Holding

Payments made under a statutory scheme in exercise of an option, and not constituting a penalty for any breach of law, are deductible business expenditures under Section 37 of the Income‑Tax Act, 1961.

Summary

The assessee, a cotton textile manufacturer, paid amounts to the Textile Commissioner under Clause 21‑C(1)(b) of the Cotton Textiles (Control) Order, 1948, in lieu of producing the minimum required cloth, and also paid a sum for non‑fulfilment of an export obligation under a bond. The assessee claimed these payments as deductible business expenditure under Section 37 of the Income‑Tax Act, 1961, but the Assessing Officer disallowed them, treating them as penalties. The Tribunal and the Gujarat High Court allowed the deductions, prompting the Revenue to appeal to the Supreme Court. The Court examined whether such payments, although labelled “penalty”, were in fact incurred as an option provided by the statutory scheme and therefore not a punishment for any breach of law. It held that when the payment is made in compliance with the law and without any infraction, it is a legitimate business expense deductible under Section 37. Consequently, the Supreme Court dismissed the Revenue’s appeal, upholding the High Court’s decision.

Issues considered

Whether the payment made to the Textile Commissioner for contravention of the direction is a penalty and therefore not deductible under Section 37 of the Income‑Tax Act.
Whether the payment under Clause 21‑C(1)(b) of the Cotton Textiles (Control) Order, 1948, can be treated as business expenditure allowable under Section 37.
Whether the amount paid for non‑fulfilment of the export obligation, termed a penalty, is deductible as business expenditure under Section 37.

Legislation cited

Cotton Textiles (Control) Order, 1948s. 21-C(1)(b)
Income Tax Act, 1961s. 28, s. 37

Subjects

Income TaxSection 37 deductionPenalty vs business expenseCotton Textiles (Control) OrderExport obligationStatutory schemeTax deduction of penalties

Judgment

THE C.l.T., GUJARAT-I, AHMEDABAD
v.
THE AHMEDABAD COTTON MFG. CO. LTD. & ORS.

OCTOBER 15, 1993
B
[B.P. JEEVAN REDDY AND N. VENKATACHALA, JJ.)

Inc01rie Tax Act, 1961 : Section 37.

Business expenditure-Company-Payment made to Textile Commis-
C sioner, in exercise of option under Clause 21-c(l)(b) of Textile Control Order,
1948, instead of producing and packing minimum quantity of specified
cloth-Nature of-Payment made to Textile Commissioner, in terms of
option under the terms of the bond, for not fulfilment of export obliga-
tion-Nature of-Held business expenditure-And not penalty.
D
A Textile Mill was being run by the assessee-Company, (In C.A. No.
2149of1977), during the accounting year 1971-72 previous to the Assess-
ment Year 1972-73. The assessee, being a manufacturer of cotton textiles,
had to comply with the directions issued from time to time by the Textile
Commissioner under the provisions of the Cotton Textiles (Control)
E Or1ler, 1948, in the matter of producing and packing minimum quantity
of specified type of cloth by it during the accounting year. However, the
assessee instead of producing and packing the minimum quantity of
specified type of cloth as required by the directions of the Textile Commis-
sioner, paid to the Textile Commissioner Rs. 1,70,766 in exercise of the
F option available to it under Clause 21-C(l)(b) of the Control Order. So
also, the assessee, which had not fulfilled its export obligation under a
bond entered into as regards exporting certain quantity of sanforized cloth
paid to the Textile Commissioner Rs. 5,17,781 for non-fulfilment of that
obligation, in exercise of its option available under the terms of the bond.
Thereafter, when the assessee filed its income-tax return relating to the
G accounting year 1971-72 with the jurisdictional Income Tax Officer, if
claimed deduction of both the said amounts out of its profits, as business
expenditure. The Income Tax Officer refused to allow the claimed deduc-
tions, taking the view that the said amounts paid by the assessee were not '
deduction which could be allowed as·ttems of its business expenditure. On
H appeal the Appellate Assistant Commissioner, allowed the amounts
392
C.I.T. v. COTTON MFG. CO. 393

claimed by the Assessee as items of its business expenditure in respect of A
its accounting year 1971-72. Revenue's appeal filed against that appellate
order before the Tribunal did not meet with success. However, at the
instance of the Revenue the Tribunal made a reference to the High Court
under Section 256(1) of the Income Tax Act. The High Court upheld the
claims of the assessee-Company. Similar orders were passed by the High
B
Court in the connected appeals also. Against the decision of the High
Court Revenue preferred appeals in this Court.

