IN THE SUPREME COURT OF PAKISTAN 
(APPELLATE JURISDICTION) 
 
 
PRESENT: MR. JUSTICE MIAN SAQIB NISAR, CJ 
 
 
MR. JUSTICE UMAR ATA BANDIAL 
 
 
MR. JUSTICE FAISAL ARAB 
 
 
CIVIL APPEALS NO.26 OF 2009 AND 228 OF 2010 
(on appeal against the judgment dated 16.10.2008 and 
27.04.2009 of the High Court of Sindh, Karachi passed in 
I.T.C.293/1992 and I.T.A.594/2000 respectively) 
 
 
 
 
Commissioner of Income Tax Karachi 
(in both cases) 
 
…Appellant(s) 
VERSUS 
 
M/s. Hassan Associates (Pvt) Ltd. 
 
(in CA 26/09) 
M/s. National Refinery Ltd.  Karachi 
(in CA 228/10) 
 
…Respondent(s) 
 
For the Appellant(s): 
(in both cases) 
 
Muhammad Siddiq Mirza 
 
 
For the Respondent(s):  
(in CA 26/09) 
(in CA 228/10) 
 
Ms. Lubna Pervez, ASC. 
Mr. Iqbal Salman Pasha, ASC. 
 
 
Date of Hearing:  
  16.05.2017 
… 
ORDER 
 
 
MIAN SAQIB NISAR, CJ.- The key question involved in these 
appeals with the leave of the Court is whether the amounts claimed to be 
expenditures by the respondents (in both cases) in their income tax returns 
are permissible deductions falling within the purview of Section 
23(1)(xviii) of the Income Tax Ordinance, 1979 (the Ordinance) or they fall 
within the ambit of fine or penalty for infraction of law to be disallowed in 
terms of the law laid down in the case of Commissioner of Income Tax 
Vs. Premier Bank of Pakistan [1999 PTD 3005 = (1999) 79 Tax (SC) 
589].  
2. 
 
Heard. The arguments of the learned counsel in both the 
cases shall be reflected in the course of this opinion. Since the facts of 
CIVIL APPEALS NO.26 OF 2009 AND 228 OF 2010 
 
 
     
 
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both the appeals are distinct, we shall first examine the relevant law and 
then discuss the individual cases. Section 15 of the Ordinance provides 
for various heads of income for the purposes of charge of income tax and 
computation of total income, one of which is ‘income from business or 
profession’ [sub-part (d)]. Section 22 of the Ordinance stipulates the 
different incomes chargeable under the head ‘income from business or 
profession’. Section 23(1) of the Ordinance goes onto list the allowances 
and deductions to be made when computing the income under the head 
‘income from business or profession’, part (xviii) whereof reads as under:- 
 
23.  
Deductions.- (1) In computing the income under the 
head "Income from business or profession", the following 
allowances and deductions shall be made, namely:- 
 
(xviii) any expenditure (not being in the nature of capital 
expenditure of personal expenses of the assessee) laid out or 
expended wholly and exclusively for the purpose of such 
business or profession; 
 
In the judgment of Premier Bank (supra) this Court was faced with the 
question as to whether the liabilities incurred by Premier Bank Limited 
(the respondent assessee therein) on account of payment of penal interest under 
Section 36(4) of the State Bank of Pakistan Act, 1956 (the Act, 1956) for 
having failed to maintain the credit balance levels as required by Section 
25 of the Banking Companies Ordinance, 1962 and Section 36(1) of the 
Act, 1956, can be claimed as deductions in terms of Section 10(2)(xvi) of 
the repealed Income Tax Act, 1922 (the Act, 1922). It was held as under:- 
 
9. 
…revenue expenses incurred by the assessee wholly 
and exclusively for the purpose of his business-can 
legitimately be claimed by him as an allowable deduction 
CIVIL APPEALS NO.26 OF 2009 AND 228 OF 2010 
 
 
     
 
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under section 10(2)(xvi) [of the repealed Income tax Act, 
1922], but expenditure incurred as penalty or fine paid on 
account of infraction of law cannot be permitted as 
expenditure laid out wholly or exclusively for the purpose 
of the business of the assessee. However, in case of 
expenditure which, although, has been incurred by the 
assessee on account of infringement of a provision of a 
statute, but is not in the nature of penalty, the question 
whether such expenditure is admissible under section 
10(2)(xvi), or not, would depend upon the circumstances of 
each case… 
[Emphasis supplied] 
 
It is pertinent to note that Section 10(2)(xvi) of the Act, 1922 is almost 
identically worded as Section 23(1)(xviii) of the Ordinance, the former of 
which read as under:- 
 
10. Business.- (2) Subject to the provisions of this Act such 
profits or gains shall be computed after making the following 
allowances,, namely;- 
 
(xvi) 
any expenditure not being in the nature of capital 
expenditure of personal expenses of the assessee laid out or 
expended wholly and exclusively for the purposes of such 
business, profession or vocation; 
 
Thus, the reasoning in the Premier Bank case (supra) would very well 
apply to the corresponding provision of Section 23(1)(xviii) of the 
Ordinance. Therefore, according to Section 23(1)(xviii) of the Ordinance, 
any expenditure, which is not in the nature of capital expenditure of 
personal expenses of the assessee, is laid out or expended wholly and 
exclusively for the purpose of such business or profession, shall be 
deducted while computing the income under the head ‘income from 
business or profession’. However, as per the law laid down by this Court 
CIVIL APPEALS NO.26 OF 2009 AND 228 OF 2010 
 
 
     
 
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in the case of Premier Bank (supra) in which the pari materia provision of 
Section 10(2)(xvi) of the Act, 1922 was being examined, any expenditure 
incurred as a penalty or fine paid on account of an infraction, breach or 
violation of law would not be allowed to be an expenditure laid out 
wholly or exclusively for the purpose of the business of the assessee. As 
per the said judgment, as regards expenditure which an assessee has 
incurred on account of a violation of law but is not in the nature of a 
penalty or fine, the question whether such expenditure would be 
admissible under Section 23(1)(xviii) of the Ordinance or not would 
depend upon the facts and circumstances of each case. 
 
It must also be noted that it was after the Premier Bank case 
(supra) that the legislature inserted vide Finance Ordinance, 2000, Section 
24(j) in the Ordinance which made “any expenditure incurred on account of 
payment of a fine or penalty for the violation of any law, rule or regulation for the time 
being in force” inadmissible as a deduction. A very similar provision was 
retained in Section 21(1)(g) of the Income Tax Ordinance, 2001. Since 
these two provisions were referred to by the learned counsel for the 
appellant (in both appeals), we would like to observe that they (the provisions) 
have in effect introduced in statutory form, the law that this Court had 
laid down in Premier Bank’s case (supra). However since they were not in 
force during the assessment years in question, we shall not delve into 
them any further.  
3. 
 
We shall now advert to the facts of each case and apply the 
law thereto. 
 
Civil Appeal No.26/2009 
4. 
 
A private limited company indulged in the business of 
construction, the respondent in this appeal was awarded a contract by 
CIVIL APPEALS NO.26 OF 2009 AND 228 OF 2010 
 
 
     
 
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the Government of Punjab (GoP) for the construction of a hockey stadium 
subject to furnishing of a performance bond (bank guarantee) to the tune of 
Rs.2,065,000/-. The GoP encashed the bank guarantee during the 
assessment year 1985-86 for alleged breach of contract by the 
respondent. The respondent claimed the said amount as expenditure in 
the income tax return filed for the relevant assessment year and also 
filed a civil suit against such encashment. The Income Tax Officer 
disallowed the said amount as expenditure and added it to the 
respondent’s income on the ground that it (the amount) was recoverable 
from the GoP. The Commissioner of Income Tax (Appeals) [CIT(A)] and the 
Income Tax Appellate Tribunal (ITAT) dismissed the respondent’s appeals 
and upheld the addition. The ITAT refused the respondent’s application 
for approval to refer the question to the learned High Court under 
Section 136 of the Ordinance, against which the respondent filed a 
reference before the learned High Court to consider the question, 
“Whether on the facts and in the circumstances of the case the learned Income Tax 
Appellate Tribunal was justified in confirming the disallowance of the claim of 
enchasment (sic) of performance bond by the Government of Punjab”. The learned 
High Court answered the question in the negative vide impugned 
judgment and the expenditure was allowed for the reason that the said 
amount was expended wholly and exclusively for the purpose of business 
and therefore, was allowable under section 23(1)(xviii) of the Ordinance, 
hence this appeal with the leave of the Court dated 2.1.2009 to consider 
whether “…the view taken by the High Court is contradictory to the view taken by this 
Court in the case of Commissioner of Income Tax Vs. Premier Bank Ltd, Karachi [ 
(1999) Tax 589 (SC Pak)] as the judgment of this Court was not properly appreciated.” 
5. 
 
