Commissioner of Income Tax, Gujarat v. M/s. S. C. Kothari

Judgment

CIVIL APPELLATE JURISDICTION: Civil Appeals Nos. 1993 of 1968 and 1173 of 1971. Appeals by certificate/special leave from the judgment and order dated August 3, 4, 1967 of the Gujarat High Court in 6 Income-tax Reference No. 18 of 1966. S. T. Desai, R. N. Sachthey and B. D. Sharma, for the appellant (in both the appeals) • . V. S. Desai, K. L. Hathi and P. C. Kapur, for trnrrespondent (in both the appeals) . II The Judgment of the Court was delivered by Grover, 1. This is an appeal from a judgment of the Gujarat High Court. Originally an appeal ( C.A. 1993 I 68) had been brought by certificate but that certificate was found to be defective as no reasons were stated therein for granting it. petition for special leave, was, therefore, filed and the same has been granted. Both !he appeals shall stand disoosed of by this judgment. The assessee is a registered firm and carried on 'the bus;ness of commission agency and general 111erchants. It also does forward l>usiness.

It is a member of the Saurashtra Oil and Oilseeds Association Ltd., Rajkot. During the assessmenit year 1958-59 the corresponding accounting period being the samvat year 2013 the assessee claimed to have incurred a loss of Rs. 3,40,443/- in certain transactions entered into with different people for the supply of groundnut oil. The transactions, accord- . ing to the assessee, were non-transferable ready delivery contracts C entered into with non-members of the Association. It was expected that these contracts would be performed bll!t owing to certain reasons some of the contracts could not be performed and differel!!;e.s had to be paid. According to the assessee it had acted as a Puc.ca Artia. The assessee claimed 'that the aforesaid loss was allowable nnder s. 10 ( 1) of the Income Tax Act, 1922 D as a deducti_on against its other business income.

The Income tax Ollicer came to the conclusion that the transactions in question were hit by the provisions of the Forward Contracts Regulation Act, 1952, hereinafter called the 'Aot' and the Rules and Regulations of the Saurashtra Oil and Oilseeds Association Ltd. · In particular the transactions were hit by the provisions of sub-ss. (1) and ( 4) of s. 15 of the Act and were not saved by s. 18. The losses were held to have been incurred in illegal transactions. He rejected the coniention of the assessee that even on the assumption that the losses were incurred in illegal transactions they could be allowed in the computation of the income. The Income tax Officer further held that the losses incurred in illegal business .could not be deducted from the speculative profits under s. 24 of the Indian Income tax Act, 1922, hereinafter called the "Act of 1922". The Appellate Assistant Commissioner confirmed the order of the Income tax Officer.

In the appeal before the Tribunal it was held that the transactions in question were not illegal contracts but w~ contracts ·which had been validly entered into ynder the Act and the bye-laws etc. The Tribunal thereafter proceeded to examine the question whe!f:her the losses incurred could be allowed on the assumption that rthe transactions were illegal. It was of the view that the assessee would be entitled to a set off under s. 24 even if the losses were incurred in illegal transactions. The Tribunal remanded the matter for a report from the Appellate Assistant Commissioner as to the applicability of the proviso to H s. 24 (1) (read with the Explanation) of the Act of 1922. After the remand report was received the Tribunal gave the following two findings : (1) the contracts under consideration were all l C.l.T. v. s. c.

KOTHARI (Grover, J.) non-transforable specific delivery contracts where <the intention ab initio was either to give or take delivery ( 2) the contracts were entered in'lo either for the purchase or sale and later on the same quanti·ty was either sold or purchased back by the assess.~e on behalf of the same constituents at the market rn:·~s prevailing at the material time i.e. they were squared up by corresponding sales oc purchases as the case might be. After referring ·to certain decisions of High Courts the Tribunal held that the loss of Rs. 3,40,443 had been incur;·~d in speculative transactions. The Tribunal next proce.~ded to consider whether notwithstanding that the losses had been incurred in speculative transactions the a>sessee could set off those against the other income under s. 10(1) of the Act of 1922. Purporting to follow the view of •the majority of the High Courts, the Tribunal held that such a loss could not be si~t off against the other income.

