1. The assessee firm carries on business as commission agents and as such commission agents they had a business connection with one Haji who was a businessman carrying on business at Port Sudan. The Income-tax Department treated the assessee as the agent of this non-resident principal and they assessed him to tax under section 42 (1) of the Income-tax Act. As the result of the assessment made by the Department the assessee paid on behalf of this non-resident principal a sum of Rs. 3,78,491. The assessee failed to recover this amount from the non-resident principal, and in the year of account he contended that this debt was irrecoverable and claimed it as a bad debt. The Tribunal held that the assessee was entitled to this deduction and the Commissioner has come on this reference.
2. It is admitted that if this was a debt which could be claimed under section 10 (2) (xi) it became irrecoverable in the year of account and therefore a bad debt which could be claimed in that year. The only question in dispute is whether this is a debt to which section 10 (2) (xi) applies. The contention of the Advocate-General is that the liability which was discharged by the assessee was a statutory liability he was not acting in the course of his business, and the debt did not arise in the course of the business. Now, under section 10 (2) (xi) a debt which can be claimed as a bad debt must be a debt in respect of the business of the assessee, and the question is whether in discharging the liability of the assessee what the assessee was doing as something connected with his business at all. Now, it is necessary to understand how the assessee came to discharge this liability. It is because he carried on this business with the non-resident that this vicarious liability under section 42 was imposed upon him. If he had not carried on this business, there would have been no liability whatsoever and therefore the liability which he discharged and in respect of which the debt arose was directly connected with his business with the non-resident. It is also significant to not that the tax liability which the assessee discharged was in respect of income earned by the non-resident in respect of this very business with the assessee. Therefore the tax which was paid was tax on the profits earned by the non-resident by doing business with the assessee. The assessee discharged the liability because he rendered himself liable by doing this business with the non-resident under section 42 and it was because he could not recover this liability which covered this debt from the non-resident in respect of the liability which he had discharged, that he claimed it as a bad debt under section 10 (2) (xi). The argument put forward by the Advocate-General is that a debt is a business debt only when it is incurred in the course of a business, and the Advocate-General's contention is that 'in the course of the business' means in the actual activity of carrying on a particular business. His submission is that the debt must be such as must appear in the profit and loss account of the business. It must be an amount spent for the purpose of enabling the business to earn forfeits. If the amount is not spent for that purpose, then the expenditure is not incurred in the course of the business and any debt arising out of that expenditure cannot be claimed as a bad debt.
3. Now, in the first place, the Legislature has not used the expression in section 10 (2) (xi) 'in the course of business'. It has used the expression with a wider connotation and the expression is 'in respect of the business'. Therefore, what the Legislature required was that there must be a connection between the debt and the business, and it is difficult to understand how in this particular case it could possibly be urged that there is no connection between the business of the assessee and the debt which has become a bad debt. As we have already said, it is precisely because he carried on this business with a non-resident that he had to discharge the liability and the non-resident became his debtor and failed to discharge his debt. The Advocate-General rather naively suggested that the assessee need not have done this business with the non-resident, in which case there would have been no liability imposed upon him and no debt would have arisen. Even though all powerful, the Taxing Department cannot dictate to an assessee what type of business he should carry on and with whom he should deal; the Taxing Department must accept the business such as it is which the assessee carries on, because it is the profits of that business that the Taxing Department seeks to tax. The question is whether a particular debt had any relation to the business which was carried on by the assessee. It is perfectly true that, even giving to the expression 'in respect of' the widest connotation, the debt must be incidental to the business. If a liability is discharged which gives rise to a debt, the business must require the discharging of that liability. If the businessman voluntarily undertakes to discharge the liability of some one, then clearly he cannot claim that if that person fails to discharge that liability, the debt becomes a bad debt which can be claimed as a deduction under section 10 (2) (xi). Now, on the facts of this case, can it be said that the liability which the assessee discharged was not required by his business to be discharged Could it be said that the tax which he paid on behalf of his principal, the non-resident, was paid voluntarily without there being any obligation upon him An obligation to discharge a liability may arise out of business custom or it may arise out of a legal obligation. In our opinion, both stand on the same footing. A businessman may have to stand surety for some one in order that he should get monies for his own business. The custom of the business may require that that is the only method whereby he could get monies in order to finance his own business, and the question might arise, if he has to discharge the surety debt, whether that debt is a business debt or not. If the custom is established and the requirement of the business is proved, then it would be a business debt. Similarly, law may cast an obligation upon the assessee to discharge a liability, and it is difficult to understand why that case would stand on a different footing from the one we have just considered. In this case the Income-tax Act imposed a liability upon the assessee by reason of his business connection with the non-resident to discharge the tax liability of his principal. The discharging of the liability was incidental to the business. The liability arose because of the business and there would have been no liability if he had not carried on this business. Therefore, it would not be true to say that this particular liability had no connection whatever with the business of the assessee. The Advocate-General says that the liability must be discharged by the assessee in his capacity as a businessman and not in any other capacity and he suggests that in this case the liability is discharged by the assessee not in his capacity as a businessman carrying on a particular business, but by reason of the obligation cast upon him by statute. But what the Advocate-General forgets is that the statute casts an obligation upon him because he is carrying on that particular business, because he has the business connection with the non-resident. If he had not been carrying on the business, the statute would not have cast an obligation upon him. Therefore, it is not in any other capacity that the liability arose and the liability was discharged, but strictly in his capacity as a businessman doing business with a non-resident. Even assuming that, in the strict sense of the term, the amount claimed by the assessee as deduction is not a debt, even so, in our opinion, the amount can be claimed by the assessee as a business or trading loss. It is because he is carrying on this particular business that he had to incur this loss and in arriving at the true profits of his business, this loss must be deducted.