It is the appellant’s case that the encashment of the bank 
guarantee was due to the respondent’s failure to fulfill its contractual 
CIVIL APPEALS NO.26 OF 2009 AND 228 OF 2010 
 
 
     
 
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obligation, therefore, it was a penalty and cannot be allowed as an 
expense. He also argued that such payment was a violation of the 
Contract Act, 1872 (the Act, 1872) and thus was a breach of the law, 
therefore was not permissible as an expenditure according to Premier 
Bank’s case (supra). On the other hand, it is the respondent’s case that 
the encashment of the bank guarantee was pursuant to a business 
transaction between the respondent and the GoP which could not be 
regarded as a fine or penalty and was not an infraction of law as per 
Premier Bank’s case (supra) which is not attracted in the instant case.  
6. 
 
At this juncture, we find it appropriate to consider the 
instances as to what constitutes an expenditure laid out or expended 
wholly and exclusively for the purpose of a business or profession. As 
regards the cases from the Pakistani jurisdiction, in Commissioner of 
Income Tax, Karachi Vs. Eastern Automobiles Ltd., Karachi [(1967) 
15 TAX 233] it was held that the damages paid for breach of contract 
were an allowable expenditure. In Karachi Steam Navigation Co. Ltd. 
Vs. Commissioner of Income Tax [(1967) 15 TAX 73] the learned High 
Court of Sindh held that damages paid in settlement of litigation for 
breach of contract was an expenditure wholly and exclusively made for 
the purposes of the business and was thus an admissible expenditure.   
7. 
 
We now advert to the cases from the Indian jurisdiction. In 
Hind Mercantile Corporation Ltd. Vs. Commissioner of Income-Tax, 
Madras [(1963) 49 ITR 23] the Madras High Court held that the 
amounts paid by way of damages and legal expenses were allowable as 
an expenditure in computing the profits and gains of the assessee’s 
business as such loss incurred in the course of the business was 
incidental to and intimately connected with the conduct of the business 
and for the purpose of earning profits for the business. In Commissioner 
CIVIL APPEALS NO.26 OF 2009 AND 228 OF 2010 
 
 
     
 
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Of Income-Tax (Central) Vs. Inden Biselers [(1973) 91 ITR 427] again 
the Madras High Court held that the discharge of promissory notes was a 
legal obligation of the assessee incurred in the course of and incidental to 
the business, therefore the damages paid by the assessee was a revenue 
loss incurred in the course of carrying on of the business and, therefore, 
liable to be deducted as an expenditure. In Addl. Commissioner Income 
Tax Vs. Rustam Jehangir Vakil Mills Ltd. [(1976) 103 ITR 298] it was 
held by the High Court of Gujarat that the payment made to the Textile 
Commissioner by the assessee for contravention of the directions given 
by the Textile Commissioner was not in the nature of penalty and was 
incidental to the carrying on of the assessee’s business and was thus 
was an allowable business expenditure. In Commissioner Income Tax 
Vs. Tarun Commercial Mills Co. Ltd. [(1977) 107 ITR 172] it was held 
by the Gujarat High Court that the amount paid to the Textile 
Commissioner for non-fulfilment of the assessee’s obligation contained in 
the bond it executed with the Government of India was business 
expenditure incurred wholly and exclusively for the purposes of the 
assessee's business. In the case of Commissioner Income Tax Vs. 
Surya Prabha Mills (P.) Ltd. [(1980) 123 ITR 654] the High Court of 
Madras held that where the assessee could not import the quantity of 
foreign cotton allotted by the Indian Cotton Mills Federation of which the 
assessee was a member and had to make payment of the guarantee 
amount for the bales that it did not import, such payment was paid only 
to avoid further loss, and could only be treated as an expenditure laid 
out wholly and exclusively for the purpose of the business; there was no 
element of any penalty, no infraction of law or offence against public 
policy. In the case of Commissioner Income Tax Vs. Bharat Vijay Mills 
Ltd. [(1981) 128 ITR 633] the High Court of Gujarat held that where the 
CIVIL APPEALS NO.26 OF 2009 AND 228 OF 2010 
 
 
     
 
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assessee had to pay certain amounts for failure to carry out the 
directions of the Textile Commissioner for production or packing of the 
minimum of the particular types of cloth, the compensation paid to the 
Textile Commissioner for the non-production of the controlled variety of 
cloth was an allowable business expenditure.  
8. 
 
