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Citation Codes
Equivalent Citations
citation codes
Case Number
Judges
  • Rajagopalan
  • Rajagopala Ayyangar, JJ.
Acts
  • Rule 81(2) of the Defence of India Rules. Clause (4)
  • rule 81(4) of the Defence of India Rules
  • Section 66(1) of the Income-tax Act.
  • Customs Consolidation Act 1876,
  • Majesty.4. Rule 10
  • order.3. Rule 7
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Cites
Cited by
Citation Codes
Equivalent Citations
citation codes
Case Number
Judges
  • Rajagopalan
  • Rajagopala Ayyangar, JJ.
Acts
  • Rule 81(2) of the Defence of India Rules. Clause (4)
  • rule 81(4) of the Defence of India Rules
  • Section 66(1) of the Income-tax Act.
  • Customs Consolidation Act 1876,
  • Majesty.4. Rule 10
  • order.3. Rule 7
See more information ...
Smart Summary

Judgment Summary — Rajagopala Ayyangar, J. (Reference under Section 66(1) of the Income‑tax Act)

Factual and Procedural Background

This is a reference under Section 66(1) of the Income‑tax Act asking whether a loss of Rs. 9,720 is an admissible deduction in computing the assessee's total income for the 1948–1949 assessment year (account year ended 31‑3‑1948).

The assessee is a firm engaged in the manufacture and sale of band room cloth. The Government of Madras, by the Madras Cotton Cloth and Apparel Export Control Order, 1946 (promulgated under Rule 81(2) of the Defence of India Rules), required permits to transport cloth outside the Province and provided for penalties and possible forfeiture for contraventions.

For the year ending 31‑3‑1947 the assessee obtained a permit to export 200 yards but sold 9,762 yards in contravention of that permit. The Textile authorities detected the attempted export, seized the goods, and the partners were prosecuted and convicted by the Chief Presidency Magistrate, Egmore. The Magistrate ordered confiscation of the 9,762 yards and directed disposal by the Provincial Textile Commissioner, deducting 10% of sale proceeds for Government and costs, and returning the balance to the company.

The Provincial Textile Commissioner caused sales (the assessee also effected part of the sale) and realised Rs. 7,962-10-9. After deducting 10% and costs totalling Rs. 875-12-9, the Government paid Rs. 7,086-14-0 to the assessee.

The assessee had earlier credited Rs. 16,806-12-0 as sale proceeds in its books for the prior year. In the relevant accounting year the assessee credited himself with the moneys received from the Government and claimed the difference between Rs. 16,806-12-0 and Rs. 7,086-14-0 as a loss.

The Income‑tax Officer disallowed the loss on the ground that the sales leading to the loss were not in the usual course of business and were necessitated by the assessee's illegal act; the Appellate Assistant Commissioner confirmed the disallowance. The Tribunal also confirmed the disallowance, relying on this Court's decision in Mask and Co. v. Commissioner of Income‑tax (AIR 1943 Mad 670).

Legal Issues Presented

  1. Whether the claimed loss of Rs. 9,720 is an admissible deduction in computing the assessee's total income for the 1948–1949 assessment year.
  2. More specifically, having excluded the sum representing the confiscated 1/10th and the costs (which together amounted to Rs. 875-12-9), whether the remaining loss of Rs. 8,844 — arising from the sale of the 9/10ths of the goods — is a "contemplable" trading loss deductible in the course of trade.

Arguments of the Parties

Revenue / Commissioner and Lower Authorities

  • The Income‑tax Officer: the sales that resulted in the claimed loss were not sales in the usual course of business and were necessitated by the assessee's illegal act; therefore the loss was inadmissible.
  • The Appellate Assistant Commissioner: confirmed the Income‑tax Officer's disallowance (no additional detailed arguments recorded in the opinion).
  • The Tribunal: held the loss, although connected with the trade, was incidental to it and inseparable from the penalty imposed; relied on this Court's decision in Mask and Co. v. Commissioner of Income‑tax to disallow the deduction.
  • Representatives for the Commissioner (as stated in the judgment): urged that the loss resulted from a sale effected "in invitum" and thus could not be considered a commercial transaction; suggested that the loss arising incidentally from enforcement of the penalty should be deemed part of the penalty.

