V.S. Desai J.
1. The question referred to us on this reference under section 66(1) is as follows :
'Whether on the facts and circumstances of the case the assessee was entitled to claim a sum of Rs. 10,960 in the assessment year 1950-51 and Rs. 15,060 in the assessment year 1951-52 as a revenue deduction before arriving at the assessable profits of the years of account ?'
2. The facts leading to the question briefly stated are as follows : The assessee carried on the business of Adatia and speculation. During the Samvat Year 2003 in certain forward transactions in turmeric which the assessee had put through on behalf of his constituents, there was a loss suffered by the constituents. One of these constituents was one Shantilal Jivraj, whose loss amounted to Rs. 14,960. The said Shantilal was in insolvent circumstances and not in a position to pay the loss suffered by him, and the loss fell on the assessee. In the Samvat Year 2005, on the 28th December, 1948, Shantilal Jivraj somehow managed to pay Rs. 4,000 to the assessee in full settlement of his debt, and the assessee wrote off the balance as a bad debt. Now, in the assessment year 1948-49, for which the relevant accounting year was S. Y. 2003, the assessee had claimed an amount of Rs. 14,960 as a loss. In disallowing the said loss in that assessment year, the Appellate Assisting Commissioner held that the amount claimed had not become 'bad' in S. Y. 2003, so that it could be written off as a bad debt in that year; it was in S. Y. 2005 that the assessee after having made attempts to recover it had succeeded in recovering only Rs. 4,000 out of that amount and had written off the balance, and, therefore, the said balance could be claimed as bad debt in S. Y. 2005. This order of the Appellate Assistant Commissioner was passed on 26th September, 1950. It may be pointed out at this stage that under the Essential Supplies Temporary Powers Act, 'the Spices Forward Control Prohibition Order, 1944' had been promulgated by the Government. Whether the said order applied to turmeric was not authoritatively decided by that time though there were certain proceedings going on in courts of law relating to the application of the said order to certain commodities including turmeric. On the 13th November, 1950, this court held that the said order did not apply to turmeric and forward transactions in turmeric, therefore, were not hit by the order and were not, therefore, rendered illegal. The view of this court was reversed by the Supreme Court in 1952, and it was held that the order applied to turmeric, rendering the forward contracts in the commodity illegal. The said decision of the Supreme Court was given on 27th May, 1952. Now, in the assessment year 1950-51, corresponding to the account year S. Y. 2005, the assessee repeated his claim for allowance of the loss. At the time when the Income-tax Officer made the assessment order, the decision of the Supreme Court referred to above was known. The Income-tax Officer took the view that since the debt had arisen out of the dealings of the assessee in forbidden wayada transactions in essential commodities, it was a debt which could not be enforced under the law, and the same, therefore, could not be considered to have become bad for income-tax purposes. He, accordingly, disallowed the assessee's claim. In the assessment year 1951-52, the assessee had claimed bad debts to the extent of Rs. 15,060, representing an aggregate of the bad debts from three of his constituents under similar circumstances. This amount was also disallowed by the Income-tax Officer for the reasons for which he had disallowed the amount claimed in the previous year, namely, that the debts had arisen out of the dealings in forbidden wayada transactions in essential commodities. In the appeals which the assessee preferred against the assessment orders to the Appellate Assistant Commissioner, the view taken by the Income-tax Officer was confirmed by the Appellate Assistant Commissioner. The assessee then took further appeals to the Tribunal. The Tribunal held that in as much as in the assessment for the S. Y. 2003 the Appellate Assistant Commissioner had already given a finding that the debt which was prematurely written off in the S. Y. 2003 would be a lawful deduction in the S. Y. 2005, it was not right for the department to disallow it in the S. Y. 2005, by changing its stand. It also held further that although the claim of the assessee was not enforceable in law, that did not affect the admissibility of the claim either under section 10(2) (xi) or section 10(2) (xv) of the Indian Income-tax Act. Looking to the transactions from a commercial angle, the amounts claimed by the assessee were revenue deductions which were liable to be deducted before arriving at his assessable profits in the years of account. According to the Tribunal, therefore, the claims made by the assessee in the assessments for the assessment years 1950-51 and 1951-52 should have been allowed. It accordingly allowed the appeals of the assessee and directed that the assessments be modified accordingly. Thereafter, at the instance of the Commissioner, it drew up the statement of the case and referred to this court the question which we have already stated.
3. Although the Tribunal has treated the facts relating to the assessment years 1950-51 and 1951-52 as similar and has proceeded on the said basis, Mr. Joshi, learned counsel for the revenue, has sought to urge before us that the facts for the two assessment years are not similar and different positions will have to be considered with regard to the two years. He points out that so far as the assessment year 1950-51 is concerned, the position on facts is that the amount claimed in that year as deduction could be said to have been irrecoverable in that year or bad debt in that year, if they were debts at all, because it was in that year that the assessee had realised part of the debt and found that the rest could not be recovered and had to be written off. As to the subsequent assessment, however, i.e., for the assessment year 1951-52, the position according to Mr. Joshi was that the amount claimed could not be said to have become irrecoverable in that year at all. There was no evidence whatsoever or any material on record which would show, according to Mr. Joshi, that any attempt had been made by the assessee to recover the debts from the constituents, and that his attempts had ended in failure, making him realise that nothing could be recovered from them. What appears to have happened, says Mr. Joshi, is that the assessee in his accounts wrote off these amounts because he regarded them as unenforceable in a court of law. That according to him would not make the debts either irrecoverable or bad debts so as to claim a deduction in respect thereof under section 10(2) (xi). We do not think we can entertain this submission of Mr. Joshi regarding the distinction between the cases for the years 1950-51 and 1951-52. It is true that in the extract from the Appellate Assistant Commissioner's order for the assessment years 1950-51 and 1951-52, or from the Tribunal's order relating to the assessment year 1951-52, no mention is found of attempts made by the assessee to recover the debts from his constituents or the failure of those attempts in the year of account. That, however, would not be sufficient to conclude that there might not have been such attempts during that year. It must be remembered that all throughout and even before the Tribunal the cases have been agitated on the footing that the facts for both the years are similar. As we have already pointed out, Mr. Joshi concedes that so far as the first year is concerned, the writing-off in the year of account has been after attempts at recovering the amount had failed. We cannot, therefore, at the present stage entertain Mr. Joshi's contention that the same was not the position for the next year also. We must, therefore, proceed on the footing that the cases for both the years are similar on facts, and there is no distinction such as is sought to be made by Mr. Joshi.
4. Mr. Joshi's argument is that, inasmuch as losses have arisen out of transactions which were forbidden by law and rendered illegal by providing a penalty for persons entering into such transactions in breach of the prohibition order, the losses could not get the character of debts at all, and consequently, there would be no question of their becoming bad or irrecoverable at a subsequent stage. Mr. Joshi says that the liability of the constituents to the assessee was unenforceable even from its very inception and did not constitute a debt at any time. It could not, therefore, be regarded as having been bad or irrecoverable at a subsequent time so as to entitle the assessee to claim a deduction thereof under section 10(2) (xi). If it could not be claimed as a bad debt, according to Mr. Joshi, there is no other basis on which the said losses could be claimed. For one thing, if a specific head is provided under section 10(2) and an item is not allowable under that head, it could not be allowed either under the residuary head or even under section 10(1). Secondly, even if the losses in the present case were capable of being regarded as commercial losses, they obviously could not be allowed in the years of assessment because they did not pertain to those years, but to earlier years on the assessee's own case, which was that the debts became bad in the years of account. In support of his submission, that a liability in order to be a debt has to be legally enforceable, Mr. Joshi invited our attention to certain observations in Commissioner of Income-tax v. Basumal Jagat Narain, which are as follows :
'A debt is that which one owes to another; any money, goods or services that one is bound to pay another; a pecuniary due; a liquidated demand; a sum of money due by certain and express agreement. It includes any claim or demand upon which a judgment for a sum of money or directing the payment of money can be recovered in an action. Debt denotes not only the obligation of the debtor to pay but also the right of creditors to receive and enforce payment. To constitute a valid debt the money must have been advanced with reasonable belief at the time that it would be paid. Evidence of an obligation to repay is the first important factor to be singled out of the surrounding facts and circumstances. For purposes of taxation, a debt is a legally enforceable obligation for payment of money.'
