S.K. Jha, J. - (1.) BY this reference under Section 256(1) of the Income-tax Act, 1961, the Income-tax Appellate Tribunal has referred the following question of law for opinion of this court: " Whether, on the facts and in the circumstances of the case, the penalty imposed under the Sea Customs Act at Rs, 9,49,287-3-0 was an allowable deduction under Section 10(1) or 10(2)(xv) of the Indian Income-tax Act, 1922?"
(2.) THE assessee is a registered firm deriving income from dealings in cotton textiles, yarn and petrol from the head office at Gaya and branch offices at Bombay, Nagpur and Calcutta. It was also acting as the Agent of the Bihar Government during the operation of Cloth and Yarn Control Order. A major change was introduced by the Government of India in its import policy in the year 1952, between the months of January and June and it was decided that the licence for the import of certain articles would be granted freely to all classes of applicants, either established importers or new-corners. THE assessee obtained the provisional licence on the 2nd of March, 1952 (wrongly printed as the 2nd of May, 1952, in the statement of the case). This provisional licence was, under the existing rules, obtained by the assessee from the Joint Chief Controller of Imports and Exports, Calcutta, to import artificial silk yarn from the soft currency area and had Rs. 1,00,00,000 as limiting factor for value. Under the free licensing scheme, January/June, 1952, mentioned above, the provisional licence had to be confirmed within two months from the date of the issue, failing which it was to be treated as cancelled, and, according to a further provision in the licensing order, no clearance of goods was permissible against any provisional licence which had not been confirmed. THE assessee then applied for confirmation of the aforesaid provisional licence dated the 2nd of March, 1952. THE Joint Chief Controller of Imports and Exports, Calcutta, refused to confirm the licence. On the 26th of July, 1952, the assessee appealed before the Joint Chief Controller of Imports and Exports for a reconsideration of the matter. While the matter was still pending, it sent a copy of its appeal or representation to the Chief Controller of Imports and Exports at New Delhi. THE matter, it seems, also did not find favour with the Chief Controller, THE assessee then filed a petition before the then Finance Minister, Shri T. T. Krishnamachari, on tbe 31st of March, 1953. In the meantime, one Sri Kalyanam, claiming himself to have influence in the Ministry of Finance, got the licence of the assessee duly confirmd. THE licence so brought by Shri Kalyanam abovementioned did not, however, contain the nature of the goods that should be imported from the soft currency- area. It was again purported to be subsequently rectified. On the basis of this licence, the assessee imported the goods and before the delivery was taken, the goods were sold to the local buyers. Subsequently, the customs authorities under the Sea Customs Act, 1878, found that the licence against which the assessee had imported the goods was invalid, it being a forged one. THE aforesaid Sri Kalyanam, who was neither a Government servant nor in any way connected with any office, was prosecuted for forgery and landed in jail. THE assessee was, however, let off only with the penalty. THE authorities confiscated the goods in consonance with the provisions of Section 167(8) of the Sea Customs Act and the assessee having been given an option under Section 183 of that Act, paid a sum of Rs. 11,02,500 as penalty for the release of the confiscated goods and also a personal penalty of Rs. 84,200 (in the statement of the case, there again seems to be an error of record in so far as the amount of penalty mentioned under the former head has been incorrectly given as Rs. 9,49,287-3-0). THEse two sums of money paid by the assessee by way of penalty where included in the assessee's books of account on the debit side resulting in book loss of Rs. 9,49,287-3-0 in the assessment year 1955-56, with which we are concerned in the present case. THEse two sums of money paid by way of penalty by the assessee were, however, disallowed by the Income-tax Officer who added back a total sum of Rs. 11,86,700 to the credit side. THE assessee having preferred an appeal before the Appellate Assistant Commissioner, that appeal also failed as it was held by the revenue authority that these two sums could not be allowable as any business expense under the Indian Income-tax Act, 1922 (hereinafter referred to as " the Act"). THE assessee having gone up in a second appeal to the Income-tax Appellate Tribunal, it was contended there that the aforesaid entire claim was an allowable expenditure under Section 10(2)(xv) of the Act or, in the alternative, it should be allowed under Section 10(1). Both the contentions put forward on behalf of the assessee were rejected by the Tribunal. THE Tribunal held on an appraisal of all the materials on record that the cumulative effect of all the circumstances led to the irresistible conclusion that the imports made by the assessee were not so made