BRIJLAL GUPTA J. - This is a reference under section 66(1) of the Income-tax Act. The question which has been referred to us for opinion is :
'Whether, on a true interpretation of section 10(1), section 10(2)(xi) and section 10(2)(xv) of the India Income-tax Act, the claims for the losses of Rs. 48,891 and Rs. 1,21,760 were permissible in the assessment years 1953-54 and 1954-55 respectively ?'
The facts giving rise to the reference may be shortly stated : The assessee is a banking company with its head office at Nainital and branches in different towns of Uttar Pradesh. One of the branches of the assessee was in Ramnagar. On June 11, 1951, there was a dacoity in the Ramnagar branch in which currency notes of the value of Rs. 1,06,000 and numerous ornaments and pieces of jewellery which had been pledged with the bank by some of its constituents had been taken away by the dacoits.
The loss of Rs. 1,06,000 was claimed by the bank as a deduction in the year 1952-53. It was disallowed by the authorities below, but on a reference to this court, this court held that that loss was allowable under section 10(1). The decision of this court is reported in Nainital Bank ltd. v. Commissioner of Income-tax. We are, however, not concerned with the amount in this income-tax reference.
In regard to the loss of jewellery and ornaments pledged with the bank the assessees case was that it had lost all hope of recovery of these articles notwithstanding the fact that the dacoits had been apprehended. The case of the assessee was that there was pressure on the bank by the pawners who demanded settlement of their respective accounts and it the interest of business and for reasons of commercial expediency the bank settled with some of the constituents in 1953-54 and with others in 1954-55.
The manner in which the settlements were arrived at way this : Where the market value of the pledged property at the time of the pledge was more than the amount which had been advanced on the security of these ornaments, the excess was paid to the pawner and where it was less, the balance was recovered from the constituents and the loan accounts were treated as adjusted. The cases where the excess was paid to the constituents were very few. The total adjustment of the debts thus made amounted to Rs. 48,891 in the assessment year 1953-54 and to Rs. 1,21,760 in the succeeding assessment year 1954-55.
From the above it will be clear that as the cases where the excess amount was paid were very few and as, where there was a deficiency, the deficiency had been recovered, the two amounts mentioned above must represent the amounts of the loans remitted or treated as adjusted.
The assessees claim was refused by the authorities below. The claim under section 10(2)(xi) was refused on the ground that it was not the assessees case that the debtors were incapable of paying the loans or that the loans could not be recovered or that the debts were bad or doubtful. The solvency of the debtors had never been questioned by the assessee. Even if the property which was pledged with the bank had been lost in the dacoity, the loans were still recoverable from the debtors. It was conceded by counsel for the assessee before the Income-tax Appellate Tribunal that in law the assessee could have filed a suit for recovery of loans and could have obtained decrees : vide Rampal Ramchand Agarwal v. Gourishankar Hanuman Prasad. Section 10(2)(xi) is a specific provision for disallowance of bad and irrecoverable loans and upon the facts stated above it is clear that the amounts claimed by the assessee could not be allowed under that section. It fact before us also learned counsel for the assessee conceded that the deduction could not be allowed to his client under section 10(2)(xi).
Next, we come to a consideration of the claim under section 10(1). The claim under that section was disallowed by the Tribunal on the ground that the remission of debts due by its constituents to the bank was a voluntary act of the assessee. A loss, on the other hand, is not necessarily a voluntary act but is something which is incurred or suffered involuntarily. The remission of debts was made by the assessee for the purpose of retaining and preserving the goodwill of its constituents. It voluntarily refrained from recovering the loans which were legally due and which, on its own showing, were recoverable. The action of the assessee in suffering detriment in this respect may have been impelled by business considerations, but in the view of the Tribunal it could not be claimed as a loss under section 10(1). The Tribunal also relied on a decision of the Supreme Court in Badridas Daga v. Commissioner of Income-tax. That was a case of embezzlement of certain sums of moneys by an employee in a money-lending business. In that case a claim was made for the deduction of that amount alternatively under section 10(2)(xi), 10(2)(xv) and 10(1). The Supreme Court overruled the claim under the first two provisions but allowed it under the last provision. In doing so it laid down two principles which are material for our purpose. The first principle is that even though section 10(2) enumerates various items which are admissible as deductions they are not exhaustive of all allowances which can be made in ascertaining the profits of a business taxable under section 10(1), and further that profits and gains which are liable to be taxed under section 10(1) are what are understood to be such under the ordinary commercial principles. It also held that when a claim is made for a deduction for which there is no specific provision in section 10(2), whether it is admissible or not will depend on whether, having regard to the accepted commercial practices and trading principles, it can be said to arise out of the carrying on of the business and is incidental to it. It follows from this principle that section 10(1) can be resorted to even if there is no specific provision for deduction under section 10(2). If there is such a provision then the deduction is allowed to be made under that provision and not under section 10(1). The other principle laid down by the Supreme Court is that the loss which is allowable as a deduction under section 10(1) must be one that springs directly from the carrying on of the business and is incidental to it and not any other loss sustained by the assessee even if it has some connection with his business. The example which the Supreme Court gave to illustrate the point was of a thief who breaks into the premises of a money-lender and runs away with funds secured therein and which must result in the depletion of the resources available to the money-lender and in that sense the loss must be a business loss but it could not be said to have been incurred in the running of the business but was one to which all owners of property were exposed whether they did business or not. In such a case the loss may be said to fall on the assessee not as a person carrying on business but as an owner of funds. The Supreme Court observed that the distinction, though fine, was very material as on it would depend whether a deduction can be made under section 10(1) or not.
