AIA ENGINEERING LTD.,AHMEDABAD vs. THE DY.CIT, CIRCLE-1(1)(1), AHMEDABAD

ORDER \nPer Sanjay Garg, Judicial Member:\nThe captioned are cross-appeals, one by the assessee and the other by\nthe Revenue preferred against the order of the Learned Commissioner of\nIncome Tax (Appeals), National Faceless Appeal Centre (NFAC), Delhi\n[hereinafter referred to as ‘CIT(A)'] dated 13/01/2025 passed u/s.250 of the\nIncome Tax Act, 1961 (hereinafter referred to as 'the Act') for the Assessment\nYear (AY) 2014-2015. Both the appeals have been heard together and are\nbeing disposed of by this consolidated order. First, we take up Revenue's\nappeal in for AY 2014-15 for adjudication.\nITA No.565/Ahd/2025 for AY 2014-15\n2. The Revenue in its appeal have been taken following grounds of\nappeal:\n3.

1. Whether the CIT(A) has erred both on facts and in law in treating Vega Industries\n(Middle East) FZC, UAE (Vega ME) as an independent body corporate/company\nIncorporated outside India Instead of the proprietary concern of the Appellant and\ndeleting of addition of Rs.44,98,11,000/- made by the Assessing Officer in the hands of\nthe Appellant?.\n2. Whether the CIT(A) has erred both on facts and in law in deleting the Disallowance\nof additional depreciation of Rs.8,09,995/-, without appreciating the facts of the case?.\n3. The appellant craves leave to amend or alter any ground or add a new ground, which\nmay be necessary.\n4. It is, therefore, prayed that the order of Ld. CIT(A) may be set aside and that of the\nAssessing Officer be restored.”\nGround No.1:- The Revenue vide Ground No.1 has agitated against\nthe action of the Ld. CIT(A) in deleting the addition of Rs.44,98,11,000/- made\nby the Assessing Officer (AO) by taxing the income of the offshore entity,\nVega Industries (Middle East), FZC, UAE, treating the same as proprietary-\nconcern of the assessee.\n4. At the outset, the Ld. Counsel for the assessee has submitted that the\nissue is squarely covered in favour of assessee by various decisions of the\nTribunal passed in earlier assessment years. He, in this respect, has\nsubmitted that this issue had arisen for first time in AY 2006-07, wherein, the\nTribunal after considering the entire material available on record, had\ndecided the issue in favour of assessee by holding that the said subsidiary is\nseparate for corporate entity and not a proprietary-concern of the assessee\nand, hence, the AO was not justified in taxing the income of the said company\nin the hands of the assessee. The Ld. Counsel, in this respect, has relied upon\nthe decisions of the Tribunal for AY 2006-07 passed in ITA No.580/Ahd/2011\nreported in (2012) 18 taxmann.com 307 (Ahd.), wherein the Tribunal has held\nthat the said Vega Industries (supra) was duly incorporated company under\nlaw of a country outside India and cannot be held to be proprietorship-\nconcern of the assessee merely because the assessee held 100% shareholding\nof that company. The relevant concluding para of the order of the Tribunal\non this issue, is reproduced as under:\n\" It goes to show that Vega UAE is duly incorporated as a body corporate under the\nlaw of a country outside India which is a requirement of Section 2(17) of the Income\ntax Act, 1961 and, therefore, Vega UAE has to be accepted as a company within the\ndefinition of Section 2(17) of the Income tax Act, 1961. Once it is accepted, the\naddition made by the A.O. by holding that Vega UAE is a sole proprietorship concern\nof the assessee company is not sustainable and hence, the addition made by the A.O.\nis to be deleted. We hold accordingly. Ground No. 1 of the assessee is allowed.\nRegarding various other contentions raised by both sides, we would like to observe\nthat the same are not relevant in view of our above decision.”\n4.

