The Judgment of the Court was delivered by
Balasubrahmanyan, J.:— Both these tax cases arise on the same appellate order of the Income-tax Appellate Tribunal. Two questions of law arise for our consideration. The question we would like to dispose of first concerns the extent of the power of remand exercisable by the Appellate Tribunal. This question has been formulated in the present case in the following terms:
“Whether, on the facts and in the circumstances of the case, the Appellate Tribunal was right in entertaining fresh grounds of appeal put forth by the assessee and in directing the Appellate Assistant Commissioner to admit the fresh grounds and decide the case on merits notwithstanding the fact that the claim for deduction sought to be raised in the fresh grounds was not a point of dispute either before the Income-tax Officer or before the Appellate Assistant Commissioner at the time of the original appeal proceedings?”
2. The controversy relates to the quantum of deduction claimed by the assessee in respect of interest tin a particular transaction. At the stage of assessment, the assessee claimed an allowance of interest in the sum of Rs. 37,132. The ITO disallowed the entire claim. The assessee appealed. The AAC allowed the appeal in part and restricted the deduction to one-fourth of the amount claimed, namely, Rs. 9,285. On further appeal by the assessee, the Tribunal remanded the matter to the AAC to go into the question once again. On remand, the AAC gave a different decision. This time he disallowed the entire claim for Rs. 37,132 and confirmed the order of assessment. The assessee once again appealed to the Tribunal. The Tribunal was inclined to allow the claim in toto. At this stage, the assessee moved an additional ground of appeal and put forward a claim for deduction not only in the sum of Rs. 37,132 which had so far figured in the discussion, but for Rs. 1,02,605.50 of which Rs. 37,132 formed part. This additional ground was opposed by the Department. The Tribunal, however, entertained this ground and once again remanded the case to the AAC directing him to go into the admissibility of the claim for deduction of Rs. 1,02,605.50. The Department's contention in this reference is that the Tribunal exceeded its jurisdiction in making its order of remand. This conclusion can be easily met by examining the position whether the Tribunal would have power to deal with the claim themselves. The answer, in our opinion, can be in no doubt. The classic example of a case where the courts have upheld the Tribunal's grant of a larger allowance to an assessee than he had himself asked for in the assessment is to be found in the Mahalakshmi Mill's case, [1967] 66 ITR 710 (SC). That was a case where an assessee claimed development rebate at the appropriate percentage on the cost of new installations in the assessee's textile mill of the value of Rs. 93,215. The claim for development rebate was disallowed by the ITO. When the assessee brought this claim in appeal before the Tribunal, the assessee apparently thought of asking for an outright deduction of the entire amount of Rs. 93,215 on the footing that it represented current repairs to machinery and not a mere capital outlay on new installations entitled only to a fractional allowance by way of development rebate. The Tribunal allowed this change of front on the part of the assessee and granted the entire sum of Rs. 93,215 as an admissible deduction in the computation of the assessee's taxable profits. This decision of the Tribunal was questioned by the Department as being in excess of their appellate jurisdiction. The Supreme Court, however, rejected that plea and sustained the Tribunal's decision observing: “There is nothing in the Income-tax Act which restricts the Tribunal to the determination of the questions raised before the departmental authorities.” The Supreme Court added: “All questions whether of law or fact which relate to the assessment of the assessee may be raised before the Tribunal”.
3. The difference between the case before the Supreme Court and the present case is that in the former the Tribunal exercised the power directly to entertain a new claim whereas in this case the Tribunal remanded the matter for a fuller inquiry. When the power exists in the Tribunal to deal with a new or additional claim, as has been held to exist by the Supreme Court, then it must be conceded that what the Tribunal can do directly it can do indirectly as well.
4. An argument was addressed for the Department to the effect that when the Tribunal admitted the additional ground it tended to enlarge the subject-matter of the appeal. In the Mahalakshmi Textile Mills' case, [1967] 66 ITR 710, the Supreme Court found that despite the change of front which the assessee was permitted in that case by the Tribunal, the subject-matter of the appeal was not enlarged. Again, the new ground permitted to the assessee before the Tribunal in that case held out a larger tax relief than the assessee had asked for during the assessment. Yet, the Supreme Court did not think this made for any change in the subject-matter of the appeal. The same principle must apply to the present case as well.
