JUDGMENT [ENTITY], J.
1. By this reference under [SECTION] of the [ACT], the Income-tax Appellate Tribunal has referred the following question of law for opinion of this court:
" Whether, on the facts and in the circumstances of the case, the penalty imposed under the [ACT] at Rs, 9,49,287-3-0 was an allowable deduction under [SECTION] or [SECTION] of the [ACT]?"
2. The assessee is a registered firm deriving income from dealings in cotton textiles, yarn and petrol from the head office at Gaya and branch offices at Bombay, Nagpur and Calcutta. It was also acting as the Agent of the Bihar Government during the operation of Cloth and Yarn Control Order. A major change was introduced by the Government of India in its import policy in the year 1952, between the months of January and June and it was decided that the licence for the import of certain articles would be granted freely to all classes of applicants, either established importers or new-corners. The assessee obtained the provisional licence on the 2nd of March, 1952 (wrongly printed as the 2nd of May, 1952, in the statement of the case). This provisional licence was, under the existing rules, obtained by the assessee from the Joint Chief Controller of Imports and Exports, Calcutta, to import artificial silk yarn from the soft currency area and had Rs. 1,00,00,000 as limiting factor for value. Under the free licensing scheme, January/June, 1952, mentioned above, the provisional licence had to be confirmed within two months from the date of the issue, failing which it was to be treated as cancelled, and, according to a further provision in the licensing order, no clearance of goods was permissible against any provisional licence which had not been confirmed. The assessee then applied for confirmation of the aforesaid provisional licence dated the 2nd of March, 1952. The Joint Chief Controller of Imports and Exports, Calcutta, refused to confirm the licence. On the 26th of July, 1952, the assessee appealed before the Joint Chief Controller of Imports and Exports for a reconsideration of the matter. While the matter was still pending, it sent a copy of its appeal or representation to the Chief Controller of Imports and Exports at New Delhi. The matter, it seems, also did not find favour with the Chief Controller, The assessee then filed a petition before the then Finance Minister, Shri [ENTITY], on tbe 31st of March, 1953. In the meantime, one Sri [ENTITY], claiming himself to have influence in the Ministry of Finance, got the licence of the assessee duly confirmd. The licence so brought by Shri [ENTITY] abovementioned did not, however, contain the nature of the goods that should be imported from the soft currency- area. It was again purported to be subsequently rectified. On the basis of this licence, the assessee imported the goods and before the delivery was taken, the goods were sold to the local buyers. Subsequently, the customs authorities under the [ACT], found that the licence against which the assessee had imported the goods was invalid, it being a forged one. The aforesaid Sri [ENTITY], who was neither a Government servant nor in any way connected with any office, was prosecuted for forgery and landed in jail. The assessee was, however, let off only with the penalty. The authorities confiscated the goods in consonance with the provisions of [SECTION] of the [ACT] and the assessee having been given an option under [SECTION] of that Act, paid a sum of Rs. 11,02,500 as penalty for the release of the confiscated goods and also a personal penalty of Rs. 84,200 (in the statement of the case, there again seems to be an error of record in so far as the amount of penalty mentioned under the former head has been incorrectly given as Rs. 9,49,287-3-0). These two sums of money paid by the assessee by way of penalty where included in the assessee's books of account on the debit side resulting in book loss of Rs. 9,49,287-3-0 in the assessment year 1955-56, with which we are concerned in the present case. These two sums of money paid by way of penalty by the assessee were, however, disallowed by the Income-tax Officer who added back a total sum of Rs. 11,86,700 to the credit side. The assessee having preferred an appeal before the Appellate Assistant Commissioner, that appeal also failed as it was held by the revenue authority that these two sums could not be allowable as any business expense under the [ACT] (hereinafter referred to as " the Act"). The assessee having gone up in a second appeal to the Income-tax Appellate Tribunal, it was contended there that the aforesaid entire claim was an allowable expenditure under [SECTION] of the Act or, in the alternative, it should be allowed under [SECTION]. Both the contentions put forward on behalf of the assessee were rejected by the Tribunal. The Tribunal held on an appraisal of all the materials on record that the cumulative effect of all the circumstances led to the irresistible conclusion that the imports made by the assessee were not so made in good faith. It was further held that the subsequent conduct of the assessee like concealing all the outstanding overseas orders and co-operating with the customs authorities in all their investigations was a virtue of necessity which might have, perpbaps, been a mitigating circumstance while assessing the assessee's guilt but certainly the act of the assessee in importing the materials in question was not bona fide. Having thus dismissed the appeal of the assessee, at its instance the aforementioned question of law has been referred to this court.
3. Mr. [ENTITY], learned counsel for the assessee, at the outset urged that the questien as framed in this case was not quite accurate nor did it fully bring out the issue involved and the questions arising out of the order of the Tribunal. In my view, this contention of the learned counsel is well-founded and in order to bring out all the issues involved, I would reframe the question thus :
" Whether, on the facts and in the circumstances of the case, the penalty of Rs. 11,86,700 imposed under the [ACT], resulting in the loss of Rs. 9,49,287-3-0 was fit to be taken into account under [SECTION] or was a deduction allowable under [SECTION] of the [ACT]?"
4. Before going into the question of law, one thing is very clear from the findings of the Tribunal, namely, that the particular isolated act of the assessee in importing the goods in contravention of the provisions of the [ACT], was not in good faith nor was it a part of the regular business activity of the assessee. In this background, I shall examine as to whether the assessee can be entitled to a relief either under the provisions of [SECTION] of the Act or the expenditure or disbursement made by it could be allowable under [SECTION]. The scheme of [SECTION] of the Act is that the profits and gains must be computed subject to certain express allowances and subject also to certain express or implied prohibitions of deductions. A deduction which is neither within the term of the prohibition nor expressly or impliedly allowable in the exclusive definition of its area must be allowed if it is, on the facts of a given case, a proper debit item to be charged against the incoming of the trade in ascertaining the true profits of an assessee. In other words, in determining a particular item which is not covered by the provisions of [SECTION] as to whether it may or may not be deducted from the profits, it is necessary first to enquire as to whether the deduction is expressly or by necessary implication prohibited by the Act. If it is found that it is not so prohibited then it falls for consideration as to whether it is of such a nature that it should be charged against the incomings in the computation of profits and gains on ordinary principles of commercial trading. As observed by [ENTITY] C.J. in Shantikumar Narottam Morarji v.
Commissioner of Income-tax, [1955] 27 ITR 69 (Bom), where the learned Chief Justice, after quoting from the decision of the Judicial Committee of the Privy Council in the case of [PRECEDENT]; [PRECEDENT], that what are chargeable to income-tax in respect of a business are the profits and gains of a year and in assessing the amount of the profits and gains of a year account must necessarily be taken of all losses incurred, otherwise a true picture of the profits and gains will not emerge, went on further to observe :
"It is true that if there is a specific prohibition in the Act, the court will not permit an allowance in face of that prohibition. It is equally true that if there is an allowance permissible under the Act and the allowance deals with the whole subject-matter, the court will not permit that subject-matter to be expanded."
5. This has all along been understood to be the true meaning and purpose of the provision of [SECTION]. Although the English income-tax statute is different in some respects, the true representation of the balance of profits or gains has always been quoted with approval from high authorities in England by the Supreme Court. Two such apt observations have always to be borne in mind while judging whether, on the facts of a particular case in a trading result, the true results have been arrived at according to ordinary commercial principles of trading. I may well refer to the two observations from those two English cases here. In [PRECEDENT] Lord [ENTITY] observed:
" The expression ' balance of the profits or gains ' is not a happy one; but the meaning obviously is the balance arrived at by setting against the receipts the expenditure necessary to earn them."
6. The case of Gresham Life Assurance Society has been cited with approval by the Supreme Court in the case of [ENTITY] v. Commissioner of Income-tax, [1958] 34 ITR 10 (SC). Another apt observation is that of Lord [ENTITY] in the case of [PRECEDENT], which is as follows:
" It is not enough that the disbursement is made in the course of, or arises out of, or is connected with, the trade, or is made out of the profits of the trade. It must be made for the purpose of earning the profits."
