Date:29/06/2009 URL: http://www.thehindu.com/thehindu/biz/2009/06/29/stories/2009062950021300.htm

QUESTIONS & ANSWERS

Breach of contract is different from breach of law

As a tax advisor in tax practice, I find that it is not infrequent that the assessing officers disallow compensation or damages paid for breach of a contract as a payment for breach of law, which is specifically disallowed under the amended Sec. 37(1). Even apart from the provision, there is a general feeling that a person has to carry on business within the bounds of law and that the breach of contract is not permissible. Such payment according to the opinion generally adopted by many officers is that it is penalty so as to require disallowance. I would like to have some authority for resisting such an unfair inference.

The law is well-settled that the breach of contract in the ordinary course of business is not to be treated as violation of law, even as pointed out by the Supreme Court in CIT v Amalgamated Development Ltd. (1967) 65 ITR 395 (SC), where the breach took place admittedly to take advantage of the ruling market conditions.

Such compensation was held allowable as a deduction in South India Viscose Ltd. v CIT (1982) 135 ITR 206 (Mad) and Jamna Auto Industries v CIT (2008) 299 ITR 92 (P&H).

There are a number of other decisions to the same effect.

Payment of a fine for violation of import regulations or for violation of foreign exchange law may well be not deductible though the law strangely would allow the same, if the assessee’s business itself was totally illegal as was decided in CIT v Piara Singh (1980) 124 ITR 40 (SC), so that a person in regular business made liable for a fine would be in a worse position than a smuggler or those engaged in such other illegal businesses.

However, it may be pointed out that even a penalty for violation of law need not always be disallowed as was pointed out by the Supreme Court in Prakash Cotton Mills P. Ltd. v CIT (1993) 201 ITR 684 (SC), where penalty has the character of it being compensatory and not punitive, as in the case of some sales tax penalties.

Breach of contract is between the two contracting parties, while breach of law is one between a citizen and the Government. There is a fundamental difference, so that even for income-tax purposes, this distinction cannot be ignored.

S. RAJARATNAM