Assessee

  • The assessee treated the sums received from the Provincial Textile Commissioner as business receipts and computed the loss on that basis (crediting initial sale price in prior year and claiming the shortfall when amounts paid by Government were received).
  • It was pointed out (by the assessee's counsel) that at least part of the goods remained the assessee's property and that a portion of the sales (99 pieces) was effected by the assessee himself; the character of the receipts and the trading nature of the transactions were therefore asserted.
  • Counsel for the assessee did not contest the correctness of the Mask's case ruling but contended that the principle in that decision did not dispose of the present point concerning loss on the portion of goods not confiscated.

Table of Precedents Cited

Precedent Rule or Principle Cited For Application by the Court
Mask and Co. v. Commissioner of Income‑tax, AIR 1943 Mad 670 Principle that penalties or damages for unlawful acts are not deductible as business losses; applied the test that a deductible loss must be "contemplable and in the nature of a commercial loss". The Tribunal relied on this decision to support disallowance. The Court accepted the correctness of Mask's case but held that it did not decide the specific issue whether loss on the non‑confiscated portion (after sale) was a contemplable trading loss; the Court therefore distinguished the present facts and determined the matter on principle.
Inland Revenue Commissioners v. Warnes & Co., 1919‑2 K.B. 444 (Rowlatt, J.) Formulated the test that a loss connected with or arising out of a trade should be "a loss which is contemplable and in the nature of a commercial loss". The Court adopted this test (as adopted in Mask's case) when considering whether the loss was a commercial/trading loss and whether parts of it were not deductible as penalties.
Inland Revenue Commissioners v. Von Glenn, 1920‑2 K.B. 553 Upheld the view that penalties imposed for breach of statutory orders/proclamations are not deductible as business losses. The Court noted this decision as supporting the general principle that penalties are not deductible, but observed that these authorities did not address the distinct point of loss on the portion of goods not confiscated and sold, which had to be decided on principle in the present case.

Court's Reasoning and Analysis

The Court proceeded by identifying the precise components of the claimed loss and separating those components which were clearly not deductible (the portion representing the confiscated 1/10th and the costs). The Court accepted the arithmetic: the full shortfall between Rs. 16,807 (sale price credited) and Rs. 7,087 (amount actually paid to the assessee) was Rs. 9,720, and after excluding the 10% and costs (Rs. 875-12-9) the maximum claimed trading loss left was Rs. 8,844.

The Court considered binding authorities (Mask's case and the English decisions cited therein) which hold that penalties for breaches of law are not deductible because they are not "contemplable" commercial losses. The Court accepted those authorities and the general test that a deductible loss must be a "contemplable" commercial loss.

The Court then analysed whether the remaining loss of Rs. 8,844 (i.e., the loss arising from sale of the 9/10ths not confiscated) fell within that commercial loss test or whether it should be treated as inseparable from the penalty.

On the facts the Court observed: (a) the 9/10ths of the goods remained the assessee's property because the confiscation did not extend to them; (b) part of those goods (99 pieces) were sold by the assessee himself, indicating the sales were at least in part on his account; and (c) even if the Government sold the goods in pursuance of the Magistrate's order, the proceeds paid over to the assessee were properly characterisable as business receipts rather than as non‑business windfalls or purely penal receipts.

The Court rejected the Revenue's contention that a sale "in invitum" could not be commercial and held that the proprietary and business character of the transaction, and the nature of the receipt, are determinative. The Court reasoned that if the sale of the 9/10ths had produced a profit, that profit would clearly have been a business receipt; symmetry required that a loss on the same sale be treated as a trading loss, subject only to the portion that was itself a confiscation/penalty.

The Court further held that the particular form of the Magistrate's order — confiscation of a portion of the sale proceeds rather than confiscation of a portion of the goods "in specie" — could not alter the substantive character of the loss on the retained portion. Finally, it rejected the suggestion that the Magistrate's direction as to the manner of enforcement should be read as imposing an additional punishment making incidental losses part of the penalty.

