Commissioner of Income-Tax, Bombay Vs.
M/S. Abdullabhai Abdulkadar  INSC 269 (6 December 1960)
CITATION: 1961 AIR 701 1961 SCR (2) 949
CITATOR INFO :
R 1964 SC1722 (9) R 1966 SC1250 (5)
Income-tax--Commission Agent's liability to
pay for nonresident principal--Test of deductible business loss--Indian
Income-tax Act, 1922 (11 of 1922), ss. 10(1), 10(2)(Xi), 42(1), 43.
The respondent was a registered firm carrying
on business as commission agents, and for the purpose of income-tax it was
treated as the agent of a non-resident principal doing business outside India.
Under s. 42(1) of the Indian Income-tax Act the respondent was deemed to be the
assessee and had to pay Rs. 3,78,49r as income-tax on behalf of the
non-resident principal. After allowing for the amounts lying with the
respondent firm the account of the nonresident principal showed a debit balance
of RS. 3,20,162.
The respondent treated this amount as a bad
debt and claimed it as a deductible loss. The Income tax Officer and the
Appellate Assistant Commissioner disallowed the respondent's claim but the
Income Tax Appellate Tribunal held it to be an allowable deduction being a bad
debt incurred as a result of the respondent's business activities with the
nonresident principal. The High Court treating the amount as a deductible
business loss incurred by the respondent affirmed the decision of the
Income-tax Tribunal. On appeal by the Commissioner of Income-tax, Held, that
the respondent was not entitled to the reduction claimed by it. The liability
to pay imposed upon it under s. 42(2) of the Income-tax Act did not arise
directly from the carrying on of the business nor was it incidental to the
business. The loss was not a commercial loss incurred in the respondent firm's
own business but it arose out of the business of another person and that was
not a permissible deduction within s. (1) or s. 10(2)(Xi) of the Act.
Gresham Life Assurance Society v. Styles, (1892)
3 T. C. 185 (H. L.), referred to.
Commissioner of Income-tax v. Sir S. M.
Chitnavis, (1932) L. R 59 I. A. 290, followed.
Badridas Daga v. Commissioner of Income-tax,
690 and Curtis v. I. and G. Oldfield, Ltd.,
(1925) 9 T. C. 319, discussed.
Lord's Dairy Farm Ltd. v. Commissioner of
Income-tax, Bombay,  27 I.T.R. 700, Calcutta Co., Ltd. v. Commissioner of
Income-tax,  37 I.T.R. 1 and C.I.R. v. Hagart and Burn Murdoch; 
A.C. 386, not applicable'.
CIVIL APPELLATE, JURISDICTION: Civil Appeal
No. 312 of 1959.
Appeal from the judgment and order dated
August 23, 1956, of the Bombay High Court in Income-tax Reference No. 21 of
Hardyal Hardy and D. Gupta, for the
A.V. Viswanatha Sastri and I. N. Shroff, for
1960. December 6. The Judgment of the Court
was delivered by KAPUR, J.-This is an appeal by special leave brought by the
Commissioner of Income-tax against the judgment and order of the High Court of
Bombay answering the question in favour of the assessee. The question referred
by the Tribunal was:
"Whether on the facts and in the
circumstances of the case the amount of Rs. 3,20,162 is an allowable deduction
under Section 10(2)(xi) or 10(2)(xv) of the Income-tax Act?" which was
amended by the High Court as follows:
"Whether on the facts and in the
circumstances of the case the amount Rs. 3,20,162 is an allowable
deduction" and was answered in the affirmative and against the appellant.
The facts of the case shortly stated are
these: The respondent is a registered firm carrying on business as commission
agents. It was treated as the agent of a nonresident principal Haji Mohamed
Syed Ali Barbari of Port Sudan (hereinafter 'referred to as the nonresident
principal. It was carrying on the business of export of cloth and kariana
(i.e., miscellaneous goods) to Aden, Saudi Arabia and sudan. It used to supply
goods from India to the nonresident principal, who on his part, was sending
cotton to the respondent and other merchants for sale in India.
For the years 1942-43, 1943-44, 1944-45 and
1945-46, the respondent firm was treated as the agent of the nonresident
principal under s. 43 of the Income-tax Act 951 (which will hereinafter be
termed 'the Act') for the purpose of income-tax and Excess Profits Tax. The
respondent firm had to pay in all Rs. 3,78,491 under s. 42(1) of the Act and
after allowing for the amounts which were in its hands the account of the
principal non-resident showed a debit balance of Rs. 3,20,162. For the year of
assessment, 1953-54, the respondent firm treated this amount as a bad debt and
claimed it as a deductible loss to be set off against profits. The Income-tax
Officer treating this claim as one under s. 10(2)(xv) of the Act, disallowed
it. The Appellate Assistant Commissioner treated it as one under s. 10 (2)(xi)
of the Act and he also disallowed it. On appeal to the Income-tax Appellate
Tribunal it was held to be a bad debt and an allowable deduction as it was
incurred as a result of the business activities which the respondent firm was
carrying on with the nonresident principal. At the instance of the Commissioner
of Income-tax, the case was stated to the High Court and the High Court
modified the question and answered the same in the affirmative, i.e., against
the appellant. The High Court held that as the law imposed an obligation upon
the respondent firm to discharge the liability and-it was incidental to the
business of the respondent the amount was a deductible loss; and even if it was
not a debt, then also the amount could be claimed by the assessee as a business
or trading loss, because in arriving at the true profit of the respondent's
business that loss had to be deducted. The High Court thus applied s. 10(1) of
the Act to the amount claimed by the respondent.
The allow ability of the amount in dispute
depends upon the nature of the liability imposed upon the respondent firm.
The contention of the respondent's counsel
was that it was carrying on foreign trade and had dealings with a foreign
merchant and in the course of the business there were imports and exports and
therefore the interconnection between the respondent firm and the non'-resident
principal was so intimate as to invite the application of s. 42(1), i.e., the
establishment of agency as 'contemplated in that section. The liability to pay
arises under a. 42(2) which provides 952 "Where a person not resident or
not ordinarily resident in the taxable territories carries on business with a
person resident in the taxable territories, and it appears to the Income-tax
Officer that owing to the close connection between such persons the course of
business is so arranged that the business done by the resident person with the
person not resident or not ordinarily resident produces to the resident either
no profits or less than the ordinary profits which might be expected to arise
in that business, the profits derived there from or which may reasonably be
deemed to have been derived there from, shall be chargeable to income-tax in
the name of the resident person who shall be deemed to be, for all the purposes
of this Act, the assessee in respect of such income-tax." Relying on this
provision it was argued that the nature of the respondent's business was
foreign trade which was interconnected with the business of the non-resident
Its nature was such as to attract the
imposition of liability on the respondent firm under s. 42(2) of the Act and
therefore the loss so incurred must be taken to be incidental to and arising
out of the business of the respondent.
"The thing to be taxed", said Lord
Halsbury, L. C., "is the amount of profits and gains. The word 'profits' I
think is to be understood in its natural and proper sense-in a sense which no
commercial man would. misunderstand": Gresham Life Assurance Society V.
Styles (1). Hence even if a deduction is not specifically enumerated in
sub-section (2) of B. 10 it would still be a debatable item to reflect the
taxable profits. The Privy Council in Commissioner of Income-tax v. Sir S. M.
Chitnavis (1) held that the Act nowhere authorises the deduction of bad debts
of a business, such a deduction is necessarily allowable because what is
chargeable to income-tax in respect of a business are the profits and gains of
a year and in assessing the amount of profits and gains of that, year account
must necessarily be taken of all losses incurred, otherwise true profits and
gains cannot be ascertained. In order (1)(1892) 3 T.C. 185, 188 (H.L.).
(2)(1932) L.R. 59 I.A. 290, 296.
953 that a loss may be deductible it must be
a loss in the business of the assessee and not payment relating to the business
of somebody else which under the provisions of the Act is deemed to be and
becomes the liability of the assessee. The loss becomes allowable if it
"springs directly from and is incidental" to the business of the
assessee. The decision therefore mainly depends upon whether the loss claimed
is a business loss of that nature.
In our opinion the amount which became
payable by the respondent firm cannot be called its business loss. In order to
be deductible the loss must be in the nature of a commercial loss and, as has
been said above, must spring directly out of it and must really be incidental
to the business itself. It is not sufficient that it falls on the trader in
some 'other capacity or is merely connected with his business.
Counsel for the respondent relied upon a
judgment of this Court in Badridas Daga v. The Commissioner of Income-tax (1).