But according to the Tribunal th.e assessee was certainly entitled 1o set off the loss agaimt the• profits in sp_eculative transactions and to that extent the contention of the assessee was acceP'ted. Both the assessee_ and the Commissioner of Income lax moved the Tribunal for submitting a case and referring c.~rtain questions of law to the High Court. Thus in all the following four questions were reforred by the Tribunal ( I ) Whether on the facts and in the circumstances of the case the contracts in respect of which the loss of Rs. 3,40,443 was claimed were illegal ccmtracts and were not validly entered into under the Forward Contracts R.~gulation Act 1952? ( 2) Whether even assuming the transactions in which· th·~ loss of Rs. 3,40,443/ - was incurred, were illegal transactions, the assessee would be entitled to the set off of the said loss ? ( 3) Whett'.er on the facts and in the circumstances of 'the case the transactions resulting in a loss of Rs. 3,40,443 were sp.~culative transactions for the purpose of s.

24 of the Indian Income tax Act 1922 merely on the ground that 1he assessee q had not performed. the contracts by giving dehvery and had paid damages in settlement of the obligations contracted for ? ( 4) Whether on the faC'ts and in the circumstances of th·~ -case the assessee is entitled to set off the balance of the loss of Rs. l ,21,3971- against the assessee's other income ?" The High <;mut did not CCilllider that it was necessary to answer the first question. The answer to the second question was that ~-l l ,S.,pCl/72 (1972) I S;C.R. even though the disputed contracts were nat validly entered into A in accordance with the provisions of s. 15 ( 4) of the Act t4e loss of Rs. 3,40,443/ - was liable to be taken into account in computing the business income of the assessee under s. 10 of 'the Act of 1922 and the assessee was entitled to set it off against 1the profits from other specula:ti_ve transactions.

The third question was answered in the aflirmatjve with the result that the transactions resulting in B the loss of Rs. 3,40,443/ - were held to be speculative for the purpose of s. 24 of the Aot of 1922. 'f\le fourth questjon was answered in the negative and against the assessee. It is the Commissioner of Income tax alone who has appealed. So far as the first ques'tion is concerned we are unable to comprehend why the High Court did not decide it. A lot of debate took place before us on the question whether the contravention of s. 15 ( 4) of the Aot would render the contracts illeg~l. According to that provision no member of a recognised Association shall, in respect of any goods spxified in the notification under sub-s.

( 1), enter into any contract on his own account wirth any person other D than a member of the recognised Association unless he has secured the consent or lluthority of such p.~rson and disclosed in the note memorandum or ag_reement of sale or purchase that he has bought or sold the goods as the case may be on his own account. It is not necessary to refer to the proviso. It is common ground and has been admitted before us that there was a clear corrtravention of the provi~ions of s. 15 ( 4) so far as the transactions in question were concerned. According to s. 20 ( e) any person who enters into any cor;tract in contravention of 'the provisiorn of s. 15 ( 4) among other sections shall on c.onviction be punishable for the first offenrn with imprisonment which may extend to one year or with fine of not less than Rs. 1,000/ - or with both. It is wholly incomprehensible how such a contrac·t would not fall directly within the ambit of the first part of s.

23 of the Indian Contract Act which deals wi'th consideration or object of an agreement which is forbidden by law. Such consideration or object would be unlawful according to 'the provisions of that section and the agreement would consequently be void. The High Court did not decide th·~ point whether the contracts which contravened the provisions of s. 15 ( 4) of the Act wer.~ illegal. It did not consider it ma•erial to decide whether the impugned contracts were illegal. In its opinion wha't was material was that the impugned contracts had been entered into unlawfullv and the question was whether the loss sustained in the unlawful business could be taken into account in computing the busine1s income of the assessee. We consider that th·~ first auestion which was referred to the High Court stands concluded by the law laid down by 'this Court in Sunder/al & Son v. Bharat Handicrafts (P) Ltd .. (1) It was laid down that the prohibition imposed by s.

