High Court Of Karnataka
J.K. Panthaki & Co. vs. ITO
Assessment Years : 1983-84 And 1984-85
Section : 37(1)
N. Kumar And H.S. Kempanna, JJ.
IT Appeal Nos. 213 & 214 Of 2010
September 7, 2010
JUDGMENT
N. Kumar, J. – These two appeals arise out of the orders passed in respect of two asst. yrs. 1983-84 and 1984-85. The question involved in both these appeals is one and the same and therefore they are taken up for consideration together and disposed of by this common order.
2. The assessee is a registered firm of construction engineers and designers. On 29th Sept., 1984, assessee filed a return admitting an income of Rs. 4,00,000. On 30th Jan., 1985 the assessee again filed a return disclosing an income of Rs. 3,95,430. Another revised return was filed on 3rd Sept., 1986. In the interregnum between the filing of the return on 30th Jan., 1985 and 3rd Sept., 1986, a search under s. 132 was conducted in the assessee’s premises on 29th July, 1986. The assessee’s main income during the year is from the contract receipts for civil construction from M/s Karnataka Ball Bearings Corporation Ltd. The material on record discloses that the assessee submitted a tender for Rs. 1,28,18,413 dt. 29th March, 1982 for civil work for the aforesaid company to their architects Master & Associates, Bangalore. On 16th July, 1982, the assessee was intimated about the allotment of the work. According to the assessee the work commenced in August, whereas, the ITO refers to the assessee’s own letter wherefrom it could be detected that the commencement of work is on 16th July, 1982. At the relevant point of time, Sri A.P. Mehta was the chairman and his son Sri Jairaj P. Mehta was the managing director. There were other relatives of Sri Mehta in the Board.
3. On the date of search the assessee’s main partner Sri J.K. Panthaki was questioned, inter alia in respect of purchases of steel from M/s Maneesh & Co., and M/s Chimanlai R. Mehta. It was pointed out that there are no delivery or sales-tax check post seals or evidence of lorry numbers. Sri Panthaki’s answer gave no indication of the bogus nature of bills. Later partner Sri J.S Dave of M/s Ashok Trading Corporation and Maneesh & Co. purchased steel admitted in the sworn deposition that he did not supply any goods to the parties. On 8th Aug., 1986, the two parties admitted in their petitions that they did not purchase steel but only obtained bills on payment of commission of 1 per cent and in turn they issued bills without delivery of goods to Sri J.K. Panthaki for a consideration of payment of commission at 3½ per cent on the value of the sale bills. In the return that was filed on 30th Jan.,1985, no claim for the above commission was made. Nor did the accounts indicate any cash balance representing the funds received back from the said suppliers. In the revised return filed on 3rd Sept., 1986 after the date of the search and after the Department came into the possession of materials indubitably showing the bogus nature of purchases claimed as deduction in the original return the assessee accepted that the goods were not delivered, the bills were havala bills only and transactions to the extent of Rs. 45,84,815.62 were not made. However, it was claimed that the moneys involved in the aforesaid transaction represented commission agreed to be paid to Sri A.C. Mehta and his group for awarding the contract. In paras 2 and 3 of the statement of facts, the assessee explained their stand as under :
“The aforesaid contract was awarded and the work started around August, 1982. During the course of negotiations in connection with the awarding of the contract, there were some changes in the structural designs of the building which resulted in a cost reduction of around Rs. 48 lakhs compared to the original estimates recommended by the architects. The directors of the KBBC Ltd., viz., Mr. A.P. Mehtal (chairman of KBBC Ltd.), Mr. Jayaraj P. Mehta (managing director of KBBC Ltd.) and other relative directors of the chairman have insisted our managing partner, Mr. J.K. Panthaki to pay such cost reduction of Rs. 48 lakhs as commission to them in consideration of awarding the construction contract of KBBC Ltd., to the assessee. Further, as per the mutual oral agreement the said commission of Rs. 48 lakhs has to be remitted to A.P. Mehtas & Group in cash and it has to be removed from the books of accounts of the assessee during the financial years ended 31st March, 1983 and 31st March, 1984. Initially A.P. Mehta & Group were refusing to acknowledge any commission due or cash receipts. Therefore, it was mutually decided to remove the said commission from the books of account during the aforesaid financial years by debiting materials accounts in the form of fictitious steel bills procured from Chimanlal R. Mehta & Manish & Co.
The commission of around 3-½ payable to Chimanlal R. Mehta and Manish & Co., for procurement of such fictitious steel bills was borne by A.P. Mehta & Group and the assessee was remitting such commission to the said steel bill suppliers on behalf of A.P. Mehta & Group. In the original return filed by the assessee the said commission was shown under materials account. Subsequently. A.P. Mehta & Group gave confirmations and cash receipts pursuant to which a revised return was filed. In the revised return filed on 3rd Sept., 1986 commission of Rs. 45,84,851 was deleted from materials account and shown correctly under the commission account resulting in no change in the income returned as compared in the original return. However, no entry could be effected in the books of account for such change.
Consequent to seizure of books of account by the Department on 29th July, 1986, the ITO disallowed the said claim for commission to the tune of Rs. 45,84,851.
