- (1.) This is an appeal by special leave brought by the Commissioner of Income-tax against the judgment and order of the High Court of Bombay answering the question in favour of the assessee. The question referred by the Tribunal was: "Whether on the facts and in the circumstances of the case the amount of Rs. 3,20,162 is an allowable deduction under Section 10(2)(xi) or 10(2) (xv) of the Income-tax Act - which was amended by the High Court as follows : "Whether on the facts and in the circumstances of the case the amount of Rs. 3,20,162 is an allowable deduction" and was answered in the affirmative and against the appellant.
(2.) The facts of the case shortly stated are these : The respondent is a registered firm carrying on business as commission agents. It was treated as the agent of a non-resident principal Haji Mohomed Syed Al Barbari of Port Sudan (hereinafter referred to as the 'non resident principal'). It was carrying on the business of export of cloth and kariana (i.e., miscellaneous goods) to Aden, Saudi Arabia and Sudan. It used to supply goods from India to the non resident principal, who on his part, was sending cotton to the respondent and other merchants for sale in India. For the years 1942-43, 1943-44, 1944-45 and 1945-46, the respondent firm was treated as the agent of the non-resident principal under S. 43 of the Income-tax Act (which will hereinafter be termed 'the Act') for the purpose of income-tax and Excess Profits Tax. The respondent firm had to pay in all Rs. 3,78,491 under S. 42 (1) of the Act and after allowing for the amounts which were in its hands the account of the principal non-resident showed a debit balance of Rs. 3,20,162. For the year of assessment,1953-54, the respondent firm treated this amount as a bad debt and claimed it as a deductible loss to be set off against profits. The Income tax officer treating this claim as one under S. 10 (2)(xv) of the Act, disallowed it. The Appellate Assistant Commissioner treated it as one under S. 10 (2) (xi) of the Act and he also disallowed it. On appeal to the Income-tax Appellate Tribunal it was held to be a bad debt and an allowable deduction as it was incurred as a result of the business activities which the respondent firm was carrying on with the non-resident principal. At the instance of the Commissioner of Income-tax, the case was stated to the High Court and the High Court modified the question and answered the same in the affirmative, i.e., against the appellant. The High Court held that as the law imposed an obligation upon the respondent firm to discharge the liability and it was incidental to the business of the respondent the amount was a deductible loss; and even if it was not a debt, then also the amount could be claimed by the assesssee as a business or trading loss, because in arriving at the true profit of the respondent's business that loss had to be deducted. The High Court thus applied S. 10(1) of the Act to the amount claimed by the respondent.
(3.) The allowability of the amount in dispute depends upon the nature of the liability imposed upon the respondent firm. The contention of the respondent's counsel was that it was carrying on foreign trade and had dealings with a foreign merchant and in the course of the business there were imports and exports and therefore the inter-connection between the respondent firm and the non-resident principal was so intimate as to invite the application of S. 42 (1), i.e., the establishment of agency as contemplated in that section. The liability to pay arises under S. 42 (2) which provides: "Where a person not resident or not ordinarily resident in the taxable territories carries on business with a person rersident in the taxable territories, and it appears to the Income-tax Officer that owing to the close connection between such persons the course of business is so arranged that the business done by the resident person with the person not resident or not ordinarily resident produces to the resident either no profits or less than the ordinary profits which might be expected to arise in that business, the profits derived therefrom or which may reasonably be deemed to have been derived therefrom, shall be chargeable to income-tax in the name of the resident person who shall be deemed to be, for all the purposes of this Act, the assessee in respect of such income-tax." Relying on this provision it was argued that the nature of the respondent's business was foreign trade which was inter-connected with the business of the non-resident principal. Its nature was such as to attract the imposition of liability on the respondent firm under S. 42 (2) of the Act and therefore the the loss so incurred must be taken to be incidental to and arising out of the business of the respondent.;