1. This is a reference under sub-section (1) of section 66 of the Indian Income-tax Act at the instance of the assessee. The assessee is a partnership firm registered for purposes of income-tax under the Income-tax Act, and carrying on wholesale cloth business. We are here concerned with the assessment year 1956-57, the relevant accounting period being October 27, 1954, to November 14, 1955 (S. Y. 2011). In the course of its business, the assessee had, from time to time, borrowed money from banks jointly by way of mutual accommodation. On December 10, 1949, the assessee had borrowed a sum of Rs. 1 lakh jointly with another firm, Sadasukh Gambhirchand of Calcutta. The said firm, Sadasukh Gambhirchand, consisted of two partners : Sadasukh Gambhirchand and Dawood Dayal Ramchandra Kothari. Out of Rs. 1 lakh borrowed form the Bank of India, the assessee-firm took Rs. 50,000 and remaining Rs. 50,000 were taken by Sadasukh Gambhirchand. The said firm, Sadasukh Gambhirchand, failed to meet its obligation and the assessee, therefore, had to pay to entire amount of Rs. 1,00,739-11-0 on account of the said loan. In the books of the account of the assessee-firm the half share of it, viz., Rs. 50,369-13-6 had been shown as the amount as the amount due from the said firm, Sadasukh Gambhirchand.
2. In the year 1950 the assessee then filed two suits on the original side of this court for recovery of the said amount from the two partners of Sadasukh Gambhirchand and the suits were decreed against the said partners on June 15, 1953, and September 23, 1953. The expenses of the litigation and the interest amounting to Rs. 2,0031-9-0 were also debited by the assessee to the account of the said partnership, Sadasukh Gambhirchand. The balance standing to the debit of the said partnership, Sadasukh Gambhirchand, amounted to Rs. 54,989-6-0. The whole of said amount was assessee at the end of the samvat year 2011. In the assessment year 1956-57 the assessee claimed deduction for the aforesaid amount of Rs. 54,989-6-0 under various provisions of section 10. It may, however, be stated that the only claim now pressed before us is one under] sub-section (1) of section 10 of the Act. In the course of the proceedings, the assessee furnished information relating to all the steps taken by it for the recovery of the said amount from the partners of the firm, Sadasukh Gambhirchand. The Income-tax Officer, disallowed the claim. On appeal, the Appellate Assistant Commissioner, relying on a decision of this court in Commissioner of Income-tax v. Jagannath Kissonlal, allowed the appeal. The material part of his reasoning is in the following terms :
'The money borrowed by the appellant on the joint and several liability of himself and Sadasukh Gambhirchand was in the course of and incidental to his business, since he has made such borrowings on many other occasions. In spite of the fact that the appellant has obtained decrees against Sadasukh Gambhirchand nothing has been realised up-till today.
Although the case is still pending with his attorneys in Calcutta, yet the appellant is not prosecuting the case any further and has in fact requested for the return of all the papers. The fact that Messrs. Sadasukh Gambhirchand are financially unsound will be clear form the fact that their assets are already in the hands of the receiver and the appellant has not realised a single pie in spite of spending money in court cases and execution proceedings. The appellant has written off this debt during the pendency of the proceedings only after he came to know that there was absolutely no chance of recovery whatsoever. As such, I think, the claim was a permissible deduction under section 10(2)(XV) of the Income-tax Act and he will be allowed a deduction of Rs. 54,989.'
3. Against this decision of the Appellate Assistant Commissioner, the Department preferred an appeal before the Tribunal. The Tribunal held that the case was governed by a decision of the Supreme Court in Madam Gopal Bagla v. Commissioner of Income-tax, and after this decision, the decision of this court in Commissioner of Income-tax v. Jagannath Kissonlal, was no more good law. It is in this view of the matter that the Tribunal held that the Appellant Assistant Commissioner was not right in allowing the deduction. The Tribunal, in the alternative, further held that the payment to the bank was on 8th February, 1950. The assessee, therefore, was not entitled in any case to claim deduction in respect of the said amount in the assessment year 1956-57 either under section 10(1) or 10(2)(XV). It is in this view of the matter that the Tribunal allowed the appeal.
4. On an application made by the assessee under sub-section (1) of section 66, the Tribunal has stated the case referring the following question of the law to this court :
'Whether Rs. 54,989 is a proper deduction as a trade loss incurred on the ground of commercial expediency under section 10(1) or an expenditure under section 10(2)(XV) ?'
