Kalpesh Classes

The taint of illegality of the business cannot detract from the losses being taken into account for the computation of​​ the taxable profits.​​ 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 a business and that cannot be done without deducting the losses and legitimate expenses of the business. For the purpose of section 28, the losses which have actually been incurred in carrying on a particular illegal business must be deducted before the true figure relating to profits which have to be brought to tax can be computed or determined. But the loss for​​ which deduction is claimed must be one that springs directly from the carrying on of the business and is incidental to it. If this is established, the deduction must be allowed provided that there is no provision against it, express or implied, in the Act​​ - CIT V/s. S.C. Kothari [1971] 82 ITR 794 (SC).

 If the activity of smuggling can be regarded as a business, those who are carrying on that business must be deemed to be aware that a necessary incident involved in the business is detection by the customs​​ authorities and the consequent confiscation of currency notes. The confiscation of the currency notes is a loss occasioned in pursuing the business; it is a loss in much the same way as if the currency notes had been stolen or dropped on the way while carrying on the business. It is a loss which springs directly from the carrying on of the business and is incidental to it - CIT V/s. Piara Singh [1980] 124 ITR 40 (SC).

Profits and gains which are liable to be taxed under section 28 are what are understood to be such under ordinary commercial principles. When a claim is made for a deduction for which there is no specific provision in the Act, whether it is admissible or not will depend on whether, having regard to accepted commercial practice and trading principles, it can be said to arise out of the carrying on of the business and to be incidental to it. If that is established, then the​​ deduction must be allowed, provided of course there is no prohibition against it, express or implied, in the Act - Badridas Daga V/s. CIT [1958] 34 ITR 10 (SC).

Loss in illegal business:

​​ The losses which have actually been incurred in carrying on a particu­lar illegal business must be deducted in computing taxable profit of that business. Thus, a smuggler of gold or currency is entitled to claim the loss arising from the confiscation of gold or currency [CIT v. Piara Singh (1980) 124 ITR 40 (SC)].

The Explanation to Sec. 37(1) inserted retrospectively from the commencement of the Act is confined only to disallowance of an expenditure for prohibited purposes. It does not apply to "Loss" which is different from "an expenditure". [Dr. T.A. Qureshi v. CIT (2006) 157 Taxman 514 (S.C.)]

272 ITR 0626- ​​​​ CIt vs. Hiranand (Raj)

If the business is illegal, neither the profits earned nor the losses incurred would be enforceable in law. But, that does not take the profits out of the taxing statute. Similarly, the taint​​ of illegality of the business cannot detract from the losses being taken into account for computation of the amount which can be subjected to tax as “profits”.

Expenditure, which would constitute offence is specifically disallowed under the Explanation to section 37(1). Losses suffered on infringement of any law is being disallowed except in rare cases, where such violation is innocent and the amount payable is compensatory in character. But where the assessee is carrying on illegal business, there is no bar for deduction of loss or expenses as decided in CIT v. S. C. Kothari [1971] 82 ITR 794 (SC) and CIT v. Piara Singh [1980] 124 ITR 40 (SC).​​ Where gold is carried by professional carrier from whom it is confiscated, such loss has been allowed in the latter case. It is this law, which was followed in CIT v. Hiranand [2005] 272 ITR 626 (Raj), where the Tribunal found that the assessee was carrying on illegal business of​​ smuggling, notwithstanding his claim to the contrary, as evident from the previous convictions and incarceration. It was in this context that the loss on account of confiscation of gold was a loss, which had to be allowed. The question of allowing the loss arose because the confiscated gold was treated as an unexplained asset, the source of which was treated unexplained, because the assessee claimed that the confiscated gold did not belong to him. The amount treated as income now stood cancelled by the loss. Such decisions bring out the anomaly of our laws.