DEDUCTION FOR PENALTIES AND FINES UNDER THE MOTOR VEHICLES ACT, 1988

Explanation 1 to section 37(1) provides that no deduction or allowance shall be made in respect of an expenditure incurred for any purpose which is an offence or which is prohibited by law; such an expenditure shall not be deemed to have been incurred for the purposes of business and profession.

Explanation 1, inserted for removal of doubts with retrospective effect from 1st April, 1962, has been the subject matter of fierce litigation even before it was inserted by the Finance No. 2 Act, 1998. Disputes regularly arise about the true meaning of the terms ‘for any purpose which is an offence’ or ‘which is prohibited by law’ in deciding the allowance of an expenditure incurred. The courts have been disallowing expenditure incurred against the public policy or payments that were made for serious violation of law even before the insertion of Explanation 1. Issues also arise about the legislative intent of Explanation 1 and about the scope of Explanation 1; whether the Explanation has limited the law as it always was or whether it has expanded its scope, or has reiterated what was always there.

In the last few years, the legislatures, Central and State, have increased the fines and penalties many-fold for violation of traffic laws and with this enormous increase the issue of allowance or deduction of such payments has also attracted the attention of the taxpayers who hitherto never viewed these seriously. The issue has been considered on several occasions by the courts and is otherwise not new, but it requires consideration in view of the sizeable increase in the quantum of expenditure and the dexterous implementation of the new fines by the traffic authorities with vigour hitherto unknown in this vast country. The recent decision of the Kolkata Bench of the Tribunal holding that such an expenditure is not allowable as a deduction in contrast to many decisions regularly delivered for allowance of such payments, requires us to examine this conflict once more, mainly with the intention to recap the law on the subject and share some of our views on the same.

THE APARNA AGENCY LTD. CASE

In an appeal to the Tribunal, the assesse challenged the orders of the A.O. and the Commissioner (Appeals). It submitted that the payments were made to the traffic department for minor traffic violations committed by its delivery vans, and the payments were not against any proved violation or infraction of law but were made in settlement of contemplated governmental actions that could have led to charging the assessee with an offence. It submitted that the payment did not prove any guilt and was made with a view to avoid prolonged litigation, save time and litigation cost.

The assessee relied on the decision of the Madras High Court in CIT vs. Parthasarathy, 212 ITR 105 to contend that the payment that was compensatory in nature should be allowed as a deduction so long as the said payment was not found to be penal in nature.

The Tribunal examined the provision of the M.V. Act, 1988, and in particular the relevant sections concerning the offence and the levy of the fine, namely, sections 119, 122, 129 and 177. It noted that the term ‘offence’ though not defined under the Income-tax Act, 1961, was, however, defined exhaustively by section 3(38) of the General Clauses Act, 1887 to mean ‘any act or omission made punishable by any law for the time being in force’. It was also noted that even the expression ‘prohibited by law’ has not been defined in the I.T. Act. Under the circumstances, the Tribunal held that the expression should be viewed either as an act arising from a contract which was prohibited by statute or which was entered into with the object of committing an illegal act. The Tribunal quoted with approval the following paragraph of the decision of the Supreme Court in the case of Haji Aziz and Abdul Shakoor Bros. vs. CIT 41 ITR 350:

‘In our opinion, no expense which is paid by way of penalty for a breach of the law can be said to be an amount wholly and exclusively laid for the purpose of the business. The distinction sought to be drawn between a personal liability and a liability of the kind now before us is not sustainable because anything done which is an infraction of the law and is visited with a penalty cannot on grounds of public policy be said to be a commercial expense for the purpose of a business or a disbursement made for the purposes of earning the profits of such business’.

The Tribunal, on perusal of various statutory provisions of the M.V. Act under which the payments in question were made, for offences committed by the employees for which the assessee was vicariously liable, held that such payments were not compensatory in nature and could not be allowed as a deduction by upholding the order of the Commissioner (Appeals) to that extent.

