Important Point
Evasion of law cannot be a trade pursuit, therefore, the expenditure incurred for evading the provisions of an Act and also the penalty levied for such evasion cannot be allowed as deduction under the Income Tax Act, as the expenditure cannot be held as wholly and exclusively laid out for the purpose of assessee’s business.

Headnote:Income Tax Act, 1961-Sections 28 and 40A(3)-Rule 6-DD(j) -Claim of deduction under-Assessee, engaged in tobacco business, indulged in transactions in violation of provisions of Foreign Exchange (Regulation) Act-Expenditure incurred for evading provisions of the Act and also penalty levied for such evasion-Whether can be allowed as deduction?-(No)-It was not enough that disbursement was made in course of trade-Purpose must be a lawful purpose-It will be against public policy to allow benefit of such a deduction.
       Held : The assessee was engaged in tobacco business. The assessee was expected to carry on the business in accordance with law. If the assessee contravenes the provisions of FERA to cut down its losses or to make larger profits while carrying on the business, it was only to be expected that proceedings will be taken against the assessee for violation of the Act. The expenditure incurred for evading the provisions of the Act and also the penalty levied for such evasion cannot be allowed as deduction. As was laid down by Lord Sterndale in the case of Alexander Von Glehn (supra) that it was not enough that the disbursement was made in the course of trade. It must be for the purpose of the trade. The purpose must be a lawful purpose. Moreover, it will be against public policy to allow the benefit of deduction under one statute of any expenditure incurred in violation of the provisions of another statute or any penalty imposed under another statute. In the instant case, if the deductions claimed are allowed the penal provisions of FERA will become meaningless. It has also to be borne in mind that evasion of law cannot be a trade pursuit. The expenditure in this case cannot, in any way, be allowed as wholly and exclusively laid out for the purpose of assessee’s business. (Paras 13, 14)
       Further held, where the entire business of the assessee is illegal and that income is sought to be taxed by the Income Tax Officer then the expenditure 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 reduce his loss, then the expenditure incurred for these unlawful activities cannot be allowed to be deducted. Even if the assessee had to pay fine or penalty because of an inadvertent infraction of law which did not involve any moral obliquity, the result will be the same. Even in such cases, deduction will not be permitted of the amounts paid as penalty or fine or of the value of the goods confiscated by the statutory authority as expenditure wholly and exclusively incurred for the purposes of carrying on the trade. It has been consistently held by the English Courts that fines or penalties payable for violation of law cannot be permitted as deduction under the Income Tax Act. That will be against public policy. Even though the need for making such payments arose out of trading operations, the payment were not wholly and exclusively for the purpose of the trade. One can carry on his trade without violating the law. In fact, Section 37 presumes that the trade will be carried on lawfully. The English Courts have consistently held that penalty or fine or money paid to compound an offence under another statute cannot be allowed as a deduction under the Income Tax Act. For the application of these principles, consideration of moral obliquity was quite immaterial. (Para 8)
       The Indian Courts have also consistently held that payments tainted with illegality cannot be treated as money spent wholly and exclusively for the purpose of business. (Para 10)

Judgment

Sen, J.-The Tribunal referred the following question of law to the Andhra Pradesh High Court under Section 256(1) of the Income Tax Act, 1961.

“1. Whether on the facts and in the circumstances of the case, a sum of Rs. 2,95,000/- has to be taken into account in computing the income of the assessee from business under the provisions of Section 28 of the Income Tax Act, 1961?

If the answer to the above question is in the negative-

Whether on the facts and in the circumstances of the case, the claim of Rs. 2,95,000/- is covered by sub-rule (j) of Rule 6-DD, framed under Section 40A(3) of the Income Tax Act, 1961?”

2. “Whether on the facts and in the circumstances of the case, the sum of Rs. 19,659/- incurred as quest-expenses is allowable as a deduction?”

2. The assessee, to start with, was a partnership consisting mostly of family members. In 1965, it was converted into a public limited company to carry on the business of export of tobacco. The first directors appointed at the time of incorporation were to hold office during their lifetime or until they resigned voluntarily.

3. On the basis of the information received, a search was conducted by the Enforcement Directorate in the assessee’s business premises. A number of letters and other documents were seized which disclosed that the assessee had indulged in transactions in violation of the provisions of Foreign Exchange (Regulation) Act (for short ‘FERA’). It was found that the assessee had remitted to a private party in Singapore in violation of law. Proceedings were taken against the assessee for infringement of Sections 4(2) and 5(1)(e) of FERA and ultimately a penalty of Rs. 35,000/- was imposed under Section 23 (1)(a) read with Section 23-C of the Act. The assessee in its income tax return for the assessment year 1970-71 claimed deduction of Rs. 2,95,000/- as business expenditure/loss. According to the assessee in course of carrying on of its business by the year 1968, it had accumulated 329.2 tonnes of sub-standard quality tobacco which it could not export over the last three years. Since the accumulated stock of tobacco was of sub-standard quality, it could not be sold at the floor price fixed by the Government of India for such tobacco. According to the assessee, it had no alternative but to sell the tobacco at a discount of 20 to a Singapore party. On paper, the full sale price was paid by the Singapore party, but in reality 20 of the price paid by the party was remitted back to him through one Shamsuddin. In pursuance of this agreement, tobacco was sold and the full floor price was received by the assessee from the Singapore party. The assessee paid a sum of Rs. 2,88,000/- to Shamsuddin who remitted the equivalent amount in Singapore currency to the Singapore party. Thus, according to the assessee, it had no alternative but to enter into such a transaction with a view to dispose of the said unsold stock of inferior quality of tobacco. In these facts of the case, it was claimed by the assessee that the amount of Rs. 2,88,000/- paid to Shamsuddin ought to be deducted as business expenditure or treated as business loss.

4. The Income Tax Officer however, disallowed the claim. According to him, payment was not genuine and it contravened the provisions of Section 40-A(3) of FERA. It was further held that the payment did not fall within any of the exceptions to Rule 6-DD. The Appellate Assistant Commissioner affirmed the order of Income Tax Officer. On further appeal, the Tribunal made the following findings :

(a) A sum of Rs. 2,95,000 was paid by the assessee-company to Shamsuddin which consisted of an amount payable to him for his services and also a sum of Rs. 2,88,000/- to be remitted to the Singapore party. The amount paid to Singapore party was difference of 20 of the floor price of tobacco fixed by the Government.

(b) The assessee was knowingly a party to the above transaction and it violated the

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