2020 (2) TMI 1039 - AT - Income Tax

Loss due to fraud and embezzlement - Expenditure allowable as a deduction u/s 37 - Whether trading loss on account of embezzlement and fraud is to be allowed in the year in which the amount is written off as irrecoverable? - HELD THAT - It is an undisputed fact that the assessee has taken legal actions, filed FIR and terminated the guilty employees. These facts on record were accepted by the DR. DR could not controvert the facts stated by the Ld. AR of the assessee. DR further could not bring on record any material/ evidence/ case laws which could controvert/raise any doubt regarding the facts already on record. It is therefore, undisputed fact that there was fraud and embezzlement for which the assessee suffered loss of ₹ 52,30,000/-. In present case of the assessee and taking guidance from the decision in the case of CIT Vs. Sales Magnesite (P) Ltd. 1994 (11) TMI 38 - BOMBAY HIGH COURT wherein considered the issue of commercial expediency and allowance of loss in the business. The main proposition which has been analyzed that deduction in the computation of business profits, it does not mean that the items go without any deduction at all, but the question has to be resolved on the basis of commercial prudency having regard to the accepted commercial practice and trading principles. To hold it to be expenditure allowable as a deduction under section 37, it is not essential that it should be necessary, legally or otherwise, to incur the same or that it should directly and immediately benefit the business of the assessee. Even expenditures incurred voluntarily on the ground of commercial expediency and in order indirectly to facilitate the carrying on of the business would be deductible under this section. In the present case, it is not disputed that the assessee took legal recourse by filing FIR and various legal actions before Higher Forum including termination of service of guilty employees. The loss that has been occurred to the assessee because of those factors which are very much irrecoverable and in the practical context, these have to be allowed since it has been incurred by the assessee for facilitating the carrying on of the business of the assessee. The Hon ble Supreme Court in the case of Bombay Steam Navigation Co. (1953) (P) Ltd. Vs. CIT 1964 (10) TMI 12 - SUPREME COURT has categorically held that the question must be viewed in the larger context of business necessity or commercial expediency. No abstract or pedantic view can be taken in the matter. In view of the aforesaid decision and on examination of facts on record, we set aside the order of the Ld. CIT(Appeals) and grounds raised by the assessee are allowed.

Summary

Issues Involved:
1. Allowability of loss due to fraud and embezzlement as a business expense.
2. Classification of the loss as bad debts under Section 36(1)(ii) of the Income Tax Act.
3. Allowability of loss on fixed deposits as a business expense.
4. Allowability of legal expenses incurred for recovery as a business expense.

Detailed Analysis:

1. Allowability of Loss Due to Fraud and Embezzlement as a Business Expense:
The assessee claimed a loss of ?52,30,000/- due to various instances of fraud and embezzlement by employees and agents. The loss included amounts from embezzlement by employees, fraudulent activities in clearing house transactions, and fraud by a recurring deposit agent. The assessee argued that the loss was incidental to the business and should be allowed as a deduction. The Ld. CIT(Appeals) upheld the Assessing Officer's view that the loss did not qualify as bad debts under Section 36(1)(ii) of the Income Tax Act, as the possibility of recovery could not be ruled out due to ongoing legal proceedings.

2. Classification of the Loss as Bad Debts Under Section 36(1)(ii) of the Income Tax Act:
The Ld. CIT(Appeals) and the Assessing Officer concluded that the loss claimed by the assessee did not fall within the ambit of bad debts under Section 36(1)(ii) because the legal proceedings were still pending, and there was a possibility of recovery. The assessee countered this by stating that the losses were irrecoverable, as evidenced by the non-recovery even after several years and the death or termination of the guilty employees.

3. Allowability of Loss on Fixed Deposits as a Business Expense:
The assessee also claimed a loss of ?10 lacs due to fraud and mismanagement in another bank where it had made fixed deposits. The Ld. CIT(Appeals) disallowed this claim, but the assessee argued that the loss was incidental to the banking business and should be allowed as a deduction, citing the necessity to maintain liquidity ratios as per RBI directives.

4. Allowability of Legal Expenses Incurred for Recovery as a Business Expense:
The assessee claimed legal expenses incurred for recovery from defaulters as a business expense. The Ld. CIT(Appeals) disallowed these expenses, but the assessee argued that these were incidental to the banking business and should be allowed as a deduction.

Judgment:
The Tribunal examined the facts and legal precedents cited by the assessee, including several Supreme Court and High Court judgments that supported the allowability of trading losses due to embezzlement and fraud in the year they are written off as irrecoverable. The Tribunal noted that the assessee had taken legal actions, filed FIRs, and terminated the guilty employees, and these facts were undisputed by the Revenue.

The Tribunal referred to various decisions, including those in the cases of Lord’s Dairy Farm Vs. CIT, Bedridas Daga Vs. CIT, and Ballarpur Industries Ltd., which established that trading losses due to embezzlement and fraud should be allowed in the year they are written off as irrecoverable. The Tribunal concluded that the losses claimed by the assessee were genuine, incurred in the course of business, and should be allowed as deductions.

The Tribunal also acknowledged the commercial expediency and practical context of the losses, emphasizing that the losses were incidental to the banking business and should be viewed in the larger context of business necessity. Consequently, the Tribunal set aside the order of the Ld. CIT(Appeals) and allowed the appeal of the assessee, granting the claimed deductions for the losses.

Conclusion:
The Tribunal allowed the appeal of the assessee, recognizing the losses due to fraud and embezzlement, the loss on fixed deposits, and the legal expenses as allowable business expenses. The judgment emphasized the practical and commercial context of the losses, aligning with established legal principles and precedents.