Keeping in mind these twin principles, we have first to consider whether the loss or remission of the debts is at all allowable under section 10(1). It appears to us that the loss of the pledged ornaments in the dacoity falls squarely within the second principle enunciated by the Supreme Court. The loss of the ornaments are valuable goods not by misappropriation or embezzlement by the employees or agents of the bank but in a dacoity by third persons cannot be said to be a loss incidental to business or arising directly from the carrying on of it. It must be taken to be a loss suffered by the bank as the holder of property and not as a businessman. It, therefore, seems to us that whether or not the Tribunal was right in its view that a business loss deductible under section 10(1) is one which is suffered involuntarily and not voluntarily, the conclusion reached by it that the loss was not allowable as a deduction under section 10(1) was correct.
We now come to a consideration of the claim for deduction under section 10(2)(xv). Under that section what can be claimed as a deduction is expenditure laid out or expended wholly and exclusively for purposes of business. The Tribunal overruled the claim under this provision on the ground that normally expenditure is an outgoing, that here there was no expenditure incurred by the assessee and that nothing went out of its till. All that the assessee did was to remit certain debts due to it from its constituents. In other words it deliberately decided not to realise what, under the law, it was entitled to realise. This, according to the Tribunal, did not amount to expenditure, and the claim was not allowable under section 10(2)(xv).
We must concede that expenditure is a positive act of laying out or spending money; there must be an outgoing from the assessees fund. The negative act of forbearing to realise something is not an expenditure. It is an expenditure, if before the act, the money belonged to the fund of the person said to incur the expenditure; if it did not belong to his fund it can never amount to his spending it. Even if money is due to a person, so long as he has not realised it, it does not form part of his fund; therefore, his refraining from realising it does not amount to an expenditure. If what happened in this case was treated as a mere act of the banks refraining to realise from its customers the loans due from them it could be said that the amounts of the loans not realised were not an expenditure. The matter however is not so simple. Though the act of spending or laying out money must be a positive act, it is not essential that it must actually be done. It was not essential that the bank should have actually paid something to its customers in order that it could be said to have incurred an expenditure. If the money that was to be received by the bank is set off against the money that the bank has to spend, with the result that there is no actual receiving of the money by the bank and no actual spending of it by it and the receipt and the spending of the money are accomplished through entries in the accounts, it is a case of the banks spending money. There is no difficulty in imagining the receipt of the money and its expenditure as almost simultaneous acts. The bank had to receive the amount of the loans from its constituents and it decided to pay to them the value of their ornaments lost in the dacoity. It is immaterial for our purpose that the bank was not bound by law to pay its constituents the price of the stolen ornaments. Its liability was that of a bailee and when there was no suggestion even that it did not take the care expected of a bailee, it was not liable to account to its constituents for the loss of their ornaments through the dacoity. The loss was to be borne by them and not by the bank. The bank, however, decided to pay to them the price of their ornaments. The position before it was that it had to receive the amounts of the loans and had to pay the price of the ornaments. Instead of actually receiving the money and paying it out, it struck a balance and paid only the excess and made entries in its accounts that it had received the loans and had paid the constituents the price of their ornaments. In these circumstances we fail to see any good reason for saying that it did not spend any money. It was not a simple case of forbearance to realise the amounts of the loans. Since it had made entries in its accounts about the advance of the loans it had to make an entry about the receipt of those loans in order to square up the accounts. The moment it made entries in its accounts about having notionally received them, it could not be said to be a mere case of its forbearance to realise them. It did not actually writ off the amounts as irrecoverable or even as unrealised; hen it adjusted the amounts against the amounts that it had decided to pay to its constituents as the price of their ornaments it could not be held to be a case of mere writing off of the amounts as irrecoverable or as unrealised. What it did was really to make entries about the receipt of the amounts of the loans from the constituents and about its having paid to them the value of their ornaments. There was, therefore, expenditure though notionally it was expenditure within the meaning of section 10(2)(xv). The expenditure consisted of the payment of the value of the ornaments and came out of its fund through entries in its accounts. An expenditure must be a voluntary act; the loss caused by the dacoity was not a voluntary act and was, therefore, not an expenditure; but the act of paying to the constituents the price of their ornaments, by not realising from them the amounts of the loans due from them, was a voluntary act.
