METAL CLOSURES PVT LTD,BANGALORE vs. ACIT, CIRCLE 4(1)(2), BANGALORE, BANGALORE
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Income Tax Appellate Tribunal, “B’’ BENCH: BANGALORE
Before: SHRI CHANDRA POOJARI & SHRI PRAKASH CHAND YADAV
PER CHANDRA POOJARI, ACCOUNTANT MEMBER:
This appeal by assessee is directed against order of NFAC for the assessment year 2014-15 dated 16.3.2024. The assessee raised following grounds of appeal: 1) The impugned order is opposed to law and facts of the case insofar as it is prejudicial to the interest of the Appellant. 2) The NFAC erred in upholding the addition made by the Ld. AO inasmuch as the NFAC failed to appreciate that: a) The amounts written off represented payments made as a consequence of the fraud committed upon the Appellant Company by its employees in connivance with certain third parties which is a loss incurred in the ordinary course of business that ought to have been allowed u/s 28 of the Act. b) The initial claim of the Appellant under a wrong section cannot be a reason to deny the Appellant the benefit that it was legitimately entitled to. Tax effect Approx Rs.7,92,81,215/- excluding interest
3) Without prejudice to Ground No. 2 above and assuming without admitting that the amounts in que ion are not allowable u/s 28, the
ITA No.941/Bang/2024 Metal Closures Pvt. Ltd., Bangalore Page 2 of 16 NFAC failed to appreciate that the addition made by the Ld. AO is more than the actual amount claimed by the Appellant itself.
Facts of the case are that the Assessee is a Private Limited Company engaged in the manufacture of ROPP caps, crown corks, shoe polish containers, battery jackets, lug caps, flash torches etc. A notice under Section 148 of the Income Tax Act, 1961 (in short “The Act”) was issued on 25/03/2017. The basis of reopening of assessment was that the Assessee had earned income but had not filed its return of income for the year. The Assessee Company furnished its return of income u/s 148 of the Act for AY 2014-15 on 16/08/2017 declaring a loss of Rs. 6,60,94,353/-. The Assessee company was the victim of a fraud committed on it by its CFO and others. In view of this, the Assessee had written off bad advances arising due to the embezzlement by the CFO of the company. It claimed a loss of Rs.25.93 crore in its Return of income on the above write off. The Cd. AO proceeded to disallow an amount of Rs. 29,93,43,000/- as bad debts written off u/s 36(2)(i) of the Act. Aggrieved by the order of the NFAC, the Assessee came in appeal before us. 3. The ld. A.R. submitted on the issue of disallowance of loss claimed by the Assessee by treating the same as bad debts as follows:
3.1 At the outset, he submitted that the amount written off by the Assessee in its financial statements is only Rs. 25.93 crores and the same is also mentioned by the Ld. AO in his Assessment order. However, while computing the assessed income, the Ld. AO has erroneously added back Rs. 29.93 crores. It is submitted that the same is to be rectified. 3.2 Without prejudice to the above, he submitted that the Assessee's Managing Director and promoter had filed a complaint before the Deputy Superintendent of Police, EOD, CID, Bengaluru
ITA No.941/Bang/2024 Metal Closures Pvt. Ltd., Bangalore Page 3 of 16 — 01 being aggrieved by the state of the company floated by him. Upon investigation by the CID, it was found that the Assessee company's CFO in connivance with senior officials of certain banks was embezzling funds from the company through various suppliers and was also accused of inflating the figures of the company and submitting the same to the banks. The details of the modus operandi of the fraud along with the details of the persons involved are provided in the Chargesheets filed by the CID. A brief description of the same is also provided by the ld. A.R. as under. 3.3 The erstwhile CFO of the Company in connivance with certain employees of the Banks where the Assessee had maintained accounts, was accused of forging the signature of the Managing Director and making unauthorized payments to various parties. The Assessee was also having regular transactions with these parties apart from the fraudulent transactions conducted by the CFO. The amounts paid by the CFO fraudulently to these parties was still- being shown 'as a balance in the Assessee's books of accounts. These balances were only appearing in the Balance Sheet of the Assessee as a consequence of this fraud and did not represent payments for actual services rendered or goods supplied. These were not recoverable by the Assessee from those parties. During the Assessment year under appeal, the Assessee wrote off these amounts as bad advances appearing in its Balance Sheet. 