5. Mr. Mehta, learned counsel for the assessee, has stated before us that he was only pressing the claim under sub-section (1) of section 10 as a trading loss on the ground of commercial expendiency.
6. Facts of this case are similar to the facts in Jagannath Kissonlal's case, except in one respect, to which we will presently advert. The decision of this court in Jagannath Kissonalal's case, has been confirmed in appeal by their Lordships of the Supreme Count in Commissioner of Income-tax Jagannath Kissonlal, Now facts in Commissioner of Income-tax v. Jagannath Kissonlal, were : The assessee, a firm carrying on business as commission agents, borrowed jointly with K a sum of Rs. 1 lakh from a bank on a promissory note executed by it and K with joint and several liability. Out of this sum, the assessee took of Rs, 50,000 for the purpose of the its business and K took the remaining Rs. 50,0000. K became a bankrupt and the assessee had to pay the bank the whole amount of Rs. 1 lakh with interest. The assessee received from the official assignee the sum of Rs. 18,805 and claimed the balance of Rs. 31,740 as an allowable deduction under section 10(2)(XV) or as a trading loss. The Appellate Tribunal found that there was a well-recognised commercial practice in Bombay carrying on business by borrowing from banks on joint and several liability. That by so doing the borrower can borrow money at a lower rate of interest than he would have otherwise to pay, and the assessee had borrowed money in accordance with the commercial practice. On a reference, the High Court had held that the assessee was entitled to claim deduction for the said amount. On appeal to the Supreme Court by the department against the decision of this court, the Supreme Court rightly held that the assessee was entitled to deduction of the loss suffered by it in the transaction. Here the facts of this case are similar. The assessee along with the firm, Sadasukh Gambhirchand, had jointly and severally borrowed from the bank an amount of Rs. 1 lakh. The said sum was divided half and half between these two persons. This was not the only borrowing but the assessee had also similarly borrowed in the previous years moneys from the bank jointly with other persons. The advantage gained was obtaining advances from the bank at a lower rate of interest. There is, however, one distinguishing feature between the facts in Jagannath Kissonlal's case, and the present case. The trading loss was claimed by the assessee-Jagannath Kissonalal - in the year in which he had to pay the money to the bank. The assessee, however, in the instant case has not claimed deduction on the ground of trading loss in the year it had to pay the amount to the bank on 8th February, 1950. The deduction has been claimed in thee assessment year 1956-57 on the ground that in that year the assessee lost all hopes of recovering the amount from the partners of Sadasukh Gambhirchand.
7. Mr. Joshi, learned counsel for the department, has not adopted the line of reasoning adopted by the Tribunal. He frankly conceded that the decision in Bagla's case, on which the Tribunal had placed reliance, would have no application to the facts of the present case. He also frankly conceded that thee decision of their Lordship in Jagannath Kissonlal's case, would have governed the decision of this case had the assessee claimed deduction in respect of the said amount Rs. 50,369-13-6, which if had to pay on behalf of the Sadasukh Gambhirchand firm in the year in which it had paid the amount to the bank. The assessee, however, has chosen not to do so. The assessee, on the other hand, debited the said amount in his books of account in the khata of Sadasukh Gambhirchand and thereby accepting Sadasukh Gambhirchand as its debtors. The debt owed by Sadasukh Gambhirchand was not a trading debt; the loss, even if any, which the assessee has incurred by reason of his inability to recover the amount Sadasukh Gambhirchand, is not a trading loss but a capital loss. The assessee, therefore, is not entitled to claim deduction in respect of this amount. In the alternative, Mr. Joshi has also raised two further contentions. Mr. Joshi contends that even assuming that the entries made by the assessee in its books of accounts have not the effect of changing the character of the loss, the loss incurred by the assessee is not the loss suffered in the year of account, inasmuch as the material on record shows that the in the assessment year 1956-57 the assessee had not given up hope of recovering the amount from the partners of the firm, Sadasukh Gambhirchand. And, lastly, Mr. Joshi contended that at any rate the assessee is not entitled to claim deduction of any amount in excess of Rs. 50,369-13-6. In other words, according to Mr. Joshi, the assessee is not entitled to claim deduction in respect of the amount of interest as well as the amount expended as legal expenses by the assessee in obtaining the decrees against the partners of the firm, Sadasukh Gambhirchand, and the recovery proceedings.
