Settlement of Foreign Patent Dispute is a Deductible Business Expense, Not a Penalty

ORDER

Sanjay Garg, Judicial Member.- The captioned are cross-appeals, one by the assessee and the other by the Revenue preferred against the order of the Learned Commissioner of Income Tax (Appeals), National Faceless Appeal Centre (NFAC), Delhi [hereinafter referred to as ‘CIT(A)’] dated 13/01/2025 passed u/ s.250 of the Income Tax Act, 1961 (hereinafter referred to as ‘the Act’) for the Assessment Year (AY) 2014-2015. Both the appeals have been heard together and are being disposed of by this consolidated order. First, we take up Revenue’s appeal in ITA No.565/ Ahd/2025 for AY 2014-15 for adjudication.

2. The Revenue in its appeal have been taken following grounds of appeal:

3. Ground No.1:- The Revenue vide Ground No.1 has agitated against the action of the Ld. CIT(A) in deleting the addition of Rs.44,98,11,000/- made by the Assessing Officer (AO) by taxing the income of the offshore entity, Vega Industries (Middle East), FZC, UAE, treating the same as proprietaryconcern of the assessee.

4. At the outset, the Ld. Counsel for the assessee has submitted that the issue is squarely covered in favour of assessee by various decisions of the Tribunal passed in earlier assessment years. He, in this respect, has submitted that this issue had arisen for first time in AY 2006-07, wherein, the Tribunal after considering the entire material available on record, had decided the issue in favour of assessee by holding that the said subsidiary is separate for corporate entity and not a proprietary-concern of the assessee and, hence, the AO was not justified in taxing the income of the said company in the hands of the assessee. The Ld. Counsel, in this respect, has relied upon the decisions of the Tribunal for AY 2006-07 passed in ITA No.580/ Ahd/2011/ AIA Engineering Ltd. v. Addl. CIT SOT 134 (Ahmedabad – Trib.), wherein the Tribunal has held that the said Vega Industries (supra) was duly incorporated company under law of a country outside India and cannot be held to be proprietorshipconcern of the assessee merely because the assessee held 100% shareholding of that company. The relevant concluding para of the order of the Tribunal on this issue, is reproduced as under:

” It goes to show that Vega UAE is duly incorporated as a body corporate under the law of a country outside India which is a requirement of Section 2(17) of the Income tax Act, 1961 and, therefore, Vega UAE has to be accepted as a company within the definition of Section 2(17) of the Income tax Act, 1961. Once it is accepted, the addition made by the A.O. by holding that Vega UAE is a sole proprietorship concern of the assessee company is not sustainable and hence, the addition made by the A.O. is to be deleted. We hold accordingly. Ground No. 1 of the assessee is allowed. Regarding various other contentions raised by both sides, we would like to observe that the same are not relevant in view of our above decision.”

4.1. The issue has time and again cropped up in subsequent years also, wherein the Tribunal has consistently decided this issue in favour of assessee. The latest decision being for AY 2016-17 passed in, AIA Engineering Ltd. v. DCIT [IT Appeal No. 397(Ahd) of 2024, dated 21-10-2024] wherein the Tribunal has taken note of the fact that the issue has already been settled in favour of assessee in earlier assessment years and further the Ld. CIT(A) has followed the decisions of the Tribunal and thereby deleted the impugned addition made by the AO on this issue.

5. The Ld. DR has also fairly agreed that the issue is covered in favour of assessee in the own case of the assessee for earlier assessment years and he could not bring out any distinguishing fact or contrary decision for the year under consideration. Therefore, we do not find any infirmity in the order of the Ld. CIT(A) on this issue, the same is upheld. Thus, Ground No.1 of Revenue’s appeal is dismissed.

6. Ground No.2:– Vide Ground No.2, the Revenue has contested the action of the CIT(A) in deleting the disallowance made by the AO on account of additional depreciation claim of Rs.8,09,995/-.

