Loading judgment…
Facts
The assessee, engaged in manufacturing Hydrogen Peroxide, faced additions primarily on account of embezzlement of funds and disallowance of expenses under section 14A. The assessee claimed the embezzlement loss as a deduction. The revenue contested the deletion of these additions by the CIT(A).
Held
The Tribunal held that the loss due to embezzlement by employees is incidental to business and allowable as a deduction in the year of discovery. For the disallowance under section 14A, the Tribunal found that the AO relied on incorrect financial data and remanded the issue for fresh examination.
Key Issues
Whether loss due to embezzlement is an allowable business deduction, and whether disallowance under section 14A was computed correctly based on relevant financial data.
Sections Cited
250, 143(3), 143(3A), 143(3B), 143(1)(a), 35D, 28(1), 10(1), 260-A, 115-P, 43B, 115-O, 14A, 8D, 46A(3), 115-P, 28, 10, 35D (XLVII of 1965), 1403/Bang/2022
AI-generated summary — verify with the full judgment below
Income Tax Appellate Tribunal, MUMBAI BENCH “B”, MUMBAI
Before: SHRI NARENDRA KUMAR BILLAIYA, ACCOUNT MEMBER & SHRI ANIKESH BANERJEE
O R D E R Per Anikesh Banerjee (JM):
Instant appeal of the revenue was filed against the order of the National Faceless Appeal center (NFAC), Delhi [in short, ‘Ld.CIT(A)] passed under section 250 of the Income-tax Act, 1961 (in short, ‘the Act’) for Assessment Year, 12018-19, date of order 13/06/2023. The impugned order emanated from the order of the National; e-Assessment Centre, Delhi (hereinafter referred to as “the Ld.AO”)
2 ITA 2816/Mum /2023 National Peroxide Ltd passed under section 143(3) read with section 143(3A) read with section 143(3B) of the Act, date of order 17/03/2021. 2. The revenue has taken the following grounds: - “
1. Whether on the facts and in the circumstances of the case and in law the Ld.CIT(A) was justified in deleting the addition of Rs.18,96,12,209/- of funds on the basis of additional evidences during the appellate proceedings without appreciating the fact that assesse failed to satisfy the condition i.e. date of discovery of embezzlement, as per the CBDT circular 35D dated 24.11.1965?
2. Whether on the facts and in the circumstances of the case and in law the Ld.CIT(A) Justified in deleting the addition of Rs.18,96,12,209/- on account of embezzlement of funds without appreciating the findings given by the Assessing Officer in its remand report i.e. the Forensic audit report submitted by the PwC is for information purpose and not relied upon by other parties, the assessee has not furnished addresses, PAN of the 29 beneficiary entities and entity wise amount of encashment of cheques, the assessee submitted the names, address & PAN of the 5 accused but failed to submit the details of accused wise amount of embezzlement.
3. Whether on the facts and in the circumstances of the case and in law, the Ld.CIT(A) was justified in deleting the addition of Rs.18,96,12,109/- on account of embezzlement of funds on the basis of additional evidences during the appellate proceedings without appreciating the facts that the claim of deduction of Rs.18.96 Cr is not supported by the supporting evidences and misappropriation of funds by employees is neither evidenced in the Charge- sheet submitted by the EOW in the Court nor in the Forensic audit report submitted by CWC.
4. Whether on the facts and in the circumstances of the case and in law, the Ld.CIT(A) was justified in deleting the addition of Rs.8,73,331/- on account of disallowance of expenses u/s 14A r.w.r 8D of the Income Tax Act on the basis of additional evidences submitted in appellate proceedings without giving the AO an opportunity to examine the additional evidences as per the provisions under rule 46A(3) of the IT Rules, 1962?
