Andhra Pradesh H.C : Whether, on the facts and in the circumstances of the case, the payment of Rs. 39,246 by the assessee in cash to the persons from whom he purchased smuggled goods can be said to be a payment made out of business expediency within the meaning of the second proviso to s. 40A(3) and is covered by r. 6DD(j) of the IT Rules, 1962, and is, therefore, deductible in computing the total income for the asst. yr. 1974-75?

Counsel Appeared

Y. Ratnakar, for the assessee : M.S.N. Murthy, for the Revenue

B.P. JEEVAN REDDY, J.:

The following question has been referred by the Tribunal under s. 256(1) of the IT Act, 1961: “Whether, on the facts and in the circumstances of the case, the payment of Rs. 39,246 by the assessee in cash to the persons from whom he purchased smuggled goods can be said to be a payment made out of business expediency within the meaning of the second proviso to s. 40A(3) and is covered by r. 6DD(j) of the IT Rules, 1962, and is, therefore, deductible in computing the total income for the asst. yr. 1974-75?”

2. On 26th Oct., 1973, the central excise and customs authorities searched the assessee’s business premises and found certain contraband commodities, like foreign cloth, cigarettes of foreign make and cloves. On 12th Dec., 1974, the assessee filed returns of his income for the asst. yrs. 1969-70 to 1974-75. In this case, we are concerned with the asst. yr. 1974-75. For this year, the assessee disclosed an income of Rs. 255 only. The assessee was carrying on business in soaps, etc. The ITO made certain additions to the income returned. One of such additions is “towards payments disallowed by invoking the provisions of s. 40A(3) of the IT Act—Rs. 39,246…” The ITO disallowed the said claim on the ground that the enquiries made by the Collector of Customs revealed that the parties from whom the assessee claimed to have purchased the said goods are all bogus. He held that the said expenditure is hit by the provisions of s. 40A(3). On appeal, the AAC held that, inasmuch as the assessee was engaged in the business of purchasing and selling smuggled goods, which is inherently an illegal business, he cannot be expected to observe or comply with the requirements of s. 40A(3). On the said basis, he held that the payment of purchase consideration in cash by the assessee for the said contraband goods was dictated by business expediency, as the sellers, in order to conceal their identity, insisted upon cash payment only. He held that the ITO was not justified in disallowing the said deduction claimed with reference to s. 40A(3) of the Act. The Revenue carried the matter in appeal to the Tribunal. The Tribunal opined that s. 40A(3) has been introduced in the statute only with a view to regulate business activities and to prevent unaccounted money being used for clandestine transactions, that the measure was conceived in the interest of the Revenue and national economy, and that, therefore, the AAC was in error in holding that s. 40A(3) has no application to such illegal business. The Tribunal also held that r. 6DD cannot come to the rescue of the assessee herein. Accordingly, it reversed the order of the AAC and upheld the ITO’s order disallowing the said claim for deduction. Thereupon, the assessee asked for and obtained this reference.

3. Sec. 40A(3), in so far as it is relevant, reads as follows: “40A(3) Where the assessee incurs any expenditure in respect of which payment is made, after such date (not being later than the 31st day of March, 1969) as may be specified in this behalf by the Central Government by notification in the Official Gazette, in a sum exceeding two thousand five hundred rupees otherwise than by a crossed cheque drawn on a bank or by a crossed bank draft, such expenditure shall not be allowed as a deduction:…… Provided further that no disallowance under this sub- section shall be made where any payment in a sum exceeding two thousand five hundred rupees is made otherwise than by a crossed cheque drawn on a bank or by a crossed bank draft, in such cases and under such circumstances as may be prescribed, having regard to the nature and extent of banking facilities available, considerations of business expediency and other relevant factors….”

As contemplated by the second proviso to sub-s. (3) of s. 40A, r. 6DD has been made. In so far as it is relevant, r. 6DD reads as follows: “6DD. Cases and circumstances in which payment in a sum exceeding two thousand five hundred rupees may be made otherwise than by a crossed cheque drawn on a bank or by a crossed bank draft.— No disallowance under sub-s. (3) of s. 40A shall be made where any payment in a sum exceeding two thousand five hundred rupees is made otherwise than by a crossed cheque drawn on a bank or by a crossed bank draft in the cases and circumstances specified hereunder, namely:—…. (j) in any other case, where the assessee satisfies the ITO that the payment could not be made by a crossed cheque drawn on a bank or by a crossed bank draft— (1) due to exceptional or unavoidable circumstances, or (2) because payment in the manner aforesaid was not practicable, or would have caused genuine difficulty to the payee, having regard to the nature of the transaction and the necessity for expeditious settlement thereof, and also furnishes evidence to the satisfaction of the ITO as to the genuineness of the payment and the identity of the payee.” A reading of sub-s. (3) of s. 40A of the Act and r. 6DD shows that the ITO is not entitled to allow as deduction any expenditure said to have been incurred by the assessee, in respect of which payment is made in a sum exceeding Rs. 2,500 otherwise than by a crossed cheque drawn on a bank, or by a crossed bank draft, except in the cases mentioned in r. 6DD. Clause (j) of r. 6DD provides that a payment made otherwise than by a crossed cheque drawn on a bank, or by a crossed bank draft, can be allowed in certain situations specified therein, viz., (i) payment being made in cash due to exceptional or unavoidable circumstances, (ii) payment by cheque or draft is not practicable in the circumstances, or would have caused genuine difficulty to the payee, having regard to the nature of the transaction and the necessity for expeditious settlement of the transaction. In either case, however, it is necessary to establish the genuineness of the payment and the identity of the payee. Mr. Y. Ratnakar, learned counsel for the assessee, urged the following contentions: (i) where the very business carried on by the assessee is an illegal business, like the one concerned herein, it is not possible to comply with the requirements of s. 40A(3); it would not be reasonable to expect the assessee to comply with the said provision in the case of such a business; (ii) so long as the assessee is able to establish the cost of acquisition of the goods in question, he cannot, in the very nature of things, be called upon to establish either the genuineness of the payment or the identity of the payee. Calling upon him to do so is to ask for the impossible in the circumstances. In this case, the ITO has not disputed the assessee’s claim that the cost of acquisition is Rs. 39,246. That by itself should be sufficient to allow the deduction having regard to the nature of the transaction, nay, the very nature of business; and (iii) that the contraband goods have actually been confiscated by the customs authorities. The result is that the assessee has lost the goods altogether and now the said sum of Rs. 39,246 is being added back to his income. It amounts to a double penalty upon the assessee.

6. There is no doubt about the proposition that profits and gains derived from an illegal business can also be taxed. The reasons for doing so are discussed and set out in some detail in the decision of this Court in CIT vs. Maddi Venkataratnam & Co. Pvt. Ltd. (1983) 35 CTR (AP) 87 : (1983) 144 ITR 373 AP) : TC18R.504 to which one of us (Jeevan Reddy, J.) was a party. Indeed, it is not disputed by the assessee herein that the profits and gains derived by him from the illegal business carried on by him are liable to be taxed. If so, the income can be taxed only under, and in accordance with, the provisions of the IT Act. Once the Act applies and the taxable income has to be determined in accordance with the provisions thereof, it is not possible to hold that some of the provisions of the Act do not apply to the assessment of taxable income in the case of an illegal business, while some others do. In other words, we do not find it possible to draw a distinction between the several provisions of the Act, one set applying to the assessment of income arising from illegal business and the other set of provisions not applying thereto. May be that in an illegal business, like smuggling, it may not be practicable to comply with the requirements of sub-s. (3) of s. 40A, but that only means that such illegal business ought not to be carried on. It is a business prohibited by law. By taxing its income, it is not legalised or validated. We are, therefore, unable to agree with Mr. Ratnakar that sub-s. (3) of s. 40A cannot apply to a business carried on illegally.

We are also of the opinion that the only circumstances in which compliance with the requirements contained in s. 40A(3) can be dispensed with are those stated in r. 6DD of the IT Rules. Unless a payment falls within one or the other clauses of r. 6DD, he has necessarily to comply with the requirements of s. 40A(3). Further, if an assessee says that he is entitled to take advantage of a particular clause in r. 6DD, he must satisfy the requirements of that clause, which means that, in this case, the assessee who is seeking to claim the benefit of cl. (j) in r. 6DD, has not only to satisfy that having regard to the nature of the business there was a genuine difficulty in complying with the requirements of s. 40A(3), but he must also establish the genuineness of the payment and the identity of the payee. Unless he does that, he cannot take advantage of cl. (j). It is not open to the assessee to say that he will only partly satisfy the requirements of cl. (j) and would still be entitled to the benefit of the said clause. We may make it clear that the satisfaction that is relevant in such cases is the satisfaction of the ITