THE COMMISSIONER OF INCOME TAX JAIPUR versus PRAKASH CHAND LUNIA (D) THR. LRS. & ANR. on 24 April 2023

[2023] 7 S.C.R. 85

THE COMMISSIONER OF INCOME TAX JAIPUR

v.

PRAKASH CHAND LUNIA (D) THR. LRS. & ANR.

(Civil Appeal Nos. 7689-90 of 2022)

APRIL 24, 2023

[M. R. SHAH AND M. M. SUNDRESH, JJ.]

Income Tax Act, 1961 – Explanation to s.37(1) – ‘anyexpenditure’ in s.37 – Expenditure/loss incurred for any purposewhich is an offence or prohibited by law, not deductible in terms ofExplanation 1 to s.37 – High Court relying upon the decision ofSupreme Court in Piara Singh case allowed the loss of confiscationof silver bars as a business loss – Sustainability of – Held: Notsustainable – Explanation to s.37(1) provides that any expenditureincurred by the assessee for any purpose which is an offence orprohibited by law is not an allowable business expense – In thepresent case, the main business of the assessee was dealing in silver– His business cannot be said to be smuggling of the silver bars aswas the case in Piara Singh – Assessee was carrying on an otherwiselegitimate silver business and in attempt to make larger profits, heindulged into smuggling of silver, which was an infraction of law –High Court erred in relying upon the Piara Singh case – Impugnedjudgment set aside – Order of the assessing officer, CIT(A) andITAT rejecting theclaim of the respondent-assessee to treat the silverbars confiscated by the customs authorities as business loss restored– Per M.M. Sundresh. J (Supplementing)‘any expenditure’ mentionedin s.37 takes in its sweep loss occasioned in the course of business,being incidental to it – Thus, any loss incurred by way of anexpenditure by an assessee for any purpose which is an offence orwhich is prohibited by law is not deductible in terms of Explanation1 to s.37 – A penalty or a confiscation is a proceeding in rem, andtherefore, a loss in pursuance to the same is not available fordeduction regardless of the nature of business, as a penalty orconfiscation cannot be said to be incidental to any business –Decisions in Piara Singh and Dr. T.A. Quereshi do not lay downcorrect law in light of the decision in Haji Aziz and the insertion ofExplanation 1 to s.37 – Impugned judgment set aside – Finance(No.2) Act 1998 – Income Tax Act, 1922 – ss.10(1), (2).

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AAllowing the appeals, the Court

HELD: 1.1 The provisions of Section 37(1) under the Acthas been amended by Finance (No.2) Act, 1998 by introducingExplanation 1 thereto w.e.f. 01.04.1962 wherein any expenditureincurred by the assessee for any purpose which is an offence orBprohibited by law is not an allowable business expense. It is truethat in the present case the respondent - assessee did not claimvalue of silver bars confiscation as business expenses thus claimedas business loss. However, the amendment to Section 37 mighthave some bearing on the issue involved. [Para 6.1][98-C-D]

C1.2 On going through the impugned judgment and orderpassed by the High Court, it appears that the High Court hassimply relied upon the decision of this Court in the case of PiaraSingh. The High Court has materially erred in relying upon thedecision of this Court in the case of Piara Singh. [Para 6.2][98-E]

DCIT, Patiala vs. Piara Singh124 ITR 4 – heldinapplicable.

Facts

1.3 In the present case the ownership of the confiscatedsilver bars of the assessee now cannot be disputed and even theassessee is not disputing the same. Even on that also there areEconcurrent findings by all the authorities below and including thecustoms authorities. Therefore, the next question which is posedfor consideration before this Court is whether the assessee canclaim the business loss of the value of the silver bar confiscatedand whether the decision of this Court in the case of Piara Singhwould be applicable? To answer to the aforesaid question, it canFbe seen that in the present case the main business of theassessee is dealing in silver. His business cannot be said to besmuggling of the silver bars as was the case in the case of PiaraSingh. In the assessee’s case he was carrying on an otherwiselegitimate silver business and in attempt to make larger profits,Ghe indulged into smuggling of silver, which was an infraction ofCivil law. In that view of the matter the decision of this Court inthe case of Piara Singh which has been relied upon by the HighCourt while passing the impugned judgment and order and it hasbeen relied upon by the assessee shall not be applicable to the H

facts of the case. On hand or the other hand the decision of thisCourt in the case of Haji Aziz and the decisions of the AndhraPradesh High Court and the Bombay High Court which werepressed into service by the Revenue in Piara Singh would beapplicable with full force. [Paras 6.7, 6.8][99-H; 100-A-D]

Haji Aziz & Abdul Shakoor Bros. v. CIT, AIR 1961 SC663 : [1961] SCR 651 – relied on.

Soni Hinduji Kushalji & Co. vs. CIT, (1973) 89 ITR112(AP); JS Parkar v. VB Palekar,(1974) 94 ITR 616(Bom) – approved.

1.4 In view of the above and for the reason stated aboveand looking to the business of the assessee namely silver businessand was not in the business of smuggling silver, the decision ofthis Court in the case of Piara Singh shall not be applicable andtherefore the impugned judgment and order passed by the HighCourt quashing and setting aside the order passed by theAssessing Officer, CIT(A) and the ITAT rejecting the claim ofthe Assessee to treat the silver bars confiscated by the customsauthorities as business loss and consequently value allowing thesame as business loss is unsustainable and the same deserves tobe quashed and set side. [Para 7][100-E-F]

CIT Patiala vs. Piara Singh, 1980 Supp SCC 166 :[1980] SCR 1122 – held inapplicable.

Chuharmal v. CIT,(1988) 3 SCC 588 : [1988] 3 SCR788; CIT v. K Chinnathamban, (2007) 7 SCC 390 :[2007] 8 SCR 496; TA Quereshi (Dr.) v. CIT, (2007) 2SCC 759 : [2006] 10 Suppl. SCR 311; ApexLaboratories (P) Ltd. v. CIT, (2022) 7 SCC 98 –referred to.

Per M.M. Sundresh, J. (Supplementing)

1.1 Explanation-I makes a declaration to remove anypossible doubts to reckon a loss suffered in the form ofexpenditure for any purpose which is an offence or one that isprohibited by law. There is no difficulty in holding that thisexplanation is clarificatory in nature. Applying the principle ofliteral interpretation with the intendment being very clear, giving A

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Ano room for further doubts, coupled with the fact that there is nochallenge to it, the meaning appears to be rather very clear. Itseeks to prohibit a deduction of any expenditure incurred by anassessee for any purpose which is an offence or which is prohibitedby law. Due regard will have to be given to the words ‘anyexpenditure’ and ‘any purpose’. The reiteration being a legislativeBclarification of the main provision is required to be taken note of,as such, the power of judicial review over an explanation, whichhas been introduced to explain and remove the doubts of themain provision, is rather limited. [Para 12][103-G-H; 104-A-B]

1.2 Though the provision speaks of expenditure while notCmaking a specific reference to loss, one has to press into servicethe accepted commercial practice and trading principles. If oneis to treat the expenditure as a genus, a loss would become aspecie. All losses would become expenditures but not vice versa.A commercial loss in trade arising out of a business being carriedDon and incidental to it would be a deductible loss. There is asimilarity in the test qua a loss as laid down by this Court, andexpenditure under Section 37 of the Act. Perhaps, there is adistinction when it comes to the accounting treatment of the twoconcepts. Thus, there is no difficulty in holding that the word‘any expenditure’ mentioned in Section 37 of the Act takes in itsEsweep loss occasioned in the course of business, as well.Therefore, I agree with the view of my learned brother thatSection 37 of the Act and Explanation 1 will have a bearing in thepresent case. [Para 13][104-C-E]

Badridas Daga v. CIT,[1959] SCR 690 – relied on.F

1.3 A little bit of interplay between Section 115BBE andSection 37(1) of the Act might throw more light on both theprovisions. If a loss in pursuance to an offence or prohibitedbusiness cannot be brought under Section 115BBE of the Act forincome assessed under 68, 69 and 69A to 69D of the Act, whichGdeals with unexplained income, expenditure etc., it can never besaid that the same would be brought under Section 37(1) of theAct, despite the fact that the objective behind both the provisionsare overlapping with some connection. Section 115BBE being asubsequent legislation, the true meaning of Section 37(1) can beHunderstood on that basis. [Para 17][106-A-C]

1.4 Conclusions:

I. The word ‘any expenditure’ mentioned in Section 37 of the Act takes in its sweep loss occasioned in the course ofbusiness, being incidental to it.

II. As a consequence, any loss incurred by way of anexpenditure by an assessee for any purpose which is an offenceor which is prohibited by law is not deductible in terms ofExplanation 1 to Section 37 of the Act.

III. Such an expenditure/loss incurred for any purposewhich is an offence shall not be deemed to have been incurredfor the purpose of business or profession or incidental to it, andhence, no deduction can be made.

IV. A penalty or a confiscation is a proceeding in rem, andtherefore, a loss in pursuance to the same is not available fordeduction regardless of the nature of business, as a penalty orconfiscation cannot be said to be incidental to any business.

V. The decisions of this Court in Piara Singh and Dr. T.A.Quereshi do not lay down correct law in light of the decision ofthis Court in Haji Aziz and the insertion of Explanation 1 to Section37. [Para 26][132-F-H; 133-A-C]

Commissioner of Income Tax vs. Piara Singh, 1980 SuppSCC 166 : [1980] SCR 1122; Dr. T.A. Quereshi v.Commissioner of Income Tax, Bhopal(2007) 2 SCC 759: [2006] 10 Suppl. SCR 311 – held not correct law.

CIT v. S.C. Kothari,1972 (4) SCC 402: [1972] 1 SCR950 – held inapplicable.

Haji Aziz & Abdul Shakoor Bros. v. CIT, [1961] 2 SCR651 – relied on.

Soni Hinduji Kushalji & Co. vs. CIT, (1973) 89 ITR112(AP); JS Parkar v. VB Palekar, (1974) 94 ITR 616(Bom) – approved.

Maqbool Hussain v. State of Bombay etc. [1953] SCR730 – referred to.

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Case Law Reference

In the judgment of M. R. Shah J.

CIVIL APPELLATE JURISDICTION : Civil Appeal Nos.7689-7690 of 2022.

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From the Judgment and Order dated 22.11.2016 of the High Courtof Judicature for Rajasthan at Jaipur in DBITA No.96 of 2003 andDBITR No.6 of 1996.

Balbir Singh, ASG, A. K. Shrivastava, Sr. Adv., Rupesh Kumar,Shyam Gopal, S. A. Haseeb, Divyansh H. Rathi, Ms. Monica Benjamin,FMs. Sunita Sharma, Raj Bahadur Yadav, Advs. for the Appellant.

Arijit Prasad, Sr. Adv., Ms. Supriya Juneja, Paritosh Gupta, AdityaSingla, Ms. A. Sahitya Veena, Advs. for the Respondents.

The Judgment of the Court was delivered by

M. R. SHAH, J.G

1. Feeling aggrieved and dissatisfied with the impugned judgmentand order dated 22.11.2016 passed by the High Court of Judicature forRajasthan at Jaipur passed in DBITA No.96/2003 and DBITR No.6/1996 by which the High Court has allowed the said appeals, the Revenuehas preferred the present appeals.H

2. The facts leading to the present appeals in nutshell are as under:

2.1 A search was conducted by the Directorate of RevenueIntelligence (DRI) officers at the premises situated at A-11, 12, Sector -VII, NOIDA taken on rent by the assessee, Shri Prakash Chand Lunia.The DRI recovered 144 slabs of silver from the premises and two silveringots from the business premises of the assessee at 1397, ChandniChowk, Delhi. The assessee was arrested under Section 104 of theCustoms Act for committing offence punishable under Section 135 ofthe Customs Act. The Collector, Customs held that the assessee ShriPrakash Chand Lunia is the owner of silver/bullion and the transactionthereof was not recorded in the books of accounts. The Collector ofCustoms, New Delhi ordered confiscation of the said 146 slabs of silverweighing 4641.962 Kilograms valued at Rs.3.06 Crores. The CollectorCustoms further imposed a personal penalty of Rs.25 Lakhs on Sh.Prakash Chand Lunia under Section 112 of the Customs Act. TheCollector held that the silver under reference was of smuggled nature.

2.2 During the course of the assessment proceedings the AssessingOfficer observed that the assessee was not able to explain the natureand source of acquisition of silver of which he is held to be the owner,therefore the deeming provisions of Section 69A of the Income Tax Act,1961 (hereinafter referred to as ‘the Act, 1961) would be applicable.The investment in this regard was not found recorded in the books ofaccounts of the assessee that were produced before the then AssessingOfficer. Accordingly, the Assessing Officer passed an assessment Orderand made an addition of Rs.3,06,36,909/- under Section 69A of the Act,1961. In appeals preferred by the Assessee against the assessment order,the CIT(A) dismissed the appeal of the assessee. Feeling aggrieved theassessee preferred the appeal before the ITAT. The ITAT, Jaipur alsoupheld the order of the CIT(A) so far as Section 69A is concerned,however, partly allowed the appeal of the assessee. As regards someother minor additions, the ITAT set aside some minor other additions andremanded the matter to the AO for fresh examination. The AO re-examined the issue and addition was made. The CIT(A) also upheld theorder of the AO. The Assessee preferred the appeal against the freshorder passed by the CIT(A) before the ITAT. The ITAT, in the secondround as well upheld the order of the authorities below. A reference wasmade by the ITAT to the High Court with the following questions of law:

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A(i)“Whether on the facts and in the circumstances of the case,the Tribunal after construing and interpreting the provisionscontained in section 69A of the Income Tax Act, 1961 wasright in law, in holding that the assessee was the owner ofthe 144 silver bars found at premises no A 11 & 12 , Sector- VII, Noida and two silver bars found at premises of M/sBLunia & Co Delhi and in sustaining addition ofRs.3,06,36,909/- being unexplained investment in the handsof the assessee under Section 69A of the Act?

(ii) If the answer to the above question is in affirmative then,whether, on the facts and in the circumstances of the case,Cthe Tribunal was right in law in distinguishing the ratio laiddown by their Lordships of the Supreme Court in the caseof Piara Singh v/s CIT, 124 ITR 41 and thereby not allowingthe loss on account of confiscation of silver bars?”

2.3 While the reference was pending before the High Court, penaltyDproceedings were initiated against the assessee. An order under Section271 (i) (c) of the Act came to be confirmed by both the CIT (A) and theITAT. Accordingly, the assessee filed an appeal under Section 260A ofthe Act against the Penalty order, before the High Court. The HighCourt while deciding both the cases together, qua the first question,Edecided in favour of the Revenue and the rental premises of the assessee,the same is to be added to his income as a natural consequence. However,with regard to the second question, the High Court held that loss ofconfiscation by the DRI official of Customs Department is businessloss. While holding the High Court has relied upon the decision of thisCourt in the case of CIT, Patiala vs. Piara Singh reported in 124FITR 41. The impugned judgment and order passed by the High Court isthe subject matter of the present appeal.

3. Shri Balbir Singh, learned ASG has appeared on behalf of theRevenue and Shri Arijit Prasad, learned Senior Advocate has appearedon behalf of the assessee.G

3.1 Shri Balbir Singh, learned ASG appearing on behalf of theRevenue has vehemently submitted that in the facts and circumstancesof the case and while dealing with the relevant provisions of the Act,1961, the High Court has materially erred in relying upon the decision ofthis Court in the case of Piara Singh (supra). It is submitted that asHsuch the AO, CIT(A) and ITAT have correctly distinguished the judgment

in case of the Piara Singh (supra) as the same pertained to an assesseewho was engaged in the business of smuggling of currency notes andfor whom confiscation of the currency notes was a loss occasioned inpursuing his business, i.e., a loss which sprung directly from carrying onof his business and was incidental to it. It is submitted that due to this,the assessee in the aforesaid case was held entitled to deduction underSection 10(1) of Income Tax Act, 1922. It is submitted that however inpara 7 of the aforesaid judgment which refers to three cases where anexception to the aforesaid rule was noted by the Court. It is submittedthat in the said decision this Court noted earlier decisions of this Court aswell as the Andhra Pradesh High Court and the Bombay High Court. Itis submitted that in the case of Haji Aziz & Abdul Shakoor Bros. v.CIT, AIR 1961 SC 663, the assessee’s claim for deduction of fine paidby him for release of his dates confiscated by customs authorities, wasrejected on the ground that the amount paid by way of penalty for breachof law was not a normal course of business carried on by it. In the othertwo cases, customs authorities had confiscated gold from assesseesotherwise engaged in legitimate businesses. It is submitted that in tworelied upon cases of Andhra Pradesh High Court and the Bombay HighCourt the assessees claimed the value of gold seized as a trading/businessloss which is identical to the Respondent-Assessee’s claim in the factsof the present SLP. It is submitted that therefore the decision of thisCourt in Haji Aziz & Abdul Shakoor Bros. v. CIT, AIR 1961 SC 663,of the Andhra Pradesh High Court in the case of Soni Hinduji Kushalji& Co. vs. CIT, (1973) 89 ITR 112(AP) and of the Bombay HighCourt in the case of JS Parkar v. VB Palekar, (1974) 94 ITR 616(Bom) shall be applicable with full force to the facts of the case onhand.

3.2 It is submitted that the Andhra Pradesh High Court observedin para 10 of the judgment in case of Soni Hinduji Kushalji (supra)that when a claim for deduction is made, the loss must be one that springsdirectly from or is incidental to the business which the assessee carrieson and not every sort or kind of loss which has absolutely no nexus orconnection with his business. In paras 11 and 12, the High Court reliedon various judgments to state that confiscation of contraband gold is anaction in rem and not a proceeding in personam and thus, a proceedingin rem in the strict sense of the term is an action taken directly againstthe property (i.e., smuggled gold) and even if the offender is not known,customs authorities have power to confiscate the contraband gold. In A

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Aview of the aforesaid, the Court stated that confiscation of contrabandgold by customs authorities cannot be said to be a trading or commercialloss connected with or incidental to assessee’s business. The High Courtfurther relied on Haji Aziz (supra) and various other judgments to statethat such confiscation of smuggled/contraband goods which results ininfraction of law and has no incidence/connection to the business ofBassessee, cannot be allowed as a business loss. Thus, the aforesaid casewhich has been referred to and distinguished in Piara Singh (supra),squarely applies to the facts of the present case herein. Similarly, thecase of JS Parkar (supra) would also be applicable to the present case

as in the former case, the assessee not only claimed the value of theCgold confiscated as a trading loss but also set off of the said loss againsthis assumed and assessed income from undisclosed sources. Furthermore,the value of gold was sought to be taxed U/s.69/69A by the tax authorities.However, in this case also the Bombay High Court rejected the contentionthat Section 110 of the Evidence Act (where a person found in possessionof anything, the onus of proving that he was not the owner is on theDperson who affirmed that he was not owner) was inapplicable to taxationproceedings and agreed that tax authorities had rightly inferred assesseeto be owner of seized gold based on circumstantial evidence and assesseewas not entitled to claim value of such gold as a trading loss.

3.3 Shri Balbir Singh, learned ASG has further relied upon theEdecisions of this Court in the case of Chuharmal v. CIT, (1988) 3 SCC588 and CIT v. K Chinnathamban, (2007) 7 SCC 390, on onus ofproving ownership being on the person who denies ownership and whois in possession. It is submitted that ownership of confiscated silver fellon the Respondent-Assessee in the present case which he failed toFdischarge and which accordingly rendered the tax authorities’ concurrentfindings on his ownership to be valid. It is submitted that when the assesseehas been unable to deny possession and ownership and in fact admittedthe same before the Settlement Commission as well as the High Court,and further claimed the value of confiscated silver as a trading lossbefore AO, CIT(A) and ITAT, to alternatively argue to the contrary andGdeny ownership in order to state that Section 69A cannot be applied inhis case may not be accepted.

3.4 It is submitted by learned ASG that assessee shall also not bepermitted to claim such loss as a business expenditure in view of theexpress prohibition under Explanation 1 to Section 37(1) of the Act whichH

was added w.e.f.01.04.1962. Reliance is placed on the decisions of thisCourt in the case of TA Quereshi (Dr.) v. CIT, (2007) 2 SCC 759 aswell as Apex Laboratories (P) Ltd. v. CIT, (2022) 7 SCC 98. It issubmitted that Explanation 1 to Section 37(1) of the Act expresslydisallows any expenditure incurred by an assessee for any purpose whichis an offence or is prohibited by law, which may be claimed as anexpenditure incurred for the purpose of business/profession.

3.5 It is submitted that in the case of TA Quereshi (supra), thisCourt clarified that the facts of the said case pertained to business lossand not business expenditure. It is submitted that in the said case, ITATfound the assessee engaged in the business of manufacturing and sellingheroin and thus, this Court held that assessee’s claim of business losswas allowable as he was in the business of heroin. It is submitted thatthe case of Apex Laboratories (supra) distinguishes the judgment inTA Quereshi (supra) and states that the case relating to the assesseebribing doctors, did not deal with business loss but business expenditurewhich was disallowable under Explanation 1 to Section 37(1). It issubmitted that thus either way, neither can the Respondent-Assesseeclaim business loss due to him not being in the smuggling business norcan he claim business expenditure as the same is prohibited underExplanation 1 to Section 37(1).

3.6 Making above submissions and relying upon the abovesubmissions, it is prayed to allow the present appeals and restore theITAT orders.

4. Shri Arijit Prasad, learned Senior Advocate appearing on behalfof the assessee has vehemently submitted that in the present case therespondent – assessee is engaged in the business of purchase and saleof silver. Total sales of Rs.1,46,07,314/- of Silver was declared by therespondent – assessee with a gross profit of Rs.1,32,712/- for theassessment year in question. Search was conducted by the officers ofDRI when unaccounted 146 slabs of silver was recovered. The Collectorof Customs ordered absolute confiscation of the said 146 slabs of silvervalued at Rs.3,06,036,909/- was proposed to be added as deemed incomeunder Section 69A of the Act. The respondent – assessee disputed beingthe owner of the slabs. In the alternative, the respondent also requestedthat 146 silver slabs having been absolutely confiscated by the CustomsDepartment, the value of such tradable silver slabs should be allowed asloss. However, the Assessing Officer made the addition of AB

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ARs.3,06,036,909/- as income under Section 69A of the Act being a valueof 146 silver bars seized from the possession of the respondent. Thesaid order of addition came to be confirmed upto ITAT, however by theimpugned judgment and order the High Court has answered the referencein favour of the assessee by holding that when the value of material isadded to the income of the respondent, as a natural consequence, theBloss by confiscation of the said material is required to be allowed asbusiness loss. It is submitted that it is through that before the High Court,the assessee did not press the argument regarding the ownership of thesilver slabs and therefore, the said question was not answered by theHigh Court.C

4.1 It is submitted that therefore present case is one where setoff is claimed of the value of the 146 silver slabs as loss on account ofabsolute confiscation rather than claim of expenditure of any penaltyand/or fine imposed for infraction of law.

4.2 It is submitted that as such the issue in the present appeals isDfairly covered in favour of the assessee in view of the decision of thisCourt in the case of TA Quereshi (Dr.) (supra). In the said decision, itis held that the judgment of the High Court applying Section 37 of theAct to the case of business loss on account of absolute confiscation ofthe goods was erroneous. It is submitted that the submission of theEassessee therein that Section 37 of the Act related to business expenditurewhereas case of absolute confiscation was one of business loss hasbeen accepted.

