FARSEEN RUBBER INDUSTRIES LTD. ,KOLKATA vs. DCIT, CIR-7(1),KOLKATA. , KOLKATA

Assessment Year : 2013-2014 Farseen Rubber Industries Limited (Appeals), National Faceless Appeal Centre (NFAC), Delhi dated 31st May, 2023 passed for A.Y. 2013-14.

The assessee has taken four grounds of appeal. However, its grievances revolve around a single issue, namely ld. CIT(Appeals) has erred in confirming the addition of Rs.1,00,00,000/-, which was made by the ld. Assessing Officer by disallowing an expenditure of Rs.1,00,00,000/- paid to M/s. JK Tyre & Industries Limited.

Brief facts of the case are that the assesee-company at the relevant time was engaged in manufacturing of automotive rubber tubes and mixing of natural rubber compound on job work basis and on production. It has filed its return of income on 30.09.2013 declaring income of Rs.(-)2,32,09,879/-. The case of the assessee was selected for scrutiny assessment and a notice under section 143(2) dated 05.09.2014 was issued and served upon the assessee.

On scrutiny of the accounts, it revealed that the assessee-company has paid an amount of Rs.1 crore as compensation to principal for non-fulfilment of contractual obligation. The ld. Assessing Officer has invited explanation of assessee as to why this expenditure be not disallowed to the assessee. In Assessment Year : 2013-2014 Farseen Rubber Industries Limited response to the query of ld. Assessing Officer, it was contended that the assessee has been carrying out job work at the instance of M/s. JK Tyre & Industries Limited. The principal had made a surprise visit to assessee’s factory and found some technical short- comings. In other words, according to the assessee, the amount of rubber required to be used for production of one item was short and, therefore, the factory was shut down. A situation arose whereby M/s. JK Tyre & Industries Limited explored for cancellation of the agreement between the parties. After a long negotiation, M/s. JK Tyre & Industries Limited raised a bill of Rs.3,00,00,000/- for compensation. The assessee further negotiated and it brought down to Rs.1,00,00,000/-. Accordingly, the assessee has made the payment of this amount. It claimed this in the Profit & Loss Account towards expenditure. The ld. Assessing Officer with the help of Explanation 1 appended to Section 37 disallowed the claim of the assessee.

Appeal filed to the ld. CIT(Appeals) did not bring any relief to the assessee.

With the assistance of ld. Representatives, we have gone through the record carefully. Explanation 1 appended to Section 37 has a direct bearing on the Assessment Year : 2013-2014 Farseen Rubber Industries Limited controversy, therefore, we deem it appropriate to take note of this Explanation, which reads as under:- “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 of 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”.

A perusal of Section 37 would indicate that it is a residuary provision for permitting the assessee to claim expenditure but such expenditure should not be in the nature described in Sections 30 to 36 and it should not be in the nature of capital expenditure. The expenditure ought to have been incurred wholly and exclusively for the purpose of the business. The expression “wholly” represents quantitatively and expression “exclusively” represents only for business. In other words, there cannot be any implied confusion. Thus any expenditure which is not a capital expenditure and which does not fall within the ambit of Sections 30 to 36 but incurred for the purpose of the business would be allowed to an assessee under this residuary provision. By way of Finance Act, 1998, Explanation 1 was appended to this Section, which was made applicable w.e.f. 1st April, 1962. The Explanation extracted supra would provide that any expenditure incurred by an assessee for any Assessment Year : 2013-2014 Farseen Rubber Industries Limited 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. The deduction of such expenditure would not be allowed to the assessee. The sole question in the present case is how a business expenditure incurred by an assessee would be categorised as penal in nature with the application of Explanation 1 to Section 37. In the present case, the assessee entered into with an agreement with M/s. JK Tyre & Industries Limited for carrying out the manufacturing activity of J.K. Tyres on job work basis. It failed to produce the end product qualitatively according to the parameters of J.K. Tyres and dispute arose between the parties. In order to resolve the dispute, the assessee has to pay something to M/s. JK Tyre &Industries Limited so that it can continue to work on behalf of M/s. JK Tyre & Industries Limited for job work basis. Therefore, the expenditure was not incurred for any infringement of law rather, it is a by- product of commercial activity. For example, the assessee was required to manufacture a tyre by using 10Kg. of rubber, but it had used 11 Kg. or 9 Kg., tyre will not be to the specification of the principal and that would spoil the market of the principal and users will raise complaint. The principal would have to replace them that would lead to some expenditure as well as bad name in the market, so the compensation given by the assessee was on Assessment Year : 2013-2014 Farseen Rubber Industries Limited account of these commercial transactions. Therefore, both the authorities are incorrect in categorizing the expenditure as hit by Explanation 1 to Section 37. We allow the appeal of the assessee and delete the addition.

In the result, the appeal of the assessee is allowed. Order pronounced in the open Court on October 13, 2023.