Explanation to s. 37 (1) does not apply to “penalty” which is not of the nature of illegal / unlawful expenditure
The assessee became liable to pay “penalty” for overloading wagons under the rules of the Railways. The question arose whether the said “penalty” was disallowable under the Explanation to s. 37 (1) which provides that “expenditure incurred for any purpose which is an offence or which is prohibited by law” shall not be allowable. HELD, deciding in favour of the assessee:
The substance of the matter had to be looked into and given preference over the form. Though the amount was termed “penalty”, it was essentially of a commercial nature and incurred in the normal course of business and was consequently allowable.
Note: The judgement also holds that provision for estimated increases in wages made during ongoing negotiations with workers pending finalization of an agreement is deductible expenditure.