The Commissioner of Income Tax Jaipur Vs. Prakash Chand Lunia (D) Thr. Lrs. & Anr. Case Summary You Can Listen To

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The Commissioner of Income Tax Jaipur Vs. Prakash Chand Lunia (D) Thr. Lrs. & Anr.

Supreme Court Of India Civil Appeal /7689-90/2022

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Case Background

As per the case facts, a search by revenue intelligence officers at the assessee's rented premises led to the recovery of a significant amount of silver slabs and ingots. The ...

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Civil Appeal Nos. 7689-90 of 2022 Page 1 of 27

REPORTABLE

IN THE SUPREME COURT OF INDIA

CIVIL APPELLATE JURISDICTION

CIVIL APPEAL NOS.7689-90 OF 2022

The Commissioner of Income Tax Jaipur .Appellant

Versus

Prakash Chand Lunia (D)

Thr.Lrs. & Anr. ..Respondents

J U D G M E N T

M. R. Shah, J.

1. Feeling aggrieved and dissatisfied with the

impugned judgment and order dated 22.11.2016

passed by the High Court of Judicature for

Rajasthan at Jaipur passed in DBITA No.96/2003

Civil Appeal Nos. 7689-90 of 2022 Page 2 of 27

and DBITR No.6/1996 by which the High Court

has allowed the said appeals, the Revenue has

preferred the present appeals.

2. The facts leading to the present appeals in nutshell

are as under:

2.1 A search was conducted by the Directorate of

Revenue Intelligence (DRI) officers at the premises

situated at A-11, 12, Sector - VII, NOIDA taken on

rent by the assessee, Shri Prakash Chand Lunia.

The DRI recovered 144 slabs of silver from the

premises and two silver ingots from the business

premises of the assessee at 1397, Chandni Chowk,

Delhi. The assessee was arrested under Section

104 of the Customs Act for committing offence

punishable under Section 135 of the Customs Act.

The Collector, Customs held that the assessee Shri

Prakash Chand Lunia is the owner of silver/bullion

and the transaction thereof was not recorded in the

books of accounts. The Collector of Customs, New

Delhi ordered confiscation of the said 146 slabs of

Civil Appeal Nos. 7689-90 of 2022 Page 3 of 27

silver weighing 4641.962 Kilograms valued at

Rs.3.06 Crores. The Collector Customs further

imposed a personal penalty of Rs.25 Lakhs on Sh.

Prakash Chand Lunia under Section 112 of the

Customs Act. The Collector held that the silver

under reference was of smuggled nature.

2.2 During the course of the assessment proceedings

the Assessing Officer observed that the assessee

was not able to explain the nature and source of

acquisition of silver of which he is held to be the

owner, therefore the deeming provisions of Section

69A of the Income Tax Act, 1961 (hereinafter

referred to as ‘the Act, 1961) would be applicable.

The investment in this regard was not found

recorded in the books of accounts of the assessee

that were produced before the then Assessing

Officer. Accordingly, the Assessing Officer passed

an assessment Order and made an addition of

Rs.3,06,36,909/- under Section 69A of the Act,

1961. In appeals preferred by the Assessee against

the assessment order, the CIT(A) dismissed the

Civil Appeal Nos. 7689-90 of 2022 Page 4 of 27

appeal of the assessee. Feeling aggrieved the

assessee preferred the appeal before the ITAT. The

ITAT, Jaipur also upheld the order of the CIT(A) so

far as Section 69A is concerned, however, partly

allowed the appeal of the assessee. As regards

some other minor additions, the ITAT set aside

some minor other additions and remanded the

matter to the AO for fresh examination. The AO re-

examined the issue and addition was made. The

CIT(A) also upheld the order of the AO. The

Assessee preferred the appeal against the fresh

order passed by the CIT(A) before the ITAT. The

ITAT, in the second round as well upheld the order

of the authorities below. A reference was made by

the ITAT to the High Court with the following

questions of law:

(i) “Whether on the facts and in the circumstances

of the case, the Tribunal after construing and

interpreting the provisions contained in section

69A of the Income Tax Act, 1961 was right in law,

in holding that the assessee was the owner of the

144 silver bars found at premises no A 11 & 12 ,

Sector - VII, Noida and two silver bars found at

premises of M/s Lunia & Co Delhi and in

Civil Appeal Nos. 7689-90 of 2022 Page 5 of 27

sustaining addition of Rs.3,06,36,909/- being

unexplained investment in the hands of the

assessee under Section 69A of the Act?

(ii) If the answer to the above question is in

affirmative then, whether, on the facts and in the

circumstances of the case, the Tribunal was right

in law in distinguishing the ratio laid down by

their Lordships of the Supreme Court in the case

of Piara Singh v/s CIT, 124 ITR 41 and thereby

not allowing the loss on account of confiscation

of silver bars?"

2.3 While the reference was pending before the High

Court, penalty proceedings were initiated against

the assessee. An order under Section 271 (i) (c) of

the Act came to be confirmed by both the CIT (A)

and the ITAT. Accordingly, the assessee filed an

appeal under Section 260A of the Act against the

Penalty order, before the High Court. The High

Court while deciding both the cases together, qua

the first question, decided in favour of the Revenue

and the rental premises of the assessee, the same

is to be added to his income as a natural

consequence. However, with regard to the second

question, the High Court held that los s of

Civil Appeal Nos. 7689-90 of 2022 Page 6 of 27

confiscation by the DRI of ficial of Customs

Department is business loss. While holding the

High Court has relied upon the decision of this

Court in the case of CIT, Patiala vs. Piara Singh

reported in 124 ITR 41. The impugned judgment

and order passed by the High Court is the subject

matter of the present appeal.

3. Shri Balbir Singh, learned ASG has appeared on

behalf of the Revenue and Shri Arijit Prasad,

learned Senior Advocate has appeared on behalf of

the assessee.

3.1 Shri Balbir Singh, learned ASG appearing on

behalf of the Revenue has vehemently submitted

that in the facts and circumstances of the case and

while dealing with the relevant provisions of the

Act, 1961, the High Court has materially erred in

relying upon the decision of this Court in the case

of Piara Singh (supra). It is submitted that as

such the AO, CIT(A) and ITAT have correctly

distinguished the judgment in case of the Piara

Civil Appeal Nos. 7689-90 of 2022 Page 7 of 27

Singh (supra) as the same pertained to an

assessee who was engaged in the business of

smuggling of currency notes and for whom

confiscation of the currency notes was a loss

occasioned in pursuing his business, i.e., a loss

which sprung directly from carrying on of his

business and was incidental to it. It is submitted

that due to this, the assessee in the aforesaid case

was held entitled to deduction under Section 10(1)

of Income Tax Act, 1922. It is submitted that

however in para 7 of the aforesaid judgment which

refers to three cases where an exception to the

aforesaid rule was noted by the Court. It is

submitted that in the said decision this Court

noted earlier decisions of this Court as well as the

Andhra Pradesh High Court and the Bombay High

Court. It is submitted that in the case of Haji Aziz

& Abdul Shakoor Bros. v. CIT, AIR 1961 SC

663, the assessee’s claim for deduction of fine paid

by him for release of his dates confiscated by

customs authorities, was rejected on the ground

that the amount paid by way of penalty for breach

Civil Appeal Nos. 7689-90 of 2022 Page 8 of 27

of law was not a normal course of business carried

on by it. In the other two cases, customs

authorities had confiscated gold from assessees

otherwise engaged in legitimate businesses. It is

submitted that in two relied upon cases of Andhra

Pradesh High Court and the Bombay High Court

the assessees claimed the value of gold seized as a

trading/business loss which is identical to the

Respondent-Assessee’s claim in the facts of the

present SLP. It is submitted that therefore the

decision of this Court in Haji Aziz & Abdul

Shakoor Bros. v. CIT, AIR 1961 SC 663 , of the

Andhra Pradesh High Court in the case of Soni

Hinduji Kushalji & Co. vs. CIT, (1973) 89 ITR

112(AP) and of the Bombay High Court in the case

of JS Parkar v. VB Palekar, (1974) 94 ITR 616

(Bom) shall be applicable with full force to the facts

of the case on hand.

3.2 It is submitted that the Andhra Pradesh High Court

observed in para 10 of the judgment in case of Soni

Hinduji Kushalji (supra) that when a claim for

Civil Appeal Nos. 7689-90 of 2022 Page 9 of 27

deduction is made, the loss must be one that

springs directly from or is incidental to the

business which the assessee carries on and not

every sort or kind of loss which has absolutely no

nexus or connection with his business. In paras 11

and 12, the High Court relied on various judgments

to state that confiscation of contraband gold is an

action in rem and not a proceeding in personam

and thus, a proceeding in rem in the strict sense of

the term is an action taken directly against the

property (i.e., smuggled gold) and even if the

offender is not known, customs authorities have

power to confiscate the contraband gold. In view of

the aforesaid, the Court stated that confiscation of

contraband gold by customs authorities cannot be

said to be a trading or commercial loss connected

with or incidental to assessee's business. The High

Court further relied on Haji Aziz (supra) and

various other judgments to state that such

confiscation of smuggled/contraband goods which

results in infraction of law and has no

incidence/connection to the business of assessee,

Civil Appeal Nos. 7689-90 of 2022 Page 10 of 27

cannot be allowed as a business loss. Thus, the

aforesaid case which has been referred to and

distinguished in Piara Singh (supra), squarely

applies to the facts of the present case herein.

Similarly, the case of JS Parkar (supra) would

also be applicable to the present case as in the

former case, the assessee not only claimed the

value of the gold confiscated as a trading loss but

also set off of the said loss against his assumed and

assessed income from undisclosed sources.

Furthermore, the value of gold was sought to be

taxed U/s.69/69A by the tax authorities. However,

in this case also the Bombay High Court rejected

the contention that Section 110 of the Evidence Act

(where a person found in possession of anything,

the onus of proving that he was not the owner is

on the person who affirmed that he was not owner)

was inapplicable to taxation proceedings and

agreed that tax authorities had rightly inferred

assessee to be owner of seized gold based on

circumstantial evidence and assessee was not

Civil Appeal Nos. 7689-90 of 2022 Page 11 of 27

entitled to claim value of such gold as a trading

loss.

3.3 Shri Balbir Singh, learned ASG has further relied

upon the decisions of this Court in the case of

Chuharmal v. CIT, (1988) 3 SCC 588 and CIT v.

K Chinnathamban, (2007) 7 SCC 390 , on onus

of proving ownership being on the person who

denies ownership and who is in possession. It is

submitted that ownership of confiscated silver fell

on the Respondent-Assessee in the present case

which he failed to discharge and which accordingly

rendered the tax authorities’ concurrent findings

on his ownership to be valid. It is submitted that

when the assessee has been unable to deny

possession and ownership and in fact admitted the

same before the Settlement Commission as well as

the High Court, and further claimed the value of

confiscated silver as a trading loss before AO,

CIT(A) and ITAT, to alternatively argue to the

contrary and deny ownership in order to state that

Civil Appeal Nos. 7689-90 of 2022 Page 12 of 27

Section 69A cannot be applied in his case may not

be accepted.

3.4 It is submitted by learned ASG that assessee shall

also not be permitted to claim such loss as a

business expenditure in view of the express

prohibition under Explanation 1 to Section 37(1) of

the Act which was added w.e.f.01.04.1962.

Reliance is placed on the decisions of this Court in

the case of TA Quereshi (Dr.) v. CIT, (2007) 2 SCC

759 as well as Apex Laboratories (P) Ltd. v. CIT,

(2022) 7 SCC 98. It is submitted that Explanation

1 to Section 37(1) of the Act expressly disallows any

expenditure incurred by an assessee for any

purpose which is an offence or is prohibited by law,

which may be claimed as an expenditure incurred

for the purpose of business/profession.

3.5 It is submitted that in the case of TA Quereshi

(supra), this Court clarified that the facts of the

said case pertained to business loss and not

Civil Appeal Nos. 7689-90 of 2022 Page 13 of 27

business expenditure. It is submitted that in the

said case, ITAT found the assessee engaged in the

business of manufacturing and selling heroin and

thus, this Court held that assessee’s claim of

business loss was allowable as he was in the

business of heroin. It is submitted that the case of

Apex Laboratories (supra) distinguishes the

judgment in TA Quereshi (supra) and states that

the case relating to the assessee bribing doctors,

did not deal with business loss but business

expenditure which was disallowable under

Explanation 1 to Section 37(1). It is submitted that

thus either way, neither can the Respondent -

Assessee claim business loss due to him not being

in the smuggling business nor can he claim

business expenditure as the same is prohibited

under Explanation 1 to Section 37(1).

3.6 Making above submissions and relying upon the

above submissions, it is prayed to allow the present

appeals and restore the ITAT orders.

Civil Appeal Nos. 7689-90 of 2022 Page 14 of 27

4. Shri Arijit Prasad, learned Senior Advocate

appearing on behalf of the assessee has

vehemently submitted that in the present case the

respondent – assessee is engaged in the business

of purchase and sale of silver. Total sales of

Rs.1,46,07,314/- of Silver was declared by the

respondent – assessee with a gross profit of

Rs.1,32,712/- for the assessment year in question.

Search was conducted by the officers of DRI when

unaccounted 146 slabs of silver was recovered.

The Collector of Customs ordered absolut e

confiscation of the said 146 slabs of silver valued

at Rs.3,06,036,909/- was proposed to be added as

deemed income under Section 69A of the Act. The

respondent – assessee disputed being the owner of

the slabs. In the alternative, the respondent also

requested that 146 silver slabs having been

absolutely confiscated by the Customs

Department, the value of such tradable silver slabs

should be allowed as loss. However, the Assessing

Officer made the addition of Rs.3,06,036,909/- as

income under Section 69A of the Act being a value

Civil Appeal Nos. 7689-90 of 2022 Page 15 of 27

of 146 silver bars seized from the possession of the

respondent. The said order of addition came to be

confirmed upto ITAT, however by the impugned

judgment and order the High Court has answered

the reference in favour of the assessee by holding

that when the value of material is added to the

income of the respondent, as a natural

consequence, the loss by confiscation of the said

material is required to be allowed as business loss.

It is submitted that it is through that before the

High Court, the assessee did not press the

argument regarding the ownership of the silver

slabs and therefore, the said question was not

answered by the High Court.

4.1 It is submitted that therefore present case is one

where set off is claimed of the value of the 146

silver slabs as loss on account of absolute

confiscation rather than claim of expenditure of

any penalty and/or fine imposed for infraction of

law.

Civil Appeal Nos. 7689-90 of 2022 Page 16 of 27

4.2 It is submitted that as such the issue in the present

appeals is fairly covered in favour of the assessee

in view of the decision of this Court in the case of

TA Quereshi (Dr.) (supra). In the said decision, it

is held that the judgment of the High Court

applying Section 37 of the Act to the case of

business loss on account of absolute confiscation

of the goods was erroneous. It is submitted that

the submission of the assessee therein that Section

37 of the Act related to business expenditure

whereas case of absolute confiscation was one of

business loss has been accepted.

4.3 It is submitted that in the present case, upon

search, 146 silver slabs were found to be in

possession of the assessee. The value of the said

silver slabs was determined to be Rs.

3,06,036,909/- and the same was added to the

computation of income of the assessee under

Section 69A of the Act as undisclosed valuable

article which was not recorded in the books of

account of the assessee.

Civil Appeal Nos. 7689-90 of 2022 Page 17 of 27

4.4 It is submitted that however as the respondent –

assessee was engaged in the business of trading of

silver and the said silver slabs were in possession

of the assessee for the purpose of trading, absolute

confiscation of the said silver slabs would result in

loss of stock in trade and the value thereof would

be available as deduction as business/trading loss.

It is submitted that therefore the decision of this

Court in the case of T.A. Quereshi (Supra) shall

be clearly applicable.

