JUDGMENT R.L. Gulati, J.
1. This is a reference under Section 256(1) of the Income-tax Act, 1961. The reference relates to the assessment year 1963-64.
2. The assessee is a partnership firm owning two sugar factories--one at Bhatni in district Deoria and the other at Motinagar in district Faizabad. At the end of the relevant previous year the assessee made a provision in its books of accounts for the payment of a sum of Rs. 1,04,023 towards interest due on arrears of cess and purchase tax, an amount which the assessee had become liable to pay but had not paid during the relevant previous year. The yum of Rs. 1,04,023 is made up of two items, (i) Rs. 1,02,461 in respect of interest payable on arrears of cess, and (ii) Rs. 1,352 in respect of interest on arrears of purchase tax in respect of Bhatni Mills, The assessee claimed to deduct this amount from its profits liable to income-tax. The claim was disallowed by the Income-tax Officer on the ground that the provision for interest represented a contingent liability only. The Appellate Assistant Commissioner of Income-tax did not agree with this view and held that the amount in question represented an accrued liability and, as such, was an allowable deduction. The department took the matter in appeal before the Income-tax Appellate Tribunal.
Before the Tribunal, the view of the Appellate Assistant Commissioner that the amount represented an accrued liability was not challenged but the deduction of the amount was contested on another ground. It was urged that the assessee had become liable for payment of interest because it violated the provisions contained in Section 3(2) of the U. P. Sugarcane Cess Act, 1956, as validated by the U. P. Sugarcane (Validation) Act, 1961. Similarly, the interest on purchase tax had become payable because the assessee had contravened a similar provision of the Sugarcane Purchase Tax Act, 1961. The interest, therefore, was in the nature of penalty and could not be allowed as business expenditure. The Tribunal accepted the contention and in doing so relied upon a decision of the Supreme Court in the case of Haji Aziz and Abdul Shakoor Bros, v. Commissioner of Income-tax, [1961] 41 ITR 350 (SC) and a decision of the Delhi High Court in the case of Commissioner of Income-tax v. Mahalaxmi Sugar Mills Ltd., [1972] 85 ITR 320 (Delhi) On this view the Tribunal allowed the department's appeal holding that the assessee v/as not entitled to deduct the amount of interest from its profits liable to tax. At the instance of the assessee, however, the Tribunal has referred the following question of law for our opinion :
"Whether the Income-tax Appellate Tribunal erred in holding that the assessee's claim for deduction of a sum of Rs. 1,04,023.43 being the payment made on account of interest as a result of violation of the provisions of Section 3(3) of the U. P. Sugarcane Cess Act, 1956, was not a business expenditure ?"
3. Before we proceed to answer the question, we must point out that the question as framed by the Tribunal is not happily worded and is also inaccurate. The entire sum of Rs. 1,04,023.43 is not the interest under the U. P. Sugarcane Cess Act but a part of it (Rs. 1,352) is under the U. P. Sugarcane Purchase Tax Act, 1961. Moreover, the interest has not been charged for violation of Section 3(3) of the Cess Act or of the Purchase Tax Act but it has been charged under Section 3(3) for the failure of the assessee to pay the tax in time as required by Section 3(2) of the two Acts. The more serious infirmity with which the question suffers is that it presumes that the deduction was claimed as business expenditure under Section 37 of the Income-tax Act. The assessee no doubt based its claim on that provision but it also claimed deduction in the alternative under Section 28(1) of the Income-tax Act. This is clear from the statement of the case annexed by the assessee to its application under Section 256(1), which has not been controverted by the department. This is what has been stated in the ultimate paragraph of the statement:
"The Appellate Tribunal overruled the plea of the applicant that even if deduction of the sum was found not to be permitted under Section 37 (corresponding to Section 10(2)(xv) of the 1922 Act) of the Income-tax Act, 1961, as a business expenditure following the above decisions, nevertheless it was liable to be allowed under Section 28(1) (corresponding to Section 10(1) of the Act of 1922) of the Income-tax Act, 1961, as an outgoing necessarily incurred in carrying out the business." We, accordingly, reframe the question to eliminate the inaccuracy and to bring out the real controversy between the parties. The reframed question would read :
"Whether, on the facts and in the circumstances of the case, the Tribunal was right in disallowing the deduction of an aggregate sum of Rs. 1,04,023 payable by the assessee as interest on arrears of cess and arrears of purchase tax in the computation of its business profits for the assessment year 1963-64 ?"