6.1. The Ld. Counsel for the assessee, at the outset, has submitted that this issue also covered in favour of assessee and against the Revenue by the earlier decisions of the Tribunal in the own case of the assessee. He has further submitted that the Ld. CIT(A) while deleting the impugned addition on this issue has followed the decisions of the Tribunal in earlier assessment years. The assessee had claimed depreciation of Rs.24,29,984/ – being depreciation calculated @ 15% on electrical fittings. The AO, however, held that depreciation on electrical fittings was allowable @ 10%. He, therefore, disallowed the excess depreciation claimed of Rs.8,09,995/-. During the appellate proceedings, the assessee explained that electric installations was part and parcel of the plant & machinery and, therefore, depreciation as applicable on plant & machinery @ 15% was allowable. The Ld. CIT(A) following the earlier decision of the Tribunal on this issue in the own case of the assessee observed that the electric fittings and installations were part and parcel of the plant & machinery without which the plant & machinery could be operated. Therefore, the depreciation @ 15% as applicable on plant & machinery was allowable. The Ld. Counsel, in this respect, has referred to the decision of the Tribunal for AY 2010-11 to AY 2013-14 vide common order dated 04/01/2021 with the lead case in ITA No.1766/Ahd/2012.

7. The Ld. DR has also fairly agreed that the issue is covered in favour of assessee in the own case of the assessee for earlier assessment years. We find that the Ld. CIT(A) has committed no error in following the earlier decisions of the Tribunal on this issue, in the absence of any distinguishing facts for the year under consideration.

8. Ground Nos.3 & 4 are general in nature which require no independent adjudication and, hence, the same are dismissed as such.

9. This appeal of the Revenue is hereby dismissed.

10. The assessee, in this appeal, has taken following grounds of appeal:

11. The assessee, vide Ground Nos.1 & 2, has agitated against the action of the Ld. CIT(A) in confirming the disallowance of Rs.31,11,00,000/- made by the AO u/s 37 of the Income Tax Act, 1961 (in short “the Act”) on account of disallowance of compensation paid for settling the patent infringement dispute.

11.1. The brief facts relevant to the issue are that the assessee is engaged in the business of design, development, manufacture, installation and servicing of high chromium wear, corrosion and abrasion resistant casting used in the cement, mining and thermal power generation industries. The assessee sells such products in India as well as outside India. One of the class of assessee’s product is part of machines or other devices that come into contact with abrasive materials such as rock or other hard, abrasive substances. These parts include those sold under Sintercast mark. These Sintercast products are claimed to be wear/abrasion resistant inter alia due to inclusion of certain combinations of metal oxide ceramics. In 2008, Magotteaux Intemational, Belgium (in short, “MI”) filed a suit against the assessee in the US International Trade Commission (‘ITC’) alleging that the assessee’s Sintercast products exported into US market were in violation of the MI’s US patent ‘RE39998’ relating to such wear resistant component/products.

11.2. The assessee filed a patent invalidation proceedings against MI in US District Court seeking a declaratory judgment that MI’s reissue patent was invalid. The US District Court in September 2010 passed a summary judgment in favour of the assessee invalidating the reissued claims of the RE’998 patent. However, MI appealed against the summary judgment before the Federal Court of Washington. In August 2011, the Federal Court passed an order reversing the finding of the summary judgement and remanded the matter back to District Court for a full trial. The jury trial passed its verdict on 2 July 2012 against the assessee and held that MI’s RE39998 patent was valid, and the assessee’s Sintercast products infringe MI’s RE39998 patent. The District Court based on the above verdict, awarded compensatory damages plus reasonable attorney fees and cost to MI. The assessee opposed the judgment and filed ‘Post Trial’ motions before the District Court to reexamine the matter. In consideration, the Court granted the assessee’s request to re-examine the motion but asked the assessee to deposit cash security of USD 7,228,544, which included the original award plus attorney’s fees and costs. Towards the above, the assessee sought Reserve Bank of India’s (‘RBI’) permission to remit above amount as a security to be placed in District Court to stay the execution of judgement award. The RBI vide its letter dated 20 September 2012 granted desired permission to the assessee. Post placing the deposit, the assessee challenged the award of damages and filed an application for re-examination of the patent in the US Patent and Trademark office. Based on a disclosure made by MI in these proceedings, the assessee also filed a motion in the trial court seeking a reconsideration of the decision based on the new evidence disclosed by MI in the re-examination procedure. However, the trial court held that the reconsideration of the decision based on new evidence can be done only after the decision of the District Court on the ‘post-trial’ motion petition. However, since the cost of litigation was expected to be exorbitant for the assessee and MI and MI at the risk of losing its patent also, both the parties mutually decided to settle the dispute amicably. Accordingly, a Settlement Agreement dated 28 August 2012 was signed to settle and adjust all differences and controversies. Pursuant to the said settlement agreement the assessee paid USD 6,000,000 to MI in consideration of the closure of the litigation and mutual release from claims/counter claims between the parties. In view of the above, the assessee sought RBI’s permission vide letters dated 24 October 2013 and 31 October 2013 to allow the payment to be made to MI from the amount deposited with District Court. The RBI vide its letter dated 18 November 2013 granted desired permission to assessee. The assessee debited an amount of Rs.31,11,00,000 (being the INR equivalent of abovementioned sum of USD 6,000,000) under the head exceptional items in Profit and Loss Account for year ending 31 March 2014 for settlement of patent infringement litigation.

12. On being show-caused by the AO as to why the said amount be not disallowed, the assessee submitted before the AO that the aforesaid amount was agreed to be paid by the assessee on account of contractual liability. That it was not a case of payment of any penalty levied by any government authority or statutory authority on account of any Act or Omission prohibited by law. It was pleaded that it was a compensation which was paid on account of loss of opportunity and probability to the MI as mutually agreed between the parties. That the payment was also approved by the RBI vide letter dated 18/11/2013 and pursuant to the mutual compromise, both the parties to the agreement had released each other from current and future proceedings and liabilities towards each other. The assessee also placed reliance on various case-laws in this respect. The AO, however, did not agree with the aforesaid contentions of the assessee and held that the amount paid to MI was penal in nature and not allowable as business expenditure in view of Explanation-1 to section 37 (1) of the Income Tax Act, 1961 (in short, “the Act”).

13. Being aggrieved by the said disallowance made by the AO, the assessee preferred appeal before the Ld. CIT(A).

14. The Ld. CIT(A), however, observed that there was already a valid patent available with MI (even if it was a reissue patent) and the Sintercast produces exported by the assessee were in violation of an effective and existent patent. That the assessee had violated an existing patent right of the MI in US market. The Ld. CIT(A) referring to the provisions of section 37 of the Act observed that any expenditure incurred by an assessee for any purpose which was an offence or which was prohibited by law would not be deemed to have been incurred for the purpose of business or profession and no deduction or allowance shall be made in respect of such expenditure. He referring to the Explanation 1 & Explanation 3 to Section 37(1) of the Act observed that expenditure incurred by an assessee for any purpose which is an offence or which is prohibited by law includes expenditure for purposes considered offences under current laws in India or outside India and includes benefits or perquisites, violating applicable laws by the recipient and further to include expenditure incurred to compound an offence under prevailing laws in India or outside India. The Ld. CIT(A) observed that the amount of Rs.31,11,00,000/- paid by the assessee to MI was for violation of patent rights of MI and, hence, the said amount was not in nature of compensation, but penal charges which the assessee would have had to pay once the issue had been decided by the Higher Courts in USA. He observed that the District Court, based on the jury’s determination holding that there was willful infringement of MI’s reissue patent by the assessee, awarded compensatory damages to MI payable by the assessee. That, though on the request of the assessee in ‘post-trial motion’, the District Court agreed to re-examine the matter, but subject to the condition of deposit of cash security of $7,228,544.64 which included the original award plus attorney’s fees and costs. That in view of these circumstances, the assessee entered into a Settlement Deed with MI to make a one time payment of USD 6 million to MI and thereby principally and evidently accepted that it had violated the patent rights of MI. The Ld. CIT(A), therefore, held that the payment made by the assessee to MI was clearly in lieu of illegal action of the assessee in selling goods which violated the legal rights of MI in the form of patent. The Ld. CIT(A) held that the assessee had willfully defaulted the US laws. That the aforesaid amount was paid by the assessee to avoid of any conviction by the Court of Law for infringement of patent which was not a normal incidence of business. That the assessee-company did not pursue the patent matter to reach its finality and entered into a settlement with MI accepting the claim of the MI that the assessee had violated its patent rights. Therefore, the Ld. CIT(A) held that the payment was made to the MI was clearly penal in nature and not compensatory and that the same was covered by the Explanation 1, read with Explanation 3 of section 37(1) of the Act and, hence, was rightly disallowed by the AO.

