BUSINESS LOSS / TRADING LOSS |
Business income ID – 46 (JBC-009) |
Profits should be understood as Including Losses also
Profits and gains represent "plus income", whereas losses represents "minus income". Both positive and negative profits are of revenue character. Both must be taken into account in computing taxable income of an assessee [CIT v. Harprasad & Co. Pvt. Ltd (1975) 99 ITR 118 (SC)].
Basic conditions / principles
Under section 28, the trading loss of a business is deductible in computing the profits earned by a business. However, every loss is not so deductible unless it is incurred in carrying out the operation of the business and is incidental to the operation. Whether loss is incidental to the operation of a business is a question of fact to be decided on the facts of each case, having regard to the nature of the operations carried on and the nature of the risk involved in carrying them out. The degree of the risk or its frequency is not much relevance but its nexus to the nature of the business is material - CIT V/s. Nainital Bank Ltd. [1965] 55 ITR 707 (SC).
Allowance for Business Losses
Business losses, though fall outside the purview of Sec. 30 to 43D, may be allowed under this section on the basis of ordinary commercial principles provided following conditions are satisfied:
(i) Losses are not of capital nature [Mandani v. CIT 161 ITR 165 (SC)]. (ii) They are not merely connected with the trade but are incidental to the trade itself [CIT v. Textile 135 ITR 200, CIT Sedhu 212 ITR 92)]. (iii) There is no provision, direct or indirect, against such deduction. These principles were affirmed by Supreme court in Badri Das Daga v. CIT (1958) 34 ITR 10 and CIT v. Nainital Bank Ltd. 55 ITR 707.
If there is a direct and proximate nexus between the business operation and the loss, such loss is deductible because without business operation and without doing all that is incidental to it, no profit can be earned. It is in this scene that such a loss is considered as trading loss from commercial standard and becomes deductible from the total income [Ram Chandar Shiv Narain v. CIT (1978)111ITR 263 (SC)].
Embezzlements
A claim for deduction of loss due to embezzlement cannot be admitted under section 37(1), because moneys which are withdrawn by an employee out of the business without authority and in fraud of the proprietor can in no sense be said to be ‘an expenditure laid out or expended wholly and exclusively’ for the purpose of the business - Badridas Daga V/s. CIT [1958] 34 ITR 10 (SC); Associated Banking Corporation of India Ltd. V/s. CIT [1965] 56 ITR 1 (SC). However it can be allowed as per 28.
Loss by embezzlement/theft
If employment of agents is incidental to the carrying on of business, it must logically follow that losses which are incidental to such employment are also incidental to the carrying on of the business. Human nature being what it is, it is impossible to rule out the possibility of an employee taking advantage of his position as such employee and misappropriating the funds of his employer, and the loss arising from such misappropriation must be held to arise out of the carrying on of business and to be incidental to it. And that is how it would be dealt with according to ordinary commercial principles of trading. It should however be emphasised that the loss for which a deduction could be made under section 28 must be one that springs directly from the carrying on of the business and is incidental to it and not any loss sustained by the assessee, even if it has some connection with his business - Badridas Daga V/s. CIT [1958] 34 ITR 10 (SC).
The theory that when once moneys are put into the bank they have got home, and that their subsequent withdrawal from the bank would be de hours the business will be altogether out of place in a business such as banking. It will be a wholly unrealistic view to take of the matter to hold that the realisations have reached the till when they are deposited in the bank, and that marks the terminus of the business activity in money-lending. Therefore, loss due to embezzlement by employee after the money has reached the till in banking/money lending business cannot be out rightly disallowed on the sole ground that it was not incurred in the course of business - Badridas Daga V/s. CIT.
Cash is a stock-in-trade of a banking business and its loss in the course of its business under varying circumstances is deductible as a trading loss in computing the total income of the business. A loss incurred due to dacoity in the banking premises is thus an allowable deduction - CIT V/s. Nainital Bank Ltd. [1965] 55 ITR 707 (SC).
Payment relating to third party’s business
In order that a loss may be deductible it must be a loss in the business of the assessee and not payment relating to the business of somebody else which under the provisions of the Act is deemed to be and becomes the liability of the assessee. Thus, where an agent of a non-resident paid the tax liability of the non-resident but was unable to recover it from the non-resident, the agent could not claim the irrecoverable amount as a business loss - CIT V/s. Abdullabhai Abdulkadar [1961] 41 ITR 545 (SC).
Loss of stock-in-trade:
A loss of stock-in-trade occasioned by enemy action or by ravages of white ants or by fire or by negligence or fraud of employees or by natural causes or loss of stock-in-trade in transit is deductible as a trading loss. If the assessee, for reasons beyond his control, cannot prove the exact amount of stock-in-trade destroyed, the loss may be estimated from such materials as are available.
