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Raghunarayan Rice Mills v. Commissioner Of Income-Tax, Bihar And Orissa.
Judgment Summary — Reference under section 256(1) of the Income-tax Act, 1961
Factual and Procedural Background
The question referred to the Court under section 256(1) of the Indian Income-tax Act, 1961, asked whether the sums of Rs. 17,061 and Rs. 2,203 fell for deduction in the hands of the assessee in respect of assessment years 1958–59 and 1959–60 respectively.
The assessee was a registered firm engaged in the business of rice, paddy and paddy milling. The relevant accounting years correspond to Diwali year ending October 21, 1957 (for assessment year 1958–59), and November 10, 1958 (for assessment year 1959–60). During those accounting periods the firm entered into various agreements to supply rice to purchasers in Calcutta, but could not dispatch the rice because the Government of Orissa imposed restrictions on the movement of paddy and rice.
Because delivery could not be effected, the assessee made settlements with the Calcutta purchasers by paying differences: Rs. 17,060.10 (rounded in the reference as Rs. 17,061) in 1958–59 and Rs. 2,203 in 1959–60. The Income-tax Officer disallowed the claim for 1958–59 on the ground that the assessee could recover the loss from the Government of Orissa if the purchasers were not satisfied; for 1959–60 the Officer disallowed the amount on the ground that the transactions were speculative and could only be set off against speculative profits.
On appeal, the Appellate Assistant Commissioner allowed the assessee's claim treating the amounts as trading loss and allowable business expenditure. The Department then appealed to the Appellate Tribunal, which concluded that the amounts were paid in settlement of transactions that were speculative in nature. The sole legal question identified for resolution by the Court was whether the transactions were of a speculative nature within the meaning of Explanation 2 to section 24 of the Income-tax Act, 1922 (as quoted in the reference).
Legal Issues Presented
- Whether, on the facts and circumstances of the case, the sums of Rs. 17,061 and Rs. 2,203 fell for deduction in the hands of the assessee in its assessments for the years 1958–59 and 1959–60 respectively?
- Whether the transactions under which these sums were paid by the assessee constituted speculative transactions within the meaning of Explanation 2 to section 24(1) of the Income-tax Act (1922)?
Arguments of the Parties
Assessee's (Respondent's) Arguments
- The assessee contended that after restrictions were imposed by the Government of Orissa there was a breach (or frustration) of the contracts and that payment of the differences was made because of that breach and not as a settlement of the contract as contemplated by Explanation 2.
- The assessee's counsel (Mr. Mohanty) argued that the payment was prompted by a desire to maintain the firm's business reputation, and that the contract had become void by frustration under section 56 of the Indian Contract Act, so no settlement within the meaning of Explanation 2 occurred.
- At the Appellate Assistant Commissioner level, the assessee's position (accepted by that officer) was that the liability to pay fell upon the assessee and the payments constituted a trading loss and an allowable business expenditure.
Revenue's (Appellant's) Arguments
- For assessment year 1958–59 the Income-tax Officer disallowed the claim on the ground that the assessee could recover the loss from the Government of Orissa if the Calcutta purchasers were not satisfied.
- For assessment year 1959–60 the Officer treated the transactions as speculative and held they could be set off only against speculative profits under the proviso to section 24(1).
- The Department, on appeal to the Appellate Tribunal, contended that the transactions were speculative in nature and not allowable as ordinary business losses for the purposes of set-off under section 24(1).
Table of Precedents Cited
| Precedent | Rule or Principle Cited For | Application by the Court |
|---|---|---|
| Commissioner of Income-tax v. Pioneer Trading Company Private Ltd. [1968] 70 I.T.R. 347, 352 | The proposition that when money is received as damages for breach of contract (i.e., after breach), the amount is not a realization of a speculative transaction; “contract settled” was held to mean settled before breach, and amounts recoverable as damages post-breach fall outside Explanation 2. | The Court accepted the legal analysis and passage in Pioneer as correctly stating the law. It distinguished the present facts from Pioneer: in Pioneer the sums received were damages after breach (thus not speculative), whereas in the present case the assessee voluntarily settled the contract (without delivery) and therefore the transaction fell within Explanation 2 as speculative. |
Court's Reasoning and Analysis
The Court's analysis proceeded in a sequence of focused legal steps:
- Definition and scope: The Court noted Explanation 2 to section 24 (as reproduced in the reference) provides an exhaustive definition of a "speculative transaction" — a transaction where a contract for purchase and sale is periodically or ultimately settled otherwise than by actual delivery or transfer of the commodity. The essential feature is settlement without actual delivery.
- Application of facts to definition: After the Orissa restrictions on movement of paddy and rice, the assessee could not deliver the goods and thus the contract was rendered unenforceable by frustration under the relevant law. The purchasers could not recover damages from the petitioner as a consequence of the legislation. This factual situation established that delivery could not be effected.