4.5 It is submitted that in the case of T.A. Quereshi

(Supra) this Court has drawn a distinction

between claim of deduction as expenditure of

penalty/fine as against claim of business loss on

account of confiscation of goods which are

unaccounted stock in trade. It is submitted that in

case of claim of deduction as expenditure of any

fine and/or penalty, the Courts have held that

such deduction would not be available to the

assessee as it would defeat the very purpose

Civil Appeal Nos. 7689-90 of 2022 Page 18 of 27

behind such penal action. Whereas, in case of

claim of set off as business loss, the unaccounted

goods though added to the income of assessee but

is not available to the assessee for his trade. It is

submitted that while extending the benefit of such

set off, this Court in the case of Piara Singh

(supra) and T.A. Quereshi (Supra) have held that

the assessee shall be entitled to the set off as

business loss.

4.6 It is submitted that unlike a case of imposition of

redemption fine where the confiscated goods are

released on payment of such amount , absolute

confiscation of the goods results in the said goods

vesting with the Central Government. In such

cases, though the value of the goods is added to the

income of the assessee, but the assessee has no

option of redeeming the goods for its onward trade.

Thus, there is an evident distinction between a

case where deduction is sought of any penalty

and/or fine as allowable expenditure and a case

where business loss is claimed on account of

Civil Appeal Nos. 7689-90 of 2022 Page 19 of 27

absolute confiscation of the goods which results in

loss of stock in trade. It is submitted that present

one is a case where the set off is claimed as

business loss on account of absolute confiscation

of the silver bars and not of any penalty and/or

fine. The judgments cited during the course of

hearing by the Petitioner are therefore rendered on

distinct and distinguishable facts and would not be

applicable to the facts of the present case.

4.7 It is submitted that the said distinction has also

been statutorily recognized. As highlighted by the

appellant, Section 37 which deals with allowance

and deduction of expenditure, was amended vide

Finance Act, 1998 w.e.f. 01 .04.1962 whereby

Explanation 1 was added to clarify 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. In contrast thereto, consciously

Civil Appeal Nos. 7689-90 of 2022 Page 20 of 27

no such restriction has been brought in law with

regard to set off of the value of the unaccounted

stock in trade which have been absolutely

confiscated.

4.8 Making above submissions it is prayed to dismiss

the present appeals.

5. Heard learned counsel for the respective parties at

length.

6. The short question which is posed for

consideration before this Court is whether the High

Court has erred in law in allowing the respondent

– assessee the loss of confiscation of silver bars by

DRI officials as a business loss, relying upon the

decision of this Court in the case of CIT Patiala

vs. Piara Singh, 1980 Supp SCC 166 ?

6.1 While considering the aforesaid question, at the

outset, it is required to be noted that the provisions

of Section 37(1) under the Act has been amended

by Finance (No.2) Act, 1998 by introducing

Civil Appeal Nos. 7689-90 of 2022 Page 21 of 27

Explanation 1 thereto w.e.f. 01.04.1962 wherein

any expenditure incurred by the assessee for any

purpose which is an offence or prohibited by law is

not an allowable business expense. It is true that

in the present case the respondent - assessee did

not claim value of silver bars confiscation as

business expenses thus claimed as business loss.

However, the amendment to Section 37 might have

some bearing on the issue involved.

6.2 On going through the impugned judgment and

order passed by the High Court, it appears that the

High Court has simply relied upon the decision of

this Court in the case of Piara Singh (supra).

Having gone through the decision of this Court in

the case of Piara Singh (supra), we are of the

opinion that the High Court has materially erred in

relying upon the decision of this Court in the case

of Piara Singh (supra).

6.3 In the case of Piara Singh (supra) the assessee

was found to be in the business of smuggling of

Civil Appeal Nos. 7689-90 of 2022 Page 22 of 27

currency notes and to that it was found that

confiscation of currency notes was a loss

occasioned in pursuing his business i.e. a loss

which sprung directly from carrying on of his

business and was incidental to it. Due to this, the

assessee in the said case held entitled to deduction

under Section 10(1) of the Income Tax Act, 1922.

In view of the above fact situation this Court in the

case of Piara Singh (supra) distinguished the

decisions of this Court in the case of Haji Aziz &

Abdul Shakoor Bros. reported in AIR 1961 SC

663, and the decision in the case of Soni Hinduji

Kushalji & Co. vs. CIT, (1973) 89 ITR 112(AP)

and not agreed with the decision of the Bombay

High Court in the case of J.S. Parkar vs. VB

Palekar, (1974 94 ITR 616 (Bom). It is to be

noted that in all the aforesaid three cases which

were relied upon by the Revenue in the case of

Piara Singh (supra) were found to be involved in

legitimate businesses and not smuggling business

but however they were found to have smuggled

goods contrary to law which resulted in an

Civil Appeal Nos. 7689-90 of 2022 Page 23 of 27

infraction of law and resultant confiscation by

customs authorities.

6.4 In the case of Haji Aziz (supra) the assessee

claimed for deduction of fine paid by him for

release of his dates confiscated by customs

authorities was rejected on the ground that the

amount paid by way of penalty for breach of law

was not a normal business carried out by it. In the

case of Soni Hinduji Kushalji (supra) and JS

Parkar (supra), the customs authorities had

confiscated gold from assessees otherwise engaged

in legitimate businesses. In the aforesaid two

cases the assessee claimed the value of gold seized

as a trading/business loss. It was held that the

assessees are not entitled to the deductions as

claimed as business loss.

6.5 In the case of Soni Hinduji (supra), the Andhra

Pradesh High Court held that when a claim for

deduction is made, the loss must be one that

springs directly from or is incidental to the

business which the assessee carries on and not

Civil Appeal Nos. 7689-90 of 2022 Page 24 of 27

every sort or kind of loss which has absolutely no

nexus or connection with his business. It was

observed that confiscation of contraband gold was

an action in rem and not a proceeding in personam

and thus, a proceeding in rem in the strict sense of

the term is an action taken directly against the

property (i.e. smuggled gold) and even if the

offender is not known, the customs authorities

have power to confiscate the contraband gold.

6.6 In the case of JS Parkar (supra), the assessee not

only claimed the value of the gold confiscated as a

trading loss but also set off of the said loss against

his assumed and assessed income from

undisclosed sources. The value of gold was sought

to be taxed under Section 69/69A of the Act by the

tax authorities. However, the Bombay High Court

held the assessee to be the owner of the smuggled

confiscated gold and the assessee was not entitled

to claim value of such gold as a trading loss.

Civil Appeal Nos. 7689-90 of 2022 Page 25 of 27

6.7 In the present case the ownership of the

confiscated silver bars of the assessee now cannot

be disputed and even the assessee is not disputing

the same. Even on that also there are concurrent

findings by all the authorities below and including

the customs authorities. Therefore, the next

question which is posed for consideration before

this Court is whether the assessee can claim the

business loss of the value of the silver bar

confiscated and whether the decision of this Court

in the case of Piara Singh (supra) would be

applicable?

6.8 To answer to the aforesaid question, it can be seen

that in the present case the main business of the

assessee is dealing in silver. His business cannot

be said to be smuggling of the silver bars as was

the case in the case of Piara Singh (supra). As

observed hereinabove in the assessee’s case he was

carrying on an otherwise legitimate silver business

and in attempt to make larger profits, he indulged

into smuggling of silver, which was an infraction of

Civil Appeal Nos. 7689-90 of 2022 Page 26 of 27

law. In that view of the matter the decision of this

Court in the case of Piara Singh (supra) which

has been relied upon by the High Court while

passing the impugned judgment and order and it

has been relied upon by the assessee shall not be

applicable to the facts of the case. On hand or the

other hand the decision of this Court in the case of

Haji Aziz (1961) 41 ITR 350 (SC) and the

decisions of the Andhra Pradesh High Court and

the Bombay High Court which were pressed into

service by the Revenue in Piara Singh (supra)

would be applicable with full force.

7. In view of the above and for the reason stated above

and looking to the business of the assessee namely

silver business and was not in the business of

smuggling silver, the decision of this Court in the

case of Piara Singh (supra) shall not be applicable

and therefore the impugned judgment and order

passed by the High Court quashing and setting

aside the order passed by the Assessing Officer,

CIT(A) and the ITAT rejecting the claim of the

Civil Appeal Nos. 7689-90 of 2022 Page 27 of 27

Assessee to treat the silver bars confiscated by the

customs authorities as business loss and

consequently value allowing the same as business

loss is unsustainable and the same deserves to be

quashed and set side.

