Bombay H.C : Reimbursement made to a unit of Government of India by cheque is against public policy

High Court Of Bombay

Brihan Maharashtra Sugar Syndicate Ltd. vs. DCIT

Section 37(1)

Asst. Year 1990-91

F.I. Rebello & R.S. Mohite, JJ.

IT Appeal No. 549 of 2005

17th February, 2009

Counsel Appeared :

S.N. Inamdar with P.C. Tripathi, for the Appellant : Vimal Gupta with P.S. Sahadevan, for the Respondent



Admit on the following questions :

“(i) Whether on the facts and in the circumstances of the case the Tribunal was justified in law in holding that reimbursement made to a unit of Government of India by cheque is against public policy ?

(ii) Whether on the facts and in the circumstances of the case the Tribunal was right in law in holding that the expenditure incurred by appellant for sales promotion is not allowable under s. 37 on the ground that it is allegedly in the nature of unlawful consideration granted to military personnel ?”

2. The appellant company is manufacturer of Indian made foreign liquor. According to them they are depending to a large extent on orders from the military canteen for the sale of its products. For the relevant accounting year 1990-91 out of the total sales of about Rs. 7.21 crores was to the military canteen which constitute 45 per cent of its total turnover. The Company’s business interest is critically linked with the sales to CSDs. The company a liquor manufacturer, is banned from direct media and T.V. advertising of its products. The military authorities on the other hand are debarred from directly accepting any free samples from a liquor manufacturer. As per the CSD Rules, the liquor required for any function are to be procured from the canteens only against actual payments. The company from the point of commercial expediency offers samples of its products at various military functions so that the personnel develop a taste for it and the company secures bigger orders from the CSD. To avoid any infringement of any rules, the concerned defense establishments buy the requisite quantity of company’s liquor from the Army liquor shops against actual payment. The regiment or the defense establishment forwards the cash memo to the company to reimburse the amount. This, it is submitted, is nothing but free sample of the company’s products which has been rightly accounted for as sales promotion expenses. Merely because the company’s product is one which is of human consumption, this free sample cannot be regarded as entertainment expenditure. In the past there has been never any disallowance on this account. It is an accepted commercial practice that the sale of any product would not increase unless the consumers are made aware about its qualities or specialities either by dissemination of information regarding the product by advertisement or actually allowing them the use of the products by way of free samples. The first method being banned for the company, it could resort to only the second method for the promotion of its sale and that cannot surely be regarded as entertainment. Such an expenditure would constitute entertainment only when the function/parties is organized by the company as host at its expenses and the entire hospitality is provided by the company. The AO has totally overlooked the fine distinction between entertainment and promotion and consequently has erred in holding this expense as entertainment.

3. As may be noted the AO disallowed the sale promotion expenses of Rs. 3,80,036 on account of liquor supplied at the time of CSD parties on the ground that it was clear entertainment of the customers. In appeal preferred before the CIT(A) the learned CIT(A) was of the opinion that the expenses are incurred no doubt for promotion of the appellant’s product but through wrongful measures prohibited by which are not for public goods and hence against public policy. Under these circumstances the expenditure was disallowed as deduction. It will thus be clear from the finding of the CIT(A) that it proceeded on the footing that the expenses are incurred for promotion of the appellant’s product.

4. The assessee aggrieved by the said order preferred an appeal before the Tribunal. The learned Tribunal confirmed the order of CIT(A). It, however, reiterated the finding that the same was against the public policy. Aggrieved by that order the present appeal.

5. On 15th Sept., 2008 a learned Bench of this Court was pleased to direct the appellant to disclose as to in whose name the liquor was purchased from the CSD and reimbursement was made to whom with documentary evidence. Pursuant to that an affidavit has been filed by Dnyaneshwar Chandrashekhar Agashe, chairman and managing director of the appellant. In the said affidavit it is set out that defense establishment draws the supply of liquor manufactured by the company from the military canteen retail store in its precincts. The cash memo for this liquor which is drawn, is issued in the name of the regiment/unit by the CSD retail store. The commanding officer of the regiment/unit then forwards the cash memo to the company accompanied by his official letter requesting reimbursement of the said cash memo. This request is processed by the company’s accounts Department in normal course and sanctioned for payment by cheque/demand draft drawn in favour of the regiment/unit. The company never sends any liquor samples or money directly to any individual defense personnel but always to the regiment/unit by cheque/draft drawn in favour of the regiment/unit. This procedure is followed to ensure strict compliance with the terms of the license and the provisions of the Bombay Prohibition Act, 1949. No affidavit has been filed countering the contents of the said affidavit.

6. At the hearing of this appeal on behalf of the appellant their learned counsel submits that reimbursing the regiment/unit for the liquor consumed cannot be said to be against the public policy. It is submitted that the right to trade in liquor may be a trade which is res extra commercium. Nevertheless the State allows sale of liquor. Once that be the case and trading in liquor is permitted the question of public policy would not arise. Public policy, it is submitted, would be in the event the contract is immoral or against the state interest. There is no immorality involved in the contract. There is no bar in military officers in the armed force drawing liquor or drinking. The very fact that they can purchase the same from CSD must result in rejecting that contention. The limited issue, therefore, is whether the reimbursement of the liquor drawn and paid by the regiment/unit on an occasion like celebrating the Regiment’s annual day which is reimbursed can be said to be against the public policy. The CIT(A) itself has accepted that the amount is spent for the purpose of promoting the sales. That finding has not been reversed by the Tribunal. We may gainfully refer to some of the judgment which were cited at the Bar. In Maddi Venkataraman & Co. (P) Ltd. vs. CIT (1998) 144 CTR (SC) 214 : (1998) 229 ITR 534 (SC) a search was conducted in the assessee’s business premises. From the documents seized it was disclosed that the assessee had indulged in transaction in violation of the provisions of the Foreign Exchange Regulation Act, (for short FERA). It was found that the assessee had remitted foreign exchange to a private party in Singapore in violation of law. In proceedings initiated for infringement penalty was imposed. The assessee claimed deduction of a specified sum as expenditure/loss. It had, according to assessee, accumulated 329.2 tonnes of sub-standard quality tobacco which it could not export over the last three years. As it was substandard it could not be sold at the floor price fixed by the Government of India. It had no alternative, but to sell the tobacco at a discount of 20 per cent to a Singapore party. On paper, the full sale price was paid by a Singapore party, but in reality 20 per cent of the price paid by the party was remitted back.

The transaction took place. The case of the assessee was that it had entered into the transaction with a view to dispose of the stock of inferior quality tobacco. Hence deduction was claimed. This was confirmed by CIT(A). The Tribunal reversed the findings. In appeal the High Court proceeded on the basis that agreement was tainted with illegality and consequently the agreement was illegal and contrary to law. The High Court held that one exception to this rule that deduction cannot be claimed in respect of payments set out illegally is where the entire business of the assessee is illegal and that income is sought to be taxed by the ITO. The expenditure thus 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 redue his loss, then the expenditure incurred for these unlawful activities cannot be allowed to be deducted. Various judgments were referred to. The Supreme Court proceeded to hold that the fear of loss cannot be justification of contravention of law and consequently, the expenditure incurred for evading the provisions of the Act and also the penalty levied for such evasion cannot be allowed as deduction. In Sri Venkata Satyanarayana Rice Mill Contractors Co. vs. CIT (1997) 137 CTR (SC) 267 : (1997) 223 ITR 101 (SC) the appellant claimed deduction of the amounts paid by it to Andhra Pradesh Welfare Fund as business expenditure. The appellant was carrying on business of export of rice. In the State of Andhra Pradesh, rice could not be exported without the appellant’s obtaining a permit from the District Collector. The permits were given only if payment was made to the Andhra Pradesh Welfare Fund which had been established. The ITO disallowed the expenditure. Appeal to CIT(A) was dismissed. A Full Bench of Tribunal came to the conclusion that there was no compulsion on the appellant to make contribution to a welfare fund, still contribution made in pursuance of the scheme which was evolved by the association in consultation with the District Collector would show that an advantage would ensue on the payment of the contribution and, therefore, the deduction was allowable under s. 37(1) of the Act. The Tribunal further held that such contribution could not be held to be opposed to public policy.

