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TMI Blog1951 (1) TMI 37X X X X Extracts X X X X X X X X Extracts X X X X ..... that the amount represented the loss sustained by them as the result of embezzlement by one Rajarathnam Aiyangar, a former clerk of their firm. In such capacity the clerk was entrusted with manifold duties. Ke wrote account books, acted as salesman, received and disbursed cash in the absence of the managing partner and collected bills. 2. The amounts received and spent by him in the course of the day used to be noted on slips of paper by him and he would hand over the slips with the cash balance in his hands to the managing partner at the close of the day. He maintained also cash chitta of transactions conducted by him including collections and expenses. In May 1941 it was discovered that he had embezzled a total sum of ₹ 36,298-3-6 during the period between 17th October 1939 and 24th October 1940. The 'modus operandi' adopted by him to embezzle the money was : while he entered the transactions faithfully in the books maintained by him, in totalling the receipts and payments of each day, he short-totalled the receipts and over-totalled the payments and prepared a statement of daily cash balance on the basis of such wrong totals and the cash actually handed over at ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ther it can be treated as an expenditure under Section 10 (2) (xii) or as bad debt under Section 10 (2) (xi). 6. The last two contentions may be disposed of first. The reference to Section 10 (2) (xii) in the question as framed is to the present Clause (xv) of Section 10 (2) which was introduced after certain alterations in 1948 by the Indian Income-tax (Amendment) Act, 1946. That clause requires, to claim an amount as a permissible deduction under the head of expenditure, that it should be made out as expended solely and exclusively for the purpose of such business, profession or vocation. It is impossible to treat an amount misappropriated by a clerk as an expenditure for the purposes of a business. No serious attempt was made on behalf of the assessees to argue the contrary. Under Clause (xi) of Section 10 (2), in order to constitute a bad debt, it must be a loan advanced in the ordinary course of business. The amount in dispute cannot be treated as a loan made by the assessees to Rajaratnam Aiyangar and therefore it was not a debt. 7. No doubt, when the misappropriation was discovered in May 1941, this amount was entered in the accounts as a debit against Rajaratnam Aiyan ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... islature, after specifying the permissible deductions in Section 10 (2), has left the determination of the profits to be made in accordance with the principles well understood by business people. That is the reason why the trade loss to be set off against the profits of the year is not specifically mentioned as an allowance. It must be remembered in this connection that every tax year is a self-contained period and the profits earned and the loss incurred during the particular year alone must be considered in order to arrive at the taxable profits. The previous year's and the subseqeunt year's profits or loss is wholly irrelevant for the purpose of computing the assessable income of a particular year. The allowances permitted under Section 10 (2) must generally be those incurred in the year in respect of which the income profits and gains are taken as the basis for assessment. 10. It is not possible to give a precise definition of trade loss which can be set off against the profits of a tax year. In order, however, to constitute a trade loss, it must be either loss of the stock in trade or a loss incurred in the course of the business and as incidental to it. It is not e ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ropriated was a trading loss and a permissible deduction from the profits for income-tax purposes, was considered by Rowlatt, J., in 'Curtis v. Oldfield Ltd.', (1925) 9 Tax Cas 319, where a managing director of a company who was in sole charge of the business of the company diverted the funds of the company for his personal use. 13. The judgment of the learned Judge in my opinion deals with the question when a defalcation or embezzlement could be treated as a trade loss and when such diversion of monies unauthorisedly by an employee goes out of the ambit of trade loss. He draws the line of demarcation between the two situations and it seems to me that the statement of the law by the learned Judge is in consonance with the practice obtaining in England. He observes at page 330 : I quite think, with Mr. Latter, that if you have a business (which for the purposes of today at any rate I will assume) in the course of which you will haye to employ subordinates, and owing to the negligence or the dishonesty of the subordinates some of the receipts of the business do not find their way into the till, or some of the bills are not collected at all or something of that sort, t ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... nd of maintaining the cash chitta with an obligation to account for the funds reaching his hands truly and faithfully to the managing partner at the end of the day and to hand over the balance. In violation of his duties and in breach of the confidence reposed in him, while he took care to see from the point of view of the customers that the entries are correctly made in the accounts, made wrong totals so as to cheat his master by representing that the balance in his hands was much less than what is really was. The managing partner was induced into the belief that the totals in the account reflected the true financial position at the end of the day and took the balance handed over by Rajarathnam Aiyangar, trusting in his integrity. It was only when suspicion was aroused and an inquiry was made that it was discovered that he had embezzled this large amount. 