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PETITIONER: COMMISSIONER OF INCOME-TAX, BOMBAY

       Vs.

RESPONDENT: M/S.  ABDULLABHAI ABDULKADAR

DATE OF JUDGMENT: 06/12/1960

BENCH: KAPUR, J.L. BENCH: KAPUR, J.L. HIDAYATULLAH, M. SHAH, J.C.

CITATION:  1961 AIR  701            1961 SCR  (2) 949  CITATOR INFO :  R          1964 SC1722  (9)  R          1966 SC1250  (5)

ACT: Income-tax--Commission  Agent’s  liability to pay  for  non- resident principal--Test of deductible business loss--Indian Income-tax  Act,  1922 (11 of 1922), ss.  10(1),  10(2)(Xi), 42(1), 43.

HEADNOTE: The respondent was a registered firm carrying on business as commission agents, and for the purpose of income-tax it  was treated  as  the  agent of a  non-resident  principal  doing business  outside  India.   Under s.  42(1)  of  the  Indian Income-tax Act the respondent was deemed to be the  assessee and  had to pay Rs. 3,78,49r as income-tax on behalf of  the non-resident  principal.   After allowing  for  the  amounts lying  with  the  respondentfirm the  account  of  the  non- resident  principal showed a debit balance of RS.  3,20,162. The respondent treated this amount as a bad debt and claimed it  as  a deductible loss.  The Incometax  Officer  and  the Appellate Assistant Commissioner disallowed the respondent’s claim but the Income Tax Appellate Tribunal held it to be an allowable deduction being a bad debt incurred as a result of the  respondent’s business activities with  the  nonresident principal.   The  High  Court  treating  the  amount  as   a deductible business loss incurred by the respondent affirmed the  decision of the Income-tax Tribunal.  On appeal by  the Commissioner of Income-tax, Held, that the respondent was not entitled to the  reduction claimed  by it.  The liability to pay imposed upon it  under s.  42(2) of the Income-tax Act did not arise directly  from the carrying on of the business nor was it incidental to the business.   The loss was not a commercial loss  incurred  in the  respondentfirm’s own business but it arose out  of  the business  of another person and that was not  a  permissible deduction within s. io(1) or s. 10(2)(Xi) of the Act. Gresham Life Assurance Society v. Styles, (1892) 3 T. C. 185 (H.  L.), referred to. Commissioner of Income-tax v.  Sir S. M. Chitnavis, (1932) L. R  59 I. A. 290, followed.

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Badridas  Daga v. Commissioner of Income-tax, [1959]  S.C.R. 690  and Curtis v. I. and G. Oldfield, Ltd., (1925) 9 T.  C. 319, discussed. Lord’s  Dairy Farm Ltd. v. Commissioner of Income-tax,  Bom- bay,   [1955]   27  I.T.R.  700,  Calcutta  Co.,   Ltd.   v. Commissioner of Income-tax, [1959] 37 I.T.R. 1 and C.I.R. v. Hagart and Burn Murdoch; [1929] A.C. 386, not applicable’. 120 950

JUDGMENT: CIVIL APPELLATE, JURISDICTION: Civil Appeal No. 312 of 1959. Appeal from the judgment and order dated August 23, 1956, of the  Bombay  High Court in Income-tax Reference  No.  21  of 1956. Hardyal Hardy and D. Gupta, for the appellant. A.V.  Viswanatha  Sastri  and  I.  N.  Shroff,  for   the respondent. 1960.   December 6. The Judgment of the Court was  delivered by KAPUR, J.-This is an appeal by special leave brought by  the Commissioner of Income-tax against the judgment and order of the High Court of Bombay answering the question in favour of the assessee.  The question referred by the Tribunal was: "Whether  on the facts and in the circumstances of the  case the  amount of Rs. 3,20,162 is an allowable deduction  under Section 10(2)(xi) or 10(2)(xv) of the Income-tax Act?" which was amended by the High Court as follows: "Whether  on the facts and in the circumstances of the  case the amount Rs. 3,20,162 is an allowable deduction" and  was   answered  in  the  affirmative  and  against  the appellant. The  facts  of  the  case  shortly  stated  are  these:  The respondent  is  a registered firm carrying  on  business  as commission  agents.  It was treated as the agent of  a  non- resident  principal  Haji Mohamed Syed Ali Barbari  of  Port Sudan   (hereinafter   ’referred  to  as   the   nonresident principal.   It  was carrying on the business of  export  of cloth and kariana (i.e., miscellaneous goods) to Aden, Saudi Arabia and sudan.  It used to supply goods from India to the nonresident  principal, who on his part, was sending  cotton to  the  respondent and other merchants for sale  in  India. For  the  years 1942-43, 1943-44, 1944-45 and  1945-46,  the respondent firm was treated as the agent of the  nonresident principal under s. 43 of the Income-tax Act 951 (which will hereinafter be termed ’the Act’) for the purpose of  income-tax and Excess Profits Tax.  The respondent  firm had to pay in all Rs. 3,78,491 under s. 42(1) of the Act and after  allowing for the amounts which were in its hands  the account of the principal non-resident showed a debit balance of  Rs. 3,20,162.  For the year of assessment, 1953-54,  the respondent  firm  treated  this amount as  a  bad  debt  and claimed  it  as  a deductible loss to  be  set  off  against profits.  The Income-tax Officer treating this claim as  one under s. 10(2)(xv) of the Act, disallowed it.  The Appellate Assistant Commissioner treated it as one under s. 10 (2)(xi) of  the  Act and he also disallowed it.  On  appeal  to  the Income-tax  Appellate Tribunal it was held to be a bad  debt and an allowable deduction as it was incurred as a result of the  business  activities  which  the  respondent  firm  was carrying on with the nonresident principal.  At the instance of  the Commissioner of Income-tax, the case was  stated  to

