JUDGMENT
G. Sivarajan, J.
All these appeals are filed by the Commissioner of Income Tax, Trichur against the order of the Income Tax Appellate Tribunal, Cochin Bench. I.T.A. Nos. 16, 18, 19, 21 and 23 of 2001 arise out of a common order of the Tribunal in I.T.A. Nos. 883, 884, 885/Coch./90, 7 & 8/Coch./91 and 271/Coch./91 in the case of Dhanalakshmi Bank, Thrissur. (I.T.A. No. 11/01 filed against I.T.A. No. 883/90 which was disposed of by the Tribunal by the common order is being dealt with separately since one more question is involved in the said appeal). I.T.A. No. 83/02 arises out of the order of the Tribunal in I.T.A. No. 79/94 in respect of the assessment year 1990-91 in the case of South Indian Bank Ltd., Thrissur. Similarly I.T.A. Nos. 127/01 and 135/01 arise out of the order of the Tribunal in I.T.A. Nos. 295 and 296 of 1993 in respect of the assessment years 1988-89 and 1989-90 in the case of Catholic Syrian Bank Ltd., Thrissur. All these appeals are being disposed of by this judgment since the sole question that arises for consideration in all these cases is as to whether the Tribunal is right in law in holding that the rate of penal interest the assessee has to pay under the relevant banking law is interest only and not penalty. In other words, the question is as to whether the payment of penal interest under the Banking Laws is for the infraction of law.
2. The respondent-assessees in all these cases are scheduled banks, all having their head offices at Thrissur. In the assessment of the respondent-assessees for the years already mentioned they have claimed deduction of the penal interest paid to the Reserve Bank of India for non-maintenance of cash reserve. The assessing officer concerned had disallowed the same on the ground that the amount represents penal interest. According to the assessees penal interest is paid to the Reserve Bank of India for non-maintenance of cash reserve as stipulated by the Banking Regulation Act which cannot be considered as payment for infraction of law. In appeals by the assessees, the Commissioner (Appeals) allowed their claim holding that the payments are not in the nature of the penalty. The first appellate authority also relied on the decision of the Supreme Court in Mahalakshmi Sugar Mills Co. v. CIT (1980) 123 ITR 429 (SC) and also the order of the Bangalore Bench of the Tribunal in Corporation Bank’s case. The Income-tax department took up the matter in appeal before the Tribunal where the parties have raised the very same contentions. The Tribunal after considering the relevant provisions of the Banking Regulation Act as well as the Reserve Bank of India Act and the principles laid down by the Supreme Court in the various decisions and the order of the Bangalore Tribunal in the case of Corporation Bank and Syndicate Bank’s case held that penal interest paid by the assessees under the provisions of the Banking Regulation Act as well as under the Reserve Bank of India Act cannot be treated as penalty for infraction of law and accordingly concurred with the decision of the first appellate authority and dismissed the appeals filed by the department. It is against these orders of the Income Tax Appellate Tribunal that the department has come up in appeal.
3. We have heard Shri P.K.R. Menon, learned Senior Central Government standing Counsel for Taxes appearing for the appellants, senior counsel Sri Sarangan assisted by Sri Vinod Chandran and also Sri P. Balakrishnan for the respondents-assessees. Both the counsel advanced their respective contentions as taken before the Tribunal and also relied on various decisions of the Supreme Court and of this court in respect of their respective contentions.
4. Before proceeding to consider the real issue involved in these cases it is necessary to refer to the relevant provisions of the Income Tax Act as well as the relevant provisions of the Banking Regulation Act and the Reserve Bank of India Act under which the penal interest is paid by the assessees to the Reserve Bank of India and on which the claim for deduction is made.
5. Section 37 of the Income Tax Act, 1961 provides that any expenditure (not being expenditure of the nature described in sections 30 to 36 and not being in the nature of capital expenditure or personal expenses of the assessees), laid out or expended wholly and exclusively for the purposes of the business or profession shall be allowed in computing the income chargeable under the head “Profits and gains of business or profession”. In the instant case there is no dispute that the payment of penal interest is not in the nature of a capital expenditure or personal expenses of the assessees. There is also no dispute that the penal interest is paid as an incidence of the banking business of the assessees. In other words, the penal interest paid to the Reserve Bank of India can be treated as laid out or expended wholly and exclusively for the purposes of the business of the assessees’ banks. The only question that has to be considered in such circumstances is as to whether the penal interest so paid cannot be allowed as deduction under section 37(1) of the Act. As already noted, according to the department since the payment is penal in character and consequently or infraction of law the same cannot be allowed as a deduction.
6. Section 42 of the Reserve Bank of India Act, 1934 provides for cash reserves of scheduled banks to be kept with the Reserve Bank. The relevant portions read thus:
“42. Cash reserves of scheduled banks to be kept with the bank(1) Every bank included in the Second Schedule shall maintain with the bank an average daily balance the amount of which shall not be less than three per cent of the total of the demand and time liabilities in India of such bank as shown in the return referred to in sub-section (2) :
Provided that the bank may, by notification in the Gazette of India, increase the said rate to such higher rate as may be specified in the notification so, however, that the rate shall not be more than fifteen per cent of the total of the demand and time liabilities.
ExplanationFor the purposes of this section,
(a) ‘average daily balance shall mean the average of the balances held at the close of business of each day of a fortnight;
(b) ‘fortnight’ shall mean the period from Saturday to the second following Friday, both days inclusive;
(c) ‘liabilities’ shall not include
(i) the paid-up capital or the reserves or any credit balance in the profit and loss account of the bank;
(ii) the amount of any loan taken from the bank or from the Development Bank or from the Exim Bank or from the Reconstruction or from the National Housing Bank or from the National Bank or from the Small Industries Bank;
(iii) in the case of a State co-operative Bank, also any loan taken by such bank from a State Government or from the National Co-operative Development Corporation Act, 1962 and any deposit of money with such bank representing the reserve fund or any part thereof maintained with it by any co-operative society within its area of operation;
(iv) in the case of a State co-operative Bank, which has granted an advance against any balance maintained with it, such balance to the extent of the amount outstanding in respect of such advance;
(v) in the case a Regional Rural Bank, also any loan taken by such bank from its sponsor bank;
(d) the aggregate of the liabilities of a scheduled bank which is not a State co-operative Bank, to,
(i) the State Bank;
(ii) a subsidiary bank as defined in section 2 of the State Bank of India (Subsidiary Banks) Act, 1959 (38 of 1959);
(iii) *** *** ***
(iiia) a corresponding new bank constituted by section 3 of the Banking Companies (Acquisition and Transfer of Undertakings) Act, 1980 (40 of 1980);
(iv) a banking company as defined in clause (c) of section 5 of the Banking Regulation Act, 1949 (10 of 1949);
(v) a co-operative bank; or
(vi) any other financial institution notified by the Central Government in this behalf,
shall be reduced by the aggregate of the liabilities of all such banks and institutions to the scheduled bank;
(e) the aggregate of the ‘liabilities’ of a scheduled bank which is a State co-operative Bank, to,
(i) the State Bank;
(ii) a subsidiary bank as defined in section 2 of the State Bank of India (Subsidiary Banks) Act, 1959 (38 of 1959);
(iii) a corresponding new bank constituted by section 3 of the Banking Companies (Acquisition and Transfer of Undertakings) Act, 1970 (5 of 1970);
(iiia) a corresponding new bank constituted by section 3 of the Banking Companies (Acquisition and Transfer of Undertakings) Act, 1980 (40 of 1980);
(iv) a banking company as defined in clause (c) of section 5 of the Banking Regulation Act, 1949 (10 of 1949);or
(v) any other financial institution notified by the Central Government in this behalf,
shall be reduced by the aggregate of the liabilities of all. such banks and institutions to the State co-operative bank.
(1A) Notwithstanding anything contained in sub-section (1), the bank may, by notification in the Gazette of India, direct that every scheduled bank shall, with effect from such date as may be specified in the notification, maintain with the bank, in addition to the balance prescribed by or under sub-section (1), and additional average daily balance the amount of which shall not be less than the rate specified in the notification, such additional balance being calculated with reference to the excess of the total of the demand and time liabilities of the banks shown in the return referred to in sub-section (2) over the total of its demand and time liabilities at the close of business on the date specified in the notification as shown by such return so, however, that the additional balance shall, in no case, be more than such excess :
** ** **
Provided that the bank may, by a separate notification in the Gazette of India, specify different dates in respect of a bank subsequently included in the Second Schedule.
(3) If the average daily balance held at the bank by a scheduled bank during any fortnight is below the minimum prescribed by or under subsection (1) or sub-section (1A), such scheduled bank shall be liable to pay to the bank in respect of that fortnight penal interest at a rate of three per cent, above the bank rate on the amount by which such balance with the bank falls short of the prescribed minimum, and if during the next succeeding fortnight, such average daily balance is still below the prescribed minimum, the rates of penal interest shall be increased to a rate of five per cent above the bank rate in respect of that fortnight and each subsequent fortnight during which the default continues on the amount by which such balance at the bank falls short of the prescribed minimum.