8. It is not possible for us to accept the first two contentions raised by Mr. Joshi. It is not disputed that the loss incurred by the assessee, on being required to pay Rs. 50,369-13-6 to the bank on behalf of Sadasukh Gambhirchand, was a trading loss. The said amount was paid on February 8, 1950. Mr. Joshi has conceded that had the assessee claimed have been entitled to obtain deduction in respect of that amount as a trading loss. The question that has to be considered is whether the assessee has disentitled himself from claiming the said amount as a trading loss on account of his having debited the amount in the books of account and proceeding to make efforts to recover the amount as a trading loss on account of his having debited the amount in the books of account and proceeding to make efforts to recover the amount from the partners of the firm, Sadasukh Gambhirchand. We fail to see how the nature and character of the loss, which was a trading loss, ceased to be trading loss merely because the assessee has made an entry in his books of account showing that the said amount was due from and payable by the firm, Sadasukh Gambhirchand. There can hardly be any dispute that the assessee, having paid the said amount of Rs. 50,369-13-6 to the bank, had become entitled to recover that amount from the partners of Sadasukh Gambhirchand. The entry in the books of account only indicates that position. The entry does not mean that the assessee was trading as if he had advanced and amount on that the date to Sadasukh Gambhirchand. The entry itself makes the position clear and it shows that the debit was in respect of the half share of the joint loan taken from the Bank of India Limited and not paid by Sadasukh Gambhirchand to the bank and it, therefore, was required to be paid by it and it is for this reason that the amount was shown to have been debited in the books of account to the khata of Sadasukh Gambhirchand. The entry itself shows that the assessee had continued to treat it as a trading loss suffered by it in the course of its business. We have also not come cross any provision of the Indian Income-tax Act, nor any has been pointed out to us that a trading loss of the nature, with which we are here dealing, if not claimed in the year of account, ceases to be a trading loss. On the other hand, certain decisions of their Lordships of there Supreme Court make it abundantly clear that deduction in respect of trading loss could be claimed by an assessee in later assessment years when the assessee finds that it is no more possible for him to recover the losses from the persons who had caused the same to the assessee.
9. Facts in Associated Banking Corporation of India Ltd. v. Commissioner of Income-tax were : The secretary of the assessee-bank had misused the power conferred on him and had withdrawn about Rs. 18 lakhs by posting false entries in the books of account of the bank in the accounting year ending 30th June, 1947. The withdrawals came to the knowledge of the liquidator at the end of the accounting year and the liquidator had to pay to the constituents of the bank about Rs. 10 lakhs and odd pursuant to the order made by the court in 1949, and a settlement in that respect of the in the year 1951. It is thereafter that the assessee had claimed deduction in respect of the loss caused on account of the embezzlement by its secretary. The question, therefore, which arose before their Lordships, was as to the point of time at the which the loss is said to have occurred. In considering the question, their Lordships held :
'It is wrong to say that irrespective of other considerations, as soon as an embezzlement of the employer's funds takes place, whether the employer is aware or not of the embezzlements, there results a trading loss. So long as there is a reasonable prospect of recovery of the amount embezzled, trading loss in commercial sense cannot be deemed to have resulted.
Embezzlement of funds by an agent, like a speculative adventure, does not necessarily result in loss immediately when the embezzlement takes place, or the adventure is commenced. Embezzlement may remain unknown to the principal and the assets embezzled may be restored by the agent or servant. In such a case in the commercial sense no real loss has occurred. Again it cannot be said that in all cases when the principal obtains knowledge of the embezzlement loss results. The erring servant may be persuaded or compelled by the process of law or otherwise to restore wholly or partially his ill-gotten gains. Therefore, so long as a reasonable chance to the obtaining restitution exists, loss may not in a commercial sense be said to have resulted.'
10. The principle thus that follows, is that a trading loss in a commercial sense arises when there is no reasonable chances or possibility to recovery the loss from the person who has occasioned the loss to the assessee.
