1. The following two questions have been referred for the opinion of this court by the Income-tax Appellate Tribunal, Hyderabad Bench, under Section 66(1) of the Indian Income-tax Act, 1922 (hereinafter referred to as 'the Act'):
'1. Whether, on the facts and in the circumstances of the case, the assessee is entitled to claim the sum of Rs. 38,394 as allowable under Section 10 of the Income-tax Act ?
2. Whether, on the facts and in the circumstances of the case, the assessee is entitled to claim Rs. 6,589 from April 1, 1959, to July 14, 1959, pertaining to the accrued profit allocatable to the deceased partner till his death is allowable as a deduction?'
2. For a proper appreciation of the scope of the reference, it is relevant and necessary to refer to the material facts that gave rise to the aforesaid two questions: M/s. N. Annaji Rao and Brother, Ongole (hereinafter referred to as 'the assessee') is a firm consisting of two partners, viz., N. Annaji Rao and N. Kuppu Rao, who are brothers. The firm which came into existence with effect from April 1, 1950, was carrying on the business of distribution of oil products of Burmah Shell and also derived income from other sources. Another firm constituted under an instrument of partnership dated December 21, 1941, for a period of five years with effect from October 9, 1941 (hereinafter referred to as 'the Nellore firm') consisted of two partners, viz., P. T. Gopalachari and Annaji Rao with equal shares in the profits or losses. One of the clauses of the deed required Sri Annaji Rao to contribute the capital of Rs. 10,000. A fresh agreement was entered into between the partners, P. T. Gopalachari, Annaji Rao, P. T. Ramanujam and P. T. Venkasam on March 31, 1947, with effect from October 8, 1946, when the period of five years under the prior deed of partnership expired. The entire capital of Rs. 20,000 required for the partnership was contributed by Shri Annaji Rao and the other partners undertook to pay their individual shares of Rs. 5,000 each to him. If the capital of Rs. 20,000 was found to be short for the effective and efficient conduct of the business, the other partners might lend as and when necessary the requisite amounts on which they would be entitled to 5% interest. Though the tenure of the firm was originally fixed at five years, it was eventually renewed at an interval of five years and the last renewal was made on March 31, 1957, with the same terms and conditions of the original deed of partnership dated March 31, 1947. Sri Annaji Rao, when he joined the Nellore firm, was a partner in his capacity as karta of the Hindu undivided family consisting of himself and Kuppu Rao. After partition of the family on April 1, 1950, when the assessee-firm came into existence, he represented the assessee firm.
3. The Nellore firm was dissolved on July 14, 1969, when Sri Annaji Rao died. However, the Ongole firm continued. A credit balance of Rs. 1,33,394 representing the capital advances arid undrawn share of profits together with accrued interest was found in the account of the deceased partner, Sri Annaji Rao, in the books of the Nellore firm. The legal representatives of the deceased, Annaji Rao and Sri Kuppu Rao, agreed on September 2, 1959, to receive a sum of Rs. 95,000 from the other partners of the Nellore firm in settlement of the credit balance of Rs. 1,33,394 referred to above on the ground that there were difficulties in realising the outstandings of the Nellore firm.