(3A) When under the provisions of sub-section (3) penal interest at the increased rate of five per cent, above the bank rate has become payable by a scheduled bank, if thereafter the average daily balance held at the bank during the next succeeding fortnight is still below the prescribed minimum,
(a) every director, manager or secretary of the scheduled bank, who is knowingly and wilfully a party to the default, shall be punishable with fine which may extend to five hundred rupees and with a further fine which may extend to five hundred rupees for each subsequent fortnight during which the default continues, and
(b) the bank may prohibit the scheduled bank from receiving after the said fortnight any fresh deposit,
and, if default is made by the scheduled bank in complying with the prohibition referred to in clause (b), every director and officer of the scheduled bank who is knowingly and wilfully a party to such default or who through negligence or otherwise contributes to such default shall in respect of each such default be punishable with fine which may extend to five hundred rupees and with a further fine which may extend to five hundred rupees for each day after the first on which a deposit received in contravention of such prohibition is retained by the scheduled bank.
** ** **
5(a) The penalties imposed by sub-sections (3) and (4) shall be payable within a period of fourteen days from the date on which a notice issued by the bank demanding the payment of the same is served on the scheduled bank, and in the event of failure of the scheduled bank to pay the same within such period, may be levied by a direction of the principal civil court having jurisdiction in the area where an office of the defaulting bank is situated, such direction to be made only upon an application made in this behalf to the court by the bank;
(b) when the court makes a direction under clause (a), it shall issue a certificate specifying the sum payable by the scheduled bank and every such certificate shall be enforceable in the same manner as if it were a decree made by the court in a suit;
(c) notwithstanding anything contained in this section, if the bank is satisfied that the defaulting bank had sufficient cause for its failure to comply with the provisions of sub-section (1), (1A) or (2), it may not demand the payment of the penal interest or the penalty, as the case may be.
** ** **
(7) The bank may for such period and subject to such conditions as may be specified, grant to any scheduled bank such exemptions from the provisions of this section as it thinks fit with reference to all or any of its offices or with reference to the whole or any part of its assets and liabilities.”
7. Section 24 of the Banking Regulation Act, 1949 regarding maintenance of a percentage of assets which reads as follows :
“24. Maintenance of a percentage of assets.(1) After the expiry of two years from the commencement of this Act, every banking company shall maintain in India in case, gold or unencumbered approved securities, valued at a price not exceeding the current market price, an amount which shall not at the close of business on any day be less than 20 per cent of the total of its demand and time liabilities in India.
ExplanationFor the purposes of this section, unencumbered approved securities’ of a banking company shall include its approved securities lodged with another institution for an advance or any other credit arrangement to the extent to which such securities have not been drawn against or availed of.
(2) In computing the amount for the purposes of sub-section (1), the deposit required under sub-section (2) of section 11 to be made with the Reserve Bank by a banking company incorporated outside India and any balances maintained in India by a banking company in current account with the Reserve Bank or the State Bank of India or with any other bank which may be notified in this behalf by the Central Government, including in the case of a scheduled bank the balance required under section 42 of the Reserve Bank of India Act, 1934, to be so maintained, shall be deemed to be cash maintained in India.
(2A)(a) Notwithstanding anything contained in sub-section (1), or in sub-section (2), after the expiry of two years from the commencement of the Banking Companies (Amendment) Act, 1962 (36 of 1962) :
(i) a scheduled bank, in addition to the average daily balance which it is, or may be, required to maintain under section 42 of the Reserve Bank of India Act, 1934 (2 of 1934), and
(ii) every other banking company, in addition to the cash reserve which it is required to maintain under section 18, shall maintain in India,
(A) in cash, or
(B) in gold valued at a price not exceeding the current market price or in unencumbered approved securities valued at a price determined in accordance with such one or more of, or combination of, the following methods of valuation, namely, valuation with reference to cost price, market price, book value or face value, as may be specified by the Reserve Bank from time to time,
an amount which shall not, at the close of business on any day, be less than twenty-five per cent or such other percentage not exceeding forty per cent as the Reserve Bank may, from time to time, by notification in the Official Gazette, specify, of the total of its demand and time liabilities in India, as on the last Friday of the second preceding fortnight;
(b) in computing the amount for the purposes of clause (a),
(i) the deposit required under sub-section (2) of section 11 to be made with the Reserve Bank by a banking company incorporated outside India;
(ii) any cash or balances maintained in India by a banking company other than a scheduled bank with itself or with the Reserve Bank or by way of net balance in current account in excess of the aggregate of the cash or balance or net balance required to be maintained under section 18;
(iii) any balances maintained by a scheduled bank with the Reserve Bank in excess of the balance required to be maintained by it under section 42 of the Reserve Bank of India Act, 1934 (2 of 1934);
(iv) the net balance in current accounts maintained in India by a scheduled bank;
(v) any balances maintained by a Regional Rural Bank in call or fixed deposit with its sponsor bank,
shall be deemed to be cash maintained in India.
Explanation.For the purpose of clause (a) of this sub-section, the market price of an approved security shall be the price as on the date of the issue of the notification or as on any earlier or later date as may be notified from time to time by the Reserve Bank in respect of any class or classes of securities.
(2B) The Reserve Bank may, by notification in the Official Gazette, vary the percentage referred to in sub-section (2A) in respect of a Regional Rural Bank.
(3) For the purpose of ensuring compliance with the provisions of this section, every banking company shall, not later than twenty days after the end of the month to which it relates, furnish to the Reserve Bank in the prescribed form and manner a monthly return showing particulars of its what proportion as compensatory. The entire sum can neither be considered as mere penalty nor as mere interest. In view of what has been stated above, our answer to question No. (1) is that only a portion (which is held to be compensation) out of the amount paid as damages under section 14B of the Employees’ Provident Funds Act is an allowable deduction under the Income Tax Act. We direct the Tribunal to determine the appropriate portion after hearing the parties and then pass consequential orders.” (p. 119)
It was further observed as follows :
“For determining the controversy whether the payment is penal or compensatory, it is necessary to examine the provisions of the Bombay Sales Tax Act, 1959. The aforesaid payment is said to have been made under section 36(3) of the said Act. Section 38 of that Act provides for the payment of, and deferred payment of, tax, etc. According to sub-section (2) of the said section, the tax has to be paid by the registered dealer into the Government Treasury along with the return to be filed by him under section 32 of the said Act. . . .” (p. 119)
This decision of the Andhra Pradesh High Court was specifically approved by the Supreme Court in Prakash Cotton Mills (P) Ltd. v. CIT (1993) 201 ITR 684 (SC) in the following words :
“The decision of this court in Mahalakshmi Sugar Mills Co. (1980)123 ITR 429 and the decision of the Division Bench of the Andhra Pradesh High Court in Hydrabad Allwyn Metal Works Ltd. (1988) 172 ITR 113 (AP) with the views of which we are in complete agreement, are, in our opinion, decisions which settle the law on the question as to when an amount paid by an assessee as interest or damages or penalty could be regarded as compensatory (reparatory) in character as would entitle such assessee to claim it as an allowable expenditure under section 37(1) of the Income Tax Act. Therefore, whenever any statutory impost paid by an assessee by way of damages or penalty or interest is claimed as an allowable expenditure under section 37(1) of the Income Tax Act, the assessing authority is required to examine the scheme of the provisions of the relevant statute providing for payment of such impost notwithstanding the nomenclature of the impost as given by the statute, to find whether it is compensatory or penal in nature. The authority has to allow deduction under section 37(1) of the Income Tax Act, wherever such examination reveals the concerned impost to be purely compensatory in nature. Wherever such impost is found to be of a composite nature, that is, partly of compensatory nature and partly of penal nature, the authorities are obligated to bifurcate the two components of the impost and give deduction to that component which is compensatory in nature and refuse to give deduction to that component which is penal in nature.” (p. 690)
9. The Supreme Court had occasion again to consider the question in Swadeshi Cotton Mills Co. Ltd. v. CIT (1998) 233 ITR 199 (SC). In that case the question which arose for consideration was as to whether the Tribunal was justified in allowing deduction of liability incurred by the assessee for payment of damages and for delayed payment of employees’ contributions under section 14B of the Employees’ Provident Funds & Miscellaneous Provisions Act, 1952 as also the question as to whether the penalty levied on the assessee under the Central Sales Tax Act for delayed payment of sales tax were allowable deductions under section 37 of the Income Tax Act, 1961. The Supreme Court noted its earlier decision in Prakash Cotton Mills (P) Ltd.’ case (supra) and the decision of the Andhra Pradesh High Court in Hyderabad Allwyn Metal Works Ltd.’s case (supra) and observed thus :
“In view of the said decision in Prakash Cotton Mills (P) Ltd.’s (supra), question No. 1 requires to be examined in accordance with the principles laid down by the Andhra Pradesh High Court in CIT v. Hyderabad Allwyn Metal Works Ltd. (1988) 172 ITR 113 (SC) which have been approved by this court. Since the question has not been examined in this light, it becomes necessary to remit the said question to the High Court for consideration.” (p. 202)
10. Regarding the penalty imposed for the delayed payment of Central Sales Tax it was observed that there is nothing on record to show that the amount of penalty had a compensatory element in it. The Supreme Court in Lachmandas Mathuradas v. CIT (2002) 254 ITR 799 held that interest on arrears of sales tax or on the outstanding balance of sales tax is not penal and that it is compensatory in nature and is an allowable deduction in computing the profits of a business. The Supreme Court in Mahalakshmi Sugar Mills Co.s case (supra) considered the question as to whether the interest paid by the appellant-company, engaged in the business of the manufacture and sale of sugar, under section 3(3) of the U.P. Sugarcane Cess Act, 1956 on arrears of cess payable “on the entry of cane into the premises of a factory for use, consumption or sale therein” and after considering the relevant provisions of the Cess Act held that the interest paid under section 3(3) of the Cess Act was not a penalty paid for any infringement of the law and was an allowable deduction under section 10(2)(xv) of the Income Tax Act, 1922.
11. The very same question came up for consideration before this court in CIT v. Travancore Electro Chemical Industries Ltd. (1995) 211 ITR 775. The question that arose for consideration was as to whether the interest payable under the Electricity Supply Act is in the nature of penalty which cannot be allowed as a deduction under section 35 of the Income Tax Act. This court relying on the principles laid down by the Andhra Pradesh High Court in Hyderabad Allwyn Metal Works Ltd. case (supra) and the decision of the Supreme Court in Mahalakshmi Sugar Mills Co.s case (supra) held that the interest liable to be paid by the Kerala State Electricity Board is not penal in nature and therefore the assessee is entitled to claim deduction under section 10(2)(xv) of the Income Tax Act.
12. Again the very same Division Bench in CIT v. Pachi Philip & Co.(1995) 212 ITR 75 (Ker) considered the issue with reference to the deductibility of the interest payable under the Abkari Act for delayed payment of kist. Referring to the provisions of the Abkari Act and the Rules and the decisions of the Supreme Court in Prakash Cotton Mills (P) Ltd.’s case (supra), Mahalakshmi Sugar Mills Co..s case (supra) and the decision of the Andhra Pradesh High Court in Hyderabad Allwyn Metal Works Ltd.’s case (supra) which held that the question whether the liability for interest was compensatory or penal in nature has to be decided with reference to the provisions of the relevant statute providing for the impost, ignoring the nomenclature of the impost as given by the statute it was held as follows :
“The case before us, has to be tested in the light of the principles laid down in the aforesaid decisions. We have already noted that there is no provision in the Abkari Act or the Rules imposing any penalty on the licensee for non-payment of the kist in time. Nor is he exposed to any criminal liability or prosecution. In fact, the liability is primarily of a civil nature, arising out of non-performance of the obligation under the rules and the agreement. The only action contemplated for default is coercive and not penal. It has, therefore, to be held that interest payable is compensatory in nature and not penal. Interest is generally intended to compensate the person entitled to receive the amount for the loss that is sustained by him by reason of the deprivation of the use of the money during a particular period. That is precisely the position under rule 6(25). As already pointed out, there is absolutely no distinction between the nature of the interest payable up to the 25th and thereafter. Having regard to all this, we are of the opinion that payment of the interest accruing on delayed payment of the kist is an expenditure incurred wholly and exclusively for the purpose of business and, therefore, liable to be deducted under section 37(1) of the Act.” (p. 81)
The Madras High Court in CIT v. Chemical Constructions (2000) 243 ITR 858 (Mad) considered the question as to whether penalty imposed under section 10A of the Central Sales Tax Act for violation of the terms of the statute can be treated as penalty for infraction of law. The Madras High Court noted that the Supreme Court in Malwa Vanaspati & Chemical Co. v. CIT (1997) 225 ITR 383 (SC) which has taken the view that the fact that a levy is termed as a penalty in a statute is not by itself decisive of its true character and observed that it is only when a levy does not have any compensatory character that it has to be regarded as penalty. The Supreme Court in Malwa Vanaspati’s case. was concerned with the question, inter alia, with the levy of penalty under section 8 of the Madhya Pradesh General Sales Tax Act, which provides for a penalty in cases where raw materials purchased by a registered dealer are utilised for any purpose other than the purpose specified in sub-section (1) of section 8 of that Act. As per the said section the penalty was to be an amount not less than the difference between the amount of tax leviable under the statute and the amount of tax payable under section 8(1) of the Act and not exceeding 11/4th times the amount of tax. Construing the said provision the Supreme Court held that section 8(2) of the Act provides both the elements of compensation and penalty; compensation insofar as payment of tax at the full rate is obligatory, and penalty insofar as something more up to 25% thereon being payable should the Commissioner so directs. In the light of the Supreme Court decision the Madras High Court held that the amount so recovered though termed penalty is in fact compensatory as the assessee had only been now made to pay what he should have paid initially as tax and, therefore, the penalty under section 10A of the Act is an allowable deduction.
13. Thus it is evident from the various decisions of the Supreme Court, this court and of the Andhra Pradesh High Court as approved by the Supreme Court that whenever any statutory impost paid by an assessee by way of damages or penalty or interest, is claimed as an allowable expenditure under section 37(1) of the Income Tax Act, 1961, the assessing officer is required to examine the scheme of the provisions of the relevant statute providing for payment of such impost notwithstanding the nomenclature of the impost as given by the statute, to find out whether it is compensatory or penal in nature. The authority has to allow deduction under section 37(1) of the Act, wherever such examination reveals the concerned impost to be purely compensatory in nature. Wherever such impost is found to be of a composite nature, i.e., partly of compensatory nature and partly of penal nature, authorities are obliged to bifurcate the two components of the impost and give deduction to that component which is compensatory in nature and refuse to give deduction to that component which is penal in nature. As observed by this court in Pachi Philip & Co.’s case (supra) one of the important test to determine whether the levy is compensatory or penal in nature is whether for the non-compliance of the provisions any criminal liability or prosecution is provided. If any criminal liability or prosecution is provided the levy is surely penal in nature.
