Rajasthan H.C : Where Assessee received payment on damages for non-performance of contract by seller, said payment was to be treated as business income and not as speculative transaction

High Court Of Rajasthan

CIT VS. Premier Vegetable Products Ltd.

Assessment Year : 1974-75

Section : 43(5), 37(2)/(2a)

Ajay Rastogi And J.K. Ranka, Jj.

IT Reference No. 42 Of 1982

November  9, 2013

JUDGMENT

J.K. Ranka, J. – This income-tax reference is directed against the order dt. 20th Dec, 1980 passed by the Income-tax Appellate Tribunal, Jaipur Bench, Jaipur (in short ‘Tribunal”) for the asst. yr. 1974-75. The Tribunal referred following questions of law :

“(1) Whether on the facts and in the circumstance of the case, the Tribunal was justified in deleting the disallowance of Rs. 4,250 made by the ITO on account of entertainment expenditure ?

(2) Whether on the facts and in the circumstances of the case the Tribunal was justified in holding that the receipt of Rs. 1,67,189 is to be treated as ‘business income’ instead of income from speculation business.”

2. The facts, necessary for disposal of this reference, are that the respondent-assessee a limited company was carrying on the business of production of vegetable ghee and oil and simultaneously also manufacturing its own commodities out of tin plates. A return was submitted by the respondent-assessee declaring a loss of Rs. 44,05,060 on 31st Aug., 1974 which was revised on 30th Oct., 1976 declaring a loss of Rs. 44,05,888. Notices were issued and during the course of hearing the AO required details on various issues on which the return was submitted.

Facts and decision on question No. 1 :

3. Insofar as the question of disallowance of Rs. 4,250 out of office expenses is concerned it was claimed that it was spent on crockery, tea, coffee, dry fruits, snacks, cold drink, pan, cigarettes etc. and it was essentially a business expenditure spent for business expediency and customary in nature for the guests and customers coming at the factory as also office of the respondent-assessee and thus allowable. However, the AO was of the view it is in the nature of entertainment and thus disallowed the amount holding it by way of entertainment. In first appeal the learned AAC also did not accept the contention of the respondent-assessee, however, the Tribunal held the expenditure to be allowable by holding that the expenditure claimed was nominal, reasonable, routine and customary in nature and, therefore, it was allowable and is not in the nature of entertainment.

4. Mr. J.K. Singhi, learned senior advocate assisted by Mr. Anuroop Singhi learned counsel for the Revenue submitted that the Tribunal erred in holding the said expenditure in routine when the expenditure was purely in the nature of entertainment and entertainment expenditure was disallowable and accordingly submitted that the finding of the Tribunal on this deserves to be reversed.

5. Heard learned counsel of the petitioner-Revenue and in our view, the Tribunal has correctly come to the conclusion that the expenditure claimed by the respondent-assessee, namely; on tea, coffee, cold drinks, pan, cigarette, biscuits, crockery are not in the nature of entertainment and looking to the turnover of the assessee, the expenditure is routine expenditure and customary in nature. Expenditure incurred are for the business considerations and cannot be said to be in the nature of entertainment.

6. The Hon’ble Supreme Court had an occasion to consider the issue relating to providing ordinary meals and refreshment to outstation customers according to the customary hospitality and trade usage satisfying the general test of commercial expediency in the case of CIT v. Patel Brothers & Co. Ltd. [1995] 215 ITR 165 (SC) and after elaborate discussion came to the conclusion that expenditure for commercial and business expediency, which is normal and not lavish, cannot be said to be falling within the meaning of entertainment expenditure.

7. Accordingly, in our view the question of law has been correctly answered by the Tribunal in favour of the respondent-assessee and against the Revenue.

