Commissioner of Income Tax Gujarat III,
Ahmadabad & ANR Vs. Kurji Jinabhai Kotecha [1977] INSC 62 (18 February
1977)
GOSWAMI, P.K.
GOSWAMI, P.K.
SINGH, JASWANT
CITATION: 1977 AIR 1142 1977 SCC (2) 719
ACT:
Income Tax Act 1922--Section 24( 1 )
(2)--Whether expenses incurred in carrying on illegal business to be
deducted---Whether loss arising out of illegal business can be set off against
profits from legal business--Whether loss of illegal business can be carried
forward to future years--Interpretation of statutes--Whether ought to be
consistent with morality--Whether continuation of illegal activity to be
recognised.
Forward Contracts (Regulation) Act
1952--Section 15(4)--Illegal contracts--Effect of income tax law.
HEADNOTE:
The assessee carries on business of running
Oil Mill and dealing in groundnuts, groundnut seeds and oil, speculative
business in groundnuts, groundnut oil and groundnut seeds, and speculation
business in cotton errands etc. The I.T.O.
disallowed loss in forward contracts and groundnut
oil, groundnuts and groundnut seeds on the ground that it arose out of illegal
contracts on account of the same being banned under section 15(4) of the
Forward Contracts (Regulation) Act, 1952. The Appellate Assistant Commissioner
on appeal confirmed the decision of the l.T.O. but bifurcated the loss into two
headings, namely, loss incurred in hedging transactions m the banned items and
loss incurred in speculative transactions. On second appeal, the Tribunal held
that notwithstanding the illegality of the transactions the loss could be set
off and carried forward in accordance with the provisions of section 24(1) and
24(2) of the Income Tax Act, 1922. The Tribunal accordingly directed that the
loss in hedging transactions of forward business in the banned contracts be set
off against the other profits of the assessee for the relevant accounting year
under section 24(1) and that balance of loss relating to the speculative
transactions in the banned contracts be carried forward to the following year
under section 24(2) of the Act to be set off against profit of the following
year from speculative business. On reference to the High Court, the High Court
answered both the questions in favour of the assessee and upheld the judgment
of the Tribunal. The High Court relied on its earlier judgment in the case of
C.I.T. v. S.C. Kothari.
Allowing the appeal by certificate HELD:
(1) The loss incurred ,in the hedging
transactions cannot be set off against other profits in the previous year in
view of the decision of this Court partly reversing the judgment of the High
Court in the case of S.C. Kothari.
[31C-D] Commissioner of Income-tax v. S.C.
Kothari, 69 ITR 1, applied.
(2) It is admitted that the contract for
speculation in the commodity in question is banned under the Forward Contracts
(Regulation) Act 1952. To allow such a loss to be carried forward is to permit
a benefit of adjustment of loss from an illegal business to spill over and
continue in the following year even in a lawful speculative business. The
speculative business which is carried on in the following year must be a
business of lawful speculation pertaining to the lawful and enforceable
contracts. An assessee carrying on a lawful speculative business in the
following year cannot derive benefit by carrying forward and setting off a loss
from illegal speculative business of the earlier year. Law will assume an
illegal business to die out of existence with all its losses to the assessee in
the year of loss itself. The assessee can derive no benefit on account of the
unlawful business in the following year. The matter will be different if a
lawful speculative business after incurring loss is 27 discontinued and loss
thereupon is carried forward for set off against any other lawful speculative
business in the following year. It is inconceivable that law can permit an
illegal activity to be carried on from which a benefit could be obtained. The
concept of carry forward is not the same thing as the setting off of loss in a
particular illegal business against profit of that illegal business in a particular
year. The two concepts have to be kept distinctly separate even in a taxing
statute. It is true that by earning income from illegal trading activity the
business does not get tainted so far as exigibility to tax is concerned. While
computing income from illegal activity in a particular year all losses incurred
in earning that particular income are also taken into account for computation
of real profits even in the illegal business. There is a marked distinction
between the computation of a particular year's profit from illegal trading
activity and carry forward of a loss to set it off against income in the subsequent
years even assuming that such illegal activity is continued against the
provisions of law. No illegal activity can be perpetuated under any provisions
of law nor benefit out of it. Law will miss its paramount object if it is not
consistent with morality and any interpretation by courts cannot lead to a
result where continuation of illegal activity or benefit attached to it is
given recognition.
