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JUDGEMENTS                                               I.T.R. 2/1977                                           Back to Index

HIGH COURT OF JAMMU AND KASHMIR AT SRINAGAR
I.T. REF NO. 2/1977

Date of decision: 9th May,2000

The Commissioner of Income-tax Amritsar v/s    M/S New Alpine Forests,  Residency Road, Srinagar.
Coram:
The Hon’ble Mr. Justice Dr. B. P. Saraf, Chief Justice.
The Hon’ble Mr. Justice N. A. Kakru, Judge.

Whether approved for reporting: Yes
For the Petitioner(s): Mr. Anil Bhan, Sr. CGSC.
For the Respondent(s): None appears.

JUDGEMENT AND ORDER

Per Dr.B.P.Saraf, Chief Justice (Oral)

By this reference under section 256(1) of the Income-tax Act, 1961 ("Act"), the Income-tax Appellate Tribunal, Amritsar Bench, Amritsar ("Tribunal") has referred the following question of law to this Court for opinion at the instance of the revenue:

"Whether on the facts and in the circumstances of the case, the tribunal was justified in law in holding that the amount of interest payable on belated payment of royalty to the Forest Department during the assessment year 1972-73 was an admissible deduction?"

.

As is evident from the question, the controversy in this case pertains to the allowability of interest payable on belated payments of royalty to the Forest Department as a deduction under section 37(1) of the Act. The material facts of the case, giving rise to this reference, are as follows: The assessee, who is a forest contractor, took lease of certain forests from the Forest Department of the Government of Jammu & Kashmir for which it was required to pay royalty to the Forest Department. In terms of clause 7 of the lease deed, in case of delay in payment of royalty, the assessee was also liable to pay interest at the rate of 9 percent per annum for the period of delay. Under the above clause, the Chief Conservator of Forests was, however, empowered to reduce the rate of interest not below 6 percent per annum for sufficient reasons to be recorded by him. In the previous year relevant to the assessment year, 1972-73, the assessee was required to pay a sum of Rs.1, 10,980/- by way of interest on delayed payment of royalty. The assessee claimed that amount as an allowable expenditure in its assessment for the assessment year 1972-73. The Income-tax Officer disallowed the assessee’s claim on various grounds, namely, that there was no provision made in accounts for the payment of any such interest, that it was in the nature of a penalty, that the calculation of interest was not correct with reference to the quantum of royalty and finally that the assessee had not charged any interest from M/S Sheikh Abdul Rashid & Co. from whom a sum of s.1, 97,330/- was due. The assessee appealed against the above order to the Appellate Assistant Commissioner .The Appellate Assistant Commissioner dismissed the appeal and upheld the disallowance made by the Income-tax Officer as he was of the opinion that the payment of interest on delayed payments of royalty was in the nature of penalty. Against the above order, the assessee appealed to the Income-tax Appellate Tribunal. The Tribunal, on hearing the parties, allowed the appeal of the assessee. The Tribunal held that the interest paid by the assessee to the Forest Department on belated payment of royalty was an allowable deduction as the assessee had not violated the provisions of any statute but entered into a lease agreement in the course of its business for which certain amount of royalty was payable in instalments and the contract of lease itself envisaged possible default in timely payment of royalty and provided for the charging of interest for delayed payments. Aggrieved by the above order, the revenue is before us by way of this reference.

We have heard Mr. Anil Bhan, learned counsel for the revenue. Mr Bhan fairly stated that if on the facts and in the circumstances of this case, the payment of interest under clause 7 of the lease deed can be regarded as payment of compensation to the Forest Department for delay in payment of royalty, it would be allowable as a deduction under section 37(1) of the Act in view of the law laid down by the Supreme Court in Mahalakshmi Sugar Mills Co v CIT (1980) 123 ITR 429.

We have carefully considered the above submission. Law is well settled that if any expenditure incurred by the assessee is compensatory in nature, deduction has to be allowed under section 37(1) of the Act in respect thereof. If the expenditure is found to be penal in character, no deduction can be allowed in respect thereof. However, where the expenditure is found to be of composite nature, that is, partly of compensatory nature and partly of penal nature, the authorities have to bifurcate the two components of the impost and give deduction of that component which is compensatory in nature and refuse to give deduction of that component which is penal in nature.