Facts and decision on question No. 2 :

8. While the claim of the respondent-assessee was that the sellers committed the breach of the contracts and no delivery was made and therefore, for breach, damages were settled and the respondent-assessee received an amount of Rs. 1,67,189 from the sellers. According, to the assessee it was a normal business transaction and it forms part of the trading and P&L a/c and a credit as business profit in the P&L a/c, however, the AO was not satisfied with the explanation offered and according to the AO, the said transaction was purely speculative in nature and he held that wherever actual delivery of goods was not there and all these contracts are settled otherwise than by actual delivery are speculative transactions and accordingly held it as speculation profit which was to be separately considered. The AO also relied upon judgments of Allahabad High Court in the case of CIT v. Ratan Lal Mohanlal [1972] 86 ITR 200, D.M. Wadhwana v. CIT [1966] 61 ITR 154 (Cal.) and Supreme Court decision in the case of Davenport & Co. (P.) Ltd. v. CIT [1975] 100 ITR 715.

9. The matter was carried in appeal before the AAC who also agreed with the finding of the AO and held the said amount of Rs. 1,67,189 as speculative in nature.

10. The matter was further agitated before the Tribunal wherein it was submitted that the respondent-assessee had received damages in the normal course of business and that the breach was committed by the supplier for the reasons unknown to the respondent-assessee and the reasons best known to the suppliers and it was further submitted that the respondent-assessee would have suffered heavily in case the suppliers did not provide the goods and therefore, at least the respondent-assessee was able to recover compensation damages. It was further submitted that it was normal business transaction and it was not at all speculative in nature. It was further submitted that the goods were required for its own use and the respondent had to purchase from the open market following the breach made by the supplier and in that process, the respondent suffered loss by paying more price to the other suppliers after the breach was committed. Before the Tribunal reliance was placed on the judgments in case of CIT v. Pioneer Trading Co. (P.) Ltd. [1968] 70 ITR 347 (Cal.); Daulatram Rawatmull v. CIT [1970] 78 ITR 503 (Cal); Bhandari Rajmal Kushalraj v. CIT [1974] 96 ITR 401 (Mysore), CIT v. Indian Commercial Co. (P) Ltd. [1977] 106 ITR 465 (Bom); Thakurlal Shivprakash Poddar v. CIT [1979] 116 ITR 190/1 Taxman 426 (MP)

11. The Tribunal ultimately, by referring to the judgment, rendered by the Bombay High Court in the case of Indian Commercial Co. (P.) Ltd. (supra) agreed with the contention of the assessee and held that the transaction was not speculative in nature and it was to be treated as normal business income and accordingly allowed the appeal of the respondent-assessee.

12. Mr. J.K. Singhi, senior advocate, learned counsel for the Revenue submitted that under s. 43(5) of the IT Act it is clearly provided that in such kind of transaction where delivery is not taken, then the transaction has to be speculative in nature. He further submits that while the AO after analyzing the facts and circumstances as also the AAC came to a clear finding that delivery having not been made, therefore, it is speculative in nature. He also relied upon judgment of this Court in the case of CIT v. Dina Lal Gupta [1988] 170 ITR 583 (Raj). He, however, candidly subimtted that this Court in a later judgment in the case of CIT v. Shree Bhaqpatia Food Industries [1994] 207 ITR 1045/[1995] 78 Taxman 65 (Raj.) has held in favour of the assessee and against the Revenue. He, further submitted that the facts of the present case are more nearer to the jugment rendered by this Court in the case of Dinalal Gupta (supra) and accordingly urged that the Tribunal erred in holding the transaction as in the nature of business income rather than speculative in nature when it was clearly proved by the conduct of the assessee itself that delivery was not effected and when delivery is not effected and transaction is settled otherwise than delivery then it is speculative in nature as defined under s. 43(5) of the IT Act.

