1. Misappropriation of funds by an agent — Claim for deduction of written-off loss in computing business profits under Section 10 of the Indian Income-tax Act, 1922. (Para 2 , 3 )
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1958 Supreme(SC) 65
SUPREME COURT OF INDIA
.K.Sarkar : P.B.Gajendragadkar : T.L.Venkatarama Ayyar
Badridas Daga
Versus
Commissioner Of Income Tax
Case No. : 149 of 1956
Date of Decision : 4/25/58
Advocates:
H.N.SANYAL, J.B.DADACHAN, J.M.THAKAR, K.N.RAJAGOPAL SASTRI, N.S.ANDLEY, R.H.Dhebar, R.J.KOLAG, RAMESH A.SHROFF, RAMESHWAR NATH ROY
H.N.SANYAL, J.B.DADACHAN, J.M.THAKAR, K.N.RAJAGOPAL SASTRI, N.S.ANDLEY, R.H.Dhebar, R.J.KOLAG, RAMESH A.SHROFF, RAMESHWAR NATH ROY
Loss resulting from embezzlement by an employee or agent is deductible as a trading loss under Section 10(1) of the Indian Income-tax Act, 1922, provided the loss is incidental to the conduct of the business and arises from the necessity of employing such personnel.
Headnote:(A) Indian Income-tax Act, 1922 - Sections 10(1), 10(2)(xi), and 10(2)(xv) - Computation of profits and gains - Loss due to embezzlement by an agent - Whether such loss is an admissible deduction - A debt arises out of a contract; misappropriation by an agent in breach of obligation is not a contractual debt, hence not a bad debt under Section 10(2)(xi) (Para 4) - Money withdrawn in fraud of the proprietor is not expenditure laid out wholly and exclusively for the purpose of business under Section 10(2)(xv) (Para 4) - Profits and gains are to be understood according to ordinary commercial principles - If a loss arises out of the carrying on of business and is incidental to it, it is deductible under Section 10(1) (Para 4) - Employment of agents is incidental to business; therefore, losses resulting from their dishonesty are also incidental to the carrying on of business (Para 5) - Distinction between loss incurred in the running of business and loss to which all owners of property are exposed, such as theft by a stranger (Para 6).
(B) Trading Loss - Nature of business - In a money-lending or banking business, continuous operation of bank accounts is incidental to the conduct of business; therefore, misappropriation of funds withdrawn from such accounts by an authorized agent is a trading loss (Para 11).
Facts of the case:
The appellant, a sole proprietor of a business involving money-lending and dealing in shares and bullion, appointed an agent with power of attorney to manage business affairs, including operating bank accounts. The agent misappropriated a significant sum from the firm's bank account for personal debts. After a legal suit, a small portion was recovered, and the balance was written off as irrecoverable. The dispute arose whether this written-off amount was an admissible deduction in computing taxable profits.
Findings of Court:
The loss sustained due to misappropriation by the agent is one which is incidental to the carrying on of the business and should therefore be deducted in computing the profits under Section 10(1) of the Act.
Issues: Whether the sum embezzled by an agent is allowable as a deduction under the Indian Income-tax Act, either as a bad debt under Section 10(2)(xi), as a business expense under Section 10(2)(xv), or as a trading loss under Section 10(1).
Ratio Decidendi: The court held that while embezzlement is not a contractual debt or a business expenditure, it constitutes a trading loss if it springs directly from the carrying on of the business. Since the employment of agents is necessary for the business, the risk of their dishonesty is incidental to the business. This differs from theft by a stranger, which is a loss sustained as an owner of property rather than as a person carrying on business.
Result: Appeal allowed; reference answered in the affirmative.
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2. Whether loss from embezzlement is admissible as a bad debt, a business expenditure, or a trading loss under Section 10 of the Act. (Para 3 , 4 )
3. Employment of agents is incidental to business; thus, losses from their dishonesty are business losses, provided they spring directly from business operations rather than asset ownership. (Para 5 , 6 , 10 , 11 , 12 )
4. Loss resulting from embezzlement by an employee is a trading loss incidental to the conduct of business and deductible in computing profits under Section 10(1). (Para 5 , 15 )
5. Appeal allowed — Loss sustained due to misappropriation held as an admissible deduction in computing business profits. (Para 15 )
6. Is embezzlement by an employee considered a bad debt or a business expenditure under the Act?
No. It is not a bad debt because it does not arise from a contract. It is not a business expenditure because the funds were not laid out or expended for the purpose of the business. (Para 4 )
7. When is a loss resulting from embezzlement deductible as a trading loss?
It is deductible if the loss springs directly from the carrying on of the business and is incidental to it, as businesses typically require employees whose dishonesty is a risk of employment. (Para 5 , 6 )
8. How does the court distinguish between a business loss and a loss sustained as an owner of funds?
Business losses spring directly from business operations. Conversely, losses such as theft by a stranger breaking into premises are losses sustained as an owner of funds, not as a person carrying on business. (Para 6 , 8 )
9. Does the nature of the business influence whether misappropriation of bank funds is a deductible business loss?
Yes. In banking or money-lending, continuous operation of bank accounts is incidental to the conduct of business; therefore, misappropriation of funds withdrawn from such accounts is a business loss. (Para 11 )
T.L.VENKATARAMA AIYAR, J.
T(1) THIS is an appeal against the judgment of the High court of Nagpur in a reference under s. 66(1) of the Indian Income-tax Act, 1922, hereinafter referred to as the Act.
(2) THE appellant is the sole proprietor of a firm called Bansilal Abirchand Kasturchand, which carries on business as money-lenders, dealers in shares and bullion and commission agents in Bombay, Calcutta and other places. He is a resident of Bikaner, and manages the business at the several places through agents. During the relevant period, the agent of the firm at Bombay was one Chandratan, who held a power-of-attorney dated 13/05/1944, conferring on him large powers of management including authority to operate on bank accounts. During the period, 15/11/1944, to No 23/11/1944, the agent withdrew from the firms bank account sums aggregating to Rs. 2,30,636.40, and applied them in satisfaction of his personal debts incurred in speculative transactions. On 25/11/1944, the cashier of the firm sent a telegram to the appellant informing him of the true state of affairs. Thereupon, the appellant went to Bombay on 3/12/1944, and on the 4th, cancelled the power-of-attorney given to the agent, and by notice dated 6/12/1944, called upon him to pay the amounts withdrawn by him. The agent replied on 8/12/1944, admitting the misappropriation of the amounts and pleading for mercy. On 16/01/1945, the appellant filed a suit against him in the High court of Bombay for recovery of Rs. 2,30,636.40 and that was decreed on 20/02/1945. A sum of Rs. 28,000.00 was recovered from Chandratan and adjusted towards the decree and the balance of Rs. 2,02,442-13-9 was written off at the end of the accounting year as irrecoverable.
(3) BEFORE the Income-tax authorities, the dispute related to the question whether this amount of Rs. 2,02,442-13-9 was an admissible deduction. The tribunal found that the amount in question represented the loss sustained by the appellant owing to misappropriation by his agent, Chandratan, but held on the authority of the decision in Curtis v. J. & G. Oldfield, Limited (1) that it was not a trading loss and therefore could not be allowed. On the application of the appellant, the tribunal referred the following question of law for the decision of the High court, Nagpur: Whether the said sum of Rs. 2,02,442-13-9 being part of the amount embezzled by the assessees Munim is allowable as a deduction under the Indian Incometax Act either under Section 10(1) or under the general principles of determining the profit and loss of the assessee or Section 10(2)(xv) ? ` The learned Judges held that the case was governed by the decision in Curtis v. J. & G. Oldfield, Limited (1), and answered the question against the appellant. An application under s. 66(A)(2) for a certificate was also dismissed and thereafter, the appellant applied for and-obtained leave to appeal to this court under Art. 136, and that is how the appeal comes before us.
(4) THE question whether moneys embezzled by an agent or employee are allowable as deduction in computing the profits of a business under s. 10 of the Act has come up for consideration frequently before the Indian courts, and the decisions have not been quite uniform. Before discussing them, it is necessary that we should examine the principles that are in law applicable to the determination of the question. Three grounds have been put forward in support of the claim for deduction: (1) that the los 3 sustained by reason of embezzlement is a bad debt allowable under s. 10(2)(xi) of the Act; (2) that it is a business expense falling within s. 10(2)(xv) of the Act; and (3) that it is a trading loss, which must be taken into account in computing the profits under s. 10(1) of the Act. As regards the first ground, the authorities have consistently held that the deduction is not admissible under s. 10(2)(xi) of the Act, and that, in our view, is correct. A debt arises out of a contract between the pa