Applying these principles, the Court concluded that the portion of the loss attributable to confiscation and sale costs (Rs. 875-12-9) was not deductible, but the remaining Rs. 8,844 was a trading loss "contemplable and in the nature of a commercial loss" and therefore deductible in computing the assessee's income for the assessment year.

Holding and Implications

Holding:

Reference answered in favour of the assessee to the extent that Rs. 8,844 is a deductible trading loss.

Consequential orders recorded in the judgment:

  • The assessee is entitled to costs; counsel's fee of Rs. 250 was awarded.

Implications:

The direct effect of the decision is that the assessee may deduct Rs. 8,844 as a trading loss for the relevant assessment year; the portion of the loss representing the confiscated 1/10th of sale proceeds and sale costs (Rs. 875-12-9) remains non‑deductible as part of the penalty/confiscation. The Court did not purport to create a broader legal precedent overturning the established principle that penalties are not deductible; rather, it distinguished those authorities on the facts and applied the established test to recognise that a loss arising from the sale of goods remaining the assessee's property may be a deductible trading loss even where the disposal was under a confiscation order.

Show full summary ...

    M.V.G. Baluswamy Iyer v. Commissioner Of Income-Tax

    The Judgment of the Court was delivered by

    Rajagopala Ayyangar, J.:— This is a reference under Section 66(1) of the Income-tax Act. The question referred for our decision is:

    “Whether the loss of Rs. 9,720 is an admissible deduction in computing the total income of the assessee for 1948-1949 assessment year?”

    2. It is necessary to set out a few facts to understand the question at issue. The assessee is a firm carrying on business in the manufacture and sale of band room cloth, and the present assessment proceedings relate to the assessment year 1948-1949, the account year being 1st which ended on 31-3-1948. On 14-3-1946 the Government of Madras promulgated the Madras Cotton Cloth and Apparel Export Control Order, 1946, under Rule 81(2) of the Defence of India Rules. Clause (4) of this order provided:

    “No person shall on or after 19-2-1946 transport or cause to be transported cloth or apparel from any place within the limits of the Province of Madras to any place in India outside the said limits except under and in accordance with the terms and conditions of a permit issued by the Commissioner under this order”.

    3. Rule 7 provided that the holder of the permit issued under the order above mentioned should be bound by the provisions of the order and the conditions specified in the permit. Under rule 81(4) of the Defence of India Rules any person contravening any order made under that rule was liable to imprisonment for a term which might extend to three years or with fine or with both and

    “if the order so provides any court trying such contravention may direct that any property in respect of which the court is satisfied that the order has been contravened shall be forfeited to His Majesty”.

    4. Rule 10 of this order made provision for this, forfeiture and confiscation in these terms:

    “Any cloth or apparel in respect of which any of the provisions of this order has been contravened shall be liable to be forfeited to His Majesty and such forfeiture may be adjudged by a Collector on a claim under sub-r. 3(d) or by a court under sub-r. (4) of R. 81 of the Defence of India Rules”.

    5. For the year ending 31-3-1947 the assessee obtained a permit to export 200 yards of cloth, but without regard to the limit of this permit he-sold to a party in Amritsar 9762 yards of cloth at a sale price of Rs. 16,807. When the assessee attempted to export this quantity in contravention of his permit, this was detected by the Textile authorities and the goods were seized. The assessee was prosecuted in the Court of the Chief Presidency Magistrate, Egmore.

    6. The Magistrate found the partners guilty of the offence with which they were charged and convicted them. In awarding the sentence the Magistrate took into account the fact that some of the partners of the firm had not taken any prominent part in the commission of the offence and therefore sentenced them to varying amounts of fine. In addition he passed an order in regard to the 97CO yards seized by the Textile authorities in these terms:

    7. The cloth 9762 yards will be confiscated “and placed at the disposal of the Provincial Textile Commissioner who will dispose of it in the manner he considers most appropriate and after deducting ten per cent of the sale price which will go to the Government the balance of the sale proceed will be returned to the accused's company”.