5. Whether on the facts and in the circumstances of the case and in law, the Ld.CIT(A) was justified in deleting the addition of Rs.1,02,78,327/- in respect of exempt income and Rs.1,73,77,069/- u/s 43B on the basis of additional evidences submitted in appellate proceedings without giving the AO an 3 ITA 2816/Mum /2023 National Peroxide Ltd opportunity to examine the genuineness of the additional evidences as per the provisions under Rule 46A(3) of the IT Rules 1962? 6. Whether on the facts and in the circumstances of the case and in law, the Ld.CIT(A) was justified in deleting the interest of Rs.17,06,252/- u/s 115-P of the Act on the basis of response which was filed before CPC and explanation submitted in appellate proceedings without giving the AO an opportunity to examine the genuineness of claim of assesse as per the provisions under rule 46A(3) of the IT Rules 1962?”
3. The brief facts of the case are that the assessee is engaged in the business of manufacturing and selling a chemical known as ‘Hydrogen Peroxide’. The case was selected for complete scrutiny under the Computer Aided Scrutiny Selection (CASS) and, accordingly, the assessment was completed under section 143(3) of the Act, determining the total income at Rs.143,75,68,470/-. In the said assessment, the Ld. AO disallowed the deduction claimed by the assessee on account of embezzlement of funds amounting to Rs.18,96,12,209/-, and further disallowed expenditure related to exempt income under section 14A of the Act read with Rule 8D of the Income-tax Rules, 1962 (hereinafter referred to as "the Rules"), amounting to Rs.8,73,331/-. Accordingly, a total sum of Rs.19,04,85,440/- was added to the income of the assessee. Additionally, the return of income filed by the assessee was processed under section 143(1)(a) of the Act on 23.02.2020. While computing the income, additions were made on account of disallowance of exempt income claimed under section 115-P amounting to Rs.17,06,252/- and disallowance under section 43B amounting to Rs.1,73,77,069/-. Both issues relating to the additions under sections 115-O and 43B were contested by the assessee before the Ld. CIT(A) in the appeal preferred against the assessment order passed under section 143(3) of the Act. The Ld. CIT(A), after due
4 ITA 2816/Mum /2023 National Peroxide Ltd consideration, adjudicated upon all issues arising from both the intimation under section 143(1)(a) and the assessment under section 143(3), and allowed the appeal in favour of the assessee. Aggrieved by the order of the Ld. CIT(A), the revenue has preferred the present appeal before us.
The Ld. DR vehemently argued and primarily contended that the addition made in the intimation under section 143(1) of the Act was erroneously considered by the Ld. CIT(A) while passing the appellate order under section 143(3) proceedings. Therefore, the clubbing of grounds arising from two distinct proceedings ought not to be permitted. With respect to the addition on account of embezzlement of funds amounting to Rs.18,96,12,109/-, the Ld. DR fully supported and relied upon the findings recorded by the Ld. AO. Similarly, regarding the disallowance made under section 14A read with Rule 8D of the Rules, amounting to Rs.8,73,331/-, the Ld. DR stood in support of the view taken by the Ld. AO.
The Ld.AR argued and filed a paper book containing pages 1 to 974 which is kept on the record. The Ld.AR stated that the assessee while computing its taxable income claimed deduction amount to Rs.18,96,12,109/-, being part of the total loss of Rs.37,02,98,000/- on account of embezzlement of funds which was unearthed during impugned assessment year. The entire loss on account of embezzlement of funds was to the extent of Rs.37,02,98,000/- and is pertaining to the period of 9-10 years. The assessee filed additional evidence before the Ld. CIT(A) and the Ld.CIT(A) called for the remand report on the basis of the documents submitted by 5 ITA 2816/Mum /2023 National Peroxide Ltd the assesse in the appellate proceeding. During the assessment proceedings, the Ld.AR stated that Covid period was going on, so assessee was not able to submit the documents properly before the Ld.AO. The Ld.CIT(A) passed the order considering the remand report of the Ld. AO. The Ld. AR respectfully relied on the order of the Ld. CIT(A) and invited our attention in relevant paragraphs. The relevant paragraph of the impugned appellate order is extracted below:- “1. I now examine the allowability of loss on embezzlement of funds of Rs. 18,96,12,109/- as a deduction in computing the taxable income or not.
