Chandrachud, J.—The assessee, Messrs. Sassoon J. David & Co. (Private) Ltd., which was formed in 1922, carried on business in shares and securities and in cotton yarn. 25 per cent. of its shares were held by Sir Percival Victor David and the remaining 75 per cent. were held by a trust of which he was the sole beneficiary.
Sir Alwyn Ezra, who joined the company in 1925, was appointed a director in 1931 and was in sole charge of the business of the company from 1937 till 1945. He held a general power of attorney from the company as also from Sir Percival who was the only other director of the company and who, at all material times, resided out of India. Sir Alwyn Ezra held one share as a nominee of Sir Percival.
Between 15th March, 1945, and 1st December, 1945, Sir Alwyn Ezra withdrew a sum of Rs. 27½ lakhs from the company's account with the Bank of India Ltd., Bombay, and utilised that amount for purchasing two immovable properties for himself. In 1945, the disputes between him and the company, including the one over the embezzlement, were referred to an arbitrator who passed an award directing him to pay the amount to the company. Under the award, a mortgage was created on the two properties in favour of the company to secure the payment of the amount due to it. A decree was passed by this court in terms of the award on the 3rd of October, 1947. Later, the company brought the mortgaged properties to sale and purchased them with the permission of the court for Rs. 9 lakhs and Rs. 6 lakhs each.
Sir Alwyn Ezra was adjudicated insolvent in 1951. On the 31st of December, 1957, that is, at the close of the accounting year relevant for the assessment year 1958-59, the company wrote off the sum of Rs. 9 lakhs. In its revised return for that year, the company claimed the amount under the head "Bad debts". In its letter dated the 24th of April, 1959, to the Income-tax Officer, the company explained the circumstances in which the deduction was claimed stating that:
"It is clear from the above that the amount of Rs. 9,00,000 forming part of the above sum of Rs. 27½ lakhs is a loss necessarily incurred in carrying on the business and the company is entitled to claim this as a deduction. This amount also became irrecoverable according to the company in the year ended 31st December, 1957, a fact which has since been confirmed by the official assignee by his letter dated 17th April, 1958."
The income-tax authorities disallowed the claim both as a bad debt under section 10(2)(xi) and as a loss incidental to business under section 10(1) of the Indian Income-tax Act, 1922. By its judgment dated the 3rd of November, 1962, the Appellate Tribunal took the same view, rejecting in addition the claim under section 10(2)(xv) also.
Arising out of this dispute the Tribunal has referred the following question for our decision under section 66(1) of the Act t
"Whether, in computing the assessee's business income of the year 1957, relevant for the assessment year 1958-59, the sum of Rs. 9 lakhs is an admissible deduction either under section 10(1) or under section 10(2)(xv) or in any event as a bad debt under section 10(2)(xi) of the Indian Income-tax Act, 1922?"
The second question which the Tribunal has referred to us arises out of a different set of facts and that question is:
"Whether, in computing the assessee's business income of the account years 1957, 1958 and 1959, relevant for the assessment years 1958-59, 1959-60 and 1960-61, the sum of Rs. 16,885 is an admissible deduction under section 10(2)(xv) of the Act?"
Facts which lead to this question are these: In 1955, the company was negotiating for the transfer of its share capital and business to Messrs. Tata Sons Private Ltd. By a resolution dated January 25, 1956, the company decided to terminate the services of most of its employees, including its manager, A. E. Joseph, and to pay them retrenchment compensation. In regard to Joseph, the company decided to pay him an annuity of Rs. 16,885 for a period of five years.
An agreement of sale was executed on the 23rd of March, 1956, under which Messrs. Tata Sons Pvt. Ltd. agreed to purchase the share capital of the company for Rs. 155 lakhs. The business of the company, including its management, was to be vested in the purchasers. Under clause 5 of the agreement, the purchasers were to deduct from the purchase price the sum of Rs. 2,32,500 which the company had resolved to pay to its employees by way of compensation on termination of their services. This amount includes the annuity payable to A.E. Joseph.
The first instalment of the annuity was paid to Joseph in the assessment year 1957-58. We are concerned in this reference with the annuity payments made to him in the assessment years 1958-59, 1959-60 and 1960-61. The claim of the company that the amount is deductible under section 10(2)(xv) of the Act has been rejected by the income-tax authorities and by the Tribunal following the view taken by them in the orders pertaining to the year 1957-58. Briefly, they had held in those orders that the payment had no commercial purpose, that it was made merely to effectuate the agreement between the company and Messrs. Tata Sons Pvt. Ltd. and was, therefore, not admissible as a deduction.