3.4 He submitted that this amount ought to have been allowed as a business loss u/s 28 of the Act itself. The Ld. AO as well as the Ld. CIT (A) have proceeded to disallow this amount u/s 36(2)(i) of the Act on the ground that the income corresponding to this bad debt was not offered to tax in a previous year. The issue of whether the loss incurred by an Assessee as a consequence of embezzlement, fraud, etc. is to be allowed as a business loss u/s 28 is no longer res integra. In support of the same, he relied upon the following decisions:
ITA No.941/Bang/2024 Metal Closures Pvt. Ltd., Bangalore Page 4 of 16 a) Hon'ble Supreme Court in the case of Badridas Daga v CIT [1958] 34 ITR 10 (SC) b) Hon'ble Supreme Court in the case of CIT v Nainital Bank Ltd [1965] 55 ITR 707 (SC) c) Hon'ble High Court of Bombay in the case of Sassoon J David & Co (P) Ltd v CIT [1 975] 98 ITR 50 (80M.) 3.5 For the above reasons, he submitted that the impugned additions made by the Ld. AO are liable to be deleted and do not stand the test of law.
The ld. D.R. submitted that assessee has raised ground before ld. CIT(A) that it should be bad debt allowable u/s 36(1)(vii) r.w.s. 36(2) of the Act. However, before the Tribunal assessee raised ground with regard to allowability of the same u/s 28 of the Act. According to the ld. D.R., assessee’s conduct is dual in nature, which cannot be appreciated and same to be rejected. 5. We have heard the rival submissions and perused the materials available on record. The contention of the assessee’s counsel is that if the loss on account of embezzlement / theft was incidental to carrying on the business and there was direct and proximate connection and nexus between the loss and the business the same has to be allowed as a deduction. In view of the above, it was submitted by ld. A.R. that the claim of deduction is bona fide. He further submitted that auditors of the assessee have confirmed the fraud. Accordingly, the loss incurred is in the course of business of the assessee, it could be allowed. The embezzlement loss in the assessee’s case has been identified in the year under appeal. The loss has been fully quantified and provided for in the books for the year under appeal. The loss has to therefore be allowed in the year under appeal as claimed by the assessee.
5.1 To grant deduction u/s 28 of the Act, assessee has to satisfy that the expenditure arise in ordinary course of its business. In other words, it would not be on capital account field, on the other hand, it should be on revenue account, deductible business
ITA No.941/Bang/2024 Metal Closures Pvt. Ltd., Bangalore Page 5 of 16 expenditure. The assessee has to prove that it is an expenditure incurred in the ordinary course of assessee’s business. Further, this fraud should be committed in the assessment year under consideration. It took place between 17.8.2010 to 6.2.2014, which is evident from copy of charge sheet filed by the CID (Economic Office and Division, Bengaluru), assessee’s paper book page 70 to 138 and this loss even cannot be said that it was incurred in the assessment year under consideration. The assessee’s claim is that the expenditure incurred in the assessment year under consideration. However, we note that the loss of embezzlement is to be incidence to the business of the assessee. Even if it is incidental to the business of the assessee, it can be allowed as a deduction in the year in which it was discovered. There is a difference between the expression “detection and discovery”. The former means that when embezzlement amount is quantified after the investigation and there is a reasonable certainty that the same cannot be recovered and not in the year in which it came to knowledge of an assessee, such embezzlement is “detected” by the assessee. The letter indicates detection as a result of uncovering, revealing or laying upon to view what was hidden, concealed or unknown. The loss must deem to have arisen only when the assessee came to know about it and realized that the amount embezzled could not be recovered and not merely the date of acquiring the knowledge on which embezzlement had taken place. Loss on account of embezzlement shall be allowable in the year in which actual amount is quantified after investigation and there is a reasonable certainty that the same cannot be recovered and not in the year in which it came to knowledge of the assessee. Further, the alleged loss by embezzlement which is not proved cannot be allowed as a detection. Reference could be made to the judgement of Hon’ble Allahabad High Court in the case of CIT Vs. Ashwini Kumar Liladhar 225 ITR 576 (All.) wherein held that:
ITA No.941/Bang/2024 Metal Closures Pvt. Ltd., Bangalore Page 6 of 16 “6. Before endeavouring to answer the aforesaid questions referred to this court, it has to be seen whether the claim of loss was proved by the assessee. No doubt the assessee lodged the first information report in Collectorganj Police Station on December 11, 1965, but it appears that after lodging the first information report the assessee did not pursue and care to find out the fate of the same. Thereafter, the assessee neither filed a protest petition if a final report was filed nor any complaint under Section 200 of the Criminal Procedure Code for taking appropriate action against Sri Somani although the huge amount of Rs. 1,72,279 was involved. No civil proceedings have been initiated to recover the huge amount said to have been embezzled by Sri Somani. The finding reached by the Income-tax Officer is that the claim of loss was not proved. The finding is affirmed in appeal by the Appellate Assistant Commissioner.
It is settled that the burden to prove a loss lies on the assessee who is seeking deductions. If the assessee does not prove the loss, the inference goes against him. 8. The Tribunal in para. 7 of its judgment has mentioned that the police submitted a final report in the first information report proceedings of the assessee, in the absence of sufficient evidence. It leads to an inference that the assessee miserably failed to adduce sufficient evidence to prove the loss.
The absence of evidence to prove the alleged embezzlement also creates a doubt that assuming that Sri Somani kept the amount of Rs. 1,72,279 out of the profit of the iron and steel business, it is not proved whether the said amount was embezzled by Sri Somani or Sri Somani has taken the same towards his 40 per cent. share in the profit of iron and steel business. Further, as per Clause 3 of the agreement, Sri Somani is responsible for bad debts to the extent of 40 per cent. in the said business. It is also not clear whether the loss of Rs. 1,72,279 includes the 40 per cent. share of Sri Somani or not.
The Tribunal, vide para. 8 of its judgment, while discussing the point as to whether Sri Somani was an employee of the assessee or partner has recorded the reasoning that in case of persons holding managerial posts it would be more like a prudent businessman to pay a portion of profits as salary rather than a high fixed salary and such persons are bound to have sufficient power to carry on the responsibility entrusted to them and it is not necessary that if they enjoy sufficient or more powers, they cease to be employees. These reasonings cannot be inferred from the statements made by the assessee in his reply dated October 22, 1971, which reads as under:
"However, Sri Ganesh Narain Somani had no money and since there was hardly any chance of recovery."
ITA No.941/Bang/2024 Metal Closures Pvt. Ltd., Bangalore Page 7 of 16 11. If the reasoning assigned by the Tribunal that Sri Somani was having more powers on managerial post attracting high fixed salary and in lieu thereof was being paid 40 per cent. of the profits in the said business, the statement of the assessee that Somani had no money and, therefore, the money was not recoverable, does not remain worth believing.
Taking into account the fact that the police submitted a final report for want of evidence, the assessee did not take proper legal steps for recovery of the said amount and considering the status of Sri Somani as discussed in the order of the Tribunal, it cannot be presumed that the amount was not recoverable. Had Sri Somani been some low paid employee, it could have been presumed that he would have no money or he would have no property from which the amount could not have been recovered. Under these circumstances, there appears to be no reason and justification to disbelieve the findings of fact recorded by the Income-tax Officer which are affirmed by the first appellate authority.
