Supreme Court Disallows Business Loss Claim on Confiscated Silver: Commissioner of Income Tax vs. Prakash Chand Lunia (2023)

Date of the Judgment: April 24, 2023

Citation: 2023 INSC 416

Judges: M. R. Shah, J. and M.M. Sundresh, J.

Can a business that deals in silver claim a loss for silver bars confiscated by customs authorities due to smuggling? The Supreme Court of India recently addressed this question, clarifying the circumstances under which a business can claim a loss for confiscated goods. The court held that a business cannot claim such a loss if the confiscation resulted from an infraction of the law, even if the business is otherwise legitimate. This judgment clarifies the scope of allowable business losses under the Income Tax Act, 1961.

The judgment was delivered by a two-judge bench comprising Justice M. R. Shah and Justice M.M. Sundresh, with Justice M.R. Shah authoring the main opinion and Justice M.M. Sundresh providing a concurring opinion.

Case Background

The case involves Shri Prakash Chand Lunia, who was engaged in the business of trading silver. On an unspecified date, the Directorate of Revenue Intelligence (DRI) conducted a search at a premises rented by Lunia in NOIDA and recovered 144 silver slabs. Two additional silver ingots were found at his business premises in Delhi. Lunia was arrested under Section 104 of the Customs Act for offenses under Section 135 of the same Act. The Collector of Customs determined that Lunia owned the silver, which was not recorded in his books of accounts. Consequently, the Collector ordered the confiscation of the 146 silver slabs, weighing 4641.962 kilograms and valued at Rs. 3.06 Crores, and imposed a personal penalty of Rs. 25 Lakhs on Lunia under Section 112 of the Customs Act, stating the silver was smuggled.

During assessment proceedings, the Assessing Officer (AO) found that Lunia could not explain the nature and source of the silver. Therefore, the AO invoked Section 69A of the Income Tax Act, 1961, adding Rs. 3,06,36,909 to Lunia’s income as unexplained investment. The Commissioner of Income Tax (Appeals) [CIT(A)] dismissed Lunia’s appeal. The Income Tax Appellate Tribunal (ITAT), Jaipur, upheld the CIT(A)’s order concerning Section 69A but partly allowed the appeal on other minor additions, remanding the matter for fresh examination. After re-examination, the AO made the addition again, which was upheld by the CIT(A) and the ITAT in the second round of appeals. The ITAT referred the following questions of law to the High Court:

• Whether the ITAT was correct in holding that Lunia was the owner of the silver bars and in sustaining the addition of Rs. 3,06,36,909 under Section 69A of the Income Tax Act, 1961?
• If the answer to the above is affirmative, whether the ITAT was correct in distinguishing the ratio of the Supreme Court’s decision in Piara Singh v. CIT, 124 ITR 41, and not allowing the loss on account of confiscation of silver bars?

While the reference was pending, penalty proceedings were initiated against Lunia under Section 271(i)(c) of the Income Tax Act, 1961, which was confirmed by the CIT(A) and the ITAT. Lunia then appealed the penalty order before the High Court. The High Court decided both cases together, ruling in favor of the Revenue on the first question, stating that the value of the silver should be added to Lunia’s income. However, on the second question, the High Court held that the loss due to confiscation 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 judgment.

Timeline:

Course of Proceedings

The Assessing Officer (AO) added Rs. 3,06,36,909 to the assessee’s income under Section 69A of the Income Tax Act, 1961, due to the unexplained source of the silver. The CIT(A) upheld this order. The ITAT also upheld the addition under Section 69A but partly allowed the appeal on other minor additions and remanded the matter to the AO. After re-examination, the AO made the addition again, which was upheld by the CIT(A) and the ITAT in the second round of appeals. The ITAT then referred questions of law to the High Court. The High Court ruled in favor of the Revenue on the ownership of the silver but held that the loss due to confiscation was a business loss, relying on the Supreme Court’s decision in CIT, Patiala vs. Piara Singh. The Revenue then appealed to the Supreme Court.

Legal Framework

The case primarily revolves around the interpretation and application of Section 69A and Section 37 of the Income Tax Act, 1961.

• Section 69A of the Income Tax Act, 1961: This section deals with unexplained money, bullion, jewelry, etc. It states that if an assessee is found to be the owner of any money, bullion, or other valuable article that is not recorded in their books of accounts and they cannot explain the nature and source of acquisition, the value of such items may be deemed as the income of the assessee. In this case, the silver bars were treated as unexplained investments and added to the income of the assessee.
• Section 37(1) of the Income Tax Act, 1961: This section allows for the deduction of any expenditure laid out wholly and exclusively for the purposes of the business or profession while computing the income chargeable under the head “Profits and gains of business or profession”. However, Explanation 1 to Section 37(1), which was 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.

The court also considered the implications of Section 115BBE of the Income Tax Act, 1961, which deals with the tax on income referred to in Sections 68, 69, 69A, 69B, 69C, or 69D. This section specifies that no deduction for any expenditure or loss is allowed when computing income under these sections.

Arguments

Arguments by the Revenue:

• The Revenue argued that the High Court erred in relying on the decision in Piara Singh. They contended that Piara Singh pertained to an assessee engaged in the business of smuggling currency notes, where confiscation was a loss directly related to the business. In contrast, Lunia was engaged in a legitimate business of silver trading, and the smuggling was an infraction of law, not a part of his business.
• The Revenue cited Haji Aziz & Abdul Shakoor Bros. v. CIT, AIR 1961 SC 663, where the Supreme Court rejected a claim for deduction of a fine paid for the release of confiscated dates, stating that a penalty for breach of law is not a normal business expense.
• The Revenue also referred to Soni Hinduji Kushalji & Co. vs. CIT, (1973) 89 ITR 112(AP) and JS Parkar v. VB Palekar, (1974) 94 ITR 616 (Bom), where the High Courts rejected claims for trading losses on confiscated gold, noting that such confiscations are actions in rem and not business losses.
• The Revenue argued that the onus of proving ownership lies on the person who denies it, and Lunia had failed to discharge this onus. They stated that Lunia had admitted ownership before the Settlement Commission and the High Court, and his claim for a trading loss indicated his acceptance of ownership.
• The Revenue further 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, which would include the loss due to confiscation. They cited TA Quereshi (Dr.) v. CIT, (2007) 2 SCC 759 and Apex Laboratories (P) Ltd. v. CIT, (2022) 7 SCC 98, to support their argument that neither business loss nor business expenditure can be claimed in such cases.

Arguments by the Assessee:

• The assessee argued that he was engaged in the business of purchasing and selling silver, with declared sales of Rs. 1,46,07,314 and a gross profit of Rs. 1,32,712. The confiscated silver was part of his stock in trade.
• The assessee contended that the confiscation of the silver was a loss of stock in trade, which should be allowed as a business loss. He relied on the decision in T.A. Quereshi (Dr.), where the Court held that Section 37 of the Income Tax Act, 1961, does not apply to business losses due to confiscation.
• The assessee argued that unlike cases involving redemption fines, where confiscated goods are released upon payment, the absolute confiscation of the silver resulted in the loss of stock in trade. Therefore, the value of the confiscated silver should be allowed as a deduction.
• The assessee highlighted that while Section 37 of the Income Tax Act, 1961, was amended to disallow expenditure for offenses, no such restriction was placed on 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 respondent-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

The following table demonstrates as to how the Court decided the issues

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?

• The Supreme Court distinguished the case of CIT Patiala vs. Piara Singh, 1980 Supp SCC 166, stating that the facts of that case were specific to a business of smuggling and did not apply to a legitimate business with incidental illegalities.
• The Supreme Court applied the case of Haji Aziz & Abdul Shakoor Bros. v. CIT, AIR 1961 SC 663, to support the view that a penalty for breach of law is not a normal business expense.
• The Supreme Court applied the case of Soni Hinduji Kushalji & Co. vs. CIT, (1973) 89 ITR 112(AP), which held that confiscation of contraband gold is not a trading or commercial loss.
• The Supreme Court applied the case of JS Parkar v. VB Palekar, (1974) 94 ITR 616 (Bom), which held that the value of confiscated gold could not be claimed as a trading loss.
• The Supreme Court cited the cases of Chuharmal v. CIT, (1988) 3 SCC 588, and CIT v. K Chinnathamban, (2007) 7 SCC 390, to support the principle that the onus of proving ownership is on the person who denies it.
• The Supreme Court 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 it was not applicable in the present facts.
• The Supreme Court cited the case of Apex Laboratories (P) Ltd. v. CIT, (2022) 7 SCC 98, to support the argument that business expenditure incurred for illegal purposes is not allowable.
• The Supreme Court cited the case of Badridas Daga v. CIT, (1959) SCR 690, to define what constitutes a business loss.

What weighed in the mind of the Court?

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

• Distinction between Illegal and Legitimate Business: The Court emphasized that the Piara Singh case was specific to a business of smuggling, where the confiscation was a direct consequence of the illegal business itself. In contrast, the present case involved a legitimate business of silver trading, where the smuggling was an incidental infraction of the law.
• Nature of Confiscation: The Court reiterated that confiscation is an action in rem, a penalty imposed on the goods for an infraction of the law, and not a commercial loss arising from the business.
• Explanation 1 to Section 37(1): The Court noted that Explanation 1 to Section 37(1) of the Income Tax Act, 1961, expressly disallows deductions for any expenditure incurred for an offense or prohibited by law. This provision was crucial in determining that the loss due to confiscation could not be claimed as a business loss.
• Onus of Proof: The Court highlighted that the onus of proving that he was not the owner of the silver was on the assessee, and he had failed to discharge this onus.

The court’s reasoning was primarily based on the legal interpretation of the relevant provisions of the Income Tax Act, 1961, and the application of established legal principles. The factual aspects of the case, such as the nature of the assessee’s business and the circumstances of the confiscation, were considered, but the legal framework played a more significant role in the court’s decision.

Logical Reasoning:

The Court considered alternative interpretations, such as whether the loss could be treated as a normal business loss due to the nature of the assessee’s business. However, it rejected these interpretations based on the legal framework and the principle that a penalty for an infraction of the law cannot be considered a normal business expense. The final decision was reached by applying the law to the facts of the case, emphasizing the distinction between a loss arising from an illegal business and a loss arising from an infraction of law in a legitimate business.

The court’s decision was clear: the loss due to confiscation of silver bars cannot be treated as a business loss for the purpose of income tax deduction. This was based on the interpretation of Section 37(1) of the Income Tax Act, 1961, and its Explanation 1,and the distinction between the facts of this case and the case of Piara Singh.

Concurring Opinion

Justice M.M. Sundresh provided a concurring opinion, emphasizing the distinction between a business loss and a penalty for an infraction of the law. Justice Sundresh noted that the confiscation of goods was a consequence of the assessee’s illegal actions and not a normal business loss. The concurring opinion reinforced the main opinion, emphasizing that the assessee cannot claim a loss for confiscated goods when the confiscation resulted from illegal activity. Justice Sundresh also highlighted the importance of the Explanation 1 to Section 37(1) of the Income Tax Act, 1961, in disallowing deductions for expenses incurred for offenses or prohibited by law.

Dissenting Opinion

There was no dissenting opinion in this case. Both Justice M.R. Shah and Justice M.M. Sundresh agreed on the final judgment, emphasizing the importance of the legal framework and the implications of Explanation 1 to Section 37(1) of the Income Tax Act, 1961.

Ratio Decidendi

The ratio decidendi of the judgment is that a business cannot claim a loss for confiscated goods if the confiscation resulted from an infraction of the law, even if the business is otherwise legitimate. The key legal principles that support this ratio are:

• Distinction between Illegal and Legitimate Business: The court differentiated between a business of smuggling, where confiscation is a direct consequence of the business, and a legitimate business where the confiscation arises from an incidental infraction of the law.
• Nature of Confiscation: The court reiterated that confiscation is an action in rem and a penalty for breach of law, not a commercial loss.
• Explanation 1 to Section 37(1): This provision of the Income Tax Act, 1961, disallows deductions for expenses incurred for an offense or prohibited by law.

Obiter Dicta

The obiter dicta in the judgment includes the discussion on the onus of proof, where the court stated that the burden of proving non-ownership lies on the person denying ownership. Additionally, the court’s discussion on the applicability of Piara Singh and T.A. Quereshi to the facts of the present case can be seen as obiter dicta, as they are not directly necessary for the final decision but provide context and reasoning for the judgment.

Implications

This judgment has significant implications for businesses and tax practitioners. It clarifies the scope of allowable business losses, particularly in cases where goods are confiscated due to legal infractions. The key implications are:

• No Deduction for Confiscated Goods: Businesses cannot claim a deduction for the value of goods confiscated due to an infraction of the law, even if the business is otherwise legitimate.
• Distinction between Business Loss and Penalty: The judgment emphasizes the distinction between a normal business loss and a penalty for breach of law. Confiscation is considered a penalty and not a normal business loss.
• Importance of Explanation 1 to Section 37(1): The judgment highlights the importance of this provision in disallowing deductions for expenses incurred for offenses or prohibited by law.
• Onus of Proof: The judgment reinforces the principle that the onus of proving non-ownership lies on the person who denies it.
• Tax Planning: Businesses need to be cautious about engaging in any activities that could lead to confiscation of goods, as the value of such goods cannot be claimed as a business loss.

This judgment provides clarity on the treatment of confiscated goods under the Income Tax Act, 1961, and will likely influence future tax assessments in similar cases. It underscores the principle that the Income Tax Act does not incentivize illegal activities by allowing deductions for losses arising from such activities.

Conclusion

The Supreme Court’s decision in Commissioner of Income Tax vs. Prakash Chand Lunia (2023) clarifies that a business cannot claim a loss for confiscated goods when the confiscation is a result of an infraction of the law. The court distinguished the facts of this case from the case of Piara Singh, emphasizing that the latter involved a business of smuggling, while the present case involved a legitimate business with an incidental illegality. The court also relied on Explanation 1 to Section 37(1) of the Income Tax Act, 1961, to disallow the deduction. This judgment reinforces the principle that the Income Tax Act does not allow deductions for losses arising from illegal activities. The decision has significant implications for businesses and tax practitioners, providing clarity on the treatment of confiscated goods and the scope of allowable business losses. The judgment also highlights the importance of adhering to legal requirements and avoiding any activities that could lead to confiscation of goods.