Ogene Systems India Limited Vs ITO (ITAT Hyderabad)
Impugned encashment of bank guarantee is outcome of failure to perform its contractual obligation only without involving any offence or penal component u/s.37(1) of the Act. we find that a catena of case law holds that such an encashment of bank guarantee is incurred in the normal course of business than involving any penalty element at all. We adopt the very reasoning herein as well and direct the Assessing Officer to delete the impugned disallowance/addition in issue.
FULL TEXT OF THE ORDER OF ITAT HYDERABAD
This assessee’s appeal for AY.2014-15 arises from the CIT(A)-4, Hyderabad’s order dated 21-12-2017 passed in case No.0395 / 16-17 / ITO,Wd.16(4) / CIT(A)-4, Hyd / 17-18, in proceedings u/s. 143(3) of the Income Tax Act, 1961 [in short, ‘the Act’].
Heard both the parties. Case file perused.
2. Coming to the sole substantive issue raised in assessee’s pleadings that both the lower authorities have erred in law and on facts in disallowing its security deposit encashment claim of Rs. 1,10,61,051/- treated as penal in nature, we notice that the CIT(A)’s detailed discussion reads as under:
“5. Ground nos. 5 to 7 and additional ground nos. 10 to 11 are with regard to addition of Rs. 1,10,61,051/- towards disallowance of security deposit. During the scrutiny proceedings, the Assessing Officer submitted as under:
The assessee has debited an amount of Rs. 1,10,61,051/- towards Security deposit non performance. When asked about the same, the AR of the assessee filed submissions. The submissions of the AR is carefully considered and it was found that the assessee paid bank guarantee for executing turnkey project with High Explosive Factory, Pune. But, the assessee failed to execute the project. The encashment of bank guarantee is in the nature of penalty levied for the default in executing the project. Further, the assessee has not realized any amount out of this project. As the expenditure claimed by the assessee is penal in nature and as there ws no income out of this project, the expenditure of Rs. 1,10,61,051/- claimed by the appellant was disallowed and added to the income.
5.1 In this regard, the appellant contended as under:
The Assessee company is engaged in the business of manufacturing and trading of bulk drugs, chemicals & & intermediates, electronic chemicals, drug development services including chemistry, analytical services and trading of bulk drugs intermediates. During the year under consideration, the assessee company has taken up a Trunkey project from “High Explosives Factory”, Khadki, Pune. For the purpose of executing the project, the assessee has entered into bank guarantee of Rs. 1,10,61,051/- which was made by the State Bank of Hyderabad. But due to the uncontrollable circumstances, the Appellate was unable to execute the contract and hence the contract was revoked.
Due to the non execution of the project, the contractee, High Explosives Factory”, as per terms of the contract encashed the bank guarantee. Later, the Bank recovered the amount from the assessee. As the assessee incurred a loss on account of revocation of contract, the loss of Rs.1,10,61,051/- was debited by the assessee as loss to P & L account. The Assessing Officer has disallowed the amount of loss of Rs.1,10,61,051/- on the ground that it is penal in nature.
(a) Loss incurred by the assessee is in the nature of the business:-
In this regard, we would like submit that the assessee accepted the contract as a part of its normal course of business. But due to the uncontrollable circumstances, the assessee was unable to execute the project and subsequently the project was revoked as the contractor (assessee) failed to execute the Trunkey project for Design, Supply Erection & Commissioning of special chemical plant as per terms and conditions of contract. Due to the non execution of the project, the general manager of High Explosives Factory has requested the State Bank of Hyderabad, who to gave guaranteed the contract to remit back the guarantee amount of Rs.1,10,61,051/- in the favour of High Explosives Factory Public Fund Account i.e Contractee. Later, the bank recovered guarantee amount from the assessee. The assessee has debited the same into P&L of the relevant FY i.e., 2013-1 4 under the sub head “Administrative and Selling Expenditure” under the head “Other Expenditure “(Note 25 of Audited Financial Statements). Thus, the assessee incurred the loss in the normal course of the business. The forfeiture of the bank guarantee is compensatory in nature.
(b) Loss incurred by the assessee is in nature of compensatory and not in the penal nature and same should be allowed u/s.37 of the Act:
In this regard, we would like to submit that merely because of the amount paid on the cancellation of contract, the same cannot be considered as penal in nature. Merely because agreement referred to, in question as a penal in nature, any such payment would not pertake character of penalty. It is further submitted that the amount of bank guarantee paid by the assessee to the bank is compensatory in nature and not penal in nature and the expenditure incurred which is in nature of compensatory is allowable u/s. 3 7(1) of the Act. In this regard, we would like to review the section 37 of the Act, Section 3 7(1): Conditions laid down under this section for allowance of
a) It should not be in the nature of expenditure described in section 30 to 36.
b) It should not be in the nature of capital or personal expenditure.
c) It must be expended wholly and exclusively for the purpose of the business.
Explanation to Section 37(1) :
Expenditure incurred for any purpose which is an offence or prohibited by law shall not be allowed.
Brief Facts related to the above discussion:
There are instances where the assessee incurs and pays certain amount for not fulfilling certain terms of any agreement. In these cases, some of the assessee’s book the expenditure under ‘Penalty’ or ‘Penal Charges’ in the Profit and loss Account. Now, they claim it to be an allowable deduction under section 3 7(1) of the Act. However, if the case is selected for regular assessment u/s 143(3) and the A.O. notices this particular heading in the P/L account then it is more likely than not that the same would be disallowed on the ground that is in the nature of penalty [i.e., Explanation to Sec 37(1)] which is incorrect.
In instant case, liability was not statutory but only contractual. It was compensation for deprivation of use of money and was part and parcel of liability and, therefore, it represented expenditure laid out wholly and exclusively for purposes of business which was allowable as deduction under section 3 7(1) of the Act.
(c) In support of the above, the reliance is placed on the following judgements:
