Case: Commissioner Of Income Tax, Gujarat Vs. M/S. S. C. Kothari

1. This is an appeal from a judgment of the Gujarat High Court. Originally an appeal (C. A. 1993/68) had been brought by certificate but that certificates was found to be defective as no reason were stated therein for granting it. A petition for special leave, was, therefore, filed and the same has been granted. Both the appeals shall stand disposed of by this judgment. The assessee is a registered firm and carries on the business of commission agency and general merchants. It also does forward business. It is a member of the Saurashtra Oil and Oilseeds Association Ltd., Rajkot. During the assessment year 1958-59 the corresponding accounting period being the samvat year 2013 the assessee claimed to have incurred a loss of Rs. 3,40,443/- in certain transactions entered into with different people for the supply of groundnut oil. The transactions, according to the assessee, were non-transferable ready delivery contracts entered into with non-members of the Association. It was expected that these contracts would be performed but owing to certain reasons some of the contracts could not be performed and differences had to be paid. According to the assessee it had acted as a Pucca Artia. The assessee claimed that the aforesaid loss was allowable under S. 10 (1) of the Income-tax Act, 1922 as a deduction against its other business income. The Income-tax Officer came to the conclusion that the transactions in question were hit by the provisions ofthe Forward Contracts (Regulation) Act, 1952 hereinafter called the Act and the Rules and Regulations of the Saurashtra Oil and Oilseeds Association Ltd. In particular the transactions were hit by the provisions of sub-ss. (1) and (4) of S. 15 of the Act and were not saved by S. 18. The losses were held to have been incurred in illegal transactions. He rejected the contention of the assessee that even on the assumption that the losses were incurred in illegal transactions they could be allowed in the computation of the income. The Income-tax Officer further held that the losses incurred in illegal business could bot be deducted from the speculative profits under S. 24 of the Indian Income-tax Act, 1922, hereinafter called the "Act of 1922". The Appellate Assistant Commissioner confirmed the order of the Income-tax Officer. In the appeal before the Tribunal it was held that the transactions in question were not the illegal contracts but were contracts which had been validly entered into under the Act and the bye-laws etc. The Tribunal thereafter proceeded to examine the question whether the losses incurred could be allowed on the assumption that the transactions were illegal. It was of the view that the assessee would be entitled to a set off under S. 24 even if the losses were incurred in illegal transactions. The Tribunal remanded the matter for a report from the Appellate Assistant Commissioner as to the applicability of the proviso to S. 24 (1) (read with the Explanation) of the Act of 1922. After the remand report was received the Tribunal gave the following two findings: (1) the contracts under consideration were all non-transferable specific delivery contracts where the intention ab initio was either to give or take delivery (2) the contracts were entered into either for the purchase or sale and later on the same quantity was either sold or purchased back by the assessee on behalf of the same constituents at the market rates prevailing at the material time i.e. they were squared up by corresponding sales or purchases as the case might be. After referring to certain decisions of High Courts the Tribunal held that the loss of Rs. 3,40,443/- had been incurred in speculative transactions. The Tribunal next proceeded to consider whether notwithstanding that the losses had been incurred in speculative transactions the assessee could set off those against the other income under S. 10 (1) of the Act of 1922.Purporting to follow the view of the majority of the High Courts, the Tribunal held that such a loss could not be set off against the other income. But according to the Tribunal the assessee was certainly entitled to set off the loss against the profits in speculative transactions and to that extent the contention of the assessee was accepted.Both the assessee and the Commissioner of Income Tax moved the Tribunal for submitting a case and referring certain questions of law to the High Court. Thus in all the following four questions were referred by theWhether on the facts and in the circumstances of the case the contracts in respect of which the loss of Rs. 3,40,443 was claimed were illegal contracts and were not validly entered into under the Forward Contracts (Regulation) Act 1952?(2) Whether even assuming the transactions in which the loss of Rupees 3,40,443/- was incurred, were illegal transactions, the assessee would be entitled to the set off of the said loss?(3) Whether on the facts and in the circumstances of the case the transactions resulting in a loss of Rs. 3,40,443 were speculative transactions for the purpose of S. 24 of the Indian Income tax Act 1922 merely on the ground that the assessee had not performed the contracts by giving delivery and had paid damages in settlement of the obligations contracted for?(4) Whether on the facts and in the circumstances of the case the assessee is entitled to set off the balance of the loss of Rs. 1,21,397/- against the assessees otherHigh Court did not consider that it was necessary to answer the first question. The answer to the second question was that even though the disputed contracts were not validly entered into in accordance with the provisions of S. 15 (4) of the Act the loss of Rs. 3,40,443/- was liable to be taken into account in computing the business income of the assessee under S. 10 of the Act of 1922 and the assessee was entitled to set it off against the profits from other speculative transactions. The third question was answered in the affirmative with the result that the transactions resulting in the loss of Rs. 3,40,443/- were held to be speculative for the purpose of S. 24 of the Act of 1922. The fourth question was answered in the negative and against the assessee. It is the Commissioner of Income tax alone who has appealed.

