1. This reference under the I.T. Act, 1961, raises a question about allowance of a claim for losses in trade. A public company called 'Mettur Chemicals' was originally being managed by a partnership firm of Calcutta, whom we will call 'Dayaram Firm', for short. There was a regular managing agency agreement for a period of years between the Dayaram Firm and Mettur Chemicals. While that agreement was still to go for some time yet, the Dayaram Firm was willing to give up its managing agency in favour of the assessee, a private company in Tiruchirapalli. The assessee agreed to assume the managing agency of Mettur Chemicals on the terms suggested by the Dayaram Firm. An agreement in writing was then entered into, under which the Dayaram Firm resigned its managing agency, and the assessee stepped in an the next managing agent of Mettur Chemicials for a fresh term of years. The consideration for the agreement between the assessee and the Dayaram Firm was that the assessee should pay to the Dayaram Firm one-eighth of the managing agency commission which it would be receiving every year from Mettur Chemicals. This sharing agreement was duly given effect to by the assessee. Every year, soon after the assessee got its managing agency commission from Mettur Chemicals, it would remit one-eighth part thereof to the Dayaram Firm at Calcutta. This went on systematically year after year.
2. There is a special provision in the income-tax statute which allows a deduction to a managing agent who parts with either the whole or a share in the managing agency remuneration to a third party although, strictly speaking, the sharing of the managing agency commission is only an appropriation out of income and not a proper charge against it. Such a provision has been there is the taxing statue for more than 40 years now. In the present I.T. Act, 1961, the enabling provisions is s. 39. It lays down certain requirements as so many conditions to be fulfilled for the grant of the deduction.
3. In the present case, all the statutory conditions were found to have been fulfilled. The ITO was satisfied about the existence of the agreement between the assessee and the Dayaram Firm, the fixing of the latter's share as one-eighth and other requirements. Year after year, the assessee was claiming the payment made by it to the Dayaram Firm as a deduction in the computation of its taxable income. On the other side of the sharing, the Dayaram Firm was also returning the one-eighth share received by it from the assessee year after year as part of its assessable income. This was the was everything had gone on despit certain changes in the constitution of the Dayaram Firm.
4. In the assessments for 1962-63 and 1963-64, however, the ITO declined to apply section 39 of the I.T. Act, 1961. He refused to exclude one-eighth share of commission from the assessee's taxable income, but brought to tax the entire managing agency remuneration, without any deduction. The reason was not that he assessee had not paid the one-eighth share to the Dayaram Firm in these two years, but that the payment cannot be treated as one made strictly in terms of the sharing agreement dated August 26, 1940. The ITO had come to know, and had recorded a finding, that over the years the Dayaram Firm had undergone many changes in its constitution. He was informed that in the last two years, presently under consideration, the Dayaram Firm did not have in its membership any of the original partner with whom the assessee had contracted for the sharing of the managing agency commission. According to the ITO, the changes in the Dayaram Firm not only altered that firm beyond all recognition, but the end result of the successive changes brought into being what, under partnership law, was a new firm altogether, having nothing whatever to do with the one with whom the assessee had originally contracted. The officer thus justified his non-application of s. 39 on the ground that the assessee had parted with a share in the managing agency remuneration to a concern which was an utter stranger to the sharing agreement of August 26, 1940.
5. The assessee took up these assessments on appeal. Before the Tribunal the assessee did not very much urge for the exclusion of the one-eighth share from its assessment as one to which s. 39 applied. The assessee put forward the claim on a different ground. The assessee represented that whatever might be the legal position of changes in the constitution of the firm of Dayaram, the assessee, for its part, was quite unaware of the changes in that firm's personnel. It was further submitted that the assessee was going on making payments of one-eighth share of the managing agency remuneration bona fide to the firm as such. What is more, the assessee's remittances were also being accepted, in the same way, at the other end. If under the technicalities of partnership law the last two payments to Dayarams were to be construed as payments to a non-contracting firm, still according to the assessee, the fact remained that the money had gone out from the coffers of the assessee. In other words, the assessee's payments had been made either under ignorance or under a mistake. What is more, the present partners of Dayaram had appropriated the payments to themselves without any question. Their stand was that they were entitled to the share even under the agreement dated August 26, 1940. It was in these circumstances that the assessee claimed the outgoings as trading losses, contending that they should be allowed in the computation of its taxable income from business.