4. For the assessment year 1960-61, relevant to the accounting year ending with March 31, 1960, the sum of Rs. 38,394 (i.e., difference between Rs. 1,33,394 and Rs. 95,000), was claimed by the assessee-firm as a bad debt deductible from its profits and gains earned in that year. The Income-tax Officer, on a scrutiny of the terms of the agreement dated September 2, 1959, and the relevant entries in the accounts of the assessee and the Nellore firm, rejected the assessee's claim holding that there was no bad debt at all satisfying the requisite conditions laid down in the Act and it was only a capital loss. The appeal to the Appellate Assistant Commissioner proved unfruitful. On further appeal to the Tribunal, the contention advanced on behalf of the assessee was two-fold : (1) that the loss of Rs. 38,394 was admissible as a bad debt, as the assessee represented by Sri Annaji Rao was carrying on the business of being a partner in the Nellore firm to which advance by way of capital was made, and (2) that the assessee who was assessed on accrual basis was a partner of the Nellore firm which was registered under the Act and the deemed profits have not reached the assessee and, hence, it is entitled to set off the amount of Rs. 38,394 in the year of adjustment. The Tribunal, on a consideration of the entire facts and circumstances, found that the assessee was merely a partner in the Nellore firm but it was not carrying on the business of being a partner in a firm and that it was carrying on money-lending business. It was further held that the profits earned by the Nellore firm have been ascertained and credited to the account of the assessee represented by Sri Annaji Rao, one of its partners and, hence, it was not right to state that the profits earned by the assessee in the Nellore firm did not reach it; that the assessee, subsequent to its allocation, had deposited the income receipts in the capacity of a depositor as the assessee had complete control and domain over the amounts standing in the account of Sri Annaji Rao in the books of account of the Nellore firm and that the loss was not a business loss or a loss of revenue nature, but it was a capital loss. The Tribunal agreeing with the view expressed by the Appellate Assistant Commissioner and the Income-tax Officer dismissed the appeal. Hence, this reference at the instance of the assessee.
5. The contentions raised before the Tribunal have been reiterated before us by Mr. Dasaratharama Reddi, the learned counsel appearing for the assessee. The sum and substance of his pleas was that the profits earned by the assessee in the Nellore firm which have been allowed to be accumulated without withdrawal by the deceased partner, Annaji Rao, must be construed to be constructive loans to the Nellore firm under Clause 8 of the deed of partnership on payment of 5% interest subject to tax in the hands of the assessee. Hence, it was argued that the amount of Rs. 38,394 and Rs. 6,589 should be allowed as bad debts or in the alternative as business losses. In any event, it was urged that the amount of Rs. 6,589 being the accrued income from April 1, 1959, to July 15, 1959, has to be allowed as notional but not real income.
6. This claim of the assessee is resisted by Mr. P. Ramarao, the learned standing counsel for the revenue, contending, inter alia, that the assessee was not carrying on money-lending business and hence, the amounts cannot be claimed to be bad debts and, in any event, they are not proved to be bad debts within the meaning of the Act nor were they referable to any year of account. It was further contended that the loss was claimed after the dissolution of the Nellore firm and it was a capital loss.
7. Before adverting to the respective contentions of the parties, it is profitable to notice the material provisions of the Act relating to income chargeable to tax. Section 3 of the Act charges the total income of the previous year of every individual, Hindu undivided family, company and local authority, and of every firm and other associations of persons or the partners of the firm or the members of the association individually, to tax at any rate or rates specified in the respective Finance Acts. 'Total income' as defined under Section 2(15) of the Act is the total amount of income, profits and gains specified in Sub-section (1) to Section 4 and computed in the manner laid down in the Act. The definition of 'income' in Section 2(6C) is only an inclusive one but not exhaustive. But, however, Section 4 states what the total income of a previous year of any person is. It is an inclusive definition which is of wider import. It takes in all income, profits and gains received, accrued or arisen or deemed to have been received, accrued or arisen to him in the year of account from whatever source derived. Chapter III deals with taxable income. Section 6 specified the heads chargeable to income-tax, namely, salaries, interest on securities, income from property, profits and gains from business, profession or vocation, income from other sources and capital gains. Section 10 provides for the computation of business income. The income derived by an assessee in respect of any business, profession or vocation carried on by him is chargeable to tax under Section 10(1), The business profits or gains chargeable under Sub-section (1) of Section 10 read with Section 3 has to be computed after making the deductions specified in Sub-section (2) to Section 10. The tax being levied on the income earned by a person in any previous year, it is the total income computed as per the provisions of the Act, but not the gross receipts of a person that is chargeable to income-tax under Section 3. The unit of assessment under the Act being the previous year, all the receipts of income of a person, from whatever source they are derived, have to be totalled up and the permissible losses, expenditure and other allowances provided in the Act have to be deducted from the gross income so arrived at, in order to compute the 'total income' chargeable to tax. For the purpose of computing the income, profits and gains earned by a person in business, all the business expenditure and allowances specified in Sub-section (2) to Section 10 must be deducted from the total income earned under the head 'business '. Hence, any capital expenditure or loss or expenditure unconnected with the business is not a permissible deduction. Clause (xi) of Sub-section (2) to Section 10 provides for the deduction from the income of the assessee of any debts due to him if it is established that they have become bad and irrecoverable in the year of account and accordingly written off in the accounts maintained by him in due course of business. Where any expenditure or loss incurred by the assessee during the year of account is proved to have a proximate relationship, nexus or connection with the business carried on by him, it is also permissible to be deducted from the profits and gains earned by him in business so as to arrive at the total income chargeable to tax. Therefore, any capital receipt by an assessee during the year of account is not liable to be taxed. Similarly, any loss or expenditure of a capital nature is not permissible to be deducted from the business profits and gains of a person.