1. The issue has time and again cropped up in subsequent years also,\nwherein the Tribunal has consistently decided this issue in favour of assessee.\nThe latest decision being for AY 2016-17 passed in 21/10/2024, wherein the Tribunal has taken note of the fact that the\nissue has already been settled in favour of assessee in earlier assessment years\nand further the Ld. CIT(A) has followed the decisions of the Tribunal and\nthereby deleted the impugned addition made by the AO on this issue.\n5. The Ld. DR has also fairly agreed that the issue is covered in favour of\nassessee in the own case of the assessee for earlier assessment years and he\ncould not bring out any distinguishing fact or contrary decision for the year\nunder consideration. Therefore, we do not find any infirmity in the order of\nthe Ld. CIT(A) on this issue, the same is upheld. Thus, Ground No.1 of\nRevenue's appeal is dismissed.\n6. Ground No.2:-\nVide Ground No.2, the Revenue has contested the\naction of the CIT(A) in deleting the disallowance made by the AO on account\nof additional depreciation claim of Rs.8,09,995/-.\n6.

1. The Ld. Counsel for the assessee, at the outset, has submitted that this\nissue also covered in favour of assessee and against the Revenue by the earlier\ndecisions of the Tribunal in the own case of the assessee. He has further\nsubmitted that the Ld. CIT(A) while deleting the impugned addition on this\nissue has followed the decisions of the Tribunal in earlier assessment years.\nThe assessee had claimed depreciation of Rs.24,29,984/- being depreciation\ncalculated @ 15% on electrical fittings. The AO, however, held that\ndepreciation on electrical fittings was allowable @ 10%. He, therefore,\ndisallowed the excess depreciation claimed of Rs.8,09,995/-. During the\nappellate proceedings, the assessee explained that electric installations was\npart and parcel of the plant & machinery and, therefore, depreciation as\napplicable on plant & machinery @ 15% was allowable. The Ld. CIT(A)\nfollowing the earlier decision of the Tribunal on this issue in the own case of\nthe assessee observed that the electric fittings and installations were part and\nparcel of the plant & machinery without which the plant & machinery could\nbe operated. Therefore, the depreciation @ 15% as applicable on plant &\nmachinery was allowable. The Ld. Counsel, in this respect, has referred to\nthe decision of the Tribunal for AY 2010-11 to AY 2013-14 vide common order\ndated 04/01/2021 with the lead case in ITA No.1766/Ahd/2012.\n7. The Ld. DR has also fairly agreed that the issue is covered in favour of\nassessee in the own case of the assessee for earlier assessment years. We find\nthat the Ld. CIT(A) has committed no error in following the earlier decisions\nof the Tribunal on this issue, in the absence of any distinguishing facts for the\nyear under consideration.\n8. Ground Nos.3 & 4 are general in nature which require no independent\nadjudication and, hence, the same are dismissed as such.\n9. This appeal of the Revenue is hereby dismissed.\nAssessee's appeal in AY 2014-15:\n10. The assessee, in this appeal, has taken following grounds of appeal:\n

1. The Ld. CIT(A) has erred in law and on facts of the case in confirming\ndisallowance of Rs.31,11,00,000/- u/s.37 of the Act made w.r.t. compensation paid\nfor settling the dispute of patent infringement.\n2. Alternatively and without prejudice, the amount of Rs.31,11,00,000/- so paid for\nsettlement of Patent dispute may kindly be allowed as business loss u/s 28 of the Act.\n3. Both the lower authorities have passed the orders without properly appreciating\nthe facts and they further erred in grossly ignoring various submissions,\nexplanations and information submitted by the appellant from time to time which\nought to have been considered before passing the impugned order. The action of the\nlower authorities is in clear breach of law and Principles of Natural Justice and\ntherefore deserves to be quashed.\n4. The Ld. CIT(A) has erred in law and on facts of the case in confirming action of\nthe Ld. AO in levying interest u/s.234B of the Act.\n5. The Ld. AO has erred in law and on facts of the case in initiating penalty\nproceedings u/s.271(1)(c) of the Act.\n6. The appellant craves leave to add, amend, alter, edit, delete, modify or change all\nor any of the grounds of appeal at the time of or before the hearing of the appeal.”\nThe assessee, vide Ground Nos.1 & 2, has agitated against the action of\nthe Ld. CIT(A) in confirming the disallowance of Rs.31,11,00,000/- made by\nthe AO u/s 37 of the Income Tax Act, 1961 (in short “the Act\") on account of\ndisallowance of compensation paid for settling the patent infringement\ndispute.\n11.

