Law:

Section:

Section 145 of the income-tax act, 1961-Method of accounting-Year in which liability/expenditure deductible-During assessment year 1967-68, notices served on assessee by military authorities for levying penalty for non-completion of contract in time-assessee following mercantile system of accounting, accepted liability and made a provision for it in its profit and loss account of assessment year 1967-68-Whether liability was deductible in assessment year 1967-68-Held, on facts, yes Section 37(1) of the income-tax act, 1961-Business expenditure-Whether damages/penalty paid by assessee-contractor to government for non-completion of contract work in time is deductible-held, yes Facts The assessee, being military contractors, while computing the net profit for the assessment year 1967-68, took into account a certain amount being penalty leviable by the military authorities for non-completion of the work within the stipulated time. The ITO and, on appeal, the AAC held that this amount was not a deductible item of expenditure. On second appeal, the Tribunal having found (i) that the notices seeking to levy penalty were served on the assessee ; (ii) that the assessee-followed the mercantile system of accounting ; and (iii) that the amount was shown as liability accrued on account of non-completion of work in time, held that the assessee was entitled to deduct this liability from the profits and gains of the business. On reference: Held 1. Undoubtedly, the assessee had accepted the impugned liability and made a provision for it in its profit and loss account. The Tribunal also seemed to have proceeded on the footing that the work was not completed in time, resulting in accrual of the impugned liability. Such a liability which had accrued was clearly a permissible deduction. 2. It is no doubt true that the amount of which deduction was sought, was described by the Tribunal as a penalty but in effect it was really compensation payable by the contractor to the Government and the nature thereof was wholly different from penalty which arises from a breach of a statutory provision. The Tribunal was, thus, justified in allowing the said amount as deduction. Case review…

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