6. The Tribunal accepted these submissions and ordered that the one-eighth share of the managing agency commission paid out by the assessee to Dayarams as at present constituted must be regarded as payments made under a bona fide mistake, and must be allowed as business losses.
7. This decision of the Tribunal is now challenged in the present reference as erroneous in point of law. Two questions arise. One is whether the payments represent trading losses. The other is whether they are revenue losses or capital losses.
8. The principle on which trading losses can claim deduction had not so far been incorporated in the income-tax statute. What is business expenditure and which business expenditure can be deducted are all laid down by the Act. Set off of losses and carry forward of losses are also governed by express provisions in the Act. But how itemized losses in a business are to be dealt with for income-tax purposes has not been laid down by the Legislature. The law relating to allowance of trading loss is, as yet, purely judge made law. The leading case is strong & Co. of Romsey Ltd. v. Woodifield  5 TC 215 (HL). This English case laid down that a loss, in order to be allowed for income-tax purposes, must be shown to be one incidental to the taxpayer's business. Another way of saying the same thing is that the loss must be incurred by the taxpayer is his character as a trader, and not in any other capacity. In the case of Strong & Co. of Romsey Ltd. v. Woodifield, the Chimney in an inn fell on a lodger and the innkeeper had to shell out damages to the injured person. Having paid the money, the innkeeper claimed it as a trading loss. The court disallowed the claim, holding that the loss was not incidental to his trade of innkeeping and the damages had to be paid by him only as a property owner. The principle laid down by this decision has been followed in our country. In a case which arose under the Indian I.T. Act, 1922, Annamalai Chettiar v. CIT : 67ITR584(Mad) , the principle obtains, perhaps, the most succinct expression, as under (p.585) :
'The term 'business losses' does not find specific mention in this section. But, though they fall outside the purview of any of the clauses of sub-section (2) of section 10, they are allowable on ordinary commercial principles of computing profits, provided the losses are of a non-capital nature and they are not merely connected with the trade but are really incidental to the trade itself.'
9. The question is the present case, therefore, is whether the payment by the assessee of one-eighth share of the managing agency commission either out of ignorance or out of mistake or out of negligence can be regarded as a loss incidental to the assessee's business.
10. The Department's learned counsel, Mr. Jayaraman, urged that the decision of the Tribunal is erroneous in point of law. He submitted that while the parting of the money, for good, by the assessee might be regarded as a loss, it cannot be regarded as a loss incidental to the trade.
11. We do not accept this contention as well founded. The Tribunal in this case had recorded a finding that the payment made by the assessee to the Dayaram Firm was the result of a genuine mistake. The kind of changes which had taken place in the Dayaram Firm were not known to the assessee. Changes in partership personnel are often kept secret, and in any case they are not published. Only 'insiders' have up-to-date knowledge of these things. No doubt, the ITO came to know about the altered constitution of the firm. But that was because the I.T. Dept. has powerful antenna with which to spot out information from every nook and corner. The assessee was not so endowed, and was going on making payments bona fide, year after year to the same firm at the same address. What is more the payments were being received and acknowledged without question at the receiving end. This was the case even with the last two payments now under consideration. In these events, the Tribunal, in our judgment, was not unjustified in holding that the payments made by the assessee were under a genuine and bona fide mistake. The most efficient business organisation in the world are apt to commit mistakes owing to information gaps. The Tribunal, in our opinion was, therefore, justified in regarding these payments under mistake as incidental to the assessee's business.
12. Mr. Jayaraman argued that a mistake, as such, in not a failing peculiar to business. To err is human, he said, both in trade and in other activities. Hence, he argued, the assessee's payments under mistake cannot be held to be incidental to business.
13. We do not think we must judge the error involved in this case merely as a human failing. For, it has peculiarly business orientations. Here is a case where the Dayaram Firm has been functioning for long as a managing agent, and it yielded place to the assessee on the Commission. The assessee dealt with this commercial deal as an arm's length transaction between one concern and another. The assessee took the Dayaram Firm as an entity, and implemented the sharing agreement, in the ordinary course of business, without going into legal technicalities. For a ripened lawyer, a firm may be an abstraction, but businessmen do not go about treating commercial firms in this fashion. Hence it is that the assessee had kept on sending the share of managing agency remuneration to the Dayaram Firm which it had known as an entity for upwards of 20 years. The mistake here might not have been committed by a hardheaded lawyer who is steeped in Lindley, but it can well be attributed to business dealings as incidental to trade.
14. Mr. Jayaraman then urged that the loss must be disallowed as capital loss. We agree, on principle, that all losses incidental to trade cannot be allowed as a deduction, and only revenue losses are so entitled. There are many cases in the books which bring out a similar distinction in the realm of business expenditure, between revenue expenditure and capital expenditure. There is, for instance the well known case of Atherton v. British Insulated and Helsby Cables Ltd.  10 TC 155 (HL) which brings out of distinction by laying down that capital expenditure is that which ordinarily, results in enduring benefit to the taxpayer's trade. We do not, however, think that this doctrine of Viscount Cave in Altherton v. British Insulated and Helsby Cables Ltd. can be applied to determine the capital character of a loss. For, while capital expenditure begets an asset of a tangible nature or begets an advantage of an intangible character, a loss begets nothing, whether it is capital loss or revenue loss. We sometimes refer to a 'dead' loss, which aptly brings out the emptiness which a loss leaves behind. In one sense, all losses of a businessman are capital losses. But this is only in the sense that all losses eat into a trader's capital, in much the reverse way that all profits augment his capital. It must still be necessary to make a sophisticated distinction between a revenue loss and a capital loss for purposes of arriving at a trader's net profit. This is because nothing which smacks of a capital element can go into the reckoning of income. If it does that would distort the profit position, for tax purposes as much as for the taxpayer's own personal accounting.
15. What then must be the criteria for our distinguishing between a capital loss and a revenue loss. One test suggests itself to us readily, especially in the context of the present case. We begin with the factual finding that the loss in this case had occurred because of a mistake. To see whether the loss is on capital account or revenue account, it would we think, be proper to see what the position would have been if there had been no mistake and the payment had gone home to the right party in accordance with the binding contract. We have no doubt that if the payment had been aright, the outgoing would be deductible. The mistake might make the payment a dead loss, instead of its being in item of expenditure, but its place in the revenue account cannot be gainsaid; this is because it fails to come out as an item of legitimate business expenditure at precisely the same point where it might have succeeded as such an item.
16. We would round up the discussion with one more aspect. Right from the days of Curtis v. J. & G. Oldfield Ltd.  9 TC 319 (KB), we have been quite familiar with the position that embezzlement by an employee results in a trading loss, allowable as such in the income-tax assessment of the employer who carries on and has to carry on business with the help of of the servants and staff. Curtis v. J. & G. Oldfield Ltd. has been applied in our country in innummerable decisions notable amongst them being two Supreme Court cases, Badridas Daga's case : 34ITR10(SC) and Nainiatal Bank's case : 55ITR707(SC) . It would, however, be a mistake to suppose that only loss due to embezzlement or theft, or loss of some other kind akin to these occurrences, would qualify for allowance under the I.T. Act. It would really depend on the kind of trade and the kind of loss which we have before us. In the case of loss of money by embezzlement in a banking or money-leading business, it is loss of a stock-in-trade and hence it is readily recognizable as a revenue loss. Other kinds of loss in other business might not be as easy to place. But even they only call for an understanding of the nature of the trade and the nature of the loss to lead to the proper conclusion. So far as cases of the present kind are concerned, losses which arise owning to a mistake committed by a business in the course of his transacting business, or owing to a mistake of his servants or agents in the course of their employment must be regarded as an allowable business loss, since it would be very much incidental to the business. No other conclusion would be reasonable. A bad business judgment leading to loss in business cannot be visited with refusal to grant deduction in the computation for tax purposes. For income-tax is not a tax on business inefficient any more than it is a tax on business efficiency. To get an allowance for such a loss, however, it must be shown that the loss had arisen in the kind of transaction which, if it had come out aright, would have qualified the outgoing for a deduction as an item of revenue expenditure. In this case, as we earlier observed, this test is fulfilled.
