Case ID: 596

Judgment:
Appeal No. 149 of 1956. Appeal by special leave from the judgment and order dated December 22	 1954	 of the former Nagpur High Court in Misc. Civil Case No. 36 of 1954. R. J. Kolah	 J. M. Thakar	 Ramesh A. Shroff	 J. B. Dadachanji	 section N. Andley and Rameshwar Nath	 for the appellant. H. N. Sanyal	 Additional Solicitor General of India	 K.N. Rajagopala Sastri and R. H. Dhebar	 for the respondent. April 25. The Judgment of the Court was delivered by VENKATARAMA AIYAR J. This is an appeal against the judgment of the High Court of Nagpur in a reference under section 66(1) of the Indian Income tax Act	 1922	 hereinafter referred to as the Act. The appellant is the sole proprietor of a firm called Bansilal Abirchand Kasturchand	 which carries on business as money lenders	 dealers in shares and bullion and commission agents in Bombay	 Calcutta and other places. He is a resident of Bikaner	 and manages the 692 business at the several places through agents. During the relevant period	 the agent of the firm at Bombay was one Chandratan	 who held a power of attorney dated May 13	 1944	 conferring on him large powers of management including authority to operate on bank accounts. During the period	 November 15	 1944	 to November 23	1944	 the agent withdrew from the firm 's bank account sums aggregating to Rs. 2	30	636 4 0	 and applied them in satisfaction of his personal debts incurred in speculative transactions. On November 25	 1944	 the cashier of the firm sent a telegram to the appellant informing him of the true state of affairs. Thereupon	 the appellant went to Bombay on December 3	 1944	 and on the 4th	 cancelled the power of attorney given to the agent	 and by notice dated December 6	 1944	 called upon him to pay the amounts withdrawn by him. The agent replied on December 8	 1944	 admitting the misappropriation of the amounts and pleading for mercy. On January 16	1945	 the appellant filed a suit against him in the High Court of Bombay for recovery of Rs. 2	30	636 4 0 and that was decreed on February 20	 1945. A sum of Rs. 28	000 was recovered from Chandratan and adjusted towards the decree and the balance of Rs. 2	02	442 13 9 was written off at the end of the accounting year as irrecoverable. Before the Income tax authorities	 the dispute related to the question whether this amount of Rs. 2	02	442 13 9 was an admissible deduction. The Tribunal found that the amount in question represented the loss sustained by the appellant owing to misappropriation by his agent	 Chandratan	 but held on the authority of the decision in Curtis vs J. & G. Oldfield	 Limited (1) that it was not a trading loss and therefore could not be allowed. On the application of the appellant	 the Tribunal referred the following question of law for the decision of the High Court	 Nagpur: Whether the said sum of Rs. 2	02	442 13 9 being part of the amount embezzled by the assessee 's Munim is allowable as a deduction under the Indian Income (1) 693 tax Act either under Section 10(1) or under the general principles of determining the profit and loss of the assessee or Section 10(2)(xv) ? " The learned Judges held that the case was governed by the decision in Curtis vs J. & G. Oldfield	 Limited (1)	 and answered the question against the appellant. An application under section 66(A)(2) for a certificate was also dismissed and thereafter	 the appellant applied for and obtained leave to appeal to this Court under article 136	 and that is how the appeal comes before us. The question whether moneys embezzled by an agent or employee are allowable as deduction in computing the profits of a business under section 10 of the Act has come up for consideration frequently before the Indian courts	 and the decisions have not been quite uniform. Before discussing them	 it is necessary that we should examine the principles that are in law applicable to the determination of the question. Three grounds have been put forward in support of the claim for deduction: (1) that the los 3 sustained by reason of embezzlement is a bad debt allowable under section 10(2)(xi) of the Act; (2) that it is a business expense falling within section 10(2)(xv) of the Act; and (3) that it is a trading loss	 which must be taken into account in computing the profits under section 10(1) of the Act. As regards the first ground	 the authorities have consistently held that the deduction is not admissible under section 10(2)(xi) of the Act	 and that	 in our view	 is correct. A debt arises out of a contract between the parties	 express or implied	 and when an agent misappropriates monies belonging to his employer in fraud of him and in breach of his obligations to him	 it cannot be said that he owes those monies under any agreement. He is no doubt liable in law to make good that amount	 but that is not an obligation arising out of a contract	 express or implied. Nor does it make a difference that in the accounts of the business the amounts embezzled are shown as debits	 the amounts realised towards them	 if any	 as credits	 