15 ( 4) of the Act was not imposed in the interest of revenue. That provision was conceived in the larger interest of 1he public to protect them against the malpractices indulged in by members of recognised associations in rnspect of transactions in which their duties as agents came into conflict with their personal interest. · Parliament had made a writing, evidencing or confirming the consent or authority of a non-member, as a condrtion of the contract if the memb·~r has entei;ed into a contract on his own account. So long as there was no writing as was contemplated by s. 15 ( 4) or its proviso there was no enforceable contraC't. It is well settled that contracts which are prohibited by statute the prohibition being either express or implied would be illegal and unenforceable if they are entered irrto in contravention of the statute. Under the provisions of the Act there is not only an express prohibjtion (s.

15 ( 4) ) but punishment is also provided for contravention of that prohibHion, (s. 20). Such contracts could not possibly be regarded as having been validly entered into under the Act. The answer 'to the first question, therefore, should have been in the affirmative and against 'the assessee. Coming to the second question, the language thereof is somewhat ambiguous and the question was not framed properly. It appears •that there were •two aspects which had come up for consideration before the departmental authorities the Tribunal and the High Court. The first aspect related to the deduction of tho~ loss of Rs. 3.40,443/- incurred in the aforesaid illegal transactions while computing the profits of the assessee's speculative business under s. 10(1). The other was the set off which can be allowed within the relevant parts of s. 24 of the Act of 1922.

The High Court referred to various English decisions as also •to Wheatcroft's Law of Income tax and Simon's Income tax for supporting the view that even where a trade is illegal it would still be a trade within tho~ meaning .of income tax law and if any profits are derived from such trade they would be assessable to tax. The High Court did not accept the cont~ntion urged on behalf of the Revenue that although the profits from an illegal trade or business would be exigible to tax the losses from such business could not be taken into account whiJ.~ computing the profits. This is what the High Court observed :-. "There is in principle no dis'tinction between profits and. losses of a business and if the profrts of an illegal business are assessable to tax, equally the losses arising I) [1968] I S.C.R. 608. ...-- [1972] l S.C.R. from illegal busi11>~ss must be held to be liable to be taken into account in computing the income of the ~ssessee'.

The High Court was not inclined to accede •to the submission on behalf of the Revenue that the same principle would be applicable as has been applied in certain cases in which the question which came up for de~mnination was whether an expenditure incurred on an illegal activity would b~ deduc1ible under s. 10 ( 2) (xv J of the Act of 1922. One of such cases is a decision of the Punja:b High Court·in Raj Woollen Industries v. Commissioner of Income tax, Simla(!). In that case the real question was whether a certain amount which was paid to achieve what was proh "bited by c law, viz., the export of wool without having the requisite export licence was an amount which tb~ assessee was entitled to deduct under s. 10(2) (xv) of the Act of 1922. It was held that according to principle and authority such a deduction could not be claimed. It was also observed that such a d.~duction would not be pefI!lissible even under s. 10(1). Following ob: et vations may be referred to :

"Profits had 1o be ascertained according to the accepted principles of commercial accountancy and if s. 10(2)(xv) did not permit o~duction of an item of expenditure which was laid out or expended for carrying on the business in contravention of the law, then such an onteoing though otherwise properly admi-<ihle, "~ set off against the gross receiots on the principles of commITcial accountancv could not be taken into consideration in computing the profits". On <the other hand according to the decision of a full bench of the Allahabad High Court in Chandrika Prasad Ram Swarup v. Commi~sioner of Income tax, U.P. & C.P. (2 ) income assessable to tax is the actual income of an individual or a firm irrespective of the manner in which the income was derived. Legality or illegality of the transaction culminating in profits or losses, was, therefore, foreign •to the scope of an inquiry into the income of an individual or a firm for the purpose of income tax. Now while s.