17. The Tribunal's approach to this aspect of the question was also more or less the same. Their conclusion was as follows :
'We, therefore, hold that these payments, had they been made to the right party, could have had to be taken into account in arriving at the profits of the assessee from the business of managing agency. The fact that they were paid over to a wrong party would only mean that it is a revenue loss, incidental to the business, which the assessee has sustained.'
18. The question as sent up by the Tribunal in this reference is couched in the following form :
'Whether, on the facts and in the circumstances of the case, the share of commission paid to firm D-6, represented a loss incidental to business and is a business expenditure ?'
19. The reference to expenditure appearing in the question, however, is wrong. For, as we earlier indicated, business expenditure is one thing and business loss is quite another. Having regard to the nature of the controversy controversy between the parties right through, we reframe the question as follows :
'Whether, on the facts and in the circumstances of the case, the share of commission paid to firm D-6, represented a loss incidental to business and is a revenue loss ?'
20. Our answer to the question, as reframed, is in the affirmative and against the Revenue.
21. This answer must ordinarily conclude the whole of the reference in this case. However, we briefly touch upon certain other question of law which has been referred to us in this stated case. One of them is as follows :
'Whether, on the facts and in the circumstances of the case, the payment of share of commission to the firm D-6 (M/s. Dayaram and Company) to whom the assessee is not liable to pay, is a business expenditure to be allowed ?'
22. The answer to this question is quite obvious. As we earlier indicated, the sharing of a managing agency commission is not an item of expenditure of the managing agent who pays the share to the third party sharer. It is not an outgoing; it is not a charge against profits. It is only an application or appropriation out of the managing agency commission after it is earned by the managing agent. The amount paid out is deductible nevertheless, provisions relating to allowance of business expenditure. In this case, as the ground that it is an item of business expenditure or even that it is special provided for under s. 39 but on the ground that it is an allowable business loss.
23. Another question propounded in this case is :
'Whether, on the facts and in the circumstances of the case, the Appellant Tribunal was right in holding that the provisions of section 39 will not have any application to the payment of share of commission ?'
24. The answer to this question is already plain to see. As we earlier indicated, the assessee had not chosen to argue for the allowance of the amount as being qualified for deduction under s. 39. The assessee had preferred to rest its claim on the basis that it is an item of revenue loss in its business. That being so, there is no question of applying s. 39 to this kind of consideration of the deduction claimed.
25. Yet another question for our opinion in this reference is :
'Whether, on the facts and in the circumstances of the case, the Appellate Tribunal was right in holding that the payment of share of commission is not a capital expenditure and is also not an application of profits after they were earned ?'
26. The first part of the question refers to the Tribunal's determination that payment by the assessee of one-eighth of the managing agency commission is not capital expenditure. In our judgment, the controversy as to capital or revenue expenditure can hardly can hardly arise in this case, because the payment is not properly considered as an item of expenditure at all. The second part of the question does arise on the facts, because the assessee parted with the one-eighth share of the meaninging agency remuneration only after earning it. But this answer does not comprehend the entire controversy in the case. Such a comprehensive answer, as respect the first question, we have discussed in the earlier paragraphs of this judgment.
27. In the result, we answer this reference in the assessee's favour and against the Revenue. The assessee is entitled to its costs. Counsel's fee Rs. 500 (one set.)