14. Now let us examine the provisions of the Reserve Bank of India Act and the Banking Regulation Act under which the assessees had paid penal interest. We have already extracted the relevant provisions in the aforesaid two enactments. Section 42 of the Reserve Bank of India Act, 1934 sub-section (1) thereof provides that every bank included in the Second Schedule (admittedly the assessees’ banks squarely fall within the said Schedule) shall maintain with the bank an average daily balance the amount of which shall not be less than three per cent of the total of the demand and time liabilities in India of such bank as shown in the return referred to in sub-section (2). Sub-section (1A) provides that notwithstanding anything contained in sub-section (1), the bank may, by notification in the Gazette of India, direct that every scheduled bank shall, with effect from such date as may be specified in the notification, maintain with the bank, in addition to the balance prescribed by or under subsection (1), an additional average daily balance the amount of which shall not be less than the rate specified in the notification, such additional balance being calculated with reference to the excess of the total of the demand and time liabilities of the bank as shown in the return referred to in sub-section (2) over the total of its demand and time liabilities at the close of business on the date specified in the notification as shown by such return so, however, that the additional balance shall, in no case, be more than such excess.
15. Sub-section (3) provides that if the average daily balance held at the bank by a scheduled bank during any fortnight is below the minimum prescribed by or under sub-section (1) or sub-section (1A), such scheduled bank shall be liable to pay to the bank in respect of that fortnight penal interest at a rate of three per cent, above the bank rate on the amount by which such balance with the bank falls short of the prescribed minimum, and if during the next succeeding fortnight, such average daily balance is still below the prescribed minimum, the rates of penal interest shall be increased to a rate of five per cent above the bank rate in respect of that fortnight and each subsequent fortnight during which the default continues on the amount by which such balance at the bank falls short of the prescribed minimum. Sub-section (3A) provides that when under the provisions of sub-section (3) penal interest at the increased rate of five per cent, above the bank rate has become payable by a scheduled bank, if thereafter the average daily balance held at the bank during the next succeeding fortnight is still below the prescribed minimum, (a) every director, manager or secretary of the scheduled bank, who is knowingly and wilfully a party to the default, shall be punishable with fine which may extend to five hundred rupees and with a further fine which may extend to five hundred rupees for each subsequent fortnight during which the default continues, and (b) the bank may prohibit the scheduled bank from receiving after the said fortnight any fresh deposit. Sub-section further provides that if default is made by the scheduled bank in complying with the prohibition referred to in clause (b), every director and officer of the scheduled bank who is knowingly and wilfully a party to such default or who through negligence or otherwise contributes to such default shall in respect of each such default be punishable with fine which may extend to five hundred rupees and with a further fine which may extend to five hundred rupees for each day after the first on which a deposit received in contravention of such prohibition is retained by the scheduled bank. Sub-section (4) provides that any scheduled bank failing to comply with the provisions of sub-section (2) shall be liable to pay to the bank a penalty of one hundred rupees for each day during which the failure continues. Sub-section (-‘;)(a) provides that the penalties imposed by sub-sections (3) and (4) shall be payable within a period of fourteen days from the date on which a notice issued by the bank demanding the payment of the same is served on the scheduled bank, and in the event of failure of the scheduled bank to pay the same within such period, may be levied by a direction of the principal civil court having jurisdiction in the area where an office of the defaulting bank is situated, such direction to be made only upon an application made in this behalf to the court by the bank and under clause (b) when the court makes a direction under clause (a), it shall issue a certificate specifying the sum payable by the scheduled bank and every such certificate shall be enforceable in the same manner as if it were a decree made by the court in a suit. Clause (c) of sub-section (5) provides that notwithstanding anything contained in this section, if the bank is satisfied that the defaulting bank and sufficient cause for its failure to comply with the provisions of sub-section (1), (1A) or (2), it may not demand the payment of the penal interest or the penalty, as the case may be. Sub-section (7) provides that the bank may, for such period and subject to such conditions as may be specified, grant to any scheduled bank such exemptions from the provisions of this section as it thinks fit with reference to all or any of its offices or with reference to the whole or any part of its assets and liabilities.