The assessee had asked the Tribunal to refer to us two more questions covering a payment of Rs. 8,000 and, on its declining to do so, the assessee approached this court under section 66(2) of the Act. In accordance with the directions of this court, the Tribunal has submitted a statement of the case on the following question:
"Whether, with regard to the assessment year 1959-60, the Tribunal erred in law or acted without evidence in holding that the expenditure of Rs. 8,000 (rupees eight thousand) was not incurred wholly and exclusively for the purposes of the business?"
We will take up the second question first under which we are required to consider whether the instalments of annuity paid by the assessee-company to its manager, A.E. Joseph, in the assessment years 1958-59, 1959-60 and 1960-61 are admissible deductions under section 10(2)(xv) of the Act. The first instalment of annuity was paid to Joseph in the assessment year 1957-58 and the claim of the assessee for deduction of that amount was rejected by the income-tax authorities and the Tribunal. The judgment of the Tribunal was upheld by a Division Bench of this court (Mody, Acting C.J., & K.K. Desai J.) by its judgment dated the 5th of February, 1970, in Income-tax Reference No. 58 of 1963 [1972] 85 ITR 83 (Bom). It was held that the payment was made for the purpose of carrying out the obligations arising under the agreement of sale between the company and Messrs. Tata Sons Pvt. Ltd. and that it was not made for "commercial considerations and expediency". For these reasons, the learned judges came to the conclusion that the payment could not be deducted under section 10(2)(xv) of the Act. Following this judgment, we hold that the three annuity payments are not admissible deductions under section 10(2)(xv) of the Act.
Coming to the first question relating to the written off amount of Rs. 9 lakhs, it is necessary to look at some of the essential facts and to recapitulate the findings of the Tribunal.
The basic facts are that:
(i) At the material time the assessee-company was dealing in shares and securities, was acting as an agent for a textile company and an insurance company and had a business in cotton yarn; (ii) 25 per cent. of its share capital was held by Sir Percival Victor David; (iii) The remaining 75 per cent. of the share capital was held by a trust of which Sir Percival was the sole beneficiary; (iv) Sir Alwyn Ezra joined the company in 1925, became a director in 1931 and held one share as the nominee of Sir Percival; (v) Sir Percival and Sir Alwyn Ezra were the only two directors of the company; (vi) Sir Percival resided out of India at all material times; (vii) Under a general power of attorney dated the 1st of February, 1929, executed by the company in favour of Sir Alwyn Ezra the latter was authorised to manage the company's business, to deposit in the bank moneys which would come to his hands as an agent of the company, to withdraw the amounts standing to the credit of the company in its bank account and to invest the same in the name and for the benefit of the company; (viii) Sir Alwyn Ezra was in sole charge of the business from 1929 to 1943; (ix) He withdrew a sum of Rs. 27½ lakhs from the company's account with the Bank of India between 15th March and 1st of December, 1943, and utilised that amount for his private ends ; (x) He was adjudicated insolvent on 20th February, 1951, and that (xi) A sum of Rs. 9 lakhs from out of the amount embezzled by him was legitimately written off by the company at the close of the accounting year corresponding to the assessment year 1958-59.
These facts have all been accepted by the Tribunal as correct but it holds:
"The question undoubtedly is whether the withdrawal from the bank was de hors the business or was incidental to it and we consider that the decision in Curtis v. J. & G. Oldfield [1925] 9 TC 319 (KB) is applicable. It is difficult to agree with the assessee's counsel that Sir Alwyn Ezra was no more than a manager with large powers. It may be that Sir Alwyn Ezra was an outsider and not a member of Sir Percival David's family, but it is difficult to shut one's eyes to the facts of the case, and Sir Alwyn's withdrawals from the bank have to be held as more like a partner overdrawing his account with the firm than an agent embezzling the funds of his employer in the course of his duties. It is clear that Sir Alwyn's overdrawings have nothing to do with the trading activities of the firm. The case in Lord's Dairy Farm Ltd. [1955] 27 ITR 700 (Bom) can be distinguished easily because the position and powers of the defalcating cashier in that case are nowhere near those of Sir Alwyn Ezra. We hold, therefore, that the income-tax authorities were right in refusing to allow deduction of the sum of Rs. 9 lakhs under section 10."
The attention of the Tribunal was specifically drawn to the judgment of the Supreme Court in Badridas Daga v. Commissioner Of Income Tax [1958] 34 ITR 10 (SC) which directly bears on the point but it has overlooked the ratio of that judgment.
The Tribunal, in our opinion, has either erred or misdirected itself in every one of the three conclusions drawn by it in the passage just quoted. The embezzlement committed by Sir Alwyn Ezra cannot be likened to a partner overdrawing his account with the firm. Secondly, had the withdrawals been made during the course and for the purpose of the business of the company, there would be no embezzlement and, therefore, while considering the admissibility of the deduction of Rs. 9 lakhs, it is irrelevant that the particular withdrawal had nothing to do with the trading activities of the firm. Thirdly, the decision of this court in the case of Lord's Dairy Farm Ltd’s case (supra) cannot be distinguished on any matter of principle, not certainly on the ground that the position and powers of the defalcating cashier in that case are nowhere near those of Sir Alwyn Ezra.
As stated earlier, the decision of the Supreme Court in Badridas Daga's case (supra) is directly in point on the question whether the company can claim the sum of Rs. 9 lakhs as a trading loss. The assessee there was the sole proprietor of a firm which carried on business as money-lenders, dealers in shares, etc., in Bombay, Calcutta and other places. The assessee was a resident of Bikaner and managed his business at several places through agents. The agent of the firm at Bombay, who held the power of attorney conferring large powers of management on him, including the authority to operate bank accounts, withdrew from the firm's account sums aggregating to over Rs. 2 lakhs and applied them in satisfaction of his personal debts in speculative transactions. A small amount was recovered by the assessee under a decree passed against the agent and the balance of Rs. 2 lakhs odd was written off. The Tribunal as well as the High Court relied on the decision in Curtis v. J. & G. Oldfield [1925] 9 TC 319 (KB) and held that the amount embezzled by the agent was not a trading loss and could not, therefore, be allowed. The Supreme Court reversed the decision of the High Court and held that though the loss could not be claimed under section 10(2)(xi) or section 10(2)(xv) of the Act, viewing the question as a businessman would, it was difficult to maintain that the loss did not arise out of the carrying on of the business and was not incidental to it. The loss could, therefore, be claimed under section 10(1).
In coming to this conclusion, the Supreme Court applied the following tests:
"(1)When a claim is made for a deduction for which there is no specific provision in section 10(2), whether it is admissible or not will depend on whether, having regard to accepted commercial practice and trading principles, it can be said to arise out of the carrying on of the business and to be incidental to it. If that is established, then the deduction must be allowed, provided of course there is no prohibition, express or implied, against it;
(2)If employment of agents is incidental to the carrying on of the business, it must logically follow that losses which are incidental to such employment are also incidental to the carrying on of the business; and
(3)The loss for which a deduction could be made under section 10(1) must be one that springs directly from the carrying on of the business and is incidental to it and not any loss sustained by the assessee, even if it has some connection with his business."
The assessee before us is not a private individual who may or may not employ an agent to carry on his business, depending on the extent and exigencies of that business, but the assessee is a company which cannot act in its own person, for it has no physical personality. It can only act through an agent, be he the director or any one else. Then again, the share capital of the company was held partly by Sir Percival David and partly by the trust for his benefit. Sir Percival who was also a director of the company was at all material times residing out of India and, therefore, there was no option for the company save to appoint an agent for carrying on its business activities in India. The employment of an agent was, therefore, incidental to the carrying on of its business in India.
Sir Alwyn Ezra joined the company in 1925 and on February 9, 1929, the company executed a general power of attorney in his favour authorising him, inter alia, "to deposit moneys in the company's account with the bank and to withdraw any moneys now standing or hereafter standing on deposit in the name of the company at any bank". Such moneys were to be employed by the attorney "in or about any of the purposes mentioned in these presents or otherwise for the use and benefit of the company" or the attorney was to "invest the same in the name of the company in any such stock, shares, funds or securities" as he thought proper.
The company was doing business in the sale of shares and securities and in cotton yarn. It was also acting as an agent for a textile concern and an insurance company. The nature of this business, particularly the business in sale of shares and securities, was such that large moneys which would come into the hands of the company would be required to be deposited in the bank and to be withdrawn from the bank from time to time. A continuous operation on the bank account was, therefore, a necessary incident of the business and the agent had to be authorised to operate on that account.
