CASE ANALYSIS -MADDI VENKATARAMAN AND COMPANY PRIVATE LTD V

COMMISSIONER OF INCOME TAX AIR 1998 SC 563

By

B.Mahathi (20LLB019)

Semester: VI

5 year (B.A., LL.B.)

SUBJECT

INTERPRETATION OF STATUTES

NAME OF THE FACULTY

DAMODARAM SANJIVAYYA NATIONAL LAW UNIVERSITY NYAYAPRASTHA,

SABBAVARAM, VISAKHAPATNAM, 531035, ANDHRA PRADESH
 ACKNOWLEDGEMENT

I Would like to express sincere gratitude towards Prof. Dr. Aruna Sri Lakshmi for
extending her knowledge, expertise, and encouragement during the project.
 ABSTRACT

This project presents a case analysis of Maddi Venkataraman v. CIT 1997, which involved a
dispute over tax liability between the taxpayer and the Income Tax Department in India. The
objective of the study is to examine the legal and factual issues involved in the case, and to
analyze the reasoning and conclusions of the courts. The scope of the study covers the
relevant provisions of the Income Tax Act, the facts of the case, the arguments advanced by
both parties, and the judgments of the lower courts and the Supreme Court of India. The
research methodology involves a qualitative analysis of primary and secondary sources,
including court documents, legal texts, and scholarly articles. The literature review provides
a comprehensive overview of the relevant legal and tax concepts, and the judicial precedents
in India and other countries. The findings of the study indicate that the case raises important
questions of law and policy concerning the interpretation and application of tax statutes, and
highlights the need for clarity and consistency in tax administration. The project contributes
to the understanding of tax law and practice, and provides insights into the challenges faced
by taxpayers and tax authorities in India and elsewhere.
Objective of the Study:

The objective of the study is to conduct a comprehensive case analysis of Maddi

Venkataraman v. CIT 1997. The study aims to analyze the facts of the case, the legal issues
involved, and the court's ruling. The study also aims to identify the significance of the case
in Indian tax law and its implications for taxpayers.

Scope of the Study:

The scope of the study is limited to the case of Maddi Venkataraman v. CIT 1997. The
study will focus on the legal aspects of the case and will not cover any political or social
implications of the case. The study will analyze the case in the context of Indian tax law and
will not compare it with the tax laws of other countries.

Research Methodology:

The research methodology for the study will involve a comprehensive analysis of the case of
Maddi Venkataraman v. CIT 1997. The study will rely on primary sources, including the
court's judgment, legal documents, and relevant statutes. Secondary sources, including
academic articles, books, and online databases, will also be used for the literature review.

Literature Review:

The literature review will provide an overview of the existing literature on the topic of the
case of Maddi Venkataraman v. CIT 1997. The review will include academic articles,
books, and other relevant publications. The literature review will identify the key legal
issues involved in the case and will provide a critical analysis of the court's ruling. The
review will also highlight the significance of the case in Indian tax law and its implications
for taxpayers.
MADDI VENKATARAMAN AND COMPANY PRIVATE LTD V COMMISSIONER
OF INCOME TAX AIR 1998 SC 563

FACTS
 The exporter of tobacco was holding sub-standard tobacco which could not be
sold/exported at the floor price fixed by the Government of India.
 It exported the same to a party in Singapore at a discount of 20% of the price fixed
by the Government.
 On paper, the full sale price was paid by the Singapore party, but in reality, 20% of
the price paid was remitted back to the party through one S.
 The tobacco was sold, and the full floor price was received by the exporter from the
Singapore party.
 The exporter paid a sum of Rs. 2,88,000 to S who remitted the equivalent amount in
Singapore currency to the Singapore party.
 Proceedings were taken against the exporter for infringement of sections 4(2) and
5(1)(e) of the Foreign Exchange Regulation Act, and a penalty was imposed.
 The exporter claimed that the amount paid to S and penalty levied under the FERA
ought to be deducted as business expenditure or treated as business loss.
 The Assessing Officer disallowed the claim on the ground that the payment was not
genuine, and it contravened section 40A(5).
 On appeal, the Commissioner (Appeals) affirmed the Assessing Officer's order.
 The Tribunal allowed the exporter's claim holding that even otherwise, the said
payment did not attract section 40A(3) since it was covered by sub-rule (j) of rule
6DD inasmuch as the said payment to 'S' was made in cash due to exceptional and
unavoidable circumstances.
 The High Court held that expenses tainted with illegality could not be allowed as the
business expenditure under section 37 or as a business loss or on any other basis.
ISSUES:

 Whether the amount paid to Singapore intermediary and the penalty levied under the
FERA could be deducted as business expenditure or treated as a business loss by the
exporter.
 Whether expenses tainted with illegality could be allowed as business expenditure or
business loss.