16. Similarly sub-section (1) of section 24 of the Banking Regulation Act provides that after the expiry of two years from the commencement of this Act, every banking company shall maintain in India in case, gold or unencumbered approved securities, valued at a price not exceeding the current market price, an amount which shall not at the close of business on any day be less than 20 per cent of the total of its demand and time liabilities in India. Sub-section (2) thereof provides that in computing the amount for the purposes of sub-section (1), the deposit required under sub-section (2) of section 11 to be made with the Reserve Bank by a banking company incorporated outside India and any balances maintained in India by a banking company in current account with the Reserve Bank or the State Bank of India or with any other bank which may be notified in this behalf by the Central Government, including in the case of a scheduled bank the balance required under section 42 of the Reserve bank of India Act, 1934, to be so maintained, shall be deemed to be cash maintained in India. Sub-section (2A)(a) provides that notwithstanding anything contained in sub-section (1), or in sub-section (2), after the expiry of two years from the commencement of the Banking Companies (Amendment) Act, 1962 (i) a scheduled bank, in addition to the average daily balance which it is, or may be, required to maintain under section 42 of the Reserve Bank of India Act, 1934, and (ii) every other banking company, in addition to the cash reserve which it is required to maintain under section 18, shall maintain in India, (A) in cash, or (B) in gold valued at a price not exceeding the current market price or in unencumbered approved securities valued at a price determined in accordance with such one or more of, or combination of, the following methods of valuation, namely, valuation with reference to cost price, market price, book value or face value, as may be specified by the Reserve Bank from time to time, an amount which shall not, at the close of business on any day, be less than twenty-five per cent or such other percentage not exceeding forty per cent as the Reserve Bank may, from time to time, by notification in the Official Gazette, specify, of the total of its demand and time liabilities in India, as on the last Friday of the second preceding fortnight. Under subsection (3) for the purpose of ensuring compliance with the provisions of this section every banking company shall, not later than twenty days after the end of the month to which it relates, furnish to the Reserve Bank in the prescribed form and manner a monthly return showing particulars of its assets maintained in accordance with this section, and its demand and time liabilities in India at the close of business on each alternate Friday during the month, or if any such Friday is a public holiday, at the close of business on the preceding working day. Sub-section (4)(a) provides that if on any alternate Friday or, if such Friday is a public holiday, on the preceding working day, the amount maintained by a banking company at the close of business on that day falls below the minimum prescribed by or under clause (a) of sub-section (2A), such banking company shall be liable to pay to the Reserve Bank in respect of that day’s default, penal interest for that day at the rate of three per cent per annum above the bank rate on the amount by which the amount actually maintained falls short of the prescribed minimum of that day; and (b) if the default occurs again on the next succeeding alternate Friday, or, if such Friday is a public holiday, on the preceding working day, and continues on succeeding alternate Fridays or preceding working days, as the case may be, the rate of penal interest shall be increased to a rate of five per cent per annum above the bank rate on each such shortfall in respect of that alternate Friday and each succeeding alternate Friday or preceding working day, if such Friday is a public holiday, on which the default continues. Sub-section (5)(b) also provides that without prejudice to the provisions of subsection (4), on the failure of a banking company to maintain as on any day, the amount so required to be maintained by or under clause (a) of sub-section (2A) the Reserve Bank may, in respect of such default, require the banking company to pay penal interest for that day as provided in clause (a) of sub-section (4) and if the default continues on the next succeeding working day, the penal interest may be increased as provided in clause (b) of sub-section (4) for the concerned days. Under sub-section (6)(a) the penalty payable under sub-section (4) and sub-section (5) shall be paid within a period of fourteen days from the date on which a notice issued by the Reserve Bank demanding payment of the same is served on the banking company and in the event of failure of the banking company to pay the same within such period, the penalty may be levied by a direction of the principal civil court having jurisdiction in the area where an office of the defaulting banking company is situated, such direction to be made only upon an application made by the Reserve Bank in this behalf to the court. Sub-section (7) provides that when under the provisions of clause (b) of sub-section (4) penal interest at the increased rate of five per cent above the bank rate has become payable by a banking company, if thereafter the amount required to be maintained on the next succeeding alternate Friday, or if such Friday is a public holiday, the next preceding working day, is still below the prescribed minimum, every director, manager or secretary of the banking company, who is knowingly and wilfully a party to the default shall be punishable with fine which may extend to five hundred rupees and with a further fine which may extend to five hundred rupees for each subsequent alternate Friday or the preceding working day, as the case may be, on which the default continues. Sub-section (8) provides that notwithstanding anything contained in this section, if the Reserve Bank is satisfied, on an application in writing by the defaulting banking company, that the banking company had sufficient cause for its failure to comply with the provisions of clause (a) of sub-section (2A), the Reserve Bank may riot demand the payment of the penal interest.
17. From the aforesaid provisions of the two enactments it would appear that those two sections contain the provisions of compensatory nature as well as penal interest. We draw the said conclusion particularly with reference to sub-section (3A) of section 42, clause (c) of sub-section (5) and sub-section (7) of section 42 of the Reserve Bank of India Act as well as sub-sections (7) and (8) of section 24 of the Banking Regulation Act, 1949 in regard to maintaining the requirement of sub-section (1) and the provisions of sub-section (3) of section 42 of the Reserve Bank of India Act providing for levy of penal interest. Under sub-section (3A) of section 42 of the said Act the payment of penal interest for not maintaining the said requirement on the first occasion cannot be treated as penal in character as is evident from the fact that the consequence of not maintaining the requirement is provided only in a case where such default is repeated for the second time. That is evident from the fact that sub-section (3A) of section 42 of the Reserve Bank of India Act, 1934 and sub-section (7) of section 24 of the Banking Regulation Act clearly provide the consequences such as punishment of the Director, Manager, Secretary of the scheduled bank with fine and prosecution of the officers apart from the prohibition from receiving fresh deposits after the second default. That apart, sub-section (5)(c) of section 42 of the Reserve Bank of India Act gives a clear discretion to the Reserve Bank of India not to demand the payment of penal interest or the penalty for the non-compliance of the provisions of sub-section (1), (1A) or (2) of section 42. This is the position with regard to the non-compliance of the requirement of the provisions of sub-section (2A) of section 24 of the Banking Regulation Act.
18. Thus considering the aforesaid provisions we are of the view that if the payment is made by the assessee-banks under sub-section (4) or under sub-section (5)(a) of section 42 of the Reserve Bank of India Act in respect of the first default in complying with the requirement imposed under the main part of the respective sections it cannot be treated as a penal provision. However, if the payment relates to the second default or subsequent default such payment has to be treated as penalties for infraction of law for the reason that sub-section (7) of section 24 of the Banking Regulation Act and sub-section (3A) of section 42 of the Reserve Bank of India Act provide for sanction in the form of punishing the Director, Manager or Secretary of the bank with fine and also for prosecution of the said officers besides the prohibition in receiving any fresh deposits. We also notice in this connection the provisions regarding penalties contained in Chapter V of the Reserve bank of India Act section 58D thereof which says that nothing contained in section 58B shall apply to or in respect of any matter dealt with in section 42. Section 58B, it must be noted, deals with penalties. It is all the more important to note that if the assessees banks are able to satisfy the Reserve Bank of India on application in writing that the bank had sufficient cause for its failure to comply with the provisions of the Reserve bank of India Act the Reserve Bank can condone the default and not to demand the payment of penal interest. If as a matter of fact if the penal interest is being paid for infraction of law there is no question of waiving the penal interest at all. Sub-section (8) of section 24 of the Banking Regulation Act and subsection (7) of section 42 of the Reserve Bank of India Act gives power to the Reserve Bank to exempt a bank from the requirement regarding the compliance of sections 24 and 42(1) respectively of the said Acts.
19. Thus, on a consideration of the relevant provisions of the aforesaid two enactments we are of the view that if the payment of penal interest relates to the first default of non-compliance of the provisions of section 42(1) of the Reserve Bank of India Act or the non-compliance of the provisions of section 24(1) of the Banking Regulation Act such payment cannot be treated as penalty for infraction of law. However, if the payment is by way of penal interest for the second default under the provisions of the aforesaid two enactments, in view of the fact that consequence by way of punishing the Director, Secretary, etc., are provided the payment of penal interest for the second default will have to be treated as penalty for infraction of law. This is so with regard to various other penalties under the other provisions of the aforesaid two enact-merits.
20. We have already noted the principles laid down by the Supreme Court and by this court in the matter of ascertaining the nature of the payment of interest. The Supreme Court has taken the view that if the payment made is compensatory in nature certainly it will not be penal in character. in these cases in the light of the discussions which we have already made it has to be treated that the payment of penal interest provided for the first default has to be treated as compensatory. There is also an element of compensation insofar as the Reserve Bank of India is concerned, for, section 42(1) of the Act requires the deposit of the amount provided therein in the Reserve Bank of India itself in which case the Reserve Bank of India can turnover the said deposit and get interest on the said amount so long as the deposit continues. To the extent of not maintaining the said requirement the Reserve Bank did not get the opportunity to turnover the amount and to get interest. In that view of the matter, there is an element of compensation also involved.
21. Now that we have considered the provisions of section 37 of the Income Tax Act as also the relevant provisions of the Reserve Bank of India Act as well as the Banking Regulation Act and have decided the main issue with regard to the nature of the levy with reference to the principles laid down by the Supreme Court and of this court now the matter must go back to the assessing authority for consideration of the claim made by the assessees in all these appeals in the light of the interpretation placed by us in this judgment.
22. We accordingly set aside the orders of the two appellate authorities relating to this question and direct the assessing authority to modify the assessment in the light of the directions issued in this judgment.
The above I.T.As. are disposed of as above.