In that case an agent of the assessee engaged for the purpose of carrying on of
the assessee's business had authority to operate a bank account. Acting under
such authority the agent withdrew from the bank monies and put them to his
personal use. The assessee was able to recover from the agent only a part of
the amount misappropriated and the balance was written off as irrecoverable
debt and it was held that it was not allowable under s. 10(2)(xi) or 10(2)(xv)
of the Act but it was a loss deductible in computing the profits under s. 10(1)
of the Act as a loss incidental to the carrying on of his business. Counsel
relied on the following observation of Venkatarama Ayyar, J., at p. 695:
"The result is that when a claim is made
for a deduction for which there is no specific provision in s. 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.,, That passage has to
be read in the circumstances of (1) S.C.R. 690.
954 that case where the employment of agents
was incidental to the carrying on of the business and it was observed that it
logically followed that the losses which were incidental to such employment
were also incidental to the carrying on of the business. At page 696, it was
observed:"At the same time it should be emphasised that the loss for which
a deduction could be made under s. 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."
Reference may also be made to an English decision in Curtis v. J. & G.
Oldfield Ltd. (1). In that case the managing director of a company of wine and
spirit merchants embezzled monies of the' company and that. was claimed as a
loss as a bad debt and it was held that it was not a trading loss and was
therefore not an admissible deduction. In that case the contention of the Crown
*as that the sum was not an ordinary trading debt and therefore could not be a
bad debt and that the loss was not connected with, and did not arise out of the
trade. Rowlatt, J., said at p. 330:
"When the Rule speaks of a bad debt it
means a debt which is a debt that would have come into the balance-sheet as a
trading debt in the trade that is in question and that it is bad. It does not
really mean any bad debt which, when it was a good debt, would not have come in
to swell the profit." In the present case the liability was imposed upon
the respondent firm because it was treated as an agent within the meaning of s.
42(1) of the Act and the liability was imposed because of the deeming provision
in sub-s. (2) of s. 42 of the Act. can it be said, in the present case, that
the liability imposed upon the respondent firm was a business debt arising out
of the business of the respondent or to use the words of Venkatarama Ayyar, J.,
"springs directly from the carrying on of the business and is incidental
to it or is a trading debt in the business of the respondent firm." As we
have said above, that condition has not (1)(1925) 9 T.C. 319.
955 been fulfilled and the loss which the
respondent has incurred is not in its own business but the liability arose
because of the business of another person and that is not a permissible
deduction within s. 10(1) of the Act. It is not a loss which has to be deducted
in respect of the business of the respondent from the profits and gains of the
Counsel for the respondent also relied on
Lord's Dairy Farm Ltd. v. Commissioner of Income-tax, Bombay(1). That 'was a
case of embezzlement by an employee and it was held that the loss directly
arose from the necessity of employing cashiers and therefore the loss by
embezzlement was a trading loss but in that very case it was held that before a
claim could be made for deduction of a debt as bad debt it must be a debt in
law. That case is not applicable to the facts of the present case and is of
little assistance in the decision of the question before us. Counsel for the respondent
next relied on Calcutta Co., Ltd. v. The Commissioner of Incometax (2). It was
held in that case that the expression "profits and gains" has to be
understood in its commercial sense and that there could be no computation of
profits and gains until the expenditure necessary for earning those profits and
gains is deducted there from and that when there is no specific provision in s.
10(2) in regard to claim made, its allow ability will depend on accepted
commercial practice and trading principles and it will be allowed if it can be
said to arise out of the carrying on of the business and is incidental to it.
As a principle it is unexceptionable but it does not carry the matter any
It was next contended that the matter falls
within s. 10(2)(xi) of the Act, i.e., it is in respect of the business. This
contention has even less substance than the claim of deduction under s. 10(1).
Under cl. (xi) also a debt is only allowable when it is a debt and arises out
of and as an incident to the trade. Except in money-lending trade debts can
only be so described (1)  27 I.T.R. 700.
(2)  37 I.T.R.
956 if they are due from customers for goods
supplied or loans to constituents or transactions of a similar kind. In every
case the test is, was the debt due as an incident to the business; if it is not
of that character it will be a capital loss. Thus a loan advanced by a firm of
Solicitors to a company in the formation of which it acted as legal adviser is
not deductible on its becoming irrecoverable because that is not a part of the
profession of a Solicitor: C. I. R. v. Hagart & Burn Murdoch (1).
In our opinion the High Court 'was in error
in answering the question in favour of the respondent. We therefore allow this
appeal, set aside the judgment and order of the High Court and answer the
question against the respondent. The appellant will have his costs in this
Court and in the High Court.