Amount on account of damages for breach of contract allowable expenditure

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Amount on account of damages for breach of contract allowable expenditure

AIT News Network

NEW DELHI. Full Bench of High Court vide a ruling dated 30th January 2008
AIT-2008-32-HC has ruled that whenever an assessee has indicated any amount, which had been paid either by way of damages or penalty, to be an allowable expenditure under Section 37(1) of the Act, the Assessing Authority is obliged to discover the nature of such amount vis-à-vis two prominent aspects, whether it is compensatory or penal. The Assessing Authority would there upon permit the amount as an allowable deduction that may be discovered to be purely of compensatory nature as payment for damages. However any statutory amount paid by the assessee which is sought to be claimed as an allowable expenditure on account of penalty, in that eventuality, the same shall be disallowed being payment for infraction of law. A situation may arise where an assessee might have to make a composite payment being ‘compensatory’ and ‘penal character’ both. In that situation, the Assessing Authority would, of course, be required to segregate the amount containing two characters. After undertaking this exercise, the amount that is held to be of compensatory nature shall be countenanced as allowable expenditure whereas the other portion of the amount, which is penal in nature, shall be refused to be an allowable expenditure.

Full Bench over-ruled the judgment in M/s. Baldev Singh Kanwar’s case which does not decide the controversy in its right perspective.

A partner of the assessee firm visited Germany where he entered into a contract for supply of certain goods of a particular value. The agreement so arrived at, however, could not be acted upon by the assessee as it did not have the requisite import licence for the material intended to be imported. The dispute was referred to an arbitrator. In terms of the award of the Arbitration Tribunal, rendered on 29.7.1974, the assessee paid a sum of Rs. 50,000/- to the German-firm, M/s. Duestsche Strahil Metail of Berlin, for failure to perform its part of the contract. Accordingly, the assessee in its return for the assessment year 1975-76, claimed deductions of the aforesaid amount as business expenses on account of damages for breach of contract.

It was held the amount of Rs. 50,000/- paid by the assessee was on account of damages for breach of contract on its part and not a liability incurred for contravention of any law. In the circumstances aforesaid and the clear legal position enunciated above, the said amount claimed as deduction would thus be an expense incurred for the purposes of the business and could not have been disallowed.

(Click here for full text of Ruling AIT-2008-32-HC)

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