Dismissing the appeals, this Court

HELD : 1. It is ture, that a payment made by an assessee doing C
business in the aceounting year is not entitled to claim deduction under
Section 37 of the Income Tax Act, 1961 of an amount paid by such assessee
during the year as an amount of penalty or an amount akin to penalty for
any breach or infraction of law or any public policy which is sought to be
achieved by such law. But if such payment is made by the assessee during
the relevant accounting year without any breach of infraction of any law D
or any public policy sought to be achieved by it and in fact in obedience to
provisions of such law as a measure of business expediency, there could
be no valid reason not to allow such payment as deductible expenditure of
the assessee under Section 37 of the Income Tax Act. [404H, 405-A, BJ
E
2. Therefore, 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 Section
37 of the Income Tax Act although called 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 F
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 fact that the amount paid by the assessee was in exercise
of the option conferred upon him under the very law or scheme concerned,
to regard such payment as business expenditure of the assessee, allowable
under Section 37 of the Income Tax Act, as an incident of business laid out G
and expended wholly and exclusively for the purposes of the business.
However, such payment of the assessee is that which is made in exercise of
the option given to such assessee by the law or the statutory scheme there
arises no need for Assessing Authority to go into the question whether the
payment could be regarded as that made as a measure of business ex· -H
394 SUPREME COURT REPORTS [1993] SUPP. 3 S.C.R.

A pediency, for it cannot ignore the fact in that, the law or the statutory
scheme enables incurring of such expenditure in the course of assessee's
business. [405-C to F]

3. The payments concerned were made in compliance with law or
scheme concerned and not for committing any breach or infraction of the
B law or statutory scheme. Therefore, the judgment of the High Court is not
liable to be interfered with. (405-G]

Addi. Comm. of Income Tax Gujarat v. Rustam Jehangir Vakil Mills
Ltd., (1976) 103 I.T.R. 298 and Commnr. of Income Tax Gujarat-III v. Tarun
Commercial Mills Co. Ltd., (1977) 107 I.T.R. 172, approved.
c
M.S.P. Senthikumara Nadar & Sons v. Commn. of Income Tal'.', (1957)
32 I.T.R.138 Mad. andHaziAziz and Abdul Shakoor Bros v. Commissioner
of Income Tal'.', (1961) 41 I.T.R. 350 S.C., held inapplicable•
.... ~
CIVIL APPELLATE JURISDICTION : Civil Appeal No. 2123 of
D 1977 Etc. Etc.

From the Judgment and Order dated 18.11.1976 of the Gujarat High
Court in Income Tax Reference Nos. 183, 125, 113, 33 and 164 of 1976.

M.L. Verma, R. Salim, P.N. Misra, C. Ramesh & P. Parmeswaran
E for the Appellant.
AK. Verma for JBD & Co. for the Respondent.

M.K. Puri for the Respondent in CAs. 726-731.

F The Judgment of the Court was delivered by

VENKATACHALA, J. These are the appeals of the Revenue arising
from different judgments of the Gujarat High Court delivered on Refer-
ences, made at its instance under Section 256(1) of the Income Tax Act,
1961, to be referred to as 'the I.T. Act', on obtaining certificates of fitness
G to appeal to this Court. As the decision to be rendered by us in Civil
Appeal No. 2149 (NT) of 1977 could form the basis for disposal of the
remaining appeals, we shall proceed to· consider that appeal and decide it
at the first instance.

