1. The assessee-family carried on a money-lending business at Madras. In the relevant year of account which ended on 1st November, 1948, Inderchand Galada, the kartha of the assessee-family, was in charge of the business.
Suganchand Ranka, who had been appointed cashier in December, 1947, was in charge of cash, and he continued to be in charge of cash during the temporary absence of Inderchand Galada from Madras in March, 1948. Whether anyone else was left in charge of the business during the absence of Inderchand Galada is not clear. But that Ranka was all along in charge of the cash was clear. During the absence of Inderchand Galada, Ranka misappropriated a sum of Rs. 13,330, which he appears to have lost on bets on horse races. When the shortage of cash was discovered and reported to him, Inderchand Galada returned to Madras Ranka confessed in writing to the defalcation and prayed for forgiveness (see Annexures A, A-1 and A-2). He was not prosecuted. On 7th April, 1948, Inderchand Galada obtained from Ranka a promissory note for Rs. 13,125, after adjusting Rs. 205 which was due to the cashier as his salary. At the end of the year of account the assessee wrote off the amount of Rs. 13,125 as irrecoverable.
2. In the assessment year 1949-50 the assessee claimed that this sum of Rs. 13,125 which he had lost should be deducted in computing his taxable income. That the cashier Ranka had taken the money and the assessee had lost it were never doubted by the Department, the Income-tax Officer and the Assistant Commissioner. But they rejected the claim of the assessee that it constituted an allowable deduction. The Tribunal sustained that rejection when it dismissed the appeal preferred to it by the assessee.
3. The question referred by the Tribunal under Section 66(2) of the Income-tax Act was:
Whether on the facts and in the circumstances of this case there were materials on which the Tribunal could disallow the claim to deduct the sum of Rs. 13,125 from the assessable income of the assessee as loss incurred in the course of the business.
4. The Department, it should be remembered, accepted the factual position, that Ranka had misappropriated the amount and that the assessee had lost it in the year of account. Even in the statement of the case submitted by the Tribunal there was nothing to indicate that the factum of loss was not established in the assessment proceedings. In the course of its appellate judgment, however, the Tribunal recorded:
Under these highly suspicious circumstances and in the absence of any evidence we are unwilling to accept the mere oral statement that there was embezzlement in this case.
That it was for money misappropriated by Ranka that he executed the promissory note was never in issue before the Department. The Tribunal however recorded:
It looks as if the money was advanced to the employee and later written off since the employee could not repay the sum. We do not want to say more or speculate about it. In case it is a loan to the employee, it is clear that it was not for business purpose and therefore it cannot be termed ft bad debt. The basic fact being unproved it is not necessary for us to consider whether it could be allowed under any of the provisions of the Act.
If the Tribunal was of the view, that the promissory note was for money advanced to Ranka, there was no material to support that view. Besides, it would be inconsistent with the further finding of the Tribunal, that the loan was not for a business purpose. The finding that it was not a case of a loan advanced in the usual course of the money-lending business of the assessee could only be on the basis, that the amount was due to the assessee but that it was not a loan, because the consideration for the promissory note was the money misappropriated by Ranka and due by him to the assessee on that basis. That the promissory note itself dated 7th April, 1948, was not supported by consideration was not and could not have been the view taken by the Tribunal. Obviously Ranka was liable to repay what he had misappropriated, quite independent of any liability of his under the Criminal law of the land, and it was in discharge of that civil liability that he executed the promissory note. The Tribunal was not justified on the material on record in coming to the conclusion that the misappropriation itself and the loss to the assessee had not been proved. As we said, it was not in issue at all at any stage. We still therefore proceed to consider the question referred to this Court on the basis, that the sum of Rs. 13,330 had been misappropriated by Ranka, and that the assessee had lost Rs. 13,125 in the year of account. Whether it is allowable as a trading loss in computing the profits of the business of the assessee is the question.
5. We do not consider it necessary to embark afresh on a review of the case -law on the subject, under what circumstances can an amount embezzled by an employee left in charge of his employer's funds be accepted as a trading loss in computing the profits of that employer under Section 10(1) of the Act. The case-law was elaborately reviewed by the Supreme Court in Badridas Daga v. Commissioner of Income-tax : 34ITR10(SC) , wherein the scope of the principle laid down by Rowlatt, J. in Curtis v. J. & G. Oldfield Ltd. (1925) 9 T.C. 319, was also explained. At page 20 of the Report their Lordships of the Supreme Court pointed out:
It would therefore be an error to suppose that the observations made by Rowlatt, J. could be regarded as an authority for the broad proposition that as a matter of law and irrespective of the nature of the business there could be no business activities with reference to monies after they have been collected and that, in consequence, embezzlement thereof could not be incidental to the carrying on of business. And we should further add that it would make no difference in the admissibility of the deduction whether the employee occupies a subordinate position in the establishment or is an agent with large powers of management.
The Supreme Court approved of the principles laid down in Venkatachalapathi Iyer v. Commissioner of Income-tax : 20ITR363(Mad) , Lord's Dairy Farm Ltd. v. Commissioner of Income-tax : 27ITR700(Bom) and Motipur Sugar Factory Ltd. v. Commissioner of Income-tax (1955) 28 I.T.R. 1228 their Lordships pointed out that Section 10(2) of the Act was not exhaustive and observed:
The result is 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 accepted commercial practice and trading principles, it can be said to arise out of the carrying on of the business and to be incidental to it. If that is established, then the deduction must be allowed, provided of course there is no prohibition against it express or implied, in the Act.
Their Lordships proceeded:
These being the governing principles, in deciding whether loss resulting from embezzlement by an employee in a business is admissible as a deduction under Section 10(1), what is to be considered is whether it arises out of the carrying on of the business and is incidental to it....A business especially such as is calculated to yield taxable profits has to be carried on through agents, cashiers, clerks and peons. Salary and remuneration paid to them are admissible under Section 10(2)(xv) as expenses incurred for the purpose of the business. If employment of agents is incidental to the carrying on of business, it must logically follow that losses which are incidental to such employment are also incidental to the carrying on of the business. Human nature being what it is, it is impossible to rule out the possibility of an employee taking advantage of his position as such employee and misappropriating the funds of his employer and the loss arising from such misappropriation must be held to arise out of the carrying on of business and to be incidental to it. And that is how it would be dealt with according to ordinary commercial principles of trading.
At the same time, it should be emphasised that the loss for which a deduction could be made 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 loss sustained by the assessee, even if it has some connection with his business.
6. In Lord's Dairy Farm Ltd. v. Commissioner of Income-tax : 27ITR700(Bom) , the decision which was approved of by the Supreme Court in Badridas Daga v. Commissioner of Income-tax : 27ITR700(Bom) , Chagla, C.J., put it thus at page 707:
Therefore if in any case it is found that it was necessary to deputise certain duties to an employee and it was also found that the loss sprang directly from the necessity of doing so, then the loss would be trading loss and the assessee would be entitled to claim that amount as a proper deduction.
7. The test to apply in deciding whether a loss sustained by a businessman, when an employee of his embezzles funds left in the charge of that employee, constitutes a trading loss of the business of the employer, is whether the loss was incidental to the carrying on of that business. Was the employment of the employee in the normal course of that business and was it a normal incident of the conduct of that business? Was the entrustment of the funds of the employer to that employee in the normal course of the conduct of that business? Was the loss caused to the employer by the embezzlement by the employee incidental to that entrustment? These questions have to be answered from the view-point of a prudent man of business. If these tests are satisfied then the loss would be a trading loss.
8. The assessee in this case carried on a money-lending business. The employment of a cashier was obviously a normal incident of that business. So was the entrusment of the cash of the business to that cashier. That Inderchand Galada was in charge of the business and that his temporary absence from Madras facilitated the embezzlement by Ranka did not really affect the determination of the question, was the embezzlement effected by Ranka incidental to his employment under the assessee. It was: therefore, the loss to the assessee caused by the embezzlement by the cashier Ranka was a trading loss.
9. We answer the question in the negative and in favour of the assessee. The assessee will be entitled to the costs of this reference. Counsel's fee Rs. 250.