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Summary of Legal Opinion: Desai, J. (Reference from Income-tax Appellate Tribunal, Bombay Bench “B”)

Factual and Procedural Background

This reference was made by the Income-tax Appellate Tribunal, Bombay Bench "B", by its order dated 19th February, 1965. The question re-framed for the Court was: “Whether, on the facts and circumstances of the case, the Tribunal was right in sustaining the addition of Rs. 4,646 in arriving at the assessee's total income?”

The assessee was a company carrying on insurance business other than life insurance. For the calendar year 1955 (the previous year relevant to assessment year 1956-57) the assessee claimed a deduction of Rs. 21,045 as a loss arising from the devaluation of the Pakistani rupee. The claimed loss arose because balances due to the head office at Bombay from the Karachi branch underwent depreciation following Pakistan's devaluation of its currency on 1st August, 1955 (prior to which 100 Pakistan rupees equalled 144 Indian rupees; after devaluation parity was established).

Certain Pakistan assets and liabilities on the balance-sheet as at 31st July, 1955 were re-valued and three items were written off to the fire revenue account as losses. The reference concerns the third item — advance tax recorded in Indian books — which showed in Pakistan currency 10,558 and Indian currency 15,203, giving a difference claimed as loss (approximately Rs. 4,646).

The Income-tax Officer disallowed the aggregate claim (treating the balance as capital in nature and not an investment for depreciation under rule 6), and the Appellate Assistant Commissioner dismissed the assessee's appeal (finding the item not allowable expenditure under section 10 of the Indian Income-tax Act, 1922). The assessee appealed to the Tribunal. The Tribunal accepted the assessee's contention on two of the three items but sustained the departmental contention that the third item (Rs. 4,646) was an "imaginary loss" and could not be allowed; thus it disallowed that third item and allowed Rs. 16,399 of the aggregate claimed loss. The Tribunal's order dated 25th April, 1960 is the subject of this reference.

Legal Issues Presented

  1. Whether, on the facts and circumstances of the case, the Tribunal was right in sustaining the addition of Rs. 4,646 in arriving at the assessee's total income?

Arguments of the Parties

Assessee's Arguments (Mr. Dastur)

  • The assessee relied on section 10(7) of the Indian Income-tax Act, 1922, read with rule 6 of the Schedule, and argued that the balance of profits disclosed by the annual accounts filed with the Controller (Controller of Insurance) is binding on the Income-tax authorities.
  • Because the item was shown as a loss (a debit) in the profit and loss account filed before the Controller of Insurance, the Income-tax Officer had no power to make any adjustment or to add it back in assessment even if the Department regarded it as an "imaginary loss".
  • The assessee relied on authorities (three Supreme Court decisions and relevant High Court decisions) that interpreted sub-section (7) of section 10 and the Schedule rules to support the proposition that the tax authorities cannot go behind the balance disclosed in the accounts filed under the Insurance Act.

Revenue's Arguments (Mr. Joshi)

  • The revenue contended that the sum could be disallowed and added back only if it were an "expenditure" properly so-called.
  • Reliance was placed on Indian Molasses Co. (P) Ltd. v. Commissioner of Income-tax [1959] 37 ITR 66 (SC) for the proposition that "expenditure" equals "expense", and that an expense is money laid out by calculation and intention; on that basis a notional loss from currency devaluation (with no disbursement) cannot be treated as "expenditure".
  • It was also urged (as a factual objection) that there was no finding that the amount had been shown as a debit (loss) in the profit and loss account; however, the Tribunal's own order (para. 2) recorded this as common ground.

