JAGADISAN J. - The question that is referred to this court under section 66 of the Indian Income-tax Act is as follows :
'Whether the expenses of Rs. 20,035 incurred in the assessment year 1949-50 and Rs. 5912 (relating to the assessment year 1950-51) being the cost paid to the Government as directed by the Privy Council were expenses incurred in the ordinary course of business and allowable as deductions.'
The assessee is a limited company, incorporated under the Indian Companies Act carrying on business in cotton spinning and weaving at Madurai. In the accounting year relevant to the assessment year 1949-50 it claimed as deduction in the computation of its business profits the sum of Rs. 20,035 representing legal expenses incurred by it in connection with a litigation to the details of which we shall refer a little later. In the assessment year 1950-51, relevant to the previous year ending on March 31, 1950, it claimed as deduction the sum of Rs. 5,912 being the costs paid to the Government as a result of the said litigation. The Income-tax Officer disallowed the claim in respect of both the years on the ground that the assessed failed to furnish detail of the expenses. The assessee went up on appeal to the Appellate Assistant Commissioner who concurred with the decision of the Income-tax Officer. The Appellate Assistant Commissioner found that the assessee infringed the provisions of a statute and improperly challenged the court proceedings, the validity of lawful orders passed in pursuance of a statute and that the expenses cannot be said to have been laid out wholly and exclusively for the purpose of the business. There was a further appeal to the Income-tax Appellate Tribunal by the assessee. The Tribunal took the view that the expenses incurred by the assessee and sought to be deducted in the computation of profits were not in the course of business and were due to; a misapprehension of the assessee in respect of the application of a statute. The result was that the Tribunal affirmed the decision of the department. The question set out above stands referred by the Tribunal on an application made to it by the assessee.
We shall now refer to the events which led the assessee to incur the expenses and costs which are now claimed as proper deductions under section 10(2) (xv) of the Act. As stated already, the assessee is carrying on business in cotton spinning and weaving. Yarn is spun out of cotton and sold. Yarn is also woven into cloth and sold as cloth by the assessee. In the mill premises owned by the assessee, there were about 80 handlooms. These looms were not sufficient to weave all the yarn produced by the mill. Yarn was therefore distributed to outside weavers who were engaged by the assessee to convert the yarn into cloth and to deliver the finished product of cloth. These weavers were paid wages at particulars rates. It appears that they were paid piece rates, that is, according to the quantity of cloth which they produced.
In the year 1945 the Government issued the Cotton Cloth and Yarn (Control) Order, which can conveniently be referred to as the Control Order. Clauses 18A and 18B of the Control Order were as follows :
'18A. (1) No manufacturer shall, save in accordance with a general or special permission of the Textile Commissioner or in compliance with a direction given under clause 18B -
(a) sell or agree to sell cloth or yarn to any person who -
(i) is not a licensed dealer under the rules framed in this behalf by the Provincial Government; and
(ii) did not as a dealer buy any cloth or yarn from him at any time during the years 1940-1941 and 1942;
(b) during any quarter, delivery to any dealer, whether in pursuance of a pre-existing contract or otherwise, cloth or yarn, in excess of his quota determined under the sub-clause (2).
18B. (1) The Textile Commissioner may, with a view to securing a proper distribution of cloth or yarn, or with a view to securing a compliance with this order, direct any manufacturer or dealer, or any class of manufacturers or dealers -
(a) to sell to such person or persons such quantities of cloth or yarn as the Textile Commissioner may specify;
(b) not to sell or deliver cloth or yarn of specified description except to such person or persons and subject to such conditions as the Textile Commissioner may specify;
(c) to furnish such returns or other information relating to his or their undertaking and in such manner as the Textile Commissioner may specify; and may issue such further instruction as he thinks fit regarding the manner in which the direction is to be carried out.
(2) Every manufacturer or dealer shall comply with the directions and instructions given under sub-clause (1).'
On February 20, 1946, the Provincial Textile Commissioner, Madras, issued a notification under clause 18B sub-clause (1) (b) of the Control Order directing the assessee to confine its delivery of yarn to three categories of persons, namely : (a) licensed yarn dealers; (b) to consumers who purchased yarn directly from the assessee during the basic years 1940-1942; (c) persons working the appellants handlooms erected in the appellants spinning mill at Madurai. In effect this order prohibited the assessee from delivering yarn to weavers outside the mill premises. Despite this prohibition the assessee delivered yarn to operators of handlooms who were not engaged by him in the mill premises. Of course the assessee continued its previous course of business which consisted of converting yarn into cloth by outside weavers at piece rate. The weavers were no doubt bound to bring the article back to the assessee as a finished product. The Textile Commissioner took the view that the delivery by the assessee of yarn to outside weavers was an infringement of his order dated February 20, 1946. He, therefore, seized quantities of yarn which had been delivered to such outside weavers. In these circumstances, the assessee filed a petition under section 45 of the Specific Relief Act on the original side of this court for directions to the Textile Commissioner :
1. to desist from seizing yarn supplied by the assessee to the weavers at or around Madurai and Rajapalayam for the purpose of converting the yarn into cloth;
2. to restore to the assessee yarn already seized; and
3. to forbear from seizing yarn that may be entrusted to the weavers by the assessee in the usual course of business for conversion of yarn into cloth.