5.2 In this regard I refer to CBDT CIRCULAR no 35D (XLVII 20) of 1965, F.NO. 10/48/65-IT(AI) dated 24, November, 1965...which is reproduced below -.
SECTION 28(1) OF THE INCOME TAX ACT, 1961 BUSINESS LOSS/DEDUCTIONS ALLOWABLE AS LOSS ARISING DUE TO EMBEZZLEMENT - WHETHER IT SHOULD BE TREATED AS INCIDENTAL TO BUSINESS AND SHOULD BE ALLOWED AS DEDUCTION IN THE YEAR IN WHICH IT IS DISCOVERED CIRCULAR: NO. 35-D (XLVII-20) [F. NO. 10/48/65-IT(A-1)]. DATED 24-11-19651. A reference is invited to the instructions on the above subject contained in the Board's Circular No. 25 of 1939 and Circular No. 13 of 1944 [Clarification 2]. In these circulars it was clarified that losses arising due to embezzlement of employees or due to negligence of employees should be allowed if the loss took place in the normal course of business and the amount involved was necessarily kept for the purpose of the business in the place from which it was lost. Since the above circulars were issued, the Supreme Court has further considered the matter and laid down the law in this regard in the following two decisions in Badridas Daga v. CIT [1958] 34 ITR 10 and Associated Banking Corporation of India Ltd. v. CIT [1965] 56 ITR 1.
In the first case, the Supreme Court has affirmed the view that the loss resulting from embezzlement by an employee or agent of a business is admissible as a deduction under section 10(1) of the 1922 Act [corresponding to section 28 of the 1961 Act] if it arises out of the carrying on of the business and is incidental to it. In the second case, the decision is that loss must be deemed to have arisen only when the employer comes to know about it and realises that the amounts embezzled cannot be recovered.
2. In the light of the above decisions of the Supreme Court, the legal position now is that loss by embezzlement by employees should be treated as incidental to a business and this loss should be allowed as deduction in the year which it is discovered.
6 ITA 2816/Mum /2023 National Peroxide Ltd 5.31 now refer consider the various case laws position as regards allowability of the claim on account of embezzlement of funds as trading loss-
The Honourable Supreme Court of India in the case of Badrida Daga V/s CIT (34 ITR 10) had occasion to examine the allowability of loss on account of embezzlement. In this it was observed as under- "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."
Ultimately it was held that "In the result, we are of opinion that the loss sustained by the appellant as a result of misappropriation by Chandratan is one which is incidental to the profits under section 10(1) of the Act.".
The Madras High Court in the case of PCIT v/s Sarvana Selvarathanam Trading & Manufacturing (P) Ltd. (415 ITR 146) 2019, Honourable Madras High Court was examining the allowability of the loss arising on the embezzlement of cash as Bad Debt.
The Court in this case observed that:
"The embezzlement by one of the Directors or an employee of the business of the Assessee Company during the ordinary course of business can be a business loss of the Assessee irrespective of criminal prosecution of the accused director/employee of the Company. The final fate of the criminal proceedings or recovery of the amount in question would not determine the claim of the Assessee in the present year writing off the same as a business loss." Honourable Madras High Court Held that – In our opinion the learned Tribunal had rightly held it to be a business loss as it was treated to be only a pilferage of the company funds by an employee or a Director on the Board of Company. Therefore, such findings of facts by the Tribunal do not give rise to any substantial question requiring our further consideration under section 260-A of the Act. Thus we do not find any merits in the Appeal feed by the Revenue and the same is liable to be dismissed.
