2006 (12) TMI 91 - SC - Income Tax

Assessee claimed that since the heroin seized from him forms part of his stock-in-trade hence its loss on account of seizure is an allowable deduction while computing his profits and gains of business/profession - Once it is found that the heroin seized formed part of the stock-intrade of the assessee it follows that the seizure and confiscation of such stock-in-trade has to be allowed as a business loss. Loss of stock-in-trade has to be considered as a trading loss

Summary

1. ISSUES PRESENTED and CONSIDERED

The core legal questions considered by the Court were:

(a) Whether possession of heroin in contravention of the Narcotic Drugs and Psychotropic Substances Act, 1985, can be treated as stock-in-trade possessed by a medical practitioner;

(b) Whether such a medical practitioner can be permitted to deduct the assessed value of the seized heroin as a business loss in computing income under the Income-tax Act;

(c) Whether the order passed by the Income-tax Appellate Tribunal allowing such deduction was perverse and illegal.

2. ISSUE-WISE DETAILED ANALYSIS

Issue (a) and (b): Treatment of heroin possession as stock-in-trade and deductibility of loss

Relevant legal framework and precedents: The Income-tax Act allows deduction of business losses incurred in the course of trade or profession. Section 37 of the Income-tax Act disallows deduction for any expenditure incurred for an illegal or prohibited purpose, as clarified by the Explanation to section 37. However, the Court distinguished between business expenditure and business loss. The precedent of CIT v. Piara Singh [1980] 124 ITR 40 was pivotal, where this Court held that loss arising from confiscation of currency notes involved in smuggling could be allowed as a business loss.

Court's interpretation and reasoning: The Court observed that the assessee, a medical practitioner, was found by the income tax authorities and the Tribunal to be engaged in the manufacture and sale of heroin, which formed part of his stock-in-trade. The Tribunal had allowed deduction of the loss resulting from seizure of heroin as a business loss. The High Court, however, had disallowed this deduction relying on the Explanation to section 37, reasoning that the possession of heroin was an offence and hence the loss was not deductible.

The Supreme Court disagreed with the High Court's reliance on section 37 Explanation, clarifying that it applies to business expenditure and not to business loss. The Court emphasized that once the heroin was held to be stock-in-trade, its seizure amounted to a loss in trade, which is allowable under ordinary commercial principles. The Court underscored that the legal question must be decided on legal principles and not moral or emotional grounds.

Key evidence and findings: The income tax authorities and the Tribunal had recorded a finding of fact that the assessee was engaged in the manufacture and sale of heroin for material gain. The Tribunal assessed the value of seized heroin at Rs. 2 lakhs and allowed this amount as a business loss deduction.

Application of law to facts: Applying the principle from CIT v. Piara Singh, the Court held that the loss due to confiscation of stock-in-trade, even if illegal, is a business loss and deductible. The Court also cited CIT v. S. N. A. S. A. Annamalai Chettiar [1972] 86 ITR 607 to reinforce that loss of stock-in-trade is a trading loss deductible in computing profits.

Treatment of competing arguments: The High Court had taken a moralistic stance, condemning the assessee's illegal activity and denying deduction on that basis. The Supreme Court rejected this approach, stating that law is distinct from morality and cases must be decided on legal principles. The Court also rejected the contention that section 37 Explanation barred the deduction, since it applies only to expenditure, not loss.

Conclusions: The Court concluded that the assessee was entitled to deduct the value of the seized heroin as a business loss. The seizure and confiscation of stock-in-trade, even if illegal, results in a loss allowable in computing business income.

Issue (c): Legality and perversity of the Tribunal's order

Relevant legal framework and precedents: The Tribunal's order was challenged as perverse and illegal. The Court considered the scope of judicial review of factual findings and application of law by the Tribunal.

Court's interpretation and reasoning: The Court found that the Tribunal's order was based on proper application of legal principles and supported by factual findings. The Tribunal had correctly applied the precedent in CIT v. Piara Singh and recognized the heroin as stock-in-trade, allowing the loss deduction accordingly.

Key evidence and findings: The Tribunal had initially reduced the value of seized heroin and later allowed deduction as a business loss after being satisfied that the assessee had claimed it as such.

Application of law to facts: The Court held that the Tribunal's order was neither perverse nor illegal, but correctly decided on the facts and law.

Treatment of competing arguments: The Revenue's contention that the order was perverse was rejected. The Court emphasized that the Tribunal's findings of fact are binding unless shown to be perverse or unsupported by evidence.

Conclusions: The Tribunal's order allowing deduction of the loss as business loss was upheld.

3. SIGNIFICANT HOLDINGS

"The Explanation to section 37 has really nothing to do with the present case as it is not a case of a business expenditure, but of business loss. Business losses are allowable on ordinary commercial principles in computing profits. Once it is found that the heroin seized formed part of the stock-in-trade of the assessee, it follows that the seizure and confiscation of such stock-in-trade has to be allowed as a business loss."

"Cases are to be decided by courts on legal principles and not on one's own moral views. Law is different from morality, as the positivist jurists Bentham and Austin pointed out."

"The facts of this case are squarely covered by the decision of this court in CIT v. Piara Singh... the loss arising out of confiscation of currency notes must be allowed as a business loss."

"Loss of stock-in-trade has to be considered as a trading loss... and is deductible."

The Court set aside the High Court judgment and restored the Tribunal's order, allowing the deduction of Rs. 2 lakhs as business loss on account of seizure of heroin forming part of stock-in-trade.