HIGH COURT:

 Payments tainted with illegality cannot be claimed as a deduction under the Income
Tax Act.
 If an assessee is penalized under one Act, he cannot claim that amount to be set off
against his income under another Act.
 The only exception to the rule is where the entire business of the assessee is illegal,
and that income is sought to be taxed by the ITO then the expenditure incurred in the
illegal activities will also have to be allowed as a deduction.
 If the business is otherwise lawful and the assessee resorts to unlawful means to
augment his profits or reduce his loss, then the expenditure incurred for these
unlawful activities cannot be allowed to be deducted.
 Even if the assessee has to pay a fine or penalty because of an inadvertent infraction
of law which does not involve any moral obliquity, the deduction will not be
permitted.
 Deduction will not be permitted for the amounts paid as a penalty or fine or the value
of the goods confiscated by the statutory authority as expenditure wholly and
exclusively incurred for the purposes of carrying on the trade.
 Fines or penalties payable for the violation of law cannot be permitted as a deduction
under the Income Tax Act.

ISSUES:

 Whether the payment made by the assessee to S, in contravention of the provisions

of the Foreign Exchange Regulation Act (FERA), can be claimed as a deduction
under the Income Tax Act?
  Whether an assessee penalized under one Act can claim that amount to be set off
against his income under another Act?

LEGAL PROVISIONS:

 Section 37 of the Income Tax Act provides that any expenditure incurred wholly and
exclusively for the purpose of carrying on the trade or business shall be allowed as a
deduction.
 Section 40A(3) of the Income Tax Act disallows cash payments above a certain
threshold and requires payment through account payee cheque or account payee
bank draft.
 Rule 6DD of the Income Tax Rules provides for certain exceptions to the cash
payment disallowance under section 40A(3), including sub-rule (j) which covers
exceptional and unavoidable circumstances.
 Sections 4(2) and 5(1)(e) of the Foreign Exchange Regulation Act (FERA) deal with
contravention of the Act and provide for penalties.

SUPREME COURT:

The Supreme Court held that payments tainted with illegality cannot be claimed as a
deduction under the Income Tax Act. The court further stated that an assessee penalized
under one Ac

It cannot claim that amount to be set off against his income under another Act, as that would
frustrate the entire object of imposing a penalty.

The court also noted that there is one exception to this rule, where the entire business of the
assessee is illegal and that income is sought to be taxed by the Income Tax Officer, in which
case the expenditure incurred in the illegal activities will also have to be allowed as a
deduction. However, if the business is otherwise lawful and the assessee resorts to unlawful
means to augment his profits or reduce his loss, then the expenditure incurred for these
unlawful activities cannot be allowed to be deducted.

The court emphasized that even if an assessee has to pay a fine or penalty because of an
inadvertent infraction of the law which does not involve any moral obliquity, deduction will
not be permitted for the amounts paid as penalty or fine or the value of the goods
confiscated by the statutory authority as expenditure wholly and exclusively incurred for the
purposes of carrying on the trade. The court referred to the consistent position taken by
English Courts on this issue, where fines or penalties payable for violation of law cannot be
permitted as deductions under the Act, as it goes against public policy. The court also noted
that section 37 of the Income Tax Act presumes that the trade will be carried on lawfully.

In this case, the assessee had indulged in transactions in violation of the provisions of the
FERA. The court held that the spur of loss could not be a justification for contravention of
the law. The assessee was engaged in the tobacco business and was expected to carry on the
business in accordance with the law. If the assessee contravened the provisions of the FERA
to cut down its losses or to make larger profits while carrying on the business, it was only to
be expected that proceedings would be taken against the assessee for violation of the Act.
The expenditure incurred for evading the provisions of the Act and also the penalty levied
for such evasion could not be allowed as a deduction. The court noted that allowing such
deductions would render the penal provisions of the FERA meaningless and would go
against public policy.

The judgement of the Supreme Court in this case reflects the principle that an assessee
cannot claim a deduction for payments made in violation of the law, even if the payments
were made to reduce the losses or increase the profits of the business. The court emphasized
that public policy considerations must be taken into account when deciding whether to allow
deductions.

INTERPRETATION

The rule adopted in the interpretation of the statute here is the rule against allowing
expenses tainted with illegality as business expenditure.