7 ITA 2816/Mum /2023 National Peroxide Ltd 3. In the case of CIT vis Mohan Trading Company 182 ITR 101 (1990) the Honourable Delhi HC wad examining the allowability of loss on embezzlement of cash in the year of discovery of the same. The Honourable Delhi High Court held as follows- The Tribunal, vide its order dated June 25, 1984, relied upon the Boards Circular dated November 24, 1965, and came to the conclusion that the aforesaid amount should be allowed as deduction. It may here be mentioned that the circular of the Board, inter alia, refers to two decisions of the Supreme Court in Badridas Daga v. CIT [1958] 34 ITR 10 and Associated Banking Corporation of India Ltd. v. CIT [1965] 56 ITR 1, in which it was held that embezzlement by an employee was allowable as a deduction in computing the business income. It was further observed in the circular that this loss should be allowed as a deduction in the year in which it is discovered. The Tribunal, applying this circular, observed that it was allowable as a deduction in the year 1972-73.
We see no question of law arising out of the decision of the Tribunal. This petition is dismissed.
5.4 Upon the analysis of the CBDT CIRCULAR which clearly states that loss by embezzlement by employees should be treated as incidental to a business and this loss should be allowed as deduction in the year which it is discovered. In this case the embezzlement has been discovered in the FY 2017-18 relevant to AY 2018-19 and that too made by employee of the Company during the course of carrying out their responsibilities Accordingly going by CBDT CIRCULAR No, 35D (XLVII of 1965, F. No. 10/48/65-IT(AI) dated 24 November, 1965 the Loss on account of an embezzlement by employees is allowable in the year of discovery. ACIT vs. Devangere district central Coop Bank Ltd. (ITAT Bangalore).
Cash loss due to embezzlement by employees allowable in the year of discovery, ITA No. 1403/Bang/2022. This above analogy is further supported by also various case laws.
I am of the considered opinion that loss on account of embezzlement of funds of Rs.18,96,12,109 is allowable as deduction.
Hence The addition made by the Learned Assessing Officer by disallowance of loss on account of embezzlement of funds of Rs. 18,96,12,109/- is deleted.
8 ITA 2816/Mum /2023 National Peroxide Ltd HENCE THE GROUND OF THE APPELLANT IS ALLOWED.”
The Ld.AR further argued that the detection of the said embezzlement was made during this impugned assessment year. The payment of Rs.37,02,98,000/- was accounted for in assessee’s books of account as payment related to sales-tax. These amounts were not actually paid to sales-tax authorities and were rather embezzled. The entries were initially passed by debiting the account titled “balance with excise, customs & sales-tax”. Part of the amounts were transferred to the ‘cost of goods sold from time to time’. The amount of funds embezzled were debited to ‘cost of goods’ head was consequently claimed as deductible expenses from year to year. However, balance lying in the head “balance with excise, customs, sales-tax, etc.” was never claimed as deduction. The position of funds embezzled which were recognized in the COGs amount / other expenses and “balance with excise, customs, sales-tax, etc.” ought to have been duly adjusted by relying on the circular 35D (XLVII of 1965), F.No. 10/48/65-IT(AI)dated 24/11/1965. The said CBDT circular which profits that loss arising on account of embezzlement by employees should be treated as incidental to a business and this loss should be allowed as a deduction in the year in which the same is discovered. The Ld.AR invited our attention in APB page 298 – 299 and the chronology of events of the said incident is as below: - SN Date Events / Particulars 1 November 2016 Appointment of new CFO (Mr. Shailesh Chauhan) by National Peroxide Limited (‘NPL’ or ‘Appellant’) 2 May, 2017 The newly appointed CFO during the course of finalization of the Appellant's annual accounts for the year ended March 31, 2017, noticed unusually huge debit balances in ledger account of "Local Sales Tax Payable", "Central Sales Tax Payable".," Deposit Sales
9 ITA 2816/Mum /2023 National Peroxide Ltd Tax", "Advance Sales Tax", "VAT Clearing", "Purchase Tax Clearing Account 3 May 10, 2017 Email of new CFO to Manager Accounts – Mr. Nipul Trivedi (NT) 4 07.11.2017 to NPL made public disclosure of the embezzlement fraud on the 15.12.2017 Bombay Stock Exchange ('BSE') and informed BSE that an independent investigating firm - PricewaterhouseCoopers ('PwC) has been appointed as forensic auditors to investigate the possibility of embezzlement fraud. 5 10.11.2017 The Appellant filed a complaint with Economic Offences Wing (EOW), Mumbai in relation to the embezzlement fraud. 6 15.12.2017 PwC conducted forensic audit of the Appellant's books of accounts and financial records pertaining to the relevant period and submitted its preliminary report inter alia observing that there was a financial fraud committed and the senior employees (including Managing Director (MD) ex-CFO and VP-Marketing, VP- Operations, etc] were grossly negligent in performing their duties inter alia on account of their involvement in signing the fraudulent cheques without any supporting documents such as vouchers/challans etc. 7 15.12.2017 to MD, other senior employees and Manager Accounts (NT) services 27.12.2017 were terminated by the Appellant on account of their involvement in embezzlement fraud. 8 06.02.2018 embezzlement fraud.
