1965 (3) TMI 2 - HC - Income Tax

Deduction - whether the loss arose in the course of the business of the assessee and whether the assessee is entitled to have it adjusted in the computation of its profits under section 10(1) - assessee would be entitled to an even larger amount since it has not been possible for the auditors to check and ascertain the exact amount involved

Summary

Issues Involved:
1. Entitlement to deduction of embezzled amount.
2. Whether the loss arose in the course of business.
3. Determination of the exact amount embezzled.
4. Impact of management's negligence on the claim.
5. Timing of the loss and its discovery.
6. Necessity of pursuing legal action for recovery.

Issue-wise Detailed Analysis:

1. Entitlement to Deduction of Embezzled Amount:
The primary question addressed was whether the assessee was entitled to the deduction of Rs. 42,718 or any portion thereof from its assessable income for the year 1955-56. The court examined if the loss from embezzlement could be adjusted in the computation of profits under section 10(1) of the Income-tax Act.

2. Whether the Loss Arose in the Course of Business:
The court noted that the assessee had to entrust cash and stamps to its employees for carrying out its business. The embezzlement by employees through manipulation of accounts was established. The Tribunal initially held that the loss did not occur in the ordinary course of business due to the management's negligence. However, the court disagreed, stating that the loss was incidental to the business, as the embezzlement occurred during the normal course of business operations.

3. Determination of the Exact Amount Embezzled:
The Tribunal recorded that the exact amount embezzled could not be ascertained, but based on the confessions of the cashier and accountant, the embezzled amount was Rs. 34,396. The court accepted this figure for the deduction, despite acknowledging that the actual amount could be higher.

4. Impact of Management's Negligence on the Claim:
The Tribunal suggested that the loss was due to the employer's negligence. The court, however, found this approach erroneous. It emphasized that the necessity to delegate responsibilities to employees inherently involves trust, and the loss from embezzlement should be considered incidental to the business, regardless of perceived negligence.

5. Timing of the Loss and Its Discovery:
The court considered when the loss from embezzlement could be said to occur. It referenced various judgments indicating that the loss is recognized when it becomes actual and present, typically upon discovery. The systematic embezzlement was discovered in the relevant accounting year, and therefore, the loss was considered to have occurred then.

6. Necessity of Pursuing Legal Action for Recovery:
The court addressed the Tribunal's point that the assessee did not take action to recover the embezzled amounts through promissory notes. It concluded that pursuing a futile legal action was not necessary. The assessee demonstrated that the employees were insolvent, making recovery impractical. Thus, the lack of legal action did not negate the occurrence of the loss.

Conclusion:
The court concluded that the loss from embezzlement was incurred in the course of carrying on the business and was incidental to it. The assessee was entitled to the deduction of Rs. 34,396, the amount covered by the employees' confessions. The question was answered in favor of the assessee, and costs were awarded to them with a counsel fee of Rs. 250.