The main contention of the assessee was that the ground on which he filed the petition under section 45 of the Specific Relief Act, that the delivery of yarn to outside weavers was not transfer of property and was not therefore a sale, and that it was delivery by way of bailment and such delivery would not fall within the provisions of the Control Order.
The Textile Commissioner resisted the application and contended that the notification issued by him was within the limits of his jurisdiction under the Control Order. Kunhiraman J. who heard the petition upheld the Textile Commissioners view point and dismissed the application of the assessee. The assessee preferred an appeal to a Division Bench consisting of Leach C.J. and Lakshmana Rao J., but failed. Against his decision the assessee preferred an appeal to the Judicial Committee of the Privy Council. This appeal was also dismissed with costs. The decision of the Judicial Committee is reported as Sree Meenakshi Mills Ltd. v. Provincial Textile Commissioner Madras. The contention of the assessee based upon its construction upon the word 'deliver' in the Control Order was repelled by Sir Madhavan Nair, who delivered the judgment of the Board, in these terms :
'It was argued on behalf of the appellant that the delivery contemplated under clause 18B(1) (b) relates only to delivery to the outside public and not delivery to outside weavers who are bailees, as in the present case. The scope of the Control Order is very wide. It relates to both dealers and manufacturers (these terms are defined in clause (c) of the Control Order), in their dealings with themselves or with outside persons, the object of the directions issued under clause 18B as already stated, being the proper distribution of cloth or yarn of a specified description. Their Lordships do not think that the operation of the clause is limited to dealings with the outside public only, as contended for by the appellant. The object aimed at by the clause will not be secured if the scope of the order is so limited.... clause 18B is wider in its scope as its object is to prohibit delivery of cloth or yarn to any person, including delivery to a bailee.'
The assessees present claim for deduction only relates to the legal expenses incurred and the costs paid in respect of the civil litigation referred to above. It appears from the record that there were also criminal proceedings taken against the assessee as a result of the violation of the Control Order. The exact nature of these proceedings does not however appear from the records. The order of the Appellate Tribunal discloses that the yarn bales seized by the authorities were returned to the assessee. The expense incurred by the assessee in respect of these criminal proceedings are not claimed as deduction. The question for our consideration therefore is whether the legal expenses and costs paid by the assessee in the litigation which commenced as an application for a mandamus under section 45 of the Specific Relief Act and which terminated against the assessee by the decision of the Judicial Committee are proper allowances falling within section 10(2) (xv) of the Act. That provision is as follows :
'Such profits or gains (as mentioned in sub-section (1)) shall be computed after making the following allowances, namely :
(xv) any expenditure (not being an allowance of the nature described in any of the clauses (i) to (xiv) inclusive, and not being in the nature of capital expenditure or personal expenses of the assessee) laid out or expenditure wholly and exclusively for the purpose of such business, profession or vocation.'
The assessee can claim the deduction of legal expenses and costs paid to the successful party in the litigation only if it satisfies the requirements of section 10(2) (xv), or if it shows that they are such inevitable business expenses intimately associated with the earning of the profits that without their deduction the true profits cannot be ascertained.
We shall first consider the question as to how far the expenses fall within section 10(2) (xv). We can readily assume, and even the department cannot murmur to this that the expenses are not in the nature of capital expenditure or personal expenses of the assessee. The pivotal question is, was the expenditure laid out or expended wholly and exclusively for the purpose of the business. The words 'wholly and exclusively' pointedly signify that the expenditure should be completely devoted to the business. It need not be essential, necessary, or compelling; it may be optional and purely voluntary. But it must be commercially expedient and should have the aim of the continuance and furtherance of the business and an eventual augmentation or stabilisation of profits. The following observation of Viscount Cave L. C. in Athertons case was approved by the Supreme Court in Eastern Investments Ltd. v. Commissioner of Income-tax.
