Interest on arrears of cess and purchase tax is an allowable deduction under Section 28(1) of the Income-tax Act, 1961.

R.L. Gulati, J.

1. This is a reference under Section 256(1) of the Income-tax Act, 1961. The reference relates to the assessment year 1963-64.

2. The assessee is a partnership firm owning two sugar factories--one at Bhatni in district Deoria and the other at Motinagar in district Faizabad. At the end of the relevant previous year the assessee made a provision in its books of accounts for the payment of a sum of Rs. 1,04,023 towards interest due on arrears of cess and purchase tax, an amount which the assessee had become liable to pay but had not paid during the relevant previous year. The sum of Rs. 1,04,023 is made up of two items, (i) Rs. 1,02,461 in respect of interest payable on arrears of cess, and (ii) Rs. 1,352 in respect of interest on arrears of purchase tax in respect of Bhatni Mills. The assessee claimed to deduct this amount from its profits liable to Income-tax. The claim was disallowed by the Income-tax Officer on the ground that the provision for interest represented a contingent liability only. The Appellate Assistant Commissioner of Income-tax did not agree with this view and held that the amount in question represented an accrued liability and, as such, was an allowable deduction. The department took the matter in appeal before the Income-tax Appellate Tribunal. Before the Tribunal, the view of the Appellate Assistant Commissioner that the amount represented an accrued liability was not challenged but the deduction of the amount was contested on another ground. It was urged that the assessee had become liable for payment of interest because it violated the provisions contained in Section 3(2) of the U. P. Sugarcane Cess Act, 1956, as validated by the U. P. Sugarcane (Validation) Act, 1961. Similarly, the interest on purchase tax had become payable because the assessee had contravened a similar provision of the Sugarcane Purchase Tax Act, 1961. The interest, therefore, was in the nature of penalty and could not be allowed as business expenditure. The Tribunal accepted the contention and in doing so relied upon a decision of the Supreme Court in the case of Haji Aziz and Abdul Shakoor Bros, v. Commissioner of Income-tax, [1961] 41 ITR 350 (SC) and a decision of the Delhi High Court in the case of Commissioner of Income-tax v. Mahalaxmi Sugar Mills Ltd., 1972 85 ITR 320 On this view the Tribunal allowed the department's appeal holding that the assessee v/as not entitled to deduct the amount of interest from its profits liable to tax. At the instance of the assessee, however, the Tribunal has referred the following question of law for our opinion :

"Whether the Income-tax Appellate Tribunal erred in holding that the assessee's claim for deduction of a sum of Rs. 1,04,023.43 being the payment made on account of interest as a result of violation of the provisions of Section 3(3) of the U. P. Sugarcane Cess Act, 1956, was not a business expenditure ?"

Before we proceed to answer the question, we must point out that the question as framed by the Tribunal is not happily worded and is also inaccurate. The entire sum of Rs. 1,04,023.43 is not the interest under the U. P. Sugarcane Cess Act but a part of it (Rs. 1,352) is under the U. P. Sugarcane Purchase Tax Act, 1961. Moreover, the interest has not been charged for violation of Section 3(3) of the Cess Act or of the Purchase Tax Act but it has been charged under Section 3(3) for the failure of the assessee to pay the tax in time as required by Section 3(2) of the two Acts. The more serious infirmity with which the question suffers is that it presumes that the deduction was claimed as business expenditure under Section 37 of the Income-tax Act. The assessee no doubt based its claim on that provision but it also claimed deduction in the alternative under Section 28(1) of the Income-tax Act. This is clear from the statement of the case annexed by the assessee to its application under Section 256(1), which has not been controverted by the department. This is what has