8. Before adverting to consider the contention of Mr. Dasaratharama Reddi that the amounts in question must be allowed as bad debts, it is necessary to consider the concept and content of a bad and irrecoverable debt permissible to be deducted from the business profits earned by an assessee. There is a catena of cases on this aspect. Suffice it to refer to a few leading cases. The earliest case that requires to be noticed is Curtis v. J. & G. Oldfield Ltd.,  9 T.C. 319, wherein Rowlatt J. observed thus:
'When the Rule speaks of a bad debt it means a debt which is a debt that would have come into the balance-sheet as a trading debt in the trade that is in question and that it. is bad. It does not really mean any bad debt which, when it was a good debt, would not have come in to swell the profits.'
9. Sir George Rankin in Arunachalam Chettiar v. Commissioner of Income-tax,  4 I.T.R. 173 (P.C.) said :
'The 'bad debt' would not, if good, have come into swell the taxable profits of the other partner. In the present case, the claim to set off is in fact made in the second year of assessment after the dissolution of the business.'
10. The Supreme Court in A. V. Thomas & Co. Ltd. v. Commissioner of Income-tax,  48 I.T.R. (S.C.), after approving the dictum of Rowlatt J. as to what is meant by a debt, observed thus :
'A debt in such cases is an outstanding which if recovered would have swelled the profits. It is not money handed over to someone for purchasing a thing which that person has failed to return even though no purchase was made. In the section a debt means something more than a mere advance. It means something which is related to business or results from it. To be claimable as a bad or doubtful debt, it must first be shown as a proper debt......Section 10(2)(xi) is in two parts. One part deals with an assessee who carries on the business of a banker or money-lender. Another part deals with business other than the aforesaid. Since this was not a loan by a banker or money-lender, the debt to be a debt proper had to be one which if good would have swelled the taxable profits.'
11. See also Devi Films Ltd. v. Commissioner of Income-tax,  49 I.T.R. 874 (Mad.).
12. True, as contended by Mr. Dasaratharama Reddi, that all payments reduce capital. However, in order to find out whether a certain expenditure is of capital or revenue nature, it is necessary to consider the nature of the expenditure in relation to the business. Though all payments reduce capital, in the ultimate analysis, it is not correct to think that all losses are of capital nature. Where the loss is incurred by a person in the course of the conduct of the business, such a loss must be held to be a revenue loss but not capital loss. Though the line that separates a capital and revenue loss is often very thin and subtle, it is but distinct and clear. It is apposite in this context to refer to the decision in Reid's Brewery Co. Ltd. v. Male, (1891] 3 T.C. 279, wherein the distinction has been very aptly pointed out in the course of the judgment thus :
'Of course, if it be capital invested, then it comes within the express provision of the Income-tax Act, that no deduction is to be made on that account.....no person who is acquainted with the habits of business can doubt that this is not capital invested. What it is is this. It is capital used by the appellants, but used only in the sense that all money which is laid out by persons who are traders, whether it be in the purchase of goods be-they traders alone, whether it be in the purchase of raw material be they manufacturers, or in the case of money-lenders, be they pawn-brokers or money-lenders, whether it be money lent in the course of their trade, it is used and it comes out of capital, but it is not an investment in the ordinary sense of the word.'
