Spending on something that is illegal or against the law is not tax deductible: SC

Fact and issue of the case

Feeling aggrieved and dissatisfied with the impugned judgment and order dated 22.11.2016 passed by the High Court of Judicature for Rajasthan at Jaipur passed in DBITA No.96/2003 and DBITR No.6/1996 by which the High Court has allowed the said appeals, the Revenue has preferred the present appeals

The facts leading to the present appeals in nutshell are as under:

A search was conducted by the Directorate of Revenue Intelligence (DRI) officers at the premises situated at A-11, 12, Sector – VII, NOIDA taken on rent by the assessee, Shri Prakash Chand Lunia. The DRI recovered 144 slabs of silver from the premises and two silver ingots from the business premises of the assessee at 1397, Chandni Chowk, Delhi. The assessee was arrested under Section 104 of the Customs Act for committing offence punishable under Section 135 of the Customs Act. The Collector, Customs held that the assessee Shri Prakash Chand Lunia is the owner of silver/bullion and the transaction thereof was not recorded in the books of accounts. The Collector of Customs, New Delhi ordered confiscation of the said 146 slabs of silver weighing 4641.962 Kilograms valued at Rs.3.06 Crores. The Collector Customs further imposed a personal penalty of Rs.25 Lakhs on Sh. Prakash Chand Lunia under Section 112 of the Customs Act. The Collector held that the silver under reference was of smuggled nature

During the course of the assessment proceedings the Assessing Officer observed that the assessee was not able to explain the nature and source of acquisition of silver of which he is held to be the owner, therefore the deeming provisions of Section 69A of the Income Tax Act, 1961 (hereinafter referred to as ‘the Act, 1961) would be applicable. The investment in this regard was not found recorded in the books of accounts of the assessee that were produced before the then Assessing Officer. Accordingly, the Assessing Officer passed an assessment Order and made an addition of Rs.3,06,36,909/- under Section 69A of the Act, 1961. In appeals preferred by the Assessee against the assessment order, the CIT(A) dismissed the appeal of the assessee. Feeling aggrieved the assessee preferred the appeal before the ITAT. The ITAT, Jaipur also upheld the order of the CIT(A) so far as Section 69A is concerned, however, partly allowed the appeal of the assessee. As regards some other minor additions, the ITAT set aside some minor other additions and remanded the matter to the AO for fresh examination. The AO re-examined the issue and addition was made. The CIT(A) also upheld the order of the AO. The Assessee preferred the appeal against the fresh order passed by the CIT(A) before the ITAT. The ITAT, in the second round as well upheld the order of the authorities below. A reference was made by the ITAT to the High Court with the following questions of law:

“Whether on the facts and in the circumstances of the case, the Tribunal after construing and interpreting the provisions contained in section 69A of the Income Tax Act, 1961 was right in law, in holding that the assessee was the owner of the 144 silver bars found at premises no A 11 & 12 , Sector – VII, Noida and two silver bars found at premises of M/s Lunia & Co Delhi and in sustaining addition of Rs.3,06,36,909/- being unexplained investment in the hands of the assessee under Section 69A of the Act?

If the answer to the above question is in affirmative then, whether, on the facts and in the circumstances of the case, the Tribunal was right in law in distinguishing the ratio laid down by their Lordships of the Supreme Court in the case of Piara Singh v/s CIT, 124 ITR 41 and thereby not allowing the loss on account of confiscation of silver bars?”

While the reference was pending before the High Court, penalty proceedings were initiated against the assessee. An order under Section 271 (i) (c) of the Act came to be confirmed by both the CIT (A) and the ITAT. Accordingly, the assessee filed an appeal under Section 260A of the Act against the Penalty order, before the High Court. The High Court while deciding both the cases together, qua the first question, decided in favour of the Revenue and the rental premises of the assessee, the same is to be added to his income as a natural consequence. However, with regard to the second question, the High Court held that loss of confiscation by the DRI official of Customs Department is business loss. While holding the High Court has relied upon the decision of this Court in the case of CIT, Patiala vs. Piara Singh reported in 124 ITR 41. The impugned judgment and order passed by the High Court is the subject matter of the present appeal

Shri Balbir Singh, learned ASG has appeared on behalf of the Revenue and Shri Arijit Prasad, learned Senior Advocate has appeared on behalf of the assessee

Shri Balbir Singh, learned ASG appearing on behalf of the Revenue has vehemently submitted that in the facts and circumstances of the case and while dealing with the relevant provisions of the Act, 1961, the High Court has materially erred in relying upon the decision of this Court in the case of Piara Singh (supra). It is submitted that as such the AO, CIT(A) and ITAT have correctly distinguished the judgment in case of the Piara Singh (supra) as the same pertained to an assessee who was engaged in the business of smuggling of currency notes and for whom confiscation of the currency notes was a loss occasioned in pursuing his business, i.e., a loss which sprung directly from carrying on of his business and was incidental to it. It is submitted that due to this, the assessee in the aforesaid case was held entitled to deduction under Section 10(1) of Income Tax Act, 1922. It is submitted that however in para 7 of the aforesaid judgment which refers to three cases where an exception to the aforesaid rule was noted by the Court. It is submitted that in the said decision this Court noted earlier decisions of this Court as well as the Andhra Pradesh High Court and the Bombay High Court. It is submitted that in the case of Haji Aziz & Abdul Shakoor Bros. v. CIT, AIR 1961 SC 663, the assessee’s claim for deduction of fine paid by him for release of his dates confiscated by customs authorities, was rejected on the ground that the amount paid by way of penalty for breach of law was not a normal course of business carried on by it. In the other two cases, customs authorities had confiscated gold from assessees otherwise engaged in legitimate businesses. It is submitted that in two relied upon cases of Andhra Pradesh High Court and the Bombay High Court the assessees claimed the value of gold seized as a trading/business loss which is identical to the Respondent-Assessee’s claim in the facts of the present SLP. It is submitted that therefore the decision of this Court in Haji Aziz & Abdul Shakoor Bros. v. CIT, AIR 1961 SC 663, of the Andhra Pradesh High Court in the case of Soni Hinduji Kushalji & Co. vs. CIT, (1973) 89 ITR 112(AP) and of the Bombay High Court in the case of JS Parkar v. VB Palekar, (1974) 94 ITR 616 (Bom) shall be applicable with full force to the facts of the case on hand