Table of Precedents Cited

Precedent Rule or Principle Cited For Application by the Court
Life Insurance Corporation of India v. Commissioner of Income-tax, [1964] 51 ITR 773 (SC) The assessment of the profits of an insurance business is governed completely by the rules in the Schedule to the Income-tax Act; the Income-tax Officer has no power to do anything not contained in those rules; there is no general right to correct errors in the accounts of an insurance business. The Court referenced these observations to support the proposition that the Income-tax Officer could not go beyond the Schedule rules to adjust items shown in the accounts filed under the Insurance Act.
Pandyan Insurance Co. Ltd. v. Commissioner of Income-tax, [1965] 55 ITR 716 (SC) Rule 3(b) of the Schedule did not empower the Income-tax Officer to adjust the accounts of an insurer on the basis of a re-valuation made by him or to correct discrepancy between accounts and fact; "expenditure" in rule 6 means "disbursement". The Court relied on the principle that "expenditure" means disbursement and therefore a loss from foreign currency devaluation (without disbursement) could not be treated as an expenditure permitting an add-back.
Commissioner of Income-tax v. Calcutta Hospital and Nursing Home Benefits Association Ltd., [1965] 57 ITR 313 (SC) Rule 6's intent is that the balance of profits disclosed by accounts submitted to and accepted by the Superintendent of Insurance is binding on the Income-tax Officer; the Income-tax Officer may only adjust that balance to exclude any expenditure other than expenditure allowable under section 10. The Court adopted this clarification to hold that the balance shown in the accounts filed under the Insurance Act should be treated as binding and not subject to adjustment unless the Schedule expressly permits it.
New Asiatic Insurance Co. Ltd. v. Commissioner of Income-Tax, [1973] 90 ITR 243 (Delhi) Application of the same principle that accounts filed under the Insurance Act and accepted by the Insurance authority are binding on the Income-tax Officer. The decision was cited as an application of the Supreme Court principle to similar facts and to support the binding effect of the filed accounts.
Commissioner of Income-tax v. New India Assurance Co. Ltd., [1969] 71 ITR 761 (Bom) Considered an exchange difference arising from Pakistan currency devaluation; reiterated that it is not open to tax authorities to go behind the balance disclosed by the annual accounts filed before the Controller of Insurance; distinguished "business loss" from "expenditure". The Court cited this Division Bench decision as directly analogous (same devaluation issue) and as support for not permitting the tax authorities to adjust the balance disclosed in the insurer's accounts.
Allen v. Farquharson Brothers and Co., [1932] 17 TC 59 (KB) Cited in the Bom. High Court decision for the distinction between "expenditure" (voluntarily incurred) and "business loss" (fortuitous or ab extra). The passage was used to emphasise that a fortuitous business loss arising from devaluation differs in character from an expenditure and therefore may not be subject to adjustment as expenditure.
Indian Molasses Co. (Private) Ltd. v. Commissioner of Income-tax, [1959] 37 ITR 66 (SC) Defines "expenditure" as equivalent to "expense", and "expense" as money laid out by calculation and intention. The revenue relied on this definition to argue that the notional loss from currency devaluation was not an "expenditure" because it was not a sum of money laid out with calculation and intention; the Court considered this authority in rejecting the revenue's contention.

Court's Reasoning and Analysis

The Court proceeded by identifying the crucial legal threshold: before the Income-tax Officer can disallow and add back an item, the item must be in the nature of an "expenditure" which the Income-tax Officer is empowered to exclude under the Schedule and section 10. The Court analyzed the relevant statutory provisions — section 10(7) of the Indian Income-tax Act, 1922, and rule 6 of the Schedule — which make the computation of profits of an insurance business subject to the Schedule's rules and treat the balance disclosed by the annual accounts (filed under the Insurance Act) as generally binding on the Income-tax Officer, subject only to specified exclusions.

The Court reviewed the authorities relied upon by the parties. It noted that the Supreme Court in Life Insurance Corporation v. Commissioner of Income-tax held that assessment of an insurance business is governed by the Schedule and that the Income-tax Officer has no general power to correct errors in the insurer's accounts. Pandyan Insurance extended that reasoning and held that the rules do not empower the Income-tax Officer to revalue or correct discrepancies between accounts and fact; it further interpreted "expenditure" in rule 6 as "disbursement." Calcutta Hospital confirmed that the balance of profits as disclosed in the accounts submitted to and accepted by the insurance regulator is binding on the Income-tax Officer and that adjustments are limited to expenditures excepted by section 10.

Applying these authorities, the Court concluded that a notional depreciation in value of a foreign currency balance (resulting from Pakistan's devaluation) does not amount to an "expenditure" in the sense required to justify disallowance and an add-back. The Court also considered the revenue's reliance on Indian Molasses for a narrow definition of "expenditure" as a money payment made with calculation and intention, and found that the notional loss from devaluation cannot be so characterized because there was no disbursement.

The Court rejected the revenue's contention that there was no finding that the amount was shown as a debit in the profit and loss account, because the Tribunal's order expressly recorded that point as common ground. On that basis and having regard to the binding effect of the accounts under rule 6 and the cited authorities, the Court held that the Income-tax Officer had no power to add the sum of Rs. 4,646 to the assessee's total income.

Holding and Implications

Holding: The question is answered in the negative. The Income-tax Officer had no power to add the amount of Rs. 4,646 when arriving at the assessee's total income, and the Tribunal was in error in sustaining that addition.

Direct Effect / Consequences: The addition of Rs. 4,646 made by the Income-tax Officer and sustained by the Tribunal is disallowed; the Commissioner (revenue) was ordered to pay the costs of the assessee. The opinion confines itself to the determination in this case — it applies existing authorities about the binding effect of insurer accounts and the meaning of "expenditure" under the Schedule; the Court did not purport to lay down a broader novel rule beyond its application to these facts.

Source of summary: opinion of Desai, J., with concurrence by Vimadalal, J., as provided in the supplied text.

Show full summary ...

    South India Insurance Company Ltd. v. Commissioner Of Income-Tax, Bombay City-I.

    Desai, J.:— This is a reference made to us by the Income-tax Appellate Tribunal, Bombay Bench “B”, Bombay, by its order dated 19th February, 1965.

    2. As we felt that the question referred by the Tribunal to us as a question of law arising from its order dated 25th April, 1960, did not bring out precisely and accurately the question for our consideration, the same was re-framed by us as follows:

    “Whether, on the facts and circumstances of the case, the Tribunal was right in sustaining the addition of Rs. 4,646 in arriving at the asses-see's total income?”

    3. A few facts may be stated: The assessee-company, which is carrying on the business of insurance other than life insurance, claimed a deduction of Rs. 21,045 as loss arising from the devaluation of the Pakistani rupee during the calendar year 1955, being the previous year for the assessment year 1956-57. The contention of the assessee was that the balance due to the head office of the company at Bombay from their Karachi branch underwent a depreciation by reason of the devaluation of Pakistani rupee, and hence there was a loss to the company. It may be mentioned that until 31st July, 1955, the rate of exchange between Pakistan and India was 100 Pakistan rupees equivalent to 144 Indian rupees. Pakistan, however, devalued its currrency on 1st August, 1955, after which there was parity between the Pakistani rupee and the Indian rupee. After the devaluation certain Pakistan assets and liabilities of the assessee-company on its balance-sheet on 31st July, 1955, were re-valued and three items written off to the fire revenue account of the assessee as loss. It may be mentioned that we are concerned in this reference with the third item only, which is as follows:

    Item Details Pakistan currency Indian currency Difference (loss) 1. … … … … 2 … … … … 3. Advance tax (Indian books) 10,558 15,203 4,645-10-5

    4. It may be mentioned that the balance-sheet is to be found as annexure “A” to the statement of the case.

    5. As stated earlier, the assessee claimed the aggregate loss of Rs. 21,044-13-10 in its account for the calendar year 1955. However, the Income-tax Officer disallowed this claim, holding that the balance was of a capital nature but not investments envisaged in rule 6, so that depreciation could not be allowed.

    6. Being aggrieved by the said order, the assessee-company preferred an appeal to the Appellate Assistant Commissioner, which appeal was also dismissed by him. According to the Appellate Assistant Commissioner, this was not allowable expenditure under section 10 of the Indian Income-tax Act, 1922.