Civil Appeal No. 2149 (NT) of 1977 - Commissioner of Income Tal'.', Gujarat
H v; Mihir Textiles Ltd. :
C.l.T. v. COTION MFG. CO. [VENKATACHALA, J.) 395

This appeal arises from the judgment in Income Tax Reference No. A
175 of 1976 decided by the Gujarat High Court. The £!Uestions referred by
the Tribunal under Section 256(1) of the I.T, Act for opinion of the High
Court in that Reference, were these :-

1. Whether, the payment made to the Textile Commissioner by
the assessee for contravention of the direction given by the B
Textile Commissioner was in the nature of penalty and not
incidental to the carrying on of the assessee's business?

2. Whether, on the facts and in the circumstances of the case,
the payment of Rs. 1,70,7(J6 made to the Textile Comm.is- C
sioner under the provisions of clause 21-C(1)(b) of the Cotton
Textiles (Control) Order, 1948, as amended from time to
time, was business expenditure allowable under S~on 28 of
the Income Tax Act, 1961?

3. Whether, the payment of Rs. 5,17,781 made by the assessee · D
to the Government for non-fulfilment of its obligation to
export specified quantity of sanforized cloth is allowable as
the payment incidental to carrying on of the assessee's busi-
ness?

Facts which led to the reference of the said questions, for opinion of E
the High Court were briefly these :-

A Textile Mill was being run by Mihir Textiles Ud., Ahmedabad, the
assessee, during the accounting year 1971-72 previous to the Assessment
Year 1972-73. The assessee, being a manufacturer of cotton textiles, had p
to comply with the directions issued from time to time by the Textile
Commissioner under the provisions of the Cotton Textiles (Control) Order,
1948, hereinafter referred to as 'the Control Order', as amended and then
in force, in the matter of producing and packing minimum 'quantity of
specified type of cloth by it during the accounting yea"r. The assessee . G
instead of producing and packing the minimum quantity of specified type
of cloth as required by the aforesaid directions of the Tt'.xtile Commis-
sioner, paid to the Textile Commissioner Rs.1,70,7()6 in' exercise of the
option available to it under clause 21-C(l)(b) of the Control Order. There-
after, when the assessee filed its income-tax return relating to the account-
ing year 1971-72, with the jurisdictional Inco ne Tax Officer (ITO), it H
396 SUPREME COURT REPORTS [1993) SUPP. 3 S.C.R.

A claimed deduction of the said amount out d its profits, as business expen- ·
diture. So also, the assessee, which had not fulfilled its export obligation
under a bond entered into as regards exporting certain quantity of san-
forized cloth and p-aid to the Textile Commissioner Rs. 5,17,781 for non-
fulfilment of that obligation, in exercise of its option available under the
terms of the bond, claimed deduction of that amount as well in its income-
B tax return of the accounting year 1971-72 as its business expenditure. The
I.T.O. who made the assessment order in respect of the said accounting
year, refused to allow the claimed deductions, taking the view that the said
amounts paid by the assessee to the Commissiop.er of Income Tax were not
deductions which could be allowed as items of its business expenditure. In
c appeal preferred by the assessee against that assessment order, the Appel-
late Assistant Commissioner, allowed the said amounts claimed by the
assessee as items of its business expenditure in respect of its accounting
year 1971-72 and made an order allowing the appeal. Revenue's appeal
filed against that appellate order before the Tribunal did not meet with
D success. However, at the instance of the Revenue, the Tribunal referred
the questions set out in the beginning of this Judgment for getting the
opinion of the High Court on them.

A Division Bench of the High Court which examined the Reference,
answered Questions 1 and 2 against the Revenue and in favour of the
E assessee following its earlier decision in.Additional Commissioner of In-
come-tax, Gujarat v. Rustam Jehangir Vakil Mills Ltd., (1976) 103 ITR 298.
It also answered Question 3 against the Revenue and in favour of the
assessee following its earlier decision in Commissioner of Income-tax,
Gujarat-III v. Tarnn Commercial Mills Co; Ltd., (1977).107 ITR 172. The
F Reference was decided accordingly by the High Court by its judgment
rendered in November 18, 1976. The Re7enue, which was not satisfied with
the said judgment of the High Court, has filed the present appeal in this
Court on certificate of fitness obtained from the High Court to appeal to
this Court.

G It was not disputed before us that the answers given by the High
Court in the Rustam Jehangir Vakil Mills' case, if are sustainable, the
answers given to Questions 1 and 2 by the High Court in the Judgment
under the present appeal also become sustainable. So also, it was not
disputed before us that the answers given by the High Court in Tarnn
H Commercial Mills' case followed in answering Question 3 in the Judgment
C.l.T. v. COTTON MFG. CO. [VENKATACHALA, J.) 397

under the present appeal, if are sustainable, the answer to Question 3 given A
by the High Court in the Judgment under appeal, as well, becomes sus-
tainable.

This situation leads us to the necessity of examining the correctness
and the sustainability of the answers given by the High Court on the
questions referred to it in References in Rustam Jehangi,r Vakil Mills' B
(Rustam Mills') Case and Tarun Commercial Mills' (Tarun Mills') case.

The questions referred for opinion of the High Court in Rustam
Mills' case (Income Tax Reference No. 14 of 1972), were :

1. Whether the payment made to the Textile Commissioner by C
the assessee for contravention of the direction given by the
Textile Commissioner was in the nature of penalty and not
incidental to the carrying on the assessee's business ?

2. Whether on the facts and in the circumstances of the case . D
the payment of Rs. 91,387 made to the Textile Commissioner
under the provisions of clause 21-C(l)(b) of the Cotton
Textiles (Control) Order, i948 was business expenditure al-
lowable under Section 28 or under Section 37 of the Act ?

The High Court answered the above Question 1, thus : E
"The payment was not in the nature of panalty and was incidental
to the carrying on of the assessee's business."

Then the High Court answered Question 2, thus :
F
"The payment was business expenditure allowable under Section
37 of the Income Tax Act, 1961."

We shall advert here to the facts of Rustam Mills' case in order to
examine the correctness and the sustainability of the answers given by the
High Court to ·the questions referred thereto. For the assessment year G
1969-70 the relevant accounting year being the financial year ending on
March 31, 1969, the assessee-Mills failed to produce and pack the mini-
mum quantity of the standard cloth required to be produced and packed
according to a direction issued by the Textile Commissioner under the
provisions of Cotton Textile (Control) Order, 1948. Rustam Mills which H
398 SUPREME COURT REPORTS [1993) SUPP. 3 S.C.R.

A had the option under clause 21-C(l)(b) of the Control Order, 1948 to pay
to the Textile Commissioner, the amount envisaged thereunder in' lieu of
non-production and non-packing of the minimum quantity of the standard
cloth in the year 1968-69, paid an amount of Rs. 91,387 to the Textile .
Commissioner. In the return of the Rustam Mills filed for the accounting
year 1968-69, deduction of the amount of Rs. 91,387 was claimed as an
B allowance under Section 37 of the l.T. Act on account of its business
expenditure of that year on the plea that it was an expense wholly and
exclusively laid out for the purpose of its business. The Income Tax Officer
refused to allow the deduction so claimed. However, in the appeal of the
Rustam Mills, the Appellate AssistaD;t Commissioner, allowed the deduc-
e tions claimed and that order was confirmed by the Tribunal in the further
appeal carried before it by the Revenue. In the Reference, carried before
the High Court, at the instance of the Revenue, the aforesaid questions
were answered against it by the High Court, as already stated. The answers
so given to the questions by the High Court were based on its view that
D the amount paid by the Rustam Mills to the Textile Commissioner was
neither penalty nor something akin to penalty paid for infraction of any law
or public policy in as much as that amount was paid by Rustam Mills by
exercising its option under clause 21-C(l)(b) of the Control Order, 19~.;
which formed part and parcel of a statutory scheme. Coming to Tan,n
Mills' case, the question referred for opinion of the High Court at ll1e
E instance of the Revenue was :

"Whether on the facts and in the circumstances of the case, penalty
of Rs. 18,247 paid to the Textile Commissioner for non-fulfilment
of the assessee's export obligation was business expenditure in-
curred wholly and exclusively for the purpose of the assessee's
F
business."