The matter was referred to the High Court at the instance of the Revenue. There was a question referred to at the instance of the assessee also. The High Court held that the contribution to the welfare fund was a precondition and hence the assessee was right in contending that it was a compulsory payment. It, however, disallowed the deduction as being opposed to public policy. The Supreme Court noted that this was not a case of the assessee paying a bribe or any contribution by way of illegal gratification. The Court first noted that the principles whether such payment can be regarded as being allowable as business expenditure. It noted that long ago as in the case of Atherton vs. British Insulated & Helsby Cables Ltd. (1925) 10 Tax Cases 155, 191 (HL), it was observed that “A sum of money expended, not of necessity and with a view to direct and immediate benefit to the trade, but voluntarily and on the grounds of commercial expediency, and in order indirectly to facilitate the carrying on of the business, may yet be expended wholly and exclusively for the purpose of the trade.” The Court noted what was to be considered is not whether it was compulsory but whether it was expended out of consideration. The test, therefore, is not to see whether it was compulsory for the assessee to make the payment or not but the correct test is that of commercial expediency. As long as the payment which is made is for the purposes of the business, and the payment made is not by way of penalty for infraction of any law, the same would be allowable as a deduction. Referring thereafter to various other cases the Supreme Court was pleased to hold that the contribution made by the assessee towards public welfare fund which is directly connected or related to the carrying on assessee’s business has to be regarded as allowable deduction and cannot be regarded as payment opposed to public policy.

In Addl. CIT vs. Kuber Singh Bhagwandas (1979) 9 CTR (MP)(FB) 94 : (1979) 118 ITR 379 (MP)(FB) a Full Bench of the Madhya Pradesh High Court was considering whether donations made to Chief Minister’s Draught Relief Fund to obtain permits to enable merchants to earn profits by exporting gram to neighbouring states where price of commodity was double, could be said to have made by infraction of law. After considering the principles involved and the test of commercial expediency the learned Full Bench answered the question in the affirmative in favour of the assessee. The crucial test was that if the sole object is business promotion, the expenditure would be one incurred wholly and exclusively for the purposes of the assessee’s business even though some other object necessarily results, being inherent in the nature and quality of the expenditure. In CIT vs. Sauser Liquor Traders (1997) 142 CTR (MP) 211 : (1996) 222 ITR 33 (MP) the deduction claimed was alleged to have been paid as bribe to officials. The question was whether it could be claimed as deduction. A finding was recorded that this amount was paid by the assessee towards bribe which is against the public policy and in view of that the expenditure was disallowed.

We now come to the facts of the present case. The Army Unit could not directly purchase liquor from a manufacturer. Liquor had to be purchased through CSD. This was done by the Army Unit. The second aspect was that the amounts spent by the unit towards purchase of that liquor was reimbursed by the assessee not to any individual but to the Army Unit itself and which went into the coffers of the Government. There was no bar in taking such reimbursement as evidenced by receipt. In other words such a contract is not prohibited by law nor was it in the nature of bribe to an officer to procure accountant (account). As noted earlier public policy would involve that income and the expenditure is from an activity which is prohibited by law or is immoral. Only then the expenditure could have been disallowed. In the instant case the amount has been spent by way of commercial expediency for promoting the assessee’s products. The finding is that this is by way of sales promotion. Such an expenditure is not against public policy. Once that be the case the deduction is allowable. In the light of that question Nos. (i) and (ii) will have to be answered in the negative against the Revenue and in favour of the assessee. Appeal disposed of accordingly.

[Citation : 320 ITR 658]

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