1951 (1) TMI 37 - HC - Income Tax

Summary

Issues Involved:
1. Whether the sum of Rs. 21,372 could be treated as a loss in the account period of the assessment year 1942-43.
2. Whether the sum could be deducted as an expenditure under Section 10 (2) (xii) or as a bad debt under Section 10 (2) (xi) of the Income-tax Act.

Detailed Analysis:

1. Whether the sum of Rs. 21,372 could be treated as a loss in the account period of the assessment year 1942-43:

The assessees, a registered firm engaged in the yarn business, claimed a deduction of Rs. 21,372 for the assessment year 1942-43, alleging it as a loss due to embezzlement by a former clerk, Rajarathnam Aiyangar. The embezzlement was discovered in May 1941, and the total amount misappropriated was Rs. 36,298-3-6. The clerk manipulated daily cash balance statements by short-totalling receipts and over-totalling payments. A criminal prosecution and civil suit followed, resulting in a compromise where the clerk paid Rs. 16,250 in full settlement. The claimed deduction was the difference between the embezzled amount and the settlement.

The Income-tax Officer and the Appellate Assistant Commissioner initially denied the deduction, doubting the embezzlement. However, the Appellate Tribunal confirmed the embezzlement but refused the deduction, stating the loss occurred in the previous accounting year (1939-40). The Tribunal also rejected the claim under the heads of expenditure and bad debt.

The court held that the loss should be considered a trade loss incurred during the accounting year and deductible from the profits. It emphasized that the loss was due to the necessity of employing subordinates and entrusting them with duties, making it incidental to the business. The court distinguished between losses occurring before the funds reached the business's control and those occurring after, ruling that the embezzlement by the clerk before the funds reached the managing partner constituted a trade loss.

2. Whether the sum could be deducted as an expenditure under Section 10 (2) (xii) or as a bad debt under Section 10 (2) (xi) of the Income-tax Act:

The court addressed the contention regarding the applicability of Section 10 (2) (xii) (now Clause (xv)) and Section 10 (2) (xi). For an amount to be deductible as an expenditure under Clause (xv), it must be expended solely for the business's purpose. The court found it impossible to classify the embezzled amount as such an expenditure. Similarly, for a bad debt under Clause (xi), the amount must be a loan advanced in the ordinary course of business, which was not the case here. The court dismissed these contentions, noting that the amount could not be treated as a loan or an expenditure for the business.

Conclusion:

The court concluded that the embezzlement was a trade loss incurred during the accounting year and should be deductible from the profits. It also determined that the loss occurred when it became certain and irrecoverable, i.e., after the compromise settlement in the relevant accounting period. The first question was answered in the negative and in favor of the assessees, and the second question was answered in the negative and against the assessees. The assessees were awarded costs of Rs. 250.