2. The assessee filed a patent invalidation proceedings against MI in US\nDistrict Court seeking a declaratory judgment that MI's reissue patent was\ninvalid. The US District Court in September 2010 passed a summary\njudgment in favour of the assessee invalidating the reissued claims of the\nRE'998 patent. However, MI appealed against the summary judgment before\nthe Federal Court of Washington. In August 2011, the Federal Court passed\nan order reversing the finding of the summary judgement and remanded the\nmatter back to District Court for a full trial. The jury trial passed its verdict\non 2 July 2012 against the assessee and held that MI's RE39998 patent was\nvalid, and the assessee's Sintercast products infringe MI's RE39998 patent.\nThe District Court based on the above verdict, awarded compensatory\ndamages plus reasonable attorney fees and cost to MI. The assessee opposed\nthe judgment and filed 'Post Trial' motions before the District Court to re-\nexamine the matter. In consideration, the Court granted the assessee's request\nto re-examine the motion but asked the assessee to deposit cash security of\nUSD 7,228,544, which included the original award plus attorney's fees and\ncosts. Towards the above, the assessee sought Reserve Bank of India's ('RBI')\npermission to remit above amount as a security to be placed in District Court\nto stay the execution of judgement award. The RBI vide its letter dated 20\nSeptember 2012 granted desired permission to the assessee. Post placing the\ndeposit, the assessee challenged the award of damages and filed an\napplication for re-examination of the patent in the US Patent and Trademark\noffice. Based on a disclosure made by MI in these proceedings, the assessee\nalso filed a motion in the trial court seeking a reconsideration of the decision\nbased on the new evidence disclosed by MI in the re-examination procedure.\nHowever, the trial court held that the reconsideration of the decision based\non new evidence can be done only after the decision of the District Court on\nthe 'post-trial' motion petition. However, since the cost of litigation was\nexpected to be exorbitant for the assessee and MI and MI at the risk of losing\nits patent also, both the parties mutually decided to settle the dispute\namicably. Accordingly, a Settlement Agreement dated 28 August 2012 was\nsigned to settle and adjust all differences and controversies. Pursuant to the\nsaid settlement agreement the assessee paid USD 6,000,000 to MI in\nconsideration of the closure of the litigation and mutual release from\nclaims/counter claims between the parties. In view of the above, the assessee\nsought RBI's permission vide letters dated 24 October 2013 and 31 October\n2013 to allow the payment to be made to MI from the amount deposited with\nDistrict Court. The RBI vide its letter dated 18 November 2013 granted\ndesired permission to assessee. The assessee debited an amount of\nRs.31,11,00,000 (being the INR equivalent of abovementioned sum of USD\n6,000,000) under the head exceptional items in Profit and Loss Account for\nyear ending 31 March 2014 for settlement of patent infringement litigation.\n12. On being show-caused by the AO as to why the said amount be not\ndisallowed, the assessee submitted before the AO that the aforesaid amount\nwas agreed to be paid by the assessee on account of contractual liability. That\nit was not a case of payment of any penalty levied by any government\nauthority or statutory authority on account of any Act or Omission prohibited\nby law. It was pleaded that it was a compensation which was paid on account\nof loss of opportunity and probability to the MI as mutually agreed between\nthe parties. That the payment was also approved by the RBI vide letter dated\n18/11/2013 and pursuant to the mutual compromise, both the parties to the\nagreement had released each other from current and future proceedings and\nliabilities towards each other. The assessee also placed reliance on various\ncase-laws in this respect. The AO, however, did not agree with the aforesaid\ncontentions of the assessee and held that the amount paid to MI was penal in\nnature and not allowable as business expenditure in view of Explanation-1 to\nsection 37 (1) of the Income Tax Act, 1961 (in short, “the Act).\n13. Being aggrieved by the said disallowance made by the AO, the assessee\npreferred appeal before the Ld. CIT(A).\n14. The Ld. CIT(A), however, observed that there was already a valid\npatent available with MI (even if it was a reissue patent) and the Sintercast\nproduces exported by the assessee were in violation of an effective and\nexistent patent. That the assessee had violated an existing patent right of the\nMI in US market. The Ld. CIT(A) referring to the provisions of section 37 of\nthe Act observed that any expenditure incurred by an assessee for any\npurpose which was an offence or which was prohibited by law would not be\ndeemed to have been incurred for the purpose of business or profession and\nno deduction or allowance shall be made in respect of such expenditure. He\nreferring to the Explanation 1 & Explanation 3 to Section 37(1) of the Act\nobserved that expenditure incurred by an assessee for any purpose which is\nan offence or which is prohibited by law includes expenditure for purposes\nconsidered offences under current laws in India or outside India and includes\nbenefits or perquisites, violating applicable laws by the recipient and further\nto include expenditure incurred to compound an offence under prevailing\nlaws in India or outside India. The Ld. CIT(A) observed that the amount of\nRs.31,11,00,000/- paid by the assessee to MI was for violation of patent rights\nof MI and, hence, the said amount was not in nature of compensation, but\npenal charges which the assessee would have had to pay once the issue had\nbeen decided by the Higher Courts in USA. He observed that the District\nCourt, based on the jury's determination holding that there was willful\ninfringement of MI's reissue patent by the assessee, awarded compensatory\ndamages to MI payable by the assessee. That, though on the request of the\nassessee in 'post-trial motion', the District Court agreed to re-examine the\nmatter, but subject to the condition of deposit of cash security of $7,228,544.64\nwhich included the original award plus attorney's fees and costs. That in\nview of these circumstances, the assessee entered into a Settlement Deed with\nMI to make a one time payment of USD 6 million to MI and thereby\nprincipally and evidently accepted that it had violated the patent rights of\nMI. The Ld. CIT(A), therefore, held that the payment made by the assessee\nto MI was clearly in lieu of illegal action of the assessee in selling goods which\nviolated the legal rights of MI in the form of patent. The Ld. CIT(A) held that\nthe assessee had willfully defaulted the US laws. That the aforesaid amount\nwas paid by the assessee to avoid of any conviction by the Court of Law for\ninfringement of patent which was not a normal incidence of business. That\nthe assessee-company did not pursue the patent matter to reach its finality\nand entered into a settlement with MI accepting the claim of the MI that the\nassessee had violated its patent rights. Therefore, the Ld. CIT(A) held that\nthe payment was made to the MI was clearly penal in nature and not\ncompensatory and that the same was covered by the Explanation 1, read with\nExplanation 3 of section 37(1) of the Act and, hence, was rightly disallowed\nby the AO.\n15. Being aggrieved by the said order of the Ld. CIT(A), the assessee has\ncome in appeal before us.\n16. The Ld. Counsel for the assessee has made the following submissions\nbefore us:\n“No disallowance can be made u/s.37 of the Act without “violation of law”\n• The pre-requisite of “violation of law” for disallowance u/s.37 is not fulfilled\nsince the matter was sub-judice when the settlement had arrived.\nPayment for settlement of patent dispute is compensatory in nature:\n•\nPatent infringement amounts to violation of \"right of a private party\" resulting\nin \"contractual liability\" of \"civil damages\" payable to the private party for\n\"loss of business/ profit/ royalty\". However, \"no payment\" is required to be\nmade \"to government\" in nature of any penalty, fees, etc.\n• Thus, the payment on patent infringement or settlement of payment dispute is\n\"compensatory & not penal in nature\". Reliance is placed on the followings:\nCIT v. Desiccant Rotors International P. Ltd. [2012] 347 ITR 32 (Delhi)\nHarbinger Systems P. Ltd. v. DCIT [2017] 77 taxmann.com 284 (Pune-\nTrib.)\nITO v. MPR Marketings P. Ltd. - The amount payable to MI represents compensatory damages as evident from\nthe followings:\nCounter claim filed by MI claiming \"compensation\" -Pgs.148-62 @ Pg.\n160 of P/b.\nUS District Court order dt. 02.07.2012 awarding \"compensatory\ndamages\"-Pgs.226-227 of P/b.\n• AO & CIT(A) distinguished the judgement of Desiccant Rotors (supra) on\nground that no patent rights are granted to assessee unlike that case where\npatent rights were granted post settlement. In fact, the assessee's case is better\nplaced than Dessicant Rotors (supra) on this ground as the amount paid is not\nfor acquiring any new capital asset (patent rights) but only for usage of the\nsame and therefore purely revenue in nature.\nPayments in relation to violation of law outside India cannot be disallowed u/s.\n37 of the Act during the year under consideration:\n• Prior to introduction of Explanation 3 to S.37(1) w.e.f. 01.04.2022, it was a\nsettled position that violation of \"laws outside India\" does not fall within the\npurview of disallowance u/s.37. Reliance is placed on the following:\nMylan Laboratories Ltd. v. DCIT-[2020] 113 taxmann.com 6 (Hyd)\n• In the present case, the settlement payment was made in FY 2013-14 and\nassessment was framed on 29.12.2017. Neither during the year under\nconsideration nor during the year of framing the assessment was the\nExplanation 3 to S.37(1) present in the statue book and hence, disallowance\ncannot be made for payment made for violation of US patent law.