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the High Court and the High Court modified the question  and answered  the  same in the affirmative,  i.e.,  against  the appellant.   The High Court held that as the law imposed  an obligation  upon  the  respondent  firm  to  discharge   the liability  and-it  was  incidental to the  business  of  the respondent the amount was a deductible loss; and even if  it was not a debt, then also the amount could be claimed by the assessee as a business or trading loss, because in  arriving at  the true profit of the respondent’s business  that  loss had to be deducted.  The High Court thus applied s. 10(1) of the Act to the amount claimed by the respondent. The  allowability of the amount in dispute depends upon  the nature  of the liability imposed upon the  respondent  firm. The  contention of the respondent’s counsel was that it  was carrying  on foreign trade and had dealings with  a  foreign merchant  and  in  the course of  the  business  there  were imports  and  exports  and  therefore  the   interconnection between the respondent firm and the non’-resident  principal was  so intimate as to invite the application of  s.  42(1), i.e.,  the establishment of agency as ’contemplated in  that section.   The liability to pay arises under a. 42(2)  which provides 952 "Where a person not resident or not ordinarily   resident in the  taxable territories carries on business with  a  person resident  in the taxable territories, and it appears to  the Income-tax  Officer  that  owing  to  the  close  connection between  such  persons  the  course  of       business is so arranged that the business done by the resident person  with the person not resident or not ordinarily resident  produces to the resident either no profits or less than the  ordinary profits  which might be expected to arise in that  business, the  profits  derived therefrom or which may  reasonably  be deemed  to have been derived therefrom, shall be  chargeable to  income-tax in the name of the resident person who  shall be  deemed  to  be, for all the purposes of  this  Act,  the assessee in respect of such income-tax." Relying  on this provision it was argued that the nature  of the respondent’s business was foreign trade which was inter- connected  with the business of the non-resident  principal. Its  nature  was  such  as  to  attract  the  imposition  of liability  on the respondent firm under s. 42(2) of the  Act and  therefore  the  loss so incurred must be  taken  to  be incidental  to  and  arising  out of  the  business  of  the respondent. "The thing to be taxed", said Lord Halsbury, L. C., "is  the amount of profits and gains.  The word ’profits’ I think  is to be understood in its natural and proper sense-in a  sense which no commercial man would. misunderstand": Gresham  Life Assurance Society V. Styles (1).  Hence even if a  deduction is  not specifically enumerated in sub-section (2) of B.  10 it  would still be a debatable item to reflect  the  taxable profits.  The Privy Council in Commissioner of Income-tax v. Sir S. M. Chitnavis (1) held that the Act nowhere authorises the  deduction of bad debts of a business, such a  deduction is  necessarily  allowable  because what  is  chargeable  to income-tax  in  respect of a business are  the  profits  and gains  of a year and in assessing the amount of profits  and gains of that, year account must necessarily be taken of all losses incurred, otherwise true profits and gains cannot  be ascertained.  In order (1)(1892) 3 T.C. 185, 188 (H.L.). (2)(1932) L.R. 59 I.A. 290, 296. 953 that  a  loss  may be deductible it must be a  loss  in  the