It is submitted that the Andhra Pradesh High Court observed in para 10 of the judgment in case of Soni Hinduji Kushalji (supra) that when a claim for deduction is made, the loss must be one that springs directly from or is incidental to the business which the assessee carries on and not every sort or kind of loss which has absolutely no nexus or connection with his business. In paras 11 and 12, the High Court relied on various judgments to state that confiscation of contraband gold is an action in rem and not a proceeding in personam and thus, a proceeding in rem in the strict sense of the term is an action taken directly against the property (i.e., smuggled gold) and even if the offender is not known, customs authorities have power to confiscate the contraband gold. In view of the aforesaid, the Court stated that confiscation of contraband gold by customs authorities cannot be said to be a trading or commercial loss connected with or incidental to assessee’s business. The High Court further relied on Haji Aziz (supra) and various other judgments to state that such confiscation of smuggled/contraband goods which results in infraction of law and has no incidence/connection to the business of assessee, cannot be allowed as a business loss. Thus, the aforesaid case which has been referred to and distinguished in Piara Singh (supra), squarely applies to the facts of the present case herein. Similarly, the case of JS Parkar (supra) would also be applicable to the present case as in the former case, the assessee not only claimed the value of the gold confiscated as a trading loss but also set off of the said loss against his assumed and assessed income from undisclosed sources. Furthermore, the value of gold was sought to be taxed U/s.69/69A by the tax authorities. However, in this case also the Bombay High Court rejected the contention that Section 110 of the Evidence Act (where a person found in possession of anything, the onus of proving that he was not the owner is on the person who affirmed that he was not owner) was inapplicable to taxation proceedings and agreed that tax authorities had rightly inferred assessee to be owner of seized gold based on circumstantial evidence and assessee was not entitled to claim value of such gold as a trading loss.

Shri Balbir Singh, learned ASG has further relied upon the decisions of this Court in the case of Chuharmal v. CIT, (1988) 3 SCC 588 and CIT v. K Chinnathamban, (2007) 7 SCC 390, on onus of proving ownership being on the person who denies ownership and who is in possession. It is submitted that ownership of confiscated silver fell on the Respondent-Assessee in the present case which he failed to discharge and which accordingly rendered the tax authorities’ concurrent findings on his ownership to be valid. It is submitted that when the assessee has been unable to deny possession and ownership and in fact admitted the same before the Settlement Commission as well as the High Court, and further claimed the value of confiscated silver as a trading loss before AO, CIT(A) and ITAT, to alternatively argue to the contrary and deny ownership in order to state that Section 69A cannot be applied in his case may not be accepted

Observation of the court

Commissioner of Income Tax v. Piara Singh, (1980) Supp. SCC 166 24.1 This Court did not differ with the view expressed by a co-ordinate bench in Haji Aziz (supra). In fact, it gave its approval to the said decision. However, reliance was placed on S.C. Kothari (supra) by drawing a distinction between an infraction of law committed in carrying out a lawful business, as against one committed in an inherently unlawful business. It was done upon a legitimate anticipation that in an illegal business there will be many pitfalls resulting in expected loss, which cannot be factored into a normal business

Law as laid down in Haji Aziz (supra) on both the issues have not been taken note of by inadvertence, particularly the nature of proceedings involved in the imposition of confiscation or penalty, being proceedings in rem. This Court did not have the benefit of the explanation as available under Section 37 of the Act, while interpreting Section 10(2) of the Old Act, apart from ignoring the word of caution mentioned in Badridas Daga (supra)

We would only clarify the position that, in any case, the law as laid down in Piara Singh (supra) may not have any application to a case of deduction of expenditure/loss incurred on account of penalty/confiscation coming under Section 37(1) of the Act, particularly in light of Explanation

Dr. T.A. Quereshi v. Commissioner of Income Tax, Bhopal (2007) 2 SCC 759

This Court merely followed Piara Singh (supra) while making a casual observation on Explanation 1 to Section 37 of the Act. The earlier decisions have not been taken into consideration as we could see in Piara Singh (supra), but the principle laid down was also not taken note of. In this connection, it has to be remembered that for a precedent to be binding there has to be a conscious consideration of an issue involved. The judgment in Dr. T.A. Quereshi (supra) was delivered by a two-Judge Bench while not taking note of a three-Judge Bench decision in Haji Aziz (supra), which has neither been disapproved nor distinguished. Hence, this decision is per incuriam and not a binding precedent. Once again, the question of a confiscation proceeding being in rem was not brought to the notice of the Court

Therefore, there cannot be a situation where an assessee carrying on an illegal business can claim deduction of expenses or losses incurred in the course of that business, while another assessee carrying on a legitimate one cannot seek deduction for loss incurred on account of either a confiscation or penalty. The interpretation of Section 37 of the Act given by the Court in Dr. T.A. Quereshi (supra) leads to a situation where the expenditure incurred in manufacturing something illegal may not be allowable as a deduction in view of the Explanation 1, however, if upon seizure, the manufactured goods are confiscated, in that case deduction will be allowable on commercial principles. This classification being artificial not borne out by statute, which mischief is sought to be clarified by the explanation, has no legal basis