Supreme Court disallows business loss claim on confiscated silver: CIT vs. Prakash Chand Lunia (24 April 2023)

Introduction

Date of the Judgment: 24 April 2023
Citation: Civil Appeal Nos. 7689-90 of 2022
Judges: M.R. Shah, J. and M.M. Sundresh, J. (Concurring Opinion by M.M. Sundresh, J.)

Can a business claim a tax deduction for goods confiscated by authorities if those goods were obtained through illegal means, even if the business itself is legitimate? The Supreme Court of India recently addressed this question in a case involving a silver trader whose silver was confiscated for being smuggled. The court had to determine whether the loss from the confiscation could be considered a business loss for tax purposes. This judgment clarifies the boundaries of what constitutes a deductible business loss under the Income Tax Act, 1961.

Case Background

The case revolves around Mr. Prakash Chand Lunia, a silver trader. In 1989, the Directorate of Revenue Intelligence (DRI) conducted a search at a premises rented by Mr. Lunia in Noida and at his business premises in Delhi. The DRI recovered 144 slabs of silver from the rented premises and two silver ingots from his business location in Delhi. Mr. Lunia was arrested under Section 104 of the Customs Act for offenses punishable under Section 135 of the Customs Act. The Collector of Customs determined that Mr. Lunia owned the silver and that the transactions were not recorded in his books. Consequently, the Collector ordered the confiscation of 4641.962 kilograms of silver, valued at Rs. 3.06 Crores and imposed a personal penalty of Rs. 25 Lakhs on Mr. Lunia under Section 112 of the Customs Act. The customs authorities concluded that the silver was smuggled.

During the assessment proceedings, the Assessing Officer (AO) noted that Mr. Lunia could not explain the source of the silver. Therefore, the AO applied Section 69A of the Income Tax Act, 1961, which deals with unexplained investments. The AO added Rs. 3,06,36,909 to Mr. Lunia’s income as unexplained investment. Mr. Lunia appealed, but the Commissioner of Income Tax (Appeals) [CIT(A)] upheld the AO’s decision. The Income Tax Appellate Tribunal (ITAT) also upheld the decision regarding Section 69A but partly allowed the appeal on other minor additions. After re-examination by the AO and further appeals, the ITAT ultimately upheld the additions made by the tax authorities.

Timeline

Course of Proceedings

The ITAT referred the following questions of law to the High Court:

1. “Whether on the facts and in the circumstances of the case, the Tribunal after construing and interpreting the provisions contained in section 69A of the Income Tax Act, 1961 was right in law, in holding that the assessee was the owner of the 144 silver bars found at premises no A 11 & 12 , Sector – VII, Noida and two silver bars found at premises of M/s Lunia & Co Delhi and in sustaining addition of Rs.3,06,36,909/ – being unexplained investment in the hands of the assessee under Section 69A of the Act?”

2. “If the answer to the above question is in affirmative then, whether, on the facts and in the circumstances of the case, the Tribunal was right in law in distinguishing the ratio laid down by their Lordships of the Supreme Court in the case of Piara Singh v/s CIT, 124 ITR 41 and thereby not allowing the loss on account of confiscation of silver bars?”

While the reference was pending, penalty proceedings were also initiated against Mr. Lunia under Section 271(i)(c) of the Income Tax Act, 1961, which was confirmed by the CIT(A) and ITAT. The High Court, while deciding both cases, ruled in favor of the Revenue on the first question, stating that the value of the silver found at the assessee’s premises should be added to his income. However, on the second question, the High Court held that the loss due to confiscation by the DRI was a business loss, relying on the Supreme Court’s decision in CIT, Patiala vs. Piara Singh (124 ITR 41). The Revenue then appealed to the Supreme Court against this High Court judgment.

Legal Framework

The primary legal provisions involved in this case are from the Income Tax Act, 1961:

• Section 69A: This section deals with unexplained money, bullion, etc. If the assessee is found to be the owner of any money, bullion, jewellery, or other valuable article which is not recorded in the books of account and the assessee offers no explanation about the nature and source of acquisition of the money, bullion, jewellery or other valuable article, or the explanation offered by him is not satisfactory, the money and the value of the bullion, jewellery or other valuable article may be deemed to be the income of the assessee.

