Citation Codes

Equivalent Citations

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Case Number

Referred Case No. 7 of 1982

Advocates

For the Appellant: M.S.N. Murthy, Y. Rathnakar, Advocates.

Judges

B.P Jeevan Reddy
Upendralal Waghray, JJ.

Acts

provisions of section 40A(3) of the Income-tax Act Rs. 39,246
provisions of the Income-tax Act. Once the Act
rule 6DD(j) of the Income-tax Rules, 1962,
sub-section (3) of section 40A, rule 6DD
section 256(1) of the Income-tax Act,
rule 6DD of the Income-tax Rules.

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Smart Summary

Court Opinion Summary — Reference under section 256(1) of the Income-tax Act, 1961

Factual and Procedural Background

This matter arises from a reference made by the Income-tax Appellate Tribunal under section 256(1) of the Income-tax Act, 1961. On October 26, 1973, customs and central excise authorities searched the assessee's business premises and found contraband items including foreign cloth, foreign-made cigarettes and cloves. The assessee (carrying on a business in soaps and related goods) filed returns for assessment years 1969-70 to 1974-75; for the assessment year 1974-75 he disclosed an income of Rs. 255.

The Income-tax Officer (ITO) made additions to income, including Rs. 39,246 by invoking section 40A(3) on the ground that certain payments in excess of Rs. 2,500 were made otherwise than by crossed bank cheques/drafts to parties found to be bogus. The Appellate Assistant Commissioner (AAC) allowed the payment as a deductible business expense, reasoning that because the assessee's business involved smuggled goods it was impracticable to comply with section 40A(3) and that cash payment was dictated by business expediency.

The Revenue appealed to the Income-tax Appellate Tribunal, which reversed the AAC and upheld the ITO's disallowance holding that section 40A(3) applies to illegal businesses and that rule 6DD could not rescue the assessee. The Tribunal referred the question to this Court under section 256(1).

Legal Issues Presented

Whether, on the facts and in the circumstances of the case, the payment of Rs. 39,246 by the assessee in cash to the persons from whom he purchased smuggled goods can be said to be a payment made out of business expediency within the meaning of the second proviso to section 40A(3) and is covered by rule 6DD(j) of the Income-tax Rules, 1962, and is therefore deductible in computing the total income for the assessment year 1974-75.

Arguments of the Parties

Assessee's Arguments (as advanced by Mr. Y. Ratnakar)

Where the business itself is illegal (as in the present case of smuggling), it is not practicable to comply with the requirements of section 40A(3); it would be unreasonable to expect compliance in such a business.
If the assessee can establish the cost of acquisition of the goods (here Rs. 39,246), it is not possible in practice to also establish the genuineness of payment and the identity of the payee; demanding such proof is to ask the impossible.
Because certain goods (notably the 467 cartons of cigarettes) were confiscated by customs, the assessee has already suffered the loss of the goods; adding back the asserted cash payment to income amounts to a double penalty.

Revenue / Tax Authorities' Position

The Income-tax Officer disallowed the deduction under section 40A(3) because enquiries revealed that the sellers claiming to have supplied the goods were bogus and the payments were made otherwise than by crossed cheques/drafts exceeding Rs. 2,500.
The Appellate Assistant Commissioner had taken the view that business expediency in an illegal trade may justify non-compliance, but the Tribunal rejected this and held that section 40A(3) applies to illegal businesses and that rule 6DD does not permit the claimed deduction in this case.

Table of Precedents Cited

Precedent	Rule or Principle Cited For	Application by the Court
CIT v. Maddi Venkataratnam & Co. Pvt. Ltd., [1983] 144 ITR 373	Establishes that profits and gains derived from an illegal business can be taxed under the Income-tax Act; reasons for taxing illegal business profits are set out in that decision.	The Court relied on this authority to confirm that taxation applies to illegal business income and that the Income-tax Act must be applied consistently to such income; it undercuts the assessee's contention that provisions like section 40A(3) do not apply to illegal businesses.