In the aforesaid contract with KBBC Ltd., the assessee offered initially an escalation of 28 per cent over the tendered rates. Consequent to further increase in cost of materials, labour etc. the architects recommended an increase in the rates of escalation i.e. from 28 per cent to 33.25 per cent. However, this increase in escalation was to take effect only after satisfactory completion of all existing work tendered and also future projected works. Whereas, during the previous year relevant to the aforesaid assessment year work was in progress and the learned ITO prematurely added a sum of Rs. 6,31,935 to the contract receipts accounted, as contract receipts pertaining to increase in escalation but not accounted by us.”
4. The ITO refused to take cognizance of the revised return. He was satisfied that the changes in the return was not bona fide omission or bona fide wrong payment and therefore, he refused to treat the return as valid revised return under s. 139(5) of the Act. Thereafter, he proceeded to pass the impugned order disallowing the aforesaid deduction claimed. Aggrieved by the same, the assessee preferred the appeal to the CIT(A). Before the appellate authority it was contended on behalf of assessee that there was an oral agreement between Sri J.K. Panthaki Group with Mehta Group on 12th Aug., 1982. The terms were reduced to writing on 2nd Jan., 1987 confirming such payment. According to the memorandum of minutes which is purported to be a record of meeting held on 12th Aug., 1982, M/s Karnataka Ball Bearings Ltd., shall make payment as per the original estimate even though the construction of the factory’ building as per the revised structural design results in cost reduction of Rs. 48 lakhs. This cost reduction has to be paid by M/s J.K. Panthaki & Co., as commission in cash to Mr. A.P. Mehta and other family members for awarding the construction contract of M/s Karnataka Ball Bearings Ltd. The said commission is to be withdrawn from the books of account of M/s J.K. Panthaki & Co., during the financial years ended 31st March, 1983 and 31st March, 1984. The time, mode, quantum and place of remittance are left to be decided by Mr. J.K. Panthaki and Mr. A.P. Mehta on behalf of other partners. Remittance is in the following manner : Mr. A.P. Mehta, Rs. 13.80 lakhs; Mr. Jayaraj A. Mehta, Rs. 12.85 lakhs; Mrs. Prabhavathi A. Mehta, Rs. 7.15 lakhs; Mrs. Susheela J. Mehta, Rs. 9.75 lakhs and Miss Raksha A. Mehta, Rs. 4.45 lakhs. Thus there is a first oral agreement confirmed by minutes dt. 2nd Jan., 1987.
5. The appellate authority after carefully considering the case of the assessee and scrutinizing the documents produced upheld the order of the ITO in disallowing the deduction of the said commission paid. Aggrieved by the same, the assessee preferred the appeal to the Tribunal. The Tribunal on reappreciation of the entire material on record, after referring to the judgments relied on, held the payment of this nature even if it is disclosed in their accounts cannot be allowed. The payer induces the other party to deceive the shareholders. The other party is a public limited company. Even if it is treated as not an offence as such, within the meaning of the section, it clearly falls within the meaning of expenditure incurred, which is prohibited by law. The directors of the company are holding the post in trust. By making the payment, the payer induces the directors its shareholders. This amounts to an abatement of not only an unethical business practice but also amounts to abetting to commit a breach of trust by the directors of the recipient company which is clearly an offence prohibited by law. The directors are holding the post in trust with regard to its shareholders (sic). Therefore, it dismissed the appeal. Aggrieved by these orders, the assessee is before this Court.
6. Sri Uday Holla, learned senior counsel appearing for the assessee contended that the Explanation added to s. 37 clearly defines what are the expenditures incurred by the assessee which are not permitted to be deducted under s. 37 of the Act. It is only the expenditure incurred by the assessee for any purpose which is an offence or it is prohibited by law could be disallowed. If the expenditure incurred does not fall under the aforesaid two categories, even if it is illegal or immoral, the assessee is entitled to the deduction. The authorities and the Courts have to look into the aspect from the angle of the assessee and has to decide as to whether it is an expenditure incurred on account of commercial expediency. In support of his contention, he relied on several judgments of various High Courts and apex Court and contended that, even if the payment is held to be not moral the assessee could not be denied the benefit conferred to him under law. Therefore, he submits that the authorities committed serious error in disallowing the deduction claimed.
7. The entire case of the assessee is to the effect that in order to procure the contract he has paid the amount claimed as deduction as commission. It is an expenditure incurred in the course of carrying on business and the person to whom the commission is paid, has declared the same in his return and paid income-tax and therefore, it is an expenditure under s. 37 of the Act and he is entitled to deduction.
Sec. 37 of the Act reads as under :
“37. General.- (1) Any expenditure (not being expenditure of the nature described in ss. 30 to 36 and not being in the nature of capital expenditure or personal expenses of the assessee), laid out or expended wholly and exclusively for the purposes of the business or profession shall be allowed in computing the income chargeable under the head ‘Profits and gains of business or profession’.
Explanation.- For the removal of doubts, it is hereby declared that any expenditure incurred by an assessee for any purpose which is an offence or which is prohibited by law shall not be deemed to have been incurred for the purpose of business or profession and no deduction or allowance shall be made in respect of such expenditure.
(2B) Notwithstanding anything contained in sub-s. (1), no allowance shall be made in respect of expenditure incurred by an assessee on advertisement in any souvenir, brochure tract, pamphlet or the like published by a political party.”