in good faith. It was further held that the subsequent conduct of the assessee like concealing all the outstanding overseas orders and co-operating with the customs authorities in all their investigations was a virtue of necessity which might have, perpbaps, been a mitigating circumstance while assessing the assessee's guilt but certainly the act of the assessee in importing the materials in question was not bona fide. Having thus dismissed the appeal of the assessee, at its instance the aforementioned question of law has been referred to this court. Mr. Tarkeshwar Prasad, learned counsel for the assessee, at the outset urged that the questien as framed in this case was not quite accurate nor did it fully bring out the issue involved and the questions arising out of the order of the Tribunal. In my view, this contention of the learned counsel is well-founded and in order to bring out all the issues involved, I would reframe the question thus : " Whether, on the facts and in the circumstances of the case, the penalty of Rs. 11,86,700 imposed under the Sea Customs Act, resulting in the loss of Rs. 9,49,287-3-0 was fit to be taken into account under Section 10(1) or was a deduction allowable under Section 10(2)(xv) of the Indian Income-tax Act, 1922?" Before going into the question of law, one thing is very clear from the findings of the Tribunal, namely, that the particular isolated act of the assessee in importing the goods in contravention of the provisions of the Sea Customs Act, 1878, was not in good faith nor was it a part of the regular business activity of the assessee. In this background, I shall examine as to whether the assessee can be entitled to a relief either under the provisions of Section 10(1) of the Act or the expenditure or disbursement made by it could be allowable under Section 10(2)(xv). The scheme of Section 10 of the Act is that the profits and gains must be computed subject to certain express allowances and subject also to certain express or implied prohibitions of deductions. A deduction which is neither within the term of the prohibition nor expressly or impliedly allowable in the exclusive definition of its area must be allowed if it is, on the facts of a given case, a proper debit item to be charged against the incoming of the trade in ascertaining the true profits of an assessee. In other words, in determining a particular item which is not covered by the provisions of Sub-section (2) of Section 10 as to whether it may or may not be deducted from the profits, it is necessary first to enquire as to whether the deduction is expressly or by necessary implication prohibited by the Act. If it is found that it is not so prohibited then it falls for consideration as to whether it is of such a nature that it should be charged against the incomings in the computation of profits and gains on ordinary principles of commercial trading. As observed by Chagla C.J. in Shantikumar Narottam Morarji v. Commissioner of Income-tax, [1955] 27 ITR 69 (Bom), where the learned Chief Justice, after quoting from the decision of the Judicial Committee of the Privy Council in the case of Income-tax Commissioner v. Chitnavis, [1932] 2 Comp Cas 464; AIR 1932 PC 178, that what are chargeable to 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 a true picture of the profits and gains will not emerge, went on further to observe : "It is true that if there is a specific prohibition in the Act, the court will not permit an allowance in face of that prohibition. It is equally true that if there is an allowance permissible under the Act and the allowance deals with the whole subject-matter, the court will not permit that subject-matter to be expanded." This has all along been understood to be the true meaning and purpose of the provision of Section 10(1). Although the English income-tax statute is different in some respects, the true representation of the balance of profits or gains has always been quoted with approval from high authorities in England by the Supreme Court. Two such apt observations have always to be borne in mind while judging whether, on the facts of a particular case in a trading result, the true results have been arrived at according to ordinary commercial principles of trading. I may well refer to the two observations from those two English cases here. In Gresham Life Assurance Society v. Styles, 1892 AC 309 HL Lord Herschell observed: " The expression ' balance of the profits or gains ' is not a happy one; but the meaning obviously is the balance arrived at by setting against the receipts the expenditure necessary to earn them." The case of Gresham Life Assurance Society has been cited with approval by the Supreme Court in the case of Badridas Daga v. Commissioner of Income-tax, 1958 34 ITR 10 (SC). Another apt observation is that of Lord Devey in the case of Strong & Co. of Romsey Ltd. v. Woodified, 1906 AC 448 HL, which is as follows: " It is not enough that the disbursement is made in the course of, or arises out of, or is connected with, the trade, or is made out of the profits of the trade. It must be made for the purpose of earning the profits."
(3.) THESE are the principles which have consistently been followed by the courts including the Supreme Court in finding out as to whether a relief under Section 10(1) could be said to be justified in a given case. In the case of Badridas Daga, Venkatarama Aiyar J., stressing the same principles 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 must be incidental to it and not any loss sustained by the assessee even if it has some connection with his business. To the same effect is the decision of the Supreme Court in Poona Electric Supply Co, Ltd. v. Commissioner of Income-tax, [1965] 57 ITR 521 (SC), a case relied upon by learned counsel for the assessee itself, to which I shall refer later also at a more appropriate place. In principle, therefore, where the assessee can be said to be entitled to a relief under Section 10(1) in judging the justifiability of the computation of the profit and loss or where it be entitled to claim an expenditure or disbursement as permissible item under Section 10(2)(xv), one thing is quite clear and that is that it must be an integral part of the nature of the business which the assessee is carrying on. If a loss or an expenditure is an incident inherent in the very nature of the trade or the business carried on by an assessee, such a loss either under Section 10(1) or as an allowable expenditure or disbursement under Section 10(2)(xv) must be granted. Judging in the light of these well-settled principles of law and applying these tests, it has to be seen in the present case as to whether the expenditure or disbursement claimed as a permissible deduction under Section 10(2)(xv) by the assessee was laid out wholly and exclusively for the purpose of the assessee's business; alternatively, whether this item or expenditure could be said to be justifiable when entered on the debit side of the trading account of the balance-sheet of the assessee resulting in a true computation of its business loss entitling it to a relief under Section 10(1) although it may not be covered by the permissible deductions under any of the provisions of Section 10(2) of the Act. Judging from either point of view, in my opinion, the assessee in the present case will not be entitled to relief either under Section 10(1) or Section 10(2)(xv) of the Act. The facts and the principles involved in the present case, in my view, are fully covered by a decision of the Supreme Court in the case of Haji Aziz and Abdul Shakoor Bros. v. Commissioner of Income-tax, 1961 41 ITR 350 (SC). In the case of Haji Aziz, the assessee had to pay a penalty under Section 167(8) of the Sea Customs Act read with Section 183 of the Act, as in the present case, and this expanditure was sought to be claimed as a permissible deduction by the assessee under Section 10(2)(xv) of the Act. Although the claim was being made expressly as an allowable item of expenditure or disbursement under Section 10(2)(xv)of the Act only, their Lordships of the Supreme Court, while examining that question, have, as a matter of fact, gone into the more general aspect of the matter also to find out as to whether, on the well-settled principles, it can be held to be a proper item of debitable expenditure and, in that connection, after reviewing most of the Indian and English decisions, Kapur J. held at page 359; " A review of these cases shows that expenses which are permitted as deductions are such as are made for the purpose of carrying on the business, i.e., to enable a person to carry on and earn profit in that business. It is not enough that the disbursements are made in the course of or arise out of or are concerned with or made out of the profits of the business but they must also be for the purpose of earning the profits of the business. As was pointed out in von Glehn's case, 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 trade cannot be described as such. If a sum is paid by an assessee conducting his business, because in conducting it he has acted in a manner which has rendered him liable to penalty, it cannot bs claimed as a deductible expense. It must be a commercial loss and in its nature must be contemplable as such. Such penalties which are incurred by an assessee in proceedings launched against him for an infraction of the law cannot be called commercial losses incurred by an assessee in carrying on his business. Infraction of the law is not a normal incident of business and, therefore, only such disbursements can be deducted as are really incidental to the business itself. They cannot be deducted if they fall on the assessee in some character other than that of a trader. Therefore, where a penalty is incurred for the contravention of any specific statutory provision, it cannot be said to be a commercial loss falling on the assessee as a trader, the test being that the expenses which are for the purpose of enabling a psrson to carry on trade for making profits in the business are permitted but not if they are merely connected with the business." It will be seen from the paragraph quoted above that such an expense over the penalty imposed for an infraction of law has been viewed by the Supreme Court as not being a commercial loss falling on the assessee as a trader, applying the test that the expenses which are for the purpose of enabling a person to carry on trade for making profits in the business were not permissible if they were merely connected with the business. And, such a payment of a sura by way of penalty has been held to be, if at all, merely remotely connected with the business. As a matter of fact, the Supreme Court has approved and relied upon a decision of the Court of Appeal in Commissioner of Inland Revenue v. Alaxander von Glehn & Company, 1920 2 KB 553 CA. In that case also the Court of Appeal was seized with a question of the present nature, and, while dealing with that question. Lord Justice Warrington, at page 568, observed as follows: " In the case of a trade loss is not always, or perhaps one may even say is not in general, measured by a definite expenditure of money. Loss in trade arises in many ways from the depreciation of goods, from the increase or decrease in prices in the market and from many causes of that kind, and it is not generally measured by some definite sum expended by the person carrying on the trade...... In the present case what is sought to be deducted is a definite sum expended by the company, and the question we have to determine is whether that is to be allowed as a deduction." ;