and the balance is finally written off. They are merely journal entries adjusting the accounts and do not import a contractual liability. (1)(1925) 694 Nor can a claim for deduction be admitted under section 10(2)(xv)	 because moneys which are withdrawn by the employee out of the business till without authority and in fraud of the proprietor can in no sense be said to be " an expenditure laid out or expended wholly and exclusively " for the purpose of the business. The controversy therefore narrows itself to the question whether amounts lost through embezzlement by an employee are a trading loss which could be deducted in computing the profits of a business under section 10(1). It is to be noted that while section 10(1) imposes a charge on the profits or gains of a trade	 it does not provide how those profits are to be computed. Section 10(2) enumerates various items which are admissible as deductions	 but it is well settled that they are not exhaustive of all allowances which could be made in ascertaining profits taxable under section 10(1). In Incometax commissioner vs chitnavis (1)	 the point for decision was whether a bad debt could be deducted under section 10(1) of the Act	 there having been in the Act	 as it then stood	 no provision corresponding to section 10(2)(xi) for deduction of such a debt. In answering the question in the affirmative	 Lord Russel observed: " Although the Act nowhere in terms authorizes the deduction of bad debts of business	 such a deduction is necessarily allowable. What are chargeable in income tax in respect of a business are the profits and gains of a year; and in assessing the amount of the profits and gains of a year account must necessarily be taken of all losses incurred	 otherwise you would not arrive at the true profits and gains. " It is likewise well settled that profits and gains which are liable to be taxed under section 10(1) are what are understood to be such according to ordinary commercial principles. 	The word " profits. . is to be understood "	 observed Lord Halsbury in Gresham Life Assurance Society vs Styles (2)	 " in its natural and proper sense in a sense which no commercial man would misunderstand ". Referring to these observa (1) (1932) L. R. 59 I.A. 290	 296	 297. (2)(1892) A.C. 309	 315 ; 	 188. 695 tions	 Lord Macmillan said in Pondicherry Railway Co.v. Income tax Commissioner (1):" English authorities can only be utilized with caution in the consideration of Indian income tax cases owing to the differences in the relevant legislation	 but the principle laid down by Lord Chancellor Halsbury in Gresham Life Assurance Society V. Styles (2)	 is of general application unaffected by the specialities of the English tax system. " The result is that when a claim is made for a deduction for which there is no specific provision in section 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. If that is established	 then the deduction must be allowed	 provided of course there is no prohibition against it	 express or implied	 in the Act. These being the governing principles	 in deciding whether loss resulting from embezzlement by an employee in a business is admissible as a deduction under section 10(1) what has to be considered is whether it arises out of the carrying on of the business and is incidental to it. Viewing the question as a businessman would	 it seems difficult to maintain that it does not. A business especially such as is calculated to yield taxable profits has to be carried on through agents	 cashiers	 clerks and peons. Salary and remuneration paid to them are admissible under section 10(2)(xv) as expenses incurred for the purpose of the business. If employment of agents is incidental to the carrying on of business	 it must logically follow that losses which are incidental to such employment are also incidental to the carrying on of the business. Human nature being what it is	 it is impossible to rule out the possibility of an employee taking advantage of his position as such employee and misappropriating the funds of his employer	 and the loss arising from such misappropriation must be held to arise out of the carrying on of business and to be incidental to it. (1) (1931) L.R. 58 I.A. 239	 252. (2) 	 315; 	 188 696 And that is how it would be dealt with according to ordinary commercial principles of trading. At the same time	 it should be emphasised that the loss for which a deduction could be made under section 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. If	 for example	 a thief were to break overnight into 	he premises of a moneylender and run away with funds secured therein	 that must result in the depletion of the resources available to him for lending and the loss must	 in that sense	 be a business loss	 but it is not one incurred in the running of the business	 but is one to which all owners of properties are exposed whether they do business or not. The loss in such a case may be said to fall on the assessee not as a person carrying on business but as owner of funds. This distinction	 