Parshva Properties Ltd. v. Commissioner Of Income-Tax, Central, Calcutta.

The Judgment of the Court was delivered by

Sabyasachi Mukharji, J.:— In this reference we are concerned with the question of deductibility of certain expenses incurred in relation to a criminal proceeding initiated against the officers of the assessee-company. The assessee is a private limited company and the assessment year involved is 1959–60. The business of the company was in quarrying lime-stone. The assessee-company also derived income from the property, letting on hire of furnitures, etc. One of the contentions urged before the Tribunal was that the Income-tax Officer and the Appellate Assistant Commissioner had erred in not allowing as deduction, expenditure to the extent of Rs. 17,057 alleged to have been incurred in defending certain employees of the company in a case which arose consequent to an accident which occurred in the mines. The amount of Rs. 17,057 included an amount of Rs. 3,000 which was paid as fine. In order to appreciate the question, it is necessary to mention that the accident occurred on the 25th April, 1957, when the labourers were engaged in a quarry of the assessee at Murlihills at two working faces, one below the other. The upper face was known as Pit No. 22 and the lower as Pit No. 10A. The latter was situate below the former pit, but extended slightly to the west of the upper pit. The labourers working in Pit No. 22 were removing the over-burden covering the lime-stone to be quarried. These pieces of stone were being thrown at the site of the old dump which lay to the east of Pit No. 10A, two coolies of the upper face were throwing their loads down from near the edge of the eastern part of the upper pit. One Nagmtia, a woman worker, in the lower pit, was hit by a flying stone thrown by a cooly working in the upper pit as a result of which she died. Consequent to this incident, criminal proceedings were initiated against Haridutta Bishnoi, a director, Ramshankar Singh, agent of the company, and Fakirchand Maheswari, manager. These persons were convicted under section 74(1)(a) of the Indian Mines Act, 1952, for violation of regulations 38 and 40 of the Indian Metalliferous Mines Regulations, 1926, by the First Class Magistrate at Sesaram and sentenced to pay a fine of Rs. 1,000 each and in default to undergo simple imprisonment for a period of two months. The conviction and sentence were upheld by the additional district judge. A revision petition was preferred and the judgment of the High Court of Patna was delivered on 14th January, 1963. The petition was allowed in respect of Haridutta Bishnoi but was dismissed in respect of the remaining two persons.

2. In appeal before the Tribunal, the Tribunal found that the woman worker died by a cooly throwing the over-burden from the upper face but the cooly was, however, throwing the over-burden from the near edge of the eastern part of the upper pit at the side of an old dump situate to the east of Pit No. 10A. The woman worker was working in Pit No. 10A and it had to be seen whether such an action on the part of the cooly could have resulted in the accidental death in the normal course of business. The Tribunal noticed that one of the charges was that there were violations of regulations 38 and 40 of the Indian Metalliferous' Mines Regulations, 1926. The Tribunal referred to the judgment of the High Court. Regulation 38 provides that the sides of the open workings shall be stopped, stepped or secured in such a manner as to prevent danger from fall of material. Regulation 40 provides that in open working trees liable to fall, the overburden and all loose ground and material shall be removed sufficiently far from the edge or otherwise made secure, in order to prevent danger to persons employed in mines. According to the assessee, there was no violation of these regulations. The assessee had contended, inter alia, that the regulations had not been framed according to law and were not valid. Secondly, the assessee contended that there was no legal evidence for the prosecution and it was apparent that the prosecution against one of them, because of the judgment, was wrongly made and as such was not valid. The period involved in this reference is the accounting period from 1st February, 1958, to 31st January, 1959. According to the judgment it appears that an inspector of mines on the 9th August, 1956, made a surprise inspection accompanied by the manager and agent and noticed certain defects. He had found that the height of the benches were 40 to 60 ft. whereas it should not have exceeded 25 ft. A show cause notice was issued to the assessee. It was further noted by the inspector of mines when he again visited the mines in the presence of the manager on 8th April, 1957, that the defects had not been removed and recommended legal action against them asking them to explain why work should not be stopped till the explanation was given. A show cause notice was also issued then. The mine was again inspected on 11th May, 1957, after the accident and it was found that the defects had continued to be there and proper steps had not been taken. It was contended before the High Court that the first two inspections were before the accident and the report did not specifically mention Pits Nos. 10 and 10A and the last inspection was stated to be after the occurrence, i.e, on May 11, 1957. The Patna High Court, while dealing with these contentions, observed, inter alia, as follows:

“In my opinion however there is no substance in this contention. It is clear that if the defects continued even after the accident it is unlikely that the position would have been better at the time of the accident. Their evidence, in any case, has been accepted by the courts below with regard to the defective working of the mine and failure to comply with regulations 38 and 40 of the Indian Metalliferous Mines Regulations of 1926. On these facts therefore I am unable to interfere with the findings of the courts below that there was violation of the regulations 38 and 40 and that the persons concerned must be held liable for the punishment provided for violating these regulations.”

3. The Tribunal observed that in the course of carrying on a business an accident might be occasioned as a result of latent defect and, in such event, it might have been argued that such accident could not have been prevented or anticipated and thus took place in the ordinary course of business. However, where the defect which existed was patent and was subsisting for a period of about a year and was a result of violation of statutory regulations and was also a defect which was not rectified in spite of due and repeated warning, the Tribunal was of the opinion that it was difficult to hold that the accident which took place as a result of such defect was one which occurred in the usual course of business. The regulations framed were intended as a matter of public policy involving the safety of the workers. In such a case it could not be said that the refusal to abide by the regulations could be attributed to the carrying on of the business. According to the Tribunal, the assessee could well have carried on the business without violating the law. In the premises, the Tribunal, after referring to the relevant authorities, came to the conclusion that the said sums were not deductible. In the above facts and circumstances, the following question under section 66(1) of the Indian Income-tax Act, 1922, has been referred to this court:

“Whether, on the facts and in the circumstances of the case, the Tribunal erred in holding that the sum of Rs. 17,057 expended by the assessee in relation to criminal proceedings initiated against the officers of the assessee-company was not an admissible deduction in computing the income from business of the assessee?”

4. The question whether the expenses incurred in litigation—civil or criminal—by the assessee are admissible as deduction has cropped up from time to time and the several authorities of different courts have dealt with this problem from different angles. We may in this connection first refer to the decision of the Supreme Court in the case of Commissioner Of Income Tax, West Bengal v. Mr H. Hirjee [1953] 23 ITR 427 SC.. There the assessee, an individual carrying on business as selling agent of a company, was prosecuted under section 13 of the Hoarding and Profiteering Ordinance, 1943, on a charge of selling goods at prices higher than were reasonable in contravention of the provisions of section 6 thereof and a part of his stock was seized and taken away. The prosecution ended in an acquittal and the assessee claimed deduction from the profits of his business under section 10(2)(xv) of the Indian Income-tax Act, 1922, a certain sum spent in defending the case. The Income-tax Appellate Tribunal found that the expenditure was incurred solely for the purpose of maintaining the assessee's name as a good businessman and also to save his stock from being under-sold if the court held that the prices charged by him were unreasonable. The High Court held that this was a finding of fact and allowed the assessee's claim for deduction. The department appealed to the. Supreme Court and the Supreme Court held that the finding of the Tribunal was vitiated by its refusal to consider the possibility of the criminal proceeding terminating in the conviction and imprisonment of the assessee and was not binding on the High Court as a finding of fact; that in the circumstances of the case the sum spent in defending the criminal proceeding was not an expenditure laid out or expended wholly and exclusively for the purpose of the business and it was, therefore, not allowable deduction under section 10(2)(xv) of the Act. The Supreme Court further observed that the deductibility of such expenses under section 10(2)(xv) should depend on the nature and purpose of the legal proceeding in relation to the business whose profits were under computation and could not be affected by the final outcome of that proceeding. The Supreme Court also observed that the income-tax assessments had to be made for every year and cannot be held up until the final result of a legal proceeding which might pass through several courts was announced. It has to be borne in mind that this was a case of an individual and he was defending the criminal proceeding against himself. The question was that in defending himself in the criminal proceeding, was he carrying on the business in the usual course or was the expenses incidental to his business. On the evaluation of the facts in that case, the Supreme Court was of the opinion that, as the Tribunal had refused to consider the possibility of the criminal proceeding terminating in the conviction and imprisonment of the respondent, being the individual assessee therein, the findings of the Tribunal were vitiated and it could not be said that the amount was deductible under section 10(2)(xv) of the Indian Income-tax Act, 1922. In the case of Haji Aziz and Abdul Shakoor Bros. v. Commissioner of Income-tax, the Supreme Court was concerned with a slightly different aspect of this problem. The assessee in that case had carried on business of importing dates from abroad and sold them in India. The assessee carried the dates from Iraq partly by steamer and partly by country craft at a time when the import of dates by steamer was prohibited and the dates which were imported by steamer were, therefore, confiscated by the customs authorities under section 167 of the Sea Customs Act, 1878, and item 8 thereto. The assessee was, however, given an option under section 83 of the Act to pay fine in lieu of confiscation. The assessee paid the fine and got the dates released. In computing its profit, the assessee sought to deduct the amount, paid by it by way of fine, as an allowable expenditure under section 10(2)(xv) of the Indian Income-tax Act, 1922. It was held by the Supreme Court that the amount paid by the assessee by way of penalty for breach of the law could not be considered to be an expenditure, wholly and exclusively for the purpose of the business. Even though it might involve no personal liability, it could not be said that the amount was paid wholly and exclusively for the purpose of the business of the assessee, within the meaning of section 10(2)(xv) of the Indian Income-tax Act, 1922, and was as such not an allowable expense under that section. The Supreme Court further held that the expenses which were permitted as deductions were such as were made in order to enable a person to carry on and earn profit in the business. It was not enough that the disbursements were made in the course of or arose out of or were concerned with or made out of the profits of the business but these must also be for the purpose of earning profits of the business. An expenditure was not deductible unless it was a commercial loss in trade and a penalty imposed for breach of the law during the course of trade could not on grounds of public policy be said to be a commercial expense for the purpose of a business of disbursement made for the purpose of earning the profits of such business. If a sum was paid by the assessee conducting his business, because in conducting it, he has acted in a manner which had rendered him liable to penalty, for an infraction of law, it could not be claimed as deductible expenses as it could not be called a commercial loss incurred in carrying on his business. Infraction of law, according to the Supreme Court, was not a normal incident of business.

5. The Punjab High Court, in the case of J.N Singh & Co. (P.) Ltd. v. Commissioner of Income-tax, had to deal with this question. There, one M, who had a quota allotment certificate for newsprint, handed over the certificate to R, the branch manager of the assessee's Bombay branch, for import and collection of the paper. The newsprint, on arrival from Canada, was not delivered to R, but was sold and the sale proceeds were credited in the books of the assessee. M initiated criminal proceedings against R.R was convicted by the trial court, but was acquitted on appeal. The expenses incurred by the assessee in defending R were claimed by the assessee as permissible deductions under section 10(2)(xv) of the Indian Income-tax Act, 1922. The Appellate Tribunal disallowed the claim. On a reference, the Punjab High Court held that the deduction was permissible. The High Court observed that the expenses incurred in defending an employee against a criminal proceeding with regard to a transaction carried out in the ordinary course of business of the assessee could be allowed as permissible deduction. In the case of an employee such an expenditure was incurred to protect the good name of the business, the prosecution having emanated with regard to an act which took place in the ordinary course of business and the expenditure would be wholly and exclusively for the business. In the case of Jagajit Cotton Textile Mills Ltd. v. Commissioner of Income-tax this court had to consider an identical question. There the director-in-charge, the secretary and the sales organiser of the assessee-company were prosecuted under section 7 of the Essential Supplies (Temporary Powers) Act, 1946, read with clause 24 of the Cotton Textile Control Order, 1948. They were sentenced for various terms but on appeal, they were all acquitted. The assessee-company incurred certain amounts as legal expenses in defending the case which it claimed as a deduction under section 10(2)(xv). It was held that the expenses were allowable under section 10(2)(xv) of the Indian Income-tax Act, 1922.

6. The Supreme Court had to consider this question also in respect of expenses of civil litigation in the case of Sree Meenakshi Mills Ltd. v. Commissioner of Income-tax [1967] 63 ITR 207 SC.. There the assessee was a limited company carrying on business in cotton spinning and weaving. The assessee-company, finding its own handlooms in its factory premises inadequate, distributed yarn produced by it to weavers outside the factory. Under clause 18B of the Cotton Cloth and Yarn (Control) Order, 1945, the Textile Commissioner was authorised to direct any manufacturer or dealer or any class of manufacturers or dealers, inter alia, not to sell or deliver any yarn or cloth of specified description except to such person or persons and subject to such conditions as he might specify. The company contended that the prohibition in general terms was ultra vires his authority and continued to deliver yarn to weavers until February 20, 1946. This yarn was seized. On February 20, 1946, the Provincial Textile Commissioner issued an order to the effect that the company should confine its delivery to, (a) licensed yarn dealers, (b) certain consumers who purchased yarn directly from it, and (c) its own handloom factory. A note appended to the order provided that any other delivery of yarn which was not covered by a special order or permission would be a contravention of his order under clause 18B of the Control Order, 1945. The Appellate Tribunal recorded that it was not disputed that the company did not deliver any yarn to weavers outside its premises after the order dated February 20, 1946. On 4th March, 1946, the company filed a petition in the Madras High Court under section 45 of the Specific Relief Act for an order directing the Provincial Textile Commissioner to desist from seizing the yarn supplied to weavers at or around Madurai and Rajapalayam in the usual course of business for the purpose of converting it into cloth and to restore to it the yarn already seized. The petition was dismissed by the learned judge of the High Court and his order was confirmed in appeal by the High Court. The company appealed therefrom to the Privy Council where also the company lost. The Privy Council held that the expression “deliver” in clause 18B(1)(b) of the Control Order was used in its ordinary broad sense of handing over possession as distinct from passing of property and included delivery of possession to a bailee and accordingly delivery of a part of its yarn to weavers outside the mill premises for conversion into cloth for the company was in contravention of the order dated February 20, 1946. The Privy Council also held that the petition was incompetent as the acts in respect of which relief was asked for took place outside the limits of the ordinary original civil jurisdiction of the High Court. In prosecuting these proceedings the company spent Rs. 20,035 and it had also to pay Rs. 5,912 as costs to the Government of its unsuccessful appeal before the Privy Council. In computing its income, the company claimed deduction of these amounts as expenditure wholly and exclusively laid out for the purpose of its business. The Supreme Court held that the object of the petition was to secure a declaration that the order dated February 20, 1946, in so far as it sought to put restrictions upon the right of the company to carry on its business in the manner in which it was accustomed to do was unauthorised, and to prevent enforcement of that order. Thereby, the company was seeking to obtain an order from the court enabling the business to be carried on without interference. The amounts expended by the company in this behalf were expenditure laid out wholly and exclusively for the purpose of its business and were deductible under section 10(2)(xv). The Supreme Court further held that the question of admissibility under section 10(2)(xv) had to be decided not on what was found or observed by the High Court in appeal from the order in the proceedings under section 45 of the Specific Relief Act or by the Privy Council but upon the findings of fact recorded by the Tribunal. Expenditure incurred to resist in a civil proceeding the enforcement of a measure, legislative or executive, which imposed restrictions on the carrying on of a business, or to obtain a declaration that the measure was invalid, would, if other conditions were satisfied, be admissible as a deduction under section 10(2)(xv). The deductibility of expenditure incurred in prosecuting a civil proceeding depended upon the nature and purpose of the legal proceeding in relation to the assessee's business and could not be affected by the final outcome of that proceeding. However wrong-headed, ill-advised, unduly optimistic or over-confident in his conviction the assessee might appear in the light of the ultimate decision, expenditure in starting and prosecuting a civil proceeding could not be denied as a permissible deduction in computing the taxable income merely because the proceeding had failed, if otherwise the expenditure was laid out for the purpose of the business wholly and exclusively, that is, reasonably and honestly incurred to promote the interest of the business. Persistence of the assessee in launching the proceeding and carrying it from court to court and incurring expenditure for that purpose was not a ground for disallowing the claim. In order that an expenditure might be admissible as a deduction under section 10(2)(xv), it was not necessary that the primary motive in incurring it must be directly to earn income thereby.

7. In the case of Deoria Sugar Mills Ltd. v. Commissioner of Income-tax, this court held that the penalty paid under section 3(5) of the U.P Sugarcane Cess Act for non-payment of arrears of sugarcane cess levied under the said Act was not entitled to be deducted as business expenditure under section 10(2)(xv) of the Indian Income-tax Act, 1922. All payments made under section 3(5) of the U.P Sugarcane Cess Act could not be said to have arisen out of the carrying on of the business of the assessee or to be incidental to it. It was observed by this court that an infraction of law was not a normal incident of trade. In the case of Commissioner of Income-tax v. Chaman Lal & Bros., the Delhi High Court had to consider this question in respect of penalty. It was held that the amount spent by the assessee-firm on the defence of its partners in the criminal case for contravention of the provisions of the Foreign Exchange Regulation Act, 1947, was not deductible under section 10(2)(xv) of the Indian Income-tax Act, 1922, and the fact that the acquittal of the partner was important for the reputation of the assessee-firm did not detract from this position. Dealing with the judgment in the case of J.N Singh & Co. (P.) Ltd. v. Commissioner of Income-tax [1966] 60 ITR 732 Punj., the court observed at page 390 of the report that the above-mentioned case was in respect of expenditure incurred in defending an employee which was admissible and not those incurred in defending the owner. In the case of Commissioner of Income-tax v. Dhanrajgirji Raja Narasingirji [1973] 91 ITR 544 SC., this question came again before the Supreme Court in respect of a criminal prosecution. There the assessee was the managing agent of the public company promoted by him and was also the chairman of its board of directors. In that case the Supreme Court held that the assessee had incurred the expenditure for the purpose of its business. It was for the assessee to decide how best to protect his own interest. It was the duty of the assessee to see that the prosecution was properly conducted. The fact that he did not leave the carriage of the case in the hands of the prosecuting agency of the Government was no ground for disallowing the expenditure. It was not open to the department to prescribe what expenditure the assessee should incur and in what circumstances he should incur that expenditure. It was further observed that the assessee not having challenged the finding of the criminal litigation, the High Court should not sit as a court of appeal and examine the case afresh. The Supreme Court made it clear that it was not correct to say that expenditure incurred in connection with a criminal case could not be deducted as business expenditure under section 10(2)(xv). That provision did not make any distinction between civil litigation and criminal litigation. It made no difference whether the proceedings were civil or criminal. All that the court had to see was whether the transaction in respect of which proceedings were taken arose out of and was incidental to the assessee's business and whether the expenditure was bona fide incurred wholly and exclusively for the purpose of the business.