Any compensation received in lieu of loss of stock-in-trade is a trading receipt [CIT v. S.N.A. S.A. Annamalai Chettiar (1972) 86ITR 607 (SC)]. For example, an assessee mortgaged his stock-in-trade to secure loan. The stock-in-trade was damaged in the custody of bank. The assessee was awarded compensation by the bank for the damage caused to the stock-in-trade. The compensation is taxable as the income of the previous year in which it is received [Ramesh Narain Saxena and others v. CIT (1996) 220 ITR 19 (SC)].
Loss through embezzlement by employee or agent:
A business is normally carried through employees and agents. Human nature being what it is, it is impossible to rule out the possibility of an employee taking advantage of his position and misappropriating the funds of his employer. An amount embezzled by the assessee's employee or agent is deductible in computing business profits. Loss caused by embezzlement is allowable as a deduction not necessarily in the year, in which the embezzlement takes place, but when there is no reasonable chance of obtaining restitution and the amount is found to be irrecoverable [Associated Banking Corporation of India Ltd. v. CIT (1965) 56 ITR 1 (SC)].
Non-recovery of advance, made during the course of business:
Where the assessee makes an advance during the course of the business and such advance is not recovered, the loss arising on account of non-recovery of such advance is allowable as a trading loss.
The assessee carried on the business of film distribution. He purchased distribution rights of a film for Rs 7,50,000. On the request of the producer, the assessee advanced Rs 1,10,000 as a loan to him for completion of the film. The picture failed at the box-office and the producer could not repay the loan amount. Non-recovery of advance is allowable as a trading loss. The advance was made during the course of business for completion of the film, failing which the assessee would have lost Rs 7,50,000 [CIT v. Cresent Films (P) Ltd. (2001) 248 ITR 670 (Mad.)].
Loss by robbery or theft:
If the loss of cash by theft or robbery is incidental to the operations of the business such loss is deductible in computing taxable profits of business or profession. For instance, when an employee who is entrusted with funds for purpose of distribution amongst sugar cane growers in accordance with statutory rules, is robbed of them on the way, the loss is deductible [Motipur Sugar Factory Ltd. v. CIT (1955) 28 ITR 128 (Pat.)]. If stolen moneys which are allowed as a deduction in any year are subsequently recovered, such receipts are taxable as the income of the previous year in which stolen moneys are received [Sec. 41(1)]. Similarly, when an assessee or his employee carrying cash to bank is robbed on the way such loss is an allowable deduction.
Likewise, the loss of cash in the robbery committed at night in the bank premises is an allowable deduction as a bank is under statutory obligation to maintain a certain amount of cash at the close of the business everyday [CIT v. Nainital Bank Ltd. (1965) 55 ITR 707 (SC)]. Similarly, keeping cash is found inevitable to carry on business operations on the next day, loss of cash due to theft or burglary in factory premises during or after working hours is deductible [CIT v. Surya Sugar Mills (P)ltd. (1968) 70 ITR 109 (All.)]. Also, see Ramachandar Shivanarayan v. CIT (1978) 111 ITR 263 (SC)].
Loss incurred as surety:
When a trader stands surety for the debt of another and such guarantee is not for the purpose of the trade, any payment made as a result of such guarantee cannot be deducted as a business loss. For instance, when money is borrowed jointly by two or more persons, and one of them has to pay the creditor on the failure of the other party to repay, the payer cannot deduct the money so paid as trading loss. But where the finding is that there is mutuality and custom to borrow money on joint promotes for carrying on business, such loss is deductible as trading loss [CIT v. Jagannath Kishanlal (1961) 41 ITR 360 (SC)].
Loss of security deposit
Loss arising from forfeiture of security deposit as a result of non-performance of a trading contract is deductible as a trading loss [Narandas Mathuradas & Co. v. CIT (1959) 35 ITR 461 (Bom.)]. On the other hand, profit arising from the forfeiture of security deposits during the course of business dealings is revenue receipt and is included in total income [Atlas Cycle Industries Ltd. v. CIT (1982) 133 ITR 231 (P&H)].
Chit fund loss
The deduction of chit fund loss is judicially controversial. One view is that where an assessee subscribes to a chit and bids the chit after paying a few instalments, the difference of chit fund amount and the price paid for the bid is deductible as business loss [CIT v. Kovue Textiles and Co. Ltd. (1982) 136 ITR 61 (AP)]. The other view is that the discount incurred in obtaining the chit is not deductible because of mutuality among contributors and participators. Once the principle of mutuality is established, the surplus is not chargeable to tax as no one can make profits out of himself. Hence, the contributions to chit fund cannot be treated as revenue expenditure. Similarly, the receipt from the fund cannot be treated as business activity. The transaction does not give rise to any income assessable to income tax nor any revenue loss, hence, no deduction can be allowed [Soda Silicate and Chemical Works v. CIT (1989) 179 ITR 588 (P&H)].
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