8. The apex Court in the case of Indian Molasses Co. (P.) Ltd. v. CIT [1959] 37 ITR 66, dealing with the principles for allowance or expenditure, held as under :
“But there is no case directly on what is ‘expenditure’, and if the authorities under the English statute were to be of real assistance, the whole of the matter should have been before us. The question, however, limits the approach to whether the payments made towards the policy were ‘expenditure’ within cl. (xv). ‘Expenditure’ is equal to ‘expense’ and ‘expense’ is money laid out by calculation and intention though in many uses of the word this element may not be present, as when we speak of a joke at another’s expense. But the idea of ‘spending’ in the sense of ‘paying out or away’ money is the primary meaning and it is with that meaning that we are concerned. ‘Expenditure’ is thus what is ‘paid out or away’ and is something which is gone irretrievably.
To be an allowance within cl. (xv), the money paid out or away must be (a) paid out wholly and exclusively for the purpose of the business and further (b) must not be (i) capital expenditure, (ii) personal expense or (iii) an allowance of the character described in cls. (i) to (xiv). But whatever the character of the expenditure, it must be a paying out or away, and we are not concerned with the other qualifying aspects of such expenditure stated in the clause either affirmatively or negatively.”
9. “Expenditure” is equal to “expense” and “expense” is money laid out by calculation and intention. But the idea of “spending” in the sense of “paying out or away” money is the primary meaning. “Expenditure” is thus what is “paid out or away” and is something which is gone irretrievably. To be an allowance within cl. (xv), the money paid out or away must be (a) paid out wholly and exclusively for the purpose of the business and further (b) must not be (i) capital expenditure, (ii) personal expense or (iii) an allowance of the character described in cls. (i) to (xiv). But whatever the character of the expenditure, it must be a paying out or away. It is not enough that the disbursements are made in the course of or arise out of or are concerned with or made out of the profits of the business, but they must also be for the purpose of earning the profits of the business. It must be a commercial loss and in its nature must be contemplable as such. The mere fact that the assessee establishes the existence of an agreement between him and his agents and the fact of actual payment, the discretion of the ITO to consider whether the expenditure was made exclusively for the purpose of the business is not taken away.
10. The expenditure incurred must be for commercial expediency. In applying the test of commercial expediency for determining whether an expenditure was wholly and exclusively laid out for the purpose of the business, reasonableness of the expenditure has to be adjudged from the point of view of the businessman and not of the Revenue. The expression “commercial expediency” is an expression of wide import and includes such expenditure as a prudent businessman incurs for the purpose of business. The expenditure may not have been incurred under any legal obligation, but yet it is allowable as a business expenditure, if it was incurred on grounds of commercial expediency.
11. The apex Court in the case of S.A. Builders Ltd. v. CIT(Appeals) [2007] 288 ITR 1/158 Taxman 74 held at para 26 as under :
“The expression ‘commercial expediency’ is an expression of wide import and includes such expenditure as a prudent businessman incurs for the purpose of business. The expenditure may not have been incurred under any legal obligation but yet it is allowable as a business expenditure if it was incurred on grounds of commercial expediency.”
12. The Supreme Court in the case of Aluminium Corporation of India Ltd. v. CIT [1972] 86 ITR 11 held as under :
“It is true that under s. 10(2)(xv), it is for the ITO to decide whether any remuneration paid by an assessee to his selling agents was wholly or exclusively expended for the purpose of his business. It is also true that by the mere fact that the assessee establishes the existence of an agreement between him and his agents and the fact of actual payment, the discretion of the ITO to consider whether the expenditure was made exclusively for the purpose of the business is not taken away. The expenditure incurred must be for commercial expediency. In applying the test of commercial expediency for determining whether an expenditure was wholly and exclusively laid out for the purpose of the business, reasonableness of the expenditure has to be adjudged from the point of view of the businessman and not of the Revenue.
It is, of course, open to the Tribunal to come to a conclusion either that the alleged payment is not real or that it is not incurred by the assessee in the character of a trader or it is not laid out wholly and exclusively for the purpose of the business of the assessee and to disallow it.”
13. The Supreme Court in the case of J.K. Woollen Mfg. v. CIT [1969] 72 ITR 612 at p. 616 held as under :
“The question as to whether an amount claimed as expenditure was laid out or expended wholly or exclusively for the purpose of business, profession or vocation as required under s. 10(2)(xv) of the IT Act has to be decided on the facts and in the light of the circumstances of each particular case. The final conclusion on the admissibility of an allowance is one of law.”
14. The word ‘commission’ is not defined in the IT Act. However, it is useful to refer to the meaning assigned to the said word in the Law Lexicon, P. Ramanatha Aiyar as under :
“In commercial law, commission is a compensation to a factor or other agent for services to be rendered in making a sale or otherwise; a sum allowed as compensation to a servant, factor or agent who manages the affairs of others, in recompense for his services. It is an allowance, recompense or reward made to agents, factors, brokers and others for effecting sales or carrying out business transactions. It is generally calculated as a certain percentage on the amount of the transaction or on the profit to the principal.”
15. In Black’s Law Dictionary, 6th Edition, the word ‘commission’ has been defined as under :
“The recompense, compensation or reward of an agent, salesman, executor, trustee, receiver, factor, broker, or bailee, when the same is calculated, as a percentage on the amount of his transactions or on the profit to the principal.”
16. The word ‘commission’ is used occasionally to mean ‘discount’. What is called ‘commission’, is a percentage deducted in the case of goods which are consigned the ordinary invoice price. It is in the nature of compensation paid to a person who has rendered service instead of paying remuneration. He has been paid compensation on percentage basis or on a price basis. The word “commission” has somewhat different connotation and is used differently in different contexts.
17. It is well settled principle that exigibility of an item to tax or tax deduction can hardly be made to depend on the label given to it by the parties. At the same time, the absence of a specific label cannot be destructive of the right of an assessee to claim a deduction, if in fact, the consideration for the receipts can be attributed to the sources indicated in the section. In fact the Supreme Court in the case of Continental Construction Ltd. v. CIT [1992] 195 ITR 81/60 Taxman 429 at para No. 30 held as under :
“It is well settled principle that exigibility of an item to tax or tax deduction can hardly be made to depend on the label given to it by the parties. An assessee cannot claim deduction under s. 80-O in respect of certain receipts merely on the basis that they are described as royalty, fee or commission in the contract between the parties. By the same token, the absence of a specific label cannot be destructive of the right of an assessee to claim a deduction, if in fact, the consideration for the receipts can be attributed to the sources indicated in the section.”
18. In the instant case, the commission said to have been paid is not a compensation to the directors of the company for any service rendered to the assessee. From the aforesaid undisputed tacts it is clear that a higher amount was agreed to be paid for performing the contract. Subsequently, the consideration for the contract was reduced. However, before the said re-deduction in cost, the assessee had been paid the entire cost of the contract. If the construction cost was reduced the excess amount received had to be returned. The assessee should have returned the said money to the person who paid it i.e., the company. Therefore, payment by the assessee is of an amount legally liable to be returned to the company. Instead of returning to the company, same may be taken as returned to directors for/on behalf of the company. Therefore, in law, the assessee was legally bound to restore the difference in price to the person who paid the said amount. Sec. 72 of the Contract Act, 1872 categorically states that person to whom money has been paid by mistake must repay or return it. Doctrine of unjust enrichment is attracted. Therefore what is repaid by the assessee cannot be construed as commission at all, as contended by him. It is a case of return of the advantage which he obtained under the contract, to the person who is lawfully entitled to the same. Instead of restoring the advantage to the company which paid him the amount, he has repaid the said amount to the directors of the company. The said payment is not made for any services rendered by them. Therefore, the said amount cannot be construed as commission or expenditure incurred under s. 37 of the Act so as to be eligible for being deducted in arriving at income of the assessee under the head ‘Profits and gains of business or profession’, because it is not an expenditure laid down or expended fully and exclusively for the purpose of business.
19. Yet another way of looking at things is, there is a clear case of collusion between the directors of the company and the assessee. In the tender which is floated, they have submitted prices which are higher than the normal price. Accordingly payment is made. After awarding the contract, they have reduced the price and agreed to receive the difference of price in their name. The assessee has obliged them. It is obvious that it is a kick back or bribe. It. is an illegal gratification. It is a scheme adopted to siphon out the money belonging to the company. They want to lend respectability to it by calling it as a ‘commission’. Therefore, seen from any angle, it cannot be construed as an expenditure at all, let alone commission.
20. Relying on the Explanation to s. 37, it was contended that, unless the said expenditure is an offence or prohibited by law, as admittedly, the assessee had paid that money in connection with getting contract, it is eligible for deduction. In support of that contention learned counsel relied on following judgments.
21. The apex Court in the case of Mysore Minerals Ltd. v. CIT [1999] 239 ITR 775/106 Taxman 166, at para 4 held as under :
“Sec. 32 of the IT Act confers a benefit on the assessee. The provision should be so interpreted and the words used therein should be assigned such meaning as would enable the assessee to secure the benefit intended to be given by the legislature to the assessee. It is also well settled that where there are two possible interpretations of a taxing provision the one which is favourable to the assessee should be preferred.”
22. In the case of A.V. Fernandez v. State of Kerala AIR 1957 SC 657, dealing with the interpretation of statutes and fiscal enactments, the apex Court has held at para 29 as under :
“It is no doubt true that in construing fiscal statutes and in determining the liability of a subject to tax. one must have regard to the strict letter of the law and not merely to the spirit of the statute or the substance of the law. If the Revenue satisfies the Court that the case falls strictly within the provisions of the law, the subject can be taxed. If on the other hand, the case is not covered within the four corners of the provisions of the taxing statute, no tax can be imposed by inference or by analogy or by trying to probe into the intentions of the legislature and by considering what was the substance of the matter. We must of necessity therefore, have regard to the actual provisions of the Act and the rules made thereunder before we can come to the conclusion that the appellant was liable to assessment as contended by the sales-tax authorities.”
23. Reliance was placed on the judgment of the Madras High Court in the case of CIT v. Coimbatore Salem Transport (P.) Ltd. [1966] 61 ITR 480, wherein, the Madras High Court dealing with the question as to whether the payments of tips or presents and mamools are illegal or allowable deduction, has held as under :
“It upheld the order of the Tribunal which has held that the expenditure was inevitable if the assessee had to run its business that they were ‘greases to run the bus business smoothly’ and since in the very nature of the expenditure there could be no documentary evidence, the amounts claimed to have been expended were reasonable having regard to the large collection and. the income returned and hence allowable. With regard to the resolution allowing the manager and cashier to receive the commissions or rebates and sale proceeds of tyres, the Tribunal interpreted the resolution as one enhancing the salary of the manager and cashier. Though tips may be improper, they were not illegal and in view of the finding of the Tribunal that the expenditure sought to be deducted was inevitable if the assessee had to carry on its business and did not pertain to anything illegal or improper, the Tribunal was right in allowing the deduction.”