The High Court answered this question against the Revenue and in
favour of Tarun Mills (the assessee). It would be necessary to advert to the
G facts of this case, in order to examine the correctness and the sustainability
of the answer of the High Cqurt given to the question. Tarun Mills became
entitled to the user of trade mark 'Sanforized' on the authority given to it
by the Jrade mark registry of the Government of India. that entitlement of
Taran Mills obligated it to export certain percentage of 'Sanforized' cloth
produced by it. Accordingly, for the period from July, 1963 to November,
H 1965, Tarun Mills was required to export 5 per cent of the )'alue of
C.l.T. v. COTTON MFG. CO. [VENKATACHALA, J.) 399

'Sanforized' cloth produced by it, along with similar Mills which had A
become entitled to the user of the trade mark 'Sanforized'. But at the end
of the year 1965, it was found that the required quantity of 'Sanforized'
cloth was not exported by several Mills. So, a scheme was evolved by the
Central Government to make the Mills concerned, to fulfil their export
obligations. Under that scheme previous years' short-fall in the concerned B
Mills' exports was required to be made good by them during the sub-
sequent years 1966 to 1972, besides the requirement on their part to export
annually a quantity of not less than 10 per cent of the 'Sanforized' cloth
produced during those years. The scheme also contained a provision
requiring the concerned Mills to execute bonds in that regard in favour of
the President of India. One of the conditions in that bond enabled the C
concerned Mills to pay to the Central Government 10 paise per linear yard
on the shortfall in its export of 'Sanforized' cloth during the relevant year
and that amount referred to as 'penalty' was required to be deposited with
the Government of India.
D
Tarun Mills which did not export the required quantity of
'Sanforzied' cloth during its accounting year 1967-68, made a deposit of Rs.
18,247 with the Central Government in exercise of its option under the
bond to pay an amount in lieu of the shortfall in the quantity of 'Sanforized'
cloth to be exported, and claimed that amount as its business expenditure
in the Income-tax Return of the said accounting year. But, the Income Tax E
Officer refused to allow the said amount of deduction claimed as business
expenditure of Tarun Mills during the relevant year. In appeal of Tarun
Mills, the Appellante Assistant Commissioner reversed the order uf I.T.O.
and allowed deduction of that amount as its business expenditure. The
Revenue's appeal therefrom filed before the Tribunals, did not succeed. F
At the instance of the Revenue, the question adverted to earlier, having
been referred to the High Court, it was answered against the Revenue and
in favour of the Tarun Mills, as stated earlier. In giving that answer, the
High Court took the view that even if the bond referred to the amount
payable by Tarun Mills for non-fulfilment of its export obligation as ·
'penalty' such amount being payable at the option of Tarun Mills for G
non-fulfilment of its export obligation under the scheme, it could not be
regarded as penalty or something akin to penalty payable for any breach
of law or public policy, for the very scheme under which that amount was
payable by Tarun Mills to the Government, provided for such payment ac
the option of the concerned Mills. H
400 SUPREME COURT REPORTS (1993) SUPP. 3 S.C.R..

A As the answers given by the High Court to the question referred for
· its opinion in Rustam Mills' case and in Tanm Mills' case have gone against
the Revenue and in favour of the concerned assessee - Mills in view of the
concerned scheme in the matter of payment of the amount to the Govern-
ment of India, the points which require our consideration and decision in
this appeal would be - whether the amount paid by the concerned Mills
B to the Government under the one or the other scheme becomes business
exi)enditure of the Mills concerned, under Section 37 of the Income Tax
Act as would entitle such Mills to crim deduction as its business expendi-
ture for the accounting year ..

