2017 (9) TMI 318 - HC - Income Tax

Loss on account of embezzlement - Held that - When embezzlement comes to the notice of an employer, it can be said that such embezzlement is detected by the employer.The word discovers has been interpreted by English Courts to means comes to the conclusion from the examination the Inspector makes, and from any information he may choose to receive or has reason to believe or finds or satisfied himself or honestly comes to the conclusion from information before him. The expression detection and discovery have different and distinct connotations in law and the expression discovery has to be interpreted so as to mean that loss must be deemed to have arisen only when employer comes to know about it and realizes that the amount embezzled cannot be recovered and not merely from the date of acquiring knowledge in which that embezzlement has taken place. Accordingly, the first substantial question of law is answered in favor of the assessee and against the Revenue. Loss by embezzlement being incidental to the banking business - allowed as deduction in the year of its detection or discovered - Held that - The second substantial question of law framed by this Court is answered by stating that loss by embezzlement being incidental to the banking business should be allowed as deduction in the year it is discovered and the expression discovered has to be read in the context of Circular dated 24.11.1965 issued by Central Board of Direct Taxes. Accordingly, the second substantial question of law is answered in favor of the assessee and against the Revenue.

Summary

Issues:
1. Claiming deduction for embezzlement loss - detection vs. discovery
2. Allowance of embezzlement loss as deduction in the banking business

Analysis:

Issue 1: Claiming deduction for embezzlement loss - detection vs. discovery
The assessee claimed embezzlement loss in the return of income for the Assessment year 1997-1998, but the Assessing Officer disallowed the deduction stating that the loss was detected in a previous accounting year. The Commissioner of Income Tax (Appeals) allowed the deduction, relying on the principle that the loss should be allowed when it is crystallized after completing all procedural formalities. The Tribunal, however, held that the loss should be claimed in the year it is detected. The Supreme Court's decision in Associated Banking Corporation of India Ltd. case highlighted that loss by embezzlement should be allowed as a deduction in the year it is discovered, not merely when it is detected. The Central Board of Direct Taxes circular dated 24.11.1965 further emphasized that the loss must be related as incidental to the business and should be allowed in the year of discovery.

Issue 2: Allowance of embezzlement loss as deduction in the banking business
The judgment analyzed the distinction between the terms "detection" and "discovery" in the context of embezzlement losses. It was clarified that while detection refers to the employer becoming aware of the embezzlement, discovery implies the realization that the embezzled amount cannot be recovered. The Court held that the expression "discovery" should be interpreted to mean that the loss arises when the employer knows about it and understands that the embezzled amount cannot be retrieved. Therefore, the embezzlement loss, being incidental to the banking business, should be allowed as a deduction in the year it is discovered, as per the Circular issued by the Central Board of Direct Taxes.

In conclusion, the High Court set aside and quashed the orders passed by the Income Tax Appellate Tribunal, allowing the appeals in favor of the assessee based on the distinction between detection and discovery in claiming deductions for embezzlement losses and the specific guidelines provided by the Central Board of Direct Taxes circular.