24. In the case of Raj Woollen Industries v. CIT [1961] 43 ITR 36 (Punj & Har.), the Punjab High Court held that, as the amount sought to be deducted as an expenditure was incurred to achieve what was prohibited by law and to carry out the business unlawfully, the assessee there was not entitled to deduction of the amount under s. 12(2)(xv) of the Act. The Court observed as under:
“The true position appears to be that where the expenses which are claimed as deductions have a direct and proximate connection with an act which is an infringement of law or is a contravention of it, they have not been allowed or regarded as deductions which can be granted under the IT law.”
25. In the case of CIT v. Haji Aziz & Abdul Sakoor Bros. [1955] 28 ITR 266 (Bom.), Chagla C.J., has opined as under :
“if an assessee spends money in order to carry out the business unlawfully, he cannot be held entitled to deduction under s. 10(2)(xv).”
26. The Madras High Court in the case of M.M.S.T. Chidambaram Chettiar v. Shanmugham Pillai AIR 1938 Mad. 129 held as under :
“In the world of business, things are often done which are betrayals of confidence and deceptions which arouse moral indignation, but are nevertheless civil wrongs which can be righted by Civil Courts and are not crimes which can be punished by a Criminal Court. Not every immoral act is criminal and it is an abuse of the process of a Court to attempt to create a new crime in order to compel men to conform to a high standard of probity in business dealings or to force them to execute their promises”
27. The apex Court in the case of Dr. T.A. Quereshi v. CIT [2006] 287 ITR 547/157 Taxman 514 at para 16 has observed as under :
“In our opinion, the High Court has adopted an emotional and moral approach rather than a legal approach. We fully agree with the High Court that the assessee was committing a highly immoral act in illegally manufacturing and selling heroin. However, cases are to be decided by the Court on legal principles and not on one’s own moral views. Law is different from morality, as the positivist jurists Bentham and Austin pointed out.”
28. Dr. T.A. Quereshi, the assessee claims that since the heroin seized from him forms part of his stock-in-trade hence its loss on account of seizure is an allowable deduction while computing his profits and gains of business/profession. The High Court wrongly applied s. 37 to the facts of the said case and the deduction was not allowed. It is in that context, the Supreme Court held that the High Court has adopted emotional and moral approach rather than a legal approach. In fact, in para 18 of the said judgment, the Supreme Court has categorically stated that Explanation to s. 37 has really nothing to do with the present case as it is not a case of business expenditure, but of business loss. Business losses are allowable on ordinary commercial principles in computing profits. Therefore the said judgment has no application to the facts of the case as in the instant case, the assessee is not claiming deduction as business loss, he is claiming deduction as business expenditure, which is not permissible in law.
29. It is true that cases are to be decided by the Court on legal principles and not on one’s own moral views. Law is different from morality. The provision should be so interpreted and the words used therein should be assigned such meaning as would enable the assessee to secure the benefit intended to be given by the legislature to the assessee. It is also well settled that where there are two possible interpretations of a taxing provision the one which is favourable to the assessee should be preferred. It is no doubt true that in construing fiscal statutes and in determining the liability of a subject to tax, one must have regard to the strict letter of the law and not merely to the spirit of the statute or the substance of the law. If the Revenue satisfies the Court that the case falls strictly within the provisions of the law, the subject can be taxed. If, on the other hand, the case is not covered within the four corners of the provisions of the taxing statute, no tax can be imposed by inference or by analogy or by trying to probe into the intentions of the legislature and by considering what was the substance of the matter.
However, the Indian Courts have consistently held that payments tainted with illegality cannot be treated as money spent wholly and exclusively for the purpose of business.
30. The Supreme Court in the case of Mannaial Khetan v. Kedar Nath Khetan [1977] 2 SCC 424 has held as under :
“19. Where a contract, express or implied, is expressly or by implication forbidden by statute, no Court will lend its assistance to give it effect. …A distinction is sometimes made between contracts entered into with the object of committing an illegal act and contracts expressly or impliedly prohibited by statute. The distinction is that in the former class one has only to look and see what acts the statute prohibits; it does not matter whether or not it prohibits a contract; In the latter class, one has to consider not what act the statute prohibits, but what contracts it prohibits.
22. Penalties are imposed by statute for two distinct purposes : (1) for the protection of the public against fraud, or for some other object of public policy; (2) for the purpose of securing certain sources of revenue either to the State or to certain public bodies. If it is clear that a penalty is imposed by statute for the purpose of preventing something from being done on some ground of public policy, the thing prohibited, if done will be treated as void, even though the penalty if imposed is not enforceable.”
31. The Delhi High Court in the case of Veerendra Singh v. Laxmi Narain AIR [2007] NOC 2039 (Delhi) has held as under :
“11. The doctrine or rule of pari delicto is the embodiment of the principle that the Courts will refuse to enforce an illegal agreement at the instance of a person who is himself a party to an illegality or fraud. As per Blacks’ Law Dictionary (Fifth Edition), the maxim—Pari delicto portior est conditio possidentis (defendentis)—means :
‘in a case of equal or mutual fault (between two parties) the condition of the party in possession (or defending) is the better one. Where each party is equally in fault the law favours him who is actually in possession. Where the fault is mutual the law will leave the case as it finds it.’