4.3 It is submitted that in the present case, upon search, 146 silverslabs were found to be in possession of the assessee. The value of theFsaid silver slabs was determined to be Rs. 3,06,036,909/- and the samewas added to the computation of income of the assessee under Section69A of the Act as undisclosed valuable article which was not recordedin the books of account of the assessee.

4.4 It is submitted that however as the respondent – assesseeGwas engaged in the business of trading of silver and the said silver slabswere in possession of the assessee for the purpose of trading, absoluteconfiscation of the said silver slabs would result in loss of stock in tradeand the value thereof would be available as deduction as business/tradingloss. It is submitted that therefore the decision of this Court in the caseof T.A. Quereshi (Supra) shall be clearly applicable.H

4.5 It is submitted that in the case of T.A. Quereshi (Supra) thisCourt has drawn a distinction between claim of deduction as expenditureof penalty/fine as against claim of business loss on account of confiscationof goods which are unaccounted stock in trade. It is submitted that incase of claim of deduction as expenditure of any fine and/or penalty, theCourts have held that such deduction would not be available to theassessee as it would defeat the very purpose behind such penal action.Whereas, in case of claim of set off as business loss, the unaccountedgoods though added to the income of assessee but is not available to theassessee for his trade. It is submitted that while extending the benefit ofsuch set off, this Court in the case of Piara Singh (supra) and T.A.Quereshi (Supra) have held that the assessee shall be entitled to theset off as business loss.

4.6 It is submitted that unlike a case of imposition of redemptionfine where the confiscated goods are released on payment of suchamount, absolute confiscation of the goods results in the said goodsvesting with the Central Government. In such cases, though the value ofthe goods is added to the income of the assessee, but the assessee hasno option of redeeming the goods for its onward trade. Thus, there is anevident distinction between a case where deduction is sought of anypenalty and/or fine as allowable expenditure and a case where businessloss is claimed on account of absolute confiscation of the goods whichresults in loss of stock in trade. It is submitted that present one is a casewhere the set off is claimed as business loss on account of absoluteconfiscation of the silver bars and not of any penalty and/or fine. Thejudgments cited during the course of hearing by the Petitioner aretherefore rendered on distinct and distinguishable facts and would notbe applicable to the facts of the present case.

4.7 It is submitted that the said distinction has also been statutorilyrecognized. As highlighted by the appellant, Section 37 which deals withallowance and deduction of expenditure, was amended vide FinanceAct, 1998 w.e.f. 01.04.1962 whereby Explanation 1 was added to clarifythat any expenditure incurred by an assessee for any purpose which isan offence or which is prohibited by law shall not be deemed to havebeen incurred for the purpose of business or profession and no deductionor allowance shall be made in respect of such expenditure. In contrastthereto, consciously no such restriction has been brought in law withregard to set off of the value of the unaccounted stock in trade whichhave been absolutely confiscated.

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[2023] 7 S.C.R.

A4.8 Making above submissions it is prayed to dismiss the presentappeals.

5. Heard learned counsel for the respective parties at length.

6. The short question which is posed for consideration before thisCourt is whether the High Court has erred in law in allowing theBrespondent – assessee the loss of confiscation of silver bars by DRIofficials as a business loss, relying upon the decision of this Court in thecase of CIT Patiala vs. Piara Singh, 1980 Supp SCC 166?

6.1 While considering the aforesaid question, at the outset, it isrequired to be noted that the provisions of Section 37(1) under the ActChas been amended by Finance (No.2) Act, 1998 by introducingExplanation 1 thereto w.e.f. 01.04.1962 wherein any expenditure incurredby the assessee for any purpose which is an offence or prohibited bylaw is not an allowable business expense. It is true that in the presentcase the respondent - assessee did not claim value of silver barsDconfiscation as business expenses thus claimed as business loss. However,the amendment to Section 37 might have some bearing on the issueinvolved.

6.2 On going through the impugned judgment and order passedby the High Court, it appears that the High Court has simply relied uponEthe decision of this Court in the case of Piara Singh (supra). Havinggone through the decision of this Court in the case of Piara Singh(supra), we are of the opinion that the High Court has materially erredin relying upon the decision of this Court in the case of Piara Singh(supra).

F6.3 In the case of Piara Singh (supra) the assessee was foundto be in the business of smuggling of currency notes and to that it wasfound that confiscation of currency notes was a loss occasioned inpursuing his business i.e. a loss which sprung directly from carrying onof his business and was incidental to it. Due to this, the assessee in thesaid case held entitled to deduction under Section 10(1) of the IncomeGTax Act, 1922. In view of the above fact situation this Court in the caseof Piara Singh (supra) distinguished the decisions of this Court in thecase of Haji Aziz & Abdul Shakoor Bros. reported in AIR 1961 SC663, and the decision in the case of Soni Hinduji Kushalji & Co. vs.CIT, (1973) 89 ITR 112(AP) and not agreed with the decision of theBombay High Court in the case of J.S. Parkar vs. VB Palekar, (1974H

94 ITR 616 (Bom). It is to be noted that in all the aforesaid three caseswhich were relied upon by the Revenue in the case of Piara Singh(supra) were found to be involved in legitimate businesses and notsmuggling business but however they were found to have smuggled goodscontrary to law which resulted in an infraction of law and resultantconfiscation by customs authorities.

6.4In the case of Haji Aziz (supra) the assessee claimed fordeduction of fine paid by him for release of his dates confiscated bycustoms authorities was rejected on the ground that the amount paid byway of penalty for breach of law was not a normal business carried outby it. In the case of Soni Hinduji Kushalji (supra) and JS Parkar(supra), the customs authorities had confiscated gold from assesseesotherwise engaged in legitimate businesses. In the aforesaid two casesthe assessee claimed the value of gold seized as a trading/business loss.It was held that the assessees are not entitled to the deductions as claimedas business loss.

6.5 In the case of Soni Hinduji (supra), the Andhra PradeshHigh Court held that when a claim for deduction is made, the loss mustbe one that springs directly from or is incidental to the business whichthe assessee carries on and not every sort or kind of loss which hasabsolutely no nexus or connection with his business. It was observedthat confiscation of contraband gold was an action in rem and not aproceeding in personam and thus, a proceeding in rem in the strict senseof the term is an action taken directly against the property (i.e. smuggledgold) and even if the offender is not known, the customs authoritieshave power to confiscate the contraband gold.

6.6 In the case of JS Parkar (supra), the assessee not onlyclaimed the value of the gold confiscated as a trading loss but also setoff of the said loss against his assumed and assessed income fromundisclosed sources. The value of gold was sought to be taxed underSection 69/69A of the Act by the tax authorities. However, the BombayHigh Court held the assessee to be the owner of the smuggled confiscatedgold and the assessee was not entitled to claim value of such gold as atrading loss.

6.7 In the present case the ownership of the confiscated silverbars of the assessee now cannot be disputed and even the assessee isnot disputing the same. Even on that also there are concurrent findingsby all the authorities below and including the customs authorities.

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ATherefore, the next question which is posed for consideration beforethis Court is whether the assessee can claim the business loss of thevalue of the silver bar confiscated and whether the decision of this Courtin the case of Piara Singh (supra) would be applicable?

6.8 To answer to the aforesaid question, it can be seen that in theBpresent case the main business of the assessee is dealing in silver. Hisbusiness cannot be said to be smuggling of the silver bars as was thecase in the case of Piara Singh (supra). As observed hereinabove inthe assessee’s case he was carrying on an otherwise legitimate silverbusiness and in attempt to make larger profits, he indulged into smugglingof silver, which was an infraction of law. In that view of the matter theCdecision of this Court in the case of Piara Singh (supra) which hasbeen relied upon by the High Court while passing the impugned judgmentand order and it has been relied upon by the assessee shall not beapplicable to the facts of the case. On hand or the other hand the decisionof this Court in the case of Haji Aziz (1961) 41 ITR 350 (SC) and theDdecisions of the Andhra Pradesh High Court and the Bombay High Courtwhich were pressed into service by the Revenue in Piara Singh (supra)would be applicable with full force.

7. In view of the above and for the reason stated above and lookingto the business of the assessee namely silver business and was not in theEbusiness of smuggling silver, the decision of this Court in the case ofPiara Singh (supra) shall not be applicable and therefore the impugnedjudgment and order passed by the High Court quashing and setting asidethe order passed by the Assessing Officer, CIT(A) and the ITAT rejectingthe claim of the Assessee to treat the silver bars confiscated by thecustoms authorities as business loss and consequently value allowingFthe same as business loss is unsustainable and the same deserves to bequashed and set side.

8.1 In view of the above and for the reason stated above presentappeals succeed. The impugned judgment and order passed by the HighCourt is hereby quashed and set aside and the order passed by theGassessing officer, CIT(A) and the ITAT are hereby restored.

Present appeals are accordingly allowed. No costs.

M. M. SUNDRESH, J.

1. The present appeal is filed by the Revenue, challenging theHdecision of the Division Bench of the Rajasthan High Court at Jaipur,

drawing a distinction between a claim for deduction of a loss incurred inan illegal business, as against a claim of a loss qua a legitimate business,though an illegality is attached to it. The aforesaid issue is to be tested onan offence committed leading to either a penalty or confiscation.

2. Heard Mr. Balbir Singh, learned Additional Solicitor General,Mr. AK Shrivastava, learned seniorcounsel for the Appellant and Mr.Arjit Prasad, learned senior counsel for the Respondents.

3. I have gone through the well-merited judgment rendered by mylearned brother, Justice M.R. Shah. While concurring with the ultimateconclusion arrived at in overturning the decision of the High Court, Iwould like to give my own reasoning on the aforesaid aspect. The factsbeing narrated with utmost clarity by my learned brother, only thosewhich are required in support of the reasoning are being recorded.

4. The Director of Revenue Intelligence set out a search at thebusiness premises of the Respondent/assessee. The recovery yieldedsilver slabs/silver ingots. The assessee was in the business of makingjewellery.

5. The Respondent/assessee filed his return for the AssessmentYear 1989-1990 followed by a petition before the Income Tax SettlementCommission.The Collector of Customs videorder dated 18.12.1990ordered confiscation of goods and imposed penalty. It was done on thepremise that the goods were smuggled by the assessee. A claim wasmade by the assessee that the loss on account of confiscation would beallowable as trading loss being incidental to the business, and hence,deductible. This argument was duly rejected as he was neither doing thebusiness of smuggling, nor he owned the silver. The plea of ownershipwas given up by the Respondent/assessee before the High Court, andtherefore, the decision of the assessing officer in bringing the loss sufferedunder Section 69A of the Income Tax Act, 1961 (hereinafter referred toas “the Act”), has become final.

6. Before the Hight Court, the Respondent/assessee placingreliance upon the judgment of this Court in Commissioner of IncomeTax v. Piara Singh(1980) Supp. SCC 166, inter alia contended thatsmuggling by itself being prohibited in law, any loss occurred thereunderis liable for deduction. The aforesaid argumentmade, found acceptanceat the hands of the High Court, which is sought to be impugned by theRevenue before us.

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102SUPREME COURT REPORTS

ARELEVANT PROVISIONS OF THE INCOME TAX ACT,1961

“2.Definitions.- In this Act, unless the context otherwiserequires,—

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(13) ”business” includes any trade, commerce or manufacture orany adventure or concern in the nature of trade, commerce ormanufacture;”

7. This provision being a definition clause merely defines variousCactivities which could be termed as a business.Section 2(13) of the Actgives a broad definition to ‘business’. Section 28 of the Act comes underthe heading ‘Profits and Gains of Business or Profession’.Various typesof income enumerated thereunder are made chargeable to income tax.The income, as referred in Section 28 of the Act, has to be computed inthe manner as prescribed under Section 30 to 43D of the Act, which isDaccordingly provided under Section 29 of the Act.