    8. In pursuance of this order of the Magistrate the Textile Commissioner utilised the services of the assessee to dispose of 99 pieces and himself effected a sale of the balance of 828 pieces. The total of the sums realised by the two sales thus effected was Rs. 7,962-10-9. The Government deducted therefrom ten per cent of the sale proceeds and costs and expenses of the sale amounting in all to Rs. 875-12-9 and paid the assessee the balance of Rs. 7,086-14-0.

    9. The assessee who kept his accounts on the mercantile basis had calculated the profits of the previous year in which the sale to Amritsar merchant had been effected, by taking credit for a sum of Rs. 16,806-12-0 as representing the price of goods sold. In the year of account with which this reference is concerned what the assessee did was this. He credited himself with the moneys received from the Government and claimed the difference between Rs. 16,806-12-0 and what was paid to him namely Rs. 7,086-14-0 as the loss incurred by him in the accounting year.

    10. The Income-tax Officer held that the sales which resulted in the loss claimed were not sales in the usual course of business and that as they were necessitated by reason of the illegal act of the assessee, the loss was inadmissible on the broad proposition, that it was the result of the illegal action of the assessee and so it could not be allowed. This was confirmed by the Appellate Assistant Commissioner on appeal.

    11. The Tribunal confirmed this disallowance on further appeal to them, for the reason that the loss though connected with the trade was incidental to it and that it was inseparable from the penalty which was imposed upon the assessee. They considered that the present case was concluded against the assessee by the decision of this court in — ‘Mask and Co., v. Commissioner of Income-tax’, Madras, AIR 1943 Mad 670 (A). The question for our consideration is where this disallowance is correct.

    12. Learned counsel for the assesse did not contest the correctness of the ruling of this court in — ‘Mask's case (A)’ nor the reasoning upon which that decision was rested. The deduction, that was claimed in the ‘Mask's case (A), and which was disallowed by this court consisted of damages paid by the assessees for breach of contract by reason of their selling goods at lower rates than they were bound to sell. The damages payable were assessed by the court at Rs. 5,000 and this with costs incurred by the assessees came to Rs. 6,203.

    13. In negativing the right of the assessees to deduct this under Section 10(2)(xv) of the Act this court adopted the test laid down by Rowlatt, J. in Inland Revenue Commisioners v. Warnes and Co., 1919-2-K.B. 444 (B) that a loss connected with or arising out of a trade should amount to “a loss which is contemplable and in the nature of a commercial loss”. In the case before Rowlatt, J. the assessees who were oil exporters were sued, for a penalty under the Customs Consolidation Act 1876, and that action was compounded on the assessees agreeing to pay a sum of 22,000 and costs, and the question debated was whether this sum comprising the penalty and costs was a loss connected with or arising out of a trade or business.

    14. The learned Judge negatived the assessee's claim for deduction. This view of Rowlatt, J. was upheld by the Court of Appeal in — ‘Inland Revenue Commissioners v. Von Glenn’, 1920-2-K.B. 553, (C), where also the deduction claimed was a penalty imposed upon the assessees for breach of orders and of a proclamation issued under statutory provisions. But the question still remains whether the entirety of the loss claimed by the assessee in the present case could be disallowed on the principle of ‘Mask's case (A)’. The problem that arises for our consideration is whether the principle that penalties imposed for breaches of the law are not “contemplable” losses and so not deductible could be extended to losses representing not the confiscation effected or the penalty or fine imposed but arising incidentally by the manner in which the confiscation was directed to be enforced.

    15. The loss of Rs. 9,720 claimed, it would be seen, is computed on the basis of the difference between Rs. 16,807 the sale price credited in the account in the previous year and Rs. 7,087 the amount paid to the asessee by the Government. Even accepting the contention of the assessee, he would not be entitled to claim the entirety of this sum since it includes the diminution in value caused by the confiscation ordered.

