Case: Commissioner Of Income Taxgujarat Iii, Ahmedabad &amp; Another Vs. Kurji Jinabhai Kotecha

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" (1) Whether, on the facts and in the circumstances of the case, the assessee was entitled to set off hedging loss of Rs. 31, 745 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. 41, 603 to the next year ? "The following facts appear from the statement of case and the order of the TribunalThe 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, erranda, 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 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) ofthe Forward Contracts (Regulation) Act, 1952It will appear that the break-up of losses in the business of illegal forward contracts is as followsRs(1) Groundnut oil Account ... 49, 664(2) Groundnut Account ... 22, 522(3) Singdana (Groundnut seeds Account) at Veraval ... 1, 162Total ... 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(1) Loss incurred in hedging transactions in the banned items ... 31, 745(2) Loss incurred in speculative transactions (other than hedging transactions) in the banned items ... 41, 603Total ... 73, 348The Appellate Assistant Commissioner held that the assessee was not entitled to the set-off of the loss against the assessees 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 ActOn 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 sections 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 businessAs 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 earlier judgment in Commissioner of Income-tax v. S. C. Kothari [1968] 69 ITR 1 (Guj)   answered both the questions in the affirmative and in favour of the assessee. That decision was, however, partly reversed by this court in Commissioner of Income-tax v. S. C. Kothari [1971] 82 ITR 794 (SC) (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 losses 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. "

Reasoning: This question has to be answered in the negative in view of the Kothari decision [1971] 82 ITR 794 (SC). The hedging loss being in respect of a banned contract under section 15(4) ofthe Forward Contracts (Regulation) Act,, cannot be set off against the profits of other business of the previous yearThe second question is with regard to the assessees 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 underthe Forward Contracts (Regulation) Act,. 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 therefrom 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 caseIt 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. There is no express warrant for the submission either under section 24(2) or under any other provision of the Act, far less on general principlesIt 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 years 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 lead to a result where continuation of illegal activity or benefit attached to it is given recognitionThe second question, therefore, must be answered in the negative and against the assessee