Section 37:

“37 General.- (1) Any expenditure (not being expenditureof the nature described in sections 30 to 36 and not being in thenature of capital expenditure or personal expenses of theEassessee), laid out or expended wholly and exclusively for thepurposes of the business or profession shall be allowed in computingthe income chargeable under the head “Profits and gains ofbusiness or profession”.

[Explanation 1.]—For the removal of doubts, it is herebyFdeclared that any expenditure incurred by an assessee for anypurpose which is an offence or which is prohibited by law shallnot be deemed to have been incurred for the purpose of businessor profession and no deduction or allowance shall be made inrespect of such expenditure.”

G8. Section 37 of the Act, being one of the provisions meant forcomputing income from profits or gains of business or profession, is aresiduary and omnibus provision which intends to cover all expenditureto the exclusion of those mentioned under Section 30 to 36 of the Act,apart from being in the nature of capital expenditure or personal expensesof the assessee. Therefore, the object behind this provision is very clearHas it includes ‘any expenditure’. The second mandate of this provision is

that the expenditure will have to be laid out or expendedwholly andexclusively for the purpose of the business or profession to comeinto the fold of income chargeable to tax as profit and gains of businessor profession.

9. An ambiguity arose as to whether a business, as defined underSection 2(13) of the Act, and as dealt with under Section 37 of the Act,would include a deduction when the said expenditure is incurred for anypurpose which is an offence or prohibited by law.

10. Since an anomaly has been created by the interpretation ofthe parimateria provision under the Income Tax Act, 1922 (hereinafterreferred to as “the Old Act”), viz. Section 10(1) and (2), therefore,Explanation-I to Section 37 of the Act came into the statute book withretrospective effect from 01.04.1962 through the Finance (No.2) Act1998, (Act 21 of 1998).

11. The purpose of theinsertion of the aforesaid Explanation wasexplained by the Central Board of Direct Taxes Circular No. 772 dated23.12.1998, “Disallowance of illegal expenses 20.1 Section 37 of the Income-tax Act is amended to provide thatany expenditure incurred by an assessee for any purpose whichis an offence or which is prohibited by law shall not be deemed tohave been incurred for the purposes of business or professionand no deduction or allowance shall be made in respect of suchex-penditure. This amendment will result in disallowance of theclaims made by certain assessees in respect of payments onac-count of protection money, extortion, hafta, bribes etc. asbusiness expenditure. It is well decided that unlawful expenditureis not an allowable deduction in computation of income.

20.2 This amendment will take effect retrospectively from 1stApril, 1962 and will, accordingly, apply in relation to the as-sessmentyear 1962-63 and subsequent years.”

12. Explanation-I makes a declaration to remove any possibledoubts to reckon a loss suffered in the form of expenditure for anypurpose which is an offence or one that is prohibited by law.There is nodifficulty in holding that this explanation is clarificatory in nature.Applyingthe principle of literal interpretation with the intendment being very clear,giving no room for further doubts, coupled with the fact that there is no

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Achallenge to it, the meaning appears to be rather very clear. It seeks toprohibit a deduction of any expenditure incurred by an assessee for anypurpose which is an offence or which is prohibited by law. Due regardwill have to be given to the words ‘any expenditure’ and ‘any purpose’.The reiteration being a legislative clarification of the main provision isrequired to be taken note of, as such,the power of judicial review overBan explanation, which has been introduced to explain and remove thedoubts of the main provision, is rather limited.

13. Though the provision speaks of expenditure while not makinga specific reference to loss, one has to press into service the acceptedcommercial practice and trading principles. If one is to treat theCexpenditure as a genus, a loss would become a specie. All losses wouldbecome expenditures but not vice versa. A commercial loss in tradearising out of a business being carried on and incidental to it would be adeductible loss as laid down by this Court in BadridasDaga v. CIT,(1959) SCR 690. There is a similarity in the test qua a loss as laid downDby this Court,and expenditure under Section 37 of the Act. Perhaps,there is a distinction when it comes to the accounting treatment of thetwo concepts. Thus, there is no difficulty in holding that the word ‘anyexpenditure’ mentioned in Section 37 of the Act takes in its sweep lossoccasioned in the course of business, as well. Therefore, I agree withthe view of my learned brother that Section 37 of the Act and ExplanationE1 will have a bearing in the present case.

Section 115BBE

“Section 115BBE.- “Tax on income referred to in section68 or section 69 or section 69A or section 69B or sectionF69C or section 69D.-(1) Where the total income of anassessee,—

(a) includes any income referred to in section 68, section 69,section 69A, section 69B, section 69C or section 69D andreflected in the return of income furnished under sectionG139; or (b)determined by the Assessing Officer includes any incomereferred to in section 68, section 69, section 69A, section69B, section 69C or section 69D, if such income is notcovered under clause (a), Hthe income-tax payable shall be the aggregate of—

(i) the amount of income-tax calculated on the income referredto in clause (a) and clause (b), at the rate of sixty per cent;and

(ii) the amount of income-tax with which the assessee wouldhave been chargeable had his total income been reducedby the amount of income referred to in clause (i).

(2) Notwithstanding anything contained in this Act, no deductionin respect of any expenditure or allowance or set off of any lossshall be allowed to the assessee under any provision of this Act incomputing his income referred to in clause (a) and clause (b) ofsub-section (1).”

14. Section 115BBE of the Act deals with levy of tax on incomeas mentioned in Section 68, 69, and 69A to 69D of the Act. If a casecomes under Section 115BBEsub-section (1) of the Act, the rate ofincome tax shall be at 60%.

15. The object of this provision is to fill up the loopholes and tomake sure unaccounted money either generated or used, more so in thenature of Black Money, is penalized. When this provision was introducedin the year 2012, the rate of tax was fixed at the rate of 30%.The Billalso speaks about the objective behind not allowing any deduction to theassessee in computing deemed income under Section 68, 69 and 69A to69D of the Act. That was the reason why a decision was made to imposegreater tax burden.The rate of tax was increased by a subsequentamendment to 60%.

16. Sub-section (2) of Section 115BBE starts with anon-obstanteclause. It will have precedence over any other provision contained in theAct, while dealing with a deduction in respect of any expenditure orallowance or set off of any loss. In other words, no such deductionwould be allowed under any provision of the Act in computing anassessee’s income under sub-section (1).An amendment has beenintroduced by Finance Act, 2016 with the inclusion of ‘set off of anyloss’ being not allowable. Sub-section (2) once again does not speakabout loss but the fact that it makes a reference to ‘set off of any loss’would reiterate the view taken earlier, while considering the scope andambit of Section 37 of the Act,that such a loss has to be read intoexpenditure, at least while applying the test for the purpose of deduction.To make the position clear one has to understand that the amendment

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Amerely speaks about the right of the assessee to set off the loss whichpresupposes that the loss has to be treated as a facet of expenditure.

17. A little bit of interplay between Section 115BBE and Section37(1) of the Act might throw more light on both the provisions. If a lossin pursuance to an offence or prohibited business cannot be broughtBunder Section 115BBE of the Act for income assessed under 68, 69 and69A to 69D of the Act, which deals with unexplained income, expenditureetc., it can never be said that the same would be brought under Section37(1) of the Act, despite the fact that the objective behind both theprovisions are overlapping with some connection. Section 115BBE beinga subsequent legislation, the true meaning of Section 37(1) can beCunderstood on that basis.

18. Having understood the provisions, I shall now consider thedecisions relied upon at the Bar as they deal with the interpretation ofthe provisions governing.

D19. BadridasDaga v. CIT , (1959) SCR 690

19.1 This Court was dealing with a loss suffered due to anembezzlement by an employee of theassessee. While interpreting Section10(2) of the Old Act over a claim made for deduction, for which therewas no specific provision, reliance was made on the accepted commercialEpractices and trading principles. Resultantly, it was held that the deductionwas allowable in a case where there is no prohibition either expressedor implied under the Act.Thus, the Court has made it clear that in theabsence of any prohibition, as stated above, a claim for deduction of aloss is allowable so long as it emanates directly from the carrying on ofthe business, being incidental to it. In other words, it does not includeFloss of any nature even if it has some connection with the business, if thesame cannot be said to be incidental to the business.

19.2 The court went onto hold that the payment of salary to anemployee being paid for the purpose of business, is deductible under thegeneral provision, therefore, logically any loss occasioned on the actionGof an employee would be incidental to the business.

19.3 Considering the aforesaid, it can be said that there is asimilarity between the test laid down for deduction of an expense in theresiduary omnibus provision under Section 10(2)(xv) of the Old Act andthe test for deduction of loss based on commercial practices and trading H

principles. The decision is therefore supporting the above statedinterpretation of Section 37 of the Act.

19.4 Relevant paragraphs:

“The question whether monies embezzled by an agent or employeeare allowable as deduction in computing the profits of a businessunder s. 10 of the Act has come up for consideration frequentlybefore the Indian Courts, and the decisions have not been quiteuniform. Before discussing them, it is necessary that we shouldexamine the principles that are in law applicable to thedetermination of the question. Three grounds have been putforward in support of the claim for deduction: (1) that the losssustained by reason of embezzlement is a bad debt allowable unders. 10(2)(xi) of the Act; (2) that it is a business expense fallingwithin s. 10(2)(xv) of the Act; and (3) that it is a trading loss,which must be taken into account in computing the profits unders. 10(1) of the Act. As regards the first ground, the authoritieshave consistently held that the deduction is not admissible unders. 10(2)(xi) of the Act, and that, in our view, is correct. A debtarises out of a contract between the parties, express or implied,and when an agent misappropriates monies belonging to hisemployer in fraud of him and in breach of his obligations to him, itcannot be said that he owes those monies under any agreement.He is no doubt liable in law to make good that amount, but that isnot an obligation arising out of a contract, express or implied. Nordoes it make a difference that in the accounts of the business theamounts embezzled are shown as debits, the amounts realisedtowards them, if any, as credits, and the balance is finally writtenoff. They are merely journal entries adjusting the accounts and donot import a contractual liability. Nor can a claim for deduction beadmitted under s. 10(2)(xv), because moneys which are withdrawnby the employee out of the business till without authority and infraud of the proprietor can in no sense be said to be “an expenditurelaid out or expended wholly and exclusively” for the purpose ofthe business. The controversy therefore narrows itself to thequestion whether amounts lost through embezzlement by anemployee are a trading loss which could be deducted in computingthe 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

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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 allowanceswhich could be made in ascertaining profits taxable under s. 10(1).In Income Tax Commissioner v. Chitnavis [(1932) LR 59 IA290, 296, 297] the point for decision was whether a bad debtcould be deducted under s. 10(1) of the Act, there having been inthe Act, as it then stood, no provision corresponding to s. 10(2)(xi)for deduction of such a debt. In answering the question in theaffirmative, Lord Russel observed:

“Although the Act nowhere in terms authorizes the deductionof bad debts of business, such a deduction is necessarilyallowable. What are chargeable in income tax in respect of abusiness are the profits and gains of a year; and in assessingthe amount of the profits and gains of a year account mustnecessarily be taken of all losses incurred, otherwise you wouldnot arrive at the true profits and gains.”

It is likewise well settled that profits and gains which are liable tobe taxed under s. 10(1) are what are understood to be suchaccording to ordinary commercial principles. “The word ‘profits’… is to be understood”, observed Lord Halsbury in GreshamLife Assurance Society v. Styles [(1892) AC 309, 315 : 3 TC185, 188] “in its natural and proper sense — in a sense which nocommercial man would misunderstand”. Referring to theseobservations Lord Macmillan said in Pondicherry Railway Co.v. Income Tax Commissioner [(1931) LR 58 IA 239, 252]:

“English authorities can only be utilized with caution in theconsideration of Indian income tax cases owing to thedifferences in the relevant legislation, but the principle laid downby Lord Chancellor Halsbury in Gresham Life AssuranceSociety v. Styles [(1892) AC 309, 315 : 3 TC 185, 188] , is ofgeneral application unaffected by the specialities of the Englishtax system.”

