JUDGMENT OF APPELLATE TRIBUNAL "This is an appeal preferred by the Income-tax Officer, Cuddalore, praying that the amount of Rs. 6,203 allowed by the Appellate Assistant Commissioner as business expense to the respondent may be disallowed. The question arose in the following circumstances :-

2. The respondent was assessed on an income of Rs. 28,971 from various sources and a sum of Rs. 6,203 was claimed by the respondent on account of court and damages which he had to pay to one Salai Mohammad Haji Ibrahim Sait. The respondent and three others, has entered into an agreement in 1933 in connection with business in crackeras to sell several kinds of cracker at the rates given in the Schedual thereto. The respondent did not abide by the terms of this agreement and sold his crackers at rates lower than those given in the schedu le, where upon Salia Mohammad Haji Ibrahim Sait filed a suit for damages of Rs. 5,000 aginst the respondent. The High Court of Judicature at Madras on its original said in suit C. S. No. 146/34 awarded damages of Rs. 5,000 as well as the court costs to the plaintiff in that case. The respondent paid the damages and incurred expenses for defending the suit amounting to Rs. 1,203. The respondent claimed this sum of Rs. 6,203 as a business expenses, which the Appellate Assistant Commissioner had allowed.

3. The Income-tax Officer, the appellant in this case, disallowed this alleged expense on the ground that the damages paid for breach of contract and the court expenses incurred by him in connection therewith could not be regarded as expenditure laid out or expended wholly and exclusively for the purposes of the assessees business within the meaning of Section 10(2)(xii) of the Indian Income-tax Act.

4. The Appellate Assistant Commissioner, whose order is under appeal, came to the conclusion that the respondent undersold the goods so that he might steal a march over his competitors. His object in doing so could have been nothing else than, the Appellate Assistant Commissioner proceeded, that to augment his profits and he must necessarily have augmented his profits. The profits earned were more than Rs. 5,000 according to the Appellate Assistant Commissioner and he thought that the breach of agreement was purposely committed for purposes of earning the profits. Relying on the authority of the case reported in Strong & Co. Ltd. v. Woodifield the Appellate Assistant Commissioner held that, the test laid down by Lord Davey in the words :

"In my opinion, it does not follow that if a loss is in any sense connected with the trade, it must always be allowed as a deduction; for it may be only remotely connected with the trade or it may be connected with something else quite as much as or even more than with the trade. I think only such losses can be deducted as are connected with the trade in the sense that they are really incidental to the trade itself.............It is not enough that the disbursement is made in the course of, or arises out of, or is connected with the trade, or is made out of the profits of the trade. It must be made for the purpose of earing the profits"

was satisfied. The only relevant section under which the expenses could be allowed is Section 10(2)(xii) of the Income-tax Act which is as under :-

"Such profits or gains shall be computed after makng the following allowance, namely, 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 purpose of such business, profession or vocation."

The purpose, therefore, must be a purpose connected with business, profession or vocation. All expenses cannot be said to be for trade or business. The basis of the allowance of the claim by the Appellate Assistant Commissioner is that the respondent has made profits on account of under-selling and that it was premeditated. It is not possible to say whether the respondent did made any more profits by under-selling than if he had kept to the terms of the agreement.

5. It is contended for the Income-tax Officer that the expenses must be in the nature of or incidental to the business and not in the nature of damages which may have to be paid for breach of contract. Certain damages arising in the course of business are certainly allowable but the payment of this nature for compensating the other competitors for the loss they have suffered is not an expense laid out for the purpose of business.

6. We are referred to the pleadings in the case and the orders passed by the learned Judges of the Madras High Court on appeal in the case C.S. No. 146/34 referred to above. The words "for purposes of trade" should mean "for purposes of earning profits in trade." The damages which have been awarded against the respondent are not in the nature of any expenses allowable and did not arise in the ordinary course of business itself. It has been extraneous to the business in committing the breach of agreement in the manner of carrying on of the business. The question whether this money has been spent wholly and exclusively for purposes of trade is to be decided, because one has to attend to the true nature of the expenditure to ask oneself the question, is it a part of the respondents working expenses ? Is it an expenditure laid out as part of the process of profit-earning or, on the other hand, is it any other ? The Appellate Assistant Commissioner relied on the observation of Lord Davey in the case of Strong & Co., Ltd. v. Woodifield, quoted above. This ruling itself indicates that the expenses should be for purposes of carrying on the business and earning profits in the trade. What is found that this payment of Rs. 6,203 is made not because the respondent has made a profit, but it has no relation either immediate or remote with the profit made or could be made by him. It was awarded because he caused wrongful loss to another. Payments for such acts cannot be said to be laid out for the purposes of business carried on by the respondent. In the same case as relied on by the Appellate Assistant Commissioner (5 I.T.C. 215) it has been laid down :-

"The payment of these damages was not money expended for the purpose of the trade. It is not enough that the disbursement is made in the course of, or arises out of, or is connected, with the trade. It must be made for the purpose of earning the profits."

The ruling laid down in the case of Commissioners of Inland Revenue v. Alexander Von Glehn & Co., Ltd., is also pertinent to the case before us. It has been held that the penalty and costs which a company had to pay for exporting goods to Russia and Scandinavia in violation of the Customs (War Powers) Act, 1915, were not admissible deductions in arriving at the profits of the companys trade for Excess Profits Duty purposes.

7. In another case reported in Secretary, Board of Revenue, Income-tax, Madras v. B. Muniswami Chetty & Sons, it has been held :-

that the assessee was not entitled in arriving at the taxable profits to deduct expenditure incurred by him (a) in employing accountants and lawyers in connection with a dispute between them and the Government as to the amount of excess profits duty payable for the previous year, and (b) similar expenses incurred in arriving at the income on which assessment to income-tax was made or was to be made.

These charges were not expended for the sole purpose of earning profits within the meaning of Section 9(2)(xi) of the Indian Income-tax Act and hence were not permissible deductions thereunder."

The expenses claimed as damages in this case, therefore, have really nothing to do with the trade itself.

8. We think, there is much force in the appeal of the Income-tax Officer and disagreeing with the Appellate Assistant Commissioner, we restore the order of the Income-tax Officer disallowing Rs. 6,203 as a business expense.

9. The result is that the appeal is allowed."

On the application of the assessee under Section 66(1) of the Indian Income-tax Act (XI of 1922) the Appellate Tribunal refer red the case to the Madras High Court.

(Judgment of the Court was delivered by the Honourable the Chief Justice).

The assessee in this case is a firm carrying on business in crackers The assessee entered into a contract with other traders in the same line of business, under which the firms goods were to be sold at specified rates. In breach of this contract, the assessee sold crackers at lower rates, to the detriment of the other parties to the contract. Consequently, the other parties filed a suit in this Court to recover the damages which they had sustained by reason of the breach of contract on the part of the assessee. The Court found that the assessee was liable in damages and assessee the sum of Rs. 5,000. With costs, the total amount payable by the assessee came of Rs. 6,203. The assessee claimed to be entailed to deduct this as a business expenditure under Section 10(2)(xii) of the Indian Income-tax Act. This contention was rejected by the Income-tax Officer, but the Appellate Tribunal agreed with the Income-tax Officer. The assessee then asked the Tribunal to state a case for this Court as it involved a question relating to the construction of the Act. This application ways granted, and consequently the Tribunal has referred to this Court the following question :-

"Whether the sum of Rs. 6,203 being costs and damages incurred in connection with an action for breach of contract is not expenditure laid out or expended wholly and exclusively for purposes of the assessees business within the meaning of Section 10(2)(xii) of the Act ?"

Section 10(2)(xii) allows the deduction of 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 a business. In Inland Revenue Commissioners v. Warnes & Co., Rowlatt, J., said that a loss connected with or arising out of a trade must, at any rate, amount to something in the nature of a loss which is contemplable and in the nature of a commercial loss. In that case, the respondents who were oil exporters were sued for a penalty under the Customs Consolidation Act, 1876, Section 139, as extended by the Customs (War Powers) Act, 1915, Section 5, sub-section (1), for the breach of orders and proclamations relating to the requirements of the Board of Customs and Excise with respect to a consignment of oil shipped by them to Norway. The result of the action was that the respondents were made to pay as a mitigated penalty the sum of Pounds 2,000 and costs, and the question was whether they were entitled to tread this as a loss connected with or arising out of the trade or business within Section 100, Schedule D, Case 1, Rule 3, of the Income-tax Act, 1842, and it was held that they were not.

The judgment Rowlatt, J., in that case was upheld by the Court of Appeal in Inland Revenue Commissioners v. Von Glehn. There a penalty of Pound 3,000 was imposed upon the appellants for the breach of orders and proclamations issued under the same statutory provisions, and they sought to deduct the amount from their profits as a loss connected with or arising out of their trade. It was held that they were not entitled to do so. In the course of his judgment, Lord Sterndale, M.R., 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 anything wrong in the sense that they willingly and knowingly sending these goods to an enemy destination : but they committed a breach of the law, and for that breach of the law they were fined. That, as it seems to me, was not a loss connected with the business, but was a fine imposed upon the company personally, so far as a company can be considered to be a person, for a breach of the law which it had committed. It is perhaps a little difficult to put the distinction into very exact language, but there seems to me to be a difference between a commercial loss 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, for that reason I thing that both the decision of Rowlatt, J., in this case, and his former decision in Inland Revenue Commissioner v. Warnes & Co. which he followed, were right, and that this appeal should be dismissed with costs.

In the present case, the assessee was not fined for a breach of law, but was made to pay damages for a breach of the contract entered into. The assessees action in disregarding the undertaking given was palpably dishonest and we are of the opinion that the award of damages which followed did not constitute an expenditure falling within section 10(2)(xiii). It was not incidental to the trade.

For the respondent, stress has been laid on the observations made by Scrutton, L.J., at the end of his judgment in Inland Revenue Commissioners v. Von Glehn. Scrutton, L.J., said that he did not wish to decide until he had heard the matter further argued, whether damage paid in civil proceedings in respect of carrying on business in a negligent manner can or cannot be deducted from the profits. This is not a case of conducting a business in a negligent manner; it is a case of conducting a business in a dishonest manner.

The question referred is answered in the negative and the Commissioner of Income-tax is entitled to his costs, which we fix at Rs. 250.

Reference answered in the negative.