According to the above case law, an amount paid as 
damages or compensation is an expenditure laid out wholly or 
exclusively for the purpose of the business of the assessee. It is a 
revenue loss incurred in the course of carrying on of the business and 
therefore an admissible deduction under Section 23(2)(xviii) of the 
Ordinance. In the instant appeal, the contract was executed between the 
respondent and the GoP in connection with the business of respondent, 
who failed to perform its part of agreement, as such the GoP encashed 
the performance bond. It was purely a business transaction between the 
parties and there was no infraction or violation of any law whatsoever. 
When we asked the learned counsel for the appellant to show us whether 
there was any infraction of law by the respondent for which the penalty, 
if any, has been imposed on the respondent, he candidly conceded that 
the penalty was imposed for violation of the contract. A weak attempt 
was made to argue that the ‘law’ in this case was the Act, 1872 which to 
our mind is completely unfounded. There was a breach of the contract 
and not the law. To put it differently, the GoP would not be able to 
recover any money from the respondent if not for the existence of the 
performance bond. Thus, the encashment of bank guarantee can at best 
be considered to be damages or compensation paid to the GoP for 
unsatisfactory performance of a contract by the respondent which is a 
revenue loss incurred by the latter in the course of carrying on its 
business. The forfeiture of an amount under a contract cannot be 
CIVIL APPEALS NO.26 OF 2009 AND 228 OF 2010 
 
 
     
 
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equated with a fine or penalty incurred due to infraction or violation of 
any law. Further, the civil suit filed by the respondent against the GoP 
having been dismissed, such amount is no more adjustable. Thus, we 
are of the view that Premier Bank’s case (supra) is not applicable in the 
instant appeal.  
9. 
 
For the forgoing reasons, we find no illegality in the 
impugned judgment of the learned High Court calling for interference. 
This appeal is accordingly dismissed.  
 
Civil Appeal No.228/2010 
10. 
 
The respondent in this appeal is a public limited company 
and is in the business of refining of crude oil into various petroleum 
products. During the assessment year 1999-2000 it (the respondent) 
imported crude oil from Aramco, Saudi Arabia under a loan from the 
Islamic Development Bank, Jeddah (IDB) on the guarantee of the State 
Bank of Pakistan (SBP). As per the SBP’s procedure, the respondent was 
required to deposit the counterpart rupee fund within ten days of 
disbursement of funds by IDB, which it failed to do, as such in terms of 
Para 44 of Chapter 13 of the Foreign Exchange Manual (the Manual), SBP 
charged an amount of Rs.4/- per day per Rs.10,000/- or part thereof for 
the period of delay amounting to Rs.30,500,000/-. The respondent 
claimed the said amount as an expenditure in its income tax returns, 
however, the Assessing Officer refused to allow the same on the ground 
that such amount was a penalty incurred on account of infraction of law 
in terms of the judgment of this Court in Premier Bank’s case (supra) and 
was thus an impermissible deduction. The CIT(A) dismissed the 
respondent’s appeal, however, the ITAT accepted its appeal holding that 
the amount paid by the respondent was not in the nature of fine or 
CIVIL APPEALS NO.26 OF 2009 AND 228 OF 2010 
 
 
     
 
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penalty in respect of any infringement of law or the SBP Regulations 
rather was a payment made on account of the delay in payment of the 
principle amount of the loan and was an expenditure laid down 
exclusively for the business of the respondent and was therefore an 
allowable deduction. On further appeal, the learned High Court upheld 
the order of the Tribunal vide impugned judgment, hence this appeal 
with the leave of the Court dated 1.4.2010 granted on the basis of the 
leave granting order dated 2.1.2009 in Civil Appeal No.26/2009.  
11. 
 
