A penalty paid by an assessee for supplying sub-standard goods is an admissible deduction under Section 10 (1) of the Income Tax Act, 1922, if it is incidental to the assessee's business and the assessee had no dishonest or criminal intent.

BARMAN, C. J.

( 1 ) THIS matter arises out of a question referred by the Income-tax Appellate tribunal to this court under Section 66 (1) of the Indian Income-tax Act, 1922, for decision. The question referred is:

"whether on the facts and circumstances of the case, the amount of Rs. 25,700 paid by the assessee by way of penalty to the Government of orissa was an admissible deduction under Section 10 (1) of the Income-tax Act, 1922. "

This Court by its judgment dated January 22, 1963 while dealing with this question, considered the provisions of Section 10 (2) of the Income-tax Act and held that the deduction claimed by the assessee was not admissible as it amounted to a penalty imposed on the assessee for his dishonest action in supplying sub-standard quality goods and, as such, it could not be said to be in expenditure incurred wholly and exclusively for the purpose of his business.

( 2 ) THE facts and circumstances in which the question was referred to the High court are these. During the calendar year 1954, which was the year previous to the assessment year 1955-56, the opposite party (hereinafter referred to as the assessee) worked as the Paddy Procuring Agent under the Government of Orissa on the basis of an agreement entered into by him with the Government of Orissa. Under that agreement the assessee was required to supply paddy and rice of certain standard quality known as Fair Average quality. The criterion for this Fair average quality was defined. There was a clause in the agreement that the quality of the foodgrains supplied must conform to the Fair Average quality standard and that the Collector may, subject to the approval of the Government of Orissa, levy such penalty as he may deem fit, for supply of food-grains not conforming to the fair Average Quality and as such penalty shall be deducted from the amount or amounts due to the Agent on pending or future bills submitted in accordance with clause 13 of the agreement. In exercise of this power, during the course of the accounting year in question, penalties amounting to Rupees 25,700/- were imposed on the assessee and were realised by deduction from the bills. The assessee claimed deduction of this amount on the assessable income under section 10 (1) of the Indian Income Tax Act. His claim was negatived by the income Tax Officer and the Appellate Assis- tant Commissioner, but was accepted by the Income Tax Appellate Tribunal. The Tribunal held that this amount of rupees 25,700/- deducted by the Government of Orissa from the bills of the assessee could not be taxed in view of Section 10 (1) of the Income Tax Act. Thereupon, the Commissioner of Income Tax asked for a reference to the High court and the Tribunal, under Section 66 (1) of the Act referred the aforesaid question for opinion to the High Court who answered the same in the negative and against the assessee, that is to say that the said sum of Rs. 25,700/- paid by way of penalty by the assessee to the Government of Orissa was not an admissible deduction.

( 3 ) THERE was an appeal from the said decision to the Supreme Court on a certificate granted by the High Court. The Supreme Court, by their judgment dated september 15, 1966, allowed the appeal and the case was sent back to this Court for answering the question referred to in the appeal on the aspect as explained in that judgment. That is how this reference has come back to this Court for hearing. The scope of the question which was referred to the High Court for decision has been explained by the Supreme Court. The material portion of the judgment explaining the aspect in which the High Court is called upon to answer the question is this:

"the High Court was actually required to answer the question whether this sum of Rs. 25,700/- which was paid by the assessee by way of penalty to the Government of Orissa was an admissible deduction under section 10 (1) of the Income Tax Act. The question was no doubt framed in rather unfortunate language, because Se