The company appointed Sir Alwyn Ezra as agent for its business in 1929, which was four years after he joined the company. In 1931, he became a director of the company but that did not affect his position as an agent of the company one way or the other. He discharged his duties honestly and faithfully till 1943—in any case there is nothing to indicate to the contrary. In 1943, he embezzled a large amount during a span of about nine months. He withdrew the amount as if the withdrawal was for the purpose of the business of the company and then pocketed it. In other words, he withdrew the amount in the purported exercise or under colour of authority conferred upon him by the power of attorney and misappropriated it. In these circumstances, it seems to us clear that the loss to the company arose out of the carrying on of its business and is incidental to it. As observed by the Supreme Court in Badridas Daga's case (supra) :
"Human nature being what it is, it is impossible to rule out the possibility of an employee taking advantage of his position as such employee and misappropriating the funds of his employer, and the loss arising from such misappropriation must be held to arise out of the carrying on of business and to be incidental to it."
That the loss was actual and present and was caused in the relevant year of account is not in dispute.
It is urged on behalf of the department that the rule in Badridas Daga's case (supra) should be restricted to cases of banking business, because while distinguishing the judgment in Curtis v. J. & G. Oldfield [1925] 9 TC 319 (KB), the Supreme Court observed :
"But, here, we are dealing with a banking business, which consists in making advances, realising them and making fresh advances, and for that purpose, it is necessary not merely to deposit amounts in banks but also to withdraw them. That is to say, a continuous operation on the bank account is incidental to the conduct of the business."
These observations, in our opinion, do not justify limiting the rule in Badridas Daga's case ( supra) to cases of banking business. The ratio of the Supreme Court judgment is that in cases where a claim is made for a deduction for which there is no specific provision in section 10(2), whether the deduction is admissible or not depends on whether the loss can be said to arise out of the carrying on of the business and to be incidental to it, having regard to accepted commercial practice and trading principles. And, secondly, that if employment of agents is incidental to the carrying on of business, it must logically follow that losses which are incidental to such employment are also incidental to the carrying on of the business.
While considering the argument that the ratio in Badridas Daga's case (supra) should be limited to cases of banking business, it is relevant that in that judgment the Supreme Court has expressly approved of three cases none of which is a case of banking business. Those cases are Venkatachala-pathy Iyer v. Commissioner of Income-tax [1951] 20 ITR 363 (Mad), Lord's Dairy Farm Ltd. v. Commissioner of Income-tax [1955] 27 ITR 700 (Bom) and Motipur Sugar Factory Ltd. v. Commissioner of Income tax [1955] 28 ITR 128 (Pat). In Venkatachalapathy Iyer's case (supra) the assessees were a firm of merchants engaged in the business of selling yarn. The accountant of the firm entered all the transactions in the cash book but while striking the balance at the foot of each day, he used to short-total the receipts and over-total the disbursements. It was held by the Madras High Court that the amount misappropriated by him was deductible under section 10(1). In Lord's Dairy Farm Ltd.'s case (supra) the assessee was a limited company whose business was that of dairy farming. The cashier of the company, whose duty it was to withdraw the moneys from the company's account in the bank, defalcated various amounts. It was held by this court that, as it was necessary for the assessee to employ the cashier and to depute to him the duty of withdrawing moneys from the bank, the loss directly arose from the necessity of deputing that duty to the cashier and was, therefore, a trading loss. In the case of Motipur Sugar Factory’s case (supra) the assessee-company carried on business in the manufacture of sugar and had entrusted an employee with its funds for the purpose of distribution among sugarcane growers. The employee was robbed on way and the loss caused by theft was claimed by the company under section 10(1). It was held by the Patna High Court that the loss was incidental to the conduct of the trade and had to be allowed.
In Commissioner Of Income Tax, U.P, Lucknow v. Nainital Bank Ltd. [1965] 55 ITR 707 (SC) the Supreme Court has called attention to the fact that the three decisions just mentioned by us were specifically approved in Badridas Daga's case (supra). In Nainital Bank's case (supra) the bank had kept large amounts in its premises in the usual course of its business. One evening, dacoits carried away the cash from the safe and the question which arose for consideration was whether the loss could be deducted under section 10(1) of the Act. It was held by the Supreme Court that in order that a loss could be so deductible it was necessary that it should be incurred in carrying out the operation of the business and be incidental to that operation:
"Whether loss is incidental to the operation of a business is a question of fact to be decided on the facts of each case, having regard to the nature of the operations carried on and the nature of the risk involved in carrying them out."
