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A. Muthukumara Pillai v. Commissioner Of Income-Tax, Madras

Madras High Court

Mar 20, 1973

Judgment

Subsequent
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Judgment Summary — Ramaswami, J.

Factual and Procedural Background

The assessee, a dealer in yarn, filed its return for the previous year ending 12 April 1962 (assessment year 1962–63) claiming a deduction of Rs. 16,000 as payments made in settlement of certain purchase contracts.

The factual matrix was as follows (summarised from the opinion):

The assessee entered into seven contracts with Kothari Textiles Ltd. to purchase 180 bales of 40's yarn at Rs. 28.75 per bundle. Shortly afterwards, the assessee entered into contracts to purchase 120 bales of 80's yarn at Rs. 76.75. In at least one illustrative lot (contracts dated 4 April 1962), the assessee took delivery of the 20 bales of 40's but cancelled the contract for 40 bales of 80's and paid Rs. 3,000 to Kothari Textiles Ltd. as the difference between the contract price and the market rate on the date of cancellation. In total the payments to Kothari in respect of the 80's transactions amounted to Rs. 11,500. The yarn under those cancelled contracts was not taken on delivery.
On 16 March 1962 the assessee contracted to purchase 50 bales of 50's from Sri Ramalinga Choodambikai Mills Ltd. The mills agreed to "repurchase" the contract; pursuant to that arrangement the assessee paid Rs. 4,500 on 25 March 1962 and on 29 March 1962 entered into a new contract for 25 bales of 40's at Rs. 28.25. The assessee is stated to have taken delivery of those 25 bales of 40's.
The assessee claimed Rs. 16,000 (Rs. 11,500 + Rs. 4,500) as a business loss in its return.

Procedural history:

The Income-tax Officer treated the Rs. 16,000 as a speculation loss on the ground that the assessee did not take delivery under the cancelled contracts and observed that the assessee had been treated as a speculator in earlier assessments. He disallowed the deduction and classified the loss as a speculative loss.
The assessee's appeals were unsuccessful before the Appellate Assistant Commissioner and the Tribunal. The Tribunal found no proof that entering the contracts was necessary for carrying on the trade, held the contracts were not shown to be "linked", and concluded that, because no delivery was given and the contracts were settled by payment, the transactions were speculative within the meaning of section 43(5) of the Income-tax Act, 1961. The Tribunal referred the following question for the court's decision:

“Whether, on the facts and in the circumstances of the case, the sum of Rs. 16,000 paid by the assessee-firm to Kothari Mills and Ramalinga Choodambikai Mills Ltd. is an admissible expense or did it constitute loss in speculation?”

Legal Issues Presented

Whether the sum of Rs. 16,000 paid in settlement of the contracts was an admissible business expense (deductible) or whether it constituted a loss in speculation within the meaning of section 43(5) of the Income-tax Act, 1961.

Arguments of the Parties

Assessee's Arguments

The assessee contended that the contracts for different varieties of yarn (40's and the other counts) formed a series of linked or combined contracts. The linked arrangement, it was argued, arose because of an unofficial ceiling on the price of 40's cotton yarn fixed by the Indian Cotton Mills Federation, and therefore the assessee had to enter into combined contracts to secure its requirements of 40's yarn.
The assessee submitted that, because these were linked transactions entered into as part of the ordinary carrying on of its business, the resulting loss was inevitable and incidental to the business and thus deductible under accepted commercial practice and trading principles.
Counsel for the assessee relied on the decision in Badridas Daga v. Commissioner Of Income Tax (1958) 34 I.T.R. 10 S.C., to support the proposition that losses which spring directly from carrying on the business and are incidental to it should be allowed, absent any statutory prohibition.

Revenue's Arguments

The Income-tax Officer and the Tribunal treated the payments as losses in speculation because the cancelled contracts were settled other than by actual delivery of the goods, invoking section 43(5) of the Income-tax Act, 1961.
It was also pointed out that the assessee had been assessed as a speculator in earlier years, indicating the nature of its dealings.
The Revenue disputed that the contracts were linked or that entering into the other contracts was a condition precedent imposed by suppliers for supply of 40's yarn.