In Herbert Broom’s “A Selection of Legal Maxims” (10th Edition) the maxim is explained as follows :
‘The maxim, in pari delicto portior est conditio possidentis, is as thoroughly settled as any proposition of law can be. It is a maxim of law, established not for the benefit of plaintiffs or defendants, but is founded on the principles of public policy, which will not assist a plaintiff who has paid over money, or handed over property, in pursuance of an illegal or immoral contract, to recover it back; ‘for the Courts will not assist an illegal transaction in any respect’. The maxim is therefore, intimately connected with the more comprehensive rule of our law, ex turpi causa non oritur actio, on account of which no Court will ‘allow itself to be made the instrument of enforcing obligations alleged to arise out of a contract or transaction which is illegal’, and the maxim may be said to be a branch of that comprehensive rule; for the well-established test, for determining whether the money or property which has been parted with in connection with an illegal transaction can be recovered in a Court of justice, is to ascertain whether the plaintiff in support of his case, or as part of his cause of action, necessarily relies upon the illegal transaction; if he ‘requires aid from the illegal transaction to establish his case,’ the Court will not entertain his claim’.”
32. The Supreme Court in the case of Haji Aziz & Abdul Shakoor Bros. v. CIT [1961] 41 ITR 350 has held as under :
“A review of these cases shows that expenses which are permitted as deductions are such as are made for the purpose of carrying on the business, i.e., to enable a person to carry on and earn profit in that business. It is not enough that the disbursements are made in the course of or arise out of or are concerned with or made out of the profits of the business but they must also be for the purpose of earning the profits of the business. As was pointed out in Von Glehn’s case (supra) an expenditure is not deductible unless it is a commercial loss in trade and a penalty imposed for breach of the law during the course of trade cannot be described as such. If a sum is paid by an assessee conducting his business, because in conducting it he has acted in a manner which had rendered him liable to penalty, it cannot be claimed as a deductible expense. It must “be a commercial loss and in its nature must be contemplable as such. Such penalties which are incurred by an assessee in proceedings launched against him for an infraction of the law cannot be called commercial losses incurred by an assessee in carrying on his business. Infraction of the law is not a normal incident of business and, therefore, only such disbursements can be deducted as are really incidental to the business itself. They cannot be deducted if they fall on the assessee in some character other than that of a trader. Therefore, where a penalty is incurred for the contravention of any specific statutory provision, it cannot be said to be a commercial loss failing on the assessee as a trader the test being that the expenses which are for the purpose of enabling a person to carry on trade for making profits in the business are permitted but not if they are merely connected with the business.
9. It was argued that unless the penally is of a nature which is personal to the assessee and if it is merely ordered against the goods imported it is an allowable deduction. That, in our opinion, is an erroneous distinction because disbursement is deductible only if it falls within s. 10(2)(xv) of the IT Act and no such deduction can be made unless it falls within the test laid down in the cases discussed above and it can be said to be expenditure wholly and exclusively laid for the purpose of the business. Can it be said that a penalty paid for an infraction of the law, even though it may involve no personal liability in the sense of a fine imposed for an offence committed, is wholly and exclusively laid for the business in the sense as those words are used in the cases that have been discussed above. In our opinion no expense which is paid by way of penalty for a breach of the law can be said to be an amount wholly and exclusively laid for the purpose of the business. The distinction sought to be drawn between a personal liability and a liability of the kind now before us is not sustainable because anything done which is an infraction of the law and is visited with a penalty cannot on grounds of public policy be said to be a commercial expense for the purpose of a business or a disbursement made for the purposes of earning the profits of such business.”
33. The Supreme Court in the case of CIT v. S.C. Kothari [1971] 82 ITR 794, has held as under :
“3. So far as the first question is concerned we are unable to comprehend why the High Court did not decide it. A lot of debate took place before us on the question whether the contravention of s. 15(4) of the Act would render the contracts illegal. According to that provision no member of a recognised association shall, in respect of any goods specified in the notification under sub-s. (1), enter into any contract on his own account with any person other than a member of the recognised association unless he has secured the consent or authority of such person and disclosed in the note, memorandum or agreement of sale or purchase that he has bought or sold the goods as the case may be on his own account. It is not necessary to refer to the proviso. It is common ground and has been admitted before us that there was a clear contravention of the provisions of s. 15(4) so far as the transactions in question were concerned. According to s. 20(a) any person who enters into any contract in contravention of the provisions of s. 15(4) among other sections shall, on conviction, be punishable for the first offence with imprisonment which may extend to one year or with fine of not less than Rs. 1,000 or with both. It is wholly incomprehensible how such a contract would not fall directly within the ambit of the first part of s. 23 of the Indian Contract Act which deals with consideration or object of an agreement which is forbidden by law. Such consideration or object would be unlawful according to the provisions of that section and the agreement would consequently be void. The High Court did not decide the point whether the contracts which contravened the provisions of s. 15(4) of the Act were illegal. It did not consider it material to decide whether the impugned contracts were illegal. In its opinion what was material was that the impugned contracts had been entered into unlawfully and the question was whether the loss sustained in the unlawful business could be taken into account in computing the business income of the assessee. We consider that the first question which was referred to the High Court stands concluded by the law laid down by this Court in Sunder Lal & Son v. Bharat Handicrafts (P) Ltd. [1968] 1 SCR 608/AIR 1968 SC 406. It was laid down that the prohibition imposed by s. 15(4) of the Act was not imposed in the interest of Revenue. That provision was conceived in the larger interest of the public to protect them against the malpractices indulged in by members of recognised associations in respect of transactions in which their duties as agents came into conflict with their personal interest. Parliament had made a writing, evidencing or confirming the consent or authority of a non-member, as a condition of the contract if the member had entered into a contract on his own account. So long as there was no writing as was contemplated by s. 15(4) or its proviso there was no enforceable contract.