C Shri M.L. Verma, the learned Senior Counsel for the Revenue,
contended that the amount paid by Rustam Mills in lieu of its failure to
manufacture . and pack the standard cloth during the accounting year
1967-68 as required under the scheme of the Control Order, 1948 has to
be treated as the amount paid as penalty or as something akin to penalty
D for infraction of the law or public policy envisaged under the scheme and
therefore, the said amount cannot be regarded as a business expenditure
of the assessee - Rustam Mills under Section 37 of the Income Tax Act.
He also contended that the amount which was claimed as deductible
expenditure by Tarun Mills for non-fulfilment of its export obligation in
relation to 'Sanforized' cloth had to be regarded as an amount paid by way
E of penalty or something akin to penalty for infraction of the law or public
policy and hence could not be regarded as business expendi.ture claimable
as deduction under Section 37 of the Income Tax Act. He sought to
support his contentions placing reliance on the decisions of the Madras
High Court in M.S.P. Senthikumara Nadar & Sons v. Commissioner of
F Income-tax, (1957) 32 I.T.R. 138 Mad., and of this Court in Haji Aziz and
Abdul Shakoor Bros. v. Commissioner of Income-tax, (1961) 41 I.T.R. 350
s.c.
In Senthikumara Nadar's case the assessee was doing business in
coffee. It had entered into contracts with the Indian Coffee Board entitling
G it to purchase coffee on a rate far below the price of coffee sold within
India, undertaking an obligation to export the whole of the coffee so
purchased outside India. The assessee which purchased coffee at a low
price because of the contracts, did not fulfil its export obligation by sending
the whole of the coffee outside India. When the assessee was found to have
H committed the breach in performing his export obligation the assessee paid
C.l.T. v. COTTON MFG. CO. [VENKATACHALA,J.) 401

liquidated damages to the Coffee Board as provided for in the terms of A
the contrac;:t. The assessee, thereupon, claimed that amount as deduction
under SectiQn 10(2)(xv) of the Income Tax Act, 1922. The Madras High
Court which examined the nature of the payment made by the assessee
found that that payment was akin to penalty, for it was paid for infraction
of public policy underlying the Coffee Market Expansion Act, 1942, which
was left to be enforced by the Coffee Board. That amount, it was found,
B
was not an amount spent in the assessee's normal trading activity and not
an amount paid as an incidental expenditure on account of business. In
fact, this is what the High Court had to say in the matter : The breach of
its contract here to the Board was not in the normal course of business,
and the liability the assessee had to discharge for such breach was not c
incidental to the trading activities that it carried on. Hence, deduction of
the said amount claimed by the assessee as business expenditure, was not
accepted by the H;gh Court.

In Haji Aziz and Abdul Shakoor Bros. case, this Court had to consider D
a situation where the assessee - Haji Aziz and Abdul Shakoor Bros. had
imported certain goods in contravention of the law and the goods were on
that account liahle to be confiscated. However, the assessee obtained a
release of the goods by paying a certain amount by way of fine. The
question was whether the assessee could claim the amount so paid as fine
as deductible business expenditure under Section 10(2)(xv) of the Income E
Tax Act, 1922. This Court, in that context, observed that a case involving
payment of penalty for an infraction of the law fell outside the scope of
permissible deductions under Section 10(2)(xv) of the Income Tax Act,
1922, by pointing out that the payment made by the assessee as liquidated
damages was akin to penalty for an act of infraction of public policy
underlying the concerned Statute. Hence, this Court held in that case that
F
the amount paid by Haji Aziz and Abdul Shakoor Bros. as fine was not
deductible as business expenditure under Section 10(2)(xv) of the LT. Act.

We are unable to see, how any support could be derived from the
said decisions for the contentions urged on behalf of the Revenue in this G
appeal.

In Rl.lstam Mills' case, the concerned statutory scheme was found in
certain clauses of the Cotton Textiles (Control) Order, 1948. Sub-clause
(1) of clause 21A read thus : H
402 SUPREME COURT REPORTS (1993) SUPP. 3 S.C.R. '

A "Where the Textile Commissioner has specified under paragraph
(a) of sub-clause (1) of clause 22, the maximum prices at which
any class or specification of cloth may be sold. ............ he may,
having regard to the matters specified in sub-clause (2) of clause
.20, by order in writing direct any producer with a spinning plant
·or a group of such producers to pack such minimum quantity of
B
such cloth and during such period as may be specified in the
direction."

