expression “money wholly and exclusively laid out or expended for the purposes of such trade.” Lord Sterndale said:—
“During the course of the trading this company committed a breach of the law As I say, it has been agreed that they did not intend to do any thing wrong in the sense that they were willingly and knowingly sending these goods to any enemy distinction, but the committed a breach of the law, and for that breach of the law they were fined, and that does not seem to me to be a loss connected with the business, but it is a fine imposed upon the company personally, as far a company can be a person, for a breach of the law which they had committed. It is perhaps a little difficult to out the distinction into very exact language, but there seems to be a difference between a commercial less in trading and a penalty imposed upon a person or a company for a breach of the law which they have committed in that trading.”
9. In Haji Aziz and Abdul Sbakoor Bros. v. Commissioner of Income-tax . 41 I.T.R 350., the Supreme Court held that a fine paid by the assesee under the Customs Act as an alternative to confiscation of the goods imported by him was not “expenditure paid out or expended wholly and exclusively for the assessee's business”. After referring to several decided cases including, Mask and Co. v. Commissioner of Income-Tax, Inland Revenue Commissioner v. Warms and Inland Revenue Commissioner v. Von Glehn & Co. the Supreme Court said:—
“A review of these cases shows that expenses which are permits as deductions are such as are made for the purpose of carrying on the business, i.e, 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 or 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 in Von Glehn's 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 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 been liable to penalty, it cannot be claimed as a deductible expense. If must be a commercial loss and in its nature must be contemplate as such. Such penalties which are incurred by an assessee in proceedings hunched against him for an 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 are really incidental to the business itself. They cannot be deducted if they fall on the assessse in some character other than that of a trader. Therefore, where a penalty is incurred for the contravention of any specific statutory provision, it cannot be said to be a commercial loss falling on the assessee as a trader the test being that the expenses which are for the purpose of enabling a person to carry on trade for miking profits in the business are permitted but not if they are merely connected with the business.”
10. In Travancore Titanium Products Ltd. v. Commissioner Of Income Tax Kerala . 60 ITR 277., Commissioner of Income Tax v. Malavam plantations Ltd. . 53 ITR 140. & Commissioner of Income Tax v. Birla Cotton Spinning and Weaving Mills Ltd. . 82 I.T.R 166., the Supreme Court, explained that the expression ‘for the purpose of the business’ was wider in scope than the expression for the purpose of earning profits' and could take in ‘the rationalization of its administration and modernization of its machinery, ‘the preservation of the business’ ‘the protection of its assets and property from expropriation, coercive process or assertion of no title’, ‘payment of statutory due and taxes imposed as a precondition to commerce or for carrying on business’ and ‘many other acts incidental to the carrying on of a business’. The learned judges took care to say that such expenditure must be incidental to the carrying on of the business.
11. Commissioner of Income Tax Punjab v. Himalaya Rosin Turpentine Manufacturing Co. . 24 I.T.R 132., the facts were that the assessee who was carrying on the business of extracting Rosin and selling it entered into an agreement with the Tehri Girhwal State for extracting Rosin according to certain terms and conditions. If he failed to observe the conditions, he was to pay compensation. The assesee was obliged to pay a sum of Rs. 5000/-, said to have been imposed by way of fine, to the Tehri Garhwal State for committing breach of some of the terms of the agreement. They claimed the sun as allowable expenditure under Section 10(2)(xv) of the Indian Income Tax Act, 1922. Falshaw and Kapur, JJ. held that the assessee was not entitled to claim the deduction. The decision of the Madras High Court in Mask & Company v. Commissioner of Income Tax was followed. Reference was also made to the observations of Rowlatt, J., and Lord Strendale M.R which we have already extracted.
12. Learned counsel for the assessee relied upon the Commissioner of Income Tax v. Royal Calcutta Turf Club . 41 I.T.R 414., Central Trading Agency v. Commissioner of Income Tax . 56 I.T.R 561., Govind Chaudhary & Sons v. Commissioner of Income Tax Bihar & Orissa, and Additional Commissioner of Income Tax v. Rustam Jahangir Vakil Mills Ltd. . 103 I.T.R 298..
13. In Commissioner of Income Tax v. Royal Calcutta Turf Club, the question was whether the Royal Calcutta Turf Club, whose business was to hold race meeting on commercial basis, was entitled to claim as a deduction the expenditure incurred in connection with a school for the training of Indian boys as Jockeys. It was found that there was a risk of Jockeys becoming unavailable and such non-availability would seriously affect the business of the Turf Club. It was for that reason that the Turf Club opened the school. On these facts the Supreme Court found that the expenditure which was incurred for preventing extinction of the assessee's business was expenditure wholly and exclusive laid out for the purpose of the assessee's business.’ We do not see how this case is of any assistance to the present assessee.
14. In Central Trading Agency v. Commissioner of Income Tax the assessee entered into a contract with the Government for the supply of 100 tonnes of dehydrated onions before a certain date, by that date the assessee was able to supply only 15 tonnes. The Government canceled the contract, but on the application of the assessee extended the date for the delivery upon the condition that the assessee paid liquid ted damages at 2 percent. The assessee accepted the terms and paid damages of Rs. 17240/- which he claimed as permissible deduction under section 10(2)(xv) of the Income Tax Act, 1982. The Allahabad High Court took the view that the amount paid by the assessee by way of liquidated damages was for the purpose of keeping the contract alive and was in reality a attempt made for the purpose of enabling the assessee to completely execute the contract. It was not a payment made as a penalty or as damages for breach of contract, it was merely the fulfillment of a condition of the agreement between the parties on the finding of the learned judges that the payment was neither penalty nor damages, the payment had to be held an admissible expenditure. It was a clear case of a commercial loss in trading.
15. In Govind Choudhary & Sons v. Commissioner of Income Tax, the assessee had to pay to the Government by way of penalty a sum of Rs. 1233/- for supply of inferior quality of paddy and rice. The Orissa High Court held that it was not admissible deduction under Section 10(2)(v), but could be treated as a loss deductible from the Income-Tax under Section 10(1) of the 1922 Act as it was a payment integrally connected with the carrying on of the business of supply of paddy. It was also a char case of a loss in trading.
16. In Additional Commissioner of Income Tax v. Rustam Jahangir Vakil Mills, the assessee had the option to pack and supply a minimum quantity of cloth as directed by the Textile Commissioner or pack and supply cloth in excess of the minimum quantity specified or to pack and supply less than the minimum quantity specified. For excess supply he was entitled to cash payment by way of assistance from the Textile Commissioner. If he supplied less he would have to compensate the Textile Commissioner at prescribed rates. The assessee who packed and supplied less than the minivan specified quantity of cloth had to pay to the Textile Commissioner certain amounts which he claimed a deductible expenditure. The Gujarat High Court accepted the claim of the assessee. They held that there was no question that the amount was paid by way of penalty or that the amount paid was akin to penalty. There was no infraction of the law. In fact the very scheme of the law was that the assessee should have option to adopt one of three course. By adopting one course, he could not be said to have committed any infraction of law. It is clear that on the facts of the case, no other conclusion was possible.
17. In the light of the aforesaid discussion, we are clearly of the opinion that the amount of Rs. 4300/- paid by the assessee by way of penalty to the East Punjab Motion Picture Association, was not allowable as revenue expenditure. The reference is answered accordingly. No costs.
Reference answered accordingly.