7. These are the principles which have consistently been followed by the courts including the Supreme Court in finding out as to whether a relief under [SECTION] could be said to be justified in a given case. In the case of [ENTITY], [ENTITY] J., stressing the same principles emphasised that the loss for which a deduction could be made under [SECTION] must be one that springs directly from the carrying on of the business and must be incidental to it and not any loss sustained by the assessee even if it has some connection with his business. To the same effect is the decision of the Supreme Court in [PRECEDENT], a case relied upon by learned counsel for the assessee itself, to which I shall refer later also at a more appropriate place. In principle, therefore, where the assessee can be said to be entitled to a relief under [SECTION] in judging the justifiability of the computation of the profit and loss or where it be entitled to claim an expenditure or disbursement as permissible item under [SECTION], one thing is quite clear and that is that it must be an integral part of the nature of the business which the assessee is carrying on. If a loss or an expenditure is an incident inherent in the very nature of the trade or the business carried on by an assessee, such a loss either under [SECTION] or as an allowable expenditure or disbursement under [SECTION] must be granted.
8. Judging in the light of these well-settled principles of law and applying these tests, it has to be seen in the present case as to whether the expenditure or disbursement claimed as a permissible deduction under [SECTION] by the assessee was laid out wholly and exclusively for the purpose of the assessee's business; alternatively, whether this item or expenditure could be said to be justifiable when entered on the debit side of the trading account of the balance-sheet of the assessee resulting in a true computation of its business loss entitling it to a relief under [SECTION] although it may not be covered by the permissible deductions under any of the provisions of [SECTION] of the Act. Judging from either point of view, in my opinion, the assessee in the present case will not be entitled to relief either under [SECTION] or [SECTION] of the Act. The facts and the principles involved in the present case, in my view, are fully covered by a decision of the Supreme Court in the case of [ENTITY] and Abdul Shakoor Bros. v. Commissioner of Income-tax, [1961] 41 ITR 350 (SC). In the case of [ENTITY], the assessee had to pay a penalty under [SECTION] of the [ACT] read with [SECTION] of the Act, as in the present case, and this expanditure was sought to be claimed as a permissible deduction by the assessee under [SECTION] of the Act. Although the claim was being made expressly as an allowable item of expenditure or disbursement under [SECTION] Act only, their Lordships of the Supreme Court, while examining that question, have, as a matter of fact, gone into the more general aspect of the matter also to find out as to whether, on the well-settled principles, it can be held to be a proper item of debitable expenditure and, in that connection, after reviewing most of the Indian and English decisions, [ENTITY] J. held at page 359;
" A review of these cases shows that expenses which are permitted as deductions are such as are made for the purpose of carrying on the business, i.e., to enable a person to carry on and earn profit in that business. It is not enough that the disbursements are made in the course of or arise out of or are concerned with or made out of the profits of the business but they must also be for the purpose of earning the profits of the business. As was pointed out in [ENTITY]'s case, an expenditure is not deductible unless it is a commercial loss in trade and a penalty imposed for breach of the law during the course of trade cannot be described as such. If a sum is paid by an assessee conducting his business, because in conducting it he has acted in a manner which has rendered him liable to penalty, it cannot bs claimed as a deductible expense. It must be a commercial loss and in its nature must be contemplable as such. Such penalties which are incurred by an assessee in proceedings launched against him for an infraction of the law cannot be called commercial losses incurred by an assessee in carrying on his business. Infraction of the law is not a normal incident of business and, therefore, only such disbursements can be deducted as are really incidental to the business itself. They cannot be deducted if they fall on the assessee in some character other than that of a trader. Therefore, where a penalty is incurred for the contravention of any specific statutory provision, it cannot be said to be a commercial loss falling on the assessee as a trader, the test being that the expenses which are for the purpose of enabling a psrson to carry on trade for making profits in the business are permitted but not if they are merely connected with the business."