'..... a sum of money expended, not of necessity and with a view to a direct and immediate benefit to the trade, but voluntarily and on the grounds of commercial expediency, and in order indirectly to facilitate the carrying on of the business, may yet be expended wholly and exclusively for the purposes of the trade', can be adopted as the best interpretation of the crucial words of section 10(2) (xv). The imprudence of the expenditure and its depressing effect on the taxable profits would not deflect the applicability of the section. The acid test is, 'did the expenditure fall on the assessee in his character as trader and was it for the purpose of the business.' The meaning of this test cannot be better stated than in the following words of Lord Davey in Strong & Co. v. Woodfield :
'It is not enough that the disbursement is made in the course of or arises out of or is connected with, the trade or is made out of the profits of the trade. It must be made for the purpose of earning the profits.'
Nothwithstanding determined attempts made by the taxpayer to show that the rule laid down by Lord Davey is not good law, it cannot be said that the dictum had lost it vitality or force. In Smiths Potato Crisps Ltd. v. Inland Revenue Commissioners, it was contended that every expense to which a trader is put because he carries on the trade would be money laid out or expended for the business. Support for this contention was sought in Ushers Wiltshire Brewery v. Bruce and in the dictum of Lord Cave in British Insulated and Helsby Cables Ltd. v. Atherton.
The learned law Lords participating in Smiths Potato case unmistakably approved of Lord Daveys rule laid down in Strong v. Woodifield. All these cases were again considered by the House of Lords in Morgan v. Tate & Lyle Ltd. We do not think that Lord Daveys observation in Strong v. Woodifield has in any way been dissented from.
We would, therefore, hold that the test propounded by Lord Davey in Strong v. Woodifield can be taken to be proper and indeed infallible. We must also reckon with hard reality that no amount of ingenuity can devise a formula so precise and clear as to solve all problems arising in respect of the applicability of the section.
Turning now to the present case the question that immediately arises is whether the expenses sought as deduction were incurred by the assessee for earning profits from the business carried on. The assessee committed an infraction of law, it cannot now be heard to say anything to the contrary, and resorted to courts repeatedly persistently and indefatigably and thereby actually invited the expense. The incurring of the expense and the payment of the costs were the direct result of the assessees failure in the proceedings of law. It is of course open to a trader to carry on the trade or business in any manner he likes, honest or dishonest, straight or devious. So long as the profits of the business are taxable irrespective of the question whether such profits are tainted with illegality or not, the tax-payer might legitimately contend that there ought to be no disallowance of deductions in respect of expenses, however wrong-headed the incurring of such expenses might have been. The question of the propriety of the deduction has only to be viewed from the standpoint, whether it was necessary for the earning of the profit. Acts of illegality committed by the assessee in the was of his business however reprehensible they may be from the moral point of view, would not be discountenanced for the limited purpose of investigating the question of taking the expenses of such acts in the computation of the taxable profits of the business. But it should however be borne in mind that violation of laws is neither necessary should however be borne in mind that violation of laws in neither necessary nor incidental in the normal way of carrying on business, and we suppose, that honest business or trade is not a contradiction in terms. If a trader contravenes the law, let us assume bonafied without a deliberate intent to break the law, and is called upon by the competent authorities not to repeat such contravention and to set right what has been illegally done, the trader is bound to conform himself according to the directions of such authorities. But it may yet be open to him to entertain the view that he has not been guilty of any infraction of law, an he may, imbued with the faith of his own conviction, raise an issue whether or not he is right. But in such cases he takes the risk of being told finally that he is wrong and if he were to incur expenses as a result of his having been engaged in controversy with the authorities, it cannot be said that the money has been expended for earning the income, but it an only be said that he learned wisdom at a price.
We shall now refer to a few cases which have a bearing on the present question. Commissioner of Inland Revenue v. E. C. Warnes was a case in which the assessee company was sued for penalty under section 5(1) of the Customs (War Powers) Act, 1915, for breach of certain orders and proclamations relating to the requirements of the board, with respect to a consignment of oil shipped by the company to Norway. The action was settled by consent of the agreement of the company to pay a mitigated penalty of pounds 2,000, such sum to cover the costs of the Crown. In defending the proceedings the company incurred legal costs amounting to pounds 5,604 18s. 10d. The assessee claimed the amount of penalty and costs incurred as proper deduction but it was held that they were not a loss connected with the arising out of the company s trade within the meaning of rule 3. Case 1, Schedule D, Income-tax Act, 1842. At page 231, Rowlatt J. observed :
'.... it seems to me that a penal liability of this kind cannot be regarded as a loss connected with or arising out of a trade. I think that a loss connected with or arising out of trade must, at any rate, amount to something in the nature of a loss which is contemplable, and in the nature of a commercial loss.'
In Commissioner of Inland Revenue v. Alexander von Glehn & Co. the facts were as follows : The assessee company carried on business as general produce merchants and exported goods to Russia and Scandinavia. It was sued for penalties under the Customs (War Powers) Act, 1915. The action was settled by consent on the company agreeing to pay a compromise penalty of pounds 3,000 without costs. The company incurred legal costs amounting to pounds 1,074 12s. 7d. in respect of the proceedings. It was held that the mitigated penalty and costs were not a dismissible deductions in arriving at page 238, Lord Sterndale M. R. observed thus :
'During the course of the trading this company committed a breach of the law. As I say, it has been agreed that they did not intend to do anything wrong in the sense that they were willingly and knowingly sending these goods to an enemy destination; but they committed a breach of the law, and for that breach of the law they were fined, and that does not seem to me to be a loss connected with the business, but it is a fine imposed upon the company personally, as far as a company can be a person, for a breach of the law which they had committed. It is perhaps a little difficult to put the distinction into very exact language, but there seems to me to be a difference between a commercial loss in trading and a penalty imposed upon a person or a company for a breach of the law which they have committed in that trading.'
Warrington L. J. stated the position thus at page 241 :
'Now it cannot be said that the disbursement in the present case is made in any way for the purpose of the trade or for the purpose of earning the profits of the trade. The disbursement is made, as I have already said -and the same remark applies to this rule as to the other -because the individual who is conducting the trade has, not from any moral obliquity but has unfortunately, been guilty of an infraction of the law.'
How far the expenses incurred in respect of an infraction of the law can be properly allowed as deduction under section 10(2) (xv) of the Act was considered by the Supreme Court in Haji Aziz and Abdul Shakoor Bros. v. Commissioner of Income-tax. The assessee there carried on the business of importing dates from abroad and selling them in India. The dates which were imported by steamer were confiscated by the customs authorities under section 167 of the Sea Customs Act, and the assessee was given an option under section 183 of the Act to pay a fine. He paid a fine and had the dates released. In computing the profits the assessee sought to deduct the amount so paid as fine. The claim was negatived by the Bombay High Court, and that decision was affirmed by the Supreme Court. It was held that no expense which was paid by way of penalty for the breach of the law even though it might involve no personal liability, can be said to be an amount wholly and exclusively laid for the purpose of the business of the assessee. At page 359 Kapur J. summarised the legal position thus :
'A review of these cases shows that expenses which are permitted as deductions are such as are made for the purpose of carrying on the business, i.e., to enable a person to carry on and earn profit in that business. It is not enough that the disbursements are made in the course of or arise our of or are concerned with or made out of the profits of the business but they must also be for the purpose of earning the profits of the business.... If a sum is paid by an assessee conducting his business because in conducting it he has acted in a manner which has rendered him liable to penalty it cannot be claimed as a deductible expense. It must be a commercial loss and in its nature must be contemplable as such. Such penalties which are incurred by an assessee in proceedings launched against him for an infraction of the law cannot be called commercial losses incurred by an assessee in carrying on his business. Infraction of the law is not a normal incident of business and, therefore, only such disbursements can be deducted as are really incidental to the business itself.'
In our opinion this observation of the Supreme Court fully applies and governs the present case.
Mr. K. R. Ramamani, learned counsel for the assessee, contends that in delivering the bales to weavers outside the mills, the assessee acted bonafied in the belief that it was not violating the provisions of the Control Order, that such delivery was effected only for the purpose of earning income, and that the fact that it was ultimately found that the delivery was illegal and in contravention of the Control Order would not in any way affect the question, whether the steps taken by the assessee and the expenses incurred by it were for the purpose of the business. Learned counsel also pointed out that the deductibilty of the expenses should not be made to depend upon the success or failure of the assessee in the legal proceedings in respect of which the moneys were spent. It is true that the Supreme Court has pointed out in Commissioner of Income-tax v. Hirjee that the distinction between the legal expenses of a successful and unsuccessful defence in an action is not 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 proceeding.'
The difficulty of the assessee in this case in the way of its claim for deduction does not arise out of its failure in the civil litigation, but is due to the fact that there are no materials before us to show that what the assessee did was for the purpose of earning income. That is one aspect of the matter. The more important point to be noted is that the assessee committed an offence, as it has now been found to be by violating the Control Order and the expense which it incurred in an infructuous attempt to vindicate itself cannot be properly said to have been laid out and expended for the purpose of earning the income. It would be more proper to say that the expenses were incurred by the assessee to justify a wrong step taken by it in the course of carrying on its business.
The other question whether, even apart from section 10(2)(xv) the expenses could be claimed as a proper commercial loss in the computation of the profits can easily be answered. It is impossible to contend that the true profits cannot be ascertained without taking the legal expenses of an improper law suit indulged in by the assessee. The assessee having chosen to defy the law and to indulge in vain litigation must quite properly bear the consequences of such acts. It is inconceivable that such expense should go in reduction of its business income brought to tax.
The question is answered in the negative and against the assessee, who will pay the costs of the department. Counsels fee Rs. 250.
Question answered in the negative.