Rastogi, J. - (1.) This is a reference under Section 256(1) of the I.T. Act, 1961 (hereafter "the Act"), made at the instance of the Commissioner of Income-tax. The assessment years are 1967-68 and 1968-69 and the question referred for opinion is : "Whether, on the facts and in the circumstances of the case, the Tribunal was correct in allowing deduction of penalty of Rs. 50,651 in assessment year 1967-68 and Rs. 67,801 in assessment year 1968-69 ?"
(2.) The assessee is a public limited company engaged in the manufacture of cloth. It follows the calendar year as its year of account. During the years under consideration, the assessee was recognised as a registered user of trade mark No. 100387 (Sanforized) of M/s. Cluett Peabody & Company by the Government of India, vide Trade Mark Registry letter No. P.R. (RU-Sanforized)/2400 dated 26th November, 1962. One of the conditions laid down for the use of the aforesaid trade mark was the export of a certain percentage of sanforized fabrics manufactured by the companies using that trade mark and such percentage was to be determined by the Government of India. It was five per cent. during the period July, 1963 to 1965. Thereafter, when the trade mark registration was revalidated for a further period of seven years to extend up to 1972, the quantum of export obligation was raised to 10 per cent. and that was by letter dated 30th April, 1966. In the event of non-fulfilment of the export obligation, the mills were to pay certain penalty. Clause (v) of that letter reads as under; "(v) Mills failing to fulfil the export obligation shall pay a penalty at the rate of 10 p. per linear yard to the extent of the annual shortfall, while mills will be permitted to discharge their export obligation reckoned in the manner prescribed above cumulatively during the period 1966-72, the performance of each mill in relation to its obligation shall be reviewed annually (in February of the year following the one to which the export obligation relates) and an amount shall be deposited in Government account by the defaulting mill by way of penalty as prescribed above. At the end of the seven year period a final review will be made of the cumulative performance of the mills against its total obligation and, where admissible, a refund of deposits will be made. "
(3.) In the calendar year 1966, relevant to the assessment year 1967-68, the assessee produced 50,65,081 yards of sanforized cloth. It should have exported 5,06,508 yards of this cloth but did not export any and hence was directed to pay Rs. 50,651 by the Textile Commissioner as penalty. Similarly, in the calendar year 1967, the assessee did not export any cloth out of sanforized cloth manufactured by it and was required to pay Rs. 67,801 by way of penalty. The assessee claimed deduction of these amounts from the profits and gains of these years, respectively. The ITO, in so far as the assessment year 1967-68 was concerned, discussed the matter in detail and, relying on a decision of the Madras High Court in the case of M.S.P. Senthikumara Nadar & Sons v. CIT [1957] 32 ITR 138, held that the assessee being under a contractual obligation to the Textile Commissioner, Ministry of Commerce, Govt. of India, New Delhi, to export the stipulated quantity of sanforized cloth, committed breach of that obligation and such breach could not be treated as one in the course of normal trading activity of the assessee. In his opinion, the amount required to be paid by way of penalty for such breach cannot be said either to have been expended or paid out for the purposes of the assessee's business or to have been incidental to the business itself and hence it was not an allowable expenditure. He, therefore, rejected the claim. Following that order, in the subsequent year as well, he disallowed the claim.;