Table of Precedents Cited

Precedent	Rule or Principle Cited For	Application by the Court
Badridas Daga v. Commissioner Of Income Tax [1958] 34 I.T.R. 10 S.C.	Principle that deductions not specifically provided by the Act may be allowed if they arise out of the carrying on of business and are incidental to it, in accordance with accepted commercial practice and trading principles; provided there is no statutory prohibition.	The court acknowledged the principle relied upon but held it inapplicable here because section 73 of the Income-tax Act expressly prohibits setting off losses of a speculation business except against profits and gains of another speculation business; therefore the statutory prohibition prevents the deduction.
T.C. No. 130/671 (decision mentioned by the court)	The court had previously held in similar circumstances that such transactions would amount to a speculation business.	The present court relied on that prior holding to treat these transactions as speculative in nature and therefore subject to the regime of section 73 regarding speculative business losses.

Court's Reasoning and Analysis

The court's reasoning proceeded in the following steps, based exclusively on the material in the opinion:

Statutory definition and simple test (section 43(5)): The court identified section 43(5) of the Income-tax Act, 1961, which defines a "speculative transaction" as one in which a contract for purchase or sale of any commodity is periodically or ultimately settled otherwise than by actual delivery or transfer of the commodity. The court characterised this as a simple, objective test: if the settlement of the contract resulted in no actual delivery, the contract falls within the definition of a speculative transaction for income-tax purposes.
Intention at contract formation irrelevant for income-tax (reference to section 30 of the Contract Act): The court explained that, for income-tax classification under section 43(5), it is immaterial whether the parties intended at the time of the original contract not to give or take delivery. The contractual intention test in section 30 of the Contract Act is dispensed with for income-tax purposes: the decisive fact is whether delivery occurred under the settlement.
Application to facts — no delivery on settlement: Because the contracts in question were settled by payments and actual delivery of the goods was not effected in respect of the cancelled contracts, section 43(5) was engaged and the transactions therefore fell within the statute's definition of speculative transactions.
Assessee's linking contention examined and rejected as fact: The court reviewed the assessee's contention that the contracts were "linked" or combination sales (entered into to obtain 40's yarn due to the price ceiling). The Tribunal had found no evidence that suppliers insisted on such linking or that linking was necessary. The court accepted that this was a finding of fact and upheld it: there was no material to establish that the contracts were linked or that entering into the other contracts was a condition precedent to obtaining 40's yarn.
Statutory scope decisive, not commercial necessity: The court emphasised that the necessity for entering into such contracts or the commercial reasons for settling by payment are immaterial to the statutory test. If the settlement of the contract is otherwise than by actual delivery, section 43(5) applies regardless of commercial rationale.
Speculation business and statutory prohibition on set-off (section 73): The court observed (and cited its own prior decision, T.C. No. 130/671) that such transactions in similar circumstances amount to a speculation business. Section 73 of the Act provides that losses from speculation business shall not be set off except against profits and gains of another speculation business. Thus even if a loss arises from carrying on a type of dealing that might be connected to business activity, the statute contains an express prohibition on setting off such losses against ordinary profits.
Application of Badridas Daga principle and its limitation: The court acknowledged the established principle from Badridas Daga that a deduction not specifically provided for in the Act may be allowed if it arises from and is incidental to carrying on the business, unless there is an express or implied statutory prohibition. The court held that section 73 constitutes such an express prohibition in relation to speculation losses; therefore the Badridas Daga principle could not assist the assessee in this case.
Conclusion on classification: In light of the foregoing statutory analysis and factual findings, the court concluded that the Rs. 16,000 constituted a loss in speculation and was not an allowable deduction as an expense of carrying on trade under the Income-tax Act.

Holding and Implications

Holding:

The sum of Rs. 16,000 paid by the assessee to Kothari Textiles Ltd. and Sri Ramalinga Choodambikai Mills Ltd. constitutes a loss in speculation and is not an admissible business deduction.

Answer to the question referred: in favour of the respondent and against the assessee.

Implications and direct effects:

The claimed deduction of Rs. 16,000 is disallowed and must be treated as a speculative loss under section 43(5) of the Income-tax Act, 1961.
Under section 73 of the Act, such a speculation loss can be set off only against profits and gains of another speculation business; it cannot be set off against ordinary income.
The court awarded costs to the respondent; counsel's fee was fixed at Rs. 250.