PwC submitted its final findings of Forensic Audit report to the Appellant. Such Forensic Audit Report inter alia records that during the relevant period, 1140 bearer cheques were drawn from the Appellant's Canara Bank account and SBI account (signed by MD, NT and other senior employees) in favor of entities which had no business connection and/or association with the Appellant. Most of these cheques were drawn in the name of RBIM sales. To conceal this fraud, journal entries were passed in the books of accounts and all these fraudulent payments were shown as payments towards VAT and Central Sales Tax (CST) All these fraudulent bearer cheques were endorsed using multiple illicit cheque discounting agents who
10 ITA 2816/Mum /2023 National Peroxide Ltd encashed these cheques in external beneficiary account with whom Appellant never had any connection and/or association. Pertinently, there were no supporting documerits such as vouchers/challans against which these cheques were signed. Upon comparison of the VAT and the Sales Tax related Ledger accounts with copies of Sales-tax returns filed with authorities, it was found that only Rs 4.83 crores were actually paid towards VAT/CST whereas as per the Appellant's books Rs.41.86 crore was shown to have been paid towards VAT/ CST. Thus, there was a discrepancy of approximately 37.03 crores which was the embezzled amount. Out of the total embezzlement, approximately 82.28% (30.47 crores) of the total value embezzled was during the last 4 financial years Le FY 2013-14 to 2016-17. 9 08.02.2018 Upon discovery of active participation and involvement in the embezzlement fraud, NPL filed addendum to the complaint originally filed on November 10, 2017 with EOW. 10 10.02.2018 PwC submitted its final Forensic Audit Report confirming its final findings. 11 27.03.2018 The Appellant filed First Information Report with the EOW of Mumbai police. 12 28.01.2019 to Ex-employees were arrested by police authorities and subsequently 06.07.2020 released on bail. 13 20.04.2019 The police authorities filed Charge sheet against NT 14 13.05.2020 The police authorities filed Charge sheet against other employees. 15 24.09.2020 The present suit is filed along with the interim application. 16 05.01.2021 Interim Application qua statutory auditors and internal auditors (Defendant No.6 to 9) was disposed of in terms of the statement made by them before the Ld. Single Judge. 17 08.02.2021 Impugned Order is passed dismissing the Interim Application against Respondent No. 1 to 5.
Note: None of the Respondents have denied that fraud to the tune of Rs.37.03 crores as asserted by the Appellant and demonstrated by PWC Report has taken place. Despite this uncontroverted fact,
11 ITA 2816/Mum /2023 National Peroxide Ltd the Application against the fraudsters, Respondent No. 1 to 5 has been dismissed.