\n• However, CIT(A) invoked Explanation 3 to S.37(1) stating that such\nexplanation is clarificatory in nature and hence, applicable retrospectively\nbased on words \"shall be deemed to have always included\" used in the\nExplanation 3 to S.37(1).\n• A cardinal principle of the tax law is that the law to be applied is that which\nis in force in the relevant assessment year unless otherwise provided expressly\nor by necessary implication.\n• It is well settled that when an Explanation widens the scope of the main\nprovision or changes the law, it cannot be given retrospective effect\nirrespective of phrases like \"it is declared\", \"for the removal of doubts\", \"in\norder to make the intention of legislation clear\", etc. Reliance is placed on the\nfollowing:\nSedeo Forex International Drill Inc. v. CIT [2005] 279 ITR 310 (SC)\nM.M. Aqua Technologies Ltd. v. CIT-[2021) 436 ITR 582 (SC)\nPCIT v. Era Infrastructure (India) Ltd. (2022) 448 ITR 674 (Delhi)\nCIT v. Vatika Township (P.) Ltd. 367 ITR 466 (SC)\n• Explanation 3 to S.37(1) was specifically inserted in statute book by Finance\nAct, 2022 to bring the violation of \"laws outside India\" within the purview of\nS.37(1) and overcome the judgements of Tribunals taking a view that S.37(1)\ndo not cover \"laws outside India\". This clearly amounts to widening the\nexisting law which can only be applied prospectively.\nEven the Memorandum to Finance Act, 2022 (Legal P/b. Pgs.86-94) states\nthat the amendment takes effect from 01.04.2022 i.e. prospectively.\nThus, the CIT(A) was wrong in confirming the disallowance by applying\nExplanation 3 to S.37(1) retrospectively.\nPayments made for \"settlement\" were not falling within the purview of\ndisallowance u/s.37 of the Act during the year under consideration:\n• It is submitted that \"settlement payments were never within the purview of S.37(1)\nof the Act until specifically brought by Finance (No. 2) Act, 2024 within the ambit\nof Explanation 3 to S.37(1) of the Act w.e.f. 01.04.2025 as evident from\nMemorandum to Finance (No. 2) Act, 2024 (Legal P/b. Pgs.95-97). This evidences\nthe intention of legislature that the settlement payments before 01.04.2025 were\nallowable as business expenditure.\nEven otherwise, the amendment in Finance (No. 2) Act, 2024 only covered the\nsettlement payments in relation to contravention of \"prescribed laws\". CBDT has\nissued a notification dated 23.04.2025 (Legal P/b. Pg. 98) prescribing only four\nlaws in this regard which do not include the \"patent law. Had it been the intention\nof legislature to disallow the settlement payments made in relation to patent\ndispute, the legislature would have also notified the \"patent law\" under such\nnotification.\nPayment made for settlement should be allowed as business loss a/s, 28 of the Act\nAlternatively and without prejudice, the settlement payment shall be allowed to\nassessee as a business loss u/s.28 of the Act since the settlement has been made\nw.r.t. alleged patent infringement made during the course of business of the\nassessee.\nIn view of above, the disallowance of settlement payment of Rs.31,11,00,000/- deserves to be deleted.\"\n17. The Ld. DR, however, has relied upon the findings of the lower\nauthorities.\n18. We have heard the rival contentions of the Ld. Representatives of the\nparties and gone through the record.\n19. Before proceeding further, it will be relevant here to reproduce the\nrelevant provisions of section 37(1) of the Act as on 1.4.2025:-\n\"37. (1) Any expenditure (not being expenditure of the nature described in sections\n30 to 36 and not being in the nature of capital expenditure or personal expenses of the asses\nsee), laid out or expended wholly and exclusively for the purposes of the business or\nprofession shall be allowed in computing the income chargeable under the head \"Profits\nand gains of business or profession\".\nExplanation 1.—For the removal of doubts, it is hereby declared that any expenditure\nincurred by an assessee for any purpose which is an offence or which is prohibited by law\nshall not be deemed to have been incurred for the purpose of business or profession and no\ndeduction or allowance shall be made in respect of such expenditure.\nExplanation 2.—For the removal of doubts, it is hereby declared that for the purposes of\nsub-section (1), any expenditure incurred by an assessee on the activities relating to\ncorporate social responsibility referred to in section 135 of the Companies Act, 2013 (18\nof 2013) shall not be deemed to be an expenditure incurred by the assessee for the purposes\nof the business or profession.