Reasoning:
2. So far as the first question is concered we are unable to comprehend why the High Court did not decide it. A lot of debate took place before us on the question whether the contravention of S. 15 (4) of the act would render the contracts illegal. According to that provision no member of a recognised Association shall, in respect of any goods specified in the notification under sub-s. (1), enter into any contract on his own account with any person other than a member of the recognised Association unless he has secured the consent or authority of such person and disclosed in the note memorandum or agreement of sale or purchase that he has bought or sold the goods as the case may be on his own account. It is not necessary to refer to the proviso. It is common ground and has been admitted before us that there was a clear contravention of the provisions of S. 15 (4) so far as the transactions in questions were concerned. According to S. 20 (e) any person who enters into any contract in contravention of the provisions of section 15 (4) among other sections shall on conviction be punishable for the first offence with imprisonment which may extend to one year or with fine of not less than Rs.1,000/- or with both. It is wholly incomprehensible how such a contract would not fall directly within the ambit of the first part of S. 23 of the Indian Contract Act which deals with consideration or object of an agreement which is forbidden by law. Such consideration or object would be unlawful according to the provisions of that section and the agreement would consequently be void. The High Court did not decide the point whether the contracts which contravened the provisions of S. 15 (4) of the Act were illegal it did not consider it material to decide whether the impugned contracts were illegal. In its opinion what was material was that the impugned contracts had been entered into unlawfully and the question was whether the loss sustained in the unlawful business could be taken into account in computing the business income of the assessee. We consider that the first question which was referred to the High Court stands concluded by the law laid down by this court in Sunderlal and Son v. Bharat Handicrafts (P) Ltd. (1968) 1 SCR 608   = (AIR 1968 SC 406  ). It was laid down that the prohibition imposed by S. 15 (4) of the act was not imposed in the interest of revenue. The provision was conceived in the largest interest of the public to protect them against the malpractices indulged in by members of recognised associations in respect of transactions on which their duties as agents came into conflict with their personal interest. Parliament had made a writing, evidencing or confirming the consent or authority of a non-member, as a condition of the contract if the member has entered into a contract on his own account. So long as there was no writing as was contemplated by section 15 (4) or its proviso there was no enforceable contract.3. It is well settled that contracts which are prohibited by statute the prohibition being either express or implied would be illegal and unenforceable if they are entered into in contravention of the statute. Under the provisions of the Act there is not only an express prohibition (S. 15 (4)) but punishment is also provided for contravention of that prohibition, (S. 20). Such contracts could not possibly be regarded as having been validly entered into under the Act. The answer to the first question, therefore, should have been in the affirmative and against the assessee.4. Coming to the second question, the language thereof is somewhat ambiguous and the question was not framed properly. It appears that there were two aspects which had come up for consideration before the departmental authorities the Tribunal and the High Court. The first aspect related to the deduction of the loss of Rs. 3,40,443/- incurred in the aforesaid illegal transactions while computing the profits of the assessees speculative business under S. 10 (1). The other was the set off which can be allowed within the relevant parts of S. 24 of the Act of 1922. The High Court referred to various English decisions as also to Wheatcrofts Law of Income tax and Simons Income tax for supporting the view that even where a trade is illegal it would still be a trade within the meaning of income tax law and if any profits are derived from such trade they would be assessable to tax. The High Court did not accept the contention urged on behalf of the Revenue that although the profits from an illegal trade or business would be exigible to tax the losses from such business could not be taken into account while computing the