PETITIONER:
COMMISSIONER OF INCOME TAXGUJARAT III, AHMEDABAD & ANOTHER
Vs.
RESPONDENT:
KURJI JINABHAI KOTECHA
DATE OF JUDGMENT18/02/1977
BENCH:
GOSWAMI, P.K.
SINGH, JASWANT
CITATION:
1977 AIR 1142 1977 SCC (2) 719
ACT
Income Tax Act 1922--Section 24( 1 ) (2)--Whether ex-
penses incurred in carrying on illegal business to be
deducted---Whether loss arising out of illegal business can
be set off against profits from legal business--Whether loss
of illegal business can be carried forward to future
years--Interpretation of statutes--Whether ought to be
consistent with morality--Whether continuation of illegal
activity to be recognised.
Forward Contracts (Regulation) Act 1952--Section
15(4)--Illegal contracts--Effect of income tax law.
HEADNOTE
The assessee carries on business of running Oil Mill and
dealing in groundnuts, groundnut seeds and oil, speculative
business in groundnuts, groundnut oil and groundnut seeds,
and speculation business in cotton errands etc. The I.T.O.
disallowed loss in forward contracts and groundnut oil,
groundnuts and groundnut seeds on the ground that it arose
out of illegal contracts on account of the same being banned
under section 15(4) of the Forward Contracts (Regulation)
Act, 1952. The Appellate Assistant Commissioner on appeal
confirmed the decision of the l.T.O. but bifurcated the loss
into two headings, namely, loss incurred in hedging transac-
tions m the banned items and loss incurred in speculative
transactions. On second appeal, the Tribunal held that
notwithstanding the illegality of the transactions the loss
could be set off and carried forward in accordance with the
provisions of section 24(1) and 24(2) of the Income Tax Act,
1922. The Tribunal accordingly directed that the loss in
hedging transactions of forward business in the banned
contracts be set off against the other profits of the asses-
see for the relevant accounting year under section 24(1) and
that balance of loss relating to the speculative transac-
tions in the banned contracts be carried forward to the
following year under section 24(2) of the Act to be set off
against profit of the following year from speculative busi-
ness. On reference to the High Court, the High Court an-
swered both the questions in favour of the assessee and
upheld the judgment of the Tribunal. The High Court relied
on its earlier judgment in the case of C.I.T. v. S.C. Ko-
thari.
Allowing the appeal by certificate
HELD:
(1) The loss incurred ,in the hedging transactions
cannot be set off against other profits in the previous year
in view of the decision of this Court partly reversing the
judgment of the High Court in the case of S.C. Kothari.
[31C-D]
Commissioner of Income-tax v. S.C. Kothari, 69 ITR 1, ap-
plied.
(2) It is admitted that the contract for speculation in
the commodity in question is banned under the Forward Con-
tracts (Regulation) Act 1952. To allow such a loss to be
carried forward is to permit a benefit of adjustment of loss
from an illegal business to spill over and continue in the
following year even in a lawful speculative business. The
speculative business which is carried on in the following
year must be a business of lawful speculation pertaining to
the lawful and enforceable contracts. An assessee carrying
on a lawful speculative business in the following year
cannot derive benefit by carrying forward and setting off a
loss from illegal speculative business of the earlier
year. Law will assume an illegal business to die out of
existence with all its losses to the assessee in the year of
loss itself. The assessee can derive no benefit on account
of the unlawful business in the following year. The matter
will be different if a lawful speculative business after
incurring loss is
27
discontinued and loss thereupon is carried forward for set
off against any other lawful speculative business in the
following year. It is inconceivable that law can permit an
illegal activity to be carried on from which a benefit could
be obtained. The concept of carry forward is not the same
thing as the setting off of loss in a particular illegal
business against profit of that illegal business in a par-
ticular year. The two concepts have to be kept distinctly
separate even in a taxing statute. It is true that by
earning income from illegal trading activity the business
does not get tainted so far as exigibility to tax is con-
cerned. While computing income from illegal activity in a
particular year all losses incurred in earning that particu-
lar income are also taken into account for computation of
real profits even in the illegal business. There is a
marked distinction between the computation of a particular
year’s profit from illegal trading activity and carry for-
ward of a loss to set it off against income in the subse-
quent years even assuming that such illegal activity is
continued against the provisions of law. No illegal activi-
ty can be perpetuated under any provisions of law nor bene-
fit out of it. Law will miss its paramount object if it is
not consistent with morality and any interpretation by
courts cannot lead to a result where continuation of illegal
activity or benefit attached to it is given recognition.
[31D-H, 32A-D]
JUDGMENT
CIVIL APPELLATE JURISDICTION: Civil Appeal No. 580 of 1972.
(From the Judgment and Order dated 8-9-1970 of the
Gujarat High Court in Income-tax Reference No. 9/68).
B.B. Ahuja and R.N. Sachthey, for the Appellants.
K.L. Hathi and P.C. Kapoor, for the respondent.
The Judgment of the Court was delivered by
GOSWAMI, J. This appeal by certificate is from the
judgment of the Gujarat High Court in an Income-tax Refer-
ence under section 66(1) of the Indian Income-tax Act, 1922
(briefly the Act).
The two questions which were earlier referred by the
Tribunal to the High Court at the instance of the Commis-
sioner of Income-tax, Gujarat III. are as follows :--
"(2) Whether, on the facts and in the
circumstances of the case, the assessee was
entitled to set off hedging. loss of Rs.
31745/- against other profits of the previous
year ?
(2) Whether on the facts and in the circum-
stances of the case, the assessee was entitled
to carry forward the speculation loss of Rs.
41603/- to the next year ?"
The following facts appear from the statement of case
and the order of the Tribunal:
The assessment year in question is 1957-58 and the
corresponding previous year is the Samvat year 2012. The
assessee is carrying on business by running an oil mill, and
also doing business in sales and purchase of groundnuts,
groundnut seeds and oil: speculation business in groundnuts,
groundnut oil and groundnut seeds; and speculation business
in cotton, errands, etc. His total income for the year in
question was determined by the Income-tax Officer as Rs.
1,71,632/-. This was after allowing set off of loss brought
forward from the year 1955-56 amounting to Rs. 2,11,431/-.
In arriving at the figure of the total income, the Income-
tax Officer disallowed loss amounting to
28
Rs. 73,348/-in forward contracts in groundnut oil, ground-
nuts and groundnut seeds. He disallowed this loss on the
ground that it arose out of illegal contracts on account of
the same being banned Under section 15(4) of the Forward
Contracts (Regulation) Act, 1952.
It will appear that the break-up of losses in the busi-
ness of illegal forward contracts is as follows :--
( 1 ) Groundnut oil Account Rs. 49,664/-
(2) Groundnut Account Rs. 22,522/-
(3) Singdana (Groundnut seeds Account)
at Veraval Rs. 1,162/-
Total Rs. 73,348/-
The above third item of loss is arrived at by the Income-tax
Officer after adjusting the profit of the forward business
in groundnut seeds at Rajkot.
On appeal by the assessee the Appellate Assistant Com-
missioner affirmed the order of the Income-tax Officer. The
Appellate Assistant Commissioner. however, bifurcated the
loss into two categories as follows :-
(1 ) Loss incurred in hedging transactions
in the banned items Rs.331,745/-
(2) Loss incurred in speculative tran-
sactions (other than hedging transac-
tions) in the banned items. Rs. 41,603:/-
Total: Rs. 73,348/-
The Appellate Assistant Commissioner held that the
assessee was not entitled to the set off of the loss against
the assessee’s other business under section 24(1 ) of the
Act and also that such loss could not be carried forward to
the following year under section 24(2) of the Act
On a second appeal by the assessee before the Appellate
Tribunal, the Tribunal held that notwithstanding the ille-
gality of the transactions the loss could be set off and
carried forward in accordance with the provisions of section
24(1) and 24(2) respectively of the Act. The Tribunal
accordingly directed that the loss in hedging transactions
of forward business in the banned contracts amounting to Rs.
31,745/- be set off against the other profits of the asses-
see for the relevant accounting year under section 24(1) and
that the balance loss of Rs. 41,603/- relating to the specu-
lative transactions in the banned contracts be carried
forward to the following year under section 24(2) of the Act
to be set off against profits of the following year from
speculative business.
As stated earlier, at the instance of the Commissioner
of Incometax, the two questions set out above Were referred
to the High ,Court under section 66(1) of the Act. The High
Court relying upon its
29
earlier judgment in the Commissioner of Income-tax v.
S.C. Kothari(1) answered both the questions in the affirma-
tive in favour of the assessee. That decision was, however,
partly reversed by this Court in the Commissioner of
Income-tax Gujarat v. S.C. Kothari(2) (hereinafter to be
referred to as Kothari decision). This Court held in the
Kothari decision as follows:
" . . the taint of illegality of the business
cannot detract from the tosses being taken
into account for computation of the amount
which can be subjected to tax as ’profits’
under section 10( 1 ) of the Act of 1922. The
tax collector cannot be heard to say that he
will bring the gross receipts to tax. He can
only tax profits of a trade or business. That
cannot be done without deducting the losses
and the legitimate expenses of the business".
This Court, however, held that the High Court
was in error in considering that any set off
could be allowed in that case under the first
proviso to section 24(1). This Court ob-
served:
"The contract contemplated by Explanation 2
to the first proviso to section 24( 1 ) of
the Income-tax Act, 1922, has to be an en-
forceable contract and not an unenforceable
one by reason of any taint of illegality
resulting in its invalidity. Set-off cannot
be allowed under the first proviso to section
24(1), read with Explanation 2 thereto, of
losses in contracts which are illegal and
unenforceable on account of contravention of
Section 15(4) of the Forward Contracts (Regu-
lation) Act, 1952".
This Court held the contracts in that case in respect of
which the loss was incurred by the assessee as illeged
contracts. It also held that the assessee was not entitled
to a set off under the first proviso to. section 24( 1 ) of
the Act of the loss against its profit in speculative trans-
actions. It, however, held that if the business in which
the loss was sustained in that case was the same as the
business in which the profit was derived then the loss had
to be taken into account while computing the profits of the
business under section 10(2) of the Act. In the view it
took this Court remitted the matter to the High Court to.
decide: the point which was not clear on the findings wheth-
er the profits and losses were incurred in the same busi-
ness even though that business involved the entering into of
contracts some of which were illegal.
In the present case there is no dispute that the losses
were incurred in connection with forward contracts which
were banned under section 15(4) of the Forward Contracts
(Regulation) Act. It is also clear that the Income-tax
Officer adjusted the profit against the loss with regard to
the illegal business in groundnut seeds which was carried on
in two places, Veraval and Rajkot. This set off is permis-
sible under section 10(2) of the Act because it is only by
(1) 69 I.T.R. 1.
(2) 82 I.T.R. 794.
30
setting off of the loss of the particular business in
groundnut seeds that true profit with regard to that par-
ticular business can be computed under section 10(2). There
is, therefore, no reason to remit this case as the.course
earnestly suggested by Mr. Hathi for the respondent. In
Kothari decision (supra) it was observed by this Court
while remitting the case that "enough attention was not
devoted to the business which the assessee was doing and in
which the profit of Rs. 2,19,046/- was made and the loss
of Rs. 3,40,443/- was sustained". Such an uncertainty,
however, is not present in the instant case. The submission
of Mr. Hathi, therefore, cannot be accepted.
The present case rests upon section 24 of the Act. That
section so far as material for our purpose reads as follows
:--
"24(1) Where any assessee sustains a loss of profits
or gains in any year under any of the heads mentioned in
section 6, he shall be entitled to have the amount of the
loss set off against his income, profits or gains under any
other head in that year:
Provided that in computing the profits and gains
chargeable under the head ’Profits and gains of business,
profession or vocation, any loss sustained in speculative
transactions which are in the nature of a business shall not
be taken into account except to the extent of the amount of
profits and gains, if any, in any other business consisting
of speculative transactions:
(2) Where any assessee sustains a loss of
profits or gains in any year, being a previ-
ous year not earlier than the previous year
for the assessment for the year ending on the
31st day of March, 1940, in any business,
profession or vocation, and the loss cannot be
wholly set off under sub-section (1), so. much
of the loss as is not so set off or the whole
loss where the assessee had no other head of
income shall be carried forward to the fol-
lowing year, and
(i) where the loss was sustained by him
in a business consisting of speculative
transactions, it shall be set off only against
the profits and gains, if any, of any business
in speculative transactions carried on by him
in that year;
(ii) whether loss was sustained by him
in any other business, profession or vocation,
it shall be set off against the profits and
gains, if any, or any business, profession or
vocation carried on by him in that year,
provided that the business, profession of
vocation in which the. loss was originally
sustained continued to be ’carried On= by him
in that year; and
31
(iii) if the loss in either case cannot be
wholly so set off, the amount of loss not so
set off shall be carried forward to the fol-
lowing year and so on but no loss shall be so
carried forward for more than eight years".