8.1 In view of the above and for the reason stated above

present appeals succeed. The impugned judgment

and order passed by the High Court is hereby

quashed and set aside and the order passed by the

assessing officer, CIT(A) and the ITAT are hereby

restored.

Present appeals are accordingly allowed. No

costs.

……………………………J.

(M. R. SHAH)

……………………………J.

(M.M. SUNDRESH )

New Delhi,

April 24, 2023

REPORTABLE

IN THE SUPREME COURT OF INDIA

CIVIL APPELLATE JURISDICTION

CIVIL APPEAL NO. 7689-7690 OF 2022

THE COMMISSIONER OF INCOME TAX, JAIPUR …APPELLANT

VERSUS

PRAKASH CHAND LUNIA (D) THR LRS & ANR. …RESPONDENTS

J U D G M E N T

M. M. Sundresh, J.

1.The present appeal is filed by the Revenue, challenging the decision of the

Division Bench of the Rajasthan High Court at Jaipur, drawing a distinction

between a claim for deduction of a loss incurred in an illegal business, as

against a claim of a loss qua a legitimate business, though an illegality is

attached to it. The aforesaid issue is to be tested on an offence committed

leading to either a penalty or confiscation.

2.Heard Mr. Balbir Singh, learned Additional Solicitor General, Mr. AK

Shrivastava, learned senior counsel for the Appellant and Mr. Arjit Prasad,

learned senior counsel for the Respondents.

3.I have gone through the well-merited judgment rendered by my learned brother,

Justice M.R. Shah. While concurring with the ultimate conclusion arrived at in

CIVIL APPEAL NO. 7689-7690 OF 2022 1

overturning the decision of the High Court, I would like to give my own

reasoning on the aforesaid aspect. The facts being narrated with utmost clarity

by my learned brother, only those which are required in support of the

reasoning are being recorded.

4.The Director of Revenue Intelligence set out a search at the business premises

of the Respondent/assessee. The recovery yielded silver slabs/silver ingots. The

assessee was in the business of making jewellery.

5.The Respondent/assessee filed his return for the Assessment Year 1989-1990

followed by a petition before the Income Tax Settlement Commission. The

Collector of Customs vide order dated 18.12.1990 ordered confiscation of

goods and imposed penalty. It was done on the premise that the goods were

smuggled by the assessee. A claim was made by the assessee that the loss on

account of confiscation would be allowable as trading loss being incidental to

the business, and hence, deductible. This argument was duly rejected as he was

neither doing the business of smuggling, nor he owned the silver. The plea of

ownership was given up by the Respondent/assessee before the High Court, and

therefore, the decision of the assessing officer in bringing the loss suffered

under Section 69A of the Income Tax Act, 1961 (hereinafter referred to as “the

Act”), has become final.

CIVIL APPEAL NO. 7689-7690 OF 2022 2

6.Before the Hight Court, the Respondent/assessee placing reliance upon the

judgment of this Court in Commissioner of Income Tax v. Piara Singh (1980)

Supp. SCC 166, inter alia contended that smuggling by itself being prohibited

in law, any loss occurred thereunder is liable for deduction. The aforesaid

argument made, found acceptance at the hands of the High Court, which is

sought to be impugned by the Revenue before us.

RELEVANT PROVISIONS OF THE INCOME TAX ACT, 1961

“2. Definitions.- In this Act, unless the context otherwise requires,—

xxxxxxxxx

(13)"business" includes any trade, commerce or manufacture or any

adventure or concern in the nature of trade, commerce or manufacture;”

7.This provision being a definition clause merely defines various activities which

could be termed as a business. Section 2(13) of the Act gives a broad definition

to ‘business’. Section 28 of the Act comes under the heading ‘Profits and Gains

of Business or Profession’. Various types of income enumerated thereunder are

made chargeable to income tax. The income, as referred in Section 28 of the

Act, has to be computed in the manner as prescribed under Section 30 to 43D of

the Act, which is accordingly provided under Section 29 of the Act.

Section 37:

“37 General.- (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 assessee), 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".

CIVIL APPEAL NO. 7689-7690 OF 2022 3

[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.”

8.Section 37 of the Act, being one of the provisions meant for computing income

from profits or gains of business or profession, is a residuary and omnibus

provision which intends to cover all expenditure to the exclusion of those

mentioned under Section 30 to 36 of the Act, apart from being in the nature of

capital expenditure or personal expenses of the assessee. Therefore, the object

behind this provision is very clear as it includes ‘any expenditure’. The second

mandate of this provision is that the expenditure will have to be laid out or

expended wholly and exclusively for the purpose of the business or profession to

come into the fold of income chargeable to tax as profit and gains of business or

profession.

9.An ambiguity arose as to whether a business, as defined under Section 2(13) of

the Act, and as dealt with under Section 37 of the Act, would include a

deduction when the said expenditure is incurred for any purpose which is an

offence or prohibited by law.

10.Since an anomaly has been created by the interpretation of the pari materia

provision under the Income Tax Act, 1922 (hereinafter referred to as “the Old

Act”), viz. Section 10(1) and (2), therefore, Explanation-I to Section 37 of the

CIVIL APPEAL NO. 7689-7690 OF 2022 4

Act came into the statute book with retrospective effect from 01.04.1962

through the Finance (No.2) Act 1998, (Act 21 of 1998).

11.The purpose of the insertion of the aforesaid Explanation was explained by the

Central Board of Direct Taxes Circular No. 772 dated 23.12.1998,

“Disallowance of illegal expenses

20.1 Section 37 of the Income-tax Act is amended to provide 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 purposes of business or

profession and no deduction or allowance shall be made in respect of such ex-

penditure. This amendment will result in disallowance of the claims made by

certain assessees in respect of payments on account of protection money,

extortion, hafta, bribes etc. as business expenditure. It is well decided that

unlawful expenditure is not an allowable deduction in computation of income.

20.2 This amendment will take effect retrospectively from 1st April, 1962 and

will, accordingly, apply in relation to the assessment year 1962-63 and subsequent

years.”

12.Explanation-I makes a declaration to remove any possible doubts to reckon a

loss suffered in the form of expenditure for any purpose which is an offence or

one that is prohibited by law. There is no difficulty in holding that this

explanation is clarificatory in nature. Applying the principle of literal

interpretation with the intendment being very clear, giving no room for further

doubts, coupled with the fact that there is no challenge to it, the meaning

appears to be rather very clear. It seeks to prohibit a deduction of any

expenditure incurred by an assessee for any purpose which is an offence or

which is prohibited by law. Due regard will have to be given to the words ‘any

expenditure’ and ‘any purpose’. The reiteration being a legislative clarification

CIVIL APPEAL NO. 7689-7690 OF 2022 5

of the main provision is required to be taken note of, as such, the power of

judicial review over an explanation, which has been introduced to explain and

remove the doubts of the main provision, is rather limited.

13.Though the provision speaks of expenditure while not making a specific

reference to loss, one has to press into service the accepted commercial practice

and trading principles. If one is to treat the expenditure as a genus, a loss would

become a specie. All losses would become expenditures but not vice versa. A

commercial loss in trade arising out of a business being carried on and

incidental to it would be a deductible loss as laid down by this Court in

Badridas Daga v. CIT, (1959) SCR 690. There is a similarity in the test qua a

loss as laid down by this Court, and expenditure under Section 37 of the Act.

Perhaps, there is a distinction when it comes to the accounting treatment of the

two concepts. Thus, there is no difficulty in holding that the word ‘any

expenditure’ mentioned in Section 37 of the Act takes in its sweep loss

occasioned in the course of business, as well. Therefore, I agree with the view

of my learned brother that Section 37 of the Act and Explanation 1 will have a

bearing in the present case.

Section 115BBE

“Section 115BBE.- “Tax on income referred to in section 68 or section

69 or section 69A or section 69B or section 69C or section 69D.- (1) Where the

total income of an assessee,—

CIVIL APPEAL NO. 7689-7690 OF 2022 6

(a) includes any income referred to in section 68, section 69, section

69A, section 69B, section 69C or section 69D and reflected in the

return of income furnished under section 139; or

(b) determined by the Assessing Officer includes any income referred to

in section 68, section 69, section 69A, section 69B, section 69C or

section 69D, if such income is not covered under clause (a),

the income-tax payable shall be the aggregate of—

(i) the amount of income-tax calculated on the income referred to in

clause (a) and clause (b), at the rate of sixty per cent; and

(ii) the amount of income-tax with which the assessee would have been

chargeable had his total income been reduced by the amount of

income referred to in clause (i).

(2) Notwithstanding anything contained in this Act, no deduction in

respect of any expenditure or allowance or set off of any loss shall be allowed to

the assessee under any provision of this Act in computing his income referred to

in clause (a) and clause (b) of sub-section (1).”

14.Section 115BBE of the Act deals with levy of tax on income as mentioned in

Section 68, 69, and 69A to 69D of the Act. If a case comes under Section

115BBE sub-section (1) of the Act, the rate of income tax shall be at 60%.

15.The object of this provision is to fill up the loopholes and to make sure

unaccounted money either generated or used, more so in the nature of Black

Money, is penalized. When this provision was introduced in the year 2012, the

rate of tax was fixed at the rate of 30%. The Bill also speaks about the objective

behind not allowing any deduction to the assessee in computing deemed income

under Section 68, 69 and 69A to 69D of the Act. That was the reason why a

decision was made to impose greater tax burden. The rate of tax was increased

by a subsequent amendment to 60%.

16.Sub-section (2) of Section 115BBE starts with a non-obstante clause. It will

have precedence over any other provision contained in the Act, while dealing

CIVIL APPEAL NO. 7689-7690 OF 2022 7

with a deduction in respect of any expenditure or allowance or set off of any

loss. In other words, no such deduction would be allowed under any provision

of the Act in computing an assessee’s income under sub-section (1). An

amendment has been introduced by Finance Act, 2016 with the inclusion of ‘set

off of any loss’ being not allowable. Sub-section (2) once again does not speak

about loss but the fact that it makes a reference to ‘set off of any loss’ would

reiterate the view taken earlier, while considering the scope and ambit of

Section 37 of the Act, that such a loss has to be read into expenditure, at least

while applying the test for the purpose of deduction. To make the position clear

one has to understand that the amendment merely speaks about the right of the

assessee to set off the loss which presupposes that the loss has to be treated as a

facet of expenditure.

17. A little bit of interplay between Section 115BBE and Section 37(1) of the Act

might throw more light on both the provisions. If a loss in pursuance to an

offence or prohibited business cannot be brought under Section 115BBE of the

Act for income assessed under 68, 69 and 69A to 69D of the Act, which deals

with unexplained income, expenditure etc., it can never be said that the same

would be brought under Section 37(1) of the Act, despite the fact that the

objective behind both the provisions are overlapping with some connection.

CIVIL APPEAL NO. 7689-7690 OF 2022 8

Section 115BBE being a subsequent legislation, the true meaning of Section

37(1) can be understood on that basis.

18. Having understood the provisions, I shall now consider the decisions relied

upon at the Bar as they deal with the interpretation of the provisions governing.

19.Badridas Daga v. CIT , (1959) SCR 690

19.1This Court was dealing with a loss suffered due to an embezzlement by an

employee of the assessee. While interpreting Section 10(2) of the Old Act

over a claim made for deduction, for which there was no specific provision,

reliance was made on the accepted commercial practices and trading

principles. Resultantly, it was held that the deduction was allowable in a case

where there is no prohibition either expressed or implied under the Act. Thus,

the Court has made it clear that in the absence of any prohibition, as stated

above, a claim for deduction of a loss is allowable so long as it emanates

directly from the carrying on of the business, being incidental to it. In other

words, it does not include loss of any nature even if it has some connection

with the business, if the same cannot be said to be incidental to the business.

19.2The court went on to hold that the payment of salary to an employee being

paid for the purpose of business, is deductible under the general provision,

therefore, logically any loss occasioned on the action of an employee would

be incidental to the business.

CIVIL APPEAL NO. 7689-7690 OF 2022 9

19.3Considering the aforesaid, it can be said that there is a similarity between the

test laid down for deduction of an expense in the residuary omnibus provision

under Section 10(2)(xv) of the Old Act and the test for deduction of loss based

on commercial practices and trading principles. The decision is therefore

supporting the above stated interpretation of Section 37 of the Act.

19.4Relevant paragraphs:

“The question whether monies embezzled by an agent or employee are

allowable as deduction in computing the profits of a business under s. 10 of the

Act has come up for consideration frequently before the Indian Courts, and the

decisions have not been quite uniform. Before discussing them, it is necessary that

we should examine the principles that are in law applicable to the determination

of the question. Three grounds have been put forward in support of the claim for

deduction: (1) that the loss sustained by reason of embezzlement is a bad debt

allowable under s. 10(2)(xi) of the Act; (2) that it is a business expense falling

within s. 10(2)(xv) of the Act; and (3) that it is a trading loss, which must be taken

into account in computing the profits under s. 10(1) of the Act. As regards the first

ground, the authorities have consistently held that the deduction is not admissible

under s. 10(2)(xi) of the Act, and that, in our view, is correct. A debt arises out of

a contract between the parties, express or implied, and when an agent

misappropriates monies belonging to his employer in fraud of him and in breach

of his obligations to him, it cannot be said that he owes those monies under any

agreement. He is no doubt liable in law to make good that amount, but that is not

an obligation arising out of a contract, express or implied. Nor does it make a

difference that in the accounts of the business the amounts embezzled are shown

as debits, the amounts realised towards them, if any, as credits, and the balance is

finally written off. They are merely journal entries adjusting the accounts and do

not import a contractual liability. Nor can a claim for deduction be admitted under

s. 10(2)(xv), because moneys which are withdrawn by the employee out of the

business till without authority and in fraud of the proprietor can in no sense be

said to be “an expenditure laid out or expended wholly and exclusively” for the

purpose of the business. The controversy therefore narrows itself to the question

whether amounts lost through embezzlement by an employee are a trading loss

which could be deducted in computing the profits of a business under s. 10(1). It

is to be noted that while s, 10(1) imposes a charge on the profits or gains of a

trade, it does not provide how those profits are to be computed. Section 10(2)

enumerates various items which are admissible as deductions, but it is well settled

that they are not exhaustive of all allowances which could be made in ascertaining

profits taxable under s. 10(1). In Income Tax Commissioner v. Chitnavis [(1932)

LR 59 IA 290, 296, 297] the point for decision was whether a bad debt could be

CIVIL APPEAL NO. 7689-7690 OF 2022 10

deducted under s. 10(1) of the Act, there having been in the Act, as it then stood,

no provision corresponding to s. 10(2)(xi) for deduction of such a debt. In

answering the question in the affirmative, Lord Russel observed:

“Although the Act nowhere in terms authorizes the deduction of

bad debts of business, such a deduction is necessarily allowable.

What are chargeable in income tax in respect of a business are the

profits and gains of a year; and in assessing the amount of the

profits and gains of a year account must necessarily be taken of all

losses incurred, otherwise you would not arrive at the true profits

and gains.”

It is likewise well settled that profits and gains which are liable to be taxed under

s. 10(1) are what are understood to be such according to ordinary commercial

principles. “The word ‘profits’ … is to be understood”, observed Lord Halsbury in

Gresham Life Assurance Society v. Styles [(1892) AC 309, 315 : 3 TC 185, 188]

“in its natural and proper sense — in a sense which no commercial man would

misunderstand”. Referring to these observations Lord Macmillan said in

Pondicherry Railway Co. v. Income Tax Commissioner [(1931) LR 58 IA 239,

252]:

“English authorities can only be utilized with caution in the

consideration of Indian income tax cases owing to the differences

in the relevant legislation, but the principle laid down by Lord

Chancellor Halsbury in Gresham Life Assurance Society v. Styles

[(1892) AC 309, 315 : 3 TC 185, 188] , is of general application

unaffected by the specialities of the English tax system.”

The result is that when a claim is made for a deduction for which there is no

specific provision in s. 10(2), whether it is admissible or not will depend on

whether, having regard to accepted commercial practice and trading principles, it

can be said to arise out of the carrying on of the business and to be incidental to it.

If that is established, then the deduction must be allowed, provided of course there

is no prohibition against it, express or implied, in the Act.