though fine	 is very material as on it will depend whether deduction could be made under section 10(1) or not. We may now examine the authorities in the light of the principles stated above. In Jagarnath Therani vs Commissioner of Income tax (1)	 the facts were that the assessee who was carrying on business entrusted a sum of Rs. 25	000 to his gumastha for payment to a creditor	 but he embezzled it. The question referred for the opinion of the High Court was whether that sum could be allowed as deduction in the computation of profits. In answering it in the affirmative	 the learned Judges observed that according to the practice obtaining in England	 sums embezzled by employees were allowed as deductions and referred to statements of the law to that effect from Sanders ' Income tax and Super tax	 Murray and Carters ' Guide to Income tax Practice and to the following passage in Snellings ' Dictionary of Income tax and Super Tax Practice: 		If a loss by embezzlement can be said to be necessarily incurred in carrying on the trade it is allowable as. deduction from profits. In an ordinary case it springs directly from the necessity of deputing (1)(1925) I.L.R. 4 Pat. 697 certain duties to an employee	 and should therefore be allowed. " They accordingly allowed the deduction as "a loss incidental to the conduct of the business". In Ramaswami Chettiar vs Commissioner of Income Tax	 Madras (1)	 the assessee was carrying on banking business in several places in India and in Burma. On October 21	 1926 thieves broke into the strong room in the business premises at Moulmiengyum and stole cash and currency notes of the value of Rs. 9	335. The question was whether this amount could be allowed as a deduction. It was held by the majority of the Jndges that it could not be. In the judgment of the learned Chief Justice	 the law was thus stated: " If any one is paid a sum due to him as profits and he puts that in his pocket and on his way home is robbed of it	 it would be	 I think	 difficult to contend that such a loss was incidental to his business. Still more so when he has reached his home and put those profits in a strong room or some other place regarded by him to be a place of safety. 1 can well understand that	 in cases where the collection of profits or payment of debts due is entrusted to a gumastha or servant for collection and that person runs away with the money or otherwise improperly deals with it	 the assessee should be allowed a deduction because such a loss as that would be incidental to his business. He has to employ servants for the purpose of collecting sums of money due to him and there is the risk that such servant may prove to be dishonest and instead of paying the profits over to him	 convert them to his own use. But I cannot distinguish the present case from the case of any professional man or trader who	 having collected his profits	 is subsequently robbed of them by a stranger to his business. In this case	 none of the thieves were the then servants of the assessee	 although one of them had formerly been his cook. " These observations	 while they support the right of the asssee to deduction of loss resulting from (1)(1930) I.L. R. 	 906	 907. 698 embezzlement by an employee	 also show the extent and limits of that right. In Bansidhar Onkarmal V. Commissioner of Incometax (1)	 there was a theft of money by an accountant	 but it took place after the office hours	 and it was held	 following the decision in Ramaswami Chettiar vs Commissioner of Income tax (2) that it could not be allowed as a deduction under section 10(1) of the Act	 as it was not incidental to the carrying on of the trade. But it was observed by Narasimham J. who delivered the leading judgment that it might have made a difference if the theft had been by the accountant during the office hours. In Venkatachalapathy Iyer vs Commissioner of Income tax (3)	 the assessees were a firm of merchants engaged in the business of selling yarn. Its accountant was one Rajarathnam lyengar	 whose duty it was to receive cash on sales	 make disbursements and maintain accounts. He duly entered all the transactions in the cash book but when striking the balance at the end of each day he short totalled the receipts and overtotalled the disbursements and misappropriated the difference. The question was whether the amounts thus embezzled could be deducted. On a review of the authorities	 Satyanarayana Rao and Raghava Rao JJ. held that the loss was incidental to the carrying on of the business and should be allowed. The appellant contends that this decision is decisive in his favour ; but the learned Judges of the Court below were of the opinion that on the facts it was distinguishable and that the present case fell within the decision in Curtis vs J. & G. Oldfield	 Limited (4). It is necessary to examine the decision in Curtis vs J. & G. oldfield (4) somewhat closely	 as the main controversy in the Indian courts has been as to what was precisely determined therein. There	 the facts were that the managing director of