The opinion does not purport to create a novel principle beyond applying the statutory definitions and the established authority cited; its effect is to apply section 43(5) and section 73 to the facts, with no broader precedent announced beyond the reasoning set out.

Show all summary ...

Ramaswami, J.:— The assessee was a dealer in yarn. In the return of income of its business for the previous year ending April 12, 1962, corresponding to the assessment year 1962–63, it claimed a deduction of Rs. 16,000 as payments made in settlement of certain contracts entered into by it. The assessee had entered into seven contracts with Kothari Textiles Ltd. for the purchase of 180 bales of 40's yarn at Rs. 28.75 per bundle. A few days later and in one or two cases on the same day, after the contracts had been entered into, the assessee also entered into contracts for the purchase of 120 bales of 80's at Rs. 76.75 During the previous year the Indian Cotton Mills Federation, Bombay, had fixed a sort of an unofficial ceiling of price of cotton yarn up to 40's. The purchase price of Rs. 28.75 fixed under the contract above referred to was in accordance with the schedule of rates fixed by the Indian Cotton Federation. The nature of the transaction could be better described with reference to one lot as an illustrative case. On April 4, 1962, the assessee-firm entered into a contract for the purchase of 20 bales of 40's at Rs. 28.75 and on the same day it also entered into another contract with the same company for purchase of 40 bales of 80's at Rs. 76.75 The assessee took delivery of the 20 bales of 40's but the contract for purchase of 40 bales of 80's was cancelled and a sum of Rs. 3,000 was paid to Kothari Textiles Ltd., representing the difference of price between the agreed contract rate of Rs. 76.75 and the market rate on the date of cancellation. The yarn was not taken delivery of by the assessee under the contracts. The total payment to Kothari Textiles Ltd. in respect of all the transactions for 80's was Rs. 11,500. The assessee had also entered into a contract on March 16, 1962, for purchase of 50 bales of 50's at Rs. 42.50 with Shri Ramalinga Choodambikai Mills Ltd. This mills agreed to repurchase the contract and its letter dated March 16, 1962, reads as follows:

“As desired by Sri V.V Balakrishnan of Madurai we send you enclosed the repurchasing contract in duplicate for 50 bales of 50's yarn together with the repurchase letter of which kindly send us one copy duly signed in token of confirmation. Please also send us the difference amount of Rs. 4,500 and the despatch instructions for 25 bales of 40's cotton yarn. On receipt of the above, we shall send our contract for 25 bales of 40's cotton yarn.”

2. As per this arrangement of repurchase the contract dated March 16, 1962, was settled and without effecting any delivery a sum of Rs. 4,500 was paid by the assessee to Sri Ramalinga Choodambikai Mills on March 25, 1962. On March 29, 1962, the assessee entered into a contract for the purchase of 25 bales of 40's at Rs. 28.25 per bundle.

3. It is stated that the assessee had taken delivery of 25 bales of 40's. The assessee claimed the total sum of Rs. 16,000 (Rs. 11,500+ Rs. 4,500) as a business loss.

4. The Income-tax Officer treated the payment of Rs. 16,000 as loss in speculation on the ground that the assessee-firm had not taken delivery of the yarn covered by these contracts. He also pointed out that the assessee was a speculator as was clear from the assessment of the prior years. Accordingly, he disallowed the claim and held the loss as a speculation loss that could be carried over and set off against speculative profits of the subsequent years. The assessee was unsuccessful before the Appellate Assistant Commissioner and the Tribunal. The Tribunal held that it had not been proved that it was necessary for the assessee to enter into such contracts for the purpose of carrying on the trade and that the contract for 40's and the contracts for other counts could not be treated as “linked” contracts. The Tribunal also held that since no delivery of the yarn was given and the contracts were settled by payment of the amount, the contracts were speculative transactions within the meaning of section 43(5) of the Income-tax Act, 1961 (hereinafter called “the Act”). At the instance of the assessee the following question has been referred by the Tribunal:

5. Section 43(5) of the Act defines a “speculative transaction” as meaning a transaction in which a contract for the purchase or sale of any commodity including stocks and shares is periodically or ultimately settled otherwise than by the actual delivery or transfer of the commodity or the scrips. It is seen from this definition that the section gives a simple test in deciding for the purpose of income-tax what a speculative transaction means. If a contract for sale or purchase is ultimately settled and no actual delivery of the goods was effected under the settlement then it is a speculative transaction. The requirement under section 30 of the Contract Act of the existence of the intention of the parties even at the time of original contract not to give or take delivery of the goods to make it a speculative or wagering transaction is dispensed with for the purpose of income-tax. If the actual delivery of the goods is not given under the settlement of the contract, then the intention of the parties at the time of the contract is immaterial. Since the delivery of goods was not effected in the settlement of the contracts which resulted in payment of Rs. 16,000 the transactions clearly come within the definition and, therefore, they are speculative transactions.

6. But it was contended by the learned counsel for the assessee that the assessee-firm had entered into contracts for the purchase of more than one variety of yarn, that the entire series of transactions should be taken as linked contracts or combination sales and that on account of the ceiling in regard to 40's cotton yarn the assessee had to enter into this sort of linked or combined contracts to enable it to purchase its requirements of 40's. In the circumstances, therefore, it was submitted that the loss was inevitable and incidental to the carrying on of the business of the assessee.

7. The Tribunal held that there was absolutely no evidence to show that the supplier insisted as a condition precedent to the supply of 40's yarn that the assessee should enter into a contract in respect of the other counts. The price fixed in regard to the counts up to 40's appeared to be of voluntary nature and was enforced from January, 1961. The transactions now under consideration started only in September, 1961, up to November, 1961 and January to March, 1962,. The assessee's purchase of 40's is to the tune of Rs. 14,00,435 and is much more than those represented by the speculative contracts. A linking of the two contracts is not based on any material. There was no material to show such a linking. It cannot, therefore, be said that it was necessary to enter into such contracts for the purpose of carrying on the trade. The Tribunal was also of the view that the letter dated March 16, 1962, of Ramalinga Choodambikai Mills did not also evidence such a linking in the sense that the supply of 40's was a condition precedent to the assessee agreeing for purchase of 50's by the mills. This is a finding of fact and cannot be challenged in this reference.

8. We are also of the view that the necessity for entering into such contracts or the reason for settling the same by payment of difference in prices is immaterial. If the settlement of the contract was otherwise than by actual delivery of the goods then section 43(5) of the Act is attracted. The section is not qualified in any manner except as regards delivery of the goods in pursuance of the settlement.

9. It was not the case of the assessee that even if the transactions are construed as speculative they are not in the nature of speculation business. We have held in similar circumstances in T.C No. 130/671 that it would amount to a speculation business. Section 73 of the Act says that the losses in speculation business shall not be set off except against profits and gains of another speculation business. The learned counsel for the assessee relied on Badridas Daga v. Commissioner Of Income Tax [1958] 34 I.T.R 10 S.C. and contended that the loss is one that springs directly from carrying on the business or at least it is incidental to it and therefore, having regard to the accepted commercial practice and trading principles, it will have to be set off against the other income. It is well-settled that when a claim is made for a deduction for which there is no specific provision in the Act, whether it is admissible or not will depend on whether having regard to the accepted commercial practice and trading principles it can be said to arise out of the carrying on of the business and to be incidental to it. But, as the Supreme Court itself had pointed out, “if that is established then the deduction must be allowed provided of course there is no prohibition against it express or implied in the Act”. Section 73, as already pointed out, prohibits the setting off of any loss incurred in speculation business except against profits and gains, if any, of another speculation business. Clearly, therefore, the loss of Rs. 16,000 is not an allowable deduction.

10. We are also unable to accept the contention of the assessee that the sum of Rs. 16,000 paid by the assessee to the said mills was an expenditure incurred for the purpose of carrying on the assessee's trade. In view of our finding that these transactions were speculative transactions and the sum of Rs. 16,000 was a speculation loss, this point does not even arise for consideration. We, therefore, hold that the sum of Rs. 16,000 constitutes a loss in speculation. We answer the question accordingly and against the assessee. The respondent will be entitled to his costs. Counsel's fee Rs. 250.