X X X X
X
In the instant case there is no dispute about the fol-
lowing findings of facts:
The assessee sustained losses in the relevant accounting
year amounting to Rs. 73,348/-. This figure was arrived at
on a legitimate computation under section 10(2) of the Act.
No further question survives for a recomputation of the
income under Section 10(2) of the Act in this case. The
only question remains is as to whether the loss of Rs.
31,745/- can be set off against other profits in the previ-
ous year. This is the first question in the reference.
This question has to be answered in the. negative in view of
Kothari decision (supra). The hedging loss being in respect
of a banned contract under section 15(4) of the Forward
Contracts (Regulation) Act, 1952, cannot be set off against
the profits of other business of the previous year.
The second question is with regard to the assessee’s claim
for entitlement to carry forward the speculation loss of Rs.
41,603/- to the next year. It is also admitted that the
contract for speculation in the commodity in question is
banned under the Forward Contracts (Regulation) Act, 1952.
It also appears that the said loss could not be set off in
the previous year against profit in the same business in
that year. The assessee contends that this loss should be
allowed to be carried forward under section 24(2) of the
Act. To allow such a claim is to permit a benefit of ad-
justment of loss from an illegal business to spill over and
continue in the following year even in a lawful speculative
business. A speculative business which is carried on in the
following year must be a business of lawful speculation
pertaining to lawful and enforceable contracts. The asses-
see carrying on a lawful speculative business in the follow-
ing year cannot derive benefit by carrying forward and
setting off a loss from an illegal speculative business of
the earlier year. Law will assume an illegal business to
die out of existence with all its losses to the assessee in
the year of loss itself. The assessee can derive no benefit
on account of the unlawful business in the following year.
The matter will be different if a lawful speculative busi-
ness after incurring loss is discontinued and loss therefrom
is carried forward for set off against any other lawful
speculative business in the following year. This is the
true legal effect of section 24(2)(i) of the Act in this
case.
It iS inconceivable that law can permit an illegal
activity to be carried on from which a benefit could be
obtained. The concept of carry forward is not the same
thing as the setting off of loss in a particular illegal
business against profit of that illegal business in a
particular year. The two concepts have to be kept distinct-
ly separate
32
even in a taxing statute. There is no express warrant for
the submission either under section 20(2) or under any other
provision of the Act, far less on general principles.
It is true that by earning income from illegal trading
activity the income does not get tainted so far as exigibil-
ity to tax is concerned. While computing income from illegal
activity in a particular year all losses incurred in earning
that particular income are also taken into account for
computation of real profits even in the illegal business.
That does not mean that fines imposed on the illegal activi-
ties detected, prosecuted and punished or otherwise pena-
lised, will be taken into account for ascertainment of real
profits. There is, therefore, a marked distinction between
computation of a particular year s profit from illegal
trading activity and carry forward of a loss to set it off
against income in subsequent years even assuming that such
illegal activity is continued against the provisions of law.
No illegal activity can be perpetuated under any provisions
of law nor benefit out of it. Law will miss its paramount
object if it is not consistent with morality and any inter-
pretation by courts cannot read to a result where continua-
tion of illegal activity or benefit attached to it is given
recognition.
The second question, therefore, must be answered in the
negative and against the assessee.
In the result the judgment of the High Court is set
aside and the two questions set out above are answered in
the negative and in favour of the Department. The appeal is
allowed with costs.
P.H.P. Appeal
allowed.
33