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Income Tax Appellate Tribunal, ‘ D‘ BENCH
Before: SHRI AMIT SHUKLA & MS. PADMAVATHY S.
This appeal against the order of learned national Faceless Appeal Centre, Delhi (herein after referred to “NFAC) dated 09.12.2022 for the assessment year 2014-15.
The assessee has raised following grounds of appeal:-
1. On the facts and in the circumstances of the case and in law, the learned Commissioner of Income-tax (Appeals) has erred in disallowing Rs.35,69,836/- being expenses incurred on payment made as attorney fees, settlement charges etc. holding that the said expenditure is not allowable u/s. 37(1) of the I.T. Act, 1961 without appreciating the fact that the copy right in designing was not intentional and was due to inadvertent mistake and as such it is allowable as business expenditure. 2 Your appellant prays that the levy of penalty u/s 271(1) (c) of the Income Tax Act on your appellant for an inadvertent error being unwarranted, unjustified and unlawful may kindly be deleted.
Your appellant craves leave to add, alter or amend any of the above grounds of appeal or take a fresh ground(s) of appeal on or before the date of hearing.”
3. The assessee is a company filed its return of income for assessment year 2014-15 on 26.11.2014 declaring total loss at Rs. 50,98,318/-. The return was processed u/s 143(1) of the Income Tax Act (‘Act’). Subsequently the case was selected for scrutiny and the notices were duly served on the assessee. The Assessing Officer completed the assessment by disallowing the following (1) Payment of damage for violation of copyright - Rs. 35,69,836/- (2) Disallowance of personal expenses - Rs. 77,870/- (3) Disallowance of interest u/s 36(1)(iii) - Rs. 1,36,490/- (4) Interest of TDS - Rs. 595/- (5) Disallowance u/s 14A - Rs. 2,53,437/-.
Aggrieved the assessee preferred an appeal before the ld. CIT(A) and the ld. CIT(A) gave partial relief with respect to the various disallowance and sustained the disallowance of payment made towards violation of copyright. The assessee is an appeal before the Tribunal against the impugned disallowance as confirmed by the ld. CIT(A).
During the course of hearing, the Assessing Officer noticed that the assessee has debited an amount of Rs. 35,69,836/- under the head damages violation of copyright. On further details asked for the assessee submitted inter-alia as under:-
"We have brought ready market fabric and made a sample of Pointsettia Apron for buyer Pier Imports. This was selected by them and sold to them. We were unaware that this was a copy right design by an American Designer. In due course, this was disputed by the designer with Pier 1 Imports. Pier 1 Imports had to withdraw all Aprons from all their stores. This resulted in loss of sales which was than debited to Diva Exports Pvt Ltd - the exporter of the Aprons. A debit note for US$ 63094.77 cents was raised towards attorney fees, settlement charges and damages on infringement of copyrights. We have made the payments in instalments as per attached statement. As the copy right violation of the design was not intentional and inadvertently committed. According to us the same is to be treated as business loss and should be allowed."
The Assessing Officer did not accept the submissions of the assessee and disallowed the expenses stating that the said expenditure incurred by the assessee expenses towards infringement of copyright which is penal in nature and any expenditure which is prohibited by law shall not be deemed to be incurred for the purpose of business. Accordingly, the AO disallowed the entire amount.
Before the ld. CIT(A) the assessee reiterated the submissions made before the AO. The assessee further, submitted that the payment was not made against any contravention of law but towards the dispute arising because of copyright in design. Accordingly, it was submitted that the resulted loss is incurred in the course of business and therefore allowable as deduction u/s 37(1) of the Act. The ld. CIT(A) held that the amount paid by the assessee is not compensatory in nature but is penal in nature. The ld. CIT(A) held that the penalty paid for violating of law in the course of conduct of business cannot be regarded as deductable expenditure as the assessee would accept the run of business in accordance with the low of land and not in violation of law, therefore, the ld. CIT(A) upheld the disallowance made by the Assessing Officer. Aggrieved the assessee in appeal before the Tribunal.