    16. The sum representing the value of 1/10 confiscated and the costs incurred in effecting the sales came to Rs. 875-12-9 and the assessee would not be entitled to claim this as a loss. Learned counsel for the assessee did not dispute this position, that he would not in any event be entitled to claim more than Rs. 8,844 as loss.

    17. The question is whether this loss of Rs. 8,844 which arose by reason of the sale of the 9/10th of the goods not ordered to be confiscated was a “contemplable loss” in the course of trade.

    18. It is clear that neither the decision in ‘Mask's case (A)’ nor that of Rowlatt, J. and of the Court of Appeal which were followed in ‘Mask's case (A)’ touch the point arising in relaation to the loss on the goods not confiscated, and this was not disputed by Mr. Rama Rao Sahib learned counsel for the Commissioner and the matter has therefore to be determined on principle.

    19. The first point urged by learned counsel for the Commissioner was that this loss resulted from a sale effected ‘in invitum’ which could not be considered as a commercial transaction. In our opinion this is neither correct nor determinative of the question. In the first place what was the character in which the sales were effected;i was it or was it not on behalf of the assessee?

    20. The 9/10 of the goods remained the property of the assessee, for the forfeiture or the confiscation did not extend to them, and we have the further fact that a portion of these sales in respect of 99 pieces was effected by the assessee himself. This would point to the other sales also being on his account, but we do not propose to rest our decision on this basis.

    21. Even conceding that the sales were effected by Government in their own right in pursuance of the orders of the Magistrate, it does not necessarily follow that the sales might not result in a commercial loss. The more important aspect is to examine whether the money paid over to the assessee by the Government was or was not a business receipt or a receipt in the course of business. The assessee has so treated it and has computed his loss on that basis.

    22. If the argument advanced on behalf of the Commissioner were accepted, this receipt from the Provincial Textile Commissioner ought to be eliminated from the credit side in the assessee's books and learned counsel for the Commissioner frankly stated that this would be the logical result of the acceptance of his argument.

    23. We are however of the opinion that the receipt in question was a business receipt and was properly entered as such by the assessee. The nature of the receipt is dependent neither on the quantum nor on the financial result of the sale. Nor in the circumstances of this case is it affected by the fact that the sale effected was controlled by the Provincial Commissioner.

    24. If for instance prices had risen and the sale of 9/10 of the goods had resulted in a profit, the sale proceeds would have constituted a business receipt. The profit could not have been treated as a windfall resulting from the order of confiscation of 1/10 of the goods. That the assessee sustained a loss would not alter the nature of the receipt of the sale proceeds.

    25. It would follow that there was a trading loss satisfying the tests formulated by learned counsel for the Commissioner. To the extent to which the Magistrate directed the confiscation to proceed, the loss was not contemplable and so not a commercial loss in the course of trade. The order of confiscation might have taken the form of a return to the assessee of 9/10th of his goods & a confiscation of the ether 1/10th.

    26. In such a case there would be no room for controversy that any loss incurred by the assessee in the sale of the 9/10th returned to him would be a trading loss. The form of the order of the Magistrate viz., a confiscation of a portion of the sale proceeds cannot make a difference in principle from a confiscation of a 1/10th of the goods in ‘specie.’

    27. Mr. Rama Rao Sahib faintly suggested that the loss incurred by the assessee in the present case arose incidentally out of the enforcement of the penalty imposed by the Magistrate and should therefore be deemed part of the penalty. In other words, the suggestion was that the Magistrate must be deemed to have inflicted a further punishment by his direction as regards the manner in which the confiscation should be enforced in addition to the confiscation ordered. We are unable to consider this as any reasonable deduction from or construction of, the order of the Magistrate. In our opinion the loss sustained by the assessee to the extent of Rs. 8,844 is a trading loss which is deductible in computing the income of the assessee for the assessment year. The reference is therefore answered in favour of the assessee to the extent stated above. The assessee is entitled to his costs. Counsel's fee Rs. 250.

    D.H.Z

    28. Answer accordingly.

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    Comments

    M.V.G. Baluswamy Iyer v. Commissioner Of Income-Tax
    (Apr 27, 1955)