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J.N Singh & Co. Private Ltd. v. Commissioner Of Income-Tax, New Delhi
Factual and Procedural Background
The Income-tax Appellate Tribunal (Delhi Bench) referred the following question under section 66(2) of the Indian Income-tax Act, 1922 for the court's opinion: whether Rs. 10,000 spent by the company in defending successfully its Bombay branch manager against charges of criminal breach of trust (section 406, Indian Penal Code) arising from a transaction in the normal course of the company's business was an expenditure "wholly and exclusively" for the company's business and therefore deductible under section 10(2)(xv) of the Income-tax Act, 1922.
The assessee is a private limited company carrying on the business of importing and selling newsprint and other paper. The head office was at Delhi and a branch in Bombay, managed by Ranbir Singh. In 1941 a quota allotment certificate held by Mauj Printing Bureau was handed to the assessee for import and collection of newsprint. The newsprint arrived from Canada but was not delivered to Mauj Printing Bureau; instead the company sold the paper and recorded the sale proceeds. Mauj Printing Bureau prosecuted the Bombay branch manager, Ranbir Singh, for criminal breach of trust under section 406 IPC. He was initially convicted (rigorous imprisonment three months and fine Rs. 1,000) but was later acquitted on appeal to the Bombay High Court.
The company incurred Rs. 10,000 in defending the manager and claimed it as a deduction under section 10(2)(xv). The Income-tax Officer disallowed the deduction, citing the decision in Commissioner of Income Tax, West Bengal v. Mr H. Hirjee [1953] 23 I.T.R. 427. The Appellate Assistant Commissioner allowed the deduction, holding that the manager's actions were in the normal course of business and the company was justified in arranging his defence. The Income-tax Appellate Tribunal (Delhi Bench), relying on the Supreme Court's observations in H. Hirjee, reversed the Appellate Assistant Commissioner. The question was referred to this court, which delivered the present opinion.
Legal Issues Presented
- Whether the legal expenses of Rs. 10,000 incurred by the company in defending successfully the Bombay branch manager, against charges of criminal breach of trust levelled by a customer in respect of a transaction arising in the normal course of the company's business, were an expenditure laid out wholly and exclusively for the purpose of the company's business and therefore a permissible deduction under section 10(2)(xv) of the Indian Income-tax Act, 1922?
Arguments of the Parties
Appellant / Assessee (as represented in the proceedings)
- The company claimed Rs. 10,000 as a deduction under section 10(2)(xv) for legal expenses incurred in defending the branch manager.
- The Appellate Assistant Commissioner accepted the contention that the newsprint transaction was carried out in the normal course of business and that, because the prosecution questioned the actions of a trusted employee, the company was justified in arranging for his defence to protect the business.
Revenue / Income-tax Officer and Department
- The Income-tax Officer disallowed the deduction, stating (in his own words) that "the sum spent in defending the criminal proceedings cannot be said to have been laid out wholly and exclusively for the purpose of the business," relying on the decision in Commissioner of Income Tax, West Bengal v. Mr H. Hirjee [1953] 23 I.T.R. 427.
- Before this court, Mr. H. Hardy for the department relied on the Supreme Court decision in Commissioner of Income-tax v. H. Hirjee and on the Rangoon decision in Commissioner of Income-tax v. Gasper and Company to support the disallowance.
Table of Precedents Cited
| Precedent | Rule or Principle Cited For | Application by the Court |
|---|---|---|
| Commissioner of Income Tax, West Bengal v. Mr H. Hirjee [1953] 23 I.T.R. 427 | Considered whether legal expenses incurred in defending a person (owner of business) in criminal prosecution arising out of business activities could be deducted; observed that deductibility depends on the nature and purpose of the proceeding and that a distinction based solely on success or failure of defence is not sound. | The Tribunal relied on this Supreme Court decision to reverse the Appellate Assistant Commissioner's allowance. The present court discussed H. Hirjee, noted its rejection of a distinction based purely on the final outcome of proceedings, and treated its principles as distinguishable on the facts when the expenditure is incurred to defend an employee rather than the owner. |
| J.B. Advani & Co. Ltd. v. Commissioner of Income-tax and Excess Profits Tax (Bombay High Court) [referred to in text, Advani's case] | Held that litigation costs protecting a business asset in civil litigation are ordinarily deductible; in criminal prosecutions the appropriate test (when prosecution ends in acquittal) is whether the transaction was in the ordinary course of business, whether the accused was charged in his capacity as a trader, and whether the primary object of incurring the expense was to protect the business's good name. | The present court found the view expressed in Advani's case to be the correct guide for the facts before it and relied on it to hold that the company's expenditure in defending its manager was deductible under section 10(2)(xv). |
| Commissioner of Income-tax v. Gasper and Company (the Rangoon case) | In the Rangoon case the partners (who were the assessees) were prosecuted and defended themselves; the court took the view that part of the object was to defend themselves against possible adverse consequences of conviction, and therefore the expenditure could not be said to be wholly and exclusively for the purposes of the business. | The present court distinguished this case on its facts: because the prosecuted persons in Gasper & Co. were the very assessees (partners) defending themselves, the expenditure had a personal element; this distinction made the Rangoon case inapplicable to the present facts where the company defended its employee. |
Court's Reasoning and Analysis
The court first set out the factual matrix: a criminal prosecution under section 406 IPC was launched against the company's Bombay manager in relation to a transaction that arose in the ordinary course of the company's business; the manager was eventually acquitted and the company incurred Rs. 10,000 in his defence, which it claimed as a deduction under section 10(2)(xv).
The court then examined relevant precedent law to determine the correct legal test. It reviewed the Bombay High Court decision in J.B. Advani & Co. Ltd., where the court drew a distinction in criminal cases between (a) prosecutions resulting in conviction (where costs would not be allowed) and (b) prosecutions resulting in acquittal (where deductibility could be allowed if the prosecution related to an ordinary business transaction, the accused was charged in his capacity as a trader, and the primary object of incurring the expense was to protect the business's good name). The Supreme Court's consideration of that view in Commissioner of Income-tax v. H. Hirjee was then examined.
The Supreme Court in H. Hirjee accepted that the deductibility inquiry must depend on the nature and purpose of the proceeding in relation to the business and observed that a rigid distinction based solely on the success or failure of defence was not sound. The Supreme Court also noted difficulties in treating expenses of an owner defending a criminal prosecution as "wholly and exclusively" for business purposes where the defence necessarily protects the individual's personal interest (fear of fine or imprisonment).
Drawing these authorities together, the court articulated and applied a key factual distinction: expenses incurred by the owner of a business in defending himself in a criminal prosecution are different in character from expenses incurred by an owner in defending an employee prosecuted for acts done in the ordinary course of the business. Where the expenditure is incurred by the business to protect the business's good name by defending an employee prosecuted in respect of an ordinary business transaction, such expenditure can be said to be "wholly and exclusively" for the purposes of the business and therefore deductible under section 10(2)(xv).
The court contrasted this with the Rangoon (Gasper & Company) decision where the partners themselves (the assessees) were prosecuted and incurred expense partly to defend themselves personally; in that factual setting the expenditure was held not to be wholly and exclusively for business purposes. Thus, the court distinguished the authorities relied upon by the department (H. Hirjee and Gasper & Company) on the facts and found that the correct precedent for the present facts was the Bombay High Court's Advani decision.
On this basis the court concluded that the Appellate Assistant Commissioner was right to allow the deduction and that the Income-tax Appellate Tribunal had erred in disallowing it.
Holding and Implications
HOLDING: The question referred was answered in the affirmative. The court held that the legal expenses of Rs. 10,000 incurred by the company in defending its Bombay branch manager (an employee) in criminal proceedings arising out of an ordinary business transaction were an expenditure laid out wholly and exclusively for the purposes of the company's business and therefore a permissible deduction under section 10(2)(xv) of the Indian Income-tax Act, 1922.
Direct implications for the parties: The Appellate Assistant Commissioner's allowance of the Rs. 10,000 deduction was correct; the Income-tax Appellate Tribunal's contrary decision was erroneous. The court made no order as to costs.
Broader implications: The opinion applies and clarifies existing authority by distinguishing cases where the prosecuted persons are the owners/assessees (where personal interest may render the expenditure not wholly and exclusively for business) from cases where a business defends an employee prosecuted for acts in the ordinary course of business (where the expense may be deductible). The opinion itself does not purport to lay down a new general rule beyond this factual application.
D.K Mahajan, J.:— The following question of law has been referred by the Income-tax Appellate Tribunal (Delhi Bench) under section 66(2) of the Indian Income-tax Act, 1922, for our opinion:
“Whether the legal expenses of Rs. 10,000 incurred by the company in defending successfully the Bombay branch manager, against charges of criminal breach of trust levelled by one of the customers in respect of a transaction which arose in the normal course and entirely out of the business of the company were an expenditure paid out wholly and exclusively for the purpose of the company's business and a permissible deduction under section 10(2)(xv) of the Indian Income-tax Act, 1922?”
2. The assessee is a private limited company and the dispute concerns the assessment year 1952-53, the period of account ending 30th June, 1951. The assessee's business is of import and sale of newsprint and other kinds of paper. The head office of the company is at Delhi while the branch office is in Bombay. Ranbir Singh was the manager of the Bombay branch. In the year 1941, paper for newsprint was issued on basis of quota allotment certificates to newspapers. One Mauj Printing Bureau had received the quota allotment certificate by the end of August, 1941. According to the procedure prevailing, the certificate was handed over by the quota-holder to the assessee for import and collection of paper. The newsprint duly arrived from Canada but was not delivered to the Mauj Printing Bureau, but instead, was sold by the company and the sale proceeds were recorded in the books of the company. Mauj Printing Bureau initiated criminal proceedings against the manager of the assessee's branch for criminal breach of trust under section 406 of the Indian Penal Code in Bombay. Ranbir Singh was sentenced to undergo rigorous imprisonment for three months and a fine of Rs. 1000. Against this decision, Ranbir Singh successfully preferred an appeal to the Bombay High Court and was acquitted. The company incurred an expenditure of Rs. 10,000 in defending Ranbir Singh. This amount was claimed as permissible deduction under section 10(2)(xv) of the Indian Income-tax Act, 1922, by the company. The Income-tax Officer disallowed this deduction for the reasons, which may be stated in his own words:
“For the reasons explained in Commissioner Of Income Tax, West Bengal v. Mr H. Hirjee [1953] 23 I.T.R 427 the sum spent in defending the criminal proceedings cannot be said to have been laid out wholly and exclusively for the purpose of the business.”
3. Against this order, the assessee went up in appeal to the Appellate Assistant Commissioner, who allowed the appeal and held the expenditure of Rs. 10,000 as a permissible deduction. While dealing with the matter, the Appellate Assistant Commissioner made the following observations:
“In my opinion, the contention of the appellant is correct. As stated above, the newsprint which was actually imported was sold by the company on its own account. The judgment of the High Court clears the Bombay manager of the charge of criminal breach of trust. The resultant position, therefore, is that whatever the manager did was in the normal course of business. Since a serious charge was brought against a trusted employee of the company questioning his action, the company was justified in arranging for his defence.”
4. The Income-tax Officer was dissatisfied with the Appellate Assistant Commissioner's decision and preferred an appeal to the Income-tax Appellate Tribunal (Delhi Bench). The Tribunal relying on the observations of the Supreme Court in Commissioner of Income-tax v. H. Hirjee, reversed the decision of the Appellate Assistant Commissioner.
5. In the present case, it is abundantly clear that the criminal prosecution was launched against an employee of the company with regard to a transaction pertaining to the business of the company or, in other words, for a transaction carried out by the company in its ordinary course of business. Its manager was proceeded against under section 406 of the Indian Penal Code. The question then arises: Is the company entitled to claim the expenditure incurred by it in defending its manager? On this matter, there is a direct decision of the Bombay High Court in J.B Advani & Co. Ltd. v. Commissioner of Income-tax and Excess Profits Tax.2 Chagla C.J, who delivered the judgment of the court, after making a review of authorities, observed as follows:
“…………… that there is no difficulty in the class of cases where an asset of a business is protected or safeguarded by the assessee carrying on the business in a civil litigation. The costs of such litigation are always a permissible deduction. The difficulty only arises when you have a criminal prosecution. There again where a criminal prosecution ends in a conviction there is no difficulty because the assessee who is guilty of a breach of the law cannot be heard to say that the costs of the litigation against him was a permissible deduction because the commission of an offence was not necessary for the purposes of his trade. The real difficulty only arises when you have a case where the prosecution terminates in acquittal. Then the true test to be applied as I suggested would be whether the assessee was charged with regard to a transaction which took place in the ordinary course of business and the other test would be whether he was charged in his capacity as a trader. If these two tests are satisfied and the court comes to the conclusion that the primary object of incurring the expenditure was to protect the good name of the business then it could be said that the expenditure was wholly and exclusively for the purposes of business.”
6. This decision was considered by the Supreme Court in Commissioner of Income-tax v. H. Hirjee. The view of the Bombay High Court in that case—a case of criminal prosecution of an employee engaged in the ordinary course of assessee's business—was considered. The correctness of the ultimate decision was not doubted, the ultimate decision being that an expense incurred by the owner of the business in defending its employee in a criminal prosecution arising in the course of its business is a permissible deduction under section 10(2)(xv). But, however, the distinction drawn by the Bombay High Court, namely, that if the prosecution ends in conviction, the expenditure incurred in connection therewith is not a permissible deduction under section 10(2)(xv) of the Act, while if it results in acquittal, it is a permissible deduction, was not accepted as correct by their Lordships of the Supreme Court. In this connection, their Lordships observed as follows:
“Nor are we satisfied, as at present advised, that a distinction drawn in the Bombay case between the legal expenses of a successful and unsuccessful defence is sound. The deductibility of such expenses under section 10(2)(xv) must depend on the nature and purpose of the legal proceeding in relation to the business whose profits are under computation, and cannot be affected by the final outcome of that proceeding; Income-tax assessments have to be made for every year and cannot be held up until the final result of a legal proceeding, which may pass through several courts, is announced.”
7. In Commissioner Of Income Tax, West Bengal v. Mr H. Hirjee, their Lordships were dealing with an expense incurred by an owner of business in defending himself from criminal prosecution. While dealing with this type of case, their Lordships observed as follows:
“If, as the High Court realised, in every criminal prosecution where the matter is defended to protect the good name of a business or a professional man, the fear of possible fine or imprisonment must always be there, it must ordinarily be difficult for any court to say, that the expenses incurred for the defence, even if they are not to be regarded as the ‘personal expenses’ of the person accused, constituted ‘expenditure laid out or expended wholly and exclusively for the purposes of the business’. Learned counsel for the respondent frankly admitted that he was not able to find a single case in the books where the expenses incurred by a person exercising a trade or profession in defending a criminal prosecution, which arises out of his business or professional activities, were allowed to be deducted in the assessment of his profits or gains for income-tax purposes.”
8. It, therefore, follows from what has been stated above that the expenses incurred in defending a criminal prosecution arising in the course of business can only be allowed as a permissibe deduction, where they are incurred in defending an employee of the business, not the owner. In the case of an employee, such an expenditure is 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. In this situation, the expenditure would be wholly and exclusively for the purposes of the business. This distinction is well illustrated if the facts of the Bombay case and the, facts of the Rangoon case in Commissioner of Income-tax v. Gasper and Company are kept in view. In the Bombay case, it was the limited company which was spending money to defend its managing director and the salesman and the charge related to a transaction which took place in the ordinary course of the business of the company while in the Rangoon case, all the partners of a firm, who were the assessees, were prosecuted for an offence and they defended themselves against the offence charged. That is why, in the Rangoon case, the learned Chief Justice took the view that a part of the object while incurring the expenditure was to defend themselves (partners) from the possible adverse consequences of a criminal conviction, and, therefore, the expenditure could not be said to have been laid out wholly and exclusively for the purposes of such business.
9. Mr. H. Hardy, who appears for the department, relied on the Supreme Court decision in Commissioner of Income-tax v. H. Hirjee and the decision of the Rangoon High Court in Commissioner of Income-tax v. Gasper and Company. Both these decisions are clearly distinguishable and have no application to the facts of the present case. As already observed, the correct view, so far as the present case is concerned, is to be found in the decision of the Bombay High Court in Advani's case [1950] 18 I.T.R 557..
10. In this view of the matter, we are clearly of the view that the Appellate Assistant Commissioner was correct in his view that the legal expenses in this case were a permissible deduction under section 10(2)(xv), whereas the Income-tax Appellate Tribunal has clearly gone wrong in holding to the contrary. The question referred to us is, therefore, answered in the affirmative. There will be no order as to costs.
S.K Kapur, J.:— I agree.
12. Question answered in the affirmative.
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