THE ACIT, CIRCLE-3(2),, AHMEDABAD vs. M/S. VISHNU PACKAGING,, AHMEDABAD

This appeal, filed by the Assessing Officer, is directed against the order dated 12.05.2016 passed by the CIT(A)-3, Ahmedabad in the matter of assessment under Section 143(3) of the Income-tax Act, 1961, for the assessment year 2012-13.

In ground no. 1, the appellant Assessing Officer has raised the following grievance:

Ground no. 1 is dismissed.

In ground no. 2, the appellant Assessing Officer has raised the following grievance: “The Ld. CIT(A) has erred in law and on facts in deleting the addition of Rs.30,80,000/- made on account of goods destroyed as per court’s order.” 6. So far as this grievance of the Assessing Officer is concerned, the relevant material facts are as follows. The assessee before us is a manufacturer of pan masala. During the course of scrutiny assessment proceedings, the Assessing Officer noticed that the assessee as claimed a deduction of Rs 30,80,000 in respect of the goods produced by the assessee which, in terms of a court order under the Prevention of Food Adulteration Act, had to be destroyed as it was found the said goods had magnesium carbonate, a known carcinogenic substance, in excess of permissible limits. The claim of the assessee was that since the loss so incurred was in the course of business inasmuch as the goods had to be destroyed by the FDI authorities ceasing it, as is the scheme of the prevention of food adulteration law, the related costs of producing the said goods is to be allowed as deduction. The Assessing Officer, however, declined this claim of deduction by invoking the provisions of Explanation to Section 37(1), which, inter alia, lays down that any expenditure incurred by the assessee for the purpose which is an offence or which is prohibited by law shall not be deemed to have been incurred for the purpose of business, and, is, accordingly not admissible as deduction in computation of business income. Aggrieved, assessee carried the matter in appeal before the CIT(A), and the CIT(A) reversed the action of the Assessing Officer and held that the destruction of stock containing impermissible levels of magnesium carbonate was a loss incurred during the course of bonafide business and is not hit by Explanation to Section 37(1). The deduction was thus allowed. The Assessing Officer is aggrieved of the relief so granted by the CIT(A) and is in further appeal before us.

It is no doubt true that under section 37(1) of the Act, “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", and, therefore, as long as the stock containing impermissible limits of magnesium carbonate was destroyed in the course of assessee’s business, which admittedly it was, the assessee is entitled to deduction under section 37(1). However, there is a paradigm shift in the scheme of the Act, by insertion of Explanation to Section 37(1) by Finance (No. 2) Act 1998 with retrospective effect from 1st April 1962, which lays down the rider to the mandate of Section 37(1) by stating that “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”. The additional test to be satisfied, in order to ensure deductibility of an expenditure, is that it must not be incurred for any purpose which is an offence or prohibited by law.

The reason as to why the stock had to be destroyed in the present case was that it contained impermissible high levels of a carcinogenic substance by the name of magnesium carbonate. Pan masala is a controversial product and, even when it is manufactured within the permissible legal norms, it is considered to be responsible for oral cancer and other severe ill effects on health. In the present case, the assessee has gone even further against the public interests. He has used the carcinogenic substance, which is direct cause of cancer, much in excess of permissible limits, resulting in manufacture of product with substantial health hazard sand that is the reason that the related stocks had to destroyed by the law enforcement agencies. Whether this situation is due to a bonafide mistake of the assessee or a conscious decision to make the product even more attractive to the customers, is irrelevant. The magnesium carbonate levels in the products manufactured by the assessee were impermissible in law and thus the expenditure, on account of making this product, was something which is admittedly “prohibited by law”. The expenses on manufacturing such a noxious product, whether deliberately or inadvertently cannot, therefore, be allowed as deduction under section 37(1) on account of disabling provisions of Explanation 1 to Section 37(1). What has been claimed as a deduction in the present case is the expense incurred on manufacturing the product which was destroyed by the law enforcement agencies due to its high carcinogenic content levels. The Assessing Officer was indeed justified in declining

In view of the above discussions, as also bearing in mind the entirety of the case, we vacate the order of the CIT(A) on this point and restore the disallowance of Rs 30,80,000.

Ground no. 2 is thus allowed.

In the result, the appeal is partly allowed in the terms indicated above. Pronounced in the open court today on the 15th th day of November, 2017.