11. Mr. Joshi tried to distinguish this case on the ground that in the case before their Lordships of the Supreme Court, the trading loss was caused by an employee, who was engaged for the purpose of business. In the case before us, the trading loss has been caused by a person, who was not an employee. We hardly fail to see what difference the distinguishing feature makes in principle. Facts in the present case indicate that right from the year 1950, the assessee had been making all possible efforts to recover the amount from the partners of Sadasukh Gambhirchand by a process of law. In the year 1950 itself, the assessee in its letter of February 20, 1957, had stated that it had sent its employee to Calcutta to find out whether there were any properties from which the amount could be recovered. The decree of the Bombay High Court was sent to Calcutta for execution. The work was entrusted to Messrs. M. G. Poddar and Co. It is only when reports were received from relatives of the partners of the assessee-firm that the assets of the debtors were vested in the official receiver that the debtors' liabilities were very heavy and the assets of the debtors were very merger to meet the demands of even the secured creditors that the debts have been written off the debt in the assessment year only after it came to know that there was absolutely no chance of recovery whatsoever. The Tribunal has no in any manner dealt with this evidenced. The Tribunal appears to have taken the view that because the payment was made to the bank on February 8, 1950, the assessee could not claim deduction in the assessment year 1956-57. The Tribunal thus has not in manner differed with the finding of facts reached by the Appellate Assistant Commissioner. The view taken by the Tribunal cannot, any more, be accepted in view of the decision of their Lordships of the Supreme Court in Associated Banking Corporation of India Ltd. v. Commissioner of Income-tax. As their Lordships have pointed out, so long as a reasonable chance of obtaining restitution exists, the loss in a commercial sense may not be said to have resulted. It found by the Appellate Assistant Commissioner, the reasonable prospects disappeared when the partners of the assessee-firm received information from their relatives in the assessment year. It is for these reasons that we are unable to accept the first two contentions of Mr. Joshi.
12. That brings us to the third contention and that is in any event the assessee is not entitled to claim deduction in respect of interest and the litigation expenses. The amount in respect of which deduction has been claimed by the assessee is Rs. 54,989-6-0. The break-up of this amount is as follows :
----------------------------------------------------------------------Amount paid by the assessee to the bankin respect of half share of Sadasukh Rs. 50,369-13-6GambhirchandInterest on the aforesaid amount Rs. 2,031-9-0-------------------Total ... Rs. 52,401-6-6----------------------------------------------------------------------
13. The remaining balance of Rs. 2,587-15-6 has been claimed by way of litigation expenses.
14. Mr. Mehta frankly conceded that the assessee is not entitled to claim any deduction in respect of the aforesaid amount of interest. He, however, contended that the assessee is entitled to legal expenses. According to Mr. Mehta, expenditure on legal expenses was a permissible deduction under section 10(2)(xv) of the Act. The expenditure that is permissible under section 10(2)(xv) is an expenditure 'laid out or expended wholly and exclusively for the purpose of business.'
15. The business of the assessee is that of a wholesale dealer in cloth. The amount, which the assessee was seeking to recover from the partners of the firm, Sadasukh Gambhirchand firm. The expenditure incurred over the litigation to recover the amount from Sadasukh Gambhirchand, therefore, cannot be said to be an expenditure laid out wholly and exclusively for the purpose of the business of the assessee. It is true that the assessee and the partnership firm of Sadasukh Gambhirchand had jointly borrowed the amount of Rs. 1 lakhs from the bank and the borrowings to the extent of half were for the purpose of the assessee's business. But the other half, which was borrowed by Sadasukh Gambhirchand, was not for the purpose of the assessee's business. By borrowing the loan on joint and several liability, the assessee had only obtained an advantage of getting the advances at a low rate of interest. It is by reason of accepting the joint liability that the assessee had to pay the entire amount and the assessee had expended the money in order to recover the amount, which it had to pay on behalf of Sadasukh Gambhirchand to the bank. The expenditure incurred on legal expenses to recover the said amount had no direct connection or relation with the business of the assessee. It is in these circumstances we find it difficult to accept the contention of Mr. Mehta that the assessee is entitled to deduction in respect of the legal expenses under section 10(2)(xv) of the Act.
16. It is for these reasons that we answer the question referred to us in the following manner :
The sum of Rs. 50,369-13-6 is a proper deduction as a trading loss incurred on the ground of commercial expediency under section 10(1) of the Income-tax Act.
17. The Commissioner shall pay the costs of the assessee.