\n{Explanation 3. For the removal of doubts, it is hereby clarified that the expression\n"expenditure incurred by an assessee for any purpose which is an offence or which is\nprohibited by law" under Explanation 1, shall include and shall be deemed to have always\nincluded the expenditure incurred by an assessee,—\n(i) for any purpose which is an offence under, or which is prohibited by, any law for\nthe time being in force, in India or outside India; or\n(ii) to provide any benefit or perquisite, in whatever form, to a person, whether or not\ncarrying on a business or exercising a profession, and acceptance of such benefit\nor perquisite by such person is in violation of any law or rule or regulation or\nguideline, as the case may be, for the time being in force, governing the conduct\nof such person; or\n(iii) to compound an offence under any law for the time being in force, in India\nor [outside India; or\n(iv) to settle proceedings initiated in relation to contravention under such law as may\nbe notified by the Central Government in the Official Gazette in this behalf ]}.\n1. Inserted by the Finance Act, 2022, w.e.f. 1-4-2022.\n2. Substituted for “outside India" by the Finance (No. 2) Act, 2024, w.e.f. 1-4-2025.\n20. As depicted above, the Explanation 3 has been inserted w.e.f. 1.4.2022,\nwhich is much after the relevant Assessment Year under consideration ( A.Y.\n2014-15) and even after the passing of the impugned Assessment Order on\n29.12.2017. Further, the clause (iv) to Explanation 3 has been inserted w.e.f.\n01.04.2025, which shows that it has come into effect even after the date of\npassing of the impugned order of the CIT(A) on 13.01.2025. However, at this\nstage we take the provisions as are in operation as on today. We will discuss\nthe issue of retrospective or prospective operation of the aforesaid amended\nprovisions in the later part of this order.\n21. The relevant provisions of the The U.S. Patent Act ( United States\nCode Title 35 – Patents), are hereby reproduced as under:\n\"281 Remedy for infringement of patent.\nA patentee shall have remedy by civil action for infringement of his patent.\n283 Injunction.\nThe several courts having jurisdiction of cases under this title may grant injunctions in\naccordance with the principles of equity to prevent the violation of any right secured by\npatent, on such terms as the court deems reasonable.\n284 Damages.\nUpon finding for the claimant the court shall award the claimant damages adequate to\ncompensate for the infringement but in no event less than a reasonable royalty for the use\nmade of the invention by the infringer, together with interest and costs as fixed by the court.\nWhen the damages are not found by a jury, the court shall assess them. In either event the\ncourt may increase the damages up to three times the amount found or assessed. Increased\ndamages under this paragraph shall not apply to provisional rights under section 154(d).\nThe court may receive expert testimony as an aid to the determination of damages or of what\nroyalty would be reasonable under the circumstances.\n285 Attorney fees.\nThe court in exceptional cases may award reasonable attorney fees to the prevailing party.”\n292 False marking.\n(a) Whoever, without the consent of the patentee, marks upon, or affixes to, or uses in\nadvertising in connection with anything made, used, offered for sale, or sold by such person\nwithin the United States, or imported by the person into the United States, the name or any\nimitation of the name of the patentee, the patent number, or the words \"patent,\" \"patentee,\"\nor the like, with the intent of counterfeiting or imitating the mark of the patentee, or of\ndeceiving the public and inducing them to believe that the thing was made, offered for sale,\nsold, or imported into the United States by or with the consent of the patentee; or\nWhoever marks upon, or affixes to, or uses in advertising in connection with any unpatented\narticle the word \"patent\" or any word or number importing the same is patented, for\nthe purpose of deceiving the public; or\nWhoever marks upon, or affixes to, or uses in advertising in connection with any article the\nwords \"patent applied for,\" \"patent pending,\" or any word importing that an application for\npatent has been made, when no application for patent has been made, or if made, is not\npending, for the purpose of deceiving the public-\nShall be fined not more than $500 for every such offense. Only the United States may sue\nfor the penalty authorized by this subsection.\n(b) A person who has suffered a competitive injury as a result of a violation of this section\nmay file a civil action in a district court of the United States for recovery of damages\nadequate to compensate for the injury.\n(c) The marking of a product, in a manner described in subsection (a), with matter relating\nto a patent that covered that product but has expired is not a violation of this section.\n37(1). A perusal of the abovementioned provisions would reveal that\nto attract disallowance under the Explanation 1 & Explanation 3 to Section\n37(1) of the Act, the expenditure should be found to have been incurred by\nan assessee ‘for any purpose' which is an offence or which is prohibited by\nlaw. Now the question here is that whether an assessee had made the\naforesaid payment of Rs.31,11,00,000/- ‘for any purpose' which is an offence\nor prohibited by law ?\n21.