The result is that when a claim is made for a deduction for whichthere is no specific provision in s. 10(2), whether it is admissibleor not will depend on whether, having regard to acceptedcommercial practice and trading principles, it can be said to ariseout of the carrying on of the business and to be incidental to it. If

that is established, then the deduction must be allowed, providedof course there is no prohibition against it, express or implied, inthe Act.

These being the governing principles, in deciding whetherloss resulting from embezzlement by an employee in a business isadmissible as a deduction under s. 10(1) what has to be consideredis whether it arises out of the carrying on of the business and isincidental to it. Viewing the question as a businessman would, itseems difficult to maintain that it does not. A business especiallysuch as is calculated to yield taxable profits has to be carried onthrough agents, cashiers, clerks and peons. Salary andremuneration paid to them are admissible under s. 10(2)(xv) asexpenses incurred for the purpose of the business. If employmentof agents is incidental to the carrying on of business, it must logicallyfollow that losses which are incidental to such employment arealso incidental to the carrying on of the business. Human naturebeing what it is, it is impossible to rule out the possibility of anemployee taking advantage of his position as such employee andmisappropriating the funds of his employer, and the loss arisingfrom such misappropriation must be held to arise out of the carryingon of business and to be incidental to it. And that is how it wouldbe dealt with according to ordinary commercial principles of trading.

At the same time, it should be emphasised that the loss forwhich a deduction could be made under s. 10(1) must be one thatsprings directly from the carrying on of the business and isincidental to it and not any loss sustained by the assessee, even ifit has some connection with his business. If, for example, a thiefwere to break overnight into the premises of a moneylender andrun away with funds secured therein, that must result in thedepletion of the resources available to him for lending and the lossmust, in that sense, be a business loss, but it is not one incurred inthe running of the business, but is one to which all owners ofproperties are exposed whether they do business or not. The lossin such a case may be said to fall on the assessee not as a personcarrying on business but as owner of funds. This distinction, thoughfine, is very material as on it will depend whether deduction couldbe made under s. 10(1) or not.”

(emphasis supplied)

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A20. Haji Aziz & Abdul Shakoor Bros. v. CIT,(1961) 2 SCR651

20.1 Thethree-Judge bench of this Court in the aforesaid casewas concerned with two principal issues which we are dealing with atpresent.In clear terms it has been held that an expenditure is notBdeductible unless it is a commercial loss in trade. A penalty incurred foran infraction of law could never be termed as a commercial loss incarrying on business, apart from being an abnormal incident, consequently,it cannot be deducted. It falls on the assesse in some character otherthan that of a trader. A mere connection between the loss and the businessof the assesseper se can never be the sole factor. To put it simply, thisCCourt has made the position abundantly clear that a penalty can neverbe understood as a commercial expenditure/loss for the purpose of thebusiness nor a disbursement made to earn profit. It was further notedthat a confiscation is a proceeding in rem, and therefore, the penalty isimposed on the goods. That being the position, in any case, an assesseeDcannot claim deduction of loss in a case of confiscation/penalty, as arisingout of carrying on of the business or incidental to it.

20.2 Relevant paragraphs:

“In support of his argument counsel for the appellant firmreferred to Maqbool Hussain v. State of Bombay etc. [(1953)ESCR 730] and to the following passage at p. 742 where Bhagwati,J., said:

“Confiscation is no doubt one of the penalties which theCustoms Authorities can impose but that is more in the natureof proceedings in rem than proceedings in personam, the objectFbeing to confiscate the offending goods which have been dealtwith contrary to the provisions of the law and in respect of theconfiscation also an option is given to the owner of the goodsto pay in lieu of confiscation such fine as the officer thinks fit.All this is for the enforcement of the levy of and safeguardingGthe recovery of the sea customs duties.”

Similar observations were made by S.K. Das, J.,in ShewpujanraiIndrasanrai Ltd. v. Collector ofCustoms&Ors. [(1959) SCR 821 at p. 836] where it was saidthat a distinction must be drawn between an action in rem andproceeding in personam and that confiscation of the goods is a H

proceeding in rem and the penalties are enforced against the goodswhether the offender is known or not. The view taken by thisCourt in the other two cases cited by counsel for the appellantsi.e. Leo Roy Frey v. Superintendent, District Jail,Amritsar [(1958) SCR 822] and Thomas Dana v. State ofPunjab [1959 Supp (1) SCR 274 at p. 298] is the same. In Danacase [(1959) SCR 821 at p. 836] Subba Rao, J., said at p. 298:

“If the authority concerned makes an order of confiscation itis only a proceeding in rem and the penalty is enforced againstthe goods. On the other hand, if it imposes a penalty againstthe person concerned, it is a proceeding against the personand he is punished for committing the offence. It follows thatin the case of confiscation there is no prosecution against theperson or imposition of a penalty on him.”

In Maqbool Hussain’s case [(1953) SCR 730] the question fordecision was whether after proceedings had been taken underthe Sea Customs Act an accused person could be prosecuted andcould or could not rely upon the plea of double jeopardy, it washeld that he could not. In Shewpujanrai case [(1959) SCR 821at p. 836] the contention raised was that after proceedings hadbeen taken under the Foreign Exchange Regulation Act it wasnot open to the Customs Authorities to take any action under theSea Customs Act. The other two cases were similar to MaqboolHussain case [(1953) SCR 730] . The contention now raisedbefore us is quite different. What is to be decided in the presentcase is whether the penalty which was paid by the appellant firmwas an allowable deduction within s. 10(2)(xv) of the Income-taxAct which provides:

S. 10. (2)(xv) “any expenditure (not being in the nature of capitalexpenditure or personal expenses of the assessee) laid out orexpended wholly and exclusively for the purpose of suchbusiness, profession or vocation.”

The words “for the purpose of such business” have been construedin Inland Revenue v. Anglo Brewing Co. Ltd. [(1925) 12 TC803, 813] to mean “for the purpose of keeping the trade going andof making it pay”. The essential condition of allowance is that theexpenditure should have been laid out or expended wholly andexclusively for the purpose of such business.

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In deciding this case, reference to decisions in some Englishcases will be fruitful. In Commissioners of InlandRevenue v. Warnes & Co. [(1919) 2 KB 444] , the assessee whocarried on the business of oil exporters were sued for a penaltyon an information exhibited by the Attorney-General under theSea Customs Consolidation Act for breach of orders andproclamations. The matter was settled by consent on the assesseeagreeing to pay a mitigated penalty of £ 2000. All imputations onthe moral culpability of the assessees were withdrawn. Theprovisions of the Act under which this information was lodgedand penalty paid was similar to the provisions of the Indian SeaCustoms Act. This amount was held not to be a proper deductionbecause in order to be within the provision similar to s. 10(2)(xv)of the Indian Act the loss had to be something within commercialcontemplation and in the nature of a commercial loss. Rowlatt, J.,relying on the observation of Lord Loreburn, L.C., in Strong &Co. v. Woodifield [(1906) AC 448] said at p. 452:

“but it seems to me that a penal liability of this kind cannot beregarded as a loss connected with or arising out of a trade. Ithink that a loss connected with or arising out of a trade must,at any rate, amount to something in the nature of a loss whichis contemplable and in the nature of a commercial loss. I donot intend that to be an exhaustive definition, but I do not thinkit is possible to say that when a fine which is what the penaltyin the present case amounted to has been inflicted upon a tradingbody, it can be said that that is a ‘loss connected, with or arisingout of’ the trade within the meaning of this rule”.

This statement of the law was approved inthe Commissioners of Inland Revenue v. Alexander VonGlehn& Co. Ltd. [(1920) 2 KB 553] where also in similarcircumstances by consent of the assessee penalty of £ 3,000 waspaid and the penalty plus the costs were claimed as deduction inarriving at the profits. The Special Commissioners had found thatthe penalty and costs were incurred by the assessee in the courseof carrying on their trade and so incidental thereto and wereadmissible deductions. Rowlatt, J., on a reference held it to be anon-deductible item. This judgment was affirmed on appeal bythe Court of Appeal. Lord Sterndale, M.R., was of the opinion

that it was immaterial whether technically the proceedings werecriminal or not. The money that was paid was paid as a penaltyand it did not matter if in the information it was called a forfeiture.

It was argued by the assesses in that case that no moralobliquity was attributed to them and that it did not matter whetherthe expense was incurred in consequence of an infraction of thelaw or whether it was a penalty for doing an illegal act. At p. 565Lord Sterndale said:

“Now what is the position here? This business could perfectlywell be carried on without any infraction of the law. This penaltywas imposed because of an infraction of the law, and thatdoes not seem to me to be, any more than the expense whichhad to be paid in Strong & Co. v. Woodifield [(1906) AC 448]appeared to Lord Davey to be, a disbursement or expensewhich was laid out or expended for the purpose of suchtrade….”

Warrington, L.J. said at p. 569:

“It is a sum which the persons conducting the trade have hadto pay because in conducting it they have so acted as to renderthemselves liable to this penalty. It is not a commercial loss,and I think when the Act speaks of a loss connected with orarising out of such trade it means a commercial loss, connectedwith or arising out of the trade.”

In Strong & Co. v. Woodifield [(1906) AC 448] a brewingcompany owned a licensed house in which they carried on thebusiness of inn-keepers. They incurred a liability to pay damageson account of injuries caused to a visitor, by the falling in of achimney. This sum was held not to be allowable as a deduction incomputing the profits. Lord Loreburn, L.C., in his speech said nosum could be deducted unless it be money wholly and exclusivelylaid out or expended for the purpose of such trade and that onlysuch losses could be deducted as were connected with it in thesense that they were really incidental to the trade itself and theycould not be deducted if they were mainly incidental to some othervocation or fell on the trader in some character other than that ofa trader. Lord Davey observed:

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“I think the disbursements permitted are such as are made forthat purpose. It is not enough that the disbursement is made inthe course of, or arise out of, or is connected with the trade oris made out of the profits of the trade. It must be made for thepurpose of earning profits.”

The following passage from Lord Sterndale’s judgment at p. 566in Von Glehn case [(1920) 2 KB 553] from which we have alreadyquoted shows the effect of incurring a penalty as a result of abreach of the law:

“During the course of the trading this company committed abreach of the law. As I say, it has been agreed that they did notintend to do anything wrong in the sense that they were willinglyand knowingly sending these goods to an enemy destination;but they committed a breach of the law, and for that breach ofthe law, they were fined. That, as it seems to me, was not aloss connected with the business, but was a fine imposed uponthe company personally, so far as a company can be consideredto be a person, for a breach of the law which it had committed.It is perhaps a little difficult to put the distinction into veryexact language, but there seems to me to be a differencebetween a commercial loss in trading and a penalty imposedupon a person or a company for a breach of the law whichthey have committed in that trading. For that reason I thinkthat both the decision of Rowlatt, J., in this case, and his formerdecision in Inland Revenue Commissioners v. Warnes &Co. [(1919) 2 KB 444] which he followed were right, and thatthis appeal should be dismissed with costs.”

In Spofforth and Prince v. Glider [(1945) 26 TC 310] theassessee was a firm of chartered accountants, who claimed adeduction for certain legal costs paid in connection with asuccessful defence of one of the partners in a Police Court. Theassessee Firm also sought legal advice in regard to mattersconnected with some proceedings. Summons were issued againstthe assesseefirm but were eventually dismissed. The assesseecontended that the whole of the costs incurred in connection withthe proceedings were “wholly and exclusively” laid out or expendedfor the appellant’s profession and were therefore allowabledeductions. The Special Commissioner had held against the

assessee which was upheld by the Court. The test laid down byLord Davey in Strong & Co. v. Woodifield [(1906) AC 448] wasapplied and applying that test it was held that except the expensesfor obtaining legal advice the other expenses were not admissible.

