SRINIVASAN J. - The question that stands referred to us is :
'Whether the assessee was entitled to the deduction of Rs. 42,718 or any portion thereof from its assessable income for the year 1955-56 ?'
In the year ended December 31, 1953, relevant to the assessment year 1954-55, the assessee wrote off in its profit and loss account a sum of Rs. 42,716-12-0 as loss arising from embezzlement of cash. In explanation of this claim, the assessee stated that the embezzlement resulted from the manipulation in the cash and the share transfer stamp account, by the employees. It was also stated by the assessee that this embezzlement had been going on for several years but had been discovered only in that accounting year and that any action in law to recover the amounts would be futile. The Income-tax Officer held that since the embezzlement was discovered only 1954, it could not be allowed in the assessment for the year 1954-55, and there the matter ended. In the assessment for the assessment year 1955-56, the assessee again put forward this claim. It was stated that the cashier and the accountant employed by the assessee had embezzled these amounts. Two letters signed by these persons were produced before the income-tax authorities in which each acknowledged his extent of his guilt in the matter. The assessee-firm also appointed an auditor to investigate into the matter and to ascertain how and in what manner the embezzlement had been effected. According to the auditors, up to April 11, 1954, a total sum of Rs. 40,744 had been so emmbezzled. The Income-tax Officer rejected the claim, taking the view that the loss did not occur in the course of the business, and that, further, as the assessee had taken promissory notes from the employees responsible for the embezzlement, but had taken no action to recover the moneys on the promissory notes, no allowance could be granted. Successive appeals to the Appellate Assistant Commissioner and the Tribunal failed.
When the matter came to this court under section 66(2) of the Income-tax Act, this court directed the Income-tax Appellate Tribunal to record a specific finding whether any amount had been embezzled at all, or if the finding was that only a portion had been embezzled what sum as ascertained or estimated was so embezzled. In its statement of the case, the Tribunal has recorded that there was undoubtedly embezzlement, but that the exact amount could not be ascertained, and on the basis of the letters of confession given by the cashier and the accountant, the amount embezzled would be Rs. 34,396.
The short question is whether the loss arose in the course of the business of the assessee and whether the assessee is entitled to have it adjusted in the computation of its profits under section 10(1) of the Act.
That the assessee in the course of the its normal business had to entrust cash and stamps for the purpose of carrying on its business to its employees can admit of no dispute. That the employees embezzled these moneys by committing deliberate mistakes in the casting of totals, in the balancing of the accounts and by making deliberate entries of erroneous carry-forwards both in the petty cash account book and the share transfer account book has been established. It is true that this method of embezzlement was carried on from 1948 onwards and resulted in a total loss of Rs. 34,396 at least, that being the amount which the two employees in question admitted in their confessional statements. The amount was indeed much larger and the special auditors who were appointed for the purpose of checking state that the total volume of misappropriation could be ascertained only if the entire accounts spread over several years were checked, which was obviously out of all proportion to the result sought to be achieved. As we have stated, the Tribunal concedes the position that there was in fact a systematic embezzlement by the employees and places the volume of that loss at Rs. 34,396. In this appellate order, however, the Tribunal held that even assuming that there was actual embezzlement, it was not satisfied that the embezzlement occurred in the ordinary course of business. In coming to that conclusion, it observed that 'in a business of any magnitude it becomes necessary to delegate certain functions to subordinates and if, owing to the negligence or dishonesty of the subordinates, some of the receipts of the business do not find their way into the till or some of the bills are not collected at all, or something of that sort, that may be expense connected with and arising or of the trade in the most complete sense of the word. But, if the controversy cause was the managements own negligence, it would be like giving free access to the thief and handing over the money to him'. It appears to be the view of the Tribunal that unless the management is vigilant and is shown to have displayed such vigilance right through, the loss which in its view arose from the contributory negligence of the employer through lack of vigilance was not a loss in the ordinary course of business. In another part of its appellate order, the Tribunal observed :
'We are aware that in all cases embezzlement, there is bound to be an element of negligence on the part of the properties; but in this case, the negligence would appear to be an indulgence shown to the employee. Since 1948, the cash balance was not counted at all at any time though on days it was very substantial. Not even ordinary care appears to have been bestowed upon the maintenance of the account which also, in our opinion, is an important part of carrying on a business. We are, therefore unable to hold that the loss was incidental to the carrying on of the business.'
Apparently, the Tribunal expects some undefined degrees of care or vigilance on the part of the employer but is prepared to draw the line between cases where such care is in its opinion sufficient and cases where the lack of care overshoots that mark. We are really unable to appreciate this question of distinction. The Tribunal is not imposing a penalty as it were by refusing to accept the loss as in reduction of the profits solely for the reason that the employer was negligent. While it appears to accept the position that in any business undertaking certain responsibilities have to be placed on the shoulders of subordinates and it is inevitable that they should be trusted in the due performance of their duties, it still appears to think that employer should look upon every act of the employee with suspicion and check it then and there. This approach seems to us to be wholly erroneous.
