O.CHINNAPPA REDDY,J. - (1.) THE assessee who carries on business in exhibition of films is a member of the East Punjab Motion Pictures Association. Under the bye-laws of the association, a member is obliged to carry out the "award and directives" of the association arising out of all disputes between members or upon complaints received by the association. A member failing to carry out the directive of the association would be suspended from membership of the association and would be eligible to be reinstated on payment of a specified sum of penalty in addition to " reinstatement circulation charges ". The assessee had to pay a sum of Rs. 4,300 by way of penalty to the association during the accounting year relevant to the assessment year 1970-71. The assessee claimed that the sum of Rs. 4,300 paid by way of penalty to the association was a sum " laid out wholly and exclusively for the purposes of the assessee's business " and was, therefore, allowable expenditure under Section 37 of the Income-tax Act, 1961. The Tribunal held that breaches of contractual obligations were not incidents of business and, therefore, the amount paid by the assessee as penalty was not allowable expenditure.
(2.) AT the instance of the assessee, the following question has been referred to us for our opinion : "whether, on the facts and in the circumstances of the case, the Tribunal was justified in holding that the sum of Rs. 4,300 paid by the assessee by way of penalty to the East Punjab Motion Pictures Association was not deductible as business expenditure under the Income-tax Act, 1961 ? The learned counsel for the assessee invited our attention to paragraph 16 (a) of the rules and regulations of the East Punjab Motion Pictures Association which prohibits every distributor-member of the association from supplying films to a non-member exhibitor and vice versa, and argued that in order to survive in the business of an exhibitor of films, the assessee was bound to seek reinstatement of membership by paying the penalty. The payment of penalty was essential to enable the assessee to continue to carry on the trade and so it must be held to have been laid out wholly and exclusively for the purposes of the assessee's business. The learned counsel argues that breaches of contractual obligations were often commercially expedient and that they should not be treated on a par with "infractions of law". We do not agree with the submissions of the learned counsel. We are unable to hold that damage paid for committing breaches of obligation can any more be said to be expenditure laid out wholly and exclusively for the assessee's business than a penalty paid for an infraction of the law. Infractions of law may be as commercially expedient as breaches of obligation. For a smuggler or a bootlegger, infraction of law is the very breath of his business but he cannot claim the " hush-money " that he may pay to corrupt officials as expenditure incurred wholly and exclusively for his business on the ground that it is commercially expedient to pay " hush-money ", otherwise he will be out of business. We do not think that commercial expediency is always a correct or conclusive test to determine whether expenditure is laid out wholly and exclusively for the assessee's business. We think it is impossible and inexpedient to define the expression " wholly and exclusively for the assessee's business". (This is a difficulty which was also expressed by Rowlatt J. and Lord Sterndale M. R. , whose observations we will presently quote ). We think it is perhaps wiser to leave the words of the statute as they are than to put a gloss upon them; All that is necessary for us to say is that the expenditure must, in some way, be connected with trade, it must be an ordinary or contemplable incident of trade. There must be a discernible nexus between the expenditure and the trade. There must be something commercial about it. We are of the view that infractions of law, including breaches of obligations, are not normal incidents of business and penalties and damages paid in connection with such infractions and breaches are not expenditure " laid out or expended wholly and exclusively for the assessee's business ".
(3.) IN Mask and Co. v. Commissioner of Income-tax [1943] 11 ITR 454 (Mad), the assessee committed a breach of contract and in a suit filed by the other party, he was obliged to pay a sum of Rs. 5,000 by way of damages. The amount was claimed by the assessee as expenditure " laid out or expended wholly and exclusively for purposes of the assessee's business ". Negativing the assessee's claim, Leach C. J. and Lakshmana Rao J. , after referring to Inland Revenue Commissioners v. E. C. Warnes and Co. (1919] 12 TC 227 (KB) and Inland Revenue Commissioners v. Alexander von Glehn and Co. [1920] 12 TC 232 (CA), said--See [1943] 11 ITR 454, 462 (Mad): " In the present case, the assessee was not fined for a breach of law, but was made to pay damages for a breach of the contract entered into. The assessee's action in disregarding the undertaking given was palpably dishonest and we are of the opinion that the award of damages which followed did not constitute an expenditure falling within Section 10 (2) (xii ). It was not incidental to the trade. ";