In Farrie v. Hall [(1947) 28 TC 200] F, a sugar broker wassued in the High Court for libel and the Court held that F hadacted maliciously and that the defence of privilege could not prevailand awarded damages against him. F sought to claim the amountof damages as an allowable deduction contending that it was anexpenditure laid out wholly and exclusively for the purposes of histrade or was a loss connected with or arising out of the trade.Relying on the cases abovementioned this amount was disallowedbecause it fell on the assessee in his character of a calumniator ofa rival sugar broker and it was only remotely connected with histrade as a sugar broker. Therefore it was not laid out exclusivelyand wholly for the purpose of his business. We were also referredto the observations of Danckwerts, J. in Newson v.Robertson [(1952) 33 TC 452 at p. 459] where it was said that ifthe expenditure is incurred by the tax-payer for more than onepurpose including the commercial purposes in the sense that it isincurred for the purposes of earning profits of the trade and alsosome outside purpose then the expenses cannot be claimed at allas not being wholly and exclusively laid out or expended for thepurpose of the trade. In that case expenses claimed by a Barristerfor travelling between his house and his chambers were disallowedbecause his object and purpose in travelling was mixed and notwholly and exclusively for the purpose of the profession.

Coming now to Indian cases; In Mask &Co. v. Commissioner of Income-tax, Madras [(1943) 11 ITR454] the assessee in breach of his contract sold crackers at alower rate and a decree was passed against him for damages forbreach of contract which he claimed as an allowable deduction.It was held that as the assessee had disregarded the undertakinggiven and his conduct was palpably dishonest it did not constitutean allowable expenditure. Sir Lionel Leach, C.J., after referringto Warne’s case [(1919) 2 KB 444] and Von Glehn’s case [(1920)2 KB 553] held that the amount did not constitute an expenditurefalling within Section 10(2)(xii). The Madras High Court A

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in Senthikumara Nadar & Sons v. Commissioner of Income-tax (1957) 32 ITR 138] held that payments of penalty for aninfraction of the law fell outside the scope of permissible deductionsunder s. 10(2)(xv). In that case the assessee had to pay liquidateddamages which was akin to penalty incurred for an act opposedto public policy a policy underlying the Coffee Market ExpansionAct, 1942, and which was left to the Coffee Board to enforce.

Reference was also made during the course of argumentsto Commissioner of Income-tax v. Hirjee [(1953) SCR 714]. Inthat case the assessee was prosecuted under the Hoarding andProfiteering Ordinance but was finally acquitted and claimed theamount spent in defending himself under s. 10(2)(xv) in hisassessment. It was held that the distinction between the legalexpenses on a successful and unsuccessful defence was not soundand that the deductibility of such expenses under s. 10(2)(xv)must depend on the nature and purpose of the legal proceedingsin relation to the business whose profits are in computation andare unaffected by the final outcome of the proceedings.

A review of these cases shows that expenses which arepermitted as deductions are such as are made for the purpose ofcarrying on the business i.e. to enable a person to carry on andearn profit in that business. It is not enough that the disbursementsare made in the course of or arise out of or are concerned with ormade out of the profits of the business but they must also be forthe purpose of earning the profits of the business. As was pointedout in Von Glehn’s case [(1920) 2 KB 553] an expenditure is notdeductible unless it is a commercial loss in trade and a penaltyimposed for breach of the law during the course of trade cannotbe described as such. If a sum is paid by an assessee conductinghis business, because in conducting it he has acted in a manner,which has rendered him liable to penalty it cannot be claimed as adeductible expense. It must be a commercial loss and in its naturemust be contemplable as such. Such penalties which are incurredby an assessee in proceedings launched against him for aninfraction of the law cannot be called commercial losses incurredby an assessee in carrying on his business. Infraction of the law isnot a normal incident of business and therefore only suchdisbursements can be deducted as are really incidental to the

business itself. They cannot be deducted if they fall on the assesseein some character other than that of a trader. Therefore where apenalty is incurred for the contravention of any specific statutoryprovision, it cannot be said to be a commercial loss falling on theassessee as a trader the test being that the expenses which arefor the purpose of enabling a person to carry on trade for makingprofits in the business are permitted but not if they are merelyconnected with the business.

It was argued that unless the penalty is of a nature which ispersonal to the assessee and if it is merely ordered against thegoods imported it is an allowable deduction. That, in our opinion,is an erroneous distinction because disbursement is deductible onlyif it falls within s. 10(2)(xv) of the Income-tax Act and no suchdeduction can be made unless it falls within the test laid down inthe cases discussed above and it can be said to be expenditurewholly and exclusively laid for the purpose of the business. Can itbe said that a penalty paid for an infraction of the law, even thoughit may involve no personal liability in the sense of a fine imposedfor an offence committed, is wholly and exclusively laid for thebusiness in the sense as those words are used in the cases thathave been discussed above. In our opinion, no expense which ispaid by way of penalty for a breach of the law can be said to bean amount wholly and exclusively laid for the purpose of thebusiness. The distinction sought to be drawn between a personalliability and a liability of the kind now before us is not sustainablebecause anything done which is an infraction of the law and isvisited with a penalty cannot on grounds of public policy be said tobe a commercial expense for the purpose of a business or adisbursement made for the purposes of earning the profits of suchbusiness.”

21. CIT v. S.C. Kothari, 1972 (4) SCC 402

21.1 The decision rendered in BadridasDaga (supra) was quotedwith approval. However, it was the view expressed that if the profit is tobe taken for the taxable income, a resultant expenditure/loss cannot beavoided, notwithstanding the nature of business. We must hasten to notethat the decision rendered in S.C. Kothari (supra)may not be in tunewith BadridasDaga (supra) wherein this Court held that allowing adeduction depends upon the statute and commercial principles, while

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Aapplying the test of ‘purpose of business’ and‘incidental to business’ andnot by way of a general principle. Hence, non-allowance of a deductionon the ground of one incurred as an expenditure for a purpose which isan offence or prohibited by law can be disallowed otherwise through astatute. This Court in SC Kothari (supra) had merely laid down thegeneral proposition of law by taking note of the position prevailing inBother countries, but in any case, it has got no application over a case ofeither a penalty or confiscation.

21.2 The law as laid down in Haji Aziz (supra)despite beingnoted, was not followed on both the counts, viz., the deduction of lossqua an offence and the consequence of a penalty imposed for anCinfraction of law.

21.3 We must further add that in S.C. Kothari(supra), this Courtwas concerned with Section 10(2)(xv)of the Old Act, which did notcontain any explanation as introduced to Section 37(1) of the Act.Thissubsequent change in law will certainly have a bearing on theDunderstanding of the said judgment.

22. Soni Hinduji Kushalji & Co. v. CIT,(1971) SCC Online AP 223

22.1 The Division Bench of the Andhra Pradesh High CourtEconsidered the law laid down on deduction of loss incurred by way of aconfiscation and penalty. It took into consideration the decision of thisCourt in S.C. Kothari (Supra).It was accordingly held that a loss mustbe one arising directly from the business or trade,being incidental to it, aslaid down by this Court in Badridas Daga (supra).The Court whilenoting the decision of this Court in Maqbool Hussain v. State of BombayFetc.,(1953) SCR 730 and Haji Aziz (supra), held that a confiscationof a contraband being an action in rem is not available for deduction, asthe same, by no process of reasoning can be said to be trading orcommercial loss connected with or incidental to the assessee’s business.

22.2 Relevant paragraphs:G

“4. Mr. Swamy appearing for the assessee-firm strongly contendedthat when the profits earned from an illegal business are not exemptfrom tax, the loss sustained in such business should be allowed tobe deducted from the profits or gains for purposes of computingthe tax payable by the assessee.

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5. What are chargeable to tax in respect of a business carried onby the assessee are the profits or gains of a particular assessmentyear. While assessing the profits, necessarily loss incurred in thebusiness during the year should be taken into account, as otherwiseit is not possible to arrive at the true profits earned by the assessee.It is well-settled that the taint of illegality associated with profitsor income is immaterial for the purpose of taxation. As observedby Lord Haldane in Minister of Finance v. Smith [[1927] A.C.193, 198.] , Income-tax Acts are not necessarily restricted in theirapplication to lawful business only. One who contravenes a statuteand trades in business prohibited by law while being liable forprosecution for the offence committed by him will, at the sametime, be liable to pay tax out of the income or profits earned fromthe illegal trade or business. We are now concerned with the lossrepresenting the value of gold on account of the confiscation ofthe gold for contravention of the provisions of the Customs Act.Can that loss be regarded as a commercial loss pertaining to thebusiness or incidental to the business the assessee was carryingon, is the real question.

6. Mr. Swamy sought to place strong reliance upon a decision ofthe Gujarat High Court in Commissioner of Income-tax v. S.C.Kothari [[1968] 69 I.T.R. 1 (Guj.).] to contend that the assesseeis entitled to claim deduction of the value of the contraband goldconfiscated by the customs authorities, as it represented the losssustained by the firm in the illegal business carried on by it. Thelearned judges in that case were of the view that, when illegalbusiness is business within the meaning of the Income-tax Actand if profits from illegal business are assessable to tax, there isno reason either in principle or on authority for refusing to takeinto account losses from illegal business. According to these, thelosses so incurred must necessarily be taken into account in orderto arrive at the true profits of the business and such profits maybe either positive in the sense that they are actual profits or theymay be negative in the sense that they are losses and there is inprinciple no distinction between profits and losses of a business…

9. Kothari’s case [[1968] 69 I.T.R. 1 (Guj.).] , as may be noticedfrom the facts stated therein, was not a case where a claim for

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deduction was made by the assessee, as he did not say that aparticular expenditure incurred by him should be allowed as apermissible deduction. It is on that ground that the learned judgesruled that the decision in Commissioner of Income-tax v. Haji Aziz& Abdul Shakoor Bros [[1955] 28 I.T.R. 266 (Bom.).] ., reliedupon by the revenue, where the claim for deduction under section10(2)(xv) of the 1922 Act was negatived, was not applicable tothe case before them. Therefore, the answers given by the learnedjudges in Kothari’s case [[1968] 69 I.T.R. 1 (Guj.).] render noassistance at all to the assessee’s contention.

10. Here is a specific claim made by the assessee for deductionof the value of the gold confiscated by the Central Governmenton the ground that it is a trading or commercial loss, though thetrade was an illegal one. It should not be lost sight of when aclaim for deduction is made, that the loss must be one that springsdirectly from the business or trade which the assessee carries onor is incidental to the business that he carries on and not everysort or kind of loss, which has absolutely no nexus or connectionwith his trade or business.

11. It is well to remember that confiscation of contraband gold isan action in rem and not a proceeding in personam. As observedby Bhagwati J. in Maqbool Hussain v. State of Bombay [[1953]S.C.R. 730, 742 (S.C.), AIR 1953 S.C. 325.] confiscation is nodoubt one of the penalties which the customs authorities canimpose but that is more in the nature of proceedings in rem thanproceedings in personam, the object being to confiscate theoffending goods which have been dealt with contrary to theprovisions of the law. To the same effect is the view expressedby S.K. Das J. in ShewpujanraiIndrasanrai Ltd. v. Collector ofCustoms [[1959] S.C.R. 821, 836 (S.C.), AIR 1958 S.C. 845.]that, so far as the confiscation of the goods is concerned, it is aproceeding in rem and the penalties are enforced against the goodswhether the offender is known or not known and the order ofconfiscation under section 182 of the Sea Customs Act operatesdirectly upon the status of the property and under section 184transfers an absolute title to the Government. Subba Rao J. (ashe then was) in Thomas Dana v. State of Punjab [AIR 1959 S.C.375.] , in his dissenting judgment (the dissent being on other points)observed that if the authority concerned makes an order of

confiscation it is only a proceeding in rem and the penalty isenforced against the goods.

12. A proceeding in rem, therefore, in the strict sense of the termis an action taken directly against the property (in this case thesmuggled gold) and even if the offender is not known, the customsauthorities have the power to confiscate the contraband gold.Therefore, by no process of reasoning can the confiscation of thecontraband gold by the customs authorities be said to be a tradingor commercial loss connected with or incidental to the assessee’sbusiness.

