Mnhd. Hanij v. As regards the Madhya Pradesh Act we likewise

Appeal by special leave from the judgment and order dated December 22, 1954, of the former Nagpur High Court in Misc. Civil Case No. 36 of 1954. R. J. Ko"lah, J. M. Thakar, Ramesh A. Shroff, J. B. Dadachanji, S. N. Andley and Rameshwar Nath, for the appellant. H. N. Sanyal, Additional Solicitor-General of India, K. N. Rajagopa"la Sastri and R. H. Dhebar, for the respondent.

#1958. April 25. The Judgment of the Court W!tS delivered by VENKATARAMA ArYAR J.-This is an a.Ppeal against the judgment of the High Court of Nagpur in a refe.r ence under s. 66(1) of the Indian Income-tax Act, 1922, hereinafter referred to as the Act. • l'he appellant is the sole proprietor of a firm called Bansilal Abirchand Kasturchand, which carries on b11siness as money-lenders, dealers in shares and bullion i1nd .ccmimission agents ~n B0m4ay, Calcutta a:r;i.d other .He is a resident of ]3ik11.1:u:~r, a:r;i.d m!l>?J.ages tht:? :Places. SS Venkatarama Aiyar ]. 692 SUPREME COURT REPORTS (1959] · , 95s ... . . Aiyar J. of Income-tax · d N sums aggregating firm's bank account business at the several places through agents. During the relevant period, the agent of the firm at Bombay Badridas Daga was one Chandratan, who held a power-of-attorney dated May 13, 1944, conferring on him large powers The Commissioner of management including authority to operate on bank accounts. Durmg the per10 , ~ ovember 15, venkatarama 1944, to November 23, 1944, the agent withdrew from Rs. 2,30,636-4-0, and applied them in satisfaction of his personal debts incurred in speculative transactions. On November 25, 1944, the cashier of the firm sent a telegram to the appellant informing him of the true state of affairs. Thereupon, the appellant went to Bombay on December 3, 1944-, and on the 4th, can celled the power-of.attorney given to the agent, and by notice dated December 6, 1944, called upon him to pay the amounts witr.drawn by him. The "agent replied on December 8, 1944, admitting the misappro priation of the amounts and pleading for mercy. On January 16, 1945, the appellant filed a suit against him in the High Court of Bombay for recovery of Rs. 2,30,636-4-0 and that was decreed on February 20, 1945. A sum of Rs. 28,000 was recovered from Chandratan and adjusted towards the decree and the balance of Rs. 2,02,442-13-9 was written off at the end of the accounting year as irrecoverable. Before the Income-tax authorities, the dispute the question whether this amount of related to Rs. 2,02,442-13-9 was an admissible deduction. The Tribunal found that the amount in question repre sented the loss sustained by the appellant owing to misappropriation by his agent, Chandratan, but held on the authority of the decision in Curtis v. J. & G. OUfield, Limited (') that it was not a trading loss and therefore copld not be allowed. On the application of the appellant, the Tribunal referred the following question of law for the decision of the High Court, Nagpur: . "Whether the said sum of Rs. 2,02,442-13-9 being part of the amount embezzled by the assessee's Munim · is allowable as a deduction under the Indian Income (•) (1925). 9 Tax, Cas. 319. • I l S.C.R. SUPREME COURT REPORTS 693 tax Act either under Section 10( I) or under the general principles of determining the profit and loss of the assessee or Section 10(2)(xv)? " The learned Judges held that the case was governed The c0 .:;;..issio by the decision in Curtis v. J. &: G. Oldfield, Limited (1 ), and answered the question against the appellant. An application under s. 66(A)(2) for a certificate was also dismissed and thereafter, the appellant applied for and obtained leave to appeal to this Court under Art. 136, and that is how the appeal comes before us. Venkatarama Aiyar J, x958 . Badridas Da&a of Income-ta:'' .• The question whether moneys embezzled by an agent or employee are allowable as deduction in com puting 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 sliould 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. l0(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 trad ing loss, which must be taken into account in comput ing 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 i1; 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 !iability .. (1) (1925) 9 Tax Cas. 319. • 694 SUPREME COURT REPORTS [1959) '958 . of Income-tax Venkatarama Aiyar J. 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 Badridas Daga The co,;:;,.issioner 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 whiles. 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 mllde in ascertaining profits taxable under s. 10(1). In Income tax Commissioner v. Ohitnavis (1 ), the point for decision was whether a bad debt could be 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 ques tion in the affirmative, Lord Russel observed : • "Although the Act nowhere in terms authorizes the deduction of bad debts of business, such a deduc tion 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 neces sarily 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 com mercial principles. "The word ' profits ' ...... is to be understood", observed Lord Halsbury in Gresham Life Assurance Society v. Styles('), "in its natural and proper sense-in a sense which no commercial man would misunderstand ". Referring to these observa- • (1) (1932) L. R. 59 I.A. 290, 296, 297 . (2) (1892) A.C. 309, 315; 3 Tax Cas. 185, 188. S.C.R. SUPREME COURT REPORTS 695 tions, Lord Macmillan said in Pondicherry Railway Co. v. Income-tax Commissioner (1 ) : " English authorities can only be utilized with r95B Badridas Daga v. of Income-tax caution in the· consideration of Indian income-tax The Commissioner cases owing to the differences in the relevant · legisla- tion, but the principle laid down by Lord Chancellor Halsbury in Gresham Life Assurance Society v. Styles (2), is of general application unaffected by the specialities of the English tax system. " The result is that when a claim is made for a deduc tion 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 tbat is established, then the deduction must be allowed, provided of course there is no prohibition against it, express or implied, in the Act. Venkatarama Aiyar J. These being the governi11g principles, in deciding whether loss resulting from embezzlement by an em ployee 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 business man 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 remu neration 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 w rule out the 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 misap.!Jropriation must be held to arise out of the carrying on of business and· to be inciden~al t() it~ (1) (1931) L.R. 58 I.A. 239, 252. (2) (1892) A.C. 309, 315; 3 Tax Cas. 185, 188,' • 696 SUPREME COURT REPORTS [1959) And that is how it would be dealt with according to ordinary commercial principles of trading. Badridas Daga v. Aiyar ]. V enkalaratua At the same time, it should be emphasised that the The Commission" loss for which a deduction could be made under s. 10(1) of Income-ta• 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 ~.he premises of a money lender and run away with fonds 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 run ning 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 foJl 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. We may now examine the authorities in the light of In Jagarnath Therani v. the principles stated above. Commissioner of Income-tax (1 ), the facts were that the assessee who was carrying on business entrusted a sum of Rs. 25,000 to his gumastha for payment to a creditor, but he embezzled it. The question referred for the opinion of the High Court was whether that sum could be allowed as deduction in the computation of profits. In answering it in the affirmative, the learned Judges observed that according to the practice obtaining in England, sums embezzled by employees were allowed as deductions and referred to statements of the law to that effect from Sanders' Income-tax and Super-tax, Murray and Carters' Guide to Income-tax Practice and• to the following passage in Snellings' Dictionary of Income-tax and Super-Tax Practice: " If a loss by embezzlement can be said to be necessarily incurred in carrying on the ·trade it is allowable as deduction from profits. In an ordinary case it springs directly from the necessity of deputing (r) (1925) I.L.R. 4 Pat. 385. 0 • ..... , . • • .. S.C.R. SUPREME COURT REPORTS 697 In Ramaswami Ohettiar v. Commissioner of Jn. certain duties to an employee, and should therefore be allowed." They accordingly allowed the deduction as "a loss incidental to the conduct of the business". Badridas Daga v. The Commissioner of Income-ta:¥ come-Tax, Madras (1), the assessee was carrying on Venkatarama banking business in several places in India and in Aiy11r 1. Burma. On October 21, 1926 thieves broke into the strong room in the business premises at Moulmiengyum and stole cash and currency notes of the value of Rs. 9,335. The question was whether this amount could be allowed as a deduction. It was held by the majority of the Judges that it could not be. In the judgment of the learned Chief Justice, the law was thus stated: :' If any one is paid a sum due to him as profits and he puts that in his pocket and on his way home is robbed of it, it would be, I think, difficult to con tend that such a loss was incidental to his business. Still more so when he has reached his home and put those profits in a strong room or some other place regarded by him to be a place of safety. I can well understand that, in cases where the collection of pro fits or payment of debts due is entrusted to a gumas. tha or servant for collection and that person runs away with the money or otherwise improperly deals with it, the assessee should be allowed a deduction because such a loss as that would be incidental to his business. He has to employ servants for . the purpose of collecting sums of money due to him and there is the risk that such servant may prove to be dishonest and instead of paying the profits over to him, convert them to his own use. But I cannot distinguish the present case from the case of any professional man or trader who, having collected his profits, i~subsequently In this robbed of them by a stranger to his business. case, none of the thieves were the· then servants of the assessee, although one of them had formerly been his cook." These "observations, while they support the right of the assessee to deduction of loss resulthig J'roni • (1) (1930) I.L.R. 53 Mad. 904. 9o6, 907. c < z95B Badridas Daga v. 698 SUPREME COURT REPORTS [1959] embezzlement by an employee, also show the extent and limits of that right. Aiyar f. In Bansidhar Onkarmal v. Commissioner of Income- The commission" tax (1), there was a theft of money by an accountant, of Income-tax but it took place after the office hours, and it was held, following the decision in Ramaswami Chettiar v. Com Venkatarama missioner of Income-tax(') that it could not be allowed as a deduction under s. 10(1) of the Act, as it was not incidental to the carrying on of the trade. But it was observed by Narasimham J. who delivered the lead- ing judgment that it might have. made a difference if the theft had been by the accountant during the office In Venkatachalapathy Iyer v. Commissioner of hours. Income-tax('), the assessees were a firm of merchants engaged in the business of selling yarn. Its accountant was one Rajarathnam Iyengar, whose duty it was to receive cash on sales, make disbursements and main- tain accounts. He duly entered all the transactions in the cash book but when striking the balance at the end of each day he short-totalled the receipts and over- total!ed the disbursements and misappropriated the difference. The question was whether the amounts thus embezzled could be deducted. On a review of the authorities, Satyanarayana Rao and Raghava Rao JJ. held that the loss was incidental to the carrying on of the business and should be allowed. The appel- lant contends that this decision is decisive in his favour ; but the learned Judges of the Court below were of the opinipn that on the facts it was distinguishable and that the present case fell within the decision in Curtis v. J. & G. Oldfield, Limited ('). It is necessary to examine the decision in Curtis v. J. & G. Oldfield(') somewhat closely, as the main con troversy in the Indian courts has been as to what was precisely determined therein. There, the facts were that the managing director of a company who was in exclusive control of its business, had, availing him self of his position as such managing director, with drawn large amounts from time to time and applied them to his own personal affairs. This wen't on for • (!) [1949] 17 I.T.R. z47. (3) [1951] zo I.T. R. 363. 0 (z) (1930) I.L.R. 53 Mad. 904. 906, 907 . (4) (19z5) g Tax Cas. 319. S.C.R. SUPREME COURT REPORTS 699 ' z958 'tt as irrecovera e. several years prior to his death, and thereafter, the fraud was discovered, and the amounts overdrawn by h • Badridas Daga e ques 10n im were wn en o v. was , whether these amounts could be allowed , as a The Commissioner deduction, and it was answered in Rowlatt J. Now, it should be observed that the learn- ed Judge did not say that· amounts embezzled by an employee in the course of business would not be admissible deductions. On the other hand, he observed: the negative by of Income-tax Venkatarama Aiyar J. Th t' "I quite think, with Mr. Latter, that if you have a business ..... .in the course of which you have to employ subordinates, and owing to the negligence or the dishonesty of the subordinates some of the receipts of the business do not find their way into the till, or some of the bills are not collected at all, or something of that sort, that may be an expense connected with and arising out of the tmde in the most complete sense of the word." He went on to observe : "I do not see that there is any evidence at all that there was a loss in the trade in that respect. It simply means that the assetfl of the Company, moneys which the Company had got and which had got home to the Company, got into the control of the Managing Director of the Company, and he took them out. It seems to me that what has happened is that he has made away with receipts of the Company de hors the trade altogether in virtue of his position as Managing Director in the office and being in a position to do exactly what he likes.'' Thus, what the learned Judge really finds is that the embezzlement was not connected with the carrying on of the trade but was outside it, and on that finding, the decision can only be that the deducti<ln should be disallowed. But the learned Judges in the Court below would appear to have read the above observations as meaning that, as a rule of law, embezzlements made prior to the receipts of the amounts by the assessees would be incidental to the carrying on of the trade and therefore admissible, but that embemlementS' 89 • .,., 700 SUPREME COURT REPORTS [1959] r958 d th t e o no so rea . ose o serva mns. Badrida-< Daga W d 7'ht Com';;,issioner turning on the facts of each case whether made after receipt are not connected with the carry ing on of the trade and are therefore inadmissible. b t' is a ques 10n of Income-tax - embezzlement in respect of which deduction is claimed took place in the carrying qn of the business, and the observations of the learned Judge that it did not so take place have reference to the facts of that case, and can afford no assistance in deciding whether in a given case the embezzlement was incidental to the conduct of the business or not. Venkatarama Aiyar J. It . t' Now, in Curtis v. J. & G. Oldfield Limited (1 ), the company was doing business in wine and spirit, and in such a business it is possible to hold that when once the price is realised and put into the bank, the trading has ceased and that the subsequent operatiops on the bank account are not incidental to the carrying on of the trade. But here, we are dealing with a banking business, which consists in making advances, realising them and making fresh advances, and for that purpose, it is necessary not merely to deposit amounts in ba.nks but also to withdraw them. That is to say, a continuous operation on the bank account is incidental to the conduct of the business. The theory that when once moneys are put into the bank they have "got home" and that their subsequent with drawal from the bank would be de hors the business, will be altogether out of place in a business such as banking. It will be a wholly unrealistic view to take of the matter, to hold that the realisations have reached the till when they are deposited in the bank, and that that marks the terminus of the business activities in money-lending. It should also be mentioned that in Curtis v. J. & G. ) t~ough the assessee was a company, it Oldfield (1 was found that the shares were all held by the members of the Oldfield family, that the company had no auditor and no minutes book, that there was " an almost entire absence of balance sheets", and that one of the members, Mr. J.E. Oldfield, was in manage In view of the fact that he . ment with wide powers. (1) (1925) 9 T"'i Cas. 319. ' S.C.R .. SUPREME COURT REPORTS 701 . d r958 ld b l'k of Income-tax 1 rawa s wou had a large number of shares in the company and that it was in substance a private company, his with- t h' Badridas Daga d e more .1 ea par ner over rawmg account with the firm than- an agent embezzling the The co,;;,.issioner funds of his employer, and it could properly be held that such overdrawing has nothing to do with the trading activities of the firm, whose profits are to be taxed. It would, therefore, be an error to suppose that the observations made by Rowlatt J. in the above context could be regarded as an authority for the broad proposition that as a matter of law, and irrespective of the n.ature of business, there could be to moneys no business activities with reference after they have been collected, and that, in conse- quence, embezzlement thereof could not be incidental to the carrying on of business. And we should further add "that admissibility of the deduction whether the employee occupies a subordinate position in the establishment or is an agent with large powers of management. it would make no difference Venkatarama Aiyar J. Subsequent to the decision now under appeal, the Bombay High Court had occasion to consider this question in Lord's Dairy Farm Ltd. v. Commissioner of Income-tax (1). On a review of the authorities including the decision in Curtis v. J. & G. Oldfiekl, Limited (2 ), Chagla C. J. and Tendolkar J. held that loss caused to a business by defalcation of an employee was a trading loss, and that it could be deducted under s. 10(1). In Motipur Sugar Factory Ltd. v. Commissioner of Income-tax (3), an emplOyee who had been entrusted with the funds of a company for purposes of distribu tion among sugarcane growers in accordance with statutory rules, was robbed of them on the way. It was held by Hiamaswami and Sahai JJ. that the loss was incidental to the conduct of the· trade, and must be allowed. we . agree with Venkatachalapathy Iyer v. Commissioner of Income tax (4 ), Lord's Dairy Farm Ltd. v. Commissioner of Income-tax (1) and Motipur Sugar Factory Ltd. v. Oommi1;sioner of Income-tax (3). the aecisions (1) [1955] 27 I.T.R. 700. (3) [1955] 28 I.T.R. 128. (2) (1925) 9 Tax Cas. 319. (.i) [1951] 20 I.T.R. 363. , 702 SUPREME COURT REPORTS [1959] '958 Aiya. f. of Income-tax It was argued for the respondent that there was no evidence, much less proof, that when Chandratan Bad•idas Dag« withdrew funds from the bank, he did so for the The comv;.ission" purpose of making any advance, and that, therefore, the withdrawal could not be held to have been for the conduct of the trade. That, in our opinion, is not Venkatarama necessary. When once it is established that Chandra tan was in charge of the business, that he had authority to operate on the bank accounts, and that he with drew the moneys in the purported exercise of that authority, his action is referable to his character ;,,s agent, and any loss resulting from misappropriation of funds by him would be a loss incidental to the carrying on of the business. It was also contended that the power-of-attorney dated May 13, 1944, under which Chandratan was constituted agent related not only to the business of the appellant but also to his private affairs, and that there was no proof that the embezzlement was in respect of the business assets of the appellant and not of his private funds. No such question was raised before the Income-tax authorities, and their finding assumes that the moneys which were misappropriated were business funds. We are also not satisfied authority conferred on the agent by the power-of. attorney extended to the personal affairs of the appellant. its true construction, that, on In the result, we are of opinion that the loss sustain ed by the appellant as a result of misappropriation by Chandratan is one which is incidental to the carry ing on of his business, and that it should therefore be deducted in computing the profits under s. 10(1) of the In this view, the order of the lower court must Act. be set aside and the reference answered in the affirmative. The · appellant will get his costs of this appeal and of the reference in the Court below. Appeal allowed . • •