Applying this test, the loss incurred by the bank due to the dacoity was held to be incidental to the carrying on of the business of banking.
In Nainital Bank's case (supra) the Supreme Court has referred with approval to a decision of the High Court of Australia in Charles Moore & Co. (W.A.) Pvt. Ltd. v. Federal Commissioner of Taxation 95 CLR 344 stating that the decision "throws considerable light on the subject". Two passages in which the reasoning of the High Court is contained as to the circumstances in which a loss can be deducted as a trading loss have been extracted by the Supreme Court from the judgment of the High Court. The assessee in that case was carrying on merely the business of a departmental store. One day, while the cashier accompanied by another employee was on his way to the bank, he was robbed of the amount which he wanted to deposit in the bank. It was held that the loss was a trading loss and was deductible from the assessable income of the assessee.
In Nainital Bank's case (supra) the Supreme Court has also referred to the judgment of the Supreme Court of New Zealand in Gold Band Services Ltd. v. Commissioners of Inland Revenue [1961] NZLR 467 in which the assessee was operating a petrol service station. An armed robber committed robbery of a substantial sum of money from the premises of the assessee. It was held that the amount was deductible from the gross income of the assessee.
In Kothari and Sons v. Commissioner of Income-tax [1966] 61 ITR 23 (Mad), the assessee carried on business as share dealers and stock brokers. It was held by the Madras High Court that, though the business was not one of money-lending or banking, the assessee had to entrust cash to the employees for the purposes of day-to-day transactions and if the employees embezzled the amounts entrusted to them, the loss must be held to have been occasioned in the course of the business and was undoubtedly incidental to that business.
In Commissioner Of Income-Tax, Madras v. V.K.T.M.S Mahmood [1969] 74 ITR 100 (Mad), the assessee was a dealer in semi-precious stones and while he was carrying a large quantity of watches to his house late at night, he was robbed by two police constables. The Madras High Court held that:
"The tests or principles laid down in Commissioner of Income-tax v. Nainital Bank Ltd’s case (supra) cannot reasonably be confined to embezzlement or misappropriation or theft of cash in bank cases, where by the rules entrustment of cash to employees or agents is necessary or unavoidable in carrying on the banking business."
On the facts and circumstances of the case it was held that the loss of the
watches was incidental to the carrying on of the business in watches and was allowable as a trading loss under section 10(1).
We, must, therefore, reject the contention that the loss caused by a defalcating agent who is authorised to deposit or withdraw moneys can be allowed as a trading loss only if the principal is engaged in a banking or money-lending business. As observed by the Supreme Court in Nainital Bank's case (supra) :
"Under section 10(1) of the Act the trading loss of a business is deductible for computing the profit earned by the business. But every loss is not so deductible unless it is incurred in carrying out the operation of the business and is incidental to the operation. Whether the loss is incidental to the operation of a business is a question of fact to be decided on the facts of each case, having regard to the nature of the operations carried on and the nature of the risk involved in carrying them out. The degree of the risk or its frequency is not of much relevance but its nexus to the nature of the business is material."
It is next urged on behalf of the department that the rule in Badridas Daga's case (supra) can have no application to our case, because here Sir Alwyn Ezra was in sole and exclusive control of the business and was in fact in the position of the proprietor himself. According to the learned counsel for the department, if a loss arises due to an embezzlement committed by a person who is in the position of a proprietor, the loss cannot be said to be incidental to the carrying on of the business and cannot, therefore, be allowed. Such a loss is said to be a loss de hors the business.