13. We have heard counsel for the petitioner-Revenue and have also gone through the impugned order as well as the judgments cited by counsel for the petitioner-Revenue and the judgments referred to by the Tribunal and have also gone through later judgments of the Hon’ble apex Court and other Courts which we shall refer to hereinafter. However, it would be fruitful to refer to s. 43(5) of the IT Act, 1961 which provides as under :

‘”Speculative transaction’, means a transaction in which a contract for the purchase or sale of any commodity, inducing stocks and shares, is periodically or ultimately settled otherwise than by the actual delivery or transfer of the commodity or scrips :

Provided that for the purpose of this clause —

(a) a contract in respect of raw materials or merchandise entered in to by a person in the course of his manufacturing or mechanting business to guard against loss through future price fluctations in respect of his contracts for actual delivery of goods manufactured by him or merchandise sold by him; or

(b) a contract in respect of stocks and shares entered into by a dealer or investor therein to guard against loss in his holdings of stocks and shares through price fluctuations; or

(c) a contract entered into by a member of a forward market or a stock exchange in the course of any transaction in the nature of jobbing or arbitrage to guard against loss which may arise in the ordinary course of his business as such member;

shall not be deemed to be a speculative transaction.”

14. Sec. 43(5) of the IT Act contemplates a transaction in which a contract for purchase or sale of any commodity is periodically or ultimately settled otherwise than by the actual delivery or transfer of the commodity. It is not only actual delivery of the goods but it must be coupled with settlement of contract in a transaction for which the payment is made. If the payment is by way of damages and not by way of settlement of a contract, then the question of actual delivery or transfer of the goods would be irrelevant. It is a finding of fact recorded by the Tribunal as also the lower authorities that the payments have been made by way of damages for non-performance of the contract and that non-performance of the contract was unknown insofar as the present matter is concerned, nevertheless, it stands proved that the respondent-assessee did receive damages to the tune of Rs. 1,67,189 and it is an admitted position all throughout. In our view, when the respondent-assessee has been able to satisfactorily prove that he was able to receive the damages for the breach of the contract and the contract was for supply of goods, it was a business transaction and in our view the damages received was certainly in the nature of business profits and not speculative in nature. In our view there was no question of settling the contract as the cause of action was no longer based on the contract itself but on the breach and therefore, settlement of the damages arising from the breach of the transaction does not result from the contract but from the breach. A contract can be settled during the subsistence of the contract and if a breach occurred by the non-performance of the contract or by the actual delivery, a party to the contract settled the amount of damages by paying the difference between the contract price and the market price on the due date of performance that would not amount in law to settling a contract. What has been settled is settling the damages consequent to the breach.

15. The Hon’ble apext court in the case of CIT v. Shantilal (P.) Ltd. [1983] 144 ITR 57/14 Taxman 1 after referring to s. 43(5) of the IT Act, observed as under :

“Is a contract for purchase or sale of any commodity settled when no actual delivery or transfer of the commodity is effected and instead compensation is awarded under an arbitration award as damages for breach of the contract ? A contract can be said to be settled if instead of effecting the delivery or transfer of the commodity envisaged by the contract the promisee, in terms of s. 63 of the Contract Act, accepts, instead of it any satisfaction which he thinks fit. It is quite another matter where instead of such acceptance the parties raise a dispute and no agreement can be reached for a discharge of the contract. There is a breach of the contract and by virtue of s. 73 of the Contract Act the party suffering by such breach becomes entitled to receive from the party who broke the contract compensation for any loss or damage caused to him thereby. There is no reason why the sense conveyed by the law relating to contracts should not be imported into the definition of “speculative transaction”. The award of damages for breach of a contract is not the same thing as party to the contract accepting satisfaction of the contract otherwise than in accordance with the original terms thereof. It may be that in a general sense the layman would understand that the contract must be regarded as settled when damages are paid by way of compensation for its breach. What is really settled by the award of such damages and their acceptance by the aggrieved party is the dispute between the parties. The law however speaks of settlement of the contract and a contract is settled when it is either performed or the promisee dispenses with or remits wholly or in part the performance of the promise made to him or accepts instead of it any satisfaction which he thinks fit. We are concerned with the sense of the law, and it is that sense which must preval in sub-s. (5) of s. 43. Accordingly, we hold that a transaction cannot be described as a ‘speculative transaction’ within the meaning of sub-s. (5) of s. 43 IT Act, 1961 where there is a breach of the contract and on a dispute between the parties damages are awarded as compensation by an arbitration award. We are unable to endorse the view to the contrary taken by the Madras High Court in R. Chinnawami Chettiar (supra) and approve of the view taken by the Calcutta High Court in CIT v. Pioneer Trading Company (P). Ltd. (supra) and by the Mysore High Court in Bhandari Rajmal Kushalraj (supra). The decisions of the Madras High Court in P.L. KN. Meenakshi Achi (supra) and A. Muthukumara Pillai (supra) are not apposite and are not concerned with the point before us. Our attention was invited by learned counsel for the Revenue to the decision of this Court in Davenvort & Co. (P) Ltd. v. CIT 1975 CTR (SC) 235 : [1975] 100 ITR 715 (SC) but this point did not arise there either.”

