Case: M/S. Maddi Venkataraman &amp; Co. (P) Ltd Vs. The Commissioner Of Income Tax

On the basis of the information received, a search was conducted by the Enforcement Directorate in the assessees business premises. A number of latters and other documents were seized which disclosed that the assessee had indulged in transactions in violation of the provisions of Foreign Exchange (Regulation) Act (for short `FERA). It was found that the assesee had remitted to a private party in Singapore in violation of law. Proceedings were taken against the assessee for infringement of Sections 4(2) and 5(1)(e) of FERA and ultimately a penalty of Rs. 35, 000/was imposed under Section 23 (1)(a) read with Sectionc of the Act. The assessee in its income tax return for the assessment year1 claimed deduction of Rs. 2.95, 000/as business expenditure/loss. According to the assessee in course of carrying on of its business by the year 1966. It had accumulated 329.2 tonnes ofd quality, tobacco which it could not export over the last three years. Since the accumulated stock of tobacco was ofd quality, it could not be sold at the floor price fixed by the Government of India for such tobacco. According to the assessee, it had no alternative but to sell the tobacco at a discount of 20% to a Singapore party. On paper, the full sale price was paid by the Singapore party but in reality 20% of the price paid by the party was remitted back to him through one Shamsuddin. In pursuance of this agreement tobacco was sold and the full floor price was received by the assessee from the Singapore party. The assessee paid a sum of Rs. 2.88, 000/to Shamsuddin who remitted the equivalent amount in Singapore currency to the Singapore party. Thus, according to the assessee, it had no alternative but to enter into such awith a view to dispose of the sold unsold stock of inferior quality of tobacco. In these facts of the case. It was claimed by the assessee that the amount of Rs. 2, 88, 000/paid to Shamsuddin ought to be deducted as business expenditure or treated as business loss.The Income Tax Officer however, disallowed the claim. According to him. Payment was not genuine and it contravened the provisions of Section) of FERA. It was further held that the payment did not fall within any of the exceptions to Rule. The appellant Assistant Commissioner affirmed the order of the Income Tax Officer. On further appeal, the Tribunal made the following) A sum of Rs. 2, 95.000 was paid by this assessee company to Shamsuddin which consisted of an amount payable to him for his services and also a sum of Rs. 2, 88, 000/to be remitted to the Singapore party. The amount paid to Singapore party was difference of 20% of the floor price of tobacco fixed by the Government.  (b) The assessee was knowingly a party to the above transaction and it violated the provisions of FERA. The Tribunal also took the view that the assessees income from export to the Singapore party in reality was not the full price shown to have been received from the Singapore party i.e., 8.86, 702.89. The figure had to be reduced by a sum of Rs. 2, 95.000/because this was the sum which was really received by the assessee. It was of the view that it was unnecessary to go into the question whether the sum of Rs. 2, 95, 000/was to be created as a deduction and if so under which Section and further whether it attracted Section 40A(3) of the Act.  (c) The Tribunal held that even otherwise, the said payment did not attract Section) since it was covered by subrule (j) RuleD inasmuch as the said payment to Shamsuddin was made in cash due to exceptional and unavoidable circumstances.In the Departments contentions that the payment made to Shamsuddin was illegal and could not be taken into account for any purpose were unsustainable in law. The income tax law did not distinguish between legal and illegal income or between legal and illegal expenditure.The High Court was of the view that the Tribunal was in error in coming to the conclusions that it had reached. The High Court pointed out that expenses tainted with illegality could not be allowed as business expenditure under Section 37 or as business loss or on any other basis. The High court was of the further view that the assessee could not be allowed to achieve the same result by invoking Section 28. The High Court also expressed the view that the assessees contentions that its real income from export of tobacco was not Rs. 6.86, 702.89 paise which was paid to it but its real income was that amount minus Rs. 2, 95.000/which he had subsequently repatriated in Singapore dollars. It was only a facade to realise the true price of the transaction which was 80% of the floor price. Therefore, the invoice which showed the floor price was not the true reflection of the real transaction between the two parties. The High Court rejected this contention by holding that the very agreement to receive 80% of the floor price which was the invoice value of the tobacco was illegal. The High Court pointed out that in law, there could not have an agreement to agree to take anything less than the invoice price. The agreement that tobacco was of thed quality was no answer. An exporter was not supposed to exportThe High Court was of the view that the sum of Rs. 2, 88, 000/had not been repatriated in a straight forward manner but has been sent to Singapore through an illegal channel. It is not a case of money being diverted under an overriding legal obligation. The High Court ultimately concluded that the agreement being illegal and contrary to law, cannot be recognised by a court of law nor can entering into such transaction be a normal incidence of carrying on business. The High court further held that argument based on real price was of no substance. If a contractor received an amount of Rs. lakhs under a contract entered into with the Government he cannot claim that in reality, the amount was Rs. 9 lakhs because at the time to awarding the contract he had an understanding with the authority to pay a sum of Rs. one lakh by way of bribe.The High Court referred to a large number