Penalty for late supply of goods allowable deduction u/s 37 being not a crime or prohibited activity

Penalty levied for late supply of goods is an allowable deduction u/s 37 as late supply neither a crime nor a prohibited activity – ITAT

In a recent judgment, ITAT Delhi has deleted addition made u/s 37 of Income Tax Act on account of penalty due to late supply of goods holding that the late supply of goods by the assessee is neither a crime nor a prohibited activity.

ABCAUS Case Law Citation:
5026 (2026) (01) abcaus.in ITAT

The appellant assessee was engaged in the business of manufacturing of Pharmaceutical products and participate in Government Tenders. The Income Tax Return (ITR) of the assessee was processed u/s 143(1)(a) of the Act and a demand was raised.

The case was selected for complete scrutiny assessment under the assessment Scheme, 2019 on the issues of large sales promotion expenses vis-is gross receipts and huge loss from currency fluctuations.

The Assessing Officer (AO) noticed that the assessee had claimed expenses on account of the penalty on late supply of goods. In reply to notice u/s 142(1) of the Act the assessee submitted that the said amount was deducted by Government as the supply was got delayed by the assessee and as per tender agreement clause, the government department had levied penalty towards late supply of goods.

It was stated that the late supply expenses were allowable business expenditure u/s 37 of the Act as having been laid out wholly and exclusively for the purpose of the business of the assessee and not being in the nature of capital expenditure or personal expenses.

However, the AO did not agree to the submissions of the assessee observing that the assessee was habitual in making late supply spread over all the years, therefore, the said activity can be stated as an offence in nature and therefore the case of the assessee would fall in explanation 1 to Section 37. Hence, those expenses were disallowed and addition was made and penalty proceeding u/s 270A of the Act were initiated. 

The CIT(A), NFAC upheld the assessment order and confirmed the addition so made. 

The question before the Tribunal was as to whether the penalty amount paid for delayed supply of goods by the assessee to the various government departments would tantamount to an offences and Explanation 1 to Section 37 of the Act or not?

The Tribunal observed that both the AO and CIT(A) had misconstrued the provision of explanation 1 to section 37 of the Act, while making the impugned addition towards amount claimed as deduction of business expenses incurred by the assessee on the ground that the said amount was paid by way of penalty due to late supply and is thus becomes a type of activity which can be stated an offence in nature. Both the Lower authorities had not supported these observations by any statutory provision or any legal precedence, instead, they misconstrued and misread the explanation 1 to section 37 of the Act.

The Tribunal further observed that it is evident from explanation 1 that expenditure incurred by the 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. Admittedly, in the instant case, the expenses were incurred by the assessee as a trader while supplying medicines to the government department as he was required to make payment of penalty due to late supply of the medicines as per the term and condition of the tender document under which supply were made. In other words, the said amount has been paid as a breach of contract for which remedy lies in payment of damages under the contractual obligation.

The Tribunal opined that the word offence primarily means a crime or a prohibited activity. The late supply of goods by the assessee is neither a crime nor a prohibited activity. The payment of penalty was on account of breach of contract only. Hence, both the lower authorities under the misconception wrongly proceeded to deny the deduction of business expenditure by the assessee which were rightly claimed as a deduction.

Accordingly, the Tribunal held that impugned order was not sustainable and was set aside. The question framed was decided in negative against the Revenue in favour of the assessee.

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