4. Now, if the principles we have laid down are appreciated, then the authorities on which the Advocate-General relies present really no difficulty. Reliance is placed in the first instance on a decision of the Madras High Court reported in Commissioner of Income-tax v. S. R. Subramanya Pillai. That was a case where the assessee was a book-seller and he jointly borrowed with another person a certain amount, part of which was utilised for his own business and the other part for the business of the other person. That other person became insolvent, and the assessee had to discharge his liability, and the assessee claimed the amount as a bad debt. The Madras High Court held that this amount could not be claimed as a bad debt. At page 94 in the judgment it is pointed out that 'the business of bookselling did not require the assessee to guarantee the debts of third persons like Lakshmana Ayyar', i.e., the other person. Therefore in guaranteeing the debt of Ayyar the assessee was doing something which the business did not require, and in this very judgment reference is made to an earlier decision of that Court in Commissioner of Income-tax v. Ramaswamy Chettiar, where it was found as a custom in the business of the Chettiars that they were in the habit of raising funds by execution of joint promissory notes in favour of bankers and when that custom was established, the Court held that 'where a Nattukottai Chetti money-lender paid off in their entirety the dues jointly due by him and another as a result of the latter's inability to pay, the loss sustained as a result of this transaction was a loss of the money-lending business itself and therefore a deductible item in computing profits'. Reference has also been made to a recent decision of the Supreme Court reported in Madan Gopal Bagla v. Commissioner of Income-tax. That was an appeal from a judgment of the Calcutta High Court, and the Supreme Court upheld the decision of the Calcutta High Court. In that case the assessee borrowed one lakh of rupees from a bank on the joint security of himself and another, B, and B simultaneously borrowed one lakh of rupees from another bank on the joint security of himself and the assessee. The assessee repaid the amount which he had borrowed, but B became insolvent and the assessee had to pay the amount B had borrowed with interest to the bank and he wrote off a certain amount which was irrecoverable from the estate of B as a bad debt and claimed it as an allowable deduction. It was contended on behalf of the assessee, and this is the significant part of the decision which one must bear in mind, that it was the usual custom in Bombay for merchants to borrow from banks on the joint security of each other and that the loss incurred by the assessee was a loss incurred in his business, and what the Supreme Court held was that the custom set up did not mean that mutual accommodation by businessmen was necessarily an ingredient part of that custom, and because of this the transaction in question could not be deemed to be one entered into by the assessee in the course of carrying on his timber business, but was one entered into for the purpose of financing the business of another person, and it appears fairly clear from the judgment that if the custom of mutual accommodation had been established, in all probability the Supreme Court, with respect, would have come to the conclusion that the loss was a loss due to discharging a financial liability which was required by the business. Reliance is also placed on a decision of the house of Lords reported in Smith's Potato Estates Ltd. v. Bolland. What the learned Law Lords were concerned with was to decide whether certain legal expenses incurred by the taxpayer with a view to reducing the assessment made upon him as a trader for excess profits tax was an admissible deduction under the income-tax law, and the House of Lords held that it was not. Now, one or two important considerations should be borne in mind. The decision of the majority of the House of Lords turned on giving to the words used in section 10 (2) (xv) the interpretation that they meant the same thing as an amount expended in order to enable the trader to earn profit in his trade. The Privy Council in Ward & Co. Ltd. v. Commissioner of Taxes has pointed out the distinction between the words used in the English Income-Tax Act which are the same as in section 10 (2) (xv) and the words of the New Zealand Act which require that the expenditure must have been incurred for the direct purpose of producing profits. Even so, the decision of the House of Lords is by a majority and two Law Lords, Viscount Simon and Lord Oaksey took a contrary view and held that the legal expenses were admissible deductions even within the meaning of the wide provision contained in the English income-tax law. Therefore, this decision is not of particular help to us in deciding the question that we have to decide. We would decide this reference on the view that the liability which the assessee discharged, although it was a statutory liability, arose by reason of the business carried on by the assessee with the non-resident and there would have been no liability if he had not carried on the business. Therefore the amount claimed by the assessee is an admissible deduction under the Income-tax Act, whether the deduction falls under section 10 (2) (xi) or may be looked upon as a trading or business loss.
5. We will amend the question as follows :
'Whether on the facts and in the circumstances of the case the amount of Rs. 3,20,162 is an allowable deduction ?'
6. and answer that question in the affirmative.
7. The Commissioner to pay the costs.
8. Reference answered in the affirmative.