9. It will be seen from the paragraph quoted above that such an expense over the penalty imposed for an infraction of law has been viewed by the Supreme Court as not being a commercial loss falling on the assessee as a trader, applying the test that the expenses which are for the purpose of enabling a person to carry on trade for making profits in the business were not permissible if they were merely connected with the business. And, such a payment of a sura by way of penalty has been held to be, if at all, merely remotely connected with the business. As a matter of fact, the Supreme Court has approved and relied upon a decision of the Court of Appeal in Commissioner of Inland Revenue v. Alaxander [ENTITY] & Company, [1920] 2 KB 553 (CA). In that case also the Court of Appeal was seized with a question of the present nature, and, while dealing with that question. Lord Justice [ENTITY], at page 568, observed as follows:
" In the case of a trade loss is not always, or perhaps one may even say is not in general, measured by a definite expenditure of money. Loss in trade arises in many ways from the depreciation of goods, from the increase or decrease in prices in the market and from many causes of that kind, and it is not generally measured by some definite sum expended by the person carrying on the trade
In the present case what is sought to be deducted is a definite sum expended by the company, and the question we have to determine is whether that is to be allowed as a deduction."
10. In that connection, the conclusion which the Lord Justice reached was expressed in these terms :
" That it arises out of the trade I think may well be conceded. It does arise out of the trade in my opinion, it is not a loss connected with or arising out of the trade. It is a sum which the persons conducting the trade have had to pay because in conducting it they have so acted as to render themselves liable to this penalty. It is not a commercial loss, and I think when the Act speaks of a loss connected with or arising out of such trade it means a commercial loss connected with or arising out of the trade."
11. And, the matter seemed to be so simple to Lord Justice [ENTITY] that, posing the question to himself as to whether such a penalty could be taken into account in coming at the true figure of the balance of profits or gains, the Lord Justice merely answered in one sentence 1 " Of course he cannot ", and reasons followed.
12. It would thus be seen that an isolated act, as it is in the present case, of the assessee causing an infraction of the law entailing a penal consequence by way of payment of fine either for the release of the confiscated goods or for the personal penalty imposed upon the assessee, the expenditure or disbursement of the two sums in question can neither be said to be incidental to the nature of the business which the assessee carried on nor could it be said to be expended wholly and exclusively for the purpose of the business which it was carrying on. It would thus be seen that the assessee in the present case could not, especially on the finding of the Tribunal that its action was also not in good faith, be entitled to any relief either under [SECTION] or under [SECTION].
13. I shall now briefly refer to some of the cases relied upon by the learned counsel for the assessee. Strong reliance was placed upon the decision of the Supreme Court in the case of [PRECEDENT], [PRECEDENT] [PRECEDENT] and [PRECEDENT], two decisions of the Orissa High Court in Commissioner of Income-tax v. [ENTITY], [1969] 73 ITR 119 (Orissa) and [ENTITY] and Sons v. Commissioner of Income-tax, [1971] 79 ITR 493 (Orissa) and two decisions of the Bombay High Court in [PRECEDENT] [1963] 49 ITR 931 (Bom)and Commissioner of Income-tax v. [ENTITY] Narottamdas & Co., [1968] 67 ITR 667 (Bom) So far as the case of [ENTITY] is concerned, the assessee, who had agreed to supply paddy and rice of " fair average quality " to the Government, had incurred a penalty imposed by the Collector under a clause of the agreement, which sum under another term of the agreement was deducted from the bills of the assessee. The Income-tax Appellate Tribunal having held that it would not be taxed in the hands of the assessee in view of [SECTION] of the Act, the High Court, on a reference made to it as to whether it could be taxed in view of [SECTION], answered a different question altogether that it was not an allowable deduction under [SECTION]. The decision of the Orissa High Court5 was set aside by the Supreme Court in [PRECEDENT], and the case remanded for a determination by the High Court as to whether the sums deducted from the bills of the assessee, in view of the penalty imposed by the Collector, could be taxed under [SECTION]; and it was on such a remand that the Orissa High Court in the case of Commissioner of Income-tax v. [ENTITY] held on those facts that it was an inevitable consequence of the assessee's business as a paddy procuring agent, that as a result of the goods delivered not being of the contract quality, breach of warranty, with the risk of liability to pay damages, should at times be committed and payment of such damages as a result of the breach of warranty in the course of or as a consequence of earning profits and gains, was incidental to the carrying on of the assessee's business. It would thus be seen that great stress was laid on an item of loss which was an inherent incident in the very nature of the trade of the assessee. The case of [ENTITY], both on facts and on the principle decided, is similar to that in [ENTITY]'s case.