16. This Court in the case of Shree Bhagpatia Food Industries (supra) held as under :

‘It is well-settled that in accordance with the provisions of s. 43 if the payment has been made as damages for breach of contract then it could not be considered to be a “contract settled”. The provisions of s. 43(5) contemplated such transaction in which a contract for the purchase or sale of any commodity is periodically or ultimately settled otherwise than by the actual delivery or transfer of the commodity. It is not only actual non-delivery of the goods but it must be coupled with settlment of contract in a transaction for which the payment is made. It the payment is by way of damages and not by way of settlement of a contract, then the question of actual delivery or transfer of the goods would be irrelevant. In view of the finding recorded by the Tribunal that the payments have been made by way of damages for non-performance of the contract and that non- performance of the contract was for reasons beyond the control of the assessee on account of closure of loading by the railway authorities or on account of non-availability of wagons and for which relevant documents were produced before the ITO as well as the AAC, the Tribunal was justified in coming to the conclusion that the amount is to be treated as a business “loss and not as a speculative loss.”‘

17. This Court in the case of CIT v. Rajasthan Wool Agencies [1986) 160 ITR 358/26 Taxman 723 (Raj.) had also an occasion to consider this issue and held as under :

“Bearing in mind the principles laid down in CIT v. Pioneer Trading Company (P). Ltd. [1968] 70 ITR 347 (Cal.)Daulatram Rawatmull v. CIT [1970] 78 ITR 503 (Cal.); Bhandari Raimal Kushalraj v. CIT [1974] 96 ITR 401 (Mysore) and CIT v. Shantilal (P.) Ltd. 35 CTR SC 395/[1983] 144 ITR 57 (SC), let us recapitulate the facts found by the Tribunal, reference to which have already been made hereinabove. The assessee failed to supply the agreed quantity of wool tops because of continous rise in the market price. It had already supplied part of the agreed quantity. It is thus clear that the parties never intended not to make actual delivery of the goods contracted to be supplied. On the other hand, the intention of the parties at the time of entering into contract and stipulating that the contracted wool tops will be supplied from December, 1972 to June, 1973 clearly shows that actual delivery was contemplated. Therefore, the Tribunal in our opinion was right when it held that the transaction could not be described as speculative transactions in the sense in which speculation is understood under the contract or in the general sense of the word. The breach was committed before the closing date of the contract. It was in June, 1973 and the assessee informed the two firms that it will not be able to supply the remaining quantity of wool tops. The assessee committed default by non-performance or non-fulfilment of the terms of the contract regarding supply of wool tops. As a result of that a dispute arose and that was settled by reducing into writing the compromise agreement by which a lump sum of Rs. 42,000 was paid as damages to the two parties by cheque. Sec. 43(5) of the Act defines, speculative transaction for the purpose of the Act and it only covers those transactions or contracts which are periodically or ultimately settled otherwise than by actual delivery. As already held in the present case, the contract was not settled but a breach of contract had taken place before the due date for performance. In these circumstances, we are disposed to think that s. 43(5) of the Act will not apply and for that matter, it will not be material whether there was actual delivery or not. This conclusion of ours stands fortified from the decisions referred to above.”

18. The Bombay High Court, in the case of CIT v. Kamani Tubes Ltd. [1994] 207 ITR 298/75 Taxman 55 held that the payment of difference between the agreed price and the market price on the date of refusal was a case of breach of contract and the payments made by the assessee were by way of damages for the breach of the contract and it was not a case of performance of a contract within the meaning of s. 33 of the Indian Contract Act and therefore, the payment could not be termed as speculative transaction within the meaning of s. 43(5) of the Act.

