M/S. G.L. CONSTRUCTION PVT. LTD,MUMBAI vs. DCIT 1 (3) (1), MUMBAI

The brief facts of the case are that the assessee-company is engaged in the business of road construction for government authorities such as the Municipal Corporation of Greater Mumbai (MCGM), Navi Mumbai Municipal Corporation (NMMC), and the Mumbai Metropolitan Region Development Authority (MMRDA). During the course of execution of such contracts, various departments/authorities deducted certain amounts from the assessee’s bills, classifying them as "penalties" for reasons including, but not limited to, non- deployment of requisite machinery, delayed commencement of work, slow progress, incorrect or missing barricades, cracks or damage observed during quality inspections, non-maintenance of mandatory measurement records, failure to remove debris, inconvenience caused to the public due to delayed completion, failure to timely submit technical reports such as mix design/job mix formula for asphaltic material, and non-compliance with tender conditions. During the year under consideration, the parties deducted a total amount of Rs.45,91,698/- towards such penalties against certified bills. In certain instances, the assessee recovered a portion of these penalties from the salaries of engineers and project managers. The typical project size ranges from Rs.100 to Rs.250 crores. These defects were identified by the Chief Officer of the concerned authority and penalties/fines were imposed as a measure to maintain discipline and ensure quality. Given the scale and nature of operations, such lapses relating to materials, labour, subcontractors, or execution are inevitable and form a part of the normal business operations of road construction. These expenses, G L Construction Pvt Ltd therefore, are not in the nature of penalties for offences or acts prohibited by law within the meaning of Explanation 1 to Section 37(1) of the Act. However, the Ld. AO, interpreting the said deductions as being violative of section 37(1), disallowed a sum of Rs.42,44,859/- claimed as business expenditure. Aggrieved by this disallowance, the assessee preferred an appeal before the Ld.CIT(A), who upheld the order of the Ld. AO. Being further aggrieved, the assessee has preferred the present appeal before this Tribunal.

During the course of hearing, the Ld. AR submitted a Paper Book comprising pages 1 to 30, which was taken on record. The Ld. AR referred to pages 1–2 of the APB which contain a summary of the so-called "penalty" payments made to MCGM and other authorities, such as HPCL, as well as certain payments made through credit card and towards car insurance. A portion of the amount was recovered from employees’ salaries. The total expenditure incurred towards penalty and late fee was Rs.44,95,698/-, out of which Rs.2,50,839 was recovered from employees, and the net balance of Rs.42,44,859 was claimed as a deductible business expense under Section 37(1).The Ld. AR submitted a detailed break-up of the payments in pages 2 to 26 of the APB. In support of the claim, reliance was placed on the decision of the Coordinate Bench of the ITAT, Delhi Bench “E” in DCIT vs. Mahavir Multitrade (P) Ltd, (2019) 180 ITD 730 (Del), wherein it was held that non-fulfilment of contractual obligations by an assessee cannot be equated with an offence or infraction of law so as to invoke Explanation 1 to Section 37(1), merely because the deduction was termed as "penalty" for non-compliance with contract terms.

The Ld. DR relied upon the orders of the revenue authorities.

We have heard the rival submissions and perused the material available on record. Upon considering the submissions of both parties, we find that the expenses incurred by the assessee towards penalty and late fees do not constitute an infraction of law. Rather, such payments arose from contractual terms in the normal course of business and were intended to preserve and facilitate business relationships with government entities. The Coordinate Benches of the Tribunal, in the cases cited above, Mahavir Multitrade (P) Ltd (supra), Farseen Rubber Industries Ltd (supra), and Ripley & Co Ltd (supra) have consistently held that such payments do not attract disallowance under Explanation 1 to Section 37(1) of the Act. Accordingly, we are of the view that the disallowance made by the Ld. AO under Section 37(1), amounting to Rs.42,44,859/-, is not sustainable. The impugned G L Construction Pvt Ltd appellate order is therefore set aside, and the disallowance is directed to be deleted.