15. Being aggrieved by the said order of the Ld. CIT(A), the assessee has come in appeal before us.

16. The Ld. Counsel for the assessee has made the following submissions before us:

17. The Ld. DR, however, has relied upon the findings of the lower authorities.

18. We have heard the rival contentions of the Ld. Representatives of the parties and gone through the record.

19. Before proceeding further, it will be relevant here to reproduce the relevant provisions of section 37(1) of the Act as on 1.4.2025:-

“37. (1) 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 asses see), 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”.

Explanation 1. —For the removal of doubts, it is hereby declared that any expenditure incurred by an assessee for any purpose which is an offence or which is prohibited by law shall not be deemed to have been incurred for the purpose of business or profession and no deduction or allowance shall be made in respect of such expenditure.

Explanation 2. — For the removal of doubts, it is hereby declared that for the purposes of sub-section (1), any expenditure incurred by an assessee on the activities relating to corporate social responsibility referred to in section 135 of the Companies Act, 2013 (18 of 2013) shall not be deemed to be an expenditure incurred by the assessee for the purposes of the business or profession.

¹(Explanation 3.— For the removal of doubts, it is hereby clarified that the expression “expenditure incurred by an assessee for any purpose which is an offence or which is prohibited by law” under Explanation 1, shall include and shall be deemed to have always included the expenditure incurred by an assessee,—

20. As depicted above, the Explanation 3 has been inserted w.e.f. 1.4.2022, which is much after the relevant Assessment Year under consideration (A.Y. 2014-15) and even after the passing of the impugned Assessment Order on 29.12.2017. Further, the clause (iv) to Explanation 3 has been inserted w.e.f. 01.04.2025, which shows that it has come into effect even after the date of passing of the impugned order of the CIT(A) on 13.01.2025. However, at this stage we take the provisions as are in operation as on today. We will discuss the issue of retrospective or prospective operation of the aforesaid amended provisions in the later part of this order.

21. The relevant provisions of the The U.S. Patent Act (United States Code Title 35 – Patents), are hereby reproduced as under:

” 281 Remedy for infringement of patent.

A patentee shall have remedy by civil action for infringement of his patent.

The several courts having jurisdiction of cases under this title may grant injunctions in accordance with the principles of equity to prevent the violation of any right secured by patent, on such terms as the court deems reasonable.

Upon finding for the claimant the court shall award the claimant damages adequate to compensate for the infringement but in no event less than a reasonable royalty for the use made of the invention by the infringer, together with interest and costs as fixed by the court. When the damages are not found by a jury, the court shall assess them. In either event the court may increase the damages up to three times the amount found or assessed. Increased damages under this paragraph shall not apply to provisional rights under section 154(d). The court may receive expert testimony as an aid to the determination of damages or of what royalty would be reasonable under the circumstances.

The court in exceptional cases may award reasonable attorney fees to the prevailing party.”

