A presumption under Section 37 of the Income-Tax Act, 1961 is that trade will be carried on lawfully. Any payment, penalty or fine paid or levied for breach of law is not an allowable expenditure. Any payment made without abiding by the law of the land cannot be claimed as a deduction.

In a recent Judgement of Maddi Venkataraman & Co. P. Ltd., the hon'able Supreme Court examined this issue and confirmed that any payment made in violation of law cannot be allowed as a business expenditure, the matter involved was:
Business expenditure: Expenses incurred in violation of provision of FERA are not taxdeductible (Maddi Venkataraman & Co. P. Ltd. v CIT, 229 ITR 534 (SC). The relevant year is the Asstt. Year 1970-71. The assessee company was carrying on business of exporting tobacco. It had accumulated 329.2 tonnes of substandard quality tobacco which it could not export at the floor price fixed by the Government. Therefore, it sold the tobacco at a discount of 20 per cent to a Singapore party. On paper, the full sale price was paid by the Singapore party, but in reality 20 per cent of the price was remitted back to the Singapore party through one `S'. The amount of discount so paid was Rs 2,88,000. The assessee company claimed the deduction of the said amount of Rs 2,88,000 as business expenditure. The Income Tax Office disallowed the claim. The Tribunal allowed the claim. The High Court reversed the decision of the Tribunal.

In the appeal, the Supreme Court held:``(i) One can carry on his trade without violating the law. In fact, Section 37 of the Income-tax Act, 1961, presumes that the trade willbe carried on lawfully. The English court have consistently held that a penalty or fine or money paid to compound an offence under another statue cannot be allowed as a deduction under the Income-Tax Act. In Haji Aziz and Abdul Shakoor Bros. v. CIT (1961) 41 ITR 350, a Bench of three judges of the Supreme Court held that the expenses which were permitted as deduction were such as were made for the purpose of carrying on the business. It was not enough that the disbursements were made in the course of, or arose out of, or were connected with, the trade. 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 penalty for infraction of law, that could not be claimed as a deduction. Infraction of law is not a normal incidence of business. It is only if it could be shown that it was spent for the purpose of the trade that thededuction can be permitted unless the entire trade was unlawful. In the case of Haji Azii and Abdul Shakoor Bros. (1961) 41 ITR 350 (SC), it was categorically held that no distinction can be made in this regard between a personal liability and a liability of any other kind.

(ii) ``Dismissing the appeal, held that the assessee had indulged in transactions in violation of the provisions of the Foreign Exchange (Regulation) Act. The assessee's case was that it would have incurred a loss. This cannot be a justification for contravention of law. The assessee was engaged in tobacco business. The assessee was expected to carry on the business in accordance with law. If the assessee contravened the provisions of the Foreign Exchange (Regulation) Act to cut down its losses or to make larger profits while carrying on the business, it was only to be expected that the proceedings would be taken against the assessee for violation of that Act. The expenditure incurred for evading the provisions of the Act and also thepenalty levied for such evasion could not be allowed as deduction.

Moreover, it would be against public policy to allow the benefit of deduction under one statute, of any expenditure incurred in violation of the provisions of another statute, or any penalty imposed under another statute.

If the deductions claimed by the assessee were allowed, the penal provisions of the Foreign Exchange (Regulation) Act would become meaningless. It has also to be borne in mind that evasion of law cannot be a trade pursuit. The expenditure in this case could not be allowed as wholly and exclusively laid out for the purpose of the assessee's business.''