Supreme Court: No Deduction Available for Loss Incurred Against Penalty or Confiscation Regardless of Nature of Business

Supreme Court: No Deduction Available for Loss Incurred Against Penalty or Confiscation Regardless of Nature of Business

The Supreme Court in a significant ruling has held that a penalty or a confiscation is a proceeding in rem, and therefore, a loss in pursuance to the same is not available for deduction regardless of the nature of business, as a penalty or confiscation cannot be said to be incidental to any business under the Income Tax Act, 1961.

In the present case, the question which came up for consideration before the division judges bench of Justices M.R. Shah and M.M. Sundresh was whether the High Court had erred in law by allowing the Assessee/Respondent- Prakash Chand Lunia (D) Thr.Lrs. and another, the loss of confiscation of silver bars by the Directorate of Revenue Intelligence officials as a business loss, relying upon the decision in the case of CIT Patiala vs. Piara Singh.

In a search conducted by the Directorate of Revenue Intelligence (DRI) officers, the DRI officers recovered slabs of silver and silver ingots from the business premises of the assessee. The assessee was arrested under Section 104 of the Customs Act for committing offence punishable under Section 135 of the Customs Act.

The Collector, Customs held that the assessee Shri Prakash Chand Lunia was the owner of silver/bullion and the transaction thereof was not recorded in the books of accounts. The Collector of Customs, New Delhi ordered confiscation of the said 146 slabs of silver weighing 4641.962 Kilograms valued at Rs.3.06 Crores. The Collector Customs further imposed a personal penalty of Rs. 25 Lakhs on Sh. Prakash Chand Lunia under Section 112 of the Customs Act. The Collector held that the silver under reference was of smuggled nature.

During the course of the assessment proceedings the Assessing Officer (AO) observed that the assessee was not able to explain the nature and source of acquisition of silver of which he is held to be the owner, therefore the deeming provisions of Section 69A of the Income Tax Act, 1961 (hereinafter referred to as ‘the Act, 1961) made additions to assessee’s income.

In appeals preferred by the Assessee against the assessment order, the Commissioner of Income Tax (Appeals) (CIT[A]) dismissed the appeal of the assessee and upheld the additions/disallowance made by the AO.

In the appeal filed by the assessee before the Rajasthan High Court, the High Court upheld the additions made under Section 69A, while allowing the loss on account of confiscation of silver bars to the assessee. Relying on the Supreme Court’s decision in Piara Singh (1980), the High Court held that loss from confiscation of items by the DRI officials of Customs department was business loss of the assessee.

Dissatisfied by the decision passed by the High Court, the Appellant- The Commissioner of Income Tax Jaipur preferred an appeal before the Apex Court.

The Supreme Court was convinced that the assessee was the owner of the confiscated silver bars. Referring to the High Court’s order, Justice Shah remarked that the High Court had materially erred in relying upon the Apex Court’s decision in Piara Singh (1980) while allowing the deduction claimed by the assessee.

In that context, it was observed that, “in the assessee’s case he was carrying on an otherwise legitimate silver business and in attempt to make larger profits, he indulged into smuggling of silver, which was an infraction of law. In that view of the matter the decision of this Court in the case of Piara Singh (supra) which has been relied upon by the High Court while passing the impugned judgment and order and it has been relied upon by the assessee shall not be applicable to the facts of the case.”

The Court perused the provisions of Explanation 1 to Section 37(1), which expressly disallows any expenditure incurred by an assessee for any purpose which is an offence or is prohibited by law, while computing the income under the head “profits and gains of business or profession.”

Agreeing with Justice Shah’s view, Justice MM Sundresh further observed that since the word ‘any expenditure’ mentioned in Section 37 of the Income Tax Act includes the loss occasioned in the course of business being incidental to it, “any loss incurred by way of an expenditure by an assessee for any purpose which is an offence or which is prohibited by law is not deductible in terms of Explanation 1 to Section 37 of the Act.”

In the same vein, the Court pertinently avowed that a penalty or a confiscation is a proceeding in rem, and therefore, a loss in pursuance to the same is not available for deduction regardless of the nature of business, as a penalty or confiscation cannot be said to be incidental to any business.

The Court discerned that in the case of Piara Singh (supra) the assessee was found to be in the business of smuggling of currency notes and to that it was found that confiscation of currency notes was a loss occasioned in pursuing his business i.e., a loss which sprung directly from carrying on of his business and was incidental to it.

Due to this, the assessee in the present case sought deduction under Section 10(1) of the Income Tax Act, 1922. Averting to the facts of the case, the Court stated that the main business of the assessee was dealing in silver and its business cannot be said to be smuggling of the silver bars, as was the case in Piara Singh (1980).

Therefore, the Court observed that in the assessee’s case he was carrying on an otherwise legitimate silver business and in attempt to make larger profits, he indulged into smuggling of silver, which was an infraction of law. In that view of the matter the decision of the Court in the case of Piara Singh (supra) which was relied upon by the High Court while passing the impugned judgment and order was not be applicable to the present case.

Lastly the Apex Court concluded by holding that there cannot be a situation where an assessee carrying on an illegal business is able to claim deduction of expenses or losses incurred in the course of that business, while another assessee carrying on a legitimate one cannot seek deduction for loss incurred on account of either a confiscation or penalty. This classification being artificial not borne out by statute had no legal basis, opined the Court.

The bench thus set aside the order of the High Court, and restored the orders passed by the AO, CIT(A) and ITAT.

Additional Solicitor General (ASG) Balbir Singh appeared for the Revenue, while Senior Advocate Arjit Prasad appeared for the assessee/respondents.