13. The approach to examine the nature of the loss incurred by a businessman must be from the commercial point of view. When approached from the angle of commercial expediency, if in a given case, the expenditure or loss, as the case may be, has arisen in the course of, or is incidental to or has nexus and proximate connection with the conduct or running of the business in question, such loss must be held to be a trade loss admissible to be deducted from the profits earned by the assessee in the year of account. In order to successfully claim the allowance under Section 10(2)(xi) of the Act, the assessee must establish that his accounts of the business are kept on mercantile basis and the debt has arisen or is in respect of his business carried on in the relevant accounting year and it is incidental to his business or it had become irrecoverable in the relevant accounting year and the amount had actually been written off as irrecoverable in the account books. See B.D. Bharucha y. Commissioner of Income-tax, : 65ITR403(SC) . If any one of the aforesaid essential ingredients is lacking or not established, the assessee will not be entitled to claim any amount as bad debt within the meaning of Section 10(2)(xi) of the Act.
14. The basis for the claim of the assessee was its assumption that it had to lend monies to the Nellore firm in the conduct of its business. This assumption was not found to be true by the Tribunal. It is pertinent to notice the following passage in paragraph 11 of the Tribunal's order :
'On a question from us, it was stated clearly by the learned counsel that the assessee was not carrying on money-lending business. We can, therefore, summarily remove this complication from our case. In our opinion, this is a case not of a business debt, but of a partnership debt, i.e., the debt owing to the assessee arises not from the carrying on of the business but by virtue of the assessee being a partner in a firm. The loss of such a debt cannot be called a bad debt, and it can best be described as a loss in partnership. We do not agree with the learned counsel that the assessee carries on the business of being a partner of a firm. That is not business. Business is carried on either by the assessee himself or by a partnership. The mere fact that the assessee is a partner of the firm is not ipso facto or by itself carrying on a business. The claim, therefore, is untenable as a claim of bad debt.'
15. The aforesaid finding of the Tribunal is perfectly valid and justified. When there was no money-lending business carried on by the assessee as conceded by the counsel before the Tribunal, the very basis for the claim of the assessee that the amounts in question are bad debts must be held to be non-existent.
16. The contention of Mr. Dasaratharama Reddy that the advancement of monies by a partner to a firm of which he is a partner would amount to carrying on of money-lending business cannot be acceded to. In support of his plea, the counsel relied upon the provisions of Section 13(d) and Section 48(b)(ii) of the Indian Partnership Act, 1932, and the decision of this court in Kasamsetty Radhakrishnaiah Chetty v. Commissioner of Income-tax,  64 I.T.R. 522 (A.P.). Under Clause (d) of Section 13 of the Indian Partnership Act, a partner, who pays or advances any amount for the purposes of the business beyond the amount of capital agreed to be subscribed by him, is entitled to 6% interest per annum on such amount. The right to the payment of 6% interest for the amounts advanced beyond the agreed capital by a partner of a firm is subject to contract between the partners. The partners may agree that no such interest need be paid or agree to pay a higher rate of interest. Section 48 of the said Act provides for the mode of settlement of accounts between the partners. Losses must be paid first out of the profits or out of capital where the profits are not sufficient. After providing for losses, the assets of the firm have to be distributed amongst the partners as specified in Clause (b) to Section 48. The debts of the firm to third parties have to be first paid from the assets of the firm. Thereafter, the advances, if any, made by the partners from their share capital have to be paid to them respectively. Thereafter, each partner shall be paid rateably what is due to him on account of capital and the residue, if any, shall be divided among the partners in the proportion in which they have been entitled to their share of profits. The mere fact that a partner of a firm has advanced monies to the firm on which he would be entitled to interest at 6% will not in any way make in every case such partner a money-lender or constitute such advancements money-lending business. There may be cases where the partners may be actually doing money-lending business and advancing monies to the firm in which they are also partners. Where a partner borrows money from third parties at lesser rates of interest and advances the same to the firm in which he is a partner at higher rates of interest he may be held to be doing money-lending business and he may be called a money-lender. In order to hold a person as doing money-lending business, there must be an activity of business of money-lending ; otherwise it is not possible to conclude that he is a money-lender. Hence, the provisions of Section 13(d) or Section 48(b)(ii) of the Indian Partnership Act, referred to above, do not advance the plea of the assessee herein that the assessee's advancing monies over and above its share of capital constitutes money-lending business. As observed by the Supreme Court in Narain Swadeshi Weaving Mills v. Commissioner of Excess Profits Tax, : 26ITR765(SC) :
'The word 'business' connotes some real, substantial and systematic or organised course of activity or conduct with a set purpose.'