BHARAT C. GANDHI’S CASE

A similar issue had arisen in the case of DCIT vs. Bharat C. Gandhi, 10 taxmann.com 256 (Mum). The assessee in the case was an individual and the proprietor of Darshan Roadlines which specialised in transporting cargo consignments of huge or massive dimensions where the weight and the size of the same exceeded the limits laid down under the M.V. Act and the rules thereunder. The assessee paid compounding fees aggregating to Rs. 73,45,953 to the RTO on various trips during the year for transportation of the massive consignments on its trailers by way of fines at the check-post at Bhachau, Gujarat on various trips during the year for Suzlon Energy Ltd. The A.O. disallowed the assessee’s claim in respect of the said payments, holding that it was in the nature of penalty and, thus, not allowable u/s 37(1). The Commissioner (Appeals), however, held that the expenditure was not in violation of the M.V. Act and the payments could not be termed as penalty. He further relied on the clarifications given by the Central Government vide letter dated 3rd August, 2008 and allowed the expenditure.

On Revenue’s appeal, the Departmental Representative submitted that the issue was not of nomenclature but the intention of the Legislature in not allowing the amounts paid for violation of law. It was further submitted that it was nowhere stated that the assessee satisfied the conditions of the Circular referred to by it before the Commissioner (Appeals). It was submitted that the payment was a penalty for violating the law and could not be allowed.

In reply, the assessee contended that the massive (or over-dimensioned) consignment was indivisible and could not be divided into parts and pieces and hence there was no other way to transport it except by exceeding the permitted limits. It was submitted that transportation in such a manner was a business necessity and commercial exigency and did not involve any deliberate intention of violating any law or rules. It was further submitted that even though it was a compounding fees paid u/s 86(5) of the M.V. Act to the RTO, it was an option given to the assessee and hence payment could not be referred to as a penalty. It was further submitted that such over-dimension charges were also paid to Western Railways for crossing the railway tracks and an amount of Rs. 2,71,380 was allowed by the A.O. It was highlighted that the Central Government vide letter dated 3rd August, 2008 had clarified that transport could take place on payment of the fines.

The assessee further referred to section 86(5) of the M.V. Act and relied on the precedents on the issue in the following cases:
(i) Chadha & Chadha Co. in IT Appeal No. 3524/Mum/2007
(ii) CIT vs. Ahmedabad Cotton Mfg. Co. Ltd. 205 ITR 163(SC)
(iii) CIT vs. N.M. Parthasarathy 212 ITR 105 (Mad)
(iv) ACIT vs. Vikas Chemicals 122 Taxman 59 (Delhi)
(v) CIT vs. Hero Cycles Ltd. 17 Taxman 484 (Punj. & Har.)
(vi) Kaira Can Co. Ltd. vs. Dy. CIT 32 DTR 485 (Mum-Trib)
(vii) Western Coalfields Ltd. vs. ACIT, 27 DTR 226 (Nag-Trib)

The Tribunal noted that the issue was elaborately discussed by the ITAT in the case of Chadha & Chadha Co., IT Appeal No. 6140/Mum/2009, dated 17th September, 2010 relied upon by the assessee wherein the ITAT in its order has considered as under:

‘9. The liability for additional freight charges was considered in the case of ITO vs. Ramesh Stone Wares by the ITAT Amritsar Bench in 62 TTJ (Asr.) 93 wherein the additional freight charges paid to Railway Department for overloading was considered and held that the expense was not penal in nature because it is not the infringement of law but same is violation of contract that too not by the assessee but by his agent, i.e., Coal Authority of India. In terms of an agreement, if coal is finally found by the authorities to be overloaded then the assessee has to pay additional freight charges which according to the terminology of the contract is called penalty freight. This liability was not considered as penal nature and allowed. In the assessee’s case also the overloading charges are to be incurred regularly in view of the nature of goods transported for the said steel company and since the nature of the goods is indivisible and generally more than the minimum limit prescribed under the Motor Vehicles Act, the assessee has to necessarily pay compounding charges for transporting goods as part of the business expenses. These are not in contravention of law and the RTO authorities neither seized the vehicle nor booked any offence but are generally collecting as a routine amount at the check-post itself while allowing the goods to be transported. In view of the nature of collection and payment which are necessary for transporting the goods in the business of the assessee, we are of the opinion that it does not contravene the M.V. Act as stated by the A.O. and the CIT(A).