The interpretation rule adopted in the interpretation of the statute in this case is that
payments tainted with illegality cannot be claimed as a deduction under the Income Tax
Act. The court held that if an assessee is penalized under one Act, they cannot claim that
amount to be set off against their income under another Act. The court further stated that
fines or penalties payable for the violation of the law cannot be permitted as a deduction
under the Act. This rule is based on the public policy that any expenditure incurred in
violation of the provisions of a statute cannot be allowed as a deduction for the purpose of
computing income under the Income Tax Act. The court also emphasized that the business
of an assessee must be carried on lawfully and that the need for making payments arising
out of trading operations does not justify violating the law.
The rule followed in this case is the principle of interpretation that expenses tainted with
illegality cannot be claimed as deductions under the Income Tax Act. This principle is based
on the public policy that violations of the law should not be encouraged or rewarded, and
that deductions should only be allowed for expenses that are incurred wholly and
exclusively for the purpose of carrying on a lawful trade or business. This is not a specific
interpretative rule like the golden rule or the mischief rule, but rather a principle of law that
is applied in the interpretation of tax statutes.

CRITICAL ANALYSIS

In the case of IRC v. E.C. Warnes1, a company had to pay a mitigated penalty of £2,000
under the Customs (Consolidation) Act, 1876 for a consignment of oil shipped to Norway
due to their carelessness. The penalty proceedings also incurred legal costs of £560 18s 10d.
The company contended that both the penalty and legal costs were deductible as losses
arising out of and incidental to trade, similar to bad debts in the computation of profits.
However, Rowlatt, J. of the High Court held that a penal liability like this cannot be
regarded as a loss connected with or arising out of trade, as it is not in the nature of a
commercial loss. This decision was cited with approval by the Court of Appeal in the case
of IRC v. Alexander Von Glehn & Co. Ltd.2, where Lord Sterndale stated that expenses
permitted as deductions must be for the purpose of the trade, and disbursements made in the
course of, arising out of, or connected with the trade, or made out of profits of the trade, are
not enough. Payments for infraction of law could not be considered for the purpose of trade,
even if the expenses were incurred in the course of, arose out of, or were connected with the
trade.

the case of Strong v. Woodifield3, it was held that for disbursements to be permitted as
deductions, they must be for the purpose of the trade. It is not enough that the disbursement
was made in connection with the trade or was made out of the profits of the trade. Lord
Sterndale observed that there is a difference between a commercial loss in trading and a
penalty imposed upon a person or a company for a breach of the law. In Cattermole (H.M.
Inspector of Taxes) v. Borax & Chemicals Ltd.4, fines imposed for infringement of anti-trust
legislation in the US were not allowed as deductions in computing the company's profits
because they were not paid wholly and exclusively for the purpose of carrying on the trade.

1
12 TC 227
2
12 TC 232
3
5 TC 215
4
61 TC 202
The Indian Courts have also consistently held that payments tainted with illegality cannot be
treated as money spent wholly and exclusively for the purpose of business. In Haji Aziz &
Abdul Shakoor Bros. v. CIT5, it was held that no deduction can be allowed if the expenditure
fell on the assessee in some character other than that of a trader, and if a sum has to be paid
by an assessee because in conducting his business, he had acted in a manner which had
rendered him liable for penalty for infraction of the law, it could not be claimed as a
deduction because it could not be called in the commercial sense as incurred in carrying on
the business.

Case 1:

Strong v. Woodifield

 Disbursements permitted as deductions must be for the purpose of the trade.

 Disbursement should not just be connected with the trade but made for the purpose
of the trade.
 A penalty imposed upon a person or a company for a breach of the law committed in
trading is different from a commercial loss in trading.
 A disbursement made due to a penalty imposed for an infraction of the law cannot be
claimed as a deduction because it could not be called a commercial expense incurred
in carrying on business.

Case 2:

Cattermole (H.M. Inspector of Taxes) v. Borax & Chemicals Ltd.

 The question was whether fines imposed in the U.S.A. upon the company and its
managing director for infringement of anti-trust legislation of the USA should be
allowed as deductions in computing the amount of the company's profits.
 It was argued that the amount was deductible as business expenditure because it was
paid to ensure the supplies.
 The amount was not paid wholly and exclusively for the purpose of carrying on the
trade.
 The amount was paid for a compromise, and one of the reasons was to get a
settlement with the American authorities as cheaply as possible.

5
[1961] 41 ITR 350 (SC)
Case 3:

Haji Aziz & Abdul Shakoor Bros. v. CIT

 Expenses permitted as deductions were those made for the purpose of carrying on
the business.
 No deduction can be allowed if the expenditure fell on the assessee in some
character other than that of a trader.
 If a sum has to be paid by an assessee because in conducting his business, he had
acted in a manner which had rendered him liable for a penalty for infraction of the
law, it could not be claimed as a deduction because it could not be called in
commercial sense as incurred in carrying on the business.
 Infraction of the law is not a normal incidence of business.