These being the governing principles, in deciding whether loss resulting

from embezzlement by an employee in a business is admissible as a deduction

under s. 10(1) what has to be considered is whether it arises out of the carrying on

of the business and is incidental to it. Viewing the question as a businessman

would, it seems difficult to maintain that it does not. A business especially such as

is calculated to yield taxable profits has to be carried on through agents, cashiers,

clerks and peons. Salary and remuneration paid to them are admissible under s.

10(2)(xv) as expenses incurred for the purpose of the business. If employment of

agents is incidental to the carrying on of business, it must logically follow that

losses which are incidental to such employment are also incidental to the carrying

on of the business. Human nature being what it is, it is impossible to rule out the

CIVIL APPEAL NO. 7689-7690 OF 2022 11

possibility of an employee taking advantage of his position as such employee and

misappropriating the funds of his employer, and the loss arising from such

misappropriation must be held to arise out of the carrying on of business and to be

incidental to it. And that is how it would be dealt with according to ordinary

commercial principles of trading.

At the same time, it should be emphasised that the loss for which a

deduction could be made under s. 10(1) must be one that springs directly from the

carrying on of the business and is incidental to it and not any loss sustained by the

assessee, even if it has some connection with his business. If, for example, a thief

were to break overnight into the premises of a moneylender and run away with

funds secured therein, that must result in the depletion of the resources available

to him for lending and the loss must, in that sense, be a business loss, but it is not

one incurred in the running of the business, but is one to which all owners of

properties are exposed whether they do business or not. The loss in such a case

may be said to fall on the assessee not as a person carrying on business but as

owner of funds. This distinction, though fine, is very material as on it will depend

whether deduction could be made under s. 10(1) or not.”

(emphasis supplied)

20.Haji Aziz & Abdul Shakoor Bros. v. CIT, (1961) 2 SCR 651

20.1The three-Judge bench of this Court in the aforesaid case was concerned with

two principal issues which we are dealing with at present. In clear terms it has

been held that an expenditure is not deductible unless it is a commercial loss

in trade. A penalty incurred for an infraction of law could never be termed as a

commercial loss in carrying on business, apart from being an abnormal

incident, consequently, it cannot be deducted. It falls on the assesse in some

character other than that of a trader. A mere connection between the loss and

the business of the assesse per se can never be the sole factor. To put it simply,

this Court has made the position abundantly clear that a penalty can never be

understood as a commercial expenditure/loss for the purpose of the business

CIVIL APPEAL NO. 7689-7690 OF 2022 12

nor a disbursement made to earn profit. It was further noted that a confiscation

is a proceeding in rem, and therefore, the penalty is imposed on the goods.

That being the position, in any case, an assessee cannot claim deduction of

loss in a case of confiscation/penalty, as arising out of carrying on of the

business or incidental to it.

20.2Relevant paragraphs:

“In support of his argument counsel for the appellant firm referred

to Maqbool Hussain v. State of Bombay etc. [(1953) SCR 730] and to the

following passage at p. 742 where Bhagwati, J., said:

“Confiscation is no doubt one of the penalties which the Customs

Authorities can impose but that is more in the nature of

proceedings in rem than proceedings in personam, the object being

to confiscate the offending goods which have been dealt with

contrary to the provisions of the law and in respect of the

confiscation also an option is given to the owner of the goods to

pay in lieu of confiscation such fine as the officer thinks fit. All this

is for the enforcement of the levy of and safeguarding the recovery

of the sea customs duties.”

Similar observations were made by S.K. Das, J., in Shewpujanrai Indrasanrai

Ltd. v. Collector of Customs & Ors. [(1959) SCR 821 at p. 836] where it was said

that a distinction must be drawn between an action in rem and proceeding

in personam and that confiscation of the goods is a proceeding in rem and the

penalties are enforced against the goods whether the offender is known or not.

The view taken by this Court in the other two cases cited by counsel for the

appellants i.e. Leo Roy Frey v. Superintendent, District Jail, Amritsar [(1958)

SCR 822] and Thomas Dana v. State of Punjab [1959 Supp (1) SCR 274 at p.

298] is the same. In Dana case [(1959) SCR 821 at p. 836] Subba Rao, J., said at

p. 298:

“If the authority concerned makes an order of confiscation it is

only a proceeding in rem and the penalty is enforced against the

goods. On the other hand, if it imposes a penalty against the person

concerned, it is a proceeding against the person and he is punished

for committing the offence. It follows that in the case of

confiscation there is no prosecution against the person or

imposition of a penalty on him.”

CIVIL APPEAL NO. 7689-7690 OF 2022 13

In Maqbool Hussain’s case [(1953) SCR 730] the question for decision was

whether after proceedings had been taken under the Sea Customs Act an accused

person could be prosecuted and could or could not rely upon the plea of double

jeopardy, it was held that he could not. In Shewpujanrai case [(1959) SCR 821 at

p. 836] the contention raised was that after proceedings had been taken under the

Foreign Exchange Regulation Act it was not open to the Customs Authorities to

take any action under the Sea Customs Act. The other two cases were similar

to Maqbool Hussain case [(1953) SCR 730] . The contention now raised before us

is quite different. What is to be decided in the present case is whether the penalty

which was paid by the appellant firm was an allowable deduction within s. 10(2)

(xv) of the Income-tax Act which provides:

S. 10. (2)(xv) “any expenditure (not being in the nature of capital

expenditure or personal expenses of the assessee) laid out or

expended wholly and exclusively for the purpose of such business,

profession or vocation.”

The words “for the purpose of such business” have been construed in Inland

Revenue v. Anglo Brewing Co. Ltd. [(1925) 12 TC 803, 813] to mean “for the

purpose of keeping the trade going and of making it pay”. The essential condition

of allowance is that the expenditure should have been laid out or expended wholly

and exclusively for the purpose of such business.

In deciding this case, reference to decisions in some English cases will be

fruitful. In Commissioners of Inland Revenue v. Warnes & Co. [(1919) 2 KB

444] , the assessee who carried on the business of oil exporters were sued for a

penalty on an information exhibited by the Attorney-General under the Sea

Customs Consolidation Act for breach of orders and proclamations. The matter

was settled by consent on the assessee agreeing to pay a mitigated penalty of £

2000. All imputations on the moral culpability of the assessees were withdrawn.

The provisions of the Act under which this information was lodged and penalty

paid was similar to the provisions of the Indian Sea Customs Act. This amount

was held not to be a proper deduction because in order to be within the provision

similar to s. 10(2)(xv) of the Indian Act the loss had to be something within

commercial contemplation and in the nature of a commercial loss. Rowlatt, J.,

relying on the observation of Lord Loreburn, L.C., in Strong &

Co. v. Woodifield [(1906) AC 448] said at p. 452:

“but it seems to me that a penal liability of this kind cannot be

regarded as a loss connected with or arising out of a trade. I think

that a loss connected with or arising out of a trade must, at any rate,

amount to something in the nature of a loss which is contemplable

and in the nature of a commercial loss. I do not intend that to be an

exhaustive definition, but I do not think it is possible to say that

when a fine which is what the penalty in the present case amounted

to has been inflicted upon a trading body, it can be said that that is

CIVIL APPEAL NO. 7689-7690 OF 2022 14

a ‘loss connected, with or arising out of’ the trade within the

meaning of this rule”.

This statement of the law was approved in the Commissioners of Inland

Revenue v. Alexander Von Glehn & Co. Ltd. [(1920) 2 KB 553] where also in

similar circumstances by consent of the assessee penalty of £ 3,000 was paid and

the penalty plus the costs were claimed as deduction in arriving at the profits. The

Special Commissioners had found that the penalty and costs were incurred by the

assessee in the course of carrying on their trade and so incidental thereto and were

admissible deductions. Rowlatt, J., on a reference held it to be a non-deductible

item. This judgment was affirmed on appeal by the Court of Appeal. Lord

Sterndale, M.R., was of the opinion that it was immaterial whether technically the

proceedings were criminal or not. The money that was paid was paid as a penalty

and it did not matter if in the information it was called a forfeiture.