With respect to the disallowance under section 14A of the Act, the Ld. AR submitted that the assessee had suo motu disallowed an amount of Rs.19,48,631/- towards expenditure incurred in relation to exempt income. However, the Ld. AO computed the disallowance by adopting 1% of the annual average of monthly average investments, which resulted in a disallowance of Rs.28,21,962/-. The assessee had earned dividend income of Rs.1,02,78,327/- during the relevant assessment year, which was claimed as exempt under section 10(34) to the extent of Rs.23,33,590/- and under section 10(35) to the extent of Rs.79,44,737/-. The Ld. AO, however, disregarded the computation made by the assessee under section 14A and proceeded to recompute the disallowance at Rs.28,21,962/- under section 14A read with Rule 8D of the Rules. Consequently, the balance disallowance of Rs.8,73,331/- was sustained and added back. The Ld. AR further contended that the entire computation made by the Ld. AO was based on the financial data of the financial year 2016–17, whereas the correct reference ought to have been the figures for the financial year 2017–18, relevant to the assessment year in question. In support, the Ld. AR invited our attention to the relevant paragraph of the impugned appellate order, which is reproduced below:- “4.1 On perusal of the paper book it is observed that AO has made disallowance of Rs. 28,21,962/- which is based on the average of monthly averages of opening and closing balance of investments income pertaining to FY 2016-17. The AO ought to have referred the financial figures of FY 2017-18. Here the AO made error in considering the financial figures of FY2016-17 thereby computing disallowance u/s 14A. It is noteworthy that the appellant has Suo moto made
12 ITA 2816/Mum /2023 National Peroxide Ltd disallowance u/s 14A for Rs. 19,48,631/. Hence the addition u/s 14A based on FY 2016-17 of Rs. 28,21,962/-made by AO is deleted. The appellant gets relief of Rs.8,73,331/-, Hence this ground of appeal is allowed.”
We have heard the rival submissions and perused the material available on record. With respect to the claim of deduction in the Profit & Loss Account on account of embezzlement of funds, we note that the assessee has furnished sufficient evidence demonstrating that the said embezzlement occurred during the impugned assessment year. The Ld. CIT(A) had called for a remand report from the Assessing Officer and, upon receipt thereof, passed the impugned appellate order. While adjudicating the matter, the Learned CIT(A) relied on CBDT Circular No. 35D [XLVII of 1965], F.No. 10/48/65-IT(AI) dated 24.11.1965, as well as the judgment of the Hon’ble Supreme Court in Badridas Daga v. CIT [1958] 34 ITR 10 (SC). The assessee had submitted all necessary evidence both during the assessment proceedings and the appellate stage, and these were not disputed or rejected by the Ld. AO. Following the ratio laid down by the Hon’ble Supreme Court in the aforementioned case, we find that the conclusion reached by the Ld. CIT(A) is justified. Accordingly, the grounds raised by the revenue on this issue are dismissed.
In relation to the addition of Rs.8,73,331/- under section 14A of the Act, we observe that the Ld. AO erroneously relied upon financial data pertaining to FY 2016–17 instead of the relevant data for FY 2017–18. As a result, the issue was not properly verified. The Ld. CIT(A) deleted the addition solely on the ground that the Ld. AO had adopted incorrect financial data. However, in our considered opinion, this matter requires fresh examination. Accordingly, we set aside this issue and 13 ITA 2816/Mum /2023 National Peroxide Ltd restore it to the file of the Ld. AO for de novo adjudication, directing that the correct financial data for FY 2017–18 be considered after affording the assessee a reasonable opportunity of being heard.
With regard to the issues raised through intimation under section 143(1), specifically the additions made under sections 43B and 115JB, which are sought to be challenged in the order passed under section 143(3), it is pertinent to note that the proceedings under sections 143(1) and 143(3) are distinct and independent in nature and cannot be clubbed. The Ld. AR failed to cite any judicial pronouncement to support the contrary position. Therefore, we hold that the relief granted by the Ld. CIT(A) on both these grounds falls outside the scope of his jurisdiction. Consequently, both grounds raised by the revenue on this issue are allowed.
In view of the above, we hold as follows: Grounds 1, 2 and 3 raised by the revenue are dismissed; Ground No. 4 is allowed for statistical purposes; and Grounds 5 and 6 are allowed.