My stock in trade was seized and confiscated. The officer says the Explanation to section 37(1) blocks the deduction because the activity was an offence. Is he right?
No. The Supreme Court set aside the Madhya Pradesh High Court's judgment and restored the Tribunal's order allowing a deduction of Rs 2 lakh. The Explanation to section 37 speaks only of expenditure incurred for a purpose which is an offence or prohibited by law. This was not expenditure but a business loss, and the Explanation has nothing to do with it. Once it was found as a fact that the seized heroin formed part of the assessee's stock in trade, the seizure and confiscation had to be allowed as a business loss on ordinary commercial principles. The Court held that the High Court had taken an emotional and moral approach rather than a legal one.
Decided by the Supreme Court (Supreme Court of India - S.B. Sinha and Markandey Katju, JJ; judgment by Markandey Katju, J) on 2006-12-06, reported as (2006) 287 ITR 547; (2007) 2 SCC 759; (2006) 13 SCALE 182; (2006) 157 Taxman 514; AIR 2007 SC (Supp) 1916. It bears on section 28, section 37(1), section 254(2) of the Income Tax Act 1961, in Deductions & Disallowances and Assessment & Scrutiny matters.
This is the clearest statement that the Explanation to section 37(1) is confined to expenditure and does not reach a trading loss, which matters far beyond its unattractive facts. Business losses are allowed on ordinary commercial principles in computing profits, and loss of stock in trade is a trading loss, so a confiscation or destruction of stock falls outside the Explanation altogether. The Court followed Piara Singh, where confiscated currency of a smuggler was allowed as a business loss, and Annamalai Chettiar on loss of stock in trade. The passage on law and morality is the one everyone quotes: the assessee's conduct was accepted to be highly immoral, and the Court still decided the case on legal principles. The other lesson is procedural - the deduction succeeded because the authorities had themselves found as a fact that the assessee carried on that business and that the seized goods were his stock.
Binding on every court and authority in India.
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The appellant was a doctor practising at Garoth in District Mandsaur. On 18 July 1985 he was arrested by the Central Bureau of Investigation while transporting a large quantity of heroin in a jeep, and a raid on his residence turned up a clandestine laboratory for manufacturing heroin powder along with other contraband. The goods were seized and proceedings under the Narcotic Drugs and Psychotropic Substances Act followed, with which the Supreme Court was not concerned. In his return for assessment year 1986-87 he claimed that the seized heroin was part of his stock in trade and that its loss on seizure was deductible. The Assessing Officer rejected this on 28 March 1989 and added Rs 5,50,000, the assessed value of the heroin, as income from an undisclosed source, and the Commissioner (Appeals) upheld him. The Tribunal on 31 March 1993 reduced the value to Rs 2 lakh but refused the deduction on the footing that no business loss had been claimed, recording in the same order a finding that the assessee was involved in manufacturing and selling heroin for material gain. On an application under section 254(2) it accepted that the claim had been made and recalled that order, and on 14 October 1998 it allowed the deduction as a business loss, finding that the heroin formed part of the stock in trade. The Madhya Pradesh High Court reversed that on 29 November 2004, relying on the Explanation to section 37.
The appeal was allowed with no costs, the judgment of the High Court set aside and the order of the Tribunal restored. The Explanation to section 37 has nothing to do with the case, because it deals with expenditure incurred for a purpose which is an offence or prohibited by law and this was a business loss, not an expenditure. Once the income tax authorities had themselves found as a fact that the assessee was engaged in the manufacture and sale of heroin, any loss from that business was a business loss; and once the heroin seized was found to form part of his stock in trade, its seizure and confiscation had to be allowed as such. The Court agreed with the High Court that the assessee was committing a highly immoral act, but held that the High Court had taken an emotional and moral approach rather than a legal one.
The Court separated the two provisions. Section 37 deals with business expenditure and its Explanation withdraws the allowance for expenditure incurred for a purpose which is an offence or prohibited by law; it says nothing about losses. Business losses, by contrast, are allowable on ordinary commercial principles in computing profits, and loss of stock in trade is a trading loss, as Annamalai Chettiar holds. The case was therefore governed by Piara Singh, where an assessee carried on smuggling and the confiscation of his currency notes was allowed as a business loss. The factual foundation was already laid by the department's own findings: the Assessing Officer rejected the assessee's story that the apparatus belonged to another man, and the Tribunal found he was manufacturing and selling heroin for material gain. Although that order was recalled, the final order of 14 October 1998, holding the heroin to be stock in trade, implicitly reiterated the same view of the business. Once that is so, the conclusion follows without any inquiry into the character of the trade, and cases are to be decided on legal principles rather than on the court's own moral views, law being different from morality as Bentham and Austin pointed out.