It cannot be disputed that Sir Alwyn Ezra was in the sole and exclusive charge of the company's business in India. But we find ourselves unable to accept the contention that for that reason or for any other, he could be said to be in the position of a proprietor. 25 per cent. of the share capital of the company was held by Sir Percival David and the remaining 75 per cent. was held by the trust of which he was the sole beneficiary. The company executed a power of attorney in favour of Sir Alwyn Ezra in 1929 and so did Sir Percival himself in 1941. But these instruments did not and could not strip the trustees of their dominion over the shares held by them. Counsel relies on clauses 5 and 29 particularly, of the general power of attorney executed by Sir Percival David in favour of Sir Alwyn Ezra in 1941 in support of his submission that Sir Percival gave to Sir Alwyn Ezra even the power to direct the trustees to act in regard to the 75 per cent. of the share capital held by them. Now clause 5 of the power empowers Sir Alwyn to attend, vote at and otherwise take part in all meetings held in connection with any company or corporation with which Sir Percival was concerned or in relation to any of his investments and to sign proxies for the purpose of voting or for any other purpose connected therewith as freely as he himself could do. Clause 29 is a residuary clause under which the attorney was empowered in general to do all other acts in regard to the estate, property and affairs of the principal to all intents and purposes as he himself could do. These provisions in the power of attorney executed by Sir Percival cannot, in our opinion, empower Sir Alwyn Ezra to exercise the powers of Sir Percival qua the shares held by the trustees. Such a specific power cannot by any known rule of construction be held to fall under a residuary clause like clause 29, and clause 5 does not by its terms convey such a power. It is, therefore, not possible to accept the submission that Sir Alwyn Ezra was in the position of the proprietor himself and that the loss caused to the company on account of the embezzlement committed by him is not incidental to the carrying on of the business.
The learned counsel has drawn our attention to a passage at page 594, paragraph 1310 of Gunn's Commonwealth Income-tax, Law and Practice, sixth edition, which says that;
"Where the loss is occasioned through the acts of a managing director or a manager of a company who is in the position of a proprietor, the proprietor has been denied a deduction of the loss."
As we have stated earlier, it is not possible to accept the contention that Sir Alwyn Ezra was in the position of a proprietor, and, therefore, the position stated in the text on which counsel relies can have no application.
Counsel for the department then contends that the loss in this case cannot be said to be incidental to the carrying on of the business of the company, because the amount was withdrawn and defalcated by Sir Alwyn Ezra after the moneys belonging to the company had "got home", that is to say, after the company had received the amount and had put it in the bank. In support of this submission reliance is placed by counsel on the much-discussed decision in Curtis v. J. & G. Oldfield [1925] 9 TC 319 (KB). The decision in Curtis's case (supra) was relied upon before the Supreme Court in Badridas Daga's case (supra) in support of a similar contention. The Supreme Court observed:
"It is necessary to examine the decision in Curtis v. J. & G. Oldfield’s case (supra) somewhat closely, as the main controversy in the Indian courts has been as to what was precisely determined therein."
The Supreme Court has accordingly considered the decision in all its aspects and has held that it did not lend support to the contention that:
"...........as a rule of law, embezzlements made prior to the receipts of the amounts by the assessees would be incidental to the carrying on of the trade and, therefore, admissible, but that embezzlements made after receipt are not connected with the carrying on of the trade and therefore inadmissible......... It is a question turning on the facts of each case whether the embezzlement in respect of which deduction is claimed took place in the carrying on of the business, and the observations of the learned judge (Rowlatt J. in Curtis' case (supra)) that it did not so take place have reference to the facts of that case, and can afford no assistance in deciding whether in a given case the embezzlement was incidental to the conduct of the business or not."
In the paragraph following this passage the Supreme Court has rejected the "got home" theory as being altogether out of place in a business such as banking.
It is important to bear in mind that apart from the fact that in Curtis' case (supra) the allowance was claimed as a bad debt, the business of the company, "J. & G. Oldfield Ltd.", was managed by a member belonging to the Oldfield family who as the managing director was in sole control of the business. The shares of the company were held by the members of Oldfield family, the company had no auditor, no minutes book and there was "an almost entire absence of balance-sheets". The managing director was allowed very great latitude in the management of the company and the accountants who had prepared the balance-sheets found that many cash payments which passed through the company's accounts did not refer to the company's business but related to the private affairs of J.E. Oldfield, the managing director. The accountants dissected the accounts and by that method ascertained the sum which was withdrawn by the managing director from the funds which could be said to belong to the company. In other words, the management of the company had abdicated wholly in favour of the managing director who was allowed to do whatever he liked with the company's funds, with the result that his own personal affairs were inextricably confused with the affairs of the company. The loss to the company which arose from such a state of affairs was held not to form an allowable basis for deduction from the company's trading profits.