4. It is well settled that contracts which are prohibited by statute, the prohibition being either express or implied would be illegal and unenforceable if they are entered into in contravention of the statute. Under the provisions of the Act there is not only an express prohibition [s. 15(4)] but punishment is also provided for contravention of that prohibition (s. 20). Such contracts could not possibly be regarded as having been validly entered into under the Act. The answer to the first question, therefore, should have been in the affirmative and against the assessee.
9. The approach of the High Court, in the present case, has been that in order to arrive at the figure of profits even of an illegal business the loss must be deducted if it has actually been incurred in the carrying on of that business. It is the net profit after deducting the out goings that can be brought to tax. It certainly seems to have been held and that view has not been shown to be incorrect that so far as the admissible deductions under s. 10(2) are concerned they cannot be claimed by the assessee if such expenses have been incurred in either payment of a penalty for infraction of law or the execution of some illegal activity. This, however, is based on the principle that an expenditure is not deductible unless it is a commercial loss in trade and a penalty imposed for breach of the law during the course of the trade cannot be described as such. Penalties which are incurred for infraction of the law are not a normal incident of business and they fall on the assessee in some character other than that of a trader [See Haji Aziz & Abdul Shakoor Bros. v. CIT [1961] 41 ITR 350 (SC)/[1961] 1 SCR 651]. In that case this Court said quite clearly that a disbursement is deductible only if it falls within s. 10(2)(xv) of the Act of 1922, and a penalty cannot be regarded as an expenditure wholly and. exclusively laid for the purpose of the business. Moreover, disbursement or expenses of a trader is something ‘which comes out of his pocket. A loss is something different. That is not a thing which he expends or disburses. That is a thing which comes upon him ab extra’ [Finlay, J. in Allen v. Farquharson Brothers & Co. [1932] 17 Tax Cases 59 (KB)]. If the business is illegal neither the profits earned nor the losses incurred would be enforceable in law. But, that does not take the profits out of the taxing statute. Similarly, the taint of illegality of the business cannot detract from the losses being taken into account for computation of the amount which can be subjected to tax as ‘profits’ under s. 10(1) of the Act of 1922. The tax collector cannot be heard to say that he will bring the gross receipts to tax. He can only tax profits of a trade or business. That cannot be done without deducting the losses and the legitimate expenses of the business. We concur in the view of the High Court that for the purpose of s. 10(1) the losses which have actually been incurred in carrying on a particular illegal business must be deducted before the true figure relating to profits which have to be brought to tax can be computed or determined. This will, however, not conclude the answer to question No. 2 because it seems to have been framed with the other aspect relating to ‘set off’ under s. 24 of the Act.”
34. The High Court of Andhra Pradesh in the case of CIT v. Maddi Venkataratnam & Co. (P) Ltd. [1983] 144 ITR 373/14 Taxman 42 (AP) has held as under :
“8. A careful reading of this passage leaves no one in doubt about the distinction between an infraction of the law committed in the carrying on of a lawful business, and an infraction of the law committed in a business inherently unlawful, and constituting a normal incident of it.”
35. The Explanation to s. 37 declares that any expenditure incurred by an assessee for any purpose which is an offence or which is prohibited by law shall not be deemed to have been incurred for the purpose of business or profession and no deduction or allowance shall be made in respect of such expenditure.
36. The word ‘offence’ has not been defined under the Act. However Chapter XXII deals with offences and prosecutions. It refers to various sections under the Act and non-compliance with those provisions are punishable with punishment as prescribed therein. Willful attempt to evade tax is an offence under the Act. The word ‘offence’ has to be understood in the context of an offence generally under any Act. It follows that if the assessee commits an offence under any law in the course of his business and incurs expenditure for any purpose in connection with the said offence, the said amount is not deductible under s. 37 of the Act. No expense which is paid by way of penalty for a breach of the law can be said to be an amount wholly and exclusively laid for the purpose of the business. Anything done which is an infraction of the law and is visited with a penalty cannot on grounds of public policy be said to be a commercial expense for the purpose of a business or a disbursement made for the purposes of earning the profits of such business. Penalties which are incurred for infraction of the law are not a normal incident of business and they fall on the assessee in some character other than that of a trader. A penalty cannot be regarded as an expenditure wholly and exclusively laid for the purpose of the business.
37. If the business is illegal neither the profits earned nor the losses incurred would be enforceable in law. But, that does not take the profits out of the taxing statute. Similarly, the taint of illegality of the business cannot detract from the losses being taken into account for computation of the amount which can be subjected to tax as “profits”. Only profits of a trade or business can be taxed. That cannot be done without deducting the losses and the legitimate expenses of the business. The losses which have actually been incurred in carrying on a particular illegal business must be deducted before the true figure relating to profits which have to be brought to tax can be computed or determined. The distinction between an infraction of the law committed in the carrying on of a lawful business, and an infraction of the law committed in a business inherently unlawful, and constituting a normal incident of it, has to be kept in mind. Not every immoral act is criminal, it is an abuse of the process of a Court to attempt to create a new crime in order to compel men to conform to a high standard of probity in business dealings or to force them to execute their promises.