19. The Delhi High Court in the case of CIT v. Hans Machoo & Co. [2001] 247 ITR 79/[2000] 113 Taxman 427 has held that a transaction cannot be described as a “speculative transaction” within the meaning of s. 43(5) of the IT Act, 1961 where there is a breach of contract and on dispute between the parties damages are awarded as compensation e.g., by an arbitration award. What is really settled by the award of such damages and their acceptance by the aggrieved party is a dispute between the parties. Sec. 43(5) however, speaks of a settlement of the contract and contract is settled when it is either performed or the promise dispenses with remits, wholly or in part, the performance of the promisee made to him or accepts, instead of it any satisfaction which he thinks fit. The word “settled” or “settlement” in connection with the contract has not been defined in the IT Act or in the Contract Act or in the Sale of Goods Act or in any other statute. However, the proper meaning to be given to the word “to contract, settled” in the definition clause would be “a contract determined or concluded or disposed of. “By the use of the expression “settled”, what is intended to be dealt with is a case of ‘performance of contract and not non-performance’ and accordingly held that the transaction was in the nature of business transaction and not speculative in nature.

20. The Madras High Court in the case of CIT v. Sri Ramalinga Choodambigai Mills Ltd. [1999] 239 ITR 120/104 Taxman 646 held as under:

“That the contracts were entered into in an ordinary course of business of running a textile mill and had been entered into bona fide to secure the supply of the raw materials required by it. The contracts were later cancelled only because that raw material was no longer fit for the assessee’s use having regard to the fact that a different variety of cotton was required for the manufacture of higher count of yarn. Entering into such contract and settling the same by paying damages does not amount to carrying on speculative business.”

21. The Bombay High Court, in the case of Indian Commercial Co. (P.) Ltd. (supra) held as under :

‘That the two letters exchanged between the assessee-company and HS Ltd. leave no room for doubt that both the parties admittedly proceeded on the footing that the assessee-company had committed breach of the contract and indeed that was the correct position as the assessee had not opened any letter of credit ‘forthwith’ as required by cl. V of the agreement, with the result that HS Ltd. was under no obligation to deliver the goods. Once a contract is broken there can be no cause of action founded on the contract itself which can be said to be capable of settlement. After the breach of contract what can be settled is only the right to damages resulting from the breach itself. In this case as the sum of Rs. 50,000 was paid to Hs Ltd. after the breach of the contract by the assessee-company, it must be held that the settlement, as a result of which that payment was made was not a settlement of the contract within the terms of s. 43(5), but was a settlement of the assessee-company’s liability for damages for breach of that contract. The contract itself cannot, by reasons of such settlement, be said to be a speculative transaction.”

22. The MP High Court in the case of Thakurlal Shivprakash Poddar (supra) held that in case it was found by the Tribunal that the assessee entered into a genuine transaction with the purchaser determining the dispute arising out of non-performance of the contract by the assessee and in those circumstances, it came to the conclusion that it cannot be held that assessee settled the contract otherwise than by actual delivery of the contracted commodity so as to render the transaction a “speculative transaction” within the meaning of that term as defined by Expln. 2 to s. 24(1) of the Act of 1922 corresponding to s. 43(5) of the Act of 1961.

23. The judgment cited by the learned counsel for the Revenue of Dinalal Gupta (supra) is distinguishable on facts. Accordingly, in view of catena of judgments on this issue and in view of the finding recorded by the Tribunal that the assessee received damages for non-performance of the contract and that non-performance of the contract was for reasons beyond the control of the assessee, we are of the view that the Tribunal was justified in coming to the conclusion that the amount of Rs. 1.67,189 is to be treated as business income and not income by way of speculative transaction, this question is also answered in negative i.e. in favour of respondent-assessee and against the Revenue.

24. Consequently, the present Income-tax Reference stands dismissed. We make no order as to costs.

[Citation : 362 ITR 464]