In Mahalakshmi Sugar Mills Co. v CIT (supra), the Supreme Court had to decide whether interest paid by the assessee under section 3(3) of the U.P. Sugarcane Cess Act, 1956 ("Cess Act") for delayed payment of cess payable thereunder was an allowable expenditure under section 10(2)(xv) of the Income-tax Act, 1922 (corresponding to section 37(1) of the Income-tax Act, 1961). The Supreme Court, on examination of the scheme of the Cess Act, held that the interest payable on an arrears of cess was in reality part and parcel of the liability to pay cess. It was observed:

" … the interest payable on an arrear of cess under s.3 (3) is in reality part and parcel of the liability to pay cess. It is an accretion to the cess. The arrear of cess ‘carries’ interest; if the cess is not paid within the prescribed period a larger sum will become payable as cess. The enlargement of liability is automatic under s.3 (3). No specific order is necessary in order that the obligation to pay interest should accrue. The liability to pay interest is as certain as the liability to pay cess. As soon as the prescribed date is crossed without the payment of the cess, interest should accrue…. In truth, the interest provided under s.3 (3) is in the nature of compensation paid to the Government for delay in the payment of cess. …".

In Prakash Cotton Mills P.Ltd. v CIT (1993) 201 ITR 684, the Supreme Court referred the above decision with approval and observed:

"…Therefore, whenever any statutory impost paid by an assessee by way of damages or penalty or interest is claimed as an allowable expenditure under section 37(1) of the Income-tax Act, the assessing authority is required to examine the scheme of the provisions of the relevant statute providing for payment of such impost notwithstanding the nomenclature of the impost as given by the statute, to find whether it is compensatory or penal in nature. The authority has to allow deduction under section 37(1) of the Income-tax Act, wherever such examination reveals the concerned impost to be purely compensatory in nature. Wherever such impost is found to be of a composite nature, that is, partly of compensatory nature and partly of penal nature, the authorities are obligated to bifurcate the two components of the impost and give deduction to that component which is compensatory in nature and refuse to give deduction to that compontent which is penal in nature."

It is clear from the above decisions of the Supreme Court that when an amount paid by an assessee as interest or damages or penalty could be regarded as compensatory in character, the authority has to allow deduction under section 37(1) of the Act, if it has been laid out wholly and exclusively for the purpose of the business.

In the light of the above legal position, we may now examine the facts of the present to decide whether the interest payable by the assessee for delay in payment of royalty to the Forest Department is allowable as a deduction under section 37(1) of the Act. For that purpose we shall have to ascertain the real nature of " interest" in the present case. In other words, whether the amount payable as "interest " under clause 7 of the lease deed, is in truth "interest" or "penalty" in the garb of interest.

"Interest" as understood in the commercial world, is the return or compensation for the retention by one person of a sum of money belonging to or owed to another. The essence of interest is that it is a payment that becomes due because the creditor has not had his money at the due date. It may be regarded either as representing the profit he might have made if he had the use of money, or conversely, the loss he suffered because he had not that use. The general idea is that he is entitled to compensation for the deprivation. It is this compensation which is allowable as a deduction under section 37(1) of the Act. In the instant case, the liability to pay interest is not statutory. It is contractual. It is by virtue of the provision in clause 7 of the lease deed that the assessee was liable to pay interest at the rate of 9 percent per annum for the period of delay in the payment of royalty. It is the arrear of royalty that carries interest. The liability to pay interest is as certain as the liability to pay royalty except that in certain circumstances the Chief Conservator is empowered to reduce the rate of interest not below 6 per cent per annum. The power to reduce the rate of interest cannot, however, change the real nature and character of the liability, which obviously is "compensation for the deprivation of the use of money". Interest payable on arrears of royalty, in reality, is part and parcel of the liability to pay royalty. It is an accretion to the royalty. If royalty is not paid within the stipulated period, a larger sum is payable as royalty. Interest payable under clause 7 of the lease deed is thus nothing but compensation paid to the Forest Department for delay in the payment of royalty. By no stretch of imagination, it can be regarded as penalty.

It is obvious from the above discussion that the interest payable under clause 7 of the lease deed to the Forest Department for delayed payment of royalty is compensatory in nature .As there is no dispute in the instant case that the payment of interest represents expenditure laid out wholly and exclusively for purpose of the business, it is allowable as a deduction under section 37(1) of the Act.

We are, therefore, of the clear opinion that on the facts and in the circumstances of this case, the tribunal was justified in law in holding that the amount of interest payable on belated payment royalty to the Forest Department during the assessment year 1972-73 was an admissible deduction under section 37 (1) of the Act. In view of the above, we answer the question referred to us in the affirmative, that is, in favour of the assessee and against the revenue.

This reference is disposed of accordingly with no order as to costs.