17. Section 2(4) of the Act defines 'business' as including 'any trade, commerce or manufacture or any adventure or concern in the nature of trade, commerce or manufacture'. It maybe noted that the definition of 'business' is of an inclusive nature and it is of wide import, Applying the aforesaid tests, we are unable to agree with Mr. Dasaratharama Reddy that there is money-lending business carried on by the assessee in the year of account, as there is no regular and organised activity which can be termed as business within the meaning of Section 2(4). We may also point out that mere advancing of money in stray cases does not amount to carrying on a money-lending business. See Ghanshyamdas Gangadhar v. Commissioner of Income-tax,  25 I.T.R. 318 (Pat.).
18. We shall now turn to the decision of this court in the case of Kasamsetty Radhakrishnaiah Chetty. In that case, the assessee had income from property, shares in two registered firms and other sources. The assessee borrowed from third parties on payment of 9% interest. He advanced a sum of Rs. 10,000 out of his borrowings from third parties at the rate of 9% interest, on October 25, 1961, on a pronote to a Hindu undivided family known as Kotrika Venkataramaiah Chetty & Bros, on payment of 12% interest. In the ledger folio of the debtor-Kotrika family, the debit entry of Rs. 10,000 was made in the accounts of the assessee. On December 29, 1953, a sum of Rs. 500 was received from another party on behalf of the debtor-family which was credited to its account. On September 30, 1954, the entire debt was discharged by paying a sum of Rs. 13,523-3-0 out of which Rs. 4,023-5-0 was the interest on which the tax was paid by the assessee for the assessment year 1955-56. The assessee made a fresh advance of Rs. 4,500 to each of the three brothers of Kotrika family who divided on September 30, 1954, and obtained separate pronotes from them. All the three brothers subsequently filed insolvency petitions. The assessee transferred in November, 1956, the three loans to one T. Venkatakrishnaiah for Rs. 1,500 each and claimed the balance of Rs. 3,000 due from each brother as bad debt after writing off the same as bad and irrecoverable. The income-tax authorities and the Tribunal disallowed the claim of the amount by the assessee as bad debt. This court, on a reference, observed that the Tribunal was 'influenced in its conclusion by the view that when a partner advances money to a firm of which he is a partner, it cannot be money-lending business'. Referring to the provisions of Section 13(d) of the Partnership Act, it was observed by this court thus:
'It is sufficient to state that we cannot accept the view of the Tribunal that in no event can a partner who advances moneys 1o a firm of which he is a partner occupy the position of a creditor or be said to carry on the business of money-lending.'
19. In that case, the learned judges reframed the question into two parts thus:
'(1) Where a partner finances a firm of which he is a partner, it could not be treated as a money-lending business, and (2) whether, in the circumstances of the case, there was money-lending business, and the sum of Rs. 9,000 is a bad debt?'
20. The learned judges have answered the first part of the question in favour of the assessee, .i. e., that where a partner finances a firm of which he was a partner, it can also be treated as money-lending business. The result of the decision is that this court did not approve the view of the Tribunal that, under no circumstances, an advance made by a partner to a firm in which he was a partner would amount to money-lending business. The principle laid down by the learned judge will not in any way render assistance to the assessee herein. As pointed out earlier the assessee in the case of Kasamsetty Radhakrishnaiah Chetty was actually borrowing monies from third parties on interest at a lesser rate of 9% and advancing on pronotes at 12% interest. The transactions also were considerable in number unlike the present case. This court has not held that the transactions amounted to money-lending business.
