D. K. MAHAJAN J. - The following question of law has been referred by the Income-tax Appellate Tribunal (Delhi Bench) under section 66(2) of the Indian Income-tax Act, 1922, for our opinion :
'Whether the legal expenses of Rs. 10,000 incurred by the company in defending successfully the Bombay branch manager, against charges of criminal breach of trust levelled by one of the customers in respect of a transaction which arose on the normal course and entirely out of the business of the company were an expenditure paid out wholly and exclusively for the propose of the companys business and a permissible deduction under section 10(2)(xv) of the Indian Income-tax Act, 1922 ?'
The assessee in a private limited company and the dispute concerns the assessment year 1952-53, the period of account ending 30th June, 1951. The assessees business is of import and sale of newsprint and other kinds of paper. The head office of the company is at Delhi while the branch office is in Bombay. Ranbir Singh was the manager of the Bombay branch. In the year 1941, paper for newsprint was issued on basis of quota allotment certificates to newspapers. One Mauj Printing Bureau had received the quota allotment certificate by the end of August, 1941. According to the procedure prevailing, the certificate was handed over by the quota-holder to the assessee for import and collection of paper. The newsprint duly arrived from Canada but was not delivered to the Mauj Printing Bureau, but instead, was sold by the company and the sale proceeds were recorded in the books of the company. Mauj Printing Bureau initiated criminal proceedings against the manager of the assessees branch for criminal breach of trust under section 406 of the Indian Penal Code in Bombay. Ranbir Singh was sentenced to undergo rigorous imprisonment for three months and a fine of Rs. 1,000. Against this decision, Ranbir Singh successfully preferred an appeal to the Bombay High Court and was acquitted. The company incurred an expenditure of Rs. 10,000 in defending Ranbir Singh. This amount was claimed as permissible deduction under section 10(2)(xv) of the Indian Income-tax Act, 1922, by the company. The Income-tax Officer disallowed this deduction for the reasons, which may be stated in his own words :
'For the reasons explained in Commissioner of Income-tax v. Hirjee the sum spent in defending the criminal proceedings cannot be said to have been laid out wholly and exclusively for the purpose of the business.'
Aganist this order, the assessee went up in appeal to the Appellate Assistant Commissioner, who allowed the appeal and held the expenditure of Rs. 10,000 as a permissible deduction. While dealing with the matter, the Appellate Assistant Commissioner made the following observations :
'In my opinion, the contention of the appellant is correct. As stated above, the newsprint which was actually imported was sold by the company on its own account. The judgment of the High Court clears the Bombay manager of the charge of criminal breach of trust. The resultant position, therefore, is that whatever the manager did was in the normal course of business. Since a serious charge was brought against a trusted employee of the company questioning his action, the company was justified in arranging for his defence.'
The Income-tax Officer was dissatisfied with the Appellate Assistant Commissioners decision and preferred an appeal to the Income-tax Appellate Tribunal (Delhi Bench.) The Tribunal relying on the observations of the Supreme Court in Commissioner of Income-tax v. H. Hirjee reversed the decision of the Appellate Assistant Commissioner.
In the present case, it is abundantly clear that the criminal prosecution was launched against an employee of the company with regard to a transaction pertaining to the business of the company or, in other words, for a transaction carried out by the company in its ordinary course of business. Its manager was proceeded against under section 406 of the Indian Penal Code. The question then arises : Is the company entitled to claim the expenditure incurred by it in defending its manager On this matter, there is a direct decision of the Bombay High Court in J. B. Advani & Co. Ltd. v. Commissioner of Income-tax and Excess Profits Tax. Chagla C.J. who delivered the judgment of the court, after making a review of authorities, observed as follows :
'.... that there is no difficulty in the class of cases where an asset of a business is protected or safeguarded by the assessee carrying on the business in a civil litigation. The costs of such litigation are always a permissible deduction. The difficulty only arises when you have a criminal prosecution. There again where a criminal prosecution ends in a conviction there is no difficulty because the assessee who is guilty of a breach of the law cannot be heard to say that the costs of the litigation against him was a permissible deduction because the commission of an offence was not necessary for the purposes of his trade. The real difficulty only arises when you have a case where the prosecution terminates in acquittal. Then the true test to be applied as I suggested would be whether the assessee was charged with regard to a transaction which took place in the ordinary course of business and the other test would be whether he was charged in his capacity as a trader. If these two tests are satisfied and the court comes to the conclusion that the primary object of incurring the expenditure was to protect the good name of the business then it could be said that the expenditure was wholly and exclusively for the purposes of business.'
This decision was considered by the Supreme Court in Commissioner of Income-tax v. H. Hirjee. The view of the Bombay High Court in that case - a case of criminal prosecution of an employee engaged in the ordinary course of assessees business-was considered. The correctness of the ultimate decision was not doubted, the ultimate decision being that an expense incurred by the owner of the business in defending its employee in a criminal prosecution arising in the course of its business is a permissible deduction under section 10(2)(xv). But, however, the distinction drawn by the Bombay High Court, namely, that if the prosecution ends in conviction, the expenditure incurred in connection therewith is not a permissible deduction under section 10(2)(xv) of the Act, while if it results in ACQUITTAL., it is a permissible deduction, was not accepted as correct by their Lordships of the Supreme Court. In this connection, their Lordships observed as follow :
'Nor are we satisfied, as at present advised, that a distinction drawn in the Bombay case between the legal expenses of a successful and unsuccessful defence is sound. The deductibility of such expenses under section 10(2)(xv) must depend on the nature and purpose of the legal proceeding in relation to the business whose profits are under computation, and cannot be affected by the final outcome of that. Income-tax assessments have to be made for every year and cannot be held up until the final result of a legal proceeding, which may pass through several courts, is announced.'
In Commissioner of Income-tax v. Hirjee their Lordships were dealing with an expense incurred by an owner of business in defending himself from criminal prosecution. While dealing with this type of case, their Lordships observed as follows :
'If, as the High Court realised, in every criminal prosecution where the matter is defended to protect the good name of a business or a professional man, the fear of possible fine of imprisonment must always be there, it must ordinarily be difficult for any court to say, that the expenses incurred for the defence, even if they are not to be regarded as the personal expensesof the person accused, constituted expenditure laid out or expended wholly and exclusively for the purposes of the business . Learned counsel for the respondent frankly admitted that he was not able to find a single case in the books where the expenses incurred by a person exercising a trade or profession in defending a criminal a criminal prosecution, which arises out of his business or professional activities, were allowed to be deducted in the assessment of his profits or gains for income-tax purposes.'
It, therefore, follows from what has been stated above that the expenses incurred in defending a criminal prosecution arising in the course of business can only be allowed as a permissible deduction, where they are incurred in defending an employee of the business, not the owner. In the case of an employee, such an expenditure is incurred to protect the good name of the business, the prosecution having emanated with regard to an act which took place in the ordinary course of business. In this situation, the expenditure would be wholly and exclusively for the purposes of the business. This distinction is well illustrated if the facts of the Bombay case and the facts of the Rangoon case in commissioner of Income-tax v. Gaspar and company are kept in view. In the Bombay case, it was the limited company which was spending money to defend its managing director and the salesman and the charge related to a transaction which took place in the ordinary course of the business of the company while in the Rangoon case, all the partners of a firm, who were the assessees, were prosecuted for as offence and they defended themselves against the offence charged. That is why, in the Rangoon case, the learned Chief justice took the view that a part of the object while incurring the expenditure was to defend themselves (partners) from the possible adverse consequences of a criminal conviction, and, therefor, the expenditure could not be said to have been laid out wholly and exclusively for the purposes of such business.
Mr. H. Hardy, who appears for the department, relied on the Supreme Court decision in Commissioner of Income-tax v. H. Hirjee and the decision of the Rangoon High Court in Commissioner of Income-tax v. Gasper and Company. Both these decisions are clearly distinguishable and have no application to the facts of the presents case. As already observed, the correct view, so far as the present case is concerned, is to be found in the decision of the Bombay High Court in Advanis case.
In this view of the matter, we are clearly of the view that the Appellate Assistant Commissioner was correct in his view that the legal expresses in this case were a permissible deduction under section 10(2)(xv), whereas the Income-tax Appellate Tribunal has clearly gone wrong in holding to the contrary. The question referred to us is, therefore, answered in the affirmative. There will be no order as to costs.
S. K. KAPUR J. - I agree.
Question answered in the affirmative.