The Commissioner of Income Tax-9 vs M/s. Regalia Apparels Pvt. Ltd.

In this appeal by the revenue for assessment year 2004-05 following question of law has been raised for our consideration.

On the facts and in the circumstances of the case and in law whether the Tribunal is justified in deleting the addition made by the Assessing Officer of Rs. 40,10,437/- on account of penalty paid by the assessee to the Apparel Export Promotion Council even though the said expenses are not allowed u/s 37 of the Income Tax Act, 1961?

The respondent assessee is a manufacturer of garments. The Apparel Export Promotion Council (APEC) granted to the respondent assessee entitlements for export of garments and knit wares. In consideration for export entitlements the respondent assessee furnished bank guarantee in support of its commitment that it shall abide by the terms and conditions in respect of the export entitlements and produce proof of shipment. It was also provided that failure to fulfil the obligation to export would render the bank guarantee to being forfeited/encashed. In view of the fact that the respondent was incurring losses, it decided not to utilize the export entitlement which led APEC to encash the bank guarantee. The respondent recorded the said payment as penalty in its books of account and claimed deduction u/s 37(1) of the Income Tax Act, 1961 ("the Act"). Before the Assessing Officer, the respondent contended that nomenclature of penalty was erroneous as the payment made to AEPC was compensatory in nature and thus allowable as deduction u/s 37(1) of the Act. However, the Assessing officer did not accept the same and concluded that the forfeiture was in the nature of penalty and disallowed the expenses u/s 37(1) of the Act in view of the explanation thereto. On appeal, the CIT(A) deleted the disallowance and allowed the appeal. On further appeal by the revenue, the Tribunal confirmed the order of the CIT(A) and in particular, his findings of facts.

The contention of the revenue is that forfeiture/encashment of the bank guarantee is penal in nature and therefore, cannot be allowed as expenses u/s 37(1) of the Act in view of the explanation. Consequently, according to the revenue, the expenditure has been correctly disallowed by the Assessing officer.

We find the finding of fact recorded by the CIT(A) and upheld by the Tribunal was that respondent took a business decision not to honour its commitment of fulfilling the export entitlement in view of loss being suffered by it. The Assessing officer does not dispute this fact nor does he doubt the genuineness of the claim of the expenditure being for business purpose. In these facts the Tribunal held that respondent assessee has not contravened any provisions of law and thus the forfeiture of bank guarantee was compensatory in nature u/s 37(1) of the Act. In view of the above finding of fact, we see no reason to entertain the proposed question of law. Accordingly, the appeal is dismissed with no order as to costs.