Court's Reasoning and Analysis

The Court began by setting out the statutory framework: section 40A(3) disallows deductions for expenditures paid in sums exceeding Rs. 2,500 otherwise than by a crossed bank cheque or crossed bank draft, subject to exceptions provided by the second proviso read with rules made thereunder. Rule 6DD (specifically clause (j)) prescribes the cases and circumstances in which such payments may be allowed notwithstanding non-compliance with the cheque/draft requirement.

Rule 6DD(j), as recited by the Court, permits allowance where the assessee satisfies the Income-tax Officer that payment could not be made by crossed cheque/draft either (1) due to exceptional or unavoidable circumstances, or (2) because payment by such means was not practicable or would have caused genuine difficulty to the payee, having regard to the nature of the transaction and the necessity for expeditious settlement; additionally, the assessee must furnish evidence to the satisfaction of the Income-tax Officer as to the genuineness of the payment and the identity of the payee.

Applying these provisions, the Court rejected the assessee's submission that illegal businesses are exempt from the obligation to comply with section 40A(3). Relying on the principle (cited from CIT v. Maddi Venkataratnam) that profits from illegal businesses are taxable, the Court reasoned that once the Income-tax Act applies, its provisions must be applied in full; it is not permissible to pick and choose which provisions apply merely because the business is unlawful. The Court emphasized that impracticability of compliance does not negate the statutory requirement; rather, if compliance is to be dispensed with it can only be done under the specific exceptions in rule 6DD.

The Court further explained that invocation of rule 6DD(j) imposes a dual burden on the assessee: he must (a) satisfy the Income-tax Officer as to exceptional/unavoidable circumstances or impracticability and (b) establish the genuineness of the payment and the identity of the payee. The satisfaction to be reached is that of the Income-tax Officer. Partial satisfaction of these conditions is insufficient.

The Court considered Circular No. 220 (CBDT, May 31, 1977) relied upon by the assessee and held that the circular only illustrates circumstances where compliance may be impracticable but does not relieve a claimant from proving genuineness of payment and identity of payee; therefore the circular did not assist the assessee.

On the factual record, the Tribunal was justified in holding that the disallowance under section 40A(3) was valid and that rule 6DD(j) did not apply to permit deduction of the Rs. 39,246.

The Court additionally observed facts relevant to the third contention: Rs. 39,246 comprised three items (costs for cloves from two suppliers and cost of 467 cartons of cigarettes). Only the cigarettes were shown as confiscated. The Court declined to decide the separate legal consequence of confiscation and add-back but noted that the Tribunal, in passing final orders under section 260, might reconsider the assessee's taxable income and examine whether the value of the confiscated cigarettes can be treated as a business loss on the basis of the record then available.

Holding and Implications

Holding: The Court answered the referred question in the negative — in favour of the Revenue and against the assessee. It held that the payment of Rs. 39,246 in cash is not covered by rule 6DD(j) of the Income-tax Rules, 1962, and therefore cannot be deducted in computing the assessee's total income for assessment year 1974-75.

Implications and direct consequences:

The disallowance under section 40A(3) of Rs. 39,246 as made by the Income-tax Officer and sustained by the Tribunal is upheld.
An assessee carrying on an illegal business remains subject to the Income-tax Act and cannot claim exemption from the procedural requirements of section 40A(3) except where the specific conditions of rule 6DD (including clause (j)) are fully satisfied to the Income-tax Officer's satisfaction.
The Court did not accept the contention that confiscation of goods results in an unfair double penalty as a question of consequence rather than the validity of disallowance; it noted that the Tribunal may, on the material on record, consider whether the value of confiscated cigarettes can be treated as a business loss when passing final orders under section 260. The Court itself did not decide that question.
There shall be no order as to costs.

Note: The opinion applies existing statutory provisions and cited authority but does not purport to lay down a novel precedent beyond applying the established principle that illegal business income is taxable and that statutory exceptions (rule 6DD) must be satisfied before they can be invoked.

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S. Venkata Subba Rao v. Commissioner Of Income-Tax.