13. In Commissioners of Inland Revenue v. Alexander Von Glehn&Co. Ltd. [[1920] 2 K.B. 553, 566 (C.A.).] . Lord Sterndale M.R.observed:

“During the course of the trading this company committed abreach of the law. As I say, it has been agreed that they did notintend to do anything wrong in the sense that they were willinglyand knowingly sending these goods to an enemy destination,but they committed a breach of the law, and for that breach ofthe law, they were fined. That, as it seems to me, was not aloss connected with the business, but was a fine imposed uponthe company personally, so far as a company can be consideredto be a person, for a breach of the law which it had committed.It is perhaps a little difficult to put the distinction into veryexact language, but there seems to me to be a differencebetween a commercial loss in trading and a penalty imposedupon a person or a company for a breach of the law whichthey have committed in that trading.”

14. The principle stated by Lord Sterndale M.R. holds good heretoo, as it is impossible to hold that the loss incurred by reason ofthe confiscation of the contraband gold is an expenditure incurredin connection with the trade or business of the assessee-firm orincidental to the carrying on of its business.

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16. Their Lordships of the Supreme Court in Haji Aziz and AbdulShakoor Bros. v. Commissioner of Income-tax [[1961] 41 I.T.R.350 (S.C.), [1961] 2 S.C.R. 651 (S.C.).] , after reviewing severalIndian and English cases, observed at page 359:

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“As was pointed out in Von Glehn’s case [[1920] 2 K.B. 553(C.A.).] , an expenditure is not deductible unless it is acommercial loss in trade and penalty imposed for breach ofthe law during the course of trade cannot be described as such.If a sum is paid by an assessee conducting his business, becausein conducting it he has acted in a manner which has renderedhim liable to penalty, it cannot be claimed as a deductibleexpense. It must be a commercial loss and in its nature mustbe contemplable as such. Such penalties which are incurredby an assessee in proceedings launched against him for aninfraction of the law cannot be called commercial losses incurredby an assessee in carrying on his business. Infraction of thelaw is not a normal incident of business and, therefore onlysuch disbursements can be deducted as are really incidental tothe business itself. They cannot be deducted if they fall on theassessee in some character other than that of a trader.Therefore, where a penalty is incurred for the contraventionof any specific statutory provision, it cannot be said to be acommercial loss falling on the assessee as a trader, the testbeing that the expenses which are for the purpose of enablinga person to carry on trade for making profits in the businessare permitted but not if they are merely connected with thebusiness…. Anything done which is an infraction of the lawand is visited with a penalty cannot on grounds of public policybe said to be a commercial expense for the purpose of abusiness or a disbursement made for the purposes of earningthe profits of such business.”

17. Similar views have been expressed by the Punjab andAllahabad High Courts in Raj Woollen Industries v. Commissionerof Income-tax [[1961] 43 I.T.R. 36 (Punj.).] , Commissioner ofIncome-tax v. Mathura Prasad Hardwar Prasad Deoria [[1965]55 I.T.R. 476 (All.).] and Mahabir Sugar Mills (P.)Ltd. v. Commissioner of Income-tax [[1969] 71 I.T.R. 87 (All.).]

18. The Supreme Court in Badridas v. Commissioner of Income-tax [[1958] 34 I.T.R. 10, [1959] S.C.R. 690 (S.C.).] , consideredwhat would amount to a trading loss. Venkatarama Aiyar J.observed:

“When a claim is made for a deduction for which there is nospecific provision in section 10(2), whether it is admissible ornot will depend on whether, having regard to acceptedcommercial pratice and trading principles, it can be said toarise out of the carrying on of the business and to be incidentalto it. If that is established, then the deduction must be allowed,provided of course there is no prohibition against it, express orimplied in the Act. The loss for which a deduction could bemade under section 10(1) must be one that springs directlyfrom the carrying on of the business and is incidental to it, andnot any loss sustained by the assessee, even if it has someconnection with his business.”

19. Judged from the test laid down by their Lordships, it isimpossible to hold that the confiscation of contraband gold, whichis in the nature of a proceeding in rem, is a loss that springs directlyfrom the business or trade carried on by the assessee-firm and isincidental to its business. Following the view expressed by theirLordships, the Punjab High Court in Ram Gopal Ram Sarup v.Commissioner of Income-tax [[1963] 47 I.T.R. 611 (Punj.).] , heldthat the mere fact that there is some remote connection betweena loss and the business would not bring the loss within the expression“loss incidental to the the”.

22. As pointed out by Lord Loreburn L.C. in Strong & Co. Ltd. v.Woodi-field [[1906] A.C. 448, 452 (H.L.).] , “They cannot bededucted if they are mainly incidental to some other vocation orfall on the trader in some character other than that of trader. Thenature of the trade is to be considered.”

23. This court in Commissioner of Income-tax v. Chakka Narayana[[1961] 43 I.T.R. 249 (A.P.).] , in a case of loss sustained by anassessee on account of theft at a railway station, held that theloss resulting thereof was not incidental to the assessee’s businessand was not an allowable deduction and that the mere fact thatthere was some remote connection between the loss and thebusiness would not bring the loss within the expression “lossincidental to the the”. The loss sustained by confiscation of thesmuggled gold is absolutely foreign to the vocation or business ofthe assessee-firm. It is a loss incurred in some character other

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Athan that of a trader. The confiscation of the gold, being the resultof a proceeding in rem, falls completely outside the trade or businesswhich the assessee was carrying on. Confiscation of contrabandgoods is one of the penalties provided under the Sea Customs Actand the penalty is enforced against the goods irrespective of thefact whether the offender is known or not traced. Infraction orBviolation of the law is not a normal incident of a trade or businessand, therefore, the penalty by way of confiscation of thecontraband gold is not a commercial loss so as to be allowed as apermissible deduction.”

22.3 The aforesaid reasoning of the Andhra Pradesh High CourtCarrived at after taking note of the earlier decisions rendered by this Courtin its support, deserves to be approved.

23. J.S Parkar v. V.B Palekar and Others,(1973) SCC OnlineBom 161D23.1 Majority view of the Bombay High Court was in line with

D23.1 Majority view of the Bombay High Court was in line withSoni HindujiKushalji& Co. (supra),though not referring to the saiddecision. It is to be noted that though Justice Mukhi dissented with theview of Justice Deshpande, the third Judge, Justice Tulzapurkar by aseparate judgment, concurred with the view of Justice Deshpande.Therefore, themajority while broadly interpreting the view of this CourtEin Haji Aziz (supra), held that confiscation of goods incurred for aninfraction of law cannot be said to be a normal incident of business, andthis loss falls on the assessee in some character other than that of atrader. The Court further noted that this principle would equally apply toa case where the business itself is prohibited by law while disagreeingFwith the view of the Punjab and Haryana High Court in Piara Singh(1970)SCC OnLine P&H 429,which decision did not reach this Court at thatpoint of time. The Court held that the decision of the Punjab and HaryanaHigh Court in PiaraSingh(1970) SCC OnLine P&H 429, was not inline with the decision of this Court in Haji Aziz(supra).

G23.2 Relevant paragraphs:

Justice Deshpande:

“23. It is then contended that, admittedly, the entire gold hasbeen confiscated by the customs department and, as such, valueof this should have been treated as a trading loss and theHassessee was entitled to a set-off of this loss against his

assumed and assessed income from undisclosed sources.Reliance was mainly placed on section 71, though faintly section70 was also referred to. This point was raised before theTribunal. The Tribunal, however, declined to entertain this plea,as it was raised for the first time before it and it thought thatthe same cannot be adjudicated without investigation of furtherfacts. Unfortunately, the order of the Tribunal is not explicit asto in what manner investigation of further facts was necessary.It is, therefore, not possible to know if the Tribunal was reluctantto allow set off for loss tainted with patent illegality, against theincome, source of which was not shown to be illegal or it treatedthe loss by confiscation as capital loss and, therefore, wasreluctant to deduct the same from the income from capitalgains as required under section 71. Be that as it may, I have nohesitation in saying that if it were a pure question of law capableof being adjudged on the material on record, the Tribunal wasunder a statutory obligation to entertain and decide the same.I, however, think that, on the admitted facts, the petitioner isnot entitled to claim any set-off. The loss suffered by theassessee consequent on the confiscation of the gold forinfraction of law cannot be said to be a commercial loss liableto set off under any provision of the Act. It will be enough torefer to the judgment of the Supreme Court in Haji Aziz andAbdul Shakoor Bros. v. Commissioner of Income-tax. TheSupreme Court upheld the view of this court in the same case.Dates were imported from abroad by the assessee incontravention of the provisions of the Sea Customs Act. Thecustoms authorities confiscated the goods under section 167-B of the Sea Customs Act. It, however, gave the assessee,under section 183 of the Act, an option to pay the fine in lieu ofconfiscation and get the goods released. The assessee exercisedthe option and got the goods released on payment of fine. Inthe course of the assessment proceedings the assessee claimeddeduction of this penalty amount under section 10(2)(xv) ofthe Indian Income-tax Act of 1922. The Bombay High Courtnegatived the claim holding that the penalty for infraction oflaw does not amount to any expenditure laid out or expendedwholly and exclusively for the purpose of such business,profession or vocation. The Supreme Court affirmed the saidview of this court on slightly broader base, observing as follows:

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“An expenditure is not deductible unless it is a commercialloss in trade and a penalty imposed for breach of the lawduring the course of trade cannot be described as such.Infraction of the law is not a normal incident of businessand, therefore, only such disbursements can be deductedas are really incidental to the business itself. They cannotbe deducted if they fall on the assessee in some characterother than that of a trader.”

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“29. Applying this test laid down by Grover J., speaking forthe Supreme Court, in S.C. Kothari’s case and the test laiddown by Kapur J., speaking for the Supreme Court, in thecase of Haji Aziz and Abdul Shakoor Bros., it shall have tobe held that confiscation of goods incurred for infraction oflaw cannot be said to be a normal incident of business and losssuffered therefrom falls on the assessee in some characterother than that of a trader. It is not possible to see how thisprinciple can make any difference where the business itself isfound to have been prohibited by the law. It is the commercialprofit that is taxable and it is the commercial loss in trade inregard to which deduction can be claimed either because itgoes to lessen the amount of profits before the quantum of netprofit is determined or because the expenses are required tobe incurred for the purposes of running the said business orbecause losses are incurred under some other sources ofbusiness under the same head or they are incurred while carryingon business or vocation under some other head. Penalty andconfiscation of goods even when incurred or suffered in thecourse of prohibited trade or business still cannot be said to bethe normal incident even of such unlawful business and theloss so suffered can still be not said to be a commercial loss inthe trade for the same reason as gains of theft, dacoity,misappropriation or cheating cannot be treated as taxableincome from any business or commerce. The claim of Mr.Albal for deduction of value of gold confiscated by way of set-off cannot, therefore, be entertained.