14. The difference between the Orissa cases and the instant case can be explained by taking an example wherein is involved breach of law as also breach of warranty. Loss resulting from the latter will be business loss while the loss resulting from the former is neither allowable under [SECTION] nor under [SECTION] of the Act. Suppose a dealer in mustard oil agrees to supply pure mustard oil to an institution Y at the rate of, say, Rs. 10 per kilogram. He purchased mustard oil in the market thinking it to be pure mustard oil at Rs. 9 per kilogram. The mustard oil supplied to Y is found to be adulterated. For breach of warranty of the quality, the dealer gets Rs. 8 per kiiogram. Then the loss of Re. 1 per kilogram is a business loss. But if for selling adulterated mustard oil he is prosecuted and a penalty is imposed in respect of the very same transaction or his goods are seized and later on released on compounding then' the loss resulting therefrom is not a business loss but arises as a result of the infraction of law by the dealer. In the same transaction is involved breach of warranty as well as breach of law; but different results follow from the different types of loss.
15. Before referring to the case of Poona Electric Supply Co. Ltd., I proceed to discuss the other cases relied upon by the learned counsel for the assessee. The decisions of the Supreme Court in [PRECEDENT] related to the deductions on account of law charges and litigation expenses; and it is already too well settled that expenses over litigation whether the litigation ultimately succeeds or fails have to be allowed as permissible deductions provided the purpose of the litigation is germane to, and is necessary for, the purpose of carrying on the trade. The decision of the Bombay High Court in [PRECEDENT], in one sense, instead of supporting the contention of the learned counsel for the assessee, goes against his contention. The assessee in that case was pursuing a business of adatia and speculation and one of the assessee's constituents incurred a loss of a certain amount which ultimately became irrecoverable and was written off by the assessee as bad debt. But that constituent had suffered the loss in the course of certain forward transactions in turmeric, which, by the time of the assessment, had been held by the Supreme Court to be illegal trade in view of the [ACT]. The revenue authorities did not give an allowance of the bad debt claimed by the assessee on the ground that the trade itself being illegal, the amount could not in any event be recoverable in law. The Bombay High Court agreeing with the Tribunal held that if the profits of illegal business were taxed, expenses incurred for such illegal profits have to be necessarily deducted, and that the debt owed to the assessee from his constituent not being capable of being enforced in a court of law could not prevent the debt from being considered as an irrecoverable or bad debt. It was further held that the profits of a trade even though illegal were as much within the purview of the taxing statute as any other legal trade. In the instant case we are not concerned wtth an assessee involved in an illegal trade. The infringement of the provisions of the [ACT] was not an incident attached to, or an ingredient essential for, the business of the present assessee. The case of Panndal Narottamdas. & Co. relied upon by the counsel for the assessee also, to soma extent, demolishes the point that he wants to make. Learned counsel had submitted at one stage relying upon this decision that it ought to be held on the facts and in the circumstances that the present assessee had acted in good faith and that he had to incur the expenditure in order to obtain or earn profit by having the goods released, which were part of its stock-in-trade. A similar contention in reverse form was raised before the Bombay High Court in the case of [ENTITY] on behalf of the revenue, at whose instance the reference had been made. In that case the Tribunal's finding, as quoted at page 671, was that the assessee was entitled to plead that he purchased the documents of title (the bills of lading in that case) in good faith and paid consideration thereon, and in the circumstances of that case the penalties paid by the assessee formed only part of the goods imported, and accordingly a proper deduction under [SECTION] itself was called for. The department seeking to assail this finding of the Tribunal, the contention on its behalf was repelled and the same reasoning, in my view, must apply to the instant case also in these words :
" It would be clear from this order that the conclusion of the Tribunal that what was paid as penalties by the assessee was to be regarded as cost of the goods imported was based on its acceptence of the contention of the assessee, which the Tribunal held he was entitled to contend. In other words, the conclusion of the Tribunal was based on its acceptance of the assessee's case that his purchase of the bills of lading was in good faith. It is urged by Mr. [ENTITY], the learned counsel for the department, that there is no evidence on record to justify a finding of good faith because, as pointed out by the Appellate Assistant Commissioner, the assessee had failed to prove that the penalty was levied for the faults of the five parties and not for his own fault.
