Case Law Details
RELEVANT PARAGRAPH
2.7 The Hon’ble Apex Court in the case of CIT v Ahmedabad Cotton Manufacturing Co. Ltd. 205 ITR 163 held as under:-
“what needs to be done by an assessing authority under the Income-tax Act, 1961, in examining the claim of an assessee that the payment made by such assessee was a deductible expenditure under $.37 of the Income-tax Act although called a penalty is to see whether the law or scheme under which the amount was paid required such payment to be made as penalty or as something akin to penalty, that is imposed by way of punishment for breach or infraction of the law or the statutory scheme. If the amount so paid is found to be not a penalty or something akin to penalty due to the act that the amount paid by the assessee was in exercise of the option conferred upon him under the very law or scheme concerned, then one has to regard such payment as business expenditure of the assessee, allowable under section 37….”
2.8 Thus, the law on the allowability of expenses debited as penalty has been fully settled by the Hon’ble Apex Court and it is the duty of the assessee to show that the amounts claimed are compensatory in nature in case these are to be allowed. As per Explanation to section 37, the expenditure incurred for any purpose, which is an offence or which is prohibited by law, is to be treated to have not been incurred for the purpose of the business. Thus, the payment, which is punitive, is not allowable and in case the payment is compensatory, then the payment to the extent of compensatory nature is to be allowed. Since the issue has not been properly dealt either by the Assessing Officer or by the learned CIT(A), therefore, we have no alternative but to set aside this issue on the file of the Assessing Officer so that the assessee files all the material before the Assessing Officer to show that the amounts are allowable because these are compensatory in nature. In case the Assessing Officer finds that the amount is punitive, then it is not allowable. In case, the amount is compensatory as well as punitive, then the Assessing Officer will bifurcate the amount and will allow the amount to the extent it is compensatory.