[31D-H, 32A-D]
CIVIL APPELLATE JURISDICTION: Civil Appeal
No. 580 of 1972.
(From the Judgment and Order dated 8-9-1970
of the Gujarat High Court in Income-tax Reference No. 9/68).
B.B. Ahuja and R.N. Sachthey, for the
Appellants.
K.L. Hathi and P.C. Kapoor, for the
respondent.
The Judgment of the Court was delivered by
GOSWAMI, J. This appeal by certificate is from the judgment of the Gujarat High
Court in an Income-tax Reference under section 66(1) of the Indian Income-tax
Act, 1922 (briefly the Act).
The two questions which were earlier referred
by the Tribunal to the High Court at the instance of the Commissioner of
Income-tax, Gujarat III. are as follows :-"(2) Whether, on the facts and
in the circumstances of the case, the assessee was entitled to set off hedging.
loss of Rs.
31745/against other profits of the previous
year ? (2) Whether on the facts and in the circumstances of the case, the
assessee was entitled to carry forward the speculation loss of Rs.
41603/to the next year ?" The following
facts appear from the statement of case and the order of the Tribunal:
The assessment year in question is 1957-58
and the corresponding previous year is the Samvat year 2012. The assessee is
carrying on business by running an oil mill, and also doing business in sales
and purchase of groundnuts, groundnut seeds and oil: speculation business in
groundnuts, groundnut oil and groundnut seeds; and speculation business in
cotton, errands, etc. His total income for the year in question was determined
by the Income-tax Officer as Rs.
1,71,632/-. This was after allowing set off
of loss brought forward from the year 1955-56 amounting to Rs. 2,11,431/-.
In arriving at the figure of the total
income, the Income tax Officer disallowed loss amounting to 28 Rs. 73,348/-in
forward contracts in groundnut oil, groundnuts and groundnut seeds. He
disallowed this loss on the ground that it arose out of illegal contracts on
account of the same being banned Under section 15(4) of the Forward Contracts
(Regulation) Act, 1952.
It will appear that the break-up of losses in
the business of illegal forward contracts is as follows :-( 1 ) Groundnut oil
Account Rs. 49,664/(2) Groundnut Account Rs. 22,522/(3) Singdana (Groundnut
seeds Account) at Veraval Rs. 1,162/Total Rs. 73,348/The above third item of
loss is arrived at by the Income-tax Officer after adjusting the profit of the
forward business in groundnut seeds at Rajkot.
On appeal by the assessee the Appellate
Assistant Commissioner affirmed the order of the Income-tax Officer. The
Appellate Assistant Commissioner. however, bifurcated the loss into two
categories as follows :(1 ) Loss incurred in hedging transactions in the banned
items Rs.331,745/(2) Loss incurred in speculative transactions (other than
hedging transactions) in the banned items. Rs. 41,603:/Total: Rs. 73,348/The
Appellate Assistant Commissioner held that the assessee was not entitled to the
set off of the loss against the assessee's other business under section 24(1 )
of the Act and also that such loss could not be carried forward to the
following year under section 24(2) of the Act On a second appeal by the
assessee before the Appellate Tribunal, the Tribunal held that notwithstanding
the illegality of the transactions the loss could be set off and carried
forward in accordance with the provisions of section 24(1) and 24(2)
respectively of the Act. The Tribunal accordingly directed that the loss in
hedging transactions of forward business in the banned contracts amounting to
Rs.
31,745/be set off against the other profits
of the assessee for the relevant accounting year under section 24(1) and that
the balance loss of Rs. 41,603/relating to the speculative transactions in the
banned contracts be carried forward to the following year under section 24(2)
of the Act to be set off against profits of the following year from speculative
business.