In Badridas Daga v. Commissioner of Income-tax their Lordships laid down that the allowances contemplated under section 10(2) of the Act are not exhaustive and that when a claim is made for deduction for which there is no specific provision under section 10(2), whether it is admissible or not will depend on whether, having regard to accepted commercial and trading principles, it can be said to arise out of the carrying on of the business and be incidental to it. The loss must spring directly from the carrying on of the business, and should be incidental to it. It should not be one which has only some connection with the business. It was pointed out that while loss sustained by a business by reason of embezzlement is not an admissible deduction under section 10(2)(i) or section 10(2)(xv), it would nevertheless be admissible as a deduction under section 10(1) of the Act if it arose out of the carrying on of the business and was incidental to it. Whether the employee occupied a subordinate position or one which was possessed of large powers of management makes little difference to this question of principle. In this case which their Lordships had to deal with, a dealer in shares and bullion carried on a business through an agent, who held a power-of-attorney. This agent withdraw large amounts and applied them in satisfaction of his personal debts. The employer was able to recover a small sum from the agent by way of suit and had to write off the balance as irrecoverable. Their Lordships pointed out that the principle that, when once the moneys had reached the till, their subsequent withdrawl was de hors the business was inapplicable to a business such as banking or money lending. That being so, the continuous operation on the bank account by the agent was incidental to the course of the business. In those circumstances, his withdrawl of the moneys was referable to his character as agent and the loss resulting from the misappropriation was necessarily incidental to the carrying on of the business. In the present case also, it is not in dispute that though the business is not one of money-lending or banking, it had necessarily to entrust cash and amounts (sic) to the employees for the purpose of day-to-day transactions, and for the purpose of carrying on another part of its business as share dealer and stock-brokers, it had to entrust the necessary share transfer stamps to the employees. If the employees embezzled amounts from either of these heads of account, it would certainly seem to follow that the loss was occassioned in the course of the business and was undoubtedly incidental to the business.
In other decision of the Supreme Court, Commissioner of Income-tax v. Nainital Bank, the decision arose whether the loss which resulted from a dacoity of a branch of the back was allowable. Their Lordships point out that it was incidental to the carrying of the business that large amounts should be kept in the premises of the branch and that though the loss was through dacoity, it was nevertheless one that was incidental to the carrying on of the business.
A case almost directly in point is Venkatachalapathi Iyer v. Commissioner of Income-tax. In that case an employee embezzled a total sum of Rs. 36,000 and odd by short-totaling receipts and over-totalling payments and pocketing the difference. A criminal prosecution was launched against him and a civil suit was also filed for recovery of the amount. A certain sum was recovered from the employee and the balance was claimed as a deduction unders section 10(1). The admissibility of this claim was upheld in this decision. The learned judges however emphasise in this case that it is only when the loss became actual and certain that there could be an accural of loss. Until the settlement of the case by way of compromise or other grounds, there could not be any loss. This point is of some importance, for the Tribunal appears to lay stress upon the fact that what was originally a loss had been converted into a civil liability on the execution of the promissory notes by the employees in favour of the assessee.
When exactly the loss arose was another aspect of the question which the Tribunal was inclined to hold against the assessee. It was established that this systematic embezzlement had been going on for several years and it was not till the account year relevant to the assessment year that the factum of embezzlement was actually discovered. The Bombay High Court in Associated Banking Corporation of India v. Commissioner of Income-tax held that the question when the loss by embezzlement can be said to occur was a mixed question of fact and law. A decision on this point would rest on the facts and circumstances of each case. The basic principle to be considered in this connection is that the loss must be actual and present. The learned judges pointed out that it cannot always be said that the moment moneys are embezzled the fact can be discovered; but that the loss ordinarily occurs when the moneys are lost to the assessee and there is no real chance of recovering them. Though the actual decision in that case went against the assessee, the principles above are worth nothing. In another case, Manavala Naidu v. Commissioner of Income-tax/Excess Profits Tax, a Bench of this court laid down that what is material is the time of discovery of the loss and it is only with reference to that year that the assessee could claim the loss. In another decision of the Bombay High Court, Lords Dairy Farm Limited v. Commissioner of Income-tax, the principle relevant to cases of this kind has been stated thus :
'If it is necessary for the assessee to appoint employees and delegate to them certain duties and if loss springs directly from the necessity of doing so, then the loss would be a trading loss, and the assessee would be entitled to claim that amount as a proper deduction. If a loss by embezzlement can be said to be necessarily incurred in carrying on the trade it is allowable as a deduction from profits.'
They further observe that only when it is clear that the money cannot be recovered that the loss is caused.
It seems to us to be unnecessary to labour the point any further. We have already pointed out that the assessee could not possibly carry on its business except by entrusting its employees with the performance of certain duties which involves the handling of cash and other valuable assets. It is not in dispute that the loss was occasioned in the relevant account year. It is true that it was discovered somewhat earlier and the employees gave statements confessing embezzlement and offering to make good the loss. They also executed promissory notes. It is claimed on behalf of the assessee that the matter could not be prosecuted further, for the employees were worth nothing and a civil action against the employees would result in no conceivable benefit to the employer. To recover any money from them was out of question. It seems to us that in those circumstances it was not incumbent upon the employer to pursue a useless remedy and waste money in such proceedings. The view taken by the departmental authorities that, because the employer had not taken any steps in that regard, it had not established that the loss had really occurred seems wholly unjustifiable. Having regard to the facts and circumstances of this case, we are satisfied that the loss was incurred in the course of carrying on the business and was undoubtedly incidental to the business. The assessee is entitled to the deduction. We would however limit it to the amount of Rs. 34,396, that being the amount covered by the confessions in question. While we are of the view that the assessee would be entitled to an even larger amount, since it has not been possible for the auditors to check and ascertain the exact amount involved, we would prefer to limit it to the amount mentioned above. The question is answered accordingly. The assessee will be entitled to its costs. Counsel Fee Rs. 250.