Govindan Nair, J.:— The Income-tax Appellate Tribunal acting under section 66(1) of the Indian Income-tax Act has referred the following question for the decision of this court:

“Whether the assessee is entitled to the deduction of Rs. 9,020-12-6 from the computation of its income in the relevant accounting year under any of the provisions of the Income-tax Act?”

2. The assessee is a limited concern called “The Anamalai Timber Trust Ltd.” For the year of assessment 1956-57, the assessee claimed a sum of Rs. 9,020-12-6 as an allowable deduction in computing its income. This amount represented part of the compensation by way of damages and costs decreed by the High Court in appeal from a suit filed by the State against the assessee. It is necessary to refer to the facts of that case.

3. The Tripunithura Devaswom owned an elephant named “Narayanan-kutty”. Before the Devaswom Board, Cochin, was formed, the said Devaswom was under the control of the Government of Cochin. An agreement dated 15-5-1117M.E. (December 30, 1941, A.D), was entered into by the assessee with the Government of Cochin by which the said elephant was hired by the assessee and the services of its two mahouts taken over. Two of the terms of that agreement are that the elephant should be used only for hauling timber which did not exceed a specified volume and that the two mahouts attached to the elephant must be engaged by the assessee. The State of Cochin instituted the suit against the assessee for compensation for the death of the elephant, which, it was alleged in the plaint, resulted from the injuries that were inflicted by its mahouts on the animal when it refused to drag the over-sized logs of timber. One of the defences that was raised by the assessee to the suit was that the mahouts concerned were not its servants but were the servants of the Government and therefore no liability could be imposed on the assessee for the tortious acts, if any, committed by the mahouts.

4. On an analysis of the evidence, the High Court of Travancore-Cochin came to the conclusion that “the mahouts were the servants of the defendant company (the assessee company) at the relevant time and that they caused the injuries to the elephant in the course of their employment as servants of the company”. So the assessee was held liable for the acts of the mahouts. The High Court had also come to the conclusion that “so far as the elephant was concerned, it has been proved beyond doubt that the relationship between the plaintiff and the defendant (assessee) was that of bailor and bailee”. And in paragraph 38 of its judgment the High Court said:

“The bailee must return the goods without demand, on the due date. Failure to return renders him liable for, the loss or damage to goods from the date of default. The law presumes negligence to be the cause and casts upon the bailee the burden to show that loss is due to causes consistent with due care on his part…. Nothing of the kind was done in this case. The defendant is, therefore, liable to account for the elephant to the plaintiff.”

5. The taxing authorities and the Tribunal on the above findings of the High Court came to the conclusion that the damages that the assessee company was called upon to pay represented its liability arising out of a breach of contract and disallowed the claim for deduction of that payment relying on the rulings in Mask and Company v. Commissioner of Income-tax [1943] 11 I.T.R 454., Commissioner of Income-tax v. Himalaya Rosin-Turpentine Manufacturing Company [1953] 24 I.T.R 132. and Senthikumara Nadar & Sons v. Commissioner of Income-tax [1957] 32 I.T.R 138..

6. Counsel for the assessee urged that, on a proper construction of the High Court judgment, it will be clear that the assessee company was directed to pay compensation not on the ground that it had committed breach of contract, but on the basis that the assessee is liable for the tortious acts of its servants committed by them during the course of their employment. Reliance was placed on the following remarks of the High Court in paragraph 36 of the judgment:

“The conclusion, therefore, is that the mahouts were the servants of the defendant company at the relevant time and that they caused the injuries to the elephant in the course of their employment as servants of the company. So, for the acts of the mahouts, the defendant company is certainly liable.”

7. We are unable to accept this contention. It is clear from paragraph 36 of the judgment of the High Court, which we have extracted above, that the liability for compensation has been imposed on the assessee also on the basis that the assessee had failed to establish that it had taken due care that was expected of it. This liability arose out of the contract of bailment which imposed an obligation on the assessee to take due and proper care and the omission to take such care amounted to negligence. The question that arises for determination in this case, therefore, is whether the damages that the assessee company had to pay because of its negligence, though arising from a breach of contract, is an allowable deduction in computing its income.

8. It was admitted before us that if the decision of the High Court had been rested solely on the principle of vicarious liability of the assessee for the tortious acts of its servants, while acting in the course of their employment, the compensation paid by the assessee would be an allowable deduction. But it was urged that if the liability was one arising from a breach of contract, the compensation payable for such breach is not an allowable deduction even if the breach consisted only of the failure to take due and proper care. Counsel for the department relied on the very same rulings which had been referred to by the Tribunal and contended that it is well settled that any amount paid on account of breach of contract committed by the assessee cannot be deducted in computing the assessee's income.

9. In Mask and Company v. Commissioner of Income-tax and in Commissioner of Income-tax v. Himalaya Rosin-Turpentine Manufacturing Company the assessees concerned had committed breaches of contracts. In the former, they sold crackers at a rate lower than that specified in the contract and in the latter the assessee committed breach of the terms and conditions subject to which alone they could extract rosin and the compensation paid was for the failure to observe those terms and conditions. In Senthikumara Nadar & Sons v. Commissioner of Income-tax also, the assessee committed breach of the contractual obligation to export the whole of the coffee, purchased from the Coffee Board at a rate far below the price of coffee to be sold within India, by selling a part of the coffee so purchased within India. The question whether compensation that an assessee had to pay for its negligence, though arising from a breach of contract, is an allowable deduction in computing its income for income-tax purposes has not been decided in any of the above cases. Sir Lionel Leach C.J referred to this aspect in the judgment which he gave in Mask and Company v. Commissioner of Income-tax in these terms:

“For the respondent, stress has been laid on the observations made by Scrutton L.J at the end of his judgment in Commissioners of Inland Revenue v. Alexander von Glehn Ltd. [1920] 2 K.B 553, 572. Scrutton L.J said that he did not wish to decide until he had heard the matter further argued, whether damage paid in civil proceedings in respect of carrying on business in a negligent manner can or cannot be deducted from the profits. This is not a case of conducting a business in a negligent manner; it is a case of conducting a business in a dishonest manner.”

10. The reference is to the following passage from the judgment of Scrutton L.J in Commissioners of Inland Revenue v. Alexander von Glehn & Co. Ltd.

“I do not wish to decide until I have heard the matter further argued, whether damages paid in civil proceedings in respect of carrying on business in a negligent manner can or cannot be deducted from the profits, for I quite see that on the language that I have used questions may arise as to such damages.”

11. The real test to be applied in these types of cases appears to be what has been laid down by the House of Lords in Strong and Company of Romsey Ltd. v. Woodifield. The Lord Chancellor said:

“I think only such losses can be deducted as are connected with it in the sense that they are really incidental to the trade itself. They cannot be deducted if they are mainly incidental to some other vocation, or fall on the trader in some character other than that of trader. The nature of the trade is to be considered. To give an illustration, losses sustained by a railway company in compensating passengers for accident in travelling might be deducted. On the other hand, if a man kept a grocer's shop, for keeping which a house is necessary, and one of the window shutters fell upon and injured a man walking in the street, the loss arising thereby to the grocer ought not to be deducted. Many cases might be put near the line, and no degree of ingenuity can frame a formula so precise and comprehensive as to solve at sight all the cases that may arise. In the present case, I think that the loss sustained by the appellants was not really incidental to their trade as innkeepers, and fell upon them in their character not of traders but of householders.”

12. It is, therefore, clear that the loss can only be deducted “if it is really incidental to the trade itself”. So stated, the principle is apparently simple. But its application to the facts of a given case can give rise to difficulties. Lord James of Hereford said in the same case:

“The only question is as to the application of that principle in one small matter to the facts of this case. If the fact were that the accident had occurred to a stranger walking in the street, then I should have no doubt at all. The doubt that did arise in my mind was when the accident occurred to a person who was a customer in the house, who would not have been injured unless the business of an innkeeper was being carried on, and when it was in the course of the carrying on of a portion of that business that the customer injured was there; then I think a different principle might arise and my doubts consequently existed. But, my Lords, my doubts are not strong enough in relation to this application of a principle about which there is no question to cause me to dissent from the judgment proposed.”

13. No subsequent cases of the courts in England where the issue was the admissibility of damages payable by a trader because of his negligence has been brought to our notice and our attention has been invited to none decided by the courts in India. But the principle stated by the House of Lords in Strong and Company of Romsey Ltd. v. Woodifield has been consistently followed in England as can be seen from the decisions in Commissioners of Inland Revenue v. Warnes and Company Ltd. and Commissioners of Inland Revenue v. Alexander von Glehn & Co. Ltd.

14. The above principle has been approved by the Supreme Court in Haji Aziz and Abdul Shakoor Bros. v. Commissioner of Income-tax. The question that arose there was whether the fine that the assessee had to pay for releasing the dates that he imported by steamer at a time when import of dates by steamer was prohibited could be deducted in computing the assessee's income. The English decisions in the above three cases among others were reviewed by the Supreme Court and it came to the conclusion:

“…….that expenses which are permitted as deductions are such as are made for the purpose of carrying on the business, i.e, to enable a person to carry on and earn profit in that business. It is not enough that the disbursements are made in the course of or arise out of or are concerned with or made out of the profits of the business but they must also be for the purpose of earning the profits of the business. It must be a commercial loss and in its nature must be contemplable as such They cannot be deducted if they fall on the assessee in some character other than that of a trader the test being that the expenses which are for the purpose of enabling a person to carry on trade for making profits in the business are permitted but not if they are merely connected with the business.”

