Relevant section: 37(1) and 57(iii)

MTNL, a notified resident-applicant, entered into an agreement with one ITI for purchase of plant and machinery. The agreement provided that MTNL would be entitled to liquidated damages in case of failure by ITI to deliver the equipment within the stipulated time. The amount recovered by MTNL towards liquidated damages was adjusted against the cost of the assets in some years and shown as income in some years. ITI sent representations to MTNL for waiver of liquidated damages stating that the delay was due to reasons beyond its control. Thereafter, MTNL received a direction from the Telecom Commission to waive the liquidated damages. Accordingly, the Board of Directors of MTNL decided to waive the liquidated damages and refunded certain amounts to ITI during the relevant assessment year. The issue under consideration is whether the amount refunded by the applicant on account of waiver of liquidated damages would be allowable as deduction from business income. The AAR observed that MTNL had reluctantly agreed to refund a part of the charges only to comply with the directions of the Telecom Commission and not voluntarily for business purpose. Since the equipments supplied by ITI were capital assets, damages recovered on account of supply of capital assets were capital in nature and were not allowable as revenue expenditure. Such expenditure was outside the purview of both section 37(1) and 57(iii). Note – The question as to whether refund of liquidated damages can be allowed as deduction would also depend on the method of accounting followed by the assessee in respect of accounting for liquidated damages. If the liquidated damages were treated as a revenue receipt and credited to the profit and loss account, then it is possible to treat refund of the same as revenue expenditure, if such refund was wholly and exclusively for the purpose of its business.