It was argued by the assesses in that case that no moral obliquity was

attributed to them and that it did not matter whether the expense was incurred in

consequence of an infraction of the law or whether it was a penalty for doing an

illegal act. At p. 565 Lord Sterndale said:

“Now what is the position here? This business could perfectly well

be carried on without any infraction of the law. This penalty was

imposed because of an infraction of the law, and that does not seem

to me to be, any more than the expense which had to be paid

in Strong & Co. v. Woodifield [(1906) AC 448] appeared to Lord

Davey to be, a disbursement or expense which was laid out or

expended for the purpose of such trade….”

Warrington, L.J. said at p. 569:

“It is a sum which the persons conducting the trade have had to pay

because in conducting it they have so acted as to render themselves

liable to this penalty. It is not a commercial loss, and I think when

the Act speaks of a loss connected with or arising out of such trade

it means a commercial loss, connected with or arising out of the

trade.”

In Strong & Co. v. Woodifield [(1906) AC 448] a brewing company owned a

licensed house in which they carried on the business of inn-keepers. They

incurred a liability to pay damages on account of injuries caused to a visitor, by

the falling in of a chimney. This sum was held not to be allowable as a deduction

in computing the profits. Lord Loreburn, L.C., in his speech said no sum could be

deducted unless it be money wholly and exclusively laid out or expended for the

purpose of such trade and that only such losses could be deducted as were

connected with it in the sense that they were really incidental to the trade itself

and they could not be deducted if they were mainly incidental to some other

CIVIL APPEAL NO. 7689-7690 OF 2022 15

vocation or fell on the trader in some character other than that of a trader. Lord

Davey observed:

“I think the disbursements permitted are such as are made for that

purpose. It is not enough that the disbursement is made in the

course of, or arise out of, or is connected with the trade or is made

out of the profits of the trade. It must be made for the purpose of

earning profits.”

The following passage from Lord Sterndale's judgment at p. 566 in Von Glehn

case [(1920) 2 KB 553] from which we have already quoted shows the effect of

incurring a penalty as a result of a breach of the law:

“During the course of the trading this company committed a breach

of the law. As I say, it has been agreed that they did not intend to do

anything wrong in the sense that they were willingly and

knowingly sending these goods to an enemy destination; but they

committed a breach of the law, and for that breach of the law, they

were fined. That, as it seems to me, was not a loss connected with

the business, but was a fine imposed upon the company personally,

so far as a company can be considered to be a person, for a breach

of the law which it had committed. It is perhaps a little difficult to

put the distinction into very exact language, but there seems to me

to be a difference between a commercial loss in trading and a

penalty imposed upon a person or a company for a breach of the

law which they have committed in that trading. For that reason I

think that both the decision of Rowlatt, J., in this case, and his

former decision in Inland Revenue Commissioners v. Warnes &

Co. [(1919) 2 KB 444] which he followed were right, and that this

appeal should be dismissed with costs.”

In Spofforth and Prince v. Glider [(1945) 26 TC 310] the assessee was a firm of

chartered accountants, who claimed a deduction for certain legal costs paid in

connection with a successful defence of one of the partners in a Police Court. The

assessee Firm also sought legal advice in regard to matters connected with some

proceedings. Summons were issued against the assessee firm but were eventually

dismissed. The assessee contended that the whole of the costs incurred in

connection with the proceedings were “wholly and exclusively” laid out or

expended for the appellant's profession and were therefore allowable deductions.

The Special Commissioner had held against the assessee which was upheld by the

Court. The test laid down by Lord Davey in Strong & Co. v. Woodifield [(1906)

AC 448] was applied and applying that test it was held that except the expenses

for obtaining legal advice the other expenses were not admissible.

In Farrie v. Hall [(1947) 28 TC 200] F, a sugar broker was sued in the

High Court for libel and the Court held that F had acted maliciously and that the

defence of privilege could not prevail and awarded damages against him. F sought

CIVIL APPEAL NO. 7689-7690 OF 2022 16

to claim the amount of damages as an allowable deduction contending that it was

an expenditure laid out wholly and exclusively for the purposes of his trade or

was a loss connected with or arising out of the trade. Relying on the cases

abovementioned this amount was disallowed because it fell on the assessee in his

character of a calumniator of a rival sugar broker and it was only remotely

connected with his trade as a sugar broker. Therefore it was not laid out

exclusively and wholly for the purpose of his business. We were also referred to

the observations of Danckwerts, J. in Newson v. Robertson [(1952) 33 TC 452 at

p. 459] where it was said that if the expenditure is incurred by the tax-payer for

more than one purpose including the commercial purposes in the sense that it is

incurred for the purposes of earning profits of the trade and also some outside

purpose then the expenses cannot be claimed at all as not being wholly and

exclusively laid out or expended for the purpose of the trade. In that case

expenses claimed by a Barrister for travelling between his house and his chambers

were disallowed because his object and purpose in travelling was mixed and not

wholly and exclusively for the purpose of the profession.

Coming now to Indian cases; In Mask & Co. v. Commissioner of Income-

tax, Madras [(1943) 11 ITR 454] the assessee in breach of his contract sold

crackers at a lower rate and a decree was passed against him for damages for

breach of contract which he claimed as an allowable deduction. It was held that as

the assessee had disregarded the undertaking given and his conduct was palpably

dishonest it did not constitute an allowable expenditure. Sir Lionel Leach, C.J.,

after referring to Warne’s case [(1919) 2 KB 444] and Von Glehn’s case [(1920) 2

KB 553] held that the amount did not constitute an expenditure falling within

Section 10(2)(xii). The Madras High Court in Senthikumara Nadar &

Sons v. Commissioner of Income-tax (1957) 32 ITR 138] held that payments of

penalty for an infraction of the law fell outside the scope of permissible

deductions under s. 10(2)(xv). In that case the assessee had to pay liquidated

damages which was akin to penalty incurred for an act opposed to public policy a

policy underlying the Coffee Market Expansion Act, 1942, and which was left to

the Coffee Board to enforce.

Reference was also made during the course of arguments to Commissioner

of Income-tax v. Hirjee [(1953) SCR 714]. In that case the assessee was

prosecuted under the Hoarding and Profiteering Ordinance but was finally

acquitted and claimed the amount spent in defending himself under s. 10(2)(xv) in

his assessment. It was held that the distinction between the legal expenses on a

successful and unsuccessful defence was not sound and that the deductibility of

such expenses under s. 10(2)(xv) must depend on the nature and purpose of the

legal proceedings in relation to the business whose profits are in computation and

are unaffected by the final outcome of the proceedings.

A review of these cases shows that expenses which are permitted as

deductions are such as are made for the purpose of carrying on the business i.e. to

enable a person to carry on and earn profit in that business. It is not enough that

CIVIL APPEAL NO. 7689-7690 OF 2022 17

the disbursements are made in the course of or arise out of or are concerned with

or made out of the profits of the business but they must also be for the purpose of

earning the profits of the business. As was pointed out in Von Glehn’s case

[(1920) 2 KB 553] an expenditure is not deductible unless it is a commercial loss

in trade and a penalty imposed for breach of the law during the course of trade

cannot be described as such. If a sum is paid by an assessee conducting his

business, because in conducting it he has acted in a manner, which has rendered

him liable to penalty it cannot be claimed as a deductible expense. It must be a

commercial loss and in its nature must be contemplable as such. Such penalties

which are incurred by an assessee in proceedings launched against him for an

infraction of the law cannot be called commercial losses incurred by an assessee

in carrying on his business. Infraction of the law is not a normal incident of

business and therefore only such disbursements can be deducted as are really

incidental to the business itself. They cannot be deducted if they fall on the

assessee in some character other than that of a trader. Therefore where a penalty is

incurred for the contravention of any specific statutory provision, it cannot be said

to be a commercial loss falling on the assessee as a trader the test being that the

expenses which are for the purpose of enabling a person to carry on trade for

making profits in the business are permitted but not if they are merely connected

with the business.

It was argued that unless the penalty is of a nature which is personal to the

assessee and if it is merely ordered against the goods imported it is an allowable

deduction. That, in our opinion, is an erroneous distinction because disbursement

is deductible only if it falls within s. 10(2)(xv) of the Income-tax Act and no such

deduction can be made unless it falls within the test laid down in the cases

discussed above and it can be said to be expenditure wholly and exclusively laid

for the purpose of the business. Can it be said that a penalty paid for an infraction

of the law, even though it may involve no personal liability in the sense of a fine

imposed for an offence committed, is wholly and exclusively laid for the business

in the sense as those words are used in the cases that have been discussed above.