10. Similar issue also arose with reference to fine and penalty paid on account of violation of National Stock Exchange Regulations in the case of Master Capital Services Ltd. vs. DCIT and the Hon’ble ITAT Chandigarh “A” Bench in ITA No. 346/Chd/2006, dated 26th February, 2007 108 TTJ (Chd) 389 has considered that fines and penalties paid by the assessee to NSE for trading beyond exposure limit, late submission of margin certificate due to software problem and delay in making deliveries of shares due to deficiencies are payments made in regular course of business and not infraction of law, hence allowable. In the assessee’s case also these fines are paid regularly in the course of the assessee’s business for transportation of goods beyond the permissible limit and these payments are being made in the regular course of business to the same RTO authorities at the check-post every year, in earlier years and in later years also. Accordingly, it has to be held that these payments are not for any infraction of law but paid in the course of assessee’s business of transportation and these are allowable expenses under section 37(1).’

In view of the legal principles established by the decisions referred to and noticing that the assessee had made about 230 trips by paying compounding fees, as per the rules in the M.V. Act, the Tribunal held that it could not be stated that the assessee’s payments of compounding fees was in violation of law. Since the assessee was engaged in transporting of over-dimensioned goods, in excess of specified capacities in its transport business, it was a necessary business expenditure, wholly and exclusively incurred for the purpose of business, and the same was allowable u/s 37(1). The order of the Commissioner (Appeals) on the issue was confirmed and in the result, the appeal of the Revenue was dismissed.

OBSERVATIONS
Section 37 is a residual provision that allows a business deduction for an expenditure not specified in sections 30 to 36, provided that the expenditure in question is incurred wholly and exclusively for the purposes of business, an essential precondition for any allowance under this section. Any expenditure that cannot be classified as such a business expenditure gets automatically disallowed under this provision unless it is specifically allowed under other provisions of the Act. Likewise, under the scheme of the Act, an expenditure of capital nature or a personal nature is also not allowable in computing the total income. The sum and substance of this is that a payment which cannot be construed as made for the purposes of business gets disallowed.

In the context of the discussion here, it is a settled position in law that the purpose of any ordinary business can never be to offend any law or to commit an act that violates the law and therefore any payments made for such an offence or as a consequence of violating any law is not allowable; such an allowance is the antithesis of the business deduction. Allowance for such payments has no place for the deduction in the general scheme of taxation. Such payments would be disallowed irrespective of any express provision, like Explanation 1, for its disallowance. It is for this reason that the payments of the nature discussed have been disallowed even before the insertion of Explanation 1 by the Finance (No. 2) Act, 1998 w.r.e.f. 1st April, 1962. It is for this reason that the insertion of this Explanation has been rightly labelled as ‘for removal of doubts’ to reiterate a provision of law which was always there.

Under the circumstances, the better view of the law is that the insertion of the Explanation is not to limit the scope of disallowance; any expenditure otherwise disallowable would remain disallowable even where it is not necessarily provided for by the express words of the Explanation. It is with this understanding of the law that the courts have been regularly disallowing the expenditure against public policy, for committing illegal acts, for making payments which are crimes by themselves and even, in some cases, expenditure incurred for defending the criminal proceedings. The disallowance here of an expenditure is without an exception and the principle would apply even in respect of an illegal business unless when it comes to the allowance of a loss of such business, in which case a different law laid down by the courts may apply.

The decisions chosen and discussed here are taken with the limited objective of highlighting the principles of the law of disallowance, even though they may not be necessarily conflicting with each other and maybe both may be correct in their own facts. The settled understanding of the law provided by the decisions of the Supreme Court in a case like Haji Aziz and Abdul Shakoor Bros. 41 ITR 350 has been given a new dimension by the subsequent decisions of the said court in the cases of Prakash Cotton Mills, 201 ITR 684 and Ahmedabad Cotton Manufacturing Co. Ltd., 205 ITR 163 for making a distinction in cases of payment of redemption fine or compounding fees. The court in these case held that it was required to examine the scheme of the provisions of the relevant statute providing for payment of an impost, ignoring its nomenclature as a penalty or fine, to find whether the payment in question was penal or compensatory in nature and allow an expenditure where an impost was found to be purely compensatory in nature. It was further held that when an impost was found to be of a composite nature, the payment was to be bifurcated and the part attributable to penalty was to be disallowed.