B.P Jeevan Reddy, J.:— The following question has been referred by the Income-tax Appellate Tribunal under section 256(1) of the Income-tax Act, 1961:

“Whether, on the facts and in the circumstances of the case, the payment of Rs. 39,246 by the assessee in cash to the persons from whom he purchased smuggled goods can be said to be a payment made out of business expediency within the meaning of the second proviso to section 40A(3) and is covered by rule 6DD(j) of the Income-tax Rules, 1962, and is, therefore, deductible in computing the total income for the assessment year 1974-75?”

2. On October 26, 1973, the central excise and customs authorities searched the assessee's business premises and found certain contraband commodities, like foreign cloth, cigarettes of foreign make and cloves. On December 12, 1974, the assessee filed returns of his income for the assessment years 1969-70 to 1974-75. In this case, we are concerned with the assessment year 1974-75. For this year, the assessee disclosed an income of Rs. 255 only. The assessee was carrying on business in soaps, etc. The Income-tax Officer made certain additions to the income returned. One of such additions is “towards payments disallowed by invoking the provisions of section 40A(3) of the Income-tax Act— Rs. 39,246…” The Income-tax Officer disallowed the said claim on the ground that the enquiries made by the Collector of Customs revealed that the parties from whom the assessee claimed to have purchased the said goods are all bogus. He held that the said expenditure is hit by the provisions of section 40A(3). On appeal, the Appellate Assistant Commissioner held that, inasmuch as the assessee was engaged in the business of purchasing and selling smuggled goods, which is inherently an illegal business, he cannot be expected to observe or comply with the requirements of section 40A(3). On the said basis, he held that the payment of purchase consideration in cash by the assessee for the said contraband goods was dictated by business expediency, as the sellers, in order to conceal their identity, insisted upon cash payment only. He held that the Income-tax Officer was not justified in disallowing the said deduction claimed with reference to section 40A(3) of the Act. The Revenue carried the matter in appeal to the Tribunal. The Tribunal opined that section 40A(3) has been introduced in the statute only with a view to regulate business activities and to prevent unaccounted money being used for clandestine transactions, that the measure was conceived in the interest of the revenue and national economy, and that, therefore, the Appellate Assistant Commissioner was in error in holding that section 40A(3) has no application to such illegal business. The Tribunal also held that rule 6DD cannot come to the rescue of the assessee herein. Accordingly, it reversed the order of the Appellate Assistant Commissioner and upheld the Income-tax Officer's order disallowing the said claim for deduction. Thereupon, the assessee asked for and obtained this reference.

3. Section 40A(3), in so far as it is relevant, reads as follows:

“40A. (3) Where the assessee incurs any expenditure in respect of which payment is made, after such date (not being later than the 31st day of March, 1969) as may be specified in this behalf by the Central Government by notification in the Official Gazette, in a sum exceeding two thousand five hundred rupees otherwise than by a crossed cheque drawn on a bank or by a crossed bank draft, such expenditure shall not be allowed as a deduction:…

Provided further that no disallowance under this sub-section shall be made where any payment in a sum exceeding two thousand five hundred rupees is made otherwise than by a crossed cheque drawn on a bank or by a crossed bank draft, in such cases and under such circum stances as may be prescribed, having regard to the nature and extent of banking facilities available, considerations of business expediency and other relevant factors……”

4. As contemplated by the second proviso to sub-section (3) of section 40A, rule 6DD has been made. In so far as it is relevant, rule 6DD reads as follows:

“6DD. Cases and circumstances in which payment in a sum exceeding two thousand five hundred rupees may be made otherwise than by a crossed cheque drawn on a bank or by a crossed bank draft.— No disallowance under sub-section (3) of section 40A shall be made where any payment in a sum exceeding two thousand five hundred rupees is made otherwise than by a crossed cheque drawn on a bank or by a crossed bank draft in the cases and circumstances specified hereunder, namely:— …

(j) in any other case, where the assessee satisfies the Income-tax Officer that the payment could not be made by a crossed cheque drawn on a bank or by a crossed bank draft—

(1) due to exceptional or unavoidable circumstances, or

(2) because payment in the manner aforesaid was not practicable, or would have caused genuine difficulty to the payee, having regard to the nature of the transaction and the necessity for expeditious settlement thereof,

and also furnishes evidence to the satisfaction of the Income-tax Officer as to the genuineness of the payment and the identity of the payee.”