10(1) of the Act of 1922 impo~es a charge on the profits or gains of a business it does not provide how these profits are to be computed. Section 10(2) enumerates various items which are admissible as deductions. They are, however, not exhaustive of all allowances which can be made in ascertaining the profits of a busines~ 1axable under s. 10(1 ). It is undoubtedly true that profits and gains which are liable to be taxed under (I) 43 l.T~R. 36. (2) 7 l.T.R. 269. Jl s. 10(1) are what are understood <to be such under ordinary commercial principles. The loss for which the deduction is claimed must be one that springs directly from the carrymg on of the business and is incidental to it. If this is establbhed the cfoduction must be allowed piovided that 1there is no provision against rt, express or impiied in the Act : (See Badridas Daga v. Commissioner of Income tax (1).

In that case Joss sustained by the business by reason of embezzlemznt by an employee was held to be an admissible deduction under s. 10 (I) although it did nat fall within s. 10(2) (xi) of 'lhe Act of 1922. Indeed profits cannot be computed without deducting the loss and permissible expenses incurred for the purpose of the business. The approach of the High Court, in •the present case, has been that in order to arrive at the figuP2 of pwfits even of an illegal business th<e loss must be deducted if it has actually been i_ncurred - in the carrying on of that business. It is 1he net pro!it after deducting the outgoings that can be brought to tax. It certainly seems •to have been held and that view has no•t be>~n shown to .be incorrect that so far as the admissible deductions under s. 10(2) are concerned they cannot be claimed by the asses&~e if such expenses have been incurred in either payment of a penalty for infraction of Jaw 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 trad·~ and a penalty imposed for breach of the law during th.~ course of the trade cannot be described as such. PenaHies which are incurred for infraction of the law is not a normal incident of business and they fall on the assessee in some charncter other than that of a trader; (See Haji Aziz & Abdul Shakoor Bros v. Commissioner of Income tax, Bombay City('). In that case this Court s1id quite clearly that a disbursement is deductible only if it falls w'thin s. 10(2)(xv) of the Act of 1922 and a penaty cannot be regarded as an expendi ure wholly and exclusively laid for the purpose of th~ business. Moreover disbursement or expense of a •trader is something "which comes out of his pocket. A loss is something different. That is not a thing which he expends or disburses. That is a •thing which comes upon him abextra" (Finlay J., in Allen v. Farquharson Brothers & Co.) ( 3 ).

If the business is ill~gal neither the profits earned nor the losses incurred would be enforceabl·~ in law. But that does not take the profits out of the taxing s' atute. Similarly the taint o.f illegality of the business cannot detract from the losses being taken into account for computation of the amount which can be subj·~cted to-tax as "profits" under s. 10(1) of the Act of (!) 34 l.T.R. 10. (2) 411.T.R. 350. (3) 17 T.C. 59. [ 1972) 1 S.C.R. 1922. The tax collector cannot be heard to say 1that he will bring the gross receipts to tax. He can only tax profits of a trade or business. That cannot be done without deducting 1the losses and the legitimate expenses of the business. We concur in the view of the High Court that for the purpose of s. 10(1) the losses which have actually been incurred in carrying on a particular illegal business must be deducted before the true figure relating to profits . which have to b~ brought to tax can be compu•ted or determined.

This will, however, not conclude the answer to question No. 2 because it seems to have been framed with the other aspect relating to "set off" under s. 24 of the Act. The High Court found tha:t the transactions were of a speculac tive nature. Ii was thus held that the loss of Rs. 3,40,443/- sustained in the impugned contracts was liable to be set off against the profit of Rs. 2,19,046/- which was admittedly a profit from speculative transactions. The concluding portion of the judgment of the High Court may be reproduced because to our mind rt creates a certain amount of difficulty. "The Joss of Rs. 3,40,443/- sustained in the impugned coll'tracts was, therefore, liable to be set off only against . the profrt of Rs. 2,19,046/- which was admittedly profit from speculative transactions and the balance of Rs. 1,21,397/- after such set off was not liable to be set off against the other income of the assessee in view of the first proviso to s. 24(1 ).