15. The same principle has been enunciated by the Supreme Court in Badridas Daga v. Commissioner of Income-tax by Venkatarama Aiyar J. in these words

“The result is that when a claim is made for a deduction for which there is no specific provision in section 10(2), whether it is admissible or not will depend on whether, having regard to 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. 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.”

16. And it was held that loss resulting from embezzlement by an employee or agent must be deducted in order to arrive at the profits or gains mentioned in section 10(1) of the Indian Income-tax Act if the loss arose out of the carrying on of the business and was incidental to it, even if it did not fall under any of the items specified in section 10(2) of the Act.

17. In the light of the above statement of the law, what is to be considered in this case is whether the loss in this case resulting from the payment of compensation by the assessee can be said to arise out of the carrying on of its business and is incidental thereto. The assessee has been carrying on business in timber. This necessitated the hauling of timber logs for which the services of an elephant were essential. The assessee hired one along with its two mahouts. It is not suggested that the mahouts were either incompetent or irresponsible. In fact,-the assessee had no choice in selecting the mahouts for the assessee was obliged by the terms of the agreement dated December 30, 1941, to engage the mahouts deputed by the owner. That the elephant was used for the purpose of carrying on the assessee's business and the injuries were inflicted on the elephant while it was being so used by the mahouts acting in the course of their employment have been found by the High Court in the civil suit. The assessee is a limited company and it is inevitable that it should carry on its business with the aid and the help of its servants. An elephant can only be controlled by trained mahouts and the only blame that was attributed to the assessee is that its other servants did not make any attempt to stop the assault on the elephant. It is not clear whether there were any officers of the company in the vicinity where the injuries were inflicted on the elephant at the time of their infliction. It is also doubtful whether they could have interfered with the mahouts regarding the manner in which they controlled the elephant. There is no finding by the High Court in the civil suit that the elephant has been used for dragging logs of timber of a volume higher than that specified in the agreement.

18. From the above, it is clear that the compensation that the assessee had to pay arose from the carrying on of its business and is incidental thereto though, according to the finding of the High Court, the assessee has been negligent in that its servants had not taken due and proper care. The question, therefore, is whether compensation paid as damages for negligence is allowable as an item of deduction. The rule laid down by Lord Loreburn in Strong and Company of Romsey Ltd. v. Woodifield has been applied by some of the Dominion Courts to allow such damages as a proper “cost of earning profits”. Some of the cases have been collected by Hannan and Farnsworth in their book The Principles of Income Taxation, at page 520. In one of those cases, Imperial Oil Company Ltd. v. Minister of National Revenue decided by the Exchequer Court of Canada, half a million dollars paid towards damages-and costs in settlement of the claim brought against the assessee for the loss occasioned to a vessel with which one of the tankers of the assessee company collided owing to the negligence of its master was allowed as a deduction. The following passage from the judgment of Thorson P. is apposite:

“It is necessary to look behind the payment and enquire whether the liability which made it necessary—and it makes no difference whether such liability was contractual or delictual—was incurred as part of the operation by which the taxpayer earned his income. Where income is earned from certain operations, as it was by the appellant from its marine operations, all the expenses wholly, exclusively and necessarily incidental to such operations must be deducted as the total cost thereof in order that the amount of the profits or gains from such operations that are to be assessed may be computed. Such cost includes not only all the ordinary operations costs but also all moneys paid in discharge of the liabilities normally incurred in the operations. When the nature of the operations is such that the risk of negligence on the part of the taxpayer's servants in the course of their duties or employment is really incidental to such operations, as was the fact in the present case, with its consequential liability to pay damages and costs, then the amount of such damages and costs is properly included as one of the items of the total cost of such operations. It may, therefore, properly be described as a disbursement or expense that is.wholly, exclusively and necessarily laid out as part of the process of earning the income from such operations.”

19. There appears to be no distinction in principle between the liability being contractual or delictual. We have no hesitation in coming to the conclusion that according to the findings of the High Court in the civil suit the liability of the assessee in this case stems from the negligence of its servants. It makes no difference that by such negligence a breach of contract has resulted. Considering the nature of the business carried on by the assessee, the risk of negligence such as the one attributed to the assessee's servants while acting in the course of their employment is clearly incidental to such business. It follows that the consequential liability to pay damages for such negligence is also incidental to the business.

20. Following the principle enunciated by the Supreme Court in Badridas Daga v. Commissioner of Income-tax and Haji Aziz and Abdul Shakoor Bros. v. Commissioner of Income-tax and applying the rule in Imperial Oil Company Ltd. v. Minister of National Revenue, we hold that the assessee is entitled to the deduction claimed and answer the question referred to us in the affirmative and in favour of the assessee. Being a case of first impression, we make no order as to costs.

21. Question answered in the affirmative.