16. The till in this case is with the managing partner and it cannot be said that the temporary custody of the money with Rajarathnam Aiyangar constituted a till and the diversion of the funds by him was de hors the trade on the analogy of the facts in 'Curtis v. Oldfieid Ltd.', (1925) 9 Tax Cas 319. The funds were not ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... of business other than money lending business is only of money lost in the course of and as incidental to the business, in circumstances which are within the line of demarcation drawn by Rowlatt, J., in 'Curtis v. Oldfield Ltd.', (1925) 9 Tax Cas 319, it may be treated as a trade loss. 19. In 'Bansidhar Onkarmal v. Commissioner of Income-tax. Bihar and Orissa', 1949-17 ITR 247 (Orissa), the Orissa High Court dealt with a case of loss by theft of money of the business of selling yarn, speculation in cotton and money lending. The theft was by the accountant of the firm but was after the office hours. It was held that it was not a trade loss. Narasimham, J., who delivered the leading judgment recognised however an exception when he observed at page 254 that the position might have been quite different if the theft had occurred during office hours prior to the crediting of the sum to the account of the employer. The implication of this, as I understand it, is that even if it is a case of theft, if it was committed by a servant or an employee during office hours, it would bring it within the course of the business and as incidental to it and therefore would have ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... difficult to say that the amount was lost the moment it was taken or misappropriated by the clerk. It is one thing to say that the amount was unauthorisedly appropriated by the clerk and it is a totally different thing to describe the amount so taken as a loss of the business. 22. Loss implies that it is an amount which is gone forever and it is impossible to recover it. The analogy of bad debts may be taken. It cannot be said that a debt becomes bad immediately it was advanced or immediately it was suspected that the debtor was not financially sound. The creditor has to establish that he had taken all available steps to realise the debt and that it was impossible to recover it. The decision of this Court in 'Alagananda Mudaliar v. Commissioner of Income-tax, Madras', 1940 48 ITR 69 (Mad) relating to the insolvency of C.K. and Sons is an instance where it was held that the creditor is entitled to wait till the decision of the Privy Council which became necessary for settling the dispute with regard to certain matters before a debt is considered as bad debt and written off as such. It is not to be assumed by this that I am treating this loss as a debt and I have already g ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ion, it is only when the loss becomes actual and certain that there can be an accrual of a loss and till then, it was merely a civil liability, of the clerk to pay back that amount based on tort. Until it is found that the liability though enforceable, it could not be materialised, it cannot be said that loss had occurred. I wish to make it clear that I do not by any means suggest that there was an unascertained loss at its inception which became certain and definite when the litigation was settled. But the point I wish to lay stress on is that until the settlement of the case by way or compromise, there was no loss at all. It was only then that the loss came into existence and accrued. It was then with definiteness and certainty the amount was known. I do not wish to refer to the other decisions which have been cited at the bar as in my opinion they are not of assistance in the solution of the questions which have been raised in the case. I am therefore of opinion differing from the Appellate Tribunal that there was a trade loss and that the loss had accrued only during the relevant accounting period. It follows that the first question referred to us must be answered in the negati ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ed counsel urged that the till remained intact according to the account books which correctly reflected the receipts and disbursements notwithstanding the defalcation and that what loss the company sustained was incidental to the misconduct of the employee 'de hors' the trade. The argument is in my opinion, clearly fallacious and far from deriving any warrant from 'Curtis v. Oldfield Ltd.', (1925) 9 Tax Cas 319 relied on by learned counsel, rests on a total misapprehension of the decision as I shall presently show. 27. The argument lays too much of emphasis on the appearances of correctness and too little of emphasis on the realities of incorrectness about the truth and fact of the financial condition of the company so far as it stands prejudiced by the misconduct of the employee. It overestimates the form and underestimates the substance of the defalcation. It identifies the resultant balance which the account books reveal with the till itself by a fiction which imports that if the former are correct the latter must be treated as sound and that all monies which have got into the make up of the former must be deemed to have necessarily got into the contents of th ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ll, it will be noticed, is not the only instance of negligent or dishonest conduct of the subordinates which justifies an allowance on the ground of an expense connected with and arising out of the trade . 