It is the appellant’s case that the amount paid by the 
respondent to SBP was a penalty for infraction of law, namely, the 
Manual, therefore, the case is fully covered under Premier Bank’s case 
(supra). It is the respondent’s case that SBP charged an ‘interest’ and not a 
fine or penalty under any law. We find that the amount was charged by 
SBP under Para 44 of Chapter 13 of the Manual. For convenience, the 
relevant paragraphs thereof are reproduced hereunder:- 
 
43.     Fine on delay in deposit of Counterpart Funds.  
In the event of delay in depositing counterpart funds with the 
State Bank within the prescribed period, the concerned 
Authorised Dealer will pay to the State Bank fine at the 
rate of Rs 4 per day per Rs 10,000 or part thereof for the 
period of delay. 
 
44.   Documents received on Collection Basis due to 
Discrepancy/Documents drawn on usance basis.  
(i)       In cases where the overseas negotiating bank does not 
make payment to the supplier but sends the documents to the 
bank in Pakistan on collection basis due to discrepancy in 
the documents, the Authorised Dealers will deposit 
counterpart funds with the State Bank on retirement of the 
documents by the importers concerned. The prescribed 
period for deposit of counterpart funds will be reckoned as 
CIVIL APPEALS NO.26 OF 2009 AND 228 OF 2010 
 
 
     
 
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from the date of retirement of bill by the importer. If the 
funds are held back by the Authorised Dealers beyond the 
prescribed period, fine would be charged as per paragraph 
43 ibid. 
[Emphasis supplied] 
 
From the above provisions it is clear that it was not a mere interest or 
additional amount demanded by SBP, rather the word used is fine which 
to our mind in this case is akin to a penalty for a violation of Para 44 of 
Chapter 13 of the Manual. The learned counsel for the respondent in 
order to take his case out of the purview of Premier Bank’s case (supra) 
argued that there was an agreement between the respondent and SBP, 
and the additional amount was paid for violation of that contract, as 
such, it was not a fine or penalty. However, he failed to show any 
contract from record. It is not the case of the respondent even before the 
lower forums that there was a contract between the respondent and SBP 
and the additional amount was paid as damages for violation of such 
contract. Essentially, crude oil was to be supplied by Aramco to the 
respondent through a loan from IDB, whereas SBP was only a guarantor.  
12. 
 
The learned counsel for the respondent also submitted that 
Premier Bank’s case (supra) is distinguishable as in the said case it was 
mandatory for the respondent-bank to maintain minimum reserves as 
per Section 10(1) of the Act, 1956, however, in the instant case the 
respondent was not required under any provision of law to deposit the 
counterpart rupee fund with SBP. We find that as per para 44 of Chapter 
13 of the Manual, the authorised dealers are bound to deposit 
counterpart funds with SBP on retirement of the documents by the 
importers concerned. In case the funds are held back by the authorized 
dealers beyond the prescribed period, a fine would be charged. The rate 
CIVIL APPEALS NO.26 OF 2009 AND 228 OF 2010 
 
 
     
 
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of fine has been mentioned in Para 43 thereof which provides that in the 
event of delay in depositing counterpart funds with SBP within the 
prescribed period, the concerned authorized dealer will pay to SBP a fine 
at the rate of Rs.4/- per day per Rs.10,000/- or part thereof for the 
period of delay. It is to be noted that the Manual contains the basic 
regulations issued by the Government of Pakistan and SBP under the 
provisions of the Foreign Exchange Regulations Act, 1947, therefore, it 
has the force of law and any violation thereof would entail the penal 
consequences provided therein. As the respondent failed to comply with 
the provisions of the Manual, a fine was charged at the prescribed rate. It 
is essentially a fine for infraction of the law, i.e. the above referred 
provisions of the Manual, and are not damages or compensation for 
breach of a contract. Thus, the law laid down in Premier Bank’s case 
(supra) is fully applicable to the instant appeal. 
13. 
 
In the light of the above, this appeal is allowed, the 
impugned judgment of the learned High Court is set aside and the order 
of the ITAT is upheld.  
 
 
CHIEF JUSTICE 
 
 
 
JUDGE 
 
 
 
JUDGE 
ISLAMABAD. 
16th May, 2017. 
Approved for reporting 
Mudassar/* 
