COMMISSIONER OF INCOME TAX

GUJARAT HI, AHMEDABAD & ANOTHER

KURJI JINABHAI KOTECIIA

February 18, 1977

[P. K. GOSWAMI AND JASWAN.T Sii; GH, JJ.]

Inco1ne Tax Act 1922-Section 24(1)(2)-Whether expenses incurred in carrying 011 illegal business to be deducted-Whether loss arising out of illegal business can be set off aKainst profits fro1n le::al business-Whether loss of

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illegal business can be1 carried forward to future years-lnterpreration of statutes-Whether, oupht to be consistent l1dth morality-Whether. io1Uinuation r of illegal activity to be recognised. l.....

. Forward Contracts (Regulation) Act 1952-Sectlo~J 15(4)-lflegal con tracts-Effect of income tax law.

The assessee carries oo business of running Oil l\.Hll anJ dealing in groundnuts, groundnut seeds . and oil, speculative business in groundnuts,_ groundnut oil and groundnut seeds, and speculation business in cotton errands etc. The l.T.0. disallo\lled 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 I.T.O. but bifurcated the loss into two headings, namely, loss incurred in hedging transactions in the banned items and loss incurred •in speculative transactions.

On second appeal, the Tribunal held that notwithstanding the illegality of the tran-sactions _ 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 accoringly directed that the loss in hedging transactions of forw&rd business . in the banned contracts he set off against the other profits of the asses3ee for the relevant accounting year under section 24 ( 1) and that balance of Toss 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 folTo\\-ing year from speculative business. On reference to the lligh 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

crise of C.l.T. v. S.C. Kothari. ,

Allowing the appeal by certificate,

HELD: (I) The Joss icuITed-; in the hedging transa::tions 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 Inco1ns.tax. v. S.C. Kothari, 69 ITR 1. applied.

(2) It is admitted that the contract for specu!ation 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 '.lnd continue in the fo1lo\ving year even in a lawful speculative business. -The , Speculative business v.hich is car- !ied on in the foltowing year must be a business of _]awful speculation pertain 1nj! to thf" t'lv.-fuJ end enforceable-- contracts.

An assesseecarrying on a lawful speculative business in the following year cannot derive benefit by carryin_g forward and setting off a loss from illegal speculative business of the earher year. Law will assume an illegal business to die out of existence with 3.tl itslosses 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

C.l.T. V. K. J. KOTECHA -- __ 21

discontinued and Joss tbereuPOn is carried forward for set off ag_ainst any_ other A lawful speculative busines_s in the following year •. It is inconceivable that Jaw , can permit an illegal activity to be carried on from which a benefit could be

obtained. . The concept of carry forward is not the san1e thing a<i the setting pff of loss in @. , Darticular illegal business against profit of that il1egal business fn a particula_r 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 th_e business does not get tainted so far as exigibility to tax is concerned. \Vhile computing income from illegal activity in a particular year all B 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 partieu1:.lr year's profit from. illegl trading activity and carry forward of a loss to set it off against income in the subsequent years even.assuming that such illegal acvitity is continued against the. provisions of law.

No illegal activity can be perpetuated under 2.ny provisions of law nor benefit out of it. Law will mi.:; s its paramount object if it is not consistent with morality and any interpretation by courts cannot lead to a result \\'here continuation C)f illegal activity or benefit attached to it is C given rcognition. [31~-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.

D 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 Ill, are as follows :-

" (2) Whether, on the facts and i~ the circumstances of the case, the assessee was entitled to set off hedging loss of Rs. 317 45 /- 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 fo:lowing 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 qoing business in sales and purchase of groundnuts, groundnut seeds and oil; speculation busin_ess in grvundnuts, groundnut oil and groundnut seeds; and speculat1n business in cotton, errands, etc.

His total income for the year m 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

A Rs. 73,348/- in forward contract:s in groundnut oil, groundnuts and

groundnut seeds.

He disallowed this loss on the ground that it arose out. of illegal contracts on account o! the same being banned under ,._,-. sect10n 15 ( 4) of the Forward Contracts (Regulation) Act, l 952.

It will appear that the break-up of losses in the business of illegal forward contracts is as fol; ows :-

(I ) Groundnut oil Account ( 2) Groundnut Account

(3) Sin, c:lana (Groundnut seeds Account) at Yeraval

Rs. 49,664/- Rs. 22,522/-

Rs. 1,162/-

Total Rs. 73,348/-

The above third item of loss is arrived at by the Income-tax Officer after adjusting the profi: of the forward business in groundnut seeds at Rajkot.

Gn appeal by the asscssce the Appellate Assistant Commissioner affirmed the orcicr of the Income-tax Officer. The Appellate Assistant D Coinmissioner, however, bifurcated the loss ino two categories as fnllO\VS :--

(I) Los incurred in hedging transactions in the banncJ items Rs.33 ! .745/-

(2) Loss incurred in speculative transactions (other than hedging transactions) in the banned items.

Rs. 41.603 1-

Total : Rs. 73,348/-

The Appellate Assistant Commissioner held that the assessee was not entitled to the set olt of the Joss against the asscssce's other business under section 24 ( 1 ) of the Act and also that such Joss could not be carried forward to the fo]owing year under section 24(2) of the Act.

On a second appeal by the assessee before the Appellate Tribunal, the Tribunal held that notwithstandring 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 contmots amounting to Rs. 31,745/- be set off against the other profits of the assessce for the relevant accounting year under section 24 (1) and that the balance loss of Rs. 41,603/- relating to the speculatiYe 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.

H As stated earlier at the instance of the Commissioner of Incometax, the two que:stios set out above were referred to the. High Court under section 66 ( 1) of the Act.

The High Court relyrng upon its

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•earlier judgment in the Commissioner of Income-tax v.

S. C.

A Kothari(') answered both the questions in the affirmative in favour of tl1e asessee.

That. decision was, however, partly reversed by this Court. m the Comnuss1011er of Income-tax Gujarat v. S. C. Kothari(') (heremafter 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 B from the losses being taken into account for computation of the amount which can be subjected to tax as 'profits' under secllon 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 JJroviso to section 24 (I) . This Court observed :

"The contract contemplated by Explanation 2 to the first proviso to section 24 (I) of the Income-tax Act, 1922, has to be an enforceable con:ract and not an unenforceable one by reason of any taint of illegality resdting 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 asscssee as illegccl contracts.

It also held that the asscssee was not entitled to a set off under the first proviso to section 24 ( l) of the Act of the loss against its profit in speculative transactions.

Jt, however, held that if the business in which the loss was sustained in that case was the same as the b.usincss 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

(I) 69 I.T.R, t,

(2) 82 I.T.R. 794.

30 SUPREME COU!lT REPORTS

[J 9771 3 SC.R.

setting off of the loss of the particular business in groundnut seed~ 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 buiness which the assessee was doing and in which the profit of Rs. 2,19,046/- was made and the loss of Rs. 3,40,4431was 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 asses see 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 hlis 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 specnfative 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 ( l), so much of the loss as is not so set off or the whole loss where the assesscc had no other head of income shal! be carried forward to the following year, and

(i) where the loss was sustained by him in a busines's cOnsisting of speculative transactions, jt shall be set off only against the profits and gains, if any, of any business in epecnlative 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

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(iii) if the loss in either case cannot he 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

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 recomputation 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 Joss 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 :he 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 i1t that year. The assessee contends that this Joss 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 qf loss from an illegal business to spill over and continue in the [ollowing year even in a hiwful 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 beneJit on account of the unlawful business in the following year.

The matter will be different if a lawful speculative business after incurring Jo'ss is discontinued and loss therefrom is carried forward for set off against any other lawful speculative business in the following y.ear.

This is the true legal effect of section 24(2) (i) of the Act in this case.

It is inconceivable that law can perm; t 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 thitt illegal business in a particular year.

The two concepts have to he kept distinctly separate

evn in a taxing statute .. There is no express. arrant for the subniission 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 1s concerned.

While computing income from illegal actidty in a particular year all lo.sses incurred in earning that particular income are also taken into a:count for computation of real profifs even in .the illegal business.

That does not mean that fines imposed on the illegal activities detected, prosecuted and punished or other.vise penalised, will be taken into account for ascertainment of real profits.

The.re is, tr.erefore, a marked distinction between computation of a particular year's. profit from illegal trading activity and carry forward of a loss to set it oil 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 b~ answered in the negative and against the assssee. '

In the result the judgment of the Hi6h Court is set aside and the t\VO questions set aut abo.ve are ans\\'ered in the negative and in favour E of the Department.

The appeal is allowed with costs.

P.H.P.

Appeal allowed.