4. Before we examine the admissibility of the deduction claimed by the assessee, it is necessary to ascertain the true nature of the amount. Section 3 of the U. P. Sugarcane Cess Act, 1956 (hereinafter referred to as the Cess Act), provides for the imposition of cess tax. Under Sub-section (1) of Section 3 of the Cess Act the State Government may by notification in the official Gazette impose a cess not exceeding four annas per maund on the entry of cane into the premises of a factory for use, consumption or sale therein. Sub-section (2) then provides :
"(2) The cess imposed under Sub-section (1) shall be payable by the owner of the factory and shall be paid on such date and at such place as may be prescribed." Then comes Sub-section (3), which says:
"(3) Any arrear of cess not paid on the date prescribed under subsection (2) shall carry interest at 6 per cent. per annum from such date to date of payment."
It is under this provision that the assessee had become liable to pay interest for which he made a provision in the account books. Similar is the position with regard to the Sugarcane Purchase Tax Act, 1961 (hereinafter referred to as the Purchase Tax Act). There also the tax is imposed by Section 3 and under Sub-section (2) it has to be paid within the time and in the manner prescribed. Sub-section (3) then provides for payment of interest if the amount is not paid within the prescribed time. The assessee has become liable to pay interest under this provision in respect of the arrears of purchase tax.
5. Now, let us examine the relevant provisions of the Income-tax Act, 1961. Section 28 deals with the profits and gains of business or profession. Section 29 then provides the manner in which the income from profits and gains of business or profession shall be computed. It says that the income referred to in Section 28 shall be computed in accordance with the provisions contained in sections 30 to 43A. Sections 30 to 43A enumerate various deductions which have to be made while computing the net profits of a business. The material sections for our purposes are sections 36 and 37. Section 36{l)(iii) provides for the deduction of the amount of interest paid in respect of capital borrowed for the purposes of the business or profession. Here we are dealing with the interest no doubt, but interest is not on capital borrowed for the purposes of business or profession. So this provision will not be attracted. Section 37 is a residuary section and provides:
"Any expenditure (not being expenditure of the nature described in sections 30 to 36 and not being in the nature of capital expenditure or personal expenses of the assessee), laid out or expended wholly and exclusively for the purposes of the business or profession shall be allowed in computing the income chargeable under the head ' profits and gains of business or profession'."
It is under this provision that the Tribunal has considered the assessee's case even though it has not said so in its appellate order. We shall, for the time being, presume that Section 37 is applicable. Now, the payment of cess and purchase tax on sugarcane consumed by the assessee in its factory for production of sugar is an expenditure laid out wholly and exclusively for the purposes of business, inasmuch as these levies directly increase the cost of sugarcane. This position is not disputed. On principle, we see no reason why interest payable on such levies should also not be a permissible deduction. If the principal (made up of cess and purchase tax) is a permissible deduction the interest payable thereon would also be a permissible deduction because principal and interest together constitute the assessee's liability.
6. We have already noticed that any interest paid by a businessman on the capital borrowed for the purposes of business is an allowable deduction under Section 36(1)(iii) and any interest paid by a businessman in respect of any of its business liability which is not an interest on borrowed capital would be an allowable deduction under Section 37 as being expenditure laid out wholly and exclusively for the purposes of the business. If a businessman purchases goods on credit with the stipulation to pay interest, in case the payment is not made within a specified time, such interest will be a business expenditure and would be an allowable deduction in the computation of business profits. Now, the payment of cess and purchase tax is admittedly a business liability and if the assessee had to pay interest on the arrears of cess and purchase tax, for its failure to make payment within time, we see no reason why interest should not be an allowable deduction. In the illustration which we have given, interest is payable under a contract while in the instant case interest is payable under a statute, but the nature of interest is the same in both the cases, namely, the failure of the businessman to discharge his obligation within the stipulated time. On principle we see no difference between a contractual liability and a statutory liability of this nature.
7. The Tribunal has described the interest as penal interest and has disallowed the same on the ground that it is in the nature of penalty. Section 3(3) of the Cess Act does not call the interest as penal and it is not a penalty. Indeed, penalty has been provided in Sub-section (5) which reads:
"(5) Where any person is in default in making the payment of the cess, the officer or authority empowered to collect the cess may direct that in Addition to the amount of the arrears and interest a sum not exceeding 10 per cent. thereof shall by way of penalty be recovered from the person liable to pay the cess."
No penalty in the instant case has been levied under this provision. What has been levied is the interest under Sub-section (3) and the two have been distinctly dealt with under the Act. This is clear from Sub-section (6) which provides:
"(6) The officer or authority empowered to collect the cess may forward to the Collector a certificate under his signature specifying the amount of arrears including interest due from any person, and on receipt of such certificate the Collector shall proceed to recover the amount specified from such person as if it were an arrear of land revenue." (Underlining Here printed in italics ours).
Sub-section (7) then makes a separate provision for recovery of penalty and is in the following words :
"(7) Any sum imposed by way of penalty under Sub-section (5) shall be recoverable in the manner provided in Sub-section (6) for the recovery of the arrears of cess."