Following this distinction, many courts and tribunals have sought to allow those payments that could be classified as compensatory in nature. Needless to say, the whole exercise of distinguishing and separating the two is discretionary and at times results in decisions that do not reconcile with each other. For example, some courts hold that the penalty under the Sales Tax Act is not disallowable while a few others hold that it is disallowable. At times the courts are led to decide even the payment admittedly made for an offence or violation of law was allowable if it was incurred under a bona fide belief out of commercial expediency.

The other extreme is disallowance of payments that are otherwise bordering on immorality as perceived by society. The Supreme Court in the case of Piara Singh 124 ITR 40 and later in the case of Dr. T.A. Qureshi 287 ITR 647 held that there was a clear distinction between morality and law and the decision of disallowance should be purely based on the considerations rooted in law and not judged by morality thereof. These decisions also explain the clear distinction in principle relating to a loss and an expenditure to hold that in cases of an illegal business, the loss pertaining to such a business may qualify for set-off against income of such business.

As noted earlier, the Income-tax Act has not defined the terms like ‘offence’ or ‘prohibited by law’ and it is for this reason, in deciding the issue, that the taxpayer and the authorities have to necessarily examine the relevant statute under which the payment is made, to determine whether such a payment can be classified to be made for any purpose which is an offence or which is prohibited by law under the respective statutes.

Needless to reiterate, the scope of disallowance is not restricted by the Explanation and the expenditure otherwise held to be disallowed by the courts should continue to be disallowed and those covered by the Explanation would surely be disallowed. In applying the law, one needs to appreciate the thin line of distinction between an infraction of law, an offence, a violation and a prohibition, each of which may carry a different connotation while deciding the allowance or otherwise of a payment. In deciding the issue of allowance or otherwise, it perhaps would be appropriate to examine the ratio of the latest and all-important decision of the Supreme Court in the case of Maddi Venkataraman & Co. (P) Ltd., 229 ITR 534 where the Court held that a penalty for an infraction of law is not deductible on grounds of public policy, even if it is paid for an act under an inadvertence. The Full Bench of the Punjab and Haryana High Court in the case of Jamna Auto Industries, 299 ITR 92 held that a penalty imposed for violation of any law even in the course of business cannot be held to be a commercial loss allowable in law. One may also see the latest decision in the case of Confederation of Indian Pharmaceutical Industry vs. CBDT, 353 ITR 388 (HP) wherein the Court examined the issue of payment by the pharmaceutical company to the medical practitioners in violation of the rules of the Indian Medical Council.

It appears that the plea that the payment was made during the course of business and the businessman was compelled to offend or violate the law out of commercial expediency is no more tenable and, in our considered opinion, not an attractive contention to support a claim for a business deduction. A payment to discharge a statutory obligation, for correcting the default when permitted under the relevant statute, can be viewed differently and favourably in deciding the allowance of such payment, but such a payment may not be allowed when it is otherwise for an offence or for violating the law inasmuch as it cannot be considered as an expenditure laid out for the purpose of the business. An infraction of law cannot be treated as a normal occurrence in business.

Having noted the law and the developments in law, it is advisable to carefully examine the relevant law under which the payment is made for ascertaining whether the payment can at all be classified as a compensatory payment, for example interest, including those which are labelled as fines and penalties but are otherwise compensatory in nature and have the effect of regularising a default. Surely a payment made for compounding an offence to avoid imprisonment is not one that can be allowed as a deduction, even where such a compounding is otherwise permitted under the relevant statute?

The tribunal and courts in the following decisions, too, have taken a stand that payments made for traffic violations were not allowable as deductions:

•  Vicky Roadways ITA No. 38/Agra/2013,

•  Sutlej Cotton Mills ITA 1775/1991 (Del) HC, dated 31st October, 1997,

•  Kranti Road Transport (P) Ltd. 50 SOT 15 (Visakhapatnam).

However, the tribunal and courts in the following cases have allowed the deduction for expenditure made for violation of the M.V. Act, 1988 in cases where the payment was made for overloading the cargo beyond the permissible limit, on the ground that the cargo in question was indivisible and there was a permission from the Central Government to allow the overloading on payment of fines:

•  Ramesh Stone Wares, 101 Taxman 176 (Mag) (Asr),

•  Vishwanath V. Kale ITA/20181/Mum/2010,

•  Chetak Carriers ITA 2934/Delhi/1996,

•  Amar Goods Carrier ITA 50 and 51/Delhi/199.