TMI Blog1982 (11) TMI 28X X X X Extracts X X X X X X X X Extracts X X X X ..... mpany, incorporated in. 1965, to carry on business of export of tobacco. Prior to the incorporation, it was a partnership firm consisting mostly of family members. The first directors appointed at the time of incorporation are to hold office during their lifetime, or until they resign voluntarily, On the basis of an intercepted letter, written by one Shamsuddin of Linghi Chetty Street, Madras; to the assessee, a search was conducted of the assessee's premises by the Enforcement Directorate. A number of letters and other documents were seized, which disclosed that the assessee had indulged in transactions violating the provisions of the Foreign Exchange (Regulation) Act. . It was, found that the assessee had remitted foreign currency to a private party in Singapore, contrary to the provisions of the Act. Proceedings were taken against the, assessee for violation of s. 4(2) and s. 5(1)(e) of the Foreign Exchange (Regulation) Act (FERA), and a penalty of. Rs. 35,000 was levied under s. 23(1)(a), read with section 23C. For the assessment year 1970-71, the assessee claimed a deduction of Rs. 2,95,000 as business loss/expenditure. According to the assessee, the claim for deduction ar ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... lternative but to enter into such a transaction with a view to dispose of the said unsold inferior quality of tobacco lying with it and, hence, the sum of Rs. 2,88,000 Plus the commission paid to Sri Shamsuddin ought to be deducted as a business expenditure or business loss, as the case may be. The ITO held that the payment was not genuine ; that, such payment contravened the provisions of s. 40A(3); and further that the payment did not fall under any of the exceptions provided in r. 6DD. This view was affirmed by the AAC in appeal. On further appeal, the Income-tax Appellate Tribunal arrived at the following findings : (i) that the sum of Rs. 2,95,000 was indeed paid by the assessee-company to Sri Shamsuddin, which comprised of the commission payable to Sri Shamsuddin for his services, and a sum of Rs. 2,88,000 to be remitted to the Singapore, party towards the aforesaid 20% difference. The assessee was knowingly a party to the above transaction, which is in violation of the provisions of FERA ; (ii) considering the said transaction as whole, which is indeed an " integrated transaction ", the assessee's income under s. 28 of the Act must be deemed to be not the full sum of Rs 8, ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... eceive the full " floor price " and then remitting 20% thereof to the purchaser. Since the tobacco was of substandard quality, the assessee could not expect the full floor price for it and, therefore, had agreed to receive only 80% of the floor price as its proper value ; hence, under. s. 28 of the Act, the income of the assessee must be deemed to be only a sum representing the difference between Rs. 8,86,702.89 minus Rs. 2,95,000. In this view it is not necessary to find out whether the said amount of Rs. 2,95,000 is a business expenditure and liable to be deducted under s. 37 or any other provisions of the Act. : Equally for this reason, s. 40A too has no application to, the facts of this case. Alternately, the counsel submitted that r . 6DD(j) applies to the facts of this case, as rightly held by the Tribunal and, therefore, s. 40A(3) does not come in the I way of the assessee. Counsel reiterated the finding of the Tribunal that the legality or illegality of a transaction is not a relevant consideration for the purpose of the income-tax law ; and so long as it is a business transaction, or a payment made on account of a business transaction it ought to be taken into account. Cou ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... osecuted the man for the lottery and taxed him for the profits at the same time ? That would at any rate have protected the State from the reflections which were made upon it in the words I have quoted, 'But, in truth, it seems to me that all that consideration is misconceived. The Revenue "representing the State, is merely looking at an accomplished fact. It is not condoning it; it has not taken part in it; it merely finds profits made from what appears to be a trade, and the Revenue laws happen to say that the profits made from trades have to be taxed, and they say: 'Give us the tax'. It is not to the purpose in my judgment to say : 'But the same State that you represent has said they are unlawful ' ; that is immaterial altogether and I do not see that there is any contact between the two propositions." This is also the view taken by the Privy Council in Canadian Minister of Finance v. Smith (1927] AC 193, and followed in India. As would be evident from a review of the decisions which I shall presently refer to, the law in India is this : If a business is a lawful one, any loss arising from, or any payment made in pursuance of, or in furtherance of an illegal transaction cannot ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ness, i.e., to enable a person to carry on and earn profit in that business. It is not enough that 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(CA), 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 ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... on in CIT v. S. C. Kothari [1971] 82 ITR 794 (SC) at p. 801: "The approach of the High Court, in the present case, has been that in order to, arrive at the figure of profits even of an illegal business the loss must be deducted if it has actually been incurred in the carrying on of that business. It is the net profit after deducting the outgoings that can be brought to tax. It certainly seems to have been held and that view has not been shown to be incorrect that so far as the admissible deductions under section 10(2) are concerned they cannot be claimed by the assessee if such expenses have been incurred in either payment of penalty for infraction of law or the execution of some illegal activity. This, however, is based on the principle that 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 the trade cannot be described as such. Penalties which are incurred for infraction of the law are not normal incident of business and they fall on the assessee in some character other than that of a trader [See Haji Aziz and Abdul Shakoor Bros. v. CIT [1961] 41 ITR 350 (SC)]. In that case this court said q ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ons and wanted to set off the said loss against the profits arising from speculative transactions. The Supreme Court held, (i) that the contracts in respect of which the loss of Rs. 3,40,443 was incurred by the assessee were illegal contracts; (ii) that the assessee was not entitled to a set off under the first proviso to s. 24(1) of the Indian I.T. Act, 1922, of the loss of Rs. 3,40,443 against its profits in speculative transactions: (the first proviso to s. 24(1) corresponds to sub-s. (1) of s. 73 of the 1961 Act); and (iii) that, however, if the business in which , the loss was sustained was the same as the business in which the profit was derived, then the loss had to be taken into account while computing the profits of the business under s. 10(1). It was also held that the contract contemplated by Expln. 2 to the first proviso to s. 24(1) of the Indian I.T. Act, 1922 (corresponding to s. 43(5) of the 1961 Act), has to be an enforceable contract and not an unenforceable one by reason of any taint of illegality resulting in its invalidity and that set off cannot be allowed under the first proviso to s. 24(1), read with Expln. 2 thereto, of losses incurred in contracts which are ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ing on the activity as any other feature of it. Having regard to the nature of the activity, possible detection by the Customs authorities constitutes a normal feature integrated into all that is implied and involved in it. The confiscation of the currency notes is a loss occasioned in pursuing the business ; it is a loss in much the same way as if the currency notes had been stolen or dropped on the way while carrying on the business. It is a loss which springs directly from the carrying on of the business and is incidental to it. Applying the principle laid down by this court in Badridas Daga v. CIT [1958] 34 ITR 10 (SC), the deduction must be allowed." Reference was also made to the decision in CIT v. S. C. Kothari [1971] 82 ITR 794 (SC). The penultimate paragraph of the judgment is, in my opinion, highly relevant, and may be set out in full (p. 43 of 124 ITR): " 'Reliance was placed by the Revenue on Haji Aziz and Abdul Shakoor Bros. v. CIT [1961] 41 ITR 350 (SC). In that case, however, the assessee carried on the lawful business of importing dates from abroad and selling them in India. The import of dates by steamer was prohibited. None the less he imported dates from Iraq ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... le to the facts of the present case, it must be held that the payment made in furtherance of an illegal transaction cannot be deducted. As pointed out by the Supreme Court in Haji Aziz and Abdul Shakoor Bros. v. CIT [1961] 41 ITR 350, with respect to the business of importing dates, the business of export of tobacco carried on by the assessee before us, is also a lawful business ; but the particular transaction is an unlawful one. Since infraction of law cannot be said to be a normal incident of business, any amount lost or expended in furtherance of such illegal transaction cannot equally be treated as a business loss or business expenditure, as the case may be. The position would have certainly been different if the very business of export of tobacco were itself an illegal business. Mr. Khazi contended that the application of such a principle would indeed result in putting a premium upon persons carrying on illegal trade or business. He submitted that, while person who carries on a business which is inherently illegal, is entitled to deduct the losses incurred by him in such illegal business, a person carrying on a lawful business but indulging in one or two illegal transactions ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... t to receive 80% of the floor price is illegal, and this is indeed conceded by Mr. Khazi. According to law, there: can be no agreement whereunder an exporter can agree to take anything less than the floor price. The argument that the tobacco was of substandard quality is no answer, because an exporter is not supposed to export substandard tobacco. The very fact that the floor price is not allowed to be reduced, means that the tobacco exported must be of the standard quality. Further, in this case, the assessee has received the full floor price, and it is out of the said sum that it has repatriated Rs. 2,88,000 through illegal channels, besides paying about Rs. 7,000 by way of commission to Shamsuddin. It is not case of money being diverted under an overriding legal obligation. In