1. Admittedly, as noted above, the amount in question had been paid by\nthe assessee as a compensation for the settlement of the civil dispute with MI.\nA perusal of the aforesaid relevant provisions of the US Patent Act/US Code\n35 would reveal that section 281 expressly provides that remedy to a patentee\nfor infringement of his patent is by civil action and further sections 283\nprovides that the aggrieved patentee can sue for injunction for prohibiting\nthe defendant from infringing his patent rights and under section 284, he can\nsue for damages/compensation. Only penal action can be taken where a\nperson has been found guilty of false marking for which such a person can be\nfined for not more than $500 for every such offense. In this case, neither\nthere was any allegation of false marking against the assessee nor any such\nproceedings were ever initiated. The only dispute raised by the MI was that\nthe assessee has infringed its RE39998 patent. However, the claim of the\nassessee was that it has not violated the MI's aforesaid patent. A\nconsideration of the entire facts and circumstances would show that the\nassessee was bonafidely contesting the claim of the MI and even in the first\nround of litigation has succeeded whereby the District Court has decided the\nissue in favour of the assessee by invalidating the MI's patent. Even in the\nsecond round when the assessee approached the District Court for\nreconsideration in the 'post trial motion' and further for stay the execution of\nthe judgement/award, the District Court though ordered the assessee to\ndeposit a sum of $7228544.64 as security to fully protect the interest of MI,\nhowever, observed, “It cannot be said (AIA) has no likelihood of success with\nregard to its post trial motions". Further, it has been observed, “In any event,\nalthough the Court will not concede that it committed error, this Court cannot\nconclude that Plaintiff has no reasonable possibility of success on merits of its post\ntrial motions or appeals”. Further, another important point in this case is that\nthough the assessee had already deposited as a security a sum of $7228544.64\nin the District Court which sum, in the event of dismissal of AIA's (assessee)\npost-trial motion, would have been disbursed by the Court to the MI,\nhowever, the MI in the compromise agree for a lesser amount of $6,000,000.00.\nThe MI's settlement for a lesser sum shows that the MI was also not sure of\nits success in the post-trial motion and prefer to settle the dispute for a lesser\nconsideration. Clause-2 of the Article V of the Settlement Agreement\nmentions, \"The Parties agree this is a mutual compensatory settlement to avoid\nlitigation and no representation is made that the foregoing consideration represents\nan underlying royalty of the patent infringement, the subject matter of the\nLitigation\". The above facts and circumstances show that the payment of\n$6,000,000.00 to MI was neither on account of any fine imposed by any Court\nnor on account of any offence committed by the assessee. The said amount\nwas paid to settle a long pending civil litigation with a private party (MI ),\nwherein, both the parties to the litigation were of the bonafide belief that their\nclaim before the Court of Law was a valid claim and that they were entitle4d\nto such rights/claims. Even the matter once decided by the District Court in\nfavour of the assessee, however, the judgement of the District Court was\nreversed by the Federal Court whereupon the assessee filed post-trial motion\npetition and also deposited the necessary security amount as directed by the\nDistrict Court. However, since both the parties realized that they would bear\na hefty cost of litigation and further the dispute was more likely to be settled\nearly as there were chances of moving to the higher courts by the\nunsuccessful litigant, therefore, they mutually decided to compromise the\nmatter and settled the consideration payable by the assessee to MI at a lesser\nprice than the awarded amount. Thus, the purpose for the payment of the\nsaid amount was settlement of civil litigation which purpose was neither an\noffence nor prohibited by law.\n21.