    7. The assessee-company thereupon preferred an appeal to the Income-tax Appellate Tribunal, in which six contentions were taken as are set out in para. 5 of the statement of the case. One of the contentions clearly indicated in ground (e) as set out in para. 5 was that the balance of profits should stand under rule 6 of the rules in the Schedule to the Indian Income-tax Act and the loss could not be added back as it was not an expenditure disallowable under section 10 of the Indian Income-tax Act. In its appellate order the Tribunal came to the conclusion that the loss was one allowable under section 10 and that this position could not be seriously disputed. It further observed that “it is common ground that the profit and loss account filed before the Controller of Insurance shows the loss in question as a debit”. However, whilst upholding the assessee's contention regarding the first two items out of the three items of “loss” the Tribunal accepted the contention of the departmental representative that the assessee had not suffered any loss on the tax paid in advance to the Pakistan authorities, in respect of which a sum of Rs. 4,646 had been claimed as loss resulting from devaluation. The Tribunal was of the view, therefore, that this was an imaginary loss to which the assessee was not entitled. Accordingly, it allowed the assessee to claim as loss a sum of Rs. 16,399 disallowing the third item of Rs. 4,646.

    8. On behalf of the assessee Mr. Dastur has drawn our attention to the provisions of section 10(7) of the Indian Income-tax Act, 1922, read with rule 6 of the rules to be found in the Schedule to the said Act. These may be set out:

    “10. (7) Notwithstanding anything to the contrary contained in section 8, 9, 10, 12 or 18, the profits and gains of any business of insurance and the tax payable thereon shall be computed in accordance with the rules contained in the Schedule to this Act.”

    “Rule 6.— The profits and gains of any business of insurance other than life insurance shall be taken to be the balance of the profits disclosed by the annual accounts, copies of which are required under the Insurance Act, 1938, to be furnished to the Controller of Insurance after adjusting such balance so as to exclude from it any expenditure other than expenditure which may under the provisions of section 10 of this Act be allowed for in computing the profits and gains of a business. Profits and losses on the realisation of investments and depreciation and appreciation of the value of investments shall be dealt with as provided in rule 3 for the business of life insurance.”

    9. It was the contention of the learned counsel for the assessee that inasmuch as this was an item shown as a loss in the profit and loss account filed before the Controller of Insurance by the assessee, the Income-tax Officer or the income-tax authorities were not entitled to make any adjustment in respect thereof even on the footing that it was an imaginary loss and add it back in the assessment of the assessee-company for the relevant assessment year. In connection with this argument he relied upon three judgments of the Supreme Court, one of the Delhi High Court and one of the Bombay High Court in which a similar question had arisen. I will briefly advert to these authorities.

    10. The Supreme Court had occasion to consider sub-section (7) of section 10 of the Indian Income-tax Act, 1922, and the rule under the Schedule in Life Insurance Corporation of India v. Commissioner of Income-tax, [1964] 51 ITR 773 (SC), in which it was observed that the assessment of the profits of an insurance business is completely governed by the rules in the Schedule to the Income-tax Act and the Income-tax Officer has no power to do anything not contained in the rules to be found in the Schedule. It was held that there is no general right to correct the errors in the accounts of an insurance business. The relevant observations in this connection are to be found at page 778 of the report. These observations were applied, the principle reiterated and perhaps carried forward to its logical extension by the Supreme Court in Pandyan Insurance Co. Ltd. v. Commissioner of Income-tax, [1965] 55 ITR 716 (SC), where it was ohserved that rule 3(b) of the Schedule to the Indian Income-tax Act, 1922, did not empower the Income-tax Officer to adjust the accounts of an insurer on the basis of a re-valuation made by him or to correct the discrepancy between what is entered in the accounts and what is fact (underlining* supplied). It may be mentioned that in the judgment in Life Insurance Corporation of India v. Commissioner of Income-tax, [1964] 51 ITR 773 (SC) the assessee was the Life Insurance Corporation, carrying on life insurance business whereas in Pandyan Insurance Co. Ltd. v. Commissioner of Income-tax, [1965] 55 ITR 716 (SC) the assessee was a public limited company carrying on the business of general insurance. I may mention that in Pandyan Insurance Co.'s case, [1965] 55 ITR 716 (SC) the Supreme Court had occasion to observe that the word “expenditure” in rule 6 meant “disbursement”. This would clearly mean and imply that a loss of the nature incurred by the assessee-company before us arising from the devaluation of a foreign currency cannot conceivably be regarded as expenditure since there was no disbursement by the assessee.