30. It is true, as observed by the Punjab and Haryana HighCourt in Piara Singh’s case, the risk of confiscation of goods

and incurring of penalties is inherent in any unlawful trading orbusiness. So is the risk of conviction and fine. It does not,however, necessarily follow that every kind of damage sufferedin such trading falls under the category of commercial loss. Itshall have to be held, at any rate, on the authority of the SupremeCourt in Haji Aziz and Abdul Shakoor Bros. that theconfiscation of property or penalty incurred while indulging inprohibited trading activities does not amount to commercialloss though it happens in fact to be a loss according to theordinary meaning of the word “loss” as understood in commonparlance. Attempt to distinguish the above Supreme Courtjudgment on the ground that the court was dealing with theclaim of the assessee for deduction of penalty under section10(2)(xv) and not under section 10(1) of the Income-tax Actof 1922 is an exercise in futility. That, in the above case, neitherthe assessee claimed deduction of such penalty by way of lossunder section 10(1) of the Act, nor the Supreme Courtconsidered it worthwhile allowing the claim under that sub-section is also indicative, if not decisive, of the untenability ofsuch contention. Though deduction was claimed under section10(1) of the Act, rejection of the claim is based on the broaderbasis that penalties and confiscations are not the normalincidents of business and do not constitute commercial loss. Ifone examines the scheme of section 10(2), and section 24 ofthe 1922 Act and corresponding provisions of sections 28, 29to 44A and sections 70 and 71 of the 1961 Act, it will be noticedthat the provisions deal with the deductions or disbursementfrom the profits earned under various contingencies. If thelosses are incurred in the same business (source of income)under the same head enumerated under section 14, the sameare liable to be deducted under section 22 (section 10(1) of theold Act) of the Act. If losses are incurred under a differentsource falling under the same head, the losses are liable to bededucted from the income of any other source falling underthe same head under section 70. When, however, net result ofall sources under any one head of income is loss, the same isliable to be deducted from the income under another head undersection 71. If the net result of all sources under all heads is aloss, the same can be carried forward under section 72 of the AB

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Act. Sections 29 to 44A corresponding to section 10(2), clauses(1) to (xvi), deal with deductions or disbursements by way ofexpenses, etc. These provisions deal with the mode ofdetermining the net taxable profits or income of the assessee.If the true ratio of the Supreme Court judgment is that penaltyincurred by infraction of law is not a commercial loss as it isnot incidental to trade or business, it matters little as to underwhat count the deduction or set-off is claimed. That the marginbetween what is and what is not incidental is very thin hasbeen noticed by the learned judges of the Supreme Courtthemselves. Ratio of this judgment is applicable to allcontingencies where such non-commercial loss is sought to bededucted on any count whatsoever. That the assessee in thatcase claimed deduction of penalty under section 10(2)(xv)cannot make any difference to the ratio of the case. I do notfind it possible to agree with the view of the Punjab High Court.I do not think that the Gujarat High Court’s judgmentin Kothari’s case supports its view. On the contrary, the ratioof the two Supreme Court judgments run counter to the ratioof the Punjab case.”

Justice Tulzapurkar:

Justice Tulzapurkar:

“179. I have already indicated above that in Haji Aziz’scase[1] while dealing with penalty or fine imposed in lieu ofconfiscation of goods, the Supreme Court has observed thatthe penalty suffered by an assessee for an infraction of lawcannot be regarded as incidental to the business and in fact itfalls upon the assessee in some character other than that of atrader. In my view, the aforesaid authorities make the positionvery clear that before any loss could be claimed as deductibleloss under section 10(1) of the Act, it must be a trading loss orcommercial loss arising out of carrying on business or it mustbe incidental to the business and such loss must also fall on theassessee in his character as a trader. The question in the presentcase is as to whether the loss consequent upon confiscation ofgoods for an infraction of law suffered by the assessee couldbe regarded as a commercial loss or could it be said to be lossincidental to the business and, what is of importance, could itbe said to have been suffered by him in his character as a

trader? In my view, it is certainly not a commercial loss arisingfrom carrying on of the business nor can it be regarded asincidental to the activity of the assessee as dealer in gold;moreover, it cannot be regarded as loss falling upon theassessee in his character as a trader. It is a loss falling uponhim as a person who had infracted law. The loss suffered byconfiscation of goods directly sprang from an illegal actcommitted by the assessee, namely, having acquired goldwithout requisite permit or permission of the Reserve Bank ofIndia and without having paid any duty for the import thereofinto India. Surely, the loss has not fallen on the assessee as atrader or businessman, for, obviously, even a lay person who isnot a businessman, if he were to import gold for his private usewithout requisite permission and without payment of customsduty, would subject himself to the penalty of having that goldconfiscated from him and he would as a consequence suffergreat loss. It is thus clear that the loss consequent uponconfiscation of goods for infraction of law suffered by theassessee must be regarded as loss falling upon him in somecharacter other than a trader. In this view of the matter, I amclearly of the view that the petitioner is not entitled to claim theloss suffered by him as a result of confiscation of the gold inquestion as allowable deduction while computing his businessincome under section 28 of the Act.

180. So far as the decision of the Gujarat High Court in S.C.Kothari’s case is concerned—which decision has beenconfirmed by the Supreme Court— it must be observed thatthe judgment is an authority only for the proposition that illegalityof any business is irrelevant for the purpose of computing thenet income thereof under the Income-tax Act and while therevenue is entitled to levy tax on the income of the assesseeearned even from unlawful business, the assessee is also entitledto insist on deduction of loss arising out of such unlawfulbusiness. There could be no quarrel with this statement of lawwhich has been approved by the Supreme Court. But eventhere, the loss in respect of which deduction could be claimedwhile computing the profits of the unlawful business must be atrade loss or commercial loss or loss incidental thereto butsuffered by the assessee in his character as a trader and not

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loss suffered as a result of confiscation of goods for an infractionof law which would be a loss suffered by him in some capacityother than as a trader. Besides, in S.C. Kothari’s case neitherthe Gujarat High Court nor the Supreme Court had to considerthe question whether the loss suffered by way of penalty orconfiscation of goods amounted to commercial loss or not. Infact, while setting out the facts of the case it has been statedby the Supreme Court in paragraph 1 of its judgment that theloss of Rs. 3,40,000 and odd which was claimed as deductibleloss had arisen out of certain transactions entered into by theassessee with different people for the supply of groundnut oiland it was expected by the assessee that those contracts wouldbe performed but owing to certain reasons some of thecontracts could not be performed and difference has to bepaid. From this it appears clear that the loss of Rs. 3,40,000which was claimed as deductible loss was clearly in the natureof commercial or trade loss for which deduction was claimedunder section 10(1) of the Act. In the circumstances, it is clearthat the statement of law enunciated in the case of S.C.Kothari is unexceptionable but, with respect, I would like topoint out that the decision is no authority for the propositionthat the loss suffered by way of penalty or confiscation ofgoods amounts to commercial loss that could be deducted whilecomputing the net profits of a business under section 10(1) ofthe Act. It is true that in Piara Singh’s case, the Punjab andHaryana High Court has taken the view that the confiscationof cash amount of Rs. 65,500 from the assessee, who wasengaged in the business activity of smuggling gold, amountedto trade loss and hence was deductible under section 10(1) ofthe Act. But for coming to that conclusion the Punjab HighCourt has principally relied upon the decision of the GujaratHigh Court and of the Supreme Court in S.C. Kothari’s case,in which, as I have stated above, neither the Gujarat High Courtnor the Supreme Court was required to consider the questionwhether the loss arising from penalty or confiscation of goodsfor an infraction of law amounted to trade loss or commercialloss; in fact admittedly the nature of loss suffered by the assesseewas commercial since it had arisen on account of payment ofdifferences. With great deference, I am unable to persuade

myself to agree with the view of the Punjab High Courtexpressed in Piara Singh’s case, especially when it runscounter to the tests laid down by the Supreme Court in HajiAziz’s case and in English cases to which the Supreme Courthas referred while deciding Haji Aziz’s case. The othercontention that this loss should be allowed to be set off againstthe income from undisclosed source under section 70 or section71 was not pressed by Mr. Albal. In view of the abovediscussion, on both the points on which there was differenceof opinion between the two learned judges I am in agreementwith the views expressed by Mr. Justice Deshpande.”

23.3 The decision of the Bombay High Court certainly falls in linewith the one rendered in Haji Aziz (supra). The cogent reasons givenby taking penalty and confiscation out of the purview of Section 10(1)ofthe Old Act appears to be the correct view.

24. Commissioner of Income Tax v. Piara Singh,(1980) Supp.SCC 166

24.1 This Court did not differ with the view expressed by a co-ordinate bench in Haji Aziz(supra). In fact, it gave its approval to thesaid decision. However, reliance was placed on S.C. Kothari (supra)by drawing a distinction between an infraction of law committed incarrying out a lawful business, as against one committed in an inherentlyunlawful business. It was done upon a legitimate anticipation that in anillegal business there will be many pitfalls resulting in expected loss,which cannot be factored into a normal business.

24.2 Law as laid down in Haji Aziz (supra) on both the issueshave not been taken note of by inadvertence, particularly the nature ofproceedings involved in the imposition of confiscation or penalty, beingproceedings in rem. This Court did not have the benefit of the explanationas available under Section 37 of the Act, while interpreting Section 10(2)of the Old Act, apart from ignoring the word of caution mentioned inBadridasDaga (supra).

24.3 We would only clarify the position that, in any case, the lawas laid down in Piara Singh(supra) may not have any application to acase of deduction of expenditure/loss incurred on account of penalty/confiscation coming under Section 37(1) of the Act, particularly in lightof Explanation 1.

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132SUPREME COURT REPORTS

[2023] 7 S.C.R.

A25.Dr. T.A. Quereshi v. Commissioner of Income Tax, Bhopal(2007) 2 SCC 759

25.1 This Court merely followed Piara Singh(supra) while makinga casual observation on Explanation 1 to Section 37 of the Act. Theearlier decisions have not been taken into consideration as we could seeBin Piara Singh(supra), but the principle laid down was also not takennote of. In this connection, it has to be remembered that for a precedentto be binding there has to be a conscious consideration of an issue involved.The judgment in Dr. T.A. Quereshi(supra) was delivered by a two-Judge Bench while not taking note of a three-Judge Bench decision inHaji Aziz (supra),which has neither been disapproved nor distinguished.CHence, this decision is per incuriamand not a binding precedent.Onceagain, the question of a confiscation proceeding being in rem was notbrought to the notice of the Court.

25.2 Therefore, there cannot be a situation where an assesseecarrying on an illegal business can claim deduction of expenses orlossesDincurred in the course of that business, while another assessee carryingon a legitimate one cannot seek deduction for loss incurred on accountof either a confiscation or penalty. The interpretation of Section 37 ofthe Act given by the Court in Dr. T. A. Quereshi (supra) leads to asituation where the expenditure incurred in manufacturing somethingEillegal may not be allowable as a deduction in view of the Explanation1,however, if upon seizure, the manufactured goodsare confiscated, inthat case deduction will be allowable on commercial principles. Thisclassification being artificial not borne out by statute, which mischief issought to be clarified by the explanation, has no legal basis.

FConclusion(s)

26. On the abovesaid analysis, the following conclusions are arrived at:

I.The word ‘any expenditure’ mentioned in Section 37 of theAct takes in its sweep loss occasioned in the course ofGbusiness, being incidental to it.

II.As a consequence, any loss incurred by way of anexpenditure by an assessee for any purpose which is anoffence or which is prohibited by law is not deductible interms of Explanation 1 to Section 37 of the Act.

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III.Such an expenditure/lossincurred for any purpose which isAan offence shall not be deemed to have been incurred forthe purpose of business or profession or incidental to it, andhence, no deduction can be made.

IV.A penalty or a confiscation is a proceeding in rem, andtherefore, a loss in pursuance to the same is not availableBfor deduction regardless of the nature of business, as apenalty or confiscation cannot be said to be incidental toany business.

V.The decisions of this Court in Piara Singh (supra) andDr. T.A. Quereshi (supra) do not lay down correct law inlight of the decision of this Court in Haji Aziz (supra) andthe insertion of Explanation 1 to Section 37.

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27. In view of the aforesaid discussion, I am inclined to hold thatthe appeal of the Revenue deserves to be allowed, though conscious ofthe fact that Section 115BBE of the Act may not have an application tothe case on hand being prospective in nature. Accordingly, the judgment&order dated 22.11.2016 passed in DBITA No. 96/2003 & DBITR No.6/1996 by the High Court of Rajasthan at Jaipur stand set aside. Nocosts.

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Divya Pandey

(Assisted by : Abhishek Pratap Singh and Shevali Monga, LCRAs)

Appeals allowed.

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