1. The authorities below attempted to distinguish this case law by stating\nthat in Desiccant Rotors, patent rights were granted post-settlement. This\nfactor, in our view, is not relevant. Whether the first party agrees to give the\npatent right to the other party is dependent upon the mutual settlement\nbetween the parties and that factor is not determinative of the fact as to\nwhether the assessee has infringed the patent rights of the MI or not. It has\nbeen clearly stated vide Clause-2 of the Article V of the Settlement Agreement\nthat the mutual compensatory settlement was to avoid litigation and that\nconsideration paid in the settlement would not represent in any manner as\nan underlying royalty of the patent infringement. Thus, the observations of\nthe Ld. CIT(A) that the assessee, by entering into the agreement deed with MI\nand making payment of USD 6 million, in the fact and circumstances, had\nprincipally accepting that it has violated the Patent rights of MI and further\nthat the payment was not in the nature of compensation but penal charges,\nare factually incorrect. The observation of the lower authorities that the\npayment was made to avoid any conviction by the US Court for infringement\nof patent laws is also factually incorrect in view of the discussion made above.\n22.

2. We also find force in the alternate contention of the Ld. AR regarding\nthe applicability of Explanation 3 to Section 37(1) of the Act for the\n Assessment year under consideration, which was inserted by the Finance Act,\n2022, with effect from April 1, 2022. As pointed out in Para 19 above, prior to\nthis amendment, the expression \"prohibited by law\" under Explanation 1 was\nconfined to the laws in force in India. Its scope has been extended to offshore\ncountries by inserting explanation 3 w.e.f. 1.4.2022 but stating into to be\nclarificatory. It is a cardinal principle of tax law, affirmed by the Hon'ble\nSupreme Court in a catena of judgments including CIT v. Vatika Township\n(P.) Ltd. 367 ITR 466 (SC) and M.M. Aqua Technologies Ltd. v. CIT (2021) 436\nITR 582 (SC), that any amendment which widens the scope of a provision to\nthe detriment of the assessee cannot be applied retrospectively unless the\nstatute expressly provides for it. Explanation 3 widened the scope of\ndisallowance to include violations of laws outside India. The Memorandum\nto the Finance Act, 2022, also clearly states that the amendment will take effect\nfrom April 1, 2022. Therefore, the CIT(A) was in error in applying this\nprovision retrospectively to the assessment year 2014-15. The assessee\nsucceeds in respect of its this alternate contention also.\n23. Another interesting point for determination is about the payment\nmade for settlement of dispute relating to infringement of patent rights\nwhether, would be covered under the newly inserted clause (iv) to\nExplanation 3 to section 37(1) of the Act w.e.f. 1.4.2025 vide the Finance (No.\n2) Act, 2024. The very insertion of this clause shows that prior to this\namendment, bona fide settlement payments were not intended to be covered\nby the disallowance u/s 37(1) of the Act. As observed above, this newly\ninserted clause (iv) can not be applied retrospectively at this stage.\n23.

1. Further, this newly inserted clause (iv) to Explanation 3 applies only to\nsettlements related to contraventions of laws notified by the Central\nGovernment. The CBDT, for this purpose, via Notification No. 38/2025 dated\nApril 23, 2025, has notified that any expenditure incurred to settle\nproceedings initiated in relation to contravention or defaults under the\nfollowing laws shall not be deemed to have been incurred for the purpose of\nbusiness or profession and no deduction or allowance shall be made in\nrespect of such expenditure:\ni). The SEBI Act, 1992,\nii). The Securities Contracts (Regulation) Act, 1956,\niii). The Depositories Act, 1996,\niv). The Competition Act, 2002.\n23.

2. The Patent Act is conspicuously absent from this list. This makes the\nlegislative intent clear that settlement payments in relation to patent disputes\nare not intended to be disallowed.\n23.