- Available legal options and the assessee's choice: The Court emphasised that the assessee had an option to treat the contract as unenforceable (i.e., resile from it) and to refuse liability; that course would have been legally tenable. Instead, the assessee voluntarily paid the differences to preserve business reputation. The Court held that such payment amounted to settling the contract by choice rather than obtaining damages for breach.
- Legal consequence of voluntary settlement: Because the contract was ultimately settled without actual delivery, the transaction fell squarely within the mischief of Explanation 2 and therefore constituted a speculative transaction for the purposes of section 24(1).
- Distinguishing authority relied upon by the assessee: The Court considered Commissioner of Income-tax v. Pioneer Trading Co. and accepted its rule that where amounts are realized as damages after breach, those amounts are not speculative. However, the Court found the facts of Pioneer materially different: in Pioneer the payment represented damages after breach and hence was non-speculative; in the present case there was no breach adjudged and the assessee voluntarily settled without delivery — making it a speculative transaction under Explanation 2.
- Concluding legal effect: Under the proviso to section 24(1) the loss sustained in speculative transactions which are in the nature of a business cannot be taken into account as business expenditure (except against profits in another speculative business). Therefore the payments made by the assessee were not allowable deductions as ordinary business losses for the assessment years in question.
The Court expressly stated that the Tribunal's view (that the transactions were speculative) was correct and adopted that conclusion.
Holding and Implications
Core Holding: The Court answered the referred question in the negative — the sums paid (Rs. 17,061 and Rs. 2,203) did not fall for deduction as ordinary business expenditure because the transactions were speculative within the meaning of Explanation 2 to section 24(1).
Direct implications and effect on the parties:
- The Tribunal's finding that the transactions were speculative was upheld and the amounts are not allowable as business expenditure for set-off under section 24(1) (except as allowed against speculative profits under the proviso, if any).
- The assessee was held liable to pay costs of the reference: hearing fee Rs. 250 (Rupees two hundred and fifty only).
The opinion applied existing authority (Commissioner of Income-tax v. Pioneer Trading Co.) by distinguishing it on facts; it did not purport to lay down a new legal principle beyond that analysis.
G.K Misra, C.J:— The question of law referred to this court under section 256(1) of the Indian Income-tax Act, 1961, runs thus:
“Whether, on the facts and circumstances of the case, the sum of Rs. 17,061 and Rs. 2,203 fell for deduction in the hands of the assessee in its assessment for the years 1958–59 and 1959–60 respectively?”
2. The facts appearing in the statement of the case may be noticed in brief. The assessee is a registered firm carrying on business in rice, paddy and paddy milling. The assessment years are 1958–59 and 1959–60. The corresponding accounting years are Diwali year ending on October 21, 1957, and November 10, 1958, respectively. The assessee, during the relevant accounting periods, entered into various agreements for supply of rice to its constituents at Calcutta. During this period, however, the rice could not be dispatched due to restrictions imposed by the Government of Orissa on the movement of paddy and rice. The assessee, accordingly, made settlement with the purchasers in Calcutta by paying the differences. In the assessment year 1958–59 it paid a sum of Rs. 17,060.10; the amount paid in the assessment year 1959–60 was Rs. 2,203. The Income-tax Officer disallowed the claim for 1958–59 on the ground that the assessee could recover this loss from the Government of Orissa if the outsider-purchasers were not satisfied. For the year 1959–60 he disallowed the loss holding that the transactions were of a speculative nature and could be only set off against future profits in speculation. In appeal, the Appellate Assistant Commissioner allowed the claim of the assessee in toto. He held that the liability to pay the aforesaid amounts fell on the assessee and it was a trading loss. The assessee, as a businessman, was bound to pay the dues arising out of his failure to carry out the contract. The expenditure was laid out for the purpose of business and was an allowable expenditure. The department filed an appeal before the Appellate Tribunal, which was of opinion that the amounts were paid by the assessee in settlement of transactions which were of a speculative nature. The sole question for consideration is whether the transactions were of a speculative nature. Section 24 of the Income-tax Act, 1922, so far as relevant, runs thus:
“24. Set off of loss in computing aggregate income.—(1) Where any assessee sustains a loss of profits or gains in any year under any of the heads mentioned in section 6, he shall be entitled to have the amount of the loss set off against his income, profits or gains under any other head in that year:
Provided that in computing the profits and gains chargeable under the head ‘Profits and gains of business, profession or vocation’, any loss sustained in speculative transactions which are in the nature of a business shall not be taken into account except to the extent of the amount of profits and gains, if any, in any other business consisting of speculative transactions:….
Explanation 1.—Where the speculative transactions carried on are of such a nature as to constitute a business, the business shall be deemed to be distinct and separate from any other business.
Explanation 2.—A speculative transaction means a transaction in which a contract for purchase and sale of any commodity including stocks and shares, is periodically or ultimately settled otherwise than by actual delivery or transfer of the commodity or scrips.”
3. (The provisos to Explanation 2 are not relevant in this case).
