A payment of damages for breach of contract is not a speculative transaction under section 43(5) of the Income-tax Act, 1961.

1. - The Income-tax Appellate Tribunal, Jaipur Bench, Jaipur ("the Tribunal" herein), has referred the following question of law for the opinion of this court:

"Whether, on the facts and in the circumstances of the case, the Tribunal was right in holding that the loss of Rs. 42,000 claimed by the assessee was a trading loss and not a speculation loss ?"

2. The assessee is a partnership concern. The assessment year under consideration is 1974-75. The relevant previous year ended on March 31, 1974. In the previous year, the assessee derived income from adat and dealing on own account in wool. The assessee's income in commission account was Rs. 1,23,222. A gross profit of Rs. 8,431 was shown from the dealings on account of sale of Rs. 11,93,226. The Income-tax Officer at the time of the scrutiny noticed a payment of Rs. 42,000 to: (1) M/s. Minerva Hosiery Mill Pvt. Ltd., and (1) M/s. Swadeshi Manufacturing Syndicate Pvt. Ltd. The amount of Rs. 42,000 represented the amount paid as damages for non-performance of contracts which are said to have been orally entered into with the aforesaid parties for supply of wool tops. The details of the aforesaid oral contracts were supplied by the assessee to the Income-tax Officer. According to the contracts, the assessee had agreed to supply 30,000 kgs. of wool tops to M/s. Minerva Hosiery Mills Pvt. Ltd. and 22,000 kgs. of wool tops to M/s. Swadeshi Manufacturing Syndicate Pvt. Ltd. in December, 1972. The supply was to be made from December, 1972, to June, 1973, in 5 or 6 instalments at the fixed rate of Rs. 24.47 per kg. The assessee, in fact, supplied 2,753 kgs. to M/s. Minerva Hosiery Mills Pvt. Ltd. and 9,140 kgs. to M/s. Swadeshi Manufacturing Syndicate Pvt. Ltd., up to March, 1973. In April 1973, both the aforesaid parties were informed by the assessee that it will not be possible for it to supply the remaining contracted quantity. That gave rise to a dispute between the parties. The dispute, however, was amicably settled in March, 1974, and the compromise agreements were drawn up according to which the assessee paid a sum of Rs. 42,000 by cheque to the aforesaid two parties. The Income-tax Officer by his order dated November 30, 1976, disallowed the sum of Rs. 42,000 on the ground that it is not an allowable deduction under section 37 of the Income-tax Act, 1961 (" the Act " hereinafter). He also opined that the nature of the transactions appeared to be colourable in view of the fact that the profit and loss did not belong to the assessee but to the parties to whom goods were supplied by the assessee. He observed as under:

"Therefore, it is doubtful that the alleged claim of deduction represents compensation for failure for non-performance of a contract alleged to have been entered into between the assessee-firm and the Ludhiana parties.

Since the assessee-firm failed to establish that it had at all entered into agreement for supply of wool tops in such circumstances of the case and that the amount of Rs. 42,000 was paid for the purpose of earning profits of business of the firm, the deduction claimed under section 37 of the Income-tax Act, 1961, is not allowed."

3. In this connection, he relied on Swadeshi Cotton Mills Co. Ltd. v. Commissioner of Income Tax [1967] 63 ITR 65 (SC) . The assessee lodged an appeal and the Appellate Assistant Commissioner by his order dated July 12, 1977, found that the claim of damages is allowable as deduction under section 37(1) of the Act. He, therefore, allowed the claim of the assessee which was disallowed by the Income-tax Officer. He also granted certain other reliefs to the assessee with which we are not concerned in this reference.

4. The Income-tax Officer, "C" Ward, Bikaner, filed an appeal before the Tribunal contesting the allowance of Rs. 42,000 paid by the assessee to the two Ludhiana firms which were allowed by the Appellate Assistant Commissioner to be an allowable expenditure under section 37 of the Act. The assessee also filed a cro