As stated earlier, at the instance of the
Commissioner of Income tax, the two questions set out above Were referred to
the High ,Court under section 66(1) of the Act. The High Court relying upon its
29 earlier judgment in the Commissioner of Income-tax v. S.C. Kothari(1)
answered both the questions in the affirmative in favour of the assessee. That
decision was, however, partly reversed by this Court in the Commissioner of
Income-tax Gujarat v. S.C. Kothari(2) (hereinafter to be referred to as Kothari
decision). This Court held in the Kothari decision as follows:
" . . the taint of illegality of the
business cannot detract from the tosses being taken into account for
computation of the amount which can be subjected to tax as 'profits' under
section 10( 1 ) of the Act of 1922. The tax collector cannot be heard to say
that he will bring the gross receipts to tax. He can only tax profits of a
trade or business. That cannot be done without deducting the losses and the
legitimate expenses of the business".
This Court, however, held that the High Court
was in error in considering that any set off could be allowed in that case
under the first proviso to section 24(1). This Court observed:
"The contract contemplated by
Explanation 2 to the first proviso to section 24( 1 ) of the Income-tax Act,
1922, has to be an enforceable contract and not an unenforceable one by reason
of any taint of illegality resulting in its invalidity. Set-off cannot be
allowed under the first proviso to section 24(1), read with Explanation 2
thereto, of losses in contracts which are illegal and unenforceable on account
of contravention of Section 15(4) of the Forward Contracts (Regulation) Act,
1952".
This Court held the contracts in that case in
respect of which the loss was incurred by the assessee as illeged contracts. It
also held that the assessee was not entitled to a set off under the first
proviso to. section 24( 1 ) of the Act of the loss against its profit in
speculative transactions. It, however, held that if the business in which the
loss was sustained in that case was the same as the business in which the
profit was derived then the loss had to be taken into account while computing
the profits of the business under section 10(2) of the Act. In the view it took
this Court remitted the matter to the High Court to.
decide: the point which was not clear on the
findings whether the profits and losses were incurred in the same business even
though that business involved the entering into of contracts some of which were
illegal.
In the present case there is no dispute that
the losses were incurred in connection with forward contracts which were banned
under section 15(4) of the Forward Contracts (Regulation) Act. It is also clear
that the Income-tax Officer adjusted the profit against the loss with regard to
the illegal business in groundnut seeds which was carried on in two places,
Veraval and Rajkot. This set off is permissible under section 10(2) of the Act
because it is only by (1) 69 I.T.R. 1.
(2) 82 I.T.R. 794.
30 setting off of the loss of the particular
business in groundnut seeds that true profit with regard to that particular
business can be computed under section 10(2). There is, therefore, no reason to
remit this case as the course earnestly suggested by Mr. Hathi for the
respondent. In Kothari decision (supra) it was observed by this Court while
remitting the case that "enough attention was not devoted to the business
which the assessee was doing and in which the profit of Rs. 2,19,046/was made
and the loss of Rs. 3,40,443/was sustained". Such an uncertainty, however,
is not present in the instant case. The submission of Mr. Hathi, therefore,
cannot be accepted.
The present case rests upon section 24 of the
Act. That section so far as material for our purpose reads as follows :-"24(1)
Where any assessee sustains a loss of profits or gains in any year under any of
the heads mentioned in section 6, he shall be entitled to have the amount of
the loss set off against his income, profits or gains under any other head in
that year:
Provided that in computing the profits and
gains chargeable under the head 'Profits and gains of business, profession or
vocation, any loss sustained in speculative transactions which are in the
nature of a business shall not be taken into account except to the extent of
the amount of profits and gains, if any, in any other business consisting of
speculative transactions:
(2) Where any assessee sustains a loss of
profits or gains in any year, being a previous year not earlier than the
previous year for the assessment for the year ending on the 31st day of March,
1940, in any business, profession or vocation, and the loss cannot be wholly
set off under sub-section (1), so. much of the loss as is not so set off or the
whole loss where the assessee had no other head of income shall be carried
forward to the following year, and (i) where the loss was sustained by him in a
business consisting of speculative transactions, it shall be set off only
against the profits and gains, if any, of any business in speculative transactions
carried on by him in that year;
(ii) whether loss was sustained by him in any
other business, profession or vocation, it shall be set off against the profits
and gains, if any, or any business, profession or vocation carried on by him in
that year, provided that the business, profession of vocation in which the.