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business  of  the assessee and not payment relating  to  the business of somebody else which under the provisions of  the Act  is  deemed  to  be and becomes  the  liability  of  the assessee.   The  loss  becomes  allowable  if  it   "springs directly  from  and is incidental" to the  business  of  the assessee.   The  decision  therefore  mainly  depends   upon whether the loss claimed is a business loss of that  nature. In  our  opinion  the amount which  became  payable  by  the respondent  firm  cannot be called its  business  loss.   In order  to be deductible the loss must be in the nature of  a commercial  loss  and, as has been said above,  must  spring directly  out  of it and must really be  incidental  to  the business itself.  It is not sufficient that it falls on  the trader  in some ’other capacity or is merely connected  with his business. Counsel  for the respondent relied upon a judgment  of  this Court  in  Badridas Daga v. The Commissioner  of  Income-tax (1).  In that case an agent of the assessee engaged for  the purpose  of  carrying  on of  the  assessee’s  business  had authority  to  operate a bank account.   Acting  under  such authority  the agent withdrew from the bank monies  and  put them to his personal use.  The assessee was able to  recover from the agent only a part of the amount misappropriated and the balance was written off as irrecoverable debt and it was held  that  it  was  not allowable  under  s.  10(2)(xi)  or 10(2)(xv)  of  the  Act  but it was  a  loss  deductible  in computing  the profits under s. 10(1) of the Act as  a  loss incidental  to  the carrying on of  his  business.   Counsel relied  on the following observation of  Venkatarama  Ayyar, J., at p. 695: "The result is that when a claim is made for a deduction 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.,, That passage has to be read in the circumstances of (1)[1959] S.C.R. 690. 954 that  case where the employment of agents was incidental  to the carrying on of the business and it was observed that  it logically followed that the losses which were incidental  to such  employment were also incidental to the carrying on  of the business.  At page 696, it was observed:- "At the same time it should be emphasised that the loss  for which  a deduction could be made under s. 10(1) 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." Reference may also be made to an English decision in  Curtis v.  J.  & G. Oldfield Ltd. (1).  In that case  the  managing director of a company of wine and spirit merchants embezzled monies of the’ company and that. was claimed as a loss as  a bad debt and it was held that it was not a trading loss  and was therefore not an admissible deduction.  In that case the contention of the Crown *as that the sum was not an ordinary trading debt and therefore could not be a bad debt and  that the  loss was not connected with, and did not arise  out  of the trade.  Rowlatt, J., said at p. 330: "When the Rule speaks of a bad debt it means a debt which is a  debt  that would have come into the  balance-sheet  as  a trading debt in the trade that is in question and that it is bad.   It does not really mean any bad debt which,  when  it was  a  good  debt,  would not have come  in  to  swell  the profit."

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In  the  present  case the liability was  imposed  upon  the respondent  firm because it was treated as an  agent  within the  meaning of s. 42(1) of  the Act and the  liability  was imposed because of the deeming provision in sub-s. (2) of s. 42 of the Act. can it be said, in the present case, that the liability  imposed upon the respondent firm was  a  business debt arising out of the business of the respondent or to use the  words of Venkatarama Ayyar, J., "springs directly  from the  carrying on of the business and is incidental to it  or is  a trading debt in the business of the respondent  firm." As we have said above, that condition has not (1)(1925) 9 T.C. 319. 955 been  fulfilled  and  the  loss  which  the  respondent  has incurred is not in its own business but the liability  arose because of the business of another person and that is not  a permissible deduction within s. 10(1) of the Act.  It is not a  loss which has to be deducted in respect of the  business of  the  respondent  from  the  profits  and  gains  of  the respondent’s business. Counsel for the respondent also relied on Lord’s Dairy  Farm Ltd. v. Commissioner of Income-tax, Bombay(1).  That ’was  a case of embezzlement by an employee and it was held that the loss directly arose from the necessity of employing cashiers and  therefore the loss by embezzlement was a  trading  loss but in that very case it was held that before a claim  could be  made  for deduction of a debt as bad debt it must  be  a debt  in law.  That case is not applicable to the  facts  of the present case and is of little assistance in the decision of the question before us.  Counsel for the respondent  next relied on Calcutta Co., Ltd. v. The Commissioner of  Income- tax  (2).   It  was held in that case  that  the  expression "profits  and gains" has to be understood in its  commercial sense and that there could be no computation of profits  and gains  until  the expenditure necessary  for  earning  those profits and gains is deducted therefrom and that when  there is  no  specific provision in s. 10(2) in  regard  to  claim made,  its allowability will depend on  accepted  commercial practice and trading principles and it will be allowed if it can be said to arise out of the carrying on of the  business and   is   incidental  to  it.   As  a   principle   it   is unexceptionable  but  it  does  not  carry  the  matter  any further. It  was  next  contended that the  matter  falls  within  s. 10(2)(xi)  of the Act, i.e., it is in respect of  the  busi- ness.   This  contention has even less  substance  than  the claim  of deduction under s. 10(1).  Under cl. (xi)  also  a debt  is only allowable when it is a debt and arises out  of and  as an incident to the trade.  Except  in  money-lending trade debts can only be so described (1) [1955] 27 I.T.R. 700. (2) [1959] 37 I.T.R. 956 if they   are due from customers for goods supplied or loans toconstituents  or  transactions of a  similar  kind.  In every  case the test is, was the debt due as an incident  to the  business; if it is not of that character it will  be  a capital  loss.   Thus  a  loan  advanced  by  a      firm of Solicitors  to a company in the formation of which it  acted as   legal  adviser  is  not  deductible  on  its   becoming irrecoverable  because that is not a part of the  profession of a Solicitor: C. I. R. v. Hagart & Burn Murdoch (1). In our opinion the High Court ’was in error in answering the question  in favour of the respondent.  We  therefore  allow this  appeal, set aside the judgment and order of  the  High

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Court  and answer the question against the respondent.   The appellant will have his costs in this Court and in the  High Court.                                          Appeal allowed.