21. We may notice the observations of the Privy Council in Arunachalam Chettiar v. Commissioner of Income-tax, , wherein the effect of the carrying on of business as money-lender in respect of advance made to his firm was considered thus:
'It is no part of the business of a money-lender to finance the moneylender's ventures in the cotton market. Conversely, it is not a sign orindex of the money-lender that one advances money to one's own firm. Thebasis of the right to deduct irrecoverable loans before arriving at theprofits of money-lending is that to the money-lender, as to the banker,money is his stock-in-trade or circulating capital: he is dealing in money.But a solvent man can hardly make a loss by lending money to himself even if another be made responsible for the loan as well. And when the loan is in reality but a putting of the hand into the pocket to pay for cotton, it seems desirable to ask what is the real equity between the parties.'
22. In view of the aforesaid weighty observations of the Privy Council, the correctness of the decision of this court in the case of Kasamsetty Radhakrishnaiah Chetty is doubted. However, we have already pointed out that the decision is not helpful to the assessee herein.
23. The next case that requires consideration is C. T. Narayanan Chettiar v. Commissioner of Income-tax,  60 I.T.R. 690 (Mad.), Therein, the assessee, a Hindu undivided family, was carrying on money-lending business at Madras and at Muar in the Federated Malay States. It was a partner in a firm constituted for the purpose of carrying on business in exports and imports. It had advanced large sums of money to the firm. The interest earned on such advances had been taxed as the assesses's income from money-lending. On July 15, 1954, when the firm was dissolved, the amounts advanced by the assessee were found to be Rs. 2,77,421, whereas the borrowals and interest amounted to Rs. 1,98,447. The net credit balance in favour of the assessee was found to be Rs. 78,974. The claim of the assessee that the sum of Rs. 78,974 should be allowed as bad debt for the assessment year 1956-57 was disallowed by the income-tax authorities and the Tribunal holding that the advances were not accompanied by any suitable money-lending instrument. The High Court, on a reference, held that the assessee invested its moneys in the firm in its capacity as money-lender and the department consistently treated the interest income on the advances so made by the assessee as income from money-lending business and, hence, allowed the claim of the assessee as bad debt. The facts of that case are distinguishable from those of the one on hand. Admittedly, the assessee in that case was a money-lender and the advances to the firm have been made in its capacity as a money-lender. Hence, this decision will not render any assistance to the assessee.
24. We are, therefore, clear in our mind that the assessee was not established to be a money-lender carrying on money-lending business and the transactions in question cannot be termed as amounting to money-lending business. Even otherwise, the assessee cannot succeed unless it is established that the debt was irrecoverable. In order to succeed in showing that the claim was a bad debt under Section 10(2)(xi), the onus is on the assessee to prove the requisite ingredients of a bad debt. It is the assessee that had to lead evidence that the debt has become bad and irrecoverable in the year of account. The Nellore firm has in fact been benefited by these amounts in the bargain. In all probability, the Nellore firm would have recovered these amounts. In any event, there is no material to show that any amounts due and payable to the Nellore firm on the date of dissolution have become bad and irrecoverable debts. The amounts now sought to be claimed as bad debts by the assessee are not referable to any particular year of account. The question of a bad debt does not arise in the case of a partner vis-a-vis a firm. The firm may have some debts but they are not proved to be bad and irrecoverable in the year of account. That is a matter that has not been agitated before the income-tax authorities and the Tribunal or decided by them. That apart, the agreement was voluntarily entered into by the heirs of the deceased partner two months after his death. They have voluntarily agreed to receive Rs. 95,000 cash towards the amount of Rs. 1,33,394 standing in the account of the deceased partner, Annaji Rao, in the books of account of Nellore firm. The Nellore firm had continued its business subsequent to the dissolution of the firm due to the death of Annaji Rao. There is no material on record to establish that the other three partners in the Nellore firm are not solvent, but the positive evidence that they continued the business of the Nellore firm subsequent to the death of Annaji Rao would disprove the claim of the assessee that the debt was bad and irrecoverable. Further, the terms of the agreement clearly disclose that they have voluntarily agreed to take the lesser amount of Rs. 95,000. Judged from any angle, we are satisfied that there is no bad and irrecoverable debt at all.