38. Infraction of the law is not a normal incident of business. Only such disbursements can be deducted as are really incidental to the business itself. They cannot be deducted if they fall on the assessee in some character other than that of a trader. It is well settled that contracts which are prohibited by statute, the prohibition being either express or implied, would be illegal and unenforceable if they are entered into in contravention of the statute. Where a contract is expressly or by implication forbidden by statute, no Court will lend its assistance to give effect to such contract. A distinction is sometimes made between contracts entered into with the object of committing an illegal act and contracts expressly or impliedly prohibited by statute. The distinction is that in the former class one has only to look and see what acts the statute prohibits; it does not matter whether or not it prohibits a contract. In the latter class, one has to consider not what act the statute prohibits, but what contracts it prohibits. Any agreement which tends to be injurious to the public or against the public good is invalidated on the ground of public policy. The question whether a particular agreement is contrary to public policy is a question of law, to be determined like any other question of law by the proper application of legal principles and prior decisions.
39. It was next contended that if what is paid by way of commission is held to be bribe, it is only receipt of bribe or payment of bribe to a public servant which is an offence. It is not an offence if paid or received by a person other than public servant, and therefore it does not fall within the mischief of the Explanation to s. 37. This argument proceeds on the basis that the assessee has paid the bribe under an agreement to a private person. It is not an offence under any law and also that there is no law prohibiting payment of bribe.
40. Sec. 23 of the Indian Contract Act declares what considerations and objects are lawful and what not. It reads as under :
“23. What considerations and objects are lawful, and. what not.—The consideration or object of an agreement is lawful, unless—
it is forbidden by law, or
is of such a nature that, if permitted, it would defeat the provisions of any law, or
is fraudulent; or
involves or implies injury to the person or property of another; or the Court regards it as immoral, or opposed to public policy.
In each of these cases, the consideration or object of an agreement is said to be unlawful. Every agreement of which the object or consideration is unlawful is void.”
41. Therefore, it is clear that, the consideration or object of an agreement is lawful unless the Court regards it as immoral or opposed to public policy. If the consideration or object of an agreement is unlawful, then the said agreement is void. Then the said agreement is not enforceable by law. Illustration (j) to s. 23, brings home the point explicitly, where it is stated as under :
“(j) A, who is B’s Mukhtar, promises to exercise his influence, as such, with B in favour of C and C promises to pay Rs. 1,000 to A. The agreement is void, because it is immoral.
42. Therefore, under the Indian law an agreement to pay illegal gratification is expressly declared as immoral and consequently such an agreement is void and not enforceable. It is not the Judge or the Court which is declaring such act as immoral. The law declares it as immoral. Though law is different from morality, in the case of illegal gratification payable under an agreement there is convergence of views. There are laws in the country expressly declaring payment of bribe and receipt of bribe by public servants as an offence and punishable under the criminal law of the country. The civil law has wider application and it declares that such payment of bribe is immoral and the agreement is void ab initio. In this context the phrase “prohibited by law” used in the Explanation to s. 37 of the Act, has wider connotation. It includes expenditure incurred by way of payment of bribe, although it is laid out or expended wholly or exclusively for the purpose of business. As the Indian laws declare such agreements as void, it is unenforceable.
43. The doctrine or rule of pari delicto is the embodiment of the principle that the Courts will refuse to enforce an illegal agreement at the instance of a person who is himself a party to an illegality or fraud. It is a maxim of law, established, not for the benefit of either of the parties to the litigation, but is founded on the principles of public policy, which will not assist a party who has paid over money, or handed over property, in pursuance of an illegal or immoral contract, to recover it back; for ‘the Courts will not assist an illegal transaction in any respect’. The maxim is therefore, intimately connected with the more comprehensive rule of law, ex turpi causa non oritur actio, on account of which no Court will allow itself to be made the instrument of enforcing obligations alleged to arise out of a contract or transaction which is illegal, and the maxim may be said to be a branch of that comprehensive rule. If he requires aid from the illegal transaction to establish his case, the Court will not entertain his claim.
44. In view of the express provision contained in s. 23 of the Contract Act, read with illustration (j) to section as stated above, the principles have been well crystallized over a period of time by the Courts in India. It is permissible for the Courts to expound and apply them to different situation.
45. In the aforesaid illustration at (j) an agreement of payment of money for exercising the influence is held to be immoral. In the present day context, the malady of corruption is entering into all the vital organs of the society and we have reached a situation where these illegal acts have been accepted as a normal practice and the attempt to prevent, let alone eradicate corruption, is beyond reach. If the Courts were to accord their approval to such transactions, that would be the end of the rule of law and amounts to upholding immoral actions by law Courts. Such an action gets credibility and respect and it will be perpetuated with the support of the Court orders. When receipt of bribe and payment of bribe by public servants is held to be an offence and the Parliament has passed legislation for preventing the same, merely because those laws are not applicable to private persons, it cannot be said that it is moral. Receiving or paying bribe is a crime. Persons indulging in the same cannot be protected by law Courts. The Courts cannot extend their aid to uphold such transactions. In that view of the matter, even if it is not an offence as contended certainly, it is immoral and it causes injury to public and therefore the expenditure incurred in such immoral acts cannot be construed as expenditure incurred for the purpose of profits and gains of business or profession and the benefit of deduction or allowance under the Parliamentary legislation cannot be extended to such persons or to such expenditure. Such a question would fall within the Explanation of s. 37 of the Act and is not deductible under s. 37 of the Act.
46. We do not find any merit in these appeals.
Accordingly, the appeals are dismissed.
[Citation : 344 ITR 329]