30. In my opinion, the learned Judge must be taken, so far as his observation last extracted goes, to consider all losses attributable to the negligence or dishonesty of subordinates acting in the course of their employment in the trade as being deductible trade losses. The learned Judge then proceeds thus to distinguish the case before him from the illustrations referred to by him in that observation : But here that is not the case at all. This gentleman was the Managing Director of the company and he was in charge of the whole thing, and all we know is that in the books of the company which do exist it is found that monies went through the books into his pocket. I do not see that there was any evidence at all that there was a loss in the trade in that respect. Pausing there, I am of opinion that the learned Judge's reference to Oldfield's position as Managing Director does not imply that only trade losses for which subordinates and not Managing Directors, ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... disbursements, apparently open to no exception. The learned Judge after instancing the two cases of failure of funds to reach their destination, the till of the company, and non-collection of debts due to the company mentions the third category in terms of something of that sort , something 'ejusdem generis', it may be, with the two cases mentioned earlier but in terms sufficiently comprehensive to take in a case of loss due to negligence or dishonesty on the part of the subordinate, however occurring, if only occurring in the course of his employment and as incidental to the business, and not, as was the factual position in 'Curtis's case', (1925) 9 TC 319 'de hors' the trade. 33. The way in which I am reading 'Curtis's case', (1925) 9 TC 319 is indeed the way in which the law is stated by Beasley, C.J., though in different language to that of Rowlatt, J., at page 906 of the report of the Full Bench case in 'Ramaswami v. Commissioner of Income-tax, Madras', 53 Mad 904 which was a case of a theft of money used in a money lending business by persons who were not at the time of the offence employed as clerks or servants in the busi ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ges in 'Ramaswami v. Commissioner, Income-tax, Madras', 53 Mad 904 is, in my judgment, perfectly correct, and applying it to the facts of the present case I have no doubt but that the loss under consideration now is an admissible deduction whether regarded as in the nature of unobstruction of monies before they reached the till or regarded as in the nature of something of that sort within the language of Rowlatt, J., in 'Curtis's case', (1925) 9 TC 319 as explained by me earlier. I regret I cannot in these circumstances find myself in agreement with Mr. Ramrao Sahib's contention which proceeds, as I think, on much too narrow a view of what is or is not a trade loss liable to deduction from profits, viz., that it must be a loss which, on the face of the accounts, is so. 35. Before parting with 'Curtis's case', (1925) 9 TC 319 it seems to me pertinent to observe that possibly the loss in question in the instant case can be regarded as an expense connected with and arising out of the trade in the language of Rowlatt, J., so as to attract Section 10 (2) (xv) of the Indian Statute which is much to the same effect. The language of the learned Ju ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... arance of cash from the company in the year in which that took place must be shown by the assessee as a deduction for that year, while if later the money came back the assessee would have to show it as a gain. This no doubt is perfectly intelligible process of reasoning in itself. What however Mr. Subbaraya Aiyar urges is that merely because the disappearance occurred in a particular year the assessee would not be bound to treat that as an irrecoverable loss for ever. He would be entitled, counsel urges, to wait for a reasonable time in order to take all steps open to him in law for the recovery of the amount. Should he be penalised, asks counsel, for taking all those steps in order to satisfy himself that the loss which occurred with the original disappearance was a permanent loss and if so to define for himself the exact quantum of the loss which he must face after all his efforts? The consideration by which the matter has to be reasonably judged is pithily put in 'Burnett v. Huff', 288 US Rep 156 : 77 Law Edn 670, at p. 783 in the passage quoted by my learned brother in his judgment, in this way, viz., that the requirement that losses be deducted in the year in which th ..... 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