(a) Whoever, without the consent of the patentee, marks upon, or affixes to, or uses in advertising in connection with anything made, used, offered for sale, or sold by such person within the United States, or imported by the person into the United States, the name or any imitation of the name of the patentee, the patent number, or the words “patent,” “patentee,” or the like, with the intent of counterfeiting or imitating the mark of the patentee, or of deceiving the public and inducing them to believe that the thing was made, offered for sale, sold, or imported into the United States by or with the consent of the patentee; or

Whoever marks upon, or affixes to, or uses in advertising in connection with any unpatented article the word “patent” or any word or number importing the same is patented, for the purpose of deceiving the public; or

Whoever marks upon, or affixes to, or uses in advertising in connection with any article the words “patent applied for,” “patent pending,” or any word importing that an application for patent has been made, when no application for patent has been made, or if made, is not pending, for the purpose of deceiving the public—

Shall be fined not more than $500 for every such offense. Only the United States may sue for the penalty authorized by this subsection.

(b) A person who has suffered a competitive injury as a result of a violation of this section may file a civil action in a district court of the United States for recovery of damages adequate to compensate for the injury.

(c) The marking of a product, in a manner described in subsection (a), with matter relating to a patent that covered that product but has expired is not a violation of this section.

37(1). A perusal of the abovementioned provisions would reveal that to attract disallowance under the Explanation 1 & Explanation 3 to Section 37(1) of the Act, the expenditure should be found to have been incurred by an assessee ‘for any purpose’ which is an offence or which is prohibited by law. Now the question here is that whether an assessee had made the aforesaid payment of Rs.31,11,00,000/- ‘for any purpose’ which is an offence or prohibited by law ?

21.1. Admittedly, as noted above, the amount in question had been paid by the assessee as a compensation for the settlement of the civil dispute with MI. A perusal of the aforesaid relevant provisions of the US Patent Act/US Code 35 would reveal that section 281 expressly provides that remedy to a patentee for infringement of his patent is by civil action and further sections 283 provides that the aggrieved patentee can sue for injunction for prohibiting the defendant from infringing his patent rights and under section 284, he can sue for damages/compensation. Only penal action can be taken where a person has been found guilty of false marking for which such a person can be fined for not more than $500 for every such offense. In this case, neither there was any allegation of false marking against the assessee nor any such proceedings were ever initiated. The only dispute raised by the MI was that the assessee has infringed its RE39998 patent. However, the claim of the assessee was that it has not violated the MI’s aforesaid patent. A consideration of the entire facts and circumstances would show that the assessee was bonafidely contesting the claim of the MI and even in the first round of litigation has succeeded whereby the District Court has decided the issue in favour of the assessee by invalidating the MI’s patent. Even in the second round when the assessee approached the District Court for reconsideration in the ‘post trial motion’ and further for stay the execution of the judgement/award, the District Court though ordered the assessee to deposit a sum of $7228544.64 as security to fully protect the interest of MI, however, observed, “It cannot be said (AIA) has no likelihood of success with regard to its post trial motions”. Further, it has been observed, “In any event, although the Court will not concede that it committed error, this Court cannot conclude that Plaintiff has no reasonable possibility of success on merits of its post trial motions or appeals”. Further, another important point in this case is that though the assessee had already deposited as a security a sum of $7228544.64 in the District Court which sum, in the event of dismissal of AIA’s (assessee) post-trial motion, would have been disbursed by the Court to the MI, however, the MI in the compromise agree for a lesser amount of $6,000,000.00. The MI’s settlement for a lesser sum shows that the MI was also not sure of its success in the post-trial motion and prefer to settle the dispute for a lesser consideration. Clause-2 of the Article V of the Settlement Agreement mentions, “The Parties agree this is a mutual compensatory settlement to avoid litigation and no representation is made that the foregoing consideration represents an underlying royalty of the patent infringement, the subject matter of the Litigation”. The above facts and circumstances show that the payment of $6,000,000.00 to MI was neither on account of any fine imposed by any Court nor on account of any offence committed by the assessee. The said amount was paid to settle a long pending civil litigation with a private party (MI), wherein, both the parties to the litigation were of the bonafide belief that their claim before the Court of Law was a valid claim and that they were entitle4d to such rights/claims. Even the matter once decided by the District Court in favour of the assessee, however, the judgement of the District Court was reversed by the Federal Court whereupon the assessee filed post-trial motion petition and also deposited the necessary security amount as directed by the District Court. However, since both the parties realized that they would bear a hefty cost of litigation and further the dispute was more likely to be settled early as there were chances of moving to the higher courts by the unsuccessful litigant, therefore, they mutually decided to compromise the matter and settled the consideration payable by the assessee to MI at a lesser price than the awarded amount. Thus, the purpose for the payment of the said amount was settlement of civil litigation which purpose was neither an offence nor prohibited by law.