We may make it clear that in taking this view we have proceeded upon the basis 1that the impugr.·~d contracts which resuhep in the loss of Rs. 3,40,443 constituted a separate business distinct from the business of forward contracts resulting in the profit of Rs. 2,19,046/-. The result would, however, be the same even if the impugned contrac's ·which resulted in tb~ loss of Rs. 3,40,443/- did not constitute a separate business but w~re part of the same business of forward contrac'is which resulted in the profit of Rs. 2,19,046/- for in that event the loss of Rs. 3,40,443 would be liable to be taken into accourrt in d.~tennining the profits from such business under section IO". Section 24, to the extent it is material for our purposes, is set out below : "Set off of loss in computing aggregate income :- ( 1)

Where any assessee sustains a loss of profits or gains in any year under any of the heads mentioned in section 6, he shall be errtitled to have the amount of the loss set off against his income, profits or gains under any other head in that year : Provided that in computing the profits and gains chargeable under the head "profits and gains of business, profession or vocation", any Joss sustained in s~e:u­ ·lative transactions which are in the nature of a busmess shall not be 'taken into accoull't except to the extent of the amount of profits and gains, if any, in any other bmines consisting of speculative transactions; Explanation 1. Wher-~ the speculative transactions carried ou are of such a na:ture as to collS'titute a business, the business shall be deemed to be distinct and separate from any other business. Explanation 2.

A speculative transaction mea.ns a transaction in which a contract for purchase and sale of any commodity including stocks and shares is periodically or ul<timately settled otherwise than by actual delivery or transfer of tb~ commodity or scripts;" In order to claim the set off the meaning of the speculative transaction has to be first looked at. Under Explanation 2 such a transaction means a transaction in which a contract for 'the purchase and sale of any commodity is periodically or ultimately settled otherwise than by actual delivery etc. Now the contract has to be an enforceable contract and not an unenforceable on·~ by reason of any taint of illegality resulting in its invalidity. It has already been found by us that the contracts in question were illegal and up.enforceable on account of contravention of s. 15 ( 4) of th.e Act. The High Court was in '~rror in considering that any set off could be allowed in the present case under •the first proviso to s.

24( I) which must be read with Explanation 2. There would have 1'.~en no difficulty in disposing of the matter finally aHer the above discussion. But enough attention was pot devoted to the business which the assessee was doing and in which the profit of Rs. 2,19,046 was made and the loss of Rs. 3.40,443 was sustained. It has b.'!en found 'to be of a speculative na'ure but the High Court has not clearly found thirt it was the same busin•:!Ss in which the amount of the profit and the loss mentioned above was earned and sus'tained in which case alone a deduction will be possible of the loss under s. 10 (I). The High Court proceeded on the basis that if the business in which the profit was made and the business in which the loss was incurred were separate a set off could ~e cla[med by the assessee under s. 24 ( 1). If, however, the busmess was the same then the loss would be liable •to be taken [1972] l 5.C R. inio account while computing •the profits under s.10 (1).

As we have come to the conclusion that no set ofI could be allowed under s. 24( 1) of the Act of 1922 it will have to be determined whether the profrts and losses were incurred in the same business even ihough that business involved the ent·~ting into contracts some of which were, in the eye of the law, illegal. If the 'trade or the business, for instance, the business of commission agency or forward business was the same in which the profits were made and the loss was incurred then in order to arrive at the figure which can be subjected to 'lax the loss will have 1to be deducted f• om the profit. For this purpose w~ shall have to remit the matter to the High Court to decide this point and if necessary, after calling for a supplementary statement of the case.

In the result our answer to the first question is that the contracts were illegal. on the third and the fourth quest:ons there is no dispute nor has any appeal been preferred by rthe assessee relating to tJi.~m that the answers returned by the High Court in the affirmative and in the negative respectively w.~re not correctly answered. As regards question No. 2 the High Court will have to answer the same in the light of our judgment. The appeal by special leave (i.e. C.A. 1173/71) shall stand disposed of accordingly and the other appeal by certificate (i.e. C.A. 1993/68) is hereby dismissed. Ther>~ will be no order as to costs. V.P.S. Appeal partly a/lowed.