Now, whether there is evidence to support the said finding is, in our opinion, quite different from whether there is such a finding recorded by the Tribunal or not. If the grievance of the department was that the finding was in the absence of any evidence, it should have asked for a proper question in that connection either in the application which it had made before the Tribunal under [SECTION] or in the event of the Tribunal refusing to refer such a question, on an application made to this court under [SECTION] of the [ACT]. It does not appear that any such question has been asked by the assessee and, consequently, the complaint made by the learned counsel with regard to the finding of the Tribunal cannot be entertained. Since, therefore, there is a finding involved in the decision of the Tribunal that the purchases of the assessee were made in good faith, the question as framed by the Tribunal is the proper and correct question."
16. And, it was on the basis of these findings of fact that the Bombay High Court held in that case that the penalty had been imposed not for the fault of the assessee but he had to bear the same for the purpose of getting his goods released from the Customs authorities and the expenses incurred by him could be regarded, on facts, as wholly and exclusively incurred for the purpose of the business. Even while coming to this conclusion the Bombay High Court was fully aware of the decision of the Supreme Court in the case of [ENTITY] and at page 672 the principle decided in that case has bean relied upon. The case of Poona Electric Supply Company before the Supreme Court involved consideration of the question as to whether certain sums set apart by the assessee, which was an electric supply undertaking, under the provisions of the [ACT], and credited to the "consumers' benefit reserve account " could be held to be deductible under [SECTION] of the Act or not, and, while holding that such a sum which was set apart and credited to the "consumers' benefit reserve account" was to be taken into account under [SECTION] [ENTITY] J., as he then was, laid down at page 525:
"Under [SECTION] of the [ACT], tax shall be payable by an assessee under the head 'Profits and gains of business' in respect of the profits and gains of any business carried on by him. The said profits and gains are not profits regulated by any statute, but profits in a business computed on business principles. They are business profits and not statutory profits. They are real profits and not notional profits. The real profit of a businessman under [SECTION] of the [ACT] cannot obviously include the amounts returned by him by way of rebate to the consumers under statutory compulsion. It is as if he received only from the consumers the original amount minus the amount he returned to them."
17. It would thus be seen that none of the decisions relied upon by the learned counsel for the assessee in any way detracts from the force of the legal principles laid down by the Supreme Court in the case of [ENTITY] and no other case referred to above can be said in any way to militate against any of the principles upon which the decision of the Supreme Court in that case is based. On the contrary, two decisions of the Delhi High Court may be referred to in support of the conclusion that I have reached. They are [PRECEDENT] and [PRECEDENT]. The latter case has, in its turn, referred to, and relied upon, the decision of the Supreme Court in the case of [ENTITY]; but in both these cases two Bench decisions of the Delhi High Court have held that penal interest paid by the assessee-sugar mills, as penalty for omission on its part to deposit cess in time, was not a legitimate business expense either under [SECTION] or under [SECTION] of the Act. In that view of the matter, I think, there is no substance in the contention of the learned counsel for the assessee for a relief either under [SECTION] or [SECTION] of the Act.
18. For the reasons given above, the question refrained as above must be answered in the negative. I would accordingly hold that, on the facts and in the circumstances of the case, the penalty of Rs. 11,86,700 imposed under the [ACT] resulting in the loss of Rs. 9,49,287-3-0 was not fit to be taken into account under [SECTION] nor a permissible deduction by way of expenditure or disbursement under [SECTION] of the [ACT]. This reference is accordingly decided in favour of the revenue and against the assessee. The assessee must pay the costs of this reference. Hearing fee, Rs. 100 only.
[ENTITY], C.J.
19. I entirely agree.