The Kolkata bench of the Income Tax Appellate Tribunal, recently ruled that the demurrage charges and penalty charges paid by a contractor to the Companies for violation of the contractual terms are allowable as deduction under section 37(1) of the Income Tax Act, 1961. Earlier, the assessing Officer had disallowed the said expenditure by holding that the payments are penal in nature.
The assessee, in the instant case was a contractor, who made payments to the Steel Authority of India and Central Coalfields Limited, on account of demurrage charges and penalty charges for breach of the contractual terms entered with these companies. While filing return, the assessee claimed deduction under the provisions of the Income Tax Act, which was disallowed by the assessing authority for the reason that the said payment is penal in nature and therefore, deduction under section 37(1) cannot be allowed.On appeal, the CIT(A) deleted the addition. Hence, the Revenue preferred an appeal before the Tribunal.
The sole issue to be resolved by the Tribunal was that whether demurrage charges and penalty charges imposed by Steel Authority of India Ltd and Central Coal Fields Ltd, are liable to be disallowed or not.
The Tribunal noted the fact that the assessee is contractually bound by the Steel Authority of India, and Central Coalfields Limited to act in various capacities. The demurrage arose out of the failure of the assessee to complete the work within the prescribed time allotted by the principal of the contractees and the same was deducted from the payments made to the contractees of the assessee who, in turn, deducted the same from the payments made to the assessee. In the opinion of the Tribunal, such imposition of demurrage charges is usual in this line of business and therefore, there is no infringement of any law, the failure of which has led to the instant imposition of demurrage but merely due to inability to comply with certain terms of the contract, the levy was imposed.
While allowing the contentions of the assessee, the Tribunal observed that “The statutory prescription contained in the Explanation along with the provisions of sec. 37(1) Act prohibits deduction of expenditure incurred by the assessee for any purpose which is an offence or which is prohibited by law as being opposed to public policy. In the instant case, incurring of the expenditure on demurrage and claiming the same as an expense was not for an offence nor prohibited by law as being opposed to public policy.
In the instant case, there was a specific requirement to complete the work in time and a clause for imposing punitive charges was included for any default. These rights and obligations arose in course of carrying on of the business of the respondent. Therefore, this payment made under a contractual obligation is to be allowed u/s. 37(1) of the Act.”
“We find that the payments in the form of punitive charges made by the assessee could under no circumstances be regarded as illegal payments or payments which were opposed to public policy. We find that as long as the payment made is not by way of default on account of infraction of any law and / or opposed to public policy, the same would be allowable as deduction. We hold that in the instant case, the punitive charges paid are only compensatory in nature pursuant to the contractual obligation which is directly connected or intrinsically related with the carrying on of its business which unequivocally qualifies as an allowable deduction u/s 37(1) of the Act. It is well settled that the nomenclature used in any provision of law to describe any payment, to be made by any person, as interest, compensation, penalty , etc is not conclusive. It is incumbent on the part of the authorities to construe the provisions as a whole to find out the true nature of the impost sought to be levied. In certain cases, the impost may be composite comprising of element of compensatory nature as well as penalty nature.”
Read the full text of the order below.