Clearly, the legislature itself has made a distinction between interest and penalty and while interest and cess have been treated at par, penalty has been dealt with separately. In Sir Shadi Lal Sugar & General Mills Ltd. v. Commissioner of Income-tax, [1976] 103 ITR 748 (All) (ITR No. 180 of 1973, decided on August 17, 1974), a Bench of this court had to deal with penalty under Section 3(5) of the Cess Act. There it was held that a penalty under Section 3(5) was not an allowable deduction. That case is clearly distinguishable because in the instant case we are concerned with interest under Sub-section (3) and not with penalty under Sub-section (5). The case of Haji Aziz and Abdul Shakoor Bros. v. Commissioner of Income-tax, [1961] 41 ITR 350 (SC) upon which main Reliance has been placed, is also distinguishable. That was also a case of fine and not of interest. There the assessee imported dates from Iraq partly by steamer and partly by country craft at a time when import of dates by steamer was prohibited. The dates which were imported by steamer were confiscated by the customs authorities under Section 167 of the Sea Customs Act. Under Section 183 of that Act the assessee was given the option to have the dates released on payment of fine. The assessee paid the fine and sought to deduct it from its business profits. This deduction was refused by the Supreme Court on the ground that a penalty for infraction of law could not be said to be a legitimate business expenditure. Clearly, that was also a case of penalty and not of payment of interest for delayed payment of tax.
8. The case of Commissioner of Income-tax v. Mahalaxmi Sugar Mills, [1972] 85 ITR 320 (Delhi) is a case directly dealing with the point arising in the instant case. There also the question arose as to whether interest paid under Section 3(3) of the Cess Act was allowable deduction. The Delhi High Court has held that the deduction was not permissible. With respect we are unable to agree with the learned judges of the Delhi High Court. The distinction between interest and penalty as has been pointed out by us was not brought to the notice of the learned judges of the Delhi High Court.
9. We might observe that there are a large number of statutes which provide for the payment of interest on delayed payments of Government dues and also provide for penalties and fines for such default. For example, for failure to pay advance tax in accordance with Sub-section (3) of Section 18A of the Indian Income-tax Act, 1922, interest is chargeable under Sub-section (6) of that section and a penalty is provided under Sub-section (9) for submitting a false estimate for the purposes of advance tax. The Madras High Court in N.V.N. Nagappa Chettiar v. Income-tax Officer, Pudukottai, [1958] 34 ITR 583 (Mad) held that interest charged under Sub-section (6) and Sub-section (8) of Section 18A was an impost in the same manner as an income-tax and there is no element of penalty either in Sub-section (6) or Sub-section (8), We are in respectful agreement with this view and hold that there is no element of penalty in the levy of interest under Section 3(3) of the Cess Act or under Section 3(3) of the Purchase Tax Act.
10. That apart, we are of the opinion that the assessee's alternative case stands on much stronger footing. It is now-well settled that permissible deductions enumerated in the Income-tax Act are not exhaustive. An item of loss or expenditure incidental to business may be deducted in computing profits and gains even though it does not fall in any of the deductions set out in the Income-tax Act, for the tax is on profits and gains properly so-
called and computed on ordinary commercial principles. This principle has been definitely established by the Privy Council in Commissioner of Income-
tax v. Chitnavis, [1932] 2 Comp Cas 464, 470, AIR 1932 PC 178. where a bad debt was held to be an admissible deduction, though there was no special allowance for bad debts in the 1922 Act, as it then stood. Lord Russell, delivering the judgment of the Board, said :
"Although the Act nowhere in terms authorises the deduction of bad debts of a business, such a deduction is necessarily allowable. What are chargeable to income-tax in respect of a business are the profits and gains of a year ; and in assessing the amount of the profits and gains of a year account must necessarily be taken of all losses incurred, otherwise you would not arrive at the true profits and gains."
11. In Badridas Daga v. Commissioner of Income-Tax, [1958] 34 ITR 10 (SC) and in Calcutta Co. Ltd. v. Commissioner of Income-tax, [1959] 37 ITR 1 (SC) the Supreme Court quoted the observations of Lord Russell with approval and held that an item of loss or expenditure not falling within any of the express deductions may be allowed if it is deductible on ordinary principles of commercial accounting. The liability of the assessee on account of cess and purchase tax is not in reality an expenditure, but it is a loss or an outgoing connected directly with the business. A business expenditure involves a volition. It is a voluntary Act on the part of a businessman to spand or set apart money for carrying on or in connection with his business with a view to earning profits. The payment of cess and purchase tax cannot be said to be voluntary expenditure incurred by an assessee for the purposes of his business. They are statutory exactions and so is the interest payable thereon. Such exactions really are in the nature of loss or an outgoing of an assessee which have to be taken into consideration in determining the true profits liable to tax under Section 28(1) itself. Under Section 28(1) of the Act the charge is not on gross receipts but profits and gains properly so-called. The word "profits" is to be understood, said Lord Halsbury in Gresham Life Assurance Society v. Styles, [1892] 3 TC 185 (HL) in its natural and proper sense--in a sense which no commercial man would misunderstand. This principle was approved by the Privy Council in Pondicherry Railway Co, Ltd. v. Commissioner of Income-tax, [1931] 5 ITC 363 (PC) and by the Supreme Court in Badridas Daga v. Commissioner of Income-tax, Calcutta. Co. Ltd. v. Commissioner of Income-tax and Commissioner of Income-tax v. Bai Shirinbai K. Kooka, [1962] 46 ITR 86 (SC). Subject to the special requirements of the Act, the profits to be assessed are the real profits and they must be ascertained on ordinary principles of commercial trading and commercial accounting. Lord Parker said in Usher's Wiltshire Brewery Ltd. v Bruce, [1914] 6 TC 399, 429 (HL) :
"......Where a deduction is proper and necessary to be made in order to ascertain the balance of profits and gains, it ought to be allowed.......
