TMI Blog1997 (12) TMI 3X X X X Extracts X X X X X X X X Extracts X X X X ..... under section 40A(3) of the Income-tax Act, 1961 ? 2. Whether, on the facts and in the circumstances of the case, the sum of Rs. 19,659 incurred as guest expenses is allowable as a deduction ?" The assessee, to start with, was a partnership consisting mostly of family members. In 1965, it was converted into a private limited company to carry on the business of export of tobacco. The first directors appointed at the time of incorporation were to hold office during their lifetime or until they resigned voluntarily. On the basis of the information received, a search was conducted by the Enforcement Directorate in the assessee's business premises. A number of letters and other documents were seized which disclosed that the assessee had indulged in transactions in violation of the provisions of the Foreign Exchange (Regulation) Act (for short "FERA"). It was found that the assessee had remitted to a private party in Singapore in violation of law. Proceedings were taken against the assessee for infringement of sections 4(2) and 5(1)(e) of the FERA and, ultimately, a penalty of Rs. 35,000, was imposed under section 23(1)(a) read with section 23C of the Act. The assessee in its incom ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... m the Singapore party, i.e., Rs. 8,86,702.89. The figure had to be reduced by a sum of Rs. 2,95,000 because this was the sum which was really received by the assessee. It was of the view that it was unnecessary to go into the question whether the sum of Rs. 2,95,000 was to be treated as a deduction and if so under which section and further whether it attracted section 40A(3) of the Act. (c) The Tribunal held that even otherwise, the said payment did not attract section 40A(3) since it was covered by sub-rule (j) of rule 6DD inasmuch as the said payment to Shamsuddin was made in cash due to exceptional and unavoidable circumstances. The Department's contention that the payment made to Shamsuddin was illegal and could not be taken into account for any purpose was unsustainable in law. The income-tax law did not distinguish between legal and illegal income or between legal and illegal expenditure. The High Court was of the view that the Tribunal was in error in coming to the conclusions that it had reached. The High Court pointed out that expenses tainted with illegality could not be allowed as business expenditure under section 37 or as business loss or on any other basis. The ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... of the assessee is illegal and that income is sought to be taxed by the Income-tax Officer then the expenditure incurred in the illegal activities will also have to be allowed as deduction. But if the business is otherwise lawful and the assessee resorts to unlawful means to augment his profits or reduce his loss, then the expenditure incurred for these unlawful activities cannot be allowed to be deducted. Even if the assessee had to pay fine or penalty because of an inadvertent infraction of law which did not involve any moral obliquity the result will be the same. Even in such cases, deduction will not be permitted of the amounts paid as penalty or fine or of the value of. the goods confiscated by the statutory authority as expenditure wholly and exclusively incurred for the purposes of carrying on the trade. It has been consistently held by the English courts that fines or penalties payable for violation of law cannot be permitted as deduction under the Income-tax Act. That will be against public policy. Even though the need for making such payments arose out of trading operation the payments were not wholly and exclusively for the purpose of the trade. One can carry on his tra ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ted 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.... but I do not think it is possible to say that when a fine, which is what it comes to, has been inflicted upon a trading body, it can be said that that is 'a loss connected with or arising out of' the trade within the meaning of this rule." This decision of Rowlatt J. was cited with approval by the Court of Appeal in the case of Commissioners of Inland Revenue v. Alexander Von Glehn and Co. Ltd. [1920] 12 TC 232. In that case Lord Sterndale noted that the assessee was a firm of high standing. A great part of its trade consisted in the exporting of goods to Russia and Scandinavia. Some goods were exported to Russia at a time when the Customs (War Powers) Act, 1915, was in force and the goods of the assessee had ultimately gone to enemy territory. Proceedings were taken for infraction of law because the assessee was not able to prove that it had taken all reasonable steps to secure that the ultimate destination of the goods was the destination mentioned in the declaration. The assessee agreed to pay a fine of pound 3,000 ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... he breach of the law which took place ; but in the sense in which the words are used in the Act, I do not think that this was connected with or arising out of such trade, manufacture, adventure, or concern, and still less do I think that it was a disbursement under the first rule which applies to the first two cases, that is to say, 'money wholly and exclusively laid out or expended for the purposes of such trade'..... 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 Mr. Justice Rowlatt in this case and his former decision in IRC v. Warnes [1919] 12 TC 227 (KB), which he followed were right, and I think this appeal should be dismissed with costs." Warrington L. J., who agreed with Lord Sterndale, observed as under: "Now, it cannot be said that the disbursement in the present case is made in any way for the purpose of the trade or for the purpose of earning the profits of the trade. The disbursement is made ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... pose of business. A long line of decisions was noted in the judgment under appeal. It is not necessary to refer to all of them. We shall refer to three cases decided by this court. In the case of Haji Aziz and Abdul Shakoor Bros. v. CIT [1961] 41 ITR 350, a Bench of three judges of this court held that the expenses which were permitted as deductions were such as were made for the purpose of carrying on the business. It was not enough that the disbursements are made in the course of, or arose out of or were connected with the trade. No deduction can be allowed if the expenditure fell on the assessee in some character other than that of a trader. If a sum has to be paid by an assessee because in conducting his business, he had acted in a manner which had rendered him liable for penalty for infraction of law, it could not be claimed as a deduction because it could not be called in a commercial sense as incurred in carrying on the business. It was emphasised in that judgment by Kapur J. that infraction of law is not a normal incidence of business. The point that the expenditure incurred for the purpose of unlawful activity must be allowed to find out the commercial profits of the c ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... he assessee claimed deduction of a sum of money spent in defending the case. The Income-tax Appellate Tribunal found that the expenditure was incurred solely for the purpose of maintaining the assessee's name as a good businessman and to save his stock from being undersold if the court held that the prices charged by him were unreasonable. The High Court rejected the reference application on the ground that the decision of the Tribunal was based on findings of fact. On appeal, this court held that the findings of the Tribunal were vitiated by its failure to consider the possibility of the criminal proceedings terminating in the conviction and imprisonment of the assessee. It was held that the deductibility of such expenses must depend upon the purpose and nature of legal proceedings and could not be affected by the final outcome of the proceedings. It was also pointed out that the income-tax assessment had to be made for every year and could not be held up until the final result of the legal proceedings which pass through several courts was announced. In the instant case, the assessee had indulged in transactions in violation of the provisions of the Foreign Exchange (Regulation) ..... X X X X Extracts X X X X X X X X Extracts X X X X
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