Loss incurred for any purpose which is ‘offence’ cannot be incidental to business/profession, hence not eligible for Sec 37(1) benefit

While stating that Section 37 seeks to prohibit a deduction of any expenditure incurred by an assessee for any purpose which is an offence or which is prohibited by law, the Supreme Court held that the word ‘any expenditure’ mentioned in Section 37 of Income tax Act takes in its sweep loss occasioned during business, as well.

Emphasizing that a loss in pursuance to an offence or prohibited business cannot be brought u/s 115BBE for income assessed u/s 68, 69 and 69A to 69D which deals with unexplained income, expenditure etc. and it can never be said that the same would be brought u/s 37(1), the Apex Court clarified that any loss incurred by way of an expenditure by an assessee for any purpose which is an offence or which is prohibited by law is not deductible in terms of Explanation 1 to Section 37.

The Division Bench of Justice M.R Shah and Justice MM Sundresh observed that such expenditure/loss incurred for any purpose which is an offence shall not be deemed to have been incurred for the purpose of business or profession or incidental to it, and hence, no deduction can be made.

Accordingly, the Bench ruled that a penalty or a confiscation is a proceeding in rem, and therefore, a loss in pursuance to the same is not available for deduction regardless of the nature of business, as a penalty or confiscation cannot be said to be incidental to any business.

ASG Balbir Singh appeared for the Appellant/Revenue, whereas AOR Supriya Juneja appeared for the Respondent/Assessee.

Briefly, a search was conducted by the DRI officers at the premises situated at NOIDA taken on rent by the assessee, Prakash Chand Lunia. The DRI recovered 144 slabs of silver from the premises and two silver ingots from the business premises of the assessee at 1397, Chandni Chowk, Delhi. The assessee was arrested u/s 104 of the Customs Act for committing offence punishable u/s 135 of the Customs Act. The Collector, Customs finding that the assessee is the owner of silver/bullion and the transaction thereof was not recorded in the books of accounts, ordered confiscation of the said slabs of silver and imposed a personal penalty of Rs.25 Lakhs on assessee u/s 112 of the Customs Act.

Parallelly, the ITO finding that the assessee was not able to explain the nature and source of acquisition of silver of which he is held to be the owner, held that the deeming provisions of Section 69A of Income Tax Act would be applicable. Since the investment in this regard was not found recorded in the books of accounts of assessee, the AO made an addition of Rs.3,06,36,909/- u/s 69A. While the reference was pending before the High Court, penalty proceedings were initiated against the assessee and an order u/s 271(1)(c) came to be confirmed by both the CIT(A) and the ITAT. Later, the High Court held that loss of confiscation by the DRI official of Customs Department is business loss.

After considering the submission, the Apex Court noted that an ambiguity arose as to whether a business, as defined under Section 2(13) of the Act, and as dealt with under Section 37 of the Act, would include a deduction when the said expenditure is incurred for any purpose which is an offence or prohibited by law.

Since an anomaly has been created by the interpretation of the pari materia provision under the Income Tax Act, 1922 viz. Section 10(1) and (2), therefore, Explanation-I to Section 37 of the Act came into the statute book with retrospective effect from 01.04.1962 through the Finance (No.2) Act 1998, added the Top Court.

Speaking for the Bench, Justice Shah highlighted that Explanation-I makes a declaration to remove any possible doubts to reckon a loss suffered in the form of expenditure for any purpose which is an offence or one that is prohibited by law. It seeks to prohibit a deduction of any expenditure incurred by an assessee for any purpose which is an offence or which is prohibited by law.

However, there is no difficulty in holding that the word ‘any expenditure’ mentioned in Section 37 of the Act takes in its sweep loss occasioned during business, as well, added the Bench.

The Top Court however made it clear that if a loss in pursuance to an offence or prohibited business cannot be brought under Section 115BBE of the Act for income assessed under 68, 69 and 69A to 69D of the Act, which deals with unexplained income, expenditure etc., it can never be said that the same would be brought under Section 37(1) of the Act, even though the objective behind both the provisions are overlapping with some connection.

Accordingly, the Apex Court concluded that there cannot be a situation where an assessee carrying on an illegal business can claim deduction of expenses or losses incurred during that business, while another assessee carrying on a legitimate one cannot seek deduction for loss incurred on account of either a confiscation or penalty.

Cause Title: CIT vs. Prakash Chand Lunia [Civil Appeal Nos. 7689-90 Of 2022 / 2023-Enterslice-8-SC-IT]

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