of decisions where it has been held that payments tainted with illegality cannot be claimed as deduction under the income Tax Act. However, if an assessee is penalised under one Act, he cannot claim that amount to be set off against his income under another Act because that will be frustrating the entire object of imposition of penalty.One exception to this rule which has been recognised by the Courts is where the entire business of the assessee is illegal and that income is sought to e taxed by the Income Tax Officer then the expenditure incurred in the illegal activities will also have to be allowed as deduction. But if the business is otherwise lawful and the assessee resorts to unlawful means to augment his profits or reduce his loss, then the expenditure incurred for these unlawful activities cannot be allowed to be deducted. Even if the assessee had to pay fine or penalty because of an inadvertent infraction of law which did not involve any moral obliquity, the result will be the same. Even in such cases, deduction will not be permitted of the amounts paid as penalty of fine or of the value of the goods confiscated by the statutory authority as expenditure wholly and exclusively incurred for the purposes of carrying on the trade. It has been consistently held by the English Courts that fines or penalties payable for violation of law cannot be permitted as deduction under the Income Tax Act. That will be against public policy. Even though the need for making such payments arose out of trading operation the payment were not wholly and exclusively for the purpose of the trade. One can carry on his trade without violating the law. In fact, Section 37 presumes that the trade will be carried on lawfully.The English Courts have consistently held that penalty or fine or money paid to compound and offence under another statute cannot be allowed as a deduction under the Income Tax Act. For the application of these principles, consideration of moral obliquity was quite immaterial.In the case of the Commissioners of Inland Revenue vs. E.C.Warnes 12 Tax(Cases) 227, the Company had to pay a penalty under the provisions of the Customs (Consolidation) Act, 1876 in respect of a consignment of oil shipped by it to Norway. The action was settled by consent on the agreement of the company to pay a mitigated penalty of Rs. 2, 000 and on all imputations as to the Companys morel culpability being withdrawn. It was declared that there was no intention from the beginning to the end of the transaction that the Company had by connivance or consent been taking part in trading with the enemy but had only been culpable of carelessness. In defending the penalty proceedings, the Company had incurred legal costs amounting to 560 18s 10d. These two amounts incurred on payment of the penalty and also legal cost have been taken for the computation of Excess Profits Duty purposes, On behalf of the company. if was contended that both the penalty and costs should be allowed as losses arising out of and incidental to trade. It was pointed out that the penalty and the costs were solely connected with and arose out of the trace carried on by them and as such were detectable in the same manner that bad debts are deductible in computation of profits. Lastly, it was argued that profits must be taken in their commercial sense. In that sense this was loss which an ordinary prudent commercial man would and could only write off against the profits of the business. The Commissioners who heard the appeal held in favour of the company. When the matter came before the High Court Rowlatt, J. recognised that the provision of law under which the penalty was imposed is "one of very great and startling stringency; but of course the liability it creates can only be regarded as a liability of penal character" andt seems to me that a penal liability of this kind cannot be regarded as a loss connected with arising out of a trace. I think that a loss connected with or arising out of trade must, at any race, amount to something in the nature of a loss which is contemplable and in the nature of a commercial loss.....but I do not think it is possible to say that when a fine, which is what it comes to has been inflicted upon a trading body. It can be said that is "a loss connected with or arising out of" the trade within the meaning of this Rule."

Reasoning:
In the instant case, the asseesee had indulged in transactions in violation of the provision of Foreign Exchange (Regulation) Act. The assessees plea is that unless it entered into such a transaction, it would have been unable to dispose of the unsold stock of inferior quality of tobacco. Another words, the assessee would have incurred a loss. Spur of loss cannot be a justification for contravention of law. The assessee was engaged in tobacco business. The asseessee was expected to carry on the business in accordance with law. If the asseesee contravenes the provision of FERA to cut down its losses or to make larger profits while carrying on the business, it was only to be expected that proceedings will be taken against the asseesee for violation of the Act. The expenditure incurred for evading the provisions of the Act and also the penalty levied for such evasion cannot be allowed as deduction. As was laid down by Lord Sterndale in the case of Alexander Von Glehn (supra) that it was not enough that the disbursement was made in the course of trade. It must be for the purpose of the trade. The purpose must be a lawful purpose.Moreover, it will be against public policy to allow the benefit of deduction under one statute of any expenditure incurred in violation of the provisions another stature or any penalty imposed under another statute. In the instant case, if the deductions claimed are allowed, the penal provisions of FERA will become meaningless. It has also to be borne in mind that evasion of law cannot be a trade pursuit. The expenditure in this case cannot, in any way, be allowed as wholly in this case cannot, in any, way be allowed as wholly and exclusively laid out for the purpose of assessees business