Destruction of Pan Masala stock on court’s order due to impermissible limits of magnesium carbonate disallowed u/s 37(1) being prohibited by law and not incurred for the purpose of business – ITAT
ABCAUS Case Law Citation:
ABCAUS 2124 (2017) (11) ITAT
The instant appeal was filed by the Assessing Officer (AO) which inter alia was directed against the order passed by the CIT(A) whereby he deleted the addition made by the AO u/s 37(1) of the Income Tax Act, 1961 (the Act) on account of stock of goods destroyed by the assessee in compliance of the court’s order.
Brief Facts of the Case:
The assessee was is a manufacturer of pan masala. During the course of scrutiny assessment proceedings, the AO noticed that the assessee had claimed a deduction in respect of the goods produced by the assessee which, in terms of a court order under the Prevention of Food Adulteration Act, had to be destroyed as it was found the said goods had magnesium carbonate, a known carcinogenic substance, in excess of permissible limits.
The claim of the assessee was that since the loss so incurred was in the course of business inasmuch as the goods had to be destroyed by the authorities ceasing it, as is the scheme of the prevention of food adulteration law, the related costs of producing the said goods is to be allowed as deduction.
The AO, however, declined the claim of deduction by invoking the provisions of Explanation to Section 37(1), which, inter alia, lays down that any expenditure incurred by the assessee for the purpose which is an offence or which is prohibited by law shall not be deemed to have been incurred for the purpose of business, and, is, accordingly not admissible as deduction in computation of business income.
Aggrieved, the assessee carried the matter in appeal before the CIT(A), and the CIT(A) reversed the action of the Assessing Officer holding that the destruction of stock containing impermissible levels of magnesium carbonate was a loss incurred during the course of bonafide business and is not hit by Explanation to Section 37(1).
The AO thus approached the Tribunal against the relief granted by the CIT(A).
Observations made by the Tribunal:
The ITAT observed that under section 37(1) of the Act, subject to exceptions provided, any expenditure laid out or expended wholly and exclusively for the purposes of the business or profession is allowed and, therefore, as long as the stock containing impermissible limits of magnesium carbonate was destroyed in the course of assessee’s business, the assessee was entitled to deduction under section 37(1).
However, the ITAT further noted that there has been a paradigm shift in the scheme of the Act, by insertion of Explanation to Section 37(1) by Finance (No. 2) Act 1998 with retrospective effect from 1st April 1962, which lays down the rider to the mandate of Section 37(1) by stating that “for the removal of doubts, it is hereby declared that any expenditure incurred by an assessee for any purpose which is an offence or which is prohibited by law shall not be deemed to have been incurred for the purpose of business or profession and no deduction or allowance shall be made in respect of such expenditure”. Thus, the additional test to be satisfied, in order to ensure deductibility of an expenditure, is that it must not be incurred for any purpose which is an offence or prohibited by law.
The ITAT observed that Pan masala is a controversial product and, even when it is manufactured within the permissible legal norms, it is considered to be responsible for oral cancer and other severe ill effects on health. The assessee had gone even further against the public interests by using carcinogenic substance, which is direct cause of cancer, much in excess of permissible limits, resulting in manufacture of product with substantial health hazard sand that is the reason that the related stocks had to destroyed by the law enforcement agencies.
The ITAT opined that whether the presence of the substance in excess of the permissible limits was due to a bonafide mistake of the assessee or a conscious decision to make the product even more attractive to the customers, was irrelevant. The magnesium carbonate levels in the products manufactured by the assessee were impermissible in law and thus the expenditure, on account of making this product, was something which is admittedly “prohibited by law”. Thus, the expenses on manufacturing such a noxious product, whether deliberately or inadvertently cannot, therefore, be allowed as deduction under section 37(1) on account of disabling provisions of Explanation 1 to Section 37(1).
The ITAT opined that what had been claimed as a deduction was the expense incurred on manufacturing the product which was destroyed by the law enforcement agencies due to its high carcinogenic content levels. The Assessing Officer was indeed justified in declining the deduction.
Regarding the contention that since the assessee was not imposed any penalty or any other proceedings for manufacturing the said product and it was clearly a case of inferior quality, the ITAT observed that admittedly the product had level of carcinogenic substance was in excess of permissible levels and the manufacturing of such product was prohibited by law, and that is all that is necessary for invoking Explanation to Section 37(1). Whether the penalty was actually imposed, or even initiated for such an infraction of law, is not really relevant for the purpose of satisfying the requirements of Explanation 1 to Section 37(1) because as long as the expenditure is incurred for a purpose which is prohibited by law, it is immaterial whether the said act of the assessee constitutes an offence or not. The ITAT rejected the plea taken by the assessee as devoid of legally sustainable merits.
The ITAT expressed concern that our laws sometime appear to be so lax and unresponsive that even those responsible, with or without any ulterior motives, for such serious health hazards escape the exemplary punishment. What is even more disturbing is the indifferent attitude to the assessee to the possible damage their products could have caused, and, without any remorse or regret in his conduct, claim business deduction of expenses incurred in products which could have seriously endangered health of the consumers of his product.
The ITAT placed on record the gracious conduct by the counsel of the assessee, who, on being told about what the Bench felt about the situation, whatever be the legal merits of the claim left the matter to the bench.
The Tribunal vacated the order of the CIT(A) on this point and restored the disallowance made by the AO u/s 371(1).