5. A later decision of the Supreme Court in Addl. CIT v. Gurjargravures P. Ltd., [1978] 111 ITR 1, was cited by Mr. Jayaraman, learned standing counsel for the Department, as striking a different note. We do not, however, think so. In that case, exemption under s. 84 of the I.T Act, 1961, was not claimed by the assessee before the ITO. The question before the Supreme Court was whether such a claim could be entertained by the Tribunal in appeal for the first time. The Supreme Court held that the appeal was not entertainable on the new plea. The precise basis of the Supreme Court's decision is to be found in the following observations (p. 5):
“In the present case, neither any claim was made before the Income-tax Officer, nor was there any material on record supporting such a claim.”
6. Clearly enough, as appearing from other observations in that judgment, the Supreme Court was not laying down any opinion on, at least, two other kinds of cases. One is a case where the assessee makes a claim before the assessing authority, but brings no supporting material on record. The other is a case where the material is already there in the assessment record, but the assessee has not made a claim before the assessing authority. Conceivably, these instances cannot be covered by the Supreme Court's decision above cited. It might well be that in both instances, an assessee can very well press a claim before the appellate authority for the first time. It is, however, unnecessary to labour this point further. For, in the face of the claim in this case having been put forward by the assessee even in the assessment stage, although at a lesser sum, the claim cannot be shut out in limine at the appellate stage merely because the appellate authority had to go into a larger question in a matter of quantum on the same subject of claim, or because the claim was sought to be put forward from a different angle. Our answer to the question of law reproduced at the beginning of this judgment is, therefore, in the assessee's favour.
7. The other question of law before us arises out of the Tribunal's decision on the merits of the assessee's claim for deduction. As earlier mentioned, the assessee's original claim for deduction was for Rs. 37,132. This was refused by the ITO, and his order was ultimately confirmed in appeal by the AAC. The Tribunal, however, allowed the claim for deduction. The Tribunal's decision in this regard is now canvassed by the Department on the following question of law:
“Whether, on the facts and in the circumstances of the case, the sum of Rs. 37,132 was not an admissible expenditure for the assessment year 1967-68?”
8. For answering this question, it is necessary to consider the relevant facts. The assessee is a private limited company running a number of buses under route permits issued by the road transport authorities. The assessee agreed to transfer one of the buses belonging to it, along with the route permit, for Rs. 1,30,000 to two joint purchasers. It received an advance of Rs. 1,00,000 from the purchasers. The delivery of the vehicle to the purchasers was to be on receipt of the balance of consideration. Till then and till the transfer of the route permit in the purchasers' name the assessee undertook to run the bus and hand over the daily collections to the purchasers. In point of fact, however, the assessee did not remit the daily collections for more than a week or so. Nor was the assessee ready and willing to deliver the bus on receiving the balance of sale consideration. The purchasers thereupon sued the assessee for damages for breach of contract. The court decreed the suit for Rs. 1,02,605.50. The quantum of damages apparently included an element of interest, reckoned at Rs. 37,132. The assessee debited this amount in its interest account and claimed it as a deduction in the computation of its taxable profits from the bus transport business.
9. The assessee's claim for deduction was put forward in various ways. Before the ITO, in the first instance, the contention was that Rs. 37,132 represented interest deductible under s. 36(1)(iii) of the I.T Act. The AAC, on the contrary, was asked to consider the claim as falling under the residuary head of expenditure in s. 37 of the Act. Before the Tribunal, the assessee did not put forward its plea for deduction under any particular provision in the statute. Instead, reliance was placed on general principles of commercial accounting.
10. We may, without wasting our breath, reject the assessee's initial plea that the sum of Rs. 37,132 qualified for deduction under s. 36(1)(iii). For, under this provision, what is deductible is interest paid by the assessee on capital borrowed by him for purpose of the business, which is not the case here.
11. Nor could the payment be regarded, strictly, as expenditure falling even under the residuary head of s. 37. The payment of Rs. 37,132 under the decree was not an outlay of money on any goods or services or on anything which brought any asset or advantage into the assesee's business. We are, therefore, left to consider the assessee's claim under the only other possibility left, namely, that the payment of damages, in the circumstances, amounted to a loss incurred by the assessee in the course of its business.
12. The I.T Act contains detailed provisions for allowance of business expenditure of various kinds, although they are by no means exhaustive. The Act also makes express provision for set-off and carry forward of business losses, where they form the end result of a year's trading. But Parliament has not enacted any rules for the treatment of what may be called, for want of a better expression, itemized losses in business. Losses of this kind might arise in various ways. A man may lose money in a particular deal in business. Or he may have to shell out money from his business under force of circumstances. Or the money may get lost from the shop or the factory, just like that, without the assessee being under any blame. These are familiar instances of itemized business losses. How to treat losses of this kind for tax purposes is not anywhere laid down in the I.T Act. Courts, however, have evolved certain tests for proper tax treatment of losses in trade. By and large, they have derived inspiration from the discipline of accountancy and the practice of commercial accountants.
13. The basic principle which courts have, again and again reiterated in the reported cases is that no loss can be allowed unless it is shown that it was incidental to the assessee's trade or business. Strong and Co. of Romsey Ltd. v. Woodifield, [1906] 5 TC 215 (HL), may be said to have established this principle at the earliest. It has been followed in this country for a long time. The Supreme Court has adopted it in two cases of trading losses resulting from embezzlement by employees: Badridas Daga, [1958] 34 ITR 10 (SC) and Nainital Bank Ltd., [1965] 55 ITR 707 (SC). The principle of these decisions is that it is not enough that the loss is somehow connected with the assessee's business, but it must be incidental to the very carrying on of the business. Particular applications of this principle have yielded varying results. For instance, a businessman or trader, in the course of carrying on business, might be rendered liable for penalties; for damages, and such like payments. The question would be whether the payments of such kind could be allowed as business losses. The decisions of courts on this subject are marked by extreme sophistication. We are asked to make a distinction, broadly, between penalties for infractions of the law, and compensation or damages for breaches of contract. Somewhere, in between, apparently fall cases relating to payment of damages in actions for negligence for other tortious acts, either of the assessee or of his employees or agents. Courts have more or less uniformly laid down that where the assessee pays a penalty for any violation or infraction of the law, he would not be entitled to a deduction of that loss in the computation of his taxable business profits. This is apparently on the theory that it is not necessary for business to be carried on anywhere by violating the law of that place. In this sense it is said that penalties cannot be regarded as being incidental to trade. In contrast, damages paid by an assessee for the breach of a trading agreement is regarded, with very few exceptions, as a loss incidental to the carrying on of the trade. This rule is justified on the basis that in the very nature and exigencies of a business it might become necessary or expedient as much to enter into contracts as to wriggle out of them, as much to make them as to break them. As for payment of damages for negligence in tort cases in which the assessee gets involved, the English case of Strong and Co. of Romsey Ltd. v. Woodifield, [1906] 5 TC 215 (HL), already quoted has itself established a peculiar test. This test is applied by asking the question: Did the liability for tort fall on the taxpayer in his character as a trader or in any other character? In the case of Strong and Co. of Romsey Ltd. v. Woodifield (supra), an innkeeper had to face an action for negligence by a lodger of his on whom a window in the inn fell and injury resulted. The decision went against the innkeeper both in the action for damages and in the income-tax proceedings for allowance of damages paid by him under the judgment. The court, considering the question in an appeal from the Commissioner by way of case stated, held that the taxpayer ran the risk of the windows in his inn falling on the heads of customers and passers-by, but he ran that risk as the owner of the structure, and not in his character as an innkeeper. The loss was not incidental to innkeeping; it was inherent in property owning. This was the distinction established in that case.
14. In our country, over-sophistication has marked the tax treatment of even damages for breaches of contract. In the early years of this century, our courts were inclined to distinguish between what they called an “honest” breach of contract and a “dishonest” breach of contract. Compensation or damages paid by the erring taxpayer was held to be deductible only in the former case, but not in the latter. Typical of this line of decisions is Mask & Co. v. CIT, [1943] 11 ITR 454 (Mad) decided by a Bench of this court. The learned judges who gave judgment in that case must have been quite aware that a distinction was usually drawn, in a broad manner, only between a breach of the law, on the one hand, and a breach of contract, on the other. Nevertheless, they thought that even in the case of a breach of contract, it might be necessary to equate it to a veritable violation of the law, if the assessee should commit the breach of contract with impunity. The following passage from the judgment in that case is oft quoted (p. 462):
“In the present case, the assessee was not fined for a breach of law, but was made to pay damages for a breach of the contract entered into. The assessee's action in disregarding the undertaking given was palpably dishonest and we are of the opinion that the award of damages which followed did not constitute an expenditure falling within section 10(2)(xii). It was not incidental to the trade.”