loss was originally sustained continued to be 'carried On= by him in that year;
and 31 (iii) if the loss in either case cannot be wholly so set off, the amount
of loss not so set off shall be carried forward to the following year and so on
but no loss shall be so carried forward for more than eight years".
X X X X X In the instant case there is no
dispute about the following findings of facts:
The assessee sustained losses in the relevant
accounting year amounting to Rs. 73,348/-. This figure was arrived at on a
legitimate computation under section 10(2) of the Act.
No further question survives for a re-computation
of the income under Section 10(2) of the Act in this case. The only question
remains is as to whether the loss of Rs.
31,745/can be set off against other profits
in the previous year. This is the first question in the reference.
This question has to be answered in the.
negative in view of Kothari decision (supra). The hedging loss being in respect
of a banned contract under section 15(4) of the Forward Contracts (Regulation)
Act, 1952, cannot be set off against the profits of other business of the
previous year.
The second question is with regard to the
assessee's claim for entitlement to carry forward the speculation loss of Rs.
41,603/to the next year. It is also admitted
that the contract for speculation in the commodity in question is banned under
the Forward Contracts (Regulation) Act, 1952.
It also appears that the said loss could not
be set off in the previous year against profit in the same business in that
year. The assessee contends that this loss should be allowed to be carried
forward under section 24(2) of the Act. To allow such a claim is to permit a
benefit of adjustment of loss from an illegal business to spill over and
continue in the following year even in a lawful speculative business. A
speculative business which is carried on in the following year must be a
business of lawful speculation pertaining to lawful and enforceable contracts.
The assessee carrying on a lawful speculative business in the following year
cannot derive benefit by carrying forward and setting off a loss from an
illegal speculative business of the earlier year. Law will assume an illegal
business to die out of existence with all its losses to the assessee in the
year of loss itself. The assessee can derive no benefit on account of the
unlawful business in the following year.
The matter will be different if a lawful
speculative business after incurring loss is discontinued and loss there from
is carried forward for set off against any other lawful speculative business in
the following year. This is the true legal effect of section 24(2)(i) of the
Act in this case.
It iS inconceivable that law can permit an
illegal activity to be carried on from which a benefit could be obtained. The
concept of carry forward is not the same thing as the setting off of loss in a
particular illegal business against profit of that illegal business in a
particular year. The two concepts have to be kept distinctly separate 32 even
in a taxing statute. There is no express warrant for the submission either
under section 20(2) or under any other provision of the Act, far less on
general principles.
It is true that by earning income from
illegal trading activity the income does not get tainted so far as exigibility
to tax is concerned. While computing income from illegal activity in a
particular year all losses incurred in earning that particular income are also
taken into account for computation of real profits even in the illegal
business.
That does not mean that fines imposed on the
illegal activities detected, prosecuted and punished or otherwise penalised,
will be taken into account for ascertainment of real profits. There is,
therefore, a marked distinction between computation of a particular year s
profit from illegal trading activity and carry forward of a loss to set it off
against income in subsequent years even assuming that such illegal activity is
continued against the provisions of law.
No illegal activity can be perpetuated under
any provisions of law nor benefit out of it. Law will miss its paramount object
if it is not consistent with morality and any interpretation by courts cannot
read to a result where continuation of illegal activity or benefit attached to
it is given recognition.
The second question, therefore, must be
answered in the negative and against the assessee.
In the result the judgment of the High Court
is set aside and the two questions set out above are answered in the negative
and in favour of the Department. The appeal is allowed with costs.
P.H.P. Appeal allowed.
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