profits.Now while S. 10 (1) of the Act of 1922 imposes a charge on the profits or gains of a business it does not provide how these profits are to be computed. Section 10 (2) enumerates various items which are admissible as deductions. They are, however, not exhaustive of all allowances which can be made in ascertaining the profits of a business taxable under S. 10 (1). It is undoubtedly true that profits and gains which are liable to be taxed under S. 10 (1) are what are understood to be such under ordinary commercial principles. The loss for which the deduction is claimed must be one that springs directly from the carrying on of the business and is incidental to it . If this is established the deduction must be allowed provided that there is no provision against it, express or implied in the Act: (See Badridas Daga v. Commr. of Income tax, 34 ITR 10   = (AIR 1958 SC 783  ). In the case loss sustained by the business by reason of embezzlement by an employee was held to be an admissible deduction under S. 10 (1) although it did not fall within S. 10 (2) (xi) of the Act of 1922. Indeed profits cannot be computed without deducting the loss and permissible expenses incurred for the purpose of the business.6. The approach of the High Court in the present case, has been that in order to arrive at the figure of profits even of an illegal business the loss must be deducted if it has actually been incurred in the carrying on of that business. It is the net profit after deducting the outgoings that can be brought to tax. It certainly seems to have been held and that view has not been shown to be incorrect that so far as the admissible deductions under S. 10 (2) are concerned they cannot be claimed by the assessee if such expenses have been incurred in either payment of a penalty for infraction of law or the execution of some illegal activity. This, however, is based on the principle that an expenditure is not deductible unless it is a commercial loss in trade and a penalty imposed for breach of the law during the course of the trade cannot be described as such. Penalties which are incurred for infraction of the law is not a normal incident of business and they fall on the assessee in some character other than that of aorder to claim the set off the meaning of the speculative transaction has to be first looked at. Under Explanation 2 such a transaction means a transaction in which a contract for the purchase and sale of any commodity is periodically or ultimately settled otherwise than by actual delivery etc. Now the contract has to be an enforceable contract and not an unenforceable one by reason of any taint of illegality resulting in its invalidity. It has already been found by us that the contracts in question were illegal and unenforceable on account of contravention of S. 15 (4) of the Act. The High Court was in error in considering that any set off could be allowed in the present case under the first proviso to S. 24 (1) which must be read with Explanation 2.8. There would have been no difficulty in disposing of the matter finally after the above discussion. But enough attention was not devoted to the business which the assessee was doing and in which the profit of Rupees 2,19,046 was made and the loss of Rs. 3,40,443 was sustained. It has been found to be of a speculative nature but the High Court has not clearly found that it was the same business in which the amount of the profit and the loss mentioned above was earned and sustained in which case alone a deduction will be possible of the loss under S. 10 (1). The High Court proceeded on the basis that if the business in which the profit was made and the business in which the loss was incurred were separate a set off could be claimed by the assessee under S. 24 (1). If, however, the business was the same then the loss would be liable to be taken into account while computing the profits under S. 10 (1). As we have come to the conclusion that no set off could be allowed under S. 24 (1) of the Act of 1922 it will have to be determined whether the profits and losses were incurred in the same business even though that business involved the entering into contracts some of which were, in the eye of the law, illegal. If the trade or the business, for instance, the business of commission agency or forward business was the same in which the profits were made and the loss was incurred than in order to arrive at the figure which can be subjected to tax the loss will have to be deducted from the profit. For this purpose we shall have to remit the matter to the High Court to decide this point and if necessary, after calling for a supplementary statement of the case.