• Section 37(1): This section allows deductions for expenditures laid out wholly and exclusively for the purposes of business or profession. However, Explanation 1 to this section, added with retrospective effect from 01.04.1962, clarifies that any expenditure incurred for any purpose which is an offense or prohibited by law shall not be deemed to have been incurred for the purpose of business or profession, and no deduction or allowance shall be made in respect of such expenditure.

  “Any expenditure (not being expenditure of the nature described in sections 30 to 36 and not being in the nature of capital expenditure or personal expenses of the assessee), laid out or expended wholly and exclusively for the purposes of the business or profession shall be allowed in computing the income chargeable under the head “Profits and gains of business or profession”. [Explanation 1.]—For the removal of doubts, it is hereby declared that any expenditure incurred by an assessee for any purpose which is an offence or which is prohibited by law shall not be deemed to have been incurred for the purpose of business or profession and no deduction or allowance shall be made in respect of such expenditure.”

• Section 115BBE: This section imposes a tax on income referred to in Sections 68, 69, 69A, 69B, 69C, or 69D of the Act. It also specifies that no deduction for any expenditure or loss shall be allowed in computing such income.

  “Tax on income referred to in section 68 or section 69 or section 69A or section 69B or section 69C or section 69D.- (1) Where the total income of an assessee,—(a) includes any income referred to in section 68, section 69, section 69A, section 69B, section 69C or section 69D and reflected in the return of income furnished under section 139; or (b) determined by the Assessing Officer includes any income referred to in section 68, section 69, section 69A, section 69B, section 69C or section 69D, if such income is not covered under clause (a), the income-tax payable shall be the aggregate of—(i) the amount of income-tax calculated on the income referred to in clause (a) and clause (b), at the rate of sixty per cent; and (ii) the amount of income-tax with which the assessee would have been chargeable had his total income been reduced by the amount of income referred to in clause (i). (2) Notwithstanding anything contained in this Act, no deduction in respect of any expenditure or allowance or set off of any loss shall be allowed to the assessee under any provision of this Act in computing his income referred to in clause (a) and clause (b) of sub-section (1).”

Arguments

Arguments by the Revenue:

• The Revenue argued that the High Court erred in relying on the Supreme Court’s decision in Piara Singh. The Revenue contended that Piara Singh was a case where the assessee was engaged in the business of smuggling currency notes, and the confiscation of the currency notes was a loss directly related to that business. In contrast, Mr. Lunia was engaged in the legitimate business of silver trading, and the smuggling was an illegal activity not directly connected to his legitimate business.
• The Revenue emphasized that the Assessing Officer (AO), CIT(A), and ITAT had correctly distinguished the Piara Singh case. They argued that the decisions in Haji Aziz & Abdul Shakoor Bros. v. CIT, AIR 1961 SC 663, Soni Hinduji Kushalji & Co. vs. CIT, (1973) 89 ITR 112(AP), and JS Parkar v. VB Palekar, (1974) 94 ITR 616 (Bom), should be applied. These cases held that losses from confiscated contraband goods in legitimate businesses are not deductible as business losses.
• The Revenue submitted that the loss must be directly related to the business, not just any loss connected to it. Confiscation of smuggled goods is an action against the property (in rem), not against the person, and is not a trading loss.
• The Revenue also argued that Explanation 1 to Section 37(1) of the Income Tax Act, 1961, expressly disallows any expenditure incurred for an offense or prohibited by law. Therefore, Mr. Lunia could not claim the loss as a business expenditure.
• The Revenue distinguished the case of TA Quereshi (Dr.) v. CIT, (2007) 2 SCC 759, clarifying that it pertained to business loss and not business expenditure, and that the case of Apex Laboratories (P) Ltd. v. CIT, (2022) 7 SCC 98, disallows business expenditure incurred for illegal purposes.

Arguments by the Assessee:

• The assessee argued that he was engaged in the business of buying and selling silver. The confiscated silver was part of his stock-in-trade, and its confiscation should be considered a business loss.
• The assessee relied on the Supreme Court’s decision in TA Quereshi (Dr.), which held that a business loss due to confiscation of goods is allowable. He argued that his case was about claiming a set-off for the value of confiscated silver, not about claiming an expenditure for a penalty or fine.
• The assessee contended that the confiscation of the silver resulted in a loss of stock-in-trade, which should be deductible as a business loss. He distinguished his case from those involving penalties or fines, where such deductions are not allowed.
• The assessee argued that unlike cases involving redemption fines where goods are released upon payment, absolute confiscation results in the goods vesting with the government. Therefore, the loss should be allowed as a business loss.
• The assessee highlighted that while Section 37 was amended to disallow illegal expenditures, no such restriction was brought in for the set-off of the value of confiscated stock-in-trade.

Issues Framed by the Supreme Court

The Supreme Court framed the following issue for consideration:

1. Whether the High Court erred in allowing the assessee the loss of confiscation of silver bars by DRI officials as a business loss, relying upon the decision of this Court in the case of CIT Patiala vs. Piara Singh, 1980 Supp SCC 166?

Treatment of the Issue by the Court

Authorities

The Supreme Court considered the following authorities:

Judgment

How each submission made by the Parties was treated by the Court?

How each authority was viewed by the Court?

• Piara Singh [1980 Supp SCC 166]*: The court distinguished this case, stating that it applied to a business of smuggling, unlike the present case where the assessee was engaged in a legitimate business but indulged in smuggling as an infraction of law.
• Haji Aziz [AIR 1961 SC 663]*: The court upheld this decision, stating that a penalty for breach of law is not a normal business expense.
• Soni Hinduji [ (1973) 89 ITR 112(AP)]*: The court applied this decision, stating that confiscation of contraband is an action in rem and not a trading loss.
• JS Parkar [(1974) 94 ITR 616 (Bom)]*: The court applied this decision, stating that the assessee was not entitled to claim the value of confiscated gold as a trading loss.
• TA Quereshi [(2007) 2 SCC 759]*: The court held that this decision was not correct law as it did not consider earlier decisions and the amendment to Section 37(1).
• Apex Laboratories [(2022) 7 SCC 98]*: The court applied this decision to disallow business expenditure incurred for illegal purposes.

Reasoning of the Court:

The Supreme Court overturned the High Court’s decision, holding that the loss from the confiscation of silver could not be claimed as a business loss. The court reasoned that:

• The assessee’s primary business was dealing in silver, not smuggling. The smuggling activity was an infraction of law and not incidental to his legitimate business.
• The decision in Piara Singh was not applicable because it involved an assessee engaged in the business of smuggling, where the confiscation was directly related to that business.
• The confiscation of silver was a penalty for an infraction of law and not a normal business loss. The court relied on the principle established in Haji Aziz that penalties for breach of law are not considered normal business expenses.
• The loss was not incidental to the assessee’s legitimate business, and the confiscation was an action in rem, against the property, not the person.
• Explanation 1 to Section 37(1) of the Income Tax Act, 1961, expressly disallows any expenditure incurred for an offense or prohibited by law, which includes the loss from confiscated goods.
• The court highlighted that the assessee cannot claim a business loss for an activity that is an infraction of law.

The court emphasized that a loss must directly spring from the business and be incidental to it, not just any loss connected with the business. The court also noted that the amendment to Section 37(1) and Explanation 1 clarified that no deduction can be allowed for an expenditure incurred for an offense or prohibited by law.

The court also noted that the decision of T.A. Quereshi was not a binding precedent as it did not consider the three judge bench decision in Haji Aziz.

What weighed in the mind of the Court?

The Supreme Court’s decision was heavily influenced by the following factors:

• Distinction between Legitimate Business and Illegal Activity: The Court emphasized that the assessee’s primary business was dealing in silver, not smuggling. The act of smuggling was an illegal activity, not a normal incident of his legitimate business. This distinction was crucial in differentiating the case from Piara Singh, where the assessee’s business itself was smuggling.
• Nature of Confiscation: The Court viewed confiscation as a penalty for an infraction of the law, not a normal business loss. This is an action in rem, against the property, not the person, and hence cannot be considered a trading loss.
• Interpretation of Section 37(1) and Explanation 1: The Court relied heavily on Explanation 1 to Section 37(1), which disallows any expenditure incurred for an offense or prohibited by law. The Court held that this provision clearly prohibits the deduction of losses arising from illegal activities.
• Precedent of Haji Aziz: The Court upheld the principle established in Haji Aziz, which states that penalties for breach of law are not normal business expenses. This precedent weighed heavily in the Court’s decision to disallow the business loss claim.

Fact:Law Ratio

The court’s reasoning was more focused on the legal interpretation of the provisions and precedents rather than the specific factual aspects of the case.

Logical Reasoning

Key Takeaways

• Confiscation of smuggled goods is not a business loss: Businesses cannot claim a tax deduction for the loss of goods confiscated due to illegal activities, even if the business is otherwiselegitimate. The loss is not considered a normal business loss but rather a consequence of an illegal activity.
• Distinction between business and illegal activity: The Supreme Court emphasized the distinction between a legitimate business and illegal activities conducted by the same entity. Losses arising from illegal activities are not considered part of normal business operations.
• Section 37(1) and Explanation 1: The Court clarified that Explanation 1 to Section 37(1) of the Income Tax Act, 1961, expressly disallows any expenditure incurred for an offense or prohibited by law. This includes losses from confiscated goods obtained through illegal means.
• Overruling of T.A. Quereshi: The Supreme Court effectively overruled its earlier decision in T.A. Quereshi, clarifying that it was not correct law due to non-consideration of earlier decisions and the amendment to Section 37(1).
• Reliance on Haji Aziz: The Court reaffirmed the principle established in Haji Aziz, stating that penalties for breach of law are not normal business expenses.
• Impact on Tax Planning: Businesses must be cautious about engaging in illegal activities, as losses arising from such activities will not be tax-deductible. This judgment reinforces the importance of conducting business operations within the bounds of the law.
• Importance of Legal Compliance: The judgment underscores the importance of adhering to legal and regulatory requirements. Businesses must ensure that their operations are fully compliant with the law to avoid tax-related issues.
• Precedent Setting: This judgment sets a precedent that will guide future cases involving similar issues. It clarifies the boundaries of what constitutes a deductible business loss under the Income Tax Act, 1961.

Concurring Opinion by M.M. Sundresh, J.

While Justice M.M. Sundresh concurred with the final judgment, he provided a separate concurring opinion to emphasize certain aspects of the case:

• Emphasis on the illegality: Justice Sundresh stressed that the goods were confiscated because they were smuggled and not accounted for. He noted that the assessee was not in the business of smuggling, and the confiscation was a result of an illegal activity.
• Application of Section 37(1): He highlighted that Explanation 1 to Section 37(1) clearly disallows any expenditure incurred for an offense or prohibited by law. This provision, according to Justice Sundresh, is crucial in determining the deductibility of the loss.
• Distinction from Piara Singh: Justice Sundresh concurred with the majority in distinguishing the case from Piara Singh. He noted that the assessee in Piara Singh was in the business of smuggling currency notes, while in the present case, the assessee was in the business of silver trading, and the smuggling was an illegal activity not directly related to his legitimate business.
• Focus on the nature of the loss: Justice Sundresh emphasized that the loss was not a normal business loss but a loss resulting from an illegal activity. He agreed that such a loss is not deductible under Section 37(1).
• Concurrence with the majority view: He ultimately concurred with the majority view that the High Court erred in allowing the loss of confiscation as a business loss.

Justice Sundresh’s concurring opinion reinforces the majority’s view, highlighting the importance of legal compliance and the disallowance of losses arising from illegal activities.

Conclusion

The Supreme Court’s decision in CIT vs. Prakash Chand Lunia clarifies that businesses cannot claim a tax deduction for losses arising from the confiscation of goods obtained through illegal activities, even if the business itself is legitimate. The court distinguished between losses incurred in the normal course of business and losses resulting from illegal activities, emphasizing that the latter are not deductible under the Income Tax Act, 1961. This judgment reinforces the importance of legal compliance for businesses and sets a precedent that will guide future cases involving similar issues. The court’s reliance on Section 37(1) and the overruling of T.A. Quereshi further strengthens the legal framework against allowing deductions for losses incurred through illegal means.

This case serves as a reminder that while businesses may seek to minimize their tax liabilities, such efforts must be within the bounds of the law. Losses arising from illegal activities are not considered normal business expenses and will not be allowed as tax deductions. The judgment underscores the need for businesses to conduct their operations in a legally compliant manner to avoid tax-related issues and penalties.