a company who was in exclusive control of its business	 had	 availing himself of his position as such managing director	 withdrawn large amounts from time to time and applied them to his own personal affairs. This went on for (1) (3) (2) Mad. 904	 906	 907. (4) 699 several years prior to his death	 and thereafter	 the fraud was discovered	 and the amounts overdrawn by him were written off as irrecoverable. The question was whether these amounts could be allowed as a deduction	 and it was answered in the negative by Rowlatt J. Now	 it should be observed that the learned Judge did not say that amounts embezzled by an employee in the course of business would not be admissible deductions. On the other hand	 he observed: " I quite think	 with Mr. Latter	 that if you have a business. in the course of which you have to employ subordinates	 and owing to the negligence or the dishonesty of the subordinates some of the receipts of the business do not find their way into the till	 or some of the bills are not collected at all	 or something of that sort	 that may be an expense connected with and arising out of the trade in the most complete sense of the word." He went on to observe: " I do not see that there is any evidence at all that there was a loss in the trade in that respect. It simply means that the assets of the Company moneys which the Company had got and which had got home to the Company	 got into the control of the Managing Director of the Company	 and he took them out. It seems to me that what has happened is that he has made away with	 receipts of the Company de hors the trade altogether in virtue of his position as Managing Director in the office and being in a position to do exactly what he likes." Thus	 what the learned Judge really finds is that the embezzlement was not connected with the carrying on of the trade but was outside it	 and on that finding	 the decision can only be that the deduction should be disallowed. But the learned Judges in the Court below would appear to have read the above observations as meaning that	 as a rule of law	 embezzlements made prior to the receipts of the amounts by the assessees would be incidental to the carrying on of the trade and therefore admissible	 but that embezzlements 89 700 made after receipt are not connected with the carrying on of the trade and are therefore inadmissible. We do not so read those observations. It is a question turning on the facts of each case whether the embezzlement in respect of which deduction is claimed took place in the carrying on of the business	 and the observations of the learned Judge that it did not so take place have reference to the facts of that case	 and can afford no assistance in deciding whether in a given case the embezzlement was incidental to the conduct of the business or not. Now	 in Curtis vs J. & G. Oldfield Limited(1)	 the company was doing business in wine and spirit	 and in such a business it is possible to hold that when once the price is realised and put into the bank	 the trading has ceased and that the subsequent operations on the bank account are not incidental to the carrying on of the trade. But here	 we are dealing with a banking business	 which consists in making advances	 realising them and making fresh advances	 and for that purpose	 it is necessary not merely to deposit amounts in banks but also to withdraw them. That is to say	 a continuous operation on the bank account is incidental to the conduct of the business. The theory that when once moneys are put into the bank they have " got home " and that their subsequent withdrawal from the bank would be de hors the business	 will be altogether out of place in a business such as banking. It will be a wholly unrealistic view to take of the matter	 to hold that the realisations have reached the till when they are deposited in the bank	 and that that marks the terminus of the business activities in money lending. It should also be mentioned that in Curtis vs J. & 'G. oldfield (1) though the assessee was a company	 it was found that the shares were all held by the members of the Oldfield family	 that the company had no auditor and no minutes book	 that there was Cc an almost entire absence of balance sheets "	 and that one of the members	 Mr. J. E. Oldfield	 was in management with wide powers. In view of the fact that he (1) 701 had a large number of shares in the company and that it was in substance a private company	 his withdrawals would be more like a partner overdrawing his account with the firm than an agent embezzling the funds of his employer	 and it could properly be held that such overdrawing has nothing to do with the trading activities of the firm	 whose profits are to be taxed. It would	 therefore	 be an error to suppose that the observations made by Rowlatt J. in the above context could be regarded as an authority for the broad proposition that as a matter of law	 and irrespective of the nature of business	 there could be no business activities with reference to moneys after they have been collected	 