Before us, the ld. AR relying on the submission made before the lower authorities submitted that the amount paid is compensatory in nature. Since there was dispute by the designer (1) due to which the company had to withdraw of the apparels from their store which resulted in loss of sales which was then debited/charged back to the assessee. The amount paid by the assessee was towards attorney fees, settlement charge with regard copyright issue due to infringement of designs. The ld. AR further submitted that the damages paid were not for any violation of law but towards breach of US copyright. Therefore, it was submitted that the amount paid towards settlement charges should be allowed as deduction. The ld. AR in this regard relied on the decision of Hon’ble Delhi High Court in the case of Commissioner of Income Tax vs. Desiccant Rotors International (P.) Ltd. (2011) 12 taxmann.com 373 (Delhi).
On the other hand, the ld. DR drew our attention to the explanation (3) to section 37 whereby it is clarified that expenditure incurred by the assessee for any purpose which is offence or which is prohibited by law shall include any offence prohibited by law for the time being enforced in India or outside India. The ld. DR submitted that the copyright of violation of US law could come within the explanation to section 37(1) of the Act and hence not allowable. The ld. DR relied on the decision of Hon’ble Delhi High Court in the case of Northern India Chemical Distributors Ltd. vs. Commissioner of Income Tax (2001) 248 ITR 790.
We have heard both the parties and perused the material available on record. Before the proceedings we will look at provisions of section 37(1) which is reproduced as under:- 37. (1) Any expenditure (not being expenditure of the nature described in sections 30 to 36 and 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 the business or profession shall be allowed in computing the income chargeable under the head "Profits and gains of business or profession". Explanation 1.—For the removal of doubts, it is hereby declared that any expenditure incurred by an assessee for any purpose which is an offence or which is prohibited by law shall not be deemed to have been incurred for the purpose of business or profession and no deduction or allowance shall be made in respect of such expenditure. Explanation 2.—For the removal of doubts, it is hereby declared that for the purposes of sub-section (1), any expenditure incurred by an assessee on the activities relating to corporate social responsibility referred to in section 135 of the Companies Act, 2013 (18 of 2013) shall not be deemed to be an expenditure incurred by the assessee for the purposes of the business or profession.”
An explanation 3 was inserted by Finance Act 2022 which reads as under –
[Explanation 3.—For the removal of doubts, it is hereby clarified that the expression "expenditure incurred by an assessee for any purpose which is an offence or which is prohibited by law" under Explanation 1, shall include and shall be deemed to have always included the expenditure incurred by an assessee,— (i) for any purpose which is an offence under, or which is prohibited by, any law for the time being in force, in India or outside India; or (ii) to provide any benefit or perquisite, in whatever form, to a person, whether or not carrying on a business or exercising a profession, and acceptance of such benefit or perquisite by such person is in violation of any law or rule or regulation or guideline, as the case may be, for the time being in force, governing the conduct of such person; or (iii) to compound an offence under any law for the time being in force, in India or outside India.] A combined reading of explanation-1 and explanation -3 would mean that if expenditure incurred for any purpose which is offence or which is prohibited by any law for the time being enforced in India or outside India shall not be deemed to have been incurred for the purpose of business or profession and accordingly no deduction shall be allowable. In the present case it is submitted that the assessee had made the payment to its customers and that the loss was incurred due to copyright breach by the customers which the assessee settled. It was submitted that the damages for breach of copyright was not an offence or prohibited by law. However, we noticed that there is no specific finding given by the lower authorities as to under which provisions of US law the assessee has violated for invoking explanation to section 37(1) of the Act. Given this, we deem it fit to remand the issue back to the ld. CIT(A) to examine the facts of the case with regard to under which specific provisions of the US law which has been violated and whether the payments are compensatory or penal in nature. The ld. CIT(A) directed to consider the ratio lay down by the Hon’ble Delhi High Court in the case of Northern India Chemical Distributors Ltd (supra) and explanation-1 r.w. explanation-3 to section 37(1) of the Act while deciding the issue on merits. Needless to say that the assessee be given reasonable opportunity of being heard. It is ordered accordingly.
In the result, the appeal of the assessee is allowed for statistical purposes.
Order pronounced on 08/05 /2023 by way of proper mentioning in the notice board.