8. Bearing the principles of the aforesaid decisions in mind, we have to examine the facts of the instant case. From the aforesaid decisions, the following principles, it appears to us, emerge:

(1) The question of deductibility of expenditure of this nature must depend on the purpose and nature of the expenditure incurred, (2) in order to determine whether the expenditure was deductible or not, it is necessary to find out in what capacity the expenditure was incurred, (3) the ultimate result or decision in which the expenses were incurred does not in any way affect the question of allowability of the expenditure. The aim and purpose of incurring the expenditure should also be examined, and (4) but a penalty for not following the law is not an expenditure which can be said to be incurred by the assessee in the course of his business.

9. In the instant case the Tribunal has observed that it was difficult to hold that the incident was one which occurred in the usual course of business. It is, in our opinion, a wrong approach to consider whether the accident occurred in the usual course of business. The question is whether in defending the employees of a limited company who were prosecuted for their work done as employees and during the course of employment of the assessee, the assessee had incurred the expenditure which could be allowed as deduction in carrying on the business of the assessee. The aim and purpose of the expenditure was to protect the assessee's employees and thereby to protect the assessee's good name and thereby to carry on the business. Further, it has to be borne in mind that unless an assessee was prepared to defend its employees for consequences while working as employees and in the course of employment, it will be difficult for an assessee to obtain the services and co-operation of its employees without which it was not possible for any assessee to carry on its business. In so far as the expenses were incurred in defending the accused persons in respect of acts alleged to have been committed in the course of employment of the assessee while carrying on the business of the assessee, in our opinion, unless it can be said that the expenditure was not incurred bona fide, which is not the case here, should be allowed in computing the total income of the assessee under section 10(2)(xv) of the Act.

10. Counsel for the revenue placed strong reliance on the findings recorded in the Tribunal's order with reference to the observations of the Patna High Court that certain defects and non-compliance with the regulations 38 and 40 were noticed by the inspector of mines and show-cause notice had been issued in respect thereof and the finding to the effect that these defects had not been removed by the assessee. The assessee might be guilty of these violations and the consequences must visit the assessee. But we are not concerned with the liability of the assessee's employees for the accident that had happened but the liability of the assessee's employees arose out of the working in the course of carrying on the business. Therefore, it was the assessee's obligation to protect or to defend these persons. In determining whether the expenses were properly incurred or not the fact that one of the accused persons was found not guilty would not in any way affect the question. The question must be determined having regard to the aim and purpose of incurring the expenditure. But it must be observed that a liability imposed upon the assessee for infraction of law or penalty imposed upon the assessee for infraction of law cannot be allowed as expenditure incurred in the course of the carrying on of the business, because that will be contrary to public policy. Of the sum of Rs. 17,000, it appears from the records that Rs. 14,057 were expenses actually incurred in defending these persons and a sum of Rs. 3,000 was fine for violation of the law. The said sum cannot be allowed as deduction. But the sum of Rs. 14,057, in our opinion, should be allowed. In the premises we answer the question in the affirmative by stating that the assessee was entitled to deduction of Rs. 14,057 as expenditure in relation to criminal proceeding against the officers of the assessee in computing the income of the business of the assessee. In the facts and circumstances of the case, each party will bear and pay its own costs.

Pyne, J.:— I agree.