Sub-clause (2) of clause 21A conferred power on the Textile Coin-
missioner to grant extension of time for complying with the directions
C issued by him in so far as the price applicable to such quantities of cloth
so packed is the price in force during the period specified in the direction
under sub-clause (1) or during the extended period, whichever is lower.

Clause 21-C of that Order read :

D "(1) Where the Textile Commissioner has issued directions under
sub-clause (1) of clause 21A to any producer to pack a specified
quantity of cloth during the period specifie.d in the directions -

(a) ................. .

E (b) such producer may, in lieu of packing the whole or part of the
minimum quantity of cloth specified in the said direction, make
payment to the Textile Commissioner in respect of the deficiency
at such rates as may be specified by the Central Government and
within such time as may be determined by the Textile Commis-

F
sioner.

(2) All payments received from producers under paragraph (a) of
sub-clause (1) shall, as far as may be, be utilised towards payments,
-
if any, to producers under the said paragraph (a)."

The Textile Commissioner's direction issued to the textile Mills to
G produce and pack a specified quantity of the standard cloth was in exercise
of the powers conferred upon him under the said clauses. Rustam Mills
instead of complying with the directions as to production and packing of
required quantity of standard cloth availed of the option of making pay-
ment as provided under clause 21-C(l)(b) and paid to the Textile Com-
H missioner a sum of ~s. 91,387. It is this amount which was claimed by
C.l.T.v. COTTONMFG.CO.[VENKATACHAlA,J.] 403

Rustam Mills as deduction under Section 37 of the Income Tax Act, 1961 A
in respect of the relevant accounting year. The High ·court found that
amount to be deductible expenditure of the assessee-Rustam Mills. The
statutory scheme contained in the said clauses was adverted to by the High
Court thus:

".. .... ...... the scheme is ihat the law itself gives an option to the B
producer concerned to adopt one of the three courses and, if be
complies with the law by choosing one of the three options offered
to him, he cannot be said to commit any infraction of law. Hence,
there is no question of any amount paid as penalty or any amount
paid being akin to penalty as was the case before the Madras High C
Court in the Coffee Board case Senthikumara Nadar & Sons v.
Commissioner of Income- Tax, (1957) 32 l.T.R. 138..........."

Referring to the facts of the case, it was held by the High Court thus-:

D
"In the instant case, the amount was spent by the manufacturer
concerned for the purpose of carrying on its business and it was
laid out and expended wholly and exclusively for the purposes of
the business so that from the commercial point of view, he would
carry on the business of manufacturing cotton cloth under the
scheme set out in clauses 21A and 21C of the Cotton Textiles E
(Control) Order. Hence, the amount spent by the manufacturer
would fall fairly and squarely within section 37(1) of the Income-tax
Act, 1961 ..........."

- Turing now to Tanm Mills' case, the payment there, was made on
account of non-fulfilment of the obligation of exporting 'Sanforized' cloth
according to a term of the bond executed in favour of the President of
F

India. The assessee - Tarun Mills paid the amount of Rs. 18,247 calculated
at the rate of 10 paise per linear yard in lieu of shortfall in the export of
'Sanforized' cloth to be made by it as it was allowed, at its option, to do
so, under another term of the bond. The contention advanced in that case G
on behalf of the Revenue was that the amount paid by Tarun Mills was an
amount of penalty or an amount akin to penalty, for infraction of law or
public policy and therefore, could not have been allowed as deduction of
its business expenditure. On consideration of the matter, the High Court
relied on Rustam Mills' case and held thus: H
404 SUPREM.E COURT REPORTS [1993) SUPP. 3 S.C.R.

A "We are of the opinion that having regard to the terms contained
in the bond we find that it is optional for the manufactures to
achieve the export target prescribed for them or to pay to the
Government the· sum or sums calculated at the rate of 10 paise by
linear yard to cover up the shortfall in the export obligations. The
option envisaged in the bond entered into between the parties
B cl~arly indicates that the option was with the manufacturers and
that option may be availed of for a variety. of reasons in the interest
of commercial expediency. Th~ export obligations which the textile
manufacturers may have incurred for the use of trade mark
'sanforized' may not be fulfilled for various factors over which the
c manufacturers may not have control. The trend and competition
in the international market, the quality and quantity of the goods
produced by the manufacturers may be some of the factors which
may ultimately have a bearing on the question of achieving the
target. In the· interest of business, textile manufacturers opt for
payment of compensation or damages to cover up the shortfall in·
D
the export obligations. It is no doubt true that the word used. in
the scheme which we have set out above for the sum to be paid in
default of fulfilling the export obligation has been described as a
penalty but in the ultimate analysis it is the substance of the
transaction between the parties which has to be considered for
.- E purposes of determining what is the nattire and import of the
sche~e and the bond executed in pursuance thereof. The exercise
of option, as stated above, may be the result of the commercial
expediency as well as certain extraneous factors over which the

F
· manufacturers might not have the control and, therefore, in view
of the scheme and the bond with which we are concerned here, it
cannot be said that there is a breach of a public policy which may
render the payment, agreed to be made for the default arising as
-
a result of the breach, as one akin to penalty. Under no circumstan-
ces, without violence to the language, it can be said to be infraction
of the law."
G
It is ture, that a payment made by an assessee doing business in the
accounting year is not entitled to claim dedu~tion under Section 37 of the
1.T. Act, 1961 of an amount paid by such assessee during the year as an
amount of penalty or an amount akin to penalty for any breach or infraction
H of law or any public policy which is sought to be achieved by such law, as
C.I.T. v. COTTON MFG. CO. [VENKATACHALA, J.] 405

is also held by this Court in Haji Aziz and Abdul Shakoor Bros.' case. But A
if such payment is made by the assessee during the relevant accounting year
without any breach or infraction of any law or any public policy sought to
be achieved by it and in fact in obedience to provisions of such iaw as a
measure of business expediency, there could be no valid reaso.1. not to allow
such payment as deductible expenditure of the assessee under Section 37 B
of the LT. Act.

Therefore, what need to be done by an assessing Authority under the
I.T. Act, 1961, in examining the claim of an assessee that the payment made
by such assessee was a deductible expenditure under Section 37 of the I.T.
Act although called penalty is, to see whether the law or scheme under C
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
fact that the amount paid by the assessee was in exercise of the option D
conferred upon him under the very law or scheme concerned the assessing
Authority has to regard such payment as business expenditure of the
assessee, allowable under Section 37 of the I.T. Act, as an incident of
business laid out and expended wholly and exclusively for the purposes of
the business. However, if such payment of the assessee is that which is
made in exercise of the option given to such assessee by the law or the E
statutory scheme there arises no need for Assessing Authority to go into
the question whether the payment could be regarded as that made as a
measure of business expediency, for it cannot ignore that fact in that, the
law or the statutory scheme enables incurring of such expenditure in the
cour:e of assessee's business.
F
As is pointed out by us already, the High Court has answered the
questions referred to in Rustam Mills' case as well as in Tarun Mills' case,
taking into consideration the facts that the payments concerned therein
were made in compliance with law or scheme concerned therein and not
for committing any breach or infraction of the law or statutory scheme. G
Therefore, the judgment of the High Court under the present appeal being
rendered following its earlier judgments Rustam Mills' case the Tarun Mills'
case, which are found by us to have been rendered in consonance with law,
the same is not liable to be interfered with.

In the result, we dismiss the Civil Appeal No. 2149 (NT) of 1977, H
406 SUPREME COURT REPORTS (1993) SUPP. 3 S.C.R.

A with no costs.
CIVIL APPEAL NOS. 2123, 2171-72, 2226, 2241 AND 2243 OF 1977.

As our Judgment in the above Civil Appeal No. 2149 (NT) of 1977
fully covers the subject matter of these appeals, they are liable to be
B dismissed, following that Judgment.

In the result, we dismiss these Appeals, as well, with no costs.

T.NA. Appeals dismissed.