01 October 1964
Supreme Court


Case number: Appeal (civil) 1013 of 1963






DATE OF JUDGMENT: 01/10/1964


CITATION:  1965 AIR 1272            1965 SCR  (1) 559

ACT: Indore  Industrial  Tax  Rules,  1927,  s.  3-Large  amounts borrowed by Managing Agents from outsiders on behalf of  the company   and  invested  with   themselves-Managing   Agents authorised  by  company resolution to do so -Debt  not  paid back  by  Managing Agents claimed as bad  debt  by  company- Whether allowable as trade loss-Indian Income-tax Act, 1922, s. 10(2).

HEADNOTE: The  appellant  company  which carried on  the  business  of manufacturing  textiles  was allowed by  its  Memorandum  of Association to borrow money for the purpose of its  business and  to invest it inter alia in loans to others.  Its  Board of  Directors  passed a resolution to the  effect  that  the company  would invest its surplus funds in  current  account with  the Managing Agents on interest.  The Managing  Agents borrowed  large sums from outsiders, entered the  borrowings in  the  books of the company and invested  large  sum  with themselves  in current account.  Before the  Annual  General Meeting  they would bring back the money into the  company’s accounts to satisfy the General Body that they had paid  off their debts, and afterwards would again withdraw large  sums for  their  own  purposes.  In  1933  the  Managing  Agents’ company went into liquidation and it large debt was due from them to the company.  In 1941 the debt having been found  to be irrecoverable, the appellant company claimed it as a  bad debt  and  trading  loss for the purpose  of  computing  its income  under  the Indore Industrial Tax  Rules,  1927,  the provisions  of which, in this regard, were similar to  those of the Indian Income-tax Act, 1922.  The assessing authority did  not allow the claim, nor did the  Appellate  Authority. The  High  Court also held that the losses incurred  by  the company were really dehors the business of the company.  The company thereupon appealed to the Supreme Court. It  was  contended  on  behalf of  the  appellant  that  the employment  of  the Managing Agents was  incidental  to  the carrying  on  of  the  appellant’s  business,  that,as   the Managing  Agents  had  the power to  borrow  funds  for  the company  and invest the surplus in loans to themselves,  the loss such investment was also incidental to the carrying  on



the  appellant’s business, and therefore the said  loss  was deductible  in  arriving  at the,  trading  profits  of  the company. HELD:     The appeal must be allowed.  The  Managing Agents had borrowed the money from  outsiders and  invested  it  with themselves in  accordance  with  the company’s  resolution.   The money borrowed  from  outsiders became  part of the funds of the company, and the  creditors could  have sued the company for it.  Similarly the  company could  have sued the Managing Agents for the  sums  invested with  them.   Both  the borrowing by  the  company  and  the investment   with   the  Managing   Agents   created   legal obligations.  Appropriate entries were made in the company’s accounts  in  accordance  with  commercial  practice.    The amounts  invested with the Managing Agents were  entered  as debts which became bad debts on becoming irrecoverable.   In the  circumstances the loss arising from the bad  debts  was incidental to the appellant’s business, 560 and  deductible  in computing the profits of  the  appellant company for the ,assessment year in question. [563 F-H;  564 B-E]. Badridas  Daga v. Commissioner of Income-tax, [1959]  S.C.R. 690  and Commissioner of Income-tax, U.P. v. M/s.   Nainital Bank Ltd., [1965] 1 S.C.R. 340.

JUDGMENT: CIVIL APPELLATE JURISDICTION: Civil Appeal No. 1013 of 1963. Appeal  from  the judgment dated November 9,  1960,  of  the Madhya Pradesh High Court in Civil Miscellaneous Appeal  No. 40 of 1955. A.   V. Viswanatha Sastri and Rameshwar Nath, for the appel- lant. B.   Sen,  Balwan  Singh  Johar and 1. N.  Shroff,  for  the respondents. The Judgment of the Court was delivered by Subba  Rao J. This appeal by certificate  preferred  against the order of the High Court of Madhya Pradesh, Indore Bench, raises  the question whether an item of  Rs.  42,63,090-14-7 should have been allowed as a trading loss in computing  the profits  of the appellant-company under S. 3 of  the  Indore Industrial Tax Rules, 1927. The  facts  may be briefly stated.   The  appellant,  Indore Malwa  United  Mills  Ltd.,  is  a  public  limited  company incorporated and registered under the Indore Companies  Act, 1914.   Since  the  incorporation it has  been  carrying  on business  of manufacturing cloth.  Under the  Memorandum  of Association  of  the said company, for the  purpose  of  the textile business it was authorized to raise or borrow  money from  time to time and to invest its funds, inter  alia,  in loans  to  others.   For  the purpose  of  carrying  on  the business,  the appellant-company originally  appointed  M/s. Karimbhai  Ibrahim  & Co. Ltd. as its Managing  Agents.   On June  8,  1926,  the Board of Directors  of  the  appellant- company passed a resolution to the following effect :               "Resolved that Surplus Fund of the company  be               invested  with the agents in  current  account               with the company at the same rate of  interest               viz., 6%." On November 28, 1929, the appellant-company entered into  an agreement  with M/s.  Karimbhai Ibrahim & Sons  Ltd.  where- under  they  were appointed as the Managing  Agents  of  the appellant-company  in place of M/s.  Karimhai Ibrahim &  Co.



Ltd. 561 On  July  19, 1932, the Board of  Directors  reaffirmed  the resolution of June 8, 1926.  Pursuant to the power conferred on  the Managing Agents under the said agency agreement  and the said resolution, Karimbhai Ibrahim & Sons Ltd.  borrowed large  sums  of money from outsiders, entered  them  in  the appellant-company’s  accounts and invested large  sums  with themselves "in current account with the company" in terms of the  said  resolution and utilised the same  for  their  own purposes.  Before the Annual General Body Meeting they  used to bring large amounts into the accounts of the company  and show  that they had paid off their debts.  After  satisfying the  General Body they would again withdraw large  sums  for their  purposes.   ’Me General Body was also  aware  of  the loans and indeed it approved the said transactions.  In  the year 1933 the Managing Agency company went into liquidation. For   the  assessment  year  1941,   the   appellant-company submitted  its  return of income and  claimed  thereunder  a deduction,  among other items, a sum of Rs. 49,13,316  under the  head  of bad debt and trading loss written off  in  the profits  and  loss account of the  appellant-company-we  are only concerned in this appeal with this item and, therefore, it  is not necessary to notice any other particulars of  the assessment.   ’Me  Assessing  Authority  allowed  only   Rs. 6,41,913-2-0 as bad debt and disallowed the amount due  from Karimbhai  lbrahim & Sons Ltd. on the ground that  the  said borrowings were not made for the purpose of the business  of the  company.  On appeal the Appellate Authority  also  took the same view.  On further appeal, the High Court  confirmed the  finding of the Appellate Authority on the  ground  that the  losses incurred by the company were really  dehars  the business  of  the  company,  though  they  might     involve fraudulent  conduct  of  the  Managing  Agents.   Hence  the present appeal. Mr. A. V. Viswanatha Sastri, learned counsel for the  appel- lant,  contended that the employment of the Managing  Agents was  incidental  to  the  carrying  on  of  the  appellant’s business,  that,   as the Managing Agents had the  power  to borrow  funds  for  the  appellant-company  and  invest  the surplus  in  loans  to themselves the loss  caused  by  such investment  was  also incidental to the carrying on  of  the appellant’s  business  and,  therefore, the  said  loss  was deductible in arriving at the trading profits of the  appel- lant-company. Mr. Sen, learned counsel for the respondents, raised  before us  two contentions, namely, (1) the assessment in  question was  made under the Indore Industrial Tax Rules, 1927,  that under 562 the  said  Rules  tax was payable only  in  respect  of  the profits  or  gains  of any cotton  mill  industry  and  that profits or loss pertaining to the money-lending activity  of the  appellant-company could not possibly be subject to  tax or  deduction under the said Rules; and (2) the debt due  by the  Managing Agents was not a trading debt inasmuch as  the Managing  Agents  borrowed  moneys  not  necessary  for  the business of the appellant-company and lent to themselves the said  amount and, therefore, it was a loss incurred  by  the appellant dehors the business of the company. The first question raised by Mr. Sen is based upon the  dis- tinction  between  the Indore Industrial Tax Rules  and  the corresponding, provisions of the Indian Income-tax Act.   It is  said  that  the Indore Industrial  Tax  Rules  are  only concerned with the cotton mill industry and the tax  payable



thereunder  is in respect of the said industry, while  under the  Income-tax  Act the tax is payable in  respect  of  the income  of the business of the assessee.  But a  perusal  of the proceedings during all the stages does not disclose that any  such argument was advanced at any time.  Assuming  that the  contention was correct, if it had been  raised  before, the  assessee might have been in a position,to establish  by relevant evidence that the particular amount borrowed by the Managing Agents was from and out of the amounts borrowed for the  purpose  of  the  said industry.   We  cannot  allow  a question  which at its best is a mixed question of fact  and law  to be raised for the first time before us.  We  do  not propose to express our opinion on the same one way or other. We  shall proceed with the appeal on the basis that for  the purpose  of  deducting trading losses in  computing  trading profits  there is no difference between the  Income-tax  Act and the relevant Indore Industrial Tax Rules. The only question, therefore, is whether the loss claimed in the  present case was a trading loss which is deductible  in computing   the  profits  of  the  company.   The   relevant principle  of  law  has  been laid down  by  this  Court  in Badridas  Daga  v. Commissioner  of  Income-tax(1).   There, after  considering  the relevant decisions on  the  subject, this Court laid down the following test :               "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               (1)   (1959] S.C.R. 690, 695.               563               to  it.   If  that is  established,  then  the               deduction must be allowed, provided of  course               there is no prohibition against it, express or               implied, in the Act." Where an agent employed by the appellant for the purpose  of carrying on his business in exercise of the powers conferred on  him operated on the bank accounts, withdrew moneys  from it  and used them for discharging his personal  debts,  this Court  in the said decision found no difficulty  in  holding that the amount misappropriated and found irrecoverable  was an  allowable deduction under the Income-tax Act.  The  only difference between that case and the present one is that the Agent  misappropriated the amount in, that case, whereas  in the  present  case the Managing Agents in exercise.  of  the powers  conferred by the appellant borrowed the moneys,  but failed  to  return  the same.   If  embezzlement  of  moneys entrusted  to an agent is incidental to a business,  by  the same  token moneys legally utilized by the agent  must  more appropriately  be incidental to the business.  In  a  recent decision  in  The Commissioner of Income-tax, U.P.  v.  M/s. Nainital  Bank Ltd. (1) this Court held that an amount  lost to the bank by dacoity was a loss incidental to the business of  banking.   There, in the course of  the  business  large amounts were, kept in the bank premises, and this Court held that the risk of loss by dacoity was incidental to a banking business.  If that be so, the fact that the Managing  Agents brought  into  the company’s till larger  amounts  than  the company’s  business demanded at a particular point  of  time would  not  make the borrowings or the lending of  money  to themselves  any  the  less  incidental  to  the   sanctioned business operations.



The question is not whether the Managing Agents committed  a fraud on the company, but whether the amounts ’borrowed were the funds of the company.  If the creditors had filed a suit against the company, could it have resisted the suit on  the ground  that the Managing Agents had no power to borrow  the amounts  for the reason that at the time they borrowed,  the amounts were in excess of the requirements of the business ? Decidedly  not.   There would not have been any  defence  to such  a  suit.   After the borrowing the  money  became  the company’s money.  That apart, there was no question of fraud in  this  case,  for the profit and  loss  account  and  the balance-sheet placed before the General Body Meeting of  the Company  every year brought to its notice the  total  amount the  company  borrowed through the Managing Agents  and  the General Body approved of it.  The only fraud, (1)  [1965] 1 S.C.R. 340. 564 if  any, consisted in the practice followed by the  Managing Agents  in  bringing into the accounts of  the  company  the entire  amount  lent  to  them  in  order  to  satisfy   the shareholders that nothing was going wrong. The  next  step is the borrowing of money  by  the  Managing Agents  from the company.  Under the memorandum of  associa- tion  as  well as under the express power conferred  by  the said  resolution, the company, through the Managing  Agents, could  invest  its funds by way of loans.  If there  was  no mishap the Managing Agents would have paid the entire amount and  if they did not, the company could have  recovered  the entire  amount from them.  ’Me result, therefore,  was  that both  the borrowing by the Managing Agents on behalf of  the company  from  third parties and the lending  to  themselves created legal obligations.  They were obligations created in the course of the business.  The money lent would be a debit item  in the accounts of the company in accordance with  the accepted commercial practice and if the amount was  realized it  would be a credit item.  Both would be proper  items  of accounts  for  ascertaining  the  profit  and  loss  of  the company.   If the debt became irrecoverable, it would  be  a bad debt. We,  therefore, find no difficulty in holding that the  said debt  which  had  become irrecoverable was  a  trading  loss deductible in computing the profit of the  appellant-company in  the  assessment year.  It was a loss incidental  to  the appellant’s   business  and  is  certainly   sanctioned   by commercial practice and trading principles.  We,  therefore, hold that the High Court went wrong in holding that the said amount represented loss incurred by the appellant dehors its business. In  the result, the appeal is allowed.  The  appellant  will have its costs here and in the High Court. Appeal allowed. 565