Damages incurred due to breach of contract may not qualify as allowable business expenditure under Section 10(2)(xii) of the Indian Income Tax Act if they are not incidental to the trade and are a result of conducting business in a dishonest manner.

Alfred Henry Lionel Leach, C.J.

1. The assessee in this case is a firm carrying on business in crackers. The assessee entered into a contract with other traders in the same line of business, under which the firms goods were to be sold at specified rates. In breach of this contract, the assessee sold crackers at lower rates, to the detriment of the other parties to the contract. Consequently, the other parties filed a suit in this Court to recover the damages which they had sustained by reason of the breach of contract on the part of the assessee. The Court found that the assessee was liable in damages and assessed the sum at Rs. 5,000. With costs, the total amount payable by the assessee came to Rs. 6,203. The assessee claimed to be entitled to deduct this as a business expenditure under Section 10(2)(xii) of the Indian Income Tax Act. This contention was rejected by the Income Tax Officer, but the Appellate Assistant Commissioner allowed it. The Income Tax Appellate Tribunal agreed with the Income Tax Officer. The assessee then asked the Tribunal to state a case for this Court, as it involved a question relating to the construction of the Act. This application was granted, and consequently the Tribunal has referred to this Court the following question:

Whether the sum of Rs. 6,203 being costs and damages incurred in connection with an action for breach of contract is not expenditure laid out or expended wholly and exclusively for purposes of the assessees business within the meaning of Section 10(2)(xii) of the Act?

2. Section 10(2)(xii) allows the deduction of any expenditure, 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 a business. In Inland Revenue Commissioners v. Warnes and Co. (1919) 2 K.B. 444 Rowlatt, J., said that a loss connected with or arising out of a trade must, at any rate, amount to something in the nature of a loss which is contemplable and in the nature of a commercial loss. In that case, the respondents who were oil exporters were sued for a penalty under the Customs Consolidation Act, 1876, Section 139, as extended by the Customs (War Powers) Act, 1915, Section 5, Sub-section (1), for breach of orders and proclamations relating to the requirements of the Board of Customs and Excise, with respect to a consignment of oil shipped by them to Norway. The result of the action was that the respondents were made to pay as a mitigated penalty the sum of 2,000 and costs, and the question was whether they were entitled to treat this as a loss connected with or arising out of the trade or business within Section 100, schedule (D) case 1 Rule 3 of the Income Tax Act, 1842, and it was held that they were not.

3. The judgment of Rowlatt, J., in that case was upheld by the Court of Appeal in Inland Revenue Commissioners v. Von Glehn (1920) 2 K.B. 553. There a penalty of 3,000 was imposed upon the appellants for the breach of orders and proclamations issued under the same statutory provisions, and they sought to deduct the amount from their profits as a loss connected with or arising out of their trade. It was held that they were not entitled to do so. In the course of his judgment, Lord Sterndale, M.R., said:

During the course of the trading this company committed a breach of the law. As I say, it has been agreed that they did not intend to do anything wrong in the sense that they were willingly and knowingly sending these goods to an enemy destination; but they committed a breach of the law, and for that breach of the law they were fined. That, as it seems to me, was not a loss connected with the business, but was a fine imposed upon the company personally, so far as the company can be considered to be a person, for a breach of the law which it had committed. It is perhaps a little difficult to put the distinction into very exact language, but there seems to me to be a difference between a commercial loss in trading