5. Mr. Joshi says that since the claim of the assessee against his constituents was not legally enforceable, the liability of the constituents did not constitute a debt.
6. In our opinion, the arguments urged by Mr. Joshi cannot be accepted. Mr. Joshi concedes and it has also been held in several cases that the profits of a trade even though it may be illegal are liable to be taxed. If the profits are liable to be taxed under the taxing statute, the computation of the profits will have to be done in accordance with the mode prescribed by the statute. The mode prescribed by the Indian Income-tax Act for the computation of the profits of the business or trade is that contained in section 10. This mode permits deduction of the items specified in section 10(2). Moreover, it is also well-settled that subject to the special requirements of the Act the computation of the profits for the purposes of section 10 will have to be arrived at in a commercial manner by deducting such expenses as in a commercial sense can be regarded as expenses of the business though not specifically provided for under any of the specific heads under section 10(2). The computation of profits under section 10(2) permits the deduction of dues or debts due to the businessman in the course of the business which have become bad or irrecoverable. The circumstance that the business is illegal so that neither the profits earned nor the losses suffered would be enforceable in law is not a circumstance which detracts from the profits being taxed. Equally so it should not be a circumstance which should detract from the losses being allowed. The argument, therefore, that because the liability of the constituent to the assessee was an unenforceable liability at law and, therefore, would not constitute a debt in the sense of a claim which is legally enforceable, would not be material in considering the deductibility of that claim in the matter of computation of the profits of the business of the assessee. Even in computing the profits of an illegal business, the expenses incurred in the running of the business, such as, for instance, the salaries to the employees or the rent paid for the premises occupied for the purposes of the business would be certainly allowed in computing the profits of the business, although such amounts, if they were not paid, could not be enforced in a court of law. Thus, the landlord who gives his premises for the purposes of carrying on an illegal business on rent will not be entitled to recover rent in the court of law in the event of rent not being paid. Unenforceability of the claim, however, of the landlord will not render the amount as not deductible for the calculation of the profits of the business if the amount is paid to the landlord. This would, therefore, show that the circumstance that the dues owing to the assessee from his constituents are not capable of being enforced in a court of law will not prevent such dues from being considered as irrecoverable or bad in the same way in which dues legally enforceable would have become irrecoverable. In the present case, at the time when the transactions were entered into by the assessee on behalf of the constituents, they were entered into under a reasonable belief that the constituents will be under an obligation to pay losses, if any such losses were suffered by them in the said transactions. Neither the assessee nor his constituents at the time knew that the prohibition order applied to turmeric, and they had not, therefore, entered into the transactions with the full knowledge that the transactions were illegal. As a matter of fact, this High Court had taken the view, though it was subsequently reversed by the Supreme Court, that the order did not apply to spices, and, therefore, the forward transactions in spices were not hit by the order. On the facts as found in the present case, the recoverability of the dues or their becoming bad was not as a consequence of the decision of the Supreme Court, but by reason of the inability of the debtor to fulfill his obligations to pay. In our opinion, therefore, for the purposes of taxation, the debts had become bad in the years of account and the assessee was, therefore, entitled to deduct them in the computation of his profits of business. There is also another way of looking at the matter. At the time when the transactions were entered into, they were entered into under the belief that the transactions were legal, or at any rate, they were entered into without any knowledge that the transactions were hit by the prohibition order, and were illegal. The dues owing to the assessee in these transactions were considered by him as good and recoverable until it was authoritatively decided by the Supreme Court that the transactions were illegal, with the consequence that the dues could not be recovered by the assessee from his constituents by legal action. If, in these circumstances, the constituent was either unable to pay dues or refuses to pay the same to the assessee, because of the legal disability on the part of the assessee to recover them from him, the loss resulting therefrom could be said to have fallen on the assessee at the point of time when the inability of the constituent or his refusal to pay occurred. If such position occurred in the year of account, the assessee would be entitled to treat it as loss of the year of account and have it deducted from his profits or gains of his business. In our opinion, therefore, the Tribunal was right in the view that it has taken, that the assessee was entitled to have the amounts allowed to him in the respective assessment years.
7. In the view that we are taking, our answer to the question referred to us is in the affirmative. The Commissioner will pay the costs of the assessee.
8. Question answered in the affirmative.