It is on account of these peculiar features of Curtis' case (supra) that the Supreme Court refused to treat the decision in that case as laying down the broad proposition for which counsel for the department contends. It is again on account of a complete abdication by the company of its powers in favour of the manager, who intermingled his personal affairs with the business of the company, that the Supreme Court observed [1958] 34 ITR 10 (SC):
".........his withdrawals would be more like a partner overdrawing his account with the firm than an agent embezzling the funds of his employer, and it could properly be held that such overdrawing has nothing to do with the trading activities of the firm, whose profits are to be taxed."
There is, therefore, no substance in the contention that the loss in the instant case cannot be allowed as a deduction as the amount was withdrawn by the agent after it was collected and credited in the company's account in the bank.
It was finally urged by the learned counsel for the department that Sir Alwyn Ezra acted purely in his capacity as a director in withdrawing the amounts and not in his capacity as an agent under the power of attorney executed in his favour by the company. It is contended that if the withdrawals are referable to Sir Alwyn Ezra's capacity as a director, the loss caused on account of the embezzlement committed by him would not be a trading loss. Now, it is true that there are some observations in the order of the Appellate Assistant Commissioner that Sir Alwyn Ezra acted rather as a director than as an agent under the power of attorney in withdrawing the amounts from the bank. But it is clear that those observations have been made by the Appellate Assistant Commissioner in order to show how the case would fall within the rule in Curtis case (supra) and that rule was thought to be that if an amount is embezzled after it was "'got home" the loss caused to the principal on account of the embezzlement is not a trading loss. As we have stated earlier, Curtis' case (supra) is not an authority for such a proposition and, therefore, it would not be correct to attach any particular importance to the observation made by the Appellate Assistant Commissioner that Sir Alwyn Ezra acted more like a director than as an agent in withdrawing the amounts from the bank. We would also like to add that the Tribunal has apparently not taken any such view of the matter. All that the Tribunal has done is to borrow the observations made by the Supreme Court in regard to the peculiar facts of Curtis' case ( supra) and to conclude on the basis of those observations that Sir Alwyn Ezra's overdrawing had nothing to do with the trading activities of the company.
We must, therefore, hold that the loss caused to the company on account of the embezzlement committed by its agent, Sir Alwyn Ezra, must be deducted while computing the company's assessable profits under section 10(1) of the Act of 1922.
The third question which is submitted for our opinion under section 66(2) of the Act relates to a sum of Rs. 8,000 paid by the company to one Mrs. Messaffi in 1958. The company used to carry on business in cotton yarn until 1946. One of its constituents was a person called Messaffi, a resident of Baghdad, who used to give cash advances to the company towards the purchase of cotton yarn. At the time of his death in 1944, a sum of Rs. 3,13,188 was found due to him by the company. Interest on this amount was credited to his account in the books of the company up to the 31st of December, 1945, but not thereafter.
Mrs. Messaffi came to Bombay in 1958 for collecting the amount due to her late husband and also for undergoing treatment for cancer. The company paid to her the sum of Rs. 3,13,188 together with interest due till the end of December, 1945. She demanded interest from 1945 till 1958 but the company stated that it was not liable to pay interest for that period. Ultimately, the company paid to her a sum of Rs. 8,000 and debited it to "office expenses account" in the year ending December 31, 1958. This sum was claimed as a deduction in the computation of the income for the assessment year 1959-60, under section 10(2)(xv) of the Act of 1922.
The Income-tax Officer disallowed the claim on the ground that the payment was obviously made towards the medical expenses of Mrs. Messaffi which amounted to Rs. 10,000 and as the payment was wholly unconnected with the business carried on by the company, it could not be deducted under section 10(2)(xv). The Appellate Assistant Commissioner came to the same conclusion on the ground that the company was not liable to pay interest, that the sum of Rs. 8,000 was paid by the company ex gratia and had nothing to do with its business and assuming that it was paid by way of interest, no deduction could be granted in the company's favour as the company while paying the amount had not deducted tax on the amount, which it was required to do under the proviso to section 10(2)(iii) of the Act, Mrs. Messaffi being a non-resident. The Tribunal has hardly discussed this question in its judgment and has contented itself by rejecting the claim without assigning any reasons. Its judgment is, therefore, of no assistance.
It appears that in pursuance of inquiries made by the Income-tax Officer, the company wrote a letter to him on the 18th of November, 1960, furnishing additional information in regard to certain matters, including the payment of Rs. 8,000 to Mrs. Messaffi. The payment is described in this letter as "ex gratia". The letter states that Mrs. Messaffi demanded payment of interest from 1945 till 1958 which could not be agreed to and that under threat of legal action the company was asked to pay at least a part of the amount. Ultimately, after some discussion, the company decided to pay Mrs. Messaffi "a sum of Rs. 8,000 as an ex gratia payment in respect of the medical and other expenses incurred by her during her stay in Bombay where she was hospitalised for treatment of cancer. Considering the fact that if we had paid the interest it would have been a very big amount, it is submitted that the sum of Rs. 8,000 paid by us should be allowed as an admissible deduction and treated in lieu of interest"
This letter, in our opinion, must be read as a whole. So read, it does not justify the view that the sum of Rs. 8,000 was paid to Mrs. Messaffi for a purpose unconnected with the business of the company. The letter undoubtedly says that the amount was paid "ex gratia", but in the context in which the phrase occurs, it is clear that what was intended to be conveyed was that the company denied its liability to pay interest to Mrs. Messaffi from 1945 to 1958 and, therefore, it was not agreeable to paying any amount to Mrs. Messaffi as and by way of interest. The only option left to the company was to pay the amount as if it was ex gratia. In these circumstances, it would be wrong to characterise the payment as a voluntary act of bounty uninfluenced by any business considerations. As observed in Edwards v. Skyways Ltd. [1964] 1 All ER 494 (QB), the words "ex gratia" are often used to indicate that the party agreeing to pay does not admit any pre-existing liability and the mere use of that phrase as part of a promise to pay does not justify the conclusion that the promise, when accepted, has no binding effect in law. It is undisputed that Mrs. Messaffi's husband was a constituent of the assessee-company and a large sum of over Rs. 3 lakhs was due to him by the company at the time of his death in 1944. The company had the use of that money from 1944 till 1958 and, therefore, Mrs. Messaffi demanded that interest should be paid to her on the amount for the period ending 1958. Perhaps, the company rightly saw justification for refusing to concede the full claim of Mrs. Messaffi but there can be no doubt that the amount which she was demanding was an amount to which she claimed to be entitled on account of a purely business transaction between her husband and the company. The sum of Rs. 10,000 spent by her for medical expenses was merely the occasion for making the payment of Rs. 8,000 but was not the object or purpose of the payment.
In other words, the demand for the payment of interest, which was made by Mrs. Messaffi, was wholly and exclusively connected with a debt which arose out of business commitments. The payment was made by the company in settlement of a claim arising out of a business dealing in consideration of the other side giving up its rights to recover a fairly large amount. The company received more than it paid and, therefore, the loose description of the payment as "ex gratia" cannot be construed to mean that the payment was in the nature of a bounty on the part of the company. We have no doubt that the payment was made as a matter of commercial expediency and for adequate consideration, though as a matter of practical exigency the medical expenses incurred by Mrs. Messaffi were made the rough measure of the payment due to her. Therefore, the expenditure incurred by the company in paying the sum of Rs. 8,000 to Mrs. Messaffi must be held to be an expenditure incurred wholly and exclusively for the purpose of the business of the company.
There is no substance in the contention that the claim cannot be allowed for the reason that the company did not deduct tax from the amount paid to Mrs. Messaffi. The proviso to section 10(2)(iii) of the Indian Income-tax Act, 1922, on which the department relies in this behalf has no application because the amount was not paid as interest but was paid in settlement of a claim for interest. Secondly, section 10(2)(iii) applies to the interest paid "in respect of capital borrowed for the purposes of the business". Assuming that what was paid to Mrs. Messaffi was interest and not an amount "in lieu of interest", the interest was not paid in respect of any amount "borrowed" from Mrs. Messaffi.
For these reasons, our answer to the first question is that in computing the assessee's business income of the year 1957, relevant for the assessment year 1958-59, the sum of Rs. 9 lakhs is an admissible deduction under section 10(1) but not under section 10(2)(xi) or under section 10(2)(xv) of the Indian Income-tax Act, 1922. Our answer to the second question is in the negative. Our answer to the third question is that, with regard to the assessment year 1959-60, the Tribunal erred in law in holding that the expenditure of Rs. 8,000 was not incurred wholly and exclusively for the purpose of the business of the company.
The Commissioner will pay the costs of this reference, including the costs of the notice of motion.
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