and that	 in consequence	 embezzlement thereof could not be incidental to the carrying on of business. And we should further add that it would make no difference in the admissibility of the deduction whether the employee occupies a subordinate position in the establishment or is an agent with large powers of management. Subsequent to the decision now under appeal	 the Bombay High Court had occasion to consider this question in Lord 's Dairy Farm Ltd. vs Commissioner of Income tax (1). On a review of the authorities including the decision in Curtis vs J. & G. Oldfield	 Limited (2)	 Chagla C. J. and Tendolkar J. held that loss caused to a business by defalcation of an employee was a trading loss	 and that it could be deducted under section 10(1). In Motipur Sugar Factory Ltd. vs Commissioner of Income tax (3)	 an employee who had been entrusted with the funds of a company for purposes of distribution among sugarcane growers in accordance with statutory rules	 was robbed of them on the way. It was held by Ramaswami and Sahai JJ. that the loss was incidental to the conduct of the trade	 and must be allowed. We agree with the decisions in Venkatachalapathy Iyer vs Commissioner of Incometax (4)	 Lord 's Dairy Farm Ltd. vs Commissioner of Income tax (1) and Motipur Sugar Factory Ltd. vs Commissioner of Income tax(3). (1) (1925) 9 Tax Cas. 319. (3) 702 It was argued for the respondent that there was no evidence	 much less proof	 that when Chandratan withdrew funds from the bank	 he did so for the purpose of making any advance	 and that	 therefore	 the withdrawal could not be held to have been for the conduct of the trade. That	 in our opinion	 is not necessary. When once it is established that Chandratan was in charge of the business	 that he had authority to operate on the bank accounts	 and that he with drew the moneys in the purported exercise of that authority	 his action is referable to his character as agent	 and any loss resulting from misappropriation of funds by him would be a loss incidental to the carrying on of the business. It was also contended that the power of attorney dated May 13	 1944	 under which Chandratan was constituted agent related not only to the business of the appellant but also to his private affairs	 and that there was no proof that the embezzlement was in respect of the business assets of the appellant and not of his private funds. No such question was raised before the Income tax authorities	 and their finding assumes that the moneys which were misappropriated were business funds. We are also not satisfied that	 on its true construction		 the authority conferred on the agent by the power of.attorney extended to the personal affairs of the appellant. In the result	 we are of opinion that the loss sustained by the appellant as a result of misappropiriation by Chandratan is one which is incidental to the carrying	 on of his business	 and that it should therefore deducted in computing the profits under section 10(1) of the	 Act. In this view	 the order of the lower court must be set aside and the reference answered in the	 affirmative. The appellant will get his costs of this appeal and of the reference in the Court below. appeal allowed.

Summary:
The appellant engaged an agent for the purposes of carrying on his business and conferred on him large powers of manage ment including authority to operate on bank accounts. While acting under such authority the agent withdrew moneys from the bank and used them for the discharge of his personal debts. The appellant was able to recover from the agent only a part of the amount misappropriated by him	 and the balance had to be written off at the end of the accounting year as irrecoverable. The question was whether the amount which was misappropriated and found irrecoverable was allowable as a deduction under the Indian Income tax Act in determining the profits of the appellant. Held	 that the amount in question is not allowable either as a bad debt under section 10(2)(Xi) or as a business expenditure under section 10(2)(XV) Of the Indian Income tax Act	 1922. It can	 however	 be deducted in computing the profits of the appellant under 691 section 10(1) of the Act as a loss incidental to the carrying on of his business. Where an agent or an employee of a businessman in charge of the business is given authority to operate on the bank accounts and withdraws moneys in the purported exercise of that authority	 his action is referable to his character as such authorised agent or employee and any loss resulting from misappropriation of the money by him would be one incidental to the carrying on of the business	 and it is not necessary to show that the money was withdrawn for the conduct of the business. Curtis vs J. & G. Oldfield	 and Rama swami Chettiar vs Commissioner of Income tax	 Madras	 Mad. 904	 explained and distinguished. Venkatachalapathy Iyer vs Commissioner of Income tax	 	 Lord 's Dairy Farm Ltd. vs Commissioner of Incometax	 and Motipur Sugar Factory Ltd. vs Commissioner of Income tax	 	 approved.