25. The next ground advanced by the counsel that the amount should be allowed as business loss is equally devoid of any merit. It is not the business of the assessee to advance monies to the Nellore firm. The amount in question can, under no stretch of reasoning, be held to be stock-in-trade of the assessee-firm. The assessee was carrying on the business of distributing the oil products of Burmah-Shell. It also derived share income from the Nellore firm. It also returned an income of Rs. 1,214 as interest on securities. The assessee did not incur any loss in the course of carrying on its business. The assessee had voluntarily agreed to receive Rs. 95,000 towards the amount due to it by the Nellore firm. The assessee has released its rights in the Nellore firm for a sum of Rs. 95,000 in full settlement and discharge of its claims. In order that a loss can be claimed as business loss, it must be established that it springs directly from the carrying on of the business and is incidental to it. See Badridas Daga v. Commissioner of Income-tax, : 34ITR10(SC) , and Commissioner of Income-tax v. Nainital Bank Ltd., : 55ITR707(SC) We may notice the legal position succinctly summarised by the learned judge, Subba Rao J. (as he then was), speaking for the court, in Commissioner of Income-tax v. Nainital Bank Ltd. at page 715 thus :
'Under Section 10(1) of the Act the trading loss of a business is deductible for computing the profit earned by the business. But every loss is not so deductible unless it is incurred in carrying out the operation of the business and is incidental to the operation. Whether loss is incidental to the operation of a business is a question of fact to be decided on the facts of each case, having regard to the nature of the operations carried on and the nature of the risk involved in carrying them out. The degree of the risk or its frequency is not of much relevance but its nexus to the nature of the business is material.'
26. See also Indore Malwa United Mills Ltd. v. State of Madhya Pradesh, : 55ITR736(SC) . On the application of the aforesaid principles, we have no hesitation to hold that the loss in question is of a capital nature but is not a trading loss.
27. The further submission of Mr. Dasaratharama Reddy that, the profits have been charged to tax on the basis of accrual system and were not actually received by his client is also devoid of any merit. The profits earned by the Nellore firm have been ascertained for all the assessment years. After ascertainment, the profits have been apportioned to the partners according to their shares, The assessee's share of profits, after ascertainment and allocation, has been credited to its account in the books of the Nellore firm. Subsequent to the credit of the share of profits earned 'by the assessee in the Nellore firm to its account, the profits would become the deposits standing to the credit of the assessee. The assessee, therefore, becomes a depositor and the firm a depository. In these circumstances, it is idle to contend on behalf of the assessee that it had full and complete control and domain over the amounts standing to its credit in the books of account of the Nellore firm till the death of Annaji Rao. The theory of real profits has no application to the facts of the present case. The assessee in fact had received its share of profits in all the earlier previous years and the same hid been credited to its account. Hence, there is no merit in this submission of the counsel.
28. We shall now proceed to examine the submission of Mr. Dasaratharama Reddy that the amount of Rs. 6,589 is deductible as notional or hypothetical income for the year April 1, 1959, till the death of Annaji Rao. In support of this plea, the counsel relied upon the decision of the Supreme Court in Kikabhai Premchand v. Commissioner of Income-tax, : 1SCR219 and Commissioner of Income-tax v. Shoorji Vallabhdas and Co., : 46ITR144(SC) In Kikabhai Premchand's case the assessee, a dealer in silver and shares, maintained his accounts on mercantile system and valued his stock at cost price both at the beginning and at the end of the year. He, being the sole owner of the business, withdrew some silver bars and shares from the business crediting the business with their cost price and settled them on certain trusts in which he was the managing trustee. The question arose whether the assessee derived income from the stock-in-trade so transferred. The transaction was held by the Supreme Court to be not of a business nature resulting in income to the assessee liable to be taxed. In that case, the assessee did not really make any profit on the date when he transferred stock-in-trade at the cost price to the trusts, even though the market price was higher than the cost price of the stocks shown in his accounts.