15. Nearly forty years have gone by since the writing of the judgment in Mask & Co.'s case, [1943] 11 ITR 454 (Mad). We have since had a number of decisions of courts in this genus. The phrase “dishonest breach of contract” has, by and large, gone out of fashion. This might be explained, without regret, by reference to the growing tendency among learned judges in the post-war period to view tax questions in the context of business realities rather than in the context of business moralities. In any case, the allowability of damages for contractual breaches is nowadays being examined in the perspective afforded by the nature of the trade, the manner of carrying it on, the circumstances attending alike on the formation, and the breach of the commercial contract in question, and the like. These are the considerations which are regarded nowadays as the real pointers to the question whether the liability incurred for damages is or is not incidental to the assessee's trade. This way of approach to the problem might seem to be amoral, but there never has been a more amoral legislative measure in the statute book than the I.T Act. If a puritanical approach were at all relevant, all contractual breaches must be regarded as violations of the sancity of contract. But we are living in an age when contract, as a mode of bringing about legal relationships, has been desanctified by the law itself. What is more, income-tax is not limited to lawful businesses only. It is imposed on the profits of illegal businesses too. Where the assessment is to be made on any one's illegal earnings, the charge must still be on the net income, after all the deductions are allowed, and not on the gross receipts. It would, therefore, seem that the true test of allowance of a trading loss is not whether it arises from an infraction of the law or from a dishonest breach of the contract, but whether it is incidental to the assessee's trade such as it is A prudish approach to this out-and-out tax question is, in our opinion, wholly alien to the discussion.
16. The Tribunal in their order have observed that the assessee's repudiation of the contract “is not illegal, but, if we may say so, merely unethical”. We do not see wherefrom they say so. As we mentioned earlier, the assessee is an incorporated company. It was being managed by certain persons up to a stage. Soon after the signing of the agreement for sale of the bus in question, a new set of people took over the company. As might be expected, the new group which got into the management took stock of the affairs of the company. They apparently believed that the amount of Rs. 1,00,000 stated to have been paid by the purchasers as advance for the transfer of the bus did not find its way into the coffers of the company. They believed that the then managing director had helped himself to the money received from the purchasers. This was apparently the reason why the assessee under the new management repudiated the sale of the bus in question. It, however, subsequently turned out, on further examination, that a portion of the advance consideration paid by the purchasers had gone in discharge of a bank loan and thereby the vehicle was relieved from a hire purchase transaction to which it was earlier tied up. This discovery apparently should have led the new management to acquiesce in the decree for damages, even though they had resisted the suit in the first instance. These facts, which clearly emerge from the order under reference, do not support the valued judgment passed by the Tribunal to the effect that the assessee had acted unethically in repudiating the contract.
17. We are satisfied that the loss occasioned by the breach committed by the assessee in the contract of sale of the bus is a loss incidental to the assessee's trade. It is as incidental as the change in the complexion and personnel of the assessee's board of directors. The only other aspect of the loss which needs verification is whether the loss, such as it is, is an item of revenue loss. For, if it is a capital loss, it being incidental to the trade, will not save it from disallowance. But we are satisfied that if the amount represents the interest element in the award of damages, it can hardly be branded as a capital loss. Indeed, there can possibly be no dispute, at this stage, at any rate, that Rs. 37,132 represents the interest part of the compensation decreed by the court. The assessment order itself had discussed the question in the background of s. 36(1)(iv), that is to say, as an interest payment. This underlines the position that the amount of Rs. 37,132 cannot be considered as capital in nature. Earlier, we have reproduced the text of the question of law referred to us by the Tribunal. The frame of the question is couched in a negative fashion, raising the query whether the sum of Rs. 37,132 is not an admissible expenditure? We think this is hardly the way of framing a question of law in a tax reference. A negative format in the framing of a question for decision, as in the framing of an issue in a suit, may be permissible to bring out considerations of burden of proof where they happen to loom large in the controversy. But that seldom applies in tax reference. The question is also defectively drawn up in another respect. The Tribunal granted the deduction in question, not on the ground that the sum of Rs. 37,132 was an item of expenditure, but, as we earlier pointed out, on the basis of general principles of deduction. We, therefore, reframe the question suitably, before proceeding to enter our formal answer thereto:
“Whether, on the facts and in the circumstances of the case, the sum of Rs. 37,132 was an admissible deduction in the computation of the assessee's business (income) for the assessment year 1967-68?”
18. Our answer to the question, as reframed, is in the affirmative and against the Department. In view of the nature of our answers to both the questions in these references, we award costs against the Department. Counsel's fee Rs. 500 (One set).
Comments