The next question is whether the expenditure was laid out or expended wholly and exclusively for the purpose of the business. The business of the bank was money-lending. In the course of this business it used to advance loans after receiving ornaments as security. Though the bank was not liable for the loss of the ornaments, it paid to the constituents their value in order to discharge what it thought was its moral liability. After all the constituents were not responsible for the loss of the ornaments. The bank had to see that the constituents maintained their confidence in it and in its business methods and high standard of morality. Though ignorance of law is no excuse there is no presumption that everybody is acquainted with the law. Many of the banks constituents would not be aware of the legal position that the loss caused by the theft of the ornaments was to be borne by them and that the bank was under no liability to compensate them. It was in the interest of the business that the bank paid them the value of their ornaments so that they might not lose confidence in the bank or in its ability to take care of pledged ornaments. If the bank had taken extraordinary precautions to prevent loss of pledged ornaments through robberies and burglaries the expenditure incurred by it over them would have been deductible. Instead of incurring such expenditure regularly it thought of making good the loss when it occurred and the money spent by it in making good the loss must be held to be spent wholly and exclusively on its business. Making the constituents feel that their pledged ornaments were safe in the bank was an act done wholly and exclusively in the interest of the business of money-lending. Paying them the price of the ornaments when they were stolen in a robbery or a burglary was as much an expenditure wholly and exclusively in the interest of the business as the act of spending money on constructing safety vaults which cannot be broken open by burglars and robbers or on engaging an armed force to keep watch over its properties. An expenditure (barring capital expenditure or personal expenses) is deductible if shown to be laid out or expended wholly and exclusively for the purpose of the assessees business. What is required is the actual fact of the expenditure having been incurred wholly and exclusively for the purpose of the business and not that it was obligatory to incur the expenditure wholly and exclusively for the purpose of the business. Whether the bank was legally bound to incur the expenditure or not was, therefore, irrelevant. An expenditure can be wholly and exclusively laid out or expended for the purpose of a business without its being obligatory according to the law or absolutely necessary or unavoidable. Business considerations or business expenditure cannot always be equated with legal rights and legal obligations. In business one has very often to make concessions in order to preserve the goodwill of its clientele. In this connection we might usefully refer to an English decision in Cooks v. Quick Shoe Repair Service. In this case the assessee purchased a shoe repair business. The agreement of purchase provided that the vendor should discharge all liabilities of the business outstanding at the date of the sale. The vendor failed to do so, and the assessee, in order to preserve the goodwill and to ensure supply of material, etc., paid certain sums in discharge of the vendors liability. The General Commissioners held that the sums so paid by the assessee were wholly and exclusively laid out for purposes of the business and were therefore allowable as deductions. The decision of the General Commissioners was upheld by the High Court (Kings Bench Division). Here also, as in our case, the act of the assessee was voluntary and in the nature of a concession by the assessee giving up its legal rights under the agreement for considerations of business expediency. The payment was not made to secure any direct or immediate benefit but to secure future benefit. The payment was also made for carrying on the business and for preserving the confidence of the clientele and for maintaining the goodwill of the business.
We are, therefore, of the view that the two amounts of Rs. 48,891 and Rs. 1,21,760 in the two assessment years 1953-54 and 1954-55 were allowable as deductions under section 10(2)(xv). Let the reference be returned to the Tribunal with this answer.
The assessee shall be entitled to the costs of this reference which we fix at Rs. 200.
Reference answered accordingly.