5. A reading of sub-section (3) of section 40A of the Act and rule 6DD shows that the Income-tax Officer is not entitled to allow as deduction any expenditure said to have been incurred by the assessee, in respect of which payment is made in a sum exceeding Rs. 2,500 otherwise than by a crossed cheque drawn on a bank, or by a crossed bank draft, except in the cases mentioned in rule 6DD. Clause (j) of rule 6DD provides that a payment made otherwise than by a crossed cheque drawn on a bank, or by a crossed bank draft, can be allowed in certain situations specified therein, viz., (i) payment being made in cash due to exceptional or unavoidable circumstances, (ii) payment by cheque or draft is not practicable in the circumstances, or would have caused genuine difficulty to the payee, having regard to the nature of the transaction and the necessity for expeditious settlement of the transaction. In either case, however, it is necessary to establish the genuineness of the payment and the identity of the payee.

6. Mr. Y. Ratnakar, learned counsel for the assessee, urged the following contentions:

(i) where the very business carried on by the assessee is an illegal business, like the one concerned herein, it is not possible to comply with the requirements of section 40A(3); it would not be reasonable to expect the assessee to comply with the said provision in the case of such a business;

(ii) so long as the assessee is able to establish the cost of acquisition of the goods in question, he cannot, in the very nature of things, be called upon to establish either the genuineness of the payment or the identity of the payee. Calling upon him to do so is to ask for the impossible in the circumstances. In this case, the Income-tax Officer has not disputed the assessee's claim that the cost of acquisition is Rs. 39,246. That by itself should be sufficient to allow the deduction having regard to the nature of the transaction, nay, the very nature of business; and

(iii) that the contraband goods have actually been confiscated by the customs authorities. The result is that the assessee has lost the goods altogether and now the said sum of Rs. 39,246 is being added back to his income. It amounts to a double penalty upon the assessee.

7. There is no doubt about the proposition that profits and gains derived from an illegal business can also be taxed. The reasons for doing so are discussed and set out in some detail in the decision of this court in CIT v. Maddi Venkataratnam and Co. Pvt. Ltd., [1983] 144 ITR 373, to which one of us (Jeevan Reddy J.) was a party. Indeed, it is not disputed by the assessee herein that the profits and gains derived by him from the illegal business carried on by him are liable to be taxed. If so, the income can be taxed only under, and in accordance with, the provisions of the Income-tax Act. Once the Act applies and the taxable income has to be determined in accordance with the provisions thereof, it is not possible to hold that some of the provisions of the Act do not apply to the assessment of taxable income in the case of an illegal business, while some others do. In other words, we do not find it possible to draw a distinction between the several provisions of the Act, one set applying to the assessment of income arising from illegal business and the other set of provisions not applying thereto. May be that in an illegal business, like smuggling, it may not be practicable to comply with the requirements of sub-section (3) of section 40A, but that only means that such illegal business ought not to be carried on. It is a business prohibited by law. By taxing its income, it is not legalised or validated. We are, therefore, unable to agree with Mr. Ratnakar that sub-section (3) of section 40A cannot apply to a business carried on illegally.

8. We are also of the opinion that the only circumstances in which compliance with the requirements contained in section 40A(3) can be dispensed with are those stated in rule 6DD of the Income-tax Rules. Unless a payment falls within one or the other clauses of rule 6DD, he has necessarily to comply with the requirements of section 40A(3). Further, if an assessee says that he is entitled to take advantage of a particular clause in rule 6DD, he must satisfy the requirements of that clause, which means that, in this case, the assessee who is seeking to claim the benefit of clause (j) in rule 6DD, has not only to satisfy that having regard to the nature of the business there was a genuine difficulty in complying with the requirements of section 40A(3), but he must also establish the genuineness of the payment and the identity of the payee. Unless he does that, he cannot take advantage of clause (j). It is not open to the assessee to say that he will only partly satisfy the requirements of clause (j) and would still be entitled to the benefit of the said clause. We may make it clear that the satisfaction that is relevant in such cases is the satisfaction of the Income-tax Officer.

9. Mr. Y. Ratnakar relied upon a circular issued by the Central Board of Direct Taxes, being Circular No. 220, dated May 31, 1977 ([1977] 108 ITR (St.) 8). We have perused the said circular. It only elaborates and illustrates—though not exhaustively—the circumstances in which it is not practicable to comply with the requirements of section 40A(3). The circular nowhere says that it is not necessary for a person claiming the benefit of rule 6DD(j) to establish the genuineness of the payment and the identity of the payee. On the contrary, the said requirement is repeatedly reiterated. We are, therefore, of the opinion that the said circular cannot in any manner advance the case of the assessee.

10. The result of the above discussion is that the Tribunal was justified in holding that the disallowance of the said claim for deduction by the Income-tax Officer with reference to section 40A(3), is perfectly in order.

11. Accordingly, we answer the question referred to us in the negative, i.e, in favour of the Revenue and against the assessee. We hold that the payment of Rs. 39,246 by the assessee to persons from whom he is said to have purchased the smuggled goods, is not covered by rule 6DD(j) of the Income-tax Rules, 1962, and cannot, therefore, be deducted in computing his total income for the assessment year 1974-75. With respect to the third contention of Mr. Y. Ratnakar, it is necessary to state a few facts: The sum of Rs. 39,246 consists of three items, viz., Rs. 4,498 said to be the cost of 50 kgs. of cloves purchased from Kamala Traders, Madurai; Rs. 16,068 said to be the cost of purchasing 200 kgs. of cloves from South Travancore Plantation Ltd., Nagarcoil, and Rs. 18,680 being the price of 467 cartons of cigarettes purchased from M/'s. Gulam Abbabhai, Bombay. The record placed before us shows that only 467 cartons of cigarettes have been confiscated, but not the cloves. (Besides cigarettes, a small quantity of textiles also have been confiscated, but no deduction was claimed on that account and, therefore, that aspect does not concern us herein). Now, the contention of Mr. Ratnakar is that by virtue of the confiscation of the cigarettes, the assessee has suffered the loss of their total value, and added to that, the sum of Rs. 18,680 is being added back as the income of the assessee. He says, merely because a deduction claimed is disallowed, it cannot be added back to the income of the assessee. It is not possible to agree with this contention. Indeed, we need not answer this contention. In this case, we are only concerned with the justifiability or otherwise of the disallowance of the deduction claimed by the assessee, in law, and we have upheld the same. What consequence follows in a given case is a matter of law which does not concern us in this reference. However, since the record placed before us shows that 467 cartons of cigarettes were confiscated and, at the same time, the cost price thereof, i.e Rs. 18,680, appears to have been added back to the income of the assessee, it may be a proper case where the Tribunal, while passing final orders under section 260 of the Act, may redetermine the assessee's taxable income, after considering the question whether the value of the cigarettes confiscated can be treated as a business loss. It is, however, evident that the said exercise shall be done by the Tribunal on the basis of the material already on record.

12. There shall be no order as to costs.

S. Venkata Subba Rao v. Commissioner Of Income-Tax.

Court Opinion Summary — Reference under section 256(1) of the Income-tax Act, 1961

Factual and Procedural Background

Legal Issues Presented

Arguments of the Parties

Assessee's Arguments (as advanced by Mr. Y. Ratnakar)

Revenue / Tax Authorities' Position

Table of Precedents Cited

Court's Reasoning and Analysis

Holding and Implications

S. Venkata Subba Rao v. Commissioner Of Income-Tax.

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