JUDGMENT

R. S. PATHAK J. - This is a reference at the instance of an assessee u/s 66(1) of the Indian Income Tax Act.

The assessee is a registered firm carrying on contract business in the supply of dehydrated vegetable products to the Government. During the course of its business the assessee undertook a contract to supply onions and potatoes to the Government of India. The contract was executed with the Director General of Food, New Delhi, in 1943, for the supply of 100 tons of dehydrated onions by December 31, 1943. The contract contained a clause stipulating that, in the event of the assessee failing to deliver supplies in accordance with the terms of the contract, it would be liable to a penalty of 2 annas per pound on the quantity which it failed to deliver by the due date, unless it failure was due to reasons beyond its control. The assessee was able to supply only about 15 tons of onions by December 31, 1943. As the entire contract was not executed by it within the time stipulated, the Government cancelled the contract and imposed a penalty at the rate of one anna per pound on the balance remaining undelivered. Upon receiving this communication from the Government, the assessee applied to the Government to reconsider its decision and informed it that the required bulk of supplies as well as the facilities for supplying them had already been arranged. Upon this, it appears that the Government recalled it decision and extended the date for delivery of the supplies to August 31, 1944, upon condition, however, that the assessee paid liquidated damages at 2 per cent. These terms were accepted by the assessee, and it paid damages totaling Rs. 17,240, of which a sum of Rs. 13,517 was paid in the previous year relating to the assessment year 1945-46 and the balance of Rs. 3,723 was paid in the previous year relaying to the assessment year 1946-47.

In the assessment proceedings for the assessment years 1945-46 and 1946-47, the assessee claimed a deduction of the aforesaid sums of Rs. 13,517 and Rs. 3,723 respectively u/s 10(2)(xv) of the Act. This claim was disallowed by the Income Tax Officer, and an appeal filed by the assessee before the Appellate Assistant Commissioner was also unsuccessful. Thereafter, the case was carried to the Income Tax Appellate Tribunal, but the Tribunal took the view that, as the payment was made as a penalty for breach of contract, it did not fall for the consideration u/s 10(2)(xv).

Accordingly, the following question has been referred by the Tribunal :

"Whether, on the fact and in the circumstances of the case, the sums of Rs. 13,517 and Rs. 3,723 relating to the assessment years 1945-46 and 1946-47 respectively are permissible deductions u/s 10(2)(xv) of the Income Tax Act ?"

It is apparent from the facts that the Government had originally cancelled the contract and imposed a penalty for the failure of the assessee to supply the entire bulk o onions by December 31, 1943. Subsequently, however, the Government cancelled this order and by modification of the terms of the original contract enabled the assessee to fulfill the contract within an extended period. The Government stipulated, and the assessee agreed, that liquidated damages would be paid if the original contract was to be kept alive. In our view, the amount paid by way of liquidated damages was merely an amount paid by the assessee for the purpose of keeping the contract alive and was in reality a payment made for the purpose of enabling the assessee to completely execute the contract. It is not, as contended on behalf of the Commissioner, a payment made as damages for breach of contract. Had the Government maintained its original order canceling the contract and imposing a penalty, it may have been possible legitimately to contend that the payment made on account of such penalty was a payment made on account of a breach of contract. But it seems to us plain that the payment under consideration was made not as a penalty or as damages for the br