provided there is no prohibition against such an allowance......."
It is thus clear that profits should be computed after deducting the losses and expenditure incurred for the purposes of business unless the losses and expenditure are expressly or by necessary implication disallowed by the Act.
12. Now, cess and purchase tax are outgoings or losses which have to be deducted out of the gross profits in order to arrive at true profits and that is done under Section 28 itself without having resort to any of the provisions contained in sections 30 to 43A of the Income-tax Act. So is the case with interest payable on such cess or purchase tax. In Prafulla Kumar Malik v. Commissioner of Income-tax, [1967] 63 ITR 62 (SC) the Supreme Court had to deal with a similar question. There the assessee, a paddy procuring agent under the Government of Orissa, was required under an agreement to supply paddy and rice of a certain standard, known as "fair average quality". Under one of the clauses -in the agreement the Collector had the power to levy such penalty as he may deem fit for supply of foodgrains not conforming to the fair average quality. In exercise of this power the Collector imposed penalty upon the assessee for supplying sub-standard foodgrains. The assessee claimed to deduct this amount from its profits under Section 10(1) of the Indian Income-tax Act, 1922, which corresponds to Section 28(1) of the Income-tax Act, 1961. The deduction was allowed by the Tribunal but at the instance of the Commissioner of Income-tax the following question was referred to the Orissa High Court:
"Whether, on the facts and circumstances of the case, the amount of Rs. 25,700 paid by the assessee by way of penalty to the Government of Orissa shall be an admissible deduction under Section 10(1) of the Indian Income-tax Act, 1922 ?"
The High Court of Orissa disallowed the deduction on the ground that the deduction claimed was not admissible as it amounted to a penalty imposed on the appellant for his dishonest action in supplying sub-standard quality goods. On appeal the Supreme Court reversed this decision holding that the High Court misdirected itself and totally misunderstood the question. What, the appellants claimed was that in the computation of profits and gains of a business under Section 10(1), this amount should be deducted and in answering that question the High Court should not have gone into the question of the applicability of Section 10(2)(xv) at all and should have confined itself to deciding whether the amount was liable to be excluded when computing the income under Section 10(1), We might reiterate here that Section 10(1) of the Indian Income-tax Act, 1922, corresponds to Section 28(1) of the income-tax Act, 1961. The Supreme Court accordingly remanded the case to the High Court for answering the question afresh. On remand, the Orissa High Court (1969] 73 ITR 119 (Orissa) held that it was one of the normal incidents of the business of acting as a paddy procuring agent that sometimes the paddy may turn out to be of sub-standard quality and as a result the assessee may become liable to pay damages in the shape of fine or breach of warranty. Such a situation was incidental to the carrying on of the assessee's business. It was an unavoidable loss arising as one of the consequences of carrying on such business and, as such, the amount paid by the assessee by way of penalty to the Government was an admissible deduction in computing the profits of the business under Section 10(1) of the Act.
13. Precisely the same position prevails in the present case. We are of the opinion that the arrears of cess and purchase tax along with interest thereon are proper deductions to be made in computing the net profits liable to tax under Section 28(1) without having recourse to the provisions contained in sections 30 to 43A of the Act. In carrying on a business an assessee may not be able to discharge his financial commitments in time and as a result may become liable to pay damages or interest. Such a situation is a normal incident of business and any loss incurred by an assessee under such circumstances would be an allowable deduction. In the instant case, the assessee was not able to discharge his commitment to pay the cess and purchase tax in time and he was required to pay interest at the stipulated rate. There was no element of penalty in it. The provision for payment of interest was thus a business liability which the assessee was entitled to deduct in the computation of his business income.
14. Hence we answer the question as refrained by us in the negative, in favour of the assessee and against the department. The assessee is entitled to the costs which we assess at Rs. 200.