any event, the said agreement being illegal and contrary to law, cannot be recognized, nor can the entering into of such transaction be treated as a normal incident of business. It cannot also be said that, while entering into this illegal transaction.: the assessee was acting as a businessman because it is no part of its business to commit a violation of law. Mr. Khaji laid stress on the fact that, accord ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... sessee to set off the loss incurred by him in illegal transactions, against his income from speculative transactions, the matter was remanded by the Supreme Court to the High Court to find out whether the transactions in which the loss was incurred and profit was made, constituted the same it business, or whether they were separate businesses. The next decision relied upon is of the Allahabad High Court in Nanhoomal Jyoti Prasad v. CIT [1980] 123 ITR 269. There, the assessee had imported certain goods under an import licence. But the Customs authorities found that the goods imported were not covered by that licence and, therefore, confiscated the goods. The assessee paid a fine in lieu of confiscation, and got the goods released. Meanwhile, the goods were lying in the port and subjected to demurrage charges. He claimed the amount paid by way of demurrage charges as " business expense ", and the High Court allowed it. This decision must be explained with reference to the finding of the High Court that the Customs authorities regularized the import licence of the assessee and allowed the assessee to clear the goods imported against the import licence held by him. Once the import li ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... was modified by an unregistered agreement raising the ground rent to Rs. 12,000 per annum. The authorities refused to deduct the higher amount of rent, on the ground that the subsequent agreement was an unregistered one and, therefore, inadmissible in evidence. The High Court held that the Tribunal was not justified in rejecting the document as inadmissible in evidence, and in holding that because the document was unregistered, the assessee was not entitled to claim deduction. In that connection, it was observed that, in the absence of fraud, the question whether a transaction had the effect of reducing the assessee's taxable income, or whether it was prudent or judicious or whether it was indispensable or necessary for the assessee to enter into the transaction, are all irrelevant in determining whether the expenditure relating to that transaction should be allowed under s. 37 or not. I see no principle emerging from this decision which can come to the rescue of the assessee herein. The transaction in the case before us is, undoubtedly, a fraudulent one, i.e., fraud on law. The next decision cited is in CIT v. Ramakrishna Mills (Coimbatore) Ltd. [1974] 93 ITR 49 (Mad), a decisi ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ich was per se illegal. Reliance is also placed upon a decision of the Madras High Court in South India Viscose Ltd. v. CIT [1982] 135 ITR 206. In that case, under the export promotion scheme, a licence was granted to the assessee which carried on the business of manufacture and sale of rayon, for import of wood pulp, which was the raw material for the manufacture of rayon yarn. The condition was that the yarn was to be sold at concessional rates to certain weavers specified by the Textile Commissioner. The assessee was complying with the said condition. But, in 1965, the Textile Commissioner increased the quantities of yarn to be delivered at concessional rates to the weavers; but, on representations being made to him, the Commissioner waived the requirement of supply of yarn at concessional rates. Meanwhile, the market price of yarn had gone up, while the rate at which the assessee had to supply yarn to the weavers, remain stationary, and the assessee would have suffered losses if it were to comply with the requirements of the Textile Commissioner. The assessee, therefore, entered into a settlement with the weavers, whereunder it paid certain amount as compensation for the non- ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... nting years relevant to the assessment years 1954-55 to 1956-57, but before the accounts were made up by the managed companies, the assessee gave up the managing agency commission, and the amount so given up was deducted as an allowable deduction under s. 10(2)(xv). The High Court affirmed the same. Neither in this case, nor in the two Gujarat cases cited above was any violation of law involved. Similarly, in Poona Electric Supply Co. Ltd. v. CIT [1965] 57 ITR 521 (SC), the assessee who was licensee, under the Electricity Supply Act, credited certain amounts in excess of the " reasonable return to the Consumers' Benefit Reserve Account, instead of distributing the same among the consumers, and claimed the same as a deduction. It was held that for the purpose of s. 10(1) of the Indian I.T. Act, 1922, the taxable income of the assessee is the income minus the amount credited to the said reserve account. No illegality was said to be involved in that transaction. Lastly, reliance is placed upon Calcutta Co. Ltd. v. CIT [1959] 37 ITR 1 (SC), a decision of the Supreme Court. In this case, the appellant (assessee) was engaged in the business of purchasing plots, developing them, and the ..... X X X X Extracts X X X X X X X X Extracts X X X X
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