29. We shall now turn to the case of Shoorji Vallabhdas & Co. Therein, the assessee-firm, a managing agent of two shipping companies, had credited to itself in the books of account and debited to the managed companies the amount of commission at the rate of 10% of the freight charge. Subsequently, when the assessee desired to transfer the managing agency to two private companies, it agreed to accept 2 1/2% as commission and gave up 75% of its earnings. The question arose whether the amounts of 75% of commission given up by the assessee, though accrued already in the year of account, are liable to income-tax. In these circumstances, it was held 'by the Supreme Court that the assessee had in fact received only the lesser amount in spite of the entries in the account books and that lesser amount alone was taxable. That case is distinguishable from the facts of the present case. We are not concerned with the transactions relating to the earning of profits for the year in question. The assessee had in fact received the amount of Rs, 6,589 in the capacity of a partner of the Nellore firm, but subsequently gave it up voluntarily in settling other matters. It is pertinent to notice the observation of the learned judge, Hidayatullah J. (as he then was), who spoke for the court:
'Income-tax is a levy on income. No doubt, the Income-tax Act takes into account two points of time at which the liability to tax is attracted, viz., the accrual of the income or its receipt; but the substance of the matter is the income. If income does not result at all, there cannot be a tax, even though in book-keeping, an entry is made about a 'hypothetical income', which does not materialise. Where income has, in fact, been received and is subsequently given up in such circumstances that it remains the income of the recipient, even though given up, the tax may be payable. Where, however, the income can be said not to have resulted at all, there is obviously neither accrual nor receipt of income, even though an entry to that effect might, in certain circumstances, have been made in the books of account.'
30. We may also refer to the decision of the Supreme Court in Poona Electric Supply Co. Ltd. v. Commissioner of Income-tax, : 57ITR521(SC) , wherein the learned judge, Subba Rao J. (as he then was), considered the content and concept of real profits thus :
'Income-tax is a tax on the real income, i.e., the profits arrived at on commercial principles subject to the provisions of the Income-tax Act. The real profit can be ascertained only by making the permissible deductions. There is a clear-cut distinction between deductions made for ascertaining the profits and distributions made out of profits. .... Another distinction that shall be borne in mind is that between the real and the statutory profits, i.e., between the commercial profits and statutory profits.'
31. We may refer to a recent decision of ours in Commissioner of Income-tax v. Smt. Allareddi Sudarsanamma, : 83ITR759(AP) , unreported judgment in R.C. No. 56 of 1968 dated 8th December, 1970, wherein a similar contention raised by the counsel was negatived.
32. As pointed out by the Income-tax Officer in his order of assessment dated January 22, 1963, the share income of the assessee from the Nellore firm for the first period commencing from April 1, 1959, and ending with July 14, 1959, was provisionally taken at Rs. 6,589 as per the particulars furnished by the assessee as shown below:
Rs.' Share of Profit4,330Interest on securities (tax deduction at source)301Interest1,958
33. The partner, Annaji Rao, died on July 14, 1959, when the Nellore firm was dissolved. The settlement was made on September 2, 1959, but the debt was actually written off subsequent to September 2, 1959. The profit of the assessee from the Nellore firm for the first period ending with July 14, 1959, was taken to be at Rs. 6,589. That was income received from the Nellore firm. In fact, the assessee was assessed on share income basis for the assessment year itself. The loss, therefore, if any, occurred on September 2, 1959, though the profits accrued to the assessee on July 14, 1959. The Tribunal, on a consideration of the entire facts and circumstances, has held that the loss took place after the accrual of the share of profit. When the share income had accrued to the assessee by July 14, 1959, there is no question of any loss unless the assessee had agreed to give up the same. The assessee himself has shown the income in its return and the same has been rightly taxed. The assessee was not entitled to claim this amount as notional or hypothetical income but not actually received. It is only the assessee that voluntarily gave up in the settlement the receiving of the amount, if any. Hence, the assessee's claim must be rejected.
34. For all these reasons stated, our answer to both the questions is in the negative and against the assessee who shall pay the costs of this reference to the Commissioner of Income-tax, Hyderabad. Counsel's fee is fixed at Rs. 300.