In our opinion, no expense which is paid by way of penalty for a breach of the law

can be said to be an amount wholly and exclusively laid for the purpose of the

business. The distinction sought to be drawn between a personal liability and a

liability of the kind now before us is not sustainable because anything done which

is an infraction of the law and is visited with a penalty cannot on grounds of

public policy be said to be a commercial expense for the purpose of a business or

a disbursement made for the purposes of earning the profits of such business.”

21.CIT v. S.C. Kothari, 1972 (4) SCC 402

21.1 The decision rendered in Badridas Daga (supra) was quoted with approval.

However, it was the view expressed that if the profit is to be taken for the

CIVIL APPEAL NO. 7689-7690 OF 2022 18

taxable income, a resultant expenditure/loss cannot be avoided,

notwithstanding the nature of business. We must hasten to note that the

decision rendered in S.C. Kothari (supra) may not be in tune with Badridas

Daga (supra) wherein this Court held that allowing a deduction depends upon

the statute and commercial principles, while applying the test of ‘purpose of

business’ and ‘incidental to business’ and not by way of a general principle.

Hence, non-allowance of a deduction on the ground of one incurred as an

expenditure for a purpose which is an offence or prohibited by law can be

disallowed otherwise through a statute. This Court in SC Kothari (supra) had

merely laid down the general proposition of law by taking note of the position

prevailing in other countries, but in any case, it has got no application over a

case of either a penalty or confiscation.

21.2The law as laid down in Haji Aziz (supra) despite being noted, was not

followed on both the counts, viz., the deduction of loss qua an offence and the

consequence of a penalty imposed for an infraction of law.

21.3We must further add that in S.C. Kothari (supra), this Court was concerned

with Section 10(2)(xv) of the Old Act, which did not contain any explanation

as introduced to Section 37(1) of the Act. This subsequent change in law will

certainly have a bearing on the understanding of the said judgment.

CIVIL APPEAL NO. 7689-7690 OF 2022 19

22.Soni Hinduji Kushalji & Co. v. CIT, (1971) SCC Online AP 223

22.1The Division Bench of the Andhra Pradesh High Court considered the law laid

down on deduction of loss incurred by way of a confiscation and penalty. It

took into consideration the decision of this Court in S.C. Kothari (Supra). It

was accordingly held that a loss must be one arising directly from the business

or trade, being incidental to it, as laid down by this Court in Badridas Daga

(supra). The Court while noting the decision of this Court in Maqbool

Hussain v. State of Bombay etc., (1953) SCR 730 and Haji Aziz (supra), held

that a confiscation of a contraband being an action in rem is not available for

deduction, as the same, by no process of reasoning can be said to be trading or

commercial loss connected with or incidental to the assessee's business.

22.2Relevant paragraphs:

“4. Mr. Swamy appearing for the assessee-firm strongly contended that when the

profits earned from an illegal business are not exempt from tax, the loss sustained

in such business should be allowed to be deducted from the profits or gains for

purposes of computing the tax payable by the assessee.

5. What are chargeable to tax in respect of a business carried on by the assessee

are the profits or gains of a particular assessment year. While assessing the profits,

necessarily loss incurred in the business during the year should be taken into

account, as otherwise it is not possible to arrive at the true profits earned by the

assessee. It is well-settled that the taint of illegality associated with profits or

income is immaterial for the purpose of taxation. As observed by Lord Haldane in

Minister of Finance v. Smith [[1927] A.C. 193, 198.] , Income-tax Acts are not

necessarily restricted in their application to lawful business only. One who

contravenes a statute and trades in business prohibited by law while being liable

for prosecution for the offence committed by him will, at the same time, be liable

to pay tax out of the income or profits earned from the illegal trade or business.

We are now concerned with the loss representing the value of gold on account of

the confiscation of the gold for contravention of the provisions of the Customs

CIVIL APPEAL NO. 7689-7690 OF 2022 20

Act. Can that loss be regarded as a commercial loss pertaining to the business or

incidental to the business the assessee was carrying on, is the real question.

6. Mr. Swamy sought to place strong reliance upon a decision of the Gujarat High

Court in Commissioner of Income-tax v. S.C. Kothari [[1968] 69 I.T.R. 1 (Guj.).]

to contend that the assessee is entitled to claim deduction of the value of the

contraband gold confiscated by the customs authorities, as it represented the loss

sustained by the firm in the illegal business carried on by it. The learned judges in

that case were of the view that, when illegal business is business within the

meaning of the Income-tax Act and if profits from illegal business are assessable

to tax, there is no reason either in principle or on authority for refusing to take

into account losses from illegal business. According to these, the losses so

incurred must necessarily be taken into account in order to arrive at the true

profits of the business and such profits may be either positive in the sense that

they are actual profits or they may be negative in the sense that they are losses and

there is in principle no distinction between profits and losses of a business…

xxx xxx xxx

9.Kothari's case [[1968] 69 I.T.R. 1 (Guj.).] , as may be noticed from the facts

stated therein, was not a case where a claim for deduction was made by the

assessee, as he did not say that a particular expenditure incurred by him should be

allowed as a permissible deduction. It is on that ground that the learned judges

ruled that the decision in Commissioner of Income-tax v. Haji Aziz & Abdul

Shakoor Bros [[1955] 28 I.T.R. 266 (Bom.).] ., relied upon by the revenue, where

the claim for deduction under section 10(2)(xv) of the 1922 Act was negatived,

was not applicable to the case before them. Therefore, the answers given by the

learned judges in Kothari's case [[1968] 69 I.T.R. 1 (Guj.).] render no assistance at

all to the assessee's contention.

10. Here is a specific claim made by the assessee for deduction of the value of the

gold confiscated by the Central Government on the ground that it is a trading or

commercial loss, though the trade was an illegal one. It should not be lost sight of

when a claim for deduction is made, that the loss must be one that springs directly

from the business or trade which the assessee carries on or is incidental to the

business that he carries on and not every sort or kind of loss, which has absolutely

no nexus or connection with his trade or business.

11. It is well to remember that confiscation of contraband gold is an action in rem

and not a proceeding in personam. As observed by Bhagwati J. in Maqbool

Hussain v. State of Bombay [[1953] S.C.R. 730, 742 (S.C.), AIR 1953 S.C. 325.]

confiscation is no doubt one of the penalties which the customs authorities can

impose but that is more in the nature of proceedings in rem than proceedings in

personam, the object being to confiscate the offending goods which have been

dealt with contrary to the provisions of the law. To the same effect is the view

expressed by S.K. Das J. in Shewpujanrai Indrasanrai Ltd. v. Collector of

Customs [[1959] S.C.R. 821, 836 (S.C.), AIR 1958 S.C. 845.] that, so far as the

confiscation of the goods is concerned, it is a proceeding in rem and the penalties

CIVIL APPEAL NO. 7689-7690 OF 2022 21

are enforced against the goods whether the offender is known or not known and

the order of confiscation under section 182 of the Sea Customs Act operates

directly upon the status of the property and under section 184 transfers an

absolute title to the Government. Subba Rao J. (as he then was) in Thomas Dana

v. State of Punjab [AIR 1959 S.C. 375.] , in his dissenting judgment (the dissent

being on other points) observed that if the authority concerned makes an order of

confiscation it is only a proceeding in rem and the penalty is enforced against the

goods.

12. A proceeding in rem, therefore, in the strict sense of the term is an action

taken directly against the property (in this case the smuggled gold) and even if the

offender is not known, the customs authorities have the power to confiscate the

contraband gold. Therefore, by no process of reasoning can the confiscation of the

contraband gold by the customs authorities be said to be a trading or commercial

loss connected with or incidental to the assessee's business.

13. In Commissioners of Inland Revenue v. Alexander Von Glehn & Co. Ltd.

[[1920] 2 K.B. 553, 566 (C.A.).] . Lord Sterndale M.R. observed:

“During the course of the trading this company committed a breach

of the law. As I say, it has been agreed that they did not intend to do

anything wrong in the sense that they were willingly and

knowingly sending these goods to an enemy destination, but they