    11. The position was clarified, if it at all required clarification, by the Supreme Court by its further decision in Commissioner of Income-tax v. Calcutta Hospital and Nursing Home Benefits Assocation Ltd., [1965] 57 ITR 313 (SC). It was unequivocally held that the intention of rule 6 of the Schedule to the Income-tax Act was that the balance of profits as disclosed by the accounts submitted to the Superintendent of Insurance (the equivalent of the Controller of Insurance) and accepted by him would be binding on the Income-tax Officer. It was further observed that the Income-tax Officer could only adjust this balance so as to exclude from it any expenditure other than expenditure which may under the provisions of section 10 be allowed in computing the profits and gains of a business.

    12. The same principle came to be applied by the Delhi High Court in New Asiatic Insurance Co. Ltd. v. Commissioner Of Income-Tax, [1973] 90 ITR 243 (Delhi).

    13. A Division Bench of the Bombay High Court had occasion to consider these provisions in Commissioner of Income-tax v. New India Assurance Co. Ltd., [1969] 71 ITR 761 (Bom). Question No. 3 considered by the Division Bench in the said case pertained to the sum of Rs. 79,592 being the difference in the exchange rates of Pakistan currency before and after its devaluation on 31st July, 1955, on account of payment under section 18A of the Pakistan Income-tax Act; and the court was called upon to consider whether the said amount was deductible under any of the provisions of the Income-tax Act or the Schedule. In respect of this item also the assessee-insurance company had claimed that it had sustained a business loss because of the devaluation of its currency by Pakistan. After considering the facts and the applicable authorities, the Division Bench observed that this was an ordinary business loss and the assessee was not claiming any allowance or any allowable deduction. It reiterated the position which had been settled by the Supreme Court authorities above referred to that it was not open to the tax authorities to go behind the balance of the profits disclosed by the annual accounts as filed before the Controller of Insurance, and that it was not open to the Income-tax Officer to make any adjustment by way of exclusion of the amount. The said Bench had occasion to consider the distinction between “business loss”and “expenditure” and, after referring to Allen v. Farquharson Brothers and Co., [1932] 17 TC 59 (KB), with approval, Kotval C.J, speaking for the Bench, observes, in [1969] 71 ITR 761, 795 (Bom):

    “This passage emphasized one important point of distinction, namely, that an expenditure is voluntarily incurred while a business loss is fortuitous or ab extra as the learned judge put it.”

    14. The short question which arises for consideration in this reference is whether the item claimed as an item of loss would be within the power of the Income-tax Officer to adjust by way of disallowing and adding back. Before the power of disallowing and adding back can be exercised in respect of this item it must be held to be in the nature of expenditure. In this connection Mr. Joshi on behalf of the revenue referred us to the primary meaning given to the word “expenditure” in Indian Molasses Co. (Private) Ltd. v. Commissioner of Income-tax, [1959] 37 ITR 66 (SC). According to the Supreme Court, “expenditure” is equal to “expense” and “expense” is money laid out by calculation and intention. By no stretch of imagination can the loss claimed by the assessee as having been sustained by it on the devaluation of the Pakistan currency be said to be money laid out by it by calculation and intention.

    15. It was also sought to be urged that there was no finding that this amount was shown as debit by way of a loss in the profit and loss account filed before the Controller of Insurance. In view of the clear observations to be found in para. 2 of the Tribunal's order dated 25th April, 1960, in which it has been stated that this was a common ground, I am unable to accept this submission.

    16. In the result, I am of opinion that the Income-tax Officer had no power to add this amount of Rs. 4,646 in arriving at the assessee's total income and the Tribunal was in error in sustaining the addition.

    Vimadalal, J.:— I agree and have nothing to add.

    By the Court.— The question is answered in the negative. The Commissioner to pay the costs of the assessee.

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    Comments

    South India Insurance Company Ltd. v. Commissioner Of Income-Tax, Bombay City-I.
    (Nov 29, 1974)