4. Speculative transaction has thus been defined in Explanation 2. The definition is exhaustive. A transaction which is speculative under the Contract Act may not be speculative under the Income-tax Act, while a transaction which is non-speculative under the Contract Act, may be speculative under the Income-tax Act. The essential feature of this definition is that the transaction must be speculative if the contract under which it takes place is not given effect to by actual delivery or transfer of the commodity or scrips.
5. Admittedly, after the imposition of restrictions on the movement of rice and paddy by the Government of Orissa, the assessee could not have honored his contract by delivery of goods. There was a frustration of the contract by the supervening event of restriction of movement of the commodity under the Orissa law. In consequence of this legislation, the contract became unenforceable and the purchasers in Calcutta were not entitled to recover even damages from the petitioner.
6. The petitioner's case is that, though it was under no legal obligation to pay the differences, it had to pay the same in order to maintain its business reputation. It was contended by Mr. Mohanty, on behalf of the petitioner, that after the restriction was imposed by the Government there was a breach of the contract and the payment of the differences was made on account of this breach and not in settlement of the contract, as enjoined upon by Explanation 2. We are unable to accept this contention. Once there was restriction on the movement of goods, the assessee was helpless and could not have honored the contract by delivery of the commodity. Two courses were open. The petitioner could have taken the stand that the contract was unenforceable on account of frustration and, as such, it had no liability to pay the dues to its constituents in Calcutta. Such a stand would be legally tenable. The petitioner did not choose this course. On the other hand, it preferred to maintain its business reputation by honoring the contract. The contract was thus settled by paying the differences and not by delivery of the commodity. The term “settled” would only mean “acted upon the contract was thus acted upon by the voluntary choice of the assessee on payment of the differences. The case, therefore comes directly within the mischief of Explanation 2. A taxing statute must be strictly construed on its plain meaning. If the petitioner would have depended on breach of contract, it had no liability to pay. The cause of action for paying the differences is not based on breach of contract, but on the desire to suffer loss for the sake of maintaining business prestige and reputation. The result, therefore, is that the contract was honored. The transaction so effected became speculative within the meaning of Explanation 2. Though the original intention might be to fulfill the contract by delivery of goods, a subsequent transaction in pursuance of the original contract, ultimately settled without actual delivery of goods, is speculative.
7. Reliance is placed on behalf of the petitioner on Commissioner of Income-tax v. Pioneer Trading Company Private Ltd. [1968] 70 I.T.R 347, 352., in support of the contention that the expression “contract settled” means “contract settled before breach Accordingly, it is urged that as, in this case, the contract became void by frustration under section 56 of the Indian Contract Act, there was breach of the contract and the payment of the difference by the petitioner to the Calcutta constituents was not settlement of the contract. Before indicating the fallacy of this reasoning, it would be appropriate to refer to the facts of the aforesaid case on the basis of which it was held therein that the payment of the difference in price was not a speculative transaction. The assessee in that case entered into a contract with a Japanese company at Tokyo. The first two parts of the contract were complied with. The third part was to consign certain tons of Indian iron ore to the Japanese company. This could not be supplied as the Japanese company defaulted in performance of their part of the contract and did not open a letter of credit as agreed upon. For breach of the contract, the assessee-company claimed from the Japanese company the difference of the price of iron ore not supplied. The claim for the difference was ultimately settled and the Japanese company agreed to pay the difference and actually paid the same in settlement of the claim. The assessee sought to set off this amount against certain unabsorbed speculative loss, brought forward from earlier years on the theory that the amount of difference obtained from the Japanese company was a speculative profit. Their Lordships rejected this contention. They held that the expression “contract settled” means “contract settled before breach”. After breach of the contract the cause of action was no longer based on the contract itself, but on its breach. The amount of money which the assessee received in that case was the amount of damages suffered by it by reason of the breach of the contract. Their Lordships observed thus:
“The nature of the contract, which we have recited hereinbefore, gives no implication that the contract was of a speculative nature. If that contract had been settled, we do not know whether it would have fallen within the meaning of Explanation 2. We have held that the contract was not settled but damages for breach of contract were realized. That makes all the difference and the transaction cannot be characterized as speculative transaction within the meaning of Explanation 2.”
8. In our view the aforesaid passage lays down the law correctly and is consistent with the analysis presented by us.
9. In this case, there was no breach of contract. By frustration, the contract became unenforceable. It was open to the petitioner to resile from the contract and take the stand that the residual contractual obligation, after the Orissa law came into operation, was incapable of performance. Without doing so and without any pressure from the Calcutta constituents, the petitioner, to save its business reputation, honored the contract which amounts to settlement of the contract within the meaning of Explanation 2.
10. On the aforesaid analysis, we hold that the impugned transactions were speculative. Under the proviso to section 24(1), the loss so sustained in the speculative transactions which are in the nature of a business cannot be construed as “business expenditure”. Such loss should, however, be taken into account in any other business consisting of speculative transactions. The Tribunal took the correct view. We would, therefore, answer the question in the negative. The references are answered accordingly. The assessee is liable to pay costs. Hearing fee Rs. 250 (Rupees two hundred and fifty only).
R.N Misra, J.:— I agree.
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