Learned counsel appearing for the assessee, relying on Associated Banking Corporation of India Ltd. v. CIT [1965] 56 ITR 1 (SC), Kothari and Sons v. CIT [1966] 61 ITR 23 (Mad) and Hopkin and Williams (Travancore) Ltd. v. CIT [1967] 64 ITR 76 (Ker), contended that the deduction claimed by the assessee was an admissible deduction as it was not possible to recover the loss from Sri Somani.
There are no two opinions about the proposition of law laid down in the aforesaid cases relied upon by learned counsel, but, on the facts and circumstances of the instant case, they are of no avail to the assessee. In Associated Banking Corporation of India Ltd. v. CIT [1965] 56 ITR 1 (SC), it has been held that in all cases when the principal obtains knowledge of the embezzlement, loss results. The erring servant may be persuaded or compelled by process of law or otherwise to restore wholly or partially his ill-gotten gains. Therefore, so long as a reasonable chance of obtaining restitution exists, loss may not in a commercial sense be said to have resulted. 15. In the instant case, as discussed above, the assessee did not compel Sri Somani by process of law or otherwise to restore wholly or partially his ill-gotten gains. Therefore, the aforesaid case does not help the assessee.
In Kothari and Sons' case [1966] 61 ITR 23 (Mad), it is held that the question when 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 being that the loss must be actual and present.
ITA No.941/Bang/2024 Metal Closures Pvt. Ltd., Bangalore Page 8 of 16 17. On the facts and in the circumstances of the present case as discussed above, the actual loss has not been proved by the assessee and Sri Somani was not a petty or low paid employee, rather he was getting 40 per cent. share in the iron and steel business of the assessee. Thus, the aforesaid case also does not help the assessee. 18. In Hopkin's case [1967] 64 ITR 76 (Ker), it is held that the deduction claimed was an admissible deduction if it was not possible to recover the loss from the persons responsible for the same. If the assessee has made the necessary attempts to recover the loss from the persons concerned and had failed or if the assessee did not make such attempts because it was useless to make them in view of the financial position of the persons concerned, then and then alone the loss could be allowed.
In the instant case, as discussed above, the assessee has not made the necessary attempt to recover the loss from Sri Somani and considering the financial position of Sri Somani as highlighted by the Tribunal in its judgment, it cannot be said that it was useless to make attempts for recovery of the amount from Sri Somani. Thus, this case is also of no avail to the present assessee.
In view of the discussions aforesaid, all the three questions referred to this court are answered in the negative, i.e., in favour of the Revenue and against the assessee. The reference is answered accordingly.
5.2 The assessee relied on CBDT Circular No.139 of 1944 dated 24.5.1944 where it was clarified that the AO has to see that the claim is bonafide and that there is unimpeachable evidence to support the actual loss. Where the ITO is not fully satisfied on these two points, the claim could be refused. In the present case, as noted by the lower authorities, there was no actual quantification of loss and the steps taken by the assessee for recovery to be seen. In these circumstances, this CBDT Circular is of no assistance to the assessee.” 5.3 The ld. A.R. placed reliance on the judgement in the case of Badridas Daga vs. CIT (1958) 34 ITR 10 (SC) in the context of embezzlement of loss where sums withdrawn by an employee from a bank account were misappropriated, the Supreme Court summed up the legal position on allowability of loss on account of embezzlement in the following words:
ITA No.941/Bang/2024 Metal Closures Pvt. Ltd., Bangalore Page 9 of 16 "... A business especially such as is calculated to yield taxable profits has to be carried on through agents, cashiers, clerks and peons 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" (p. 15) “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 carrying on of his business, and that it should therefore be deducted in computing the profits under section 10(1) of the Act.”
5.4 In this case, assessee claimed a deduction of Rs.25.93 crores as bad debt in its P&L account and claimed deduction under the Income Tax Act, u/s 36(1)(iii) of the Act. It was noted by the lower authorities that no such deduction to be allowed unless it has been taken only while computing income of the assessee in the previous year in which the amount of such debt or part there of is written off or of an earlier previous year, or represent money lent in the ordinary course of business of the banking or money lending, which is carried on by the assessee. Since in the present case, the income is not gone into computation of income by offering the income generated from such debt to taxation, the claim of assessee has been denied by placing reliance on the judgement of Hon’ble Kerala High Court in the case of CIT Vs. Hotel Ambassador 253 ITR 430 (Ker.). Now the plea of the assessee is that it has to be allowed u/s 28 of the Act. The section 28 of the Act reads as follows: “28. Profits and gains of business or profession. - The following income shall be chargeable to income-tax under the head "Profits and gains of business of profession",- (i)the profits and gains of any business or profession which was carried on by the assessee at any time during the previous year; (ii)any compensation or other payment due to or received by,-
ITA No.941/Bang/2024 Metal Closures Pvt. Ltd., Bangalore Page 10 of 16 (a)any person, by whatever name called, managing the whole or substantially the whole of the affairs of an Indian company, at or in connection with the termination of his management or the modification of the terms and conditions relating thereto;
(b)any person by whatever name called, managing the whole or substantially the whole of the affairs in India of any other company, at or in connection with the termination of his office or the modification of the terms and conditions relating thereto;
(c)any person, by whatever name called, holding an agency in India for any part of the activities relating to the business of any other person, at or in connection with the termination of the agency or the modification of the terms and conditions relating thereto;
(d)[ any person, for or in connection with the vesting in the Government, or in any corporation owned or controlled by the Government, under any law for the time being in force, of the management of any property or business;] [ Inserted by Act 21 of 1973, Section 4 (w.r.e.f. 1.4.1972).
](e)[ any person, by whatever name called, at or in connection with the termination or the modification of the terms and conditions, of any contract relating to his business;] [Inserted by Finance Act, 2018 (Act No. 13 of 2018), dated 29.3.2018.] (iii)income derived by a trade, professional or similar association from specific services performed for its members;
(iiia)[ profits on sale of a licence granted under the Imports (Control) Order, 1955, made under the Imports and Exports (Control) Act, 1947 (18 of 1947);] [ Inserted by Act 12 of 1990, Section 6 (w.r.e.f. 1.4.1962).] (iiib)[ cash assistance (by whatever name called) received or receivable by any person against exports under any scheme of the Government of India;] [ Inserted by Act 12 of 1990, Section 6 (w.r.e.f. 1.4.1967).] (iiic)[ any duty of customs or excise re-paid or re-payable as drawback to any person against exports under the Customs and Central Excise Duties Drawback Rules, 1971;] [ Inserted by Act 12 of 1990, Section 6 (w.r.e.f. 1.4.1972).]
(iiid)[ any profit on the transfer of the Duty Entitlement Pass Book Scheme, being the Duty Remission Scheme under the export and import policy formulated and announced under section 5 of the Foreign Trade (Development and Regulation) Act, 1992 (22 of 1992);] [ Inserted by Act 55 of 2005, Section 3 (w.r.e.f. 1.4.1998).] (iiie)[ any profit on the transfer of the Duty Free Replenishment Certificate, being the Duty Remission Scheme under the export and import policy formulated and
ITA No.941/Bang/2024 Metal Closures Pvt. Ltd., Bangalore Page 11 of 16 announced under section 5 of the Foreign Trade (Development and Regulation) Act, 1992 (22 of 1992);] [ Inserted by Act 55 of 2005, Section 3 (w.r.e.f. 1.4.2001).]
(iv)[ the value of any benefit or perquisite, whether convertible into money or not, arising from business or the exercise of a profession;] [ Inserted by Act 5 of 1964, Section 7 (w.e.f. 1.4.1964).]
(v)[ any interest, salary, bonus, commission or remuneration, by whatever name called, due to, or received by, a partner of a firm from such firm: [ Inserted by Act 18 of 1992, Section 11 (w.e.f. 1.4.1993).]Provided that where any interest, salary, bonus, commission or remuneration, by whatever name called, or any part thereof has not been allowed to be deducted under clause (b) of section 40, the income under this clause shall be adjusted to the extent of the amount not so allowed to be deducted;] [Substituted by the North-Eastern (Reorganisation) (Adaptation of Law of Union Subjects) Order, 1974, for Clause (26) (w.r.e.f. 21.1.1972).]
(va)[ any sum, whether received or receivable, in cash or kind, under an agreement for- [ Inserted by Act 20 of 2002, Section 13 (w.e.f. 1.4.2003).] (a)not carrying out any activity in relation to any business; or
(b)not sharing any know-how, patent, copyright, trade-mark, licence, franchise or any other business or commercial right of similar nature or information or technique likely to assist in the manufacture or processing of goods or provision for services: Provided that sub-clause (a) shall not apply to-
(i)any sum, whether received or receivable, in cash or kind, on account of transfer of the right to manufacture, produce or process any article or thing or right to carry on any business, which is chargeable under the head "Capital gains"; (ii)any sum received as compensation, from the multilateral fund of the Montreal Protocol on Substances that Delete the Ozone Layer under the United Nations Environment Programme, in accordance with the terms of agreement entered into with the Government of India. Explanation. - For the purposes of this clause,-
(i)"agreement" includes any arrangement or understanding or action in concert,-
(A)whether or not such arrangement, understanding or action is formal or in writing; or
(B)whether or not such arrangement, understanding or action is intended to be enforceable by legal proceedings;
ITA No.941/Bang/2024 Metal Closures Pvt. Ltd., Bangalore Page 12 of 16 (ii)"service" means service of any description which is made available to potential users and includes the provision of services in connection with business of any industrial or commercial nature such as accounting, banking, communication, conveying of news or information, advertising, entertainment, amusement, education, financing, insurance, chit funds, real estate, construction, transport, storage, processing, supply of electrical or other energy, boarding and lodging; ] (vi)[ any sum received under a Keyman insurance policy including the sum allocated by way of bonus on such policy. [ Inserted by Act 33 of 1996, Section 10 (w.e.f. 1.10.1996).] Explanation. - For the purposes of this clause, the expression "Keyman insurance policy" shall have the meaning assigned to it in clause (10-D) of section 10;] [ Substituted by Act 33 of 1996, Section 4, for Clause (24) (w.e.f. 1.4.1997).]
[(vi-a) the fair market value of inventory as on the date on which it is converted into, or treated as, a capital asset determined in the prescribed manner;] [Inserted by Finance Act, 2018 (Act No. 13 of 2018), dated 29.3.2018.]
(vii)[ any sum, whether received or receivable, in cash or kind, on account of any capital asset (other than land or goodwill or financial instrument) being demolished, destroyed, discarded or transferred, if the whole of the expenditure on such capital asset has been allowed as a deduction under section 35-AD;] [ Inserted by Act 33 of 2009, Section 10 (w.e.f. 1.4.2010).][* * *] [ Explanation 1 omitted by Act 4 of 1987, Section 28 (w.e.f. 1.4.1989).]Explanation 2. - Where speculative transactions carried on by an assessee are of such a nature as to constitute a business, the business (hereinafter referred to as "speculation business") shall be deemed to be distinct and separate from any other business.”
5.5 We find that the quantification of the embezzlement amount was not in the assessment year under consideration and it was only vide charge sheet dated 7.12.2018. As such, it is to be seen that whether there was any quantification in the assessment year 2015- 16. For this purpose, we rely on the judgement of Hon’ble J&K High Court in the case of J and K Bank Ltd. Vs. ACIT in ITA No.17/2007, 8/2007, 18/2007 & 6/2008 dated 29.8.2017 wherein held as under: 6. We have considered the submissions made by both the sides and have perused the record. The Supreme Court in the case of Associated c/w Banking Corporation of India Ltd (supra) has held that The problem as to when loss resulting from misapplication of
ITA No.941/Bang/2024 Metal Closures Pvt. Ltd., Bangalore Page 13 of 16 funds by an agent occurs must b9viewed like many other problems arising under the Income-tax Act on a conspectus of all the facts and circumstances in the context of principles of commercial trading. Embezzlement of funds by an agent; like a speculative adventure, does not necessarily result in loss immediately when the embezzlement takes place, or the adventure is commenced. Embezzlement may remain unknown to the principal, and the assets embezzled may be restored by the agent or servant. Again it cannot be said that in all cases when the principal obtains knowledge of the embezzlement the loss results. The erring servant may be persuaded or compelled by process of law or otherwise to restore wholly or partially his ill-gotten gains. Therefore so long as a reasonable chance of obtaining restitution exists, loss may not in a commercial sense be said to have resulted. Embezzlements of funds of the Bank took place in 1946. They were then unknown to the Bank. Even after the embezzlements came to the knowledge of the Liquidator, trading loss cannot be deemed to have resulted. The proposition that irrespective of other considerations, as soon as the embezzlement takes place of the employer's funds, whether the employer is aware or not of the embezzlement, there results a trading loss is not tenable. So long as there was a reasonable prospect of recovering the amounts embezzled by the Bank, trading loss in a commercial sense may not be deemed to have resulted. 7. The Central Board of Direct Taxes has issued a circular dated 24.11.1965 by taking note of the decision of the Supreme Court in the case of Associated Banking Corporation of India ltd (supra) and in Badri Das Daga v. CIT (1958) 34 ITR IO(SC) which reads as under:- "A reference is invited to the instructions on the above subject contained in Board’s Circular No.25 of 1939 and Circular No.13 of c/w 1944. 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 cases:- (1) Badri Das Daga vs. CIT (1958) 34 ITR IO(SC): TC 14R 202 (2) Associated Banking Corporation of India Ltd vs. CIT (1965) 56 ITR 1 (SC): TC 14R.211. 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/s. 10(1) of the IT Act, 1922 (corresponding to s.28 of the IT Act, 1961) 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
ITA No.941/Bang/2024 Metal Closures Pvt. Ltd., Bangalore Page 14 of 16 employer comes to know it and realizes 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 related as incidental to a business and this loss should be allowed as deduction in the year in which it is discovered."
From a conjoint reading of the decision of the Supreme Court in the case of Associated Banking Corporation of India Ltd supra as well as circular dated 24.11.1965 issued by the Central Board of Direct Taxes, it is evident 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 in which it was discovered. In Badri Das Daga supra, the Supreme Court has held that loss resulting from embezzlement by employee or agent of a business as deduction under Section 10(1) of the Act if it arises out of carrying on of business and is incidental to it. In the c/w case of Associated Banking Corporation of India Ltd supra, it has been held that loss must be deemed to have arisen only when employer comes to know about it and it realizes that the amount embezzled cannot be recovered. Thus the date of discovery in view of circular issued by CBDT has to be treated as the date from which the employer comes to know that the amount embezzled cannot be recovered. 9. The expression detection and discovery have different connotations. When embezzlement comes to the notice of an employer, it can be said that such embezzlement is detected by the employer. However, the expression „discovers« indicates detection as the result of uncovering, revealing or laying open to view what was hidden, concealed or unknown. But words do not always retain their abstract or primary definitions and their meanings vary in accordance with contextual use:$The work „discovers" has been interpreted by English Courts to means "comes to the conclusion from the examination the Inspector makes, and from any information he may choose to receive" or "has reason to believe" or "finds or satisfied himself" or "honestly comes to the conclusion from information before him." [ See: Commissioner of Income Tax. Puniab. Himachal Pradesh and Bilaspur, Shimla v. Shree Jagannath Maheshwari Amritsar AIR 1957 PUNJAB 226 (V 44 C 87 Oct.]. 10. In view of aforesaid enunciation of law, we hold that the expression detection and discovery have different and distinct connotations in law and the expression „discovery" has to be interpreted so as to mean that loss must be deemed to have arisen only when employer comes to know about it and realizes that the amount embezzled cannot be recovered and not merely from the date of acquiring knowledge in which that embezzlement has taken place. Accordingly, the first substantial question of law is answered in
ITA No.941/Bang/2024 Metal Closures Pvt. Ltd., Bangalore Page 15 of 16 favour of the assessee and against the Revenue. On c/w the same analogy, the second substantial question of law framed by this Court is answered by stating that loss by embezzlement being incidental to the banking business should be allowed as deduction in the year it is discovered and the expression „discovered" has to be read in the context of Circular dated 24.11.1965 issued by Central Board of Direct Taxes. Accordingly, the second substantial question of law is answered in favour of the assessee and against the Revenue. 11. In view of the preceding analysis, the orders passed by the Income Tax Appellate Tribunal in ITA No.17/2007, ITA No.10/2007, ITA No.18/2007 and ITA No.6/2008 dated 20.07.2007, 01.12.2006, 20.07.2007 and 25.01.2008 are hereby set aside and quashed. In the result, the appeals are allowed.”
5.6 Further, coordinate bench in the case of ACIT Vs. Davangere District Central Co-op Bank Limited in ITA No.1403/Bang/2019 dated 17.6.2022 held as under: “8. On perusal of clause-1 of the aforesaid circular, it is clear that loss due to embezzlement by employees should be treated as a loss incidental to business. To this extent, in this case, there is no doubt that the assessee suffered a loss on account of embezzlement in the sense a fraud was carried out in one of its branches. With regard to the year in which the deduction is to be allowed, the circular lays down that the loss should be allowed as a deduction in the year in which the embezzlement was discovered. Factually, this aspect has neither been examined nor substantiated by the assessee either before the AO or the CIT(A). We are therefore of the view that the issue requires to be set aside to the AO for consideration afresh in the light of the CBDT’s circular referred to above only on the question as to in which year the loss has to be allowed as deduction. 9. The learned Counsel for the assessee submitted that in the set aside proceedings, if it is found that the loss was not detected in the relevant previous year, direction should be given that it should be allowed in the year in which it was detected, as is laid down in the CBDT’s Circular referred to above. We are of the view that the submissions so made by the learned Counsel for the assessee is fair and reasonable and therefore the AO is directed to allow deduction in the year in which the embezzlement by the employee was discovered by the assessee. With these observations, we allow the appeal of the Revenue for statistical purposes. 10. In the result, the appeal of the Revenue is treated as allowed for statistical purpose.”
ITA No.941/Bang/2024 Metal Closures Pvt. Ltd., Bangalore Page 16 of 16 5.7 In view of the above discussion, it is appropriate to remit the issue to the file of ld. AO to examine the allowability of this expenditure in this assessment year if it fulfills all the requirements as above and if the amount involved herein is in revenue field. The issues/grounds in this appeal of the assessee are partly allowed for statistical purposes.
In the result, appeal of the assessee is partly allowed for statistical purposes. Order pronounced in the open court on 29th July, 2024
Sd/- Sd/- (Prakash Chand Yadav) (Chandra Poojari) Judicial Member Accountant Member
Bangalore, Dated 29th July, 2024. VG/SPS
Copy to:
The Applicant 2. The Respondent 3. The CIT 4. The DR, ITAT, Bangalore. 5 Guard file By order
Asst. Registrar, ITAT, Bangalore.