21.2. The words, “Prohibited by law” would not mean that it would cover every bonafide claim litigated before a Court of Law or any other authority. In our view, in context of section 37 (1) of the Income Tax Act, 1961, what is covered is an act or omission which is an offence or is declared illegal because of it being against the public policy, societal welfare, ethical standards, common good or unconscionable. The individual or private disputes between the parties would not fall within this scope an ambit of section 37(1) of the Act. In our view, an out of court settlement of a dispute and payment of settled amount to finally and amicably close the litigated claim/counter-claim over private/civil rights relating to ownership/ title/ license etc., would not be covered within the scope and definition of ” prohibited by law” in context of section 37(1) of the Act, though, in such a litigation the act or omission or claim of the person who could not succeed may be found to be in suppression or violation of the rights of the person who succeeds in litigation. In every contested civil litigation, there is a claim by the Plaintiff/applicant/first party that his legal right has been infringed/violated by the Respondent/opposite party and there is denial of such violation by such Respondent/opposite party and sometimes there may be counterclaim also, and both the parties to the litigation are of the bonafide belief that their claim/right is legal and valid, however, finally the Court decides the issue in favour of one party and holds that the action/omission of the other party was against the rights of the first party to the litigation, and there may be cases that the appellate court reverses the findings of the lower court, in such type of private and Bonafide litigation, the provisions of section 37(1) cannot be enforced to deny the deduction of expenditure incurred in contesting such bonafide litigation. If the view of the lower authorities is to be accepted, then in every contested litigation, such an assessee whose claim is rejected will not be allowed deduction of expenditure in pursuing such bonafide litigation for the protection or for defending its business rights. The words, “prohibited by law” in our view, can not be given such a narrow interpretation to include in its ambit and scope every bonafide claim litigated before the courts/tribunals or other such authorities.

22. We have carefully considered the rival submissions and perused the materials on record. The central issue revolves around the disallowance of Rs. 31,11,00,000/- paid by the assessee to M/s. Magneco/Metrel, Inc. (MI) towards the settlement of a patent infringement dispute in the USA. The lower authorities disallowed the expenditure, treating it as a payment for a purpose prohibited by law, falling within the mischief of Explanation 1 to Section 37(1) of the Act. The issue is otherwise squarely covered by the decision of the Hon’ble Delhi High court in the case of “ CIT v. Desiccant Rotors International (P.) Ltd. ITR 32 (Delhi), wherein it has been held that where a payment is made under a settlement to avoid the expenses and uncertainty of exorbitant litigation, the payment is to be treated as compensatory and not penal in nature. Moreover, the Hon’ble Delhi High Court has also emphasized that the remedy for patent infringement, under both US and Indian law, is a civil action for damages, not a penalty. The Hon’ble High Court held that an expenditure motivated purely by commercial purpose is allowable under section 37(1) of the Act.

22.1. The authorities below attempted to distinguish this case law by stating that in Desiccant Rotors, patent rights were granted post-settlement. This factor, in our view, is not relevant. Whether the first party agrees to give the patent right to the other party is dependent upon the mutual settlement between the parties and that factor is not determinative of the fact as to whether the assessee has infringed the patent rights of the MI or not. It has been clearly stated vide Clause-2 of the Article V of the Settlement Agreement that the mutual compensatory settlement was to avoid litigation and that consideration paid in the settlement would not represent in any manner as an underlying royalty of the patent infringement. Thus, the observations of the Ld. CIT(A) that the assessee, by entering into the agreement deed with MI and making payment of USD 6 million, in the fact and circumstances, had principally accepting that it has violated the Patent rights of MI and further that the payment was not in the nature of compensation but penal charges, are factually incorrect. The observation of the lower authorities that the payment was made to avoid any conviction by the US Court for infringement of patent laws is also factually incorrect in view of the discussion made above.

22.2. We also find force in the alternate contention of the Ld. AR regarding the applicability of Explanation 3 to Section 37(1) of the Act for the Assessment year under consideration, which was inserted by the Finance Act, 2022, with effect from April 1, 2022. As pointed out in Para 19 above, prior to this amendment, the expression “prohibited by law” under Explanation 1 was confined to the laws in force in India. Its scope has been extended to offshore countries by inserting explanation 3 w.e.f. 1.4.2022 but stating into to be clarificatory. It is a cardinal principle of tax law, affirmed by the Hon’ble Supreme Court in a catena of judgments including CIT (Central)-I v. Vatika Township (P.) Ltd.  ITR 466 (SC) and M.M. Aqua Technologies Ltd. v. CIT ITR 582 (SC), that any amendment which widens the scope of a provision to the detriment of the assessee cannot be applied retrospectively unless the statute expressly provides for it. Explanation 3 widened the scope of disallowance to include violations of laws outside India. The Memorandum to the Finance Act, 2022, also clearly states that the amendment will take effect from April 1, 2022. Therefore, the CIT(A) was in error in applying this provision retrospectively to the assessment year 2014-15. The assessee succeeds in respect of its this alternate contention also.

23. Another interesting point for determination is about the payment made for settlement of dispute relating to infringement of patent rights whether, would be covered under the newly inserted clause (iv) to Explanation 3 to section 37(1) of the Act w.e.f. 1.4.2025 vide the Finance (No. 2) Act, 2024. The very insertion of this clause shows that prior to this amendment, bona fide settlement payments were not intended to be covered by the disallowance u/s 37(1) of the Act. As observed above, this newly inserted clause (iv) can not be applied retrospectively at this stage.

23.1. Further, this newly inserted clause (iv) to Explanation 3 applies only to settlements related to contraventions of laws notified by the Central Government. The CBDT, for this purpose, via Notification No. 38/2025 dated April 23, 2025, has notified that any expenditure incurred to settle proceedings initiated in relation to contravention or defaults under the following laws shall not be deemed to have been incurred for the purpose of business or profession and no deduction or allowance shall be made in respect of such expenditure:

23.2. The Patent Act is conspicuously absent from this list. This makes the legislative intent clear that settlement payments in relation to patent disputes are not intended to be disallowed.

23.3. In view of the detailed discussion above, we conclude that the payment of Rs. 31,11,00,000/- was a compensatory payment made out of commercial expediency to settle a civil dispute and protect the assessee’s business interests. It was not a penalty for an offense or for a purpose prohibited by law under Explanation 1 to Section 37(1). Even the Explanation 3 to Section 37(1) is not applicable to the year under consideration. Even the issue is also not covered under newly inserted clause (iv) to Explanation 3 to section 37(1) of the Act. We, therefore, find the disallowance to be unsustainable and the same is ordered to be deleted. Grounds No. 1 and 2 of the assessee’s appeal are allowed.

24. Since we have allowed the claim of the assessee under section 37 of the Act, the alternative plea of the assessee vide Ground No. 2 to treat the same as a business loss under section 28 of the Act becomes academic and is not adjudicated upon separately.

25. Ground No. 3 is general in nature and alleges a breach of the Principles of Natural Justice. As we have decided the primary issue on merits in favor of the assessee, this ground has become infructuous and requires no separate adjudication.

26. Ground No. 4 relates to the levy of interest under section 234B of the Act. This is consequential in nature. The Assessing Officer is directed to recompute the interest, if any, chargeable under the Act after giving effect to the relief granted by us in this order.

27. Ground No. 5 concerning the initiation of penalty proceedings under section 271(1)(c), is premature and does not require any adjudication at this stage. Accordingly, this ground is dismissed.

28. Ground No. 6 is general in nature.

29. In the result, the appeal of the Revenue is dismissed, whereas, the appeal of the assessee stands allowed.