The explanation to Section 37 has really nothing to do with the present case as it is not a case of a business expenditure, but of business loss.
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Handle my notice → Ask a CA on WhatsAppNo. The Supreme Court set aside the Madhya Pradesh High Court's judgment and restored the Tribunal's order allowing a deduction of Rs 2 lakh. The Explanation to section 37 speaks only of expenditure incurred for a purpose which is an offence or prohibited by law. This was not expenditure but a business loss, and the Explanation has nothing to do with it. Once it was found as a fact that the seized heroin formed part of the assessee's stock in trade, the seizure and confiscation had to be allowed as a business loss on ordinary commercial principles. The Court held that the High Court had taken an emotional and moral approach rather than a legal one. This was decided by the Supreme Court (Supreme Court of India - S.B. Sinha and Markandey Katju, JJ; judgment by Markandey Katju, J) and bears on section 28, section 37(1), section 254(2) of the Income Tax Act 1961. It is reported as (2006) 287 ITR 547; (2007) 2 SCC 759; (2006) 13 SCALE 182; (2006) 157 Taxman 514; AIR 2007 SC (Supp) 1916. This is the clearest statement that the Explanation to section 37(1) is confined to expenditure and does not reach a trading loss, which matters far beyond its unattractive facts. Business losses are allowed on ordinary commercial principles in computing profits, and loss of stock in trade is a trading loss, so a confiscation or destruction of stock falls outside the Explanation altogether. The Court followed Piara Singh, where confiscated currency of a smuggler was allowed as a business loss, and Annamalai Chettiar on loss of stock in trade. The passage on law and morality is the one everyone quotes: the assessee's conduct was accepted to be highly immoral, and the Court still decided the case on legal principles. The other lesson is procedural - the deduction succeeded because the authorities had themselves found as a fact that the assessee carried on that business and that the seized goods were his stock. If it applies to you, the first step is this: Characterise the claim precisely: if the outgoing is a loss of stock rather than an expenditure, the Explanation to section 37(1) does not apply and section 37 is not the provision in issue at all.
The appellant was a doctor practising at Garoth in District Mandsaur. On 18 July 1985 he was arrested by the Central Bureau of Investigation while transporting a large quantity of heroin in a jeep, and a raid on his residence turned up a clandestine laboratory for manufacturing heroin powder along with other contraband. The goods were seized and proceedings under the Narcotic Drugs and Psychotropic Substances Act followed, with which the Supreme Court was not concerned. In his return for assessment year 1986-87 he claimed that the seized heroin was part of his stock in trade and that its loss on seizure was deductible. The Assessing Officer rejected this on 28 March 1989 and added Rs 5,50,000, the assessed value of the heroin, as income from an undisclosed source, and the Commissioner (Appeals) upheld him. The Tribunal on 31 March 1993 reduced the value to Rs 2 lakh but refused the deduction on the footing that no business loss had been claimed, recording in the same order a finding that the assessee was involved in manufacturing and selling heroin for material gain. On an application under section 254(2) it accepted that the claim had been made and recalled that order, and on 14 October 1998 it allowed the deduction as a business loss, finding that the heroin formed part of the stock in trade. The Madhya Pradesh High Court reversed that on 29 November 2004, relying on the Explanation to section 37. The matter was decided on 2006-12-06 by the Supreme Court (Supreme Court of India - S.B. Sinha and Markandey Katju, JJ; judgment by Markandey Katju, J). On those facts the Supreme Court held as follows. The appeal was allowed with no costs, the judgment of the High Court set aside and the order of the Tribunal restored. The Explanation to section 37 has nothing to do with the case, because it deals with expenditure incurred for a purpose which is an offence or prohibited by law and this was a business loss, not an expenditure. Once the income tax authorities had themselves found as a fact that the assessee was engaged in the manufacture and sale of heroin, any loss from that business was a business loss; and once the heroin seized was found to form part of his stock in trade, its seizure and confiscation had to be allowed as such. The Court agreed with the High Court that the assessee was committing a highly immoral act, but held that the High Court had taken an emotional and moral approach rather than a legal one.
The Court separated the two provisions. Section 37 deals with business expenditure and its Explanation withdraws the allowance for expenditure incurred for a purpose which is an offence or prohibited by law; it says nothing about losses. Business losses, by contrast, are allowable on ordinary commercial principles in computing profits, and loss of stock in trade is a trading loss, as Annamalai Chettiar holds. The case was therefore governed by Piara Singh, where an assessee carried on smuggling and the confiscation of his currency notes was allowed as a business loss. The factual foundation was already laid by the department's own findings: the Assessing Officer rejected the assessee's story that the apparatus belonged to another man, and the Tribunal found he was manufacturing and selling heroin for material gain. Although that order was recalled, the final order of 14 October 1998, holding the heroin to be stock in trade, implicitly reiterated the same view of the business. Once that is so, the conclusion follows without any inquiry into the character of the trade, and cases are to be decided on legal principles rather than on the court's own moral views, law being different from morality as Bentham and Austin pointed out. In the words reproduced by the source cited on this page: "The explanation to Section 37 has really nothing to do with the present case as it is not a case of a business expenditure, but of business loss."
It was decided by the Supreme Court on 2006-12-06 and is reported as (2006) 287 ITR 547; (2007) 2 SCC 759; (2006) 13 SCALE 182; (2006) 157 Taxman 514; AIR 2007 SC (Supp) 1916. Binding on every court and authority in India. A Supreme Court decision binds every assessing officer, every Commissioner (Appeals), every bench of the Income Tax Appellate Tribunal and every High Court in India. An officer who declines to follow it is acting contrary to law, and that refusal is itself a ground of appeal. On section 28, section 37(1), section 254(2), the practical question is whether the facts of your own notice match the facts of this case closely enough for the same rule to apply.
It helps the taxpayer. The appeal was allowed with no costs, the judgment of the High Court set aside and the order of the Tribunal restored. The Explanation to section 37 has nothing to do with the case, because it deals with expenditure incurred for a purpose which is an offence or prohibited by law and this was a business loss, not an expenditure. Once the income tax authorities had themselves found as a fact that the assessee was engaged in the manufacture and sale of heroin, any loss from that business was a business loss; and once the heroin seized was found to form part of his stock in trade, its seizure and confiscation had to be allowed as such. The Court agreed with the High Court that the assessee was committing a highly immoral act, but held that the High Court had taken an emotional and moral approach rather than a legal one. It arises in Deductions & Disallowances and Assessment & Scrutiny matters, on section 28, section 37(1), section 254(2) of the Income Tax Act 1961, and was decided by Supreme Court of India - S.B. Sinha and Markandey Katju, JJ; judgment by Markandey Katju, J. Before relying on it, read the source linked on this page and check whether it has since been distinguished, overruled or overtaken by an amendment to the Income Tax Act. In practice the steps that follow from it are these. Establish on the record that the goods were stock in trade of a business actually carried on; the deduction here turned on findings of fact by the Assessing Officer and the Tribunal. Resist arguments about the moral quality of the activity; the question is whether the Act allows the deduction. Where the Tribunal has overlooked a claim actually made, use section 254(2) to have the order recalled, as was done here.
Validity check could not be completed. No later history was checked, and no check was made of whether any subsequent amendment extends the disallowance in section 37 beyond expenditure or otherwise affects the treatment of a loss of illegal stock in trade. No source could be cited for that finding. Checking whether an authority still stands matters as much as knowing what it held: a decision may be overruled on one point and survive on another, or the provision it interprets may have been amended since. Read the source and the editor's note on this page before relying on it in a reply to an Assessing Officer or in an appeal.
The judgment does not decide the first question framed by the High Court, whether heroin could be stock in trade of a medical practitioner, in terms; it proceeds on the finding of fact already recorded that the assessee carried on the business of manufacturing and selling heroin. It also does not deal with the Assessing Officer's alternative basis for the addition, that the Rs 5,50,000 was income from an undisclosed source, beyond restoring the Tribunal's order. The Explanation to section 37 is quoted in the judgment without identifying it as the Explanation to sub-section (1). The judgment cites Piara Singh at two different references, 124 ITR 40 and AIR 1980 SC 1271. This library shows the verification state of every entry openly. This entry has not yet been read in full by a chartered accountant. The summary reflects the sources listed on this page. Read the source before you rely on it in a reply to an Assessing Officer or in an appeal before the Commissioner (Appeals) or the Income Tax Appellate Tribunal.
The appeal was allowed with no costs, the judgment of the High Court set aside and the order of the Tribunal restored. The Explanation to section 37 has nothing to do with the case, because it deals with expenditure incurred for a purpose which is an offence or prohibited by law and this was a business loss, not an expenditure. Once the income tax authorities had themselves found as a fact that the assessee was engaged in the manufacture and sale of heroin, any loss from that business was a business loss; and once the heroin seized was found to form part of his stock in trade, its seizure and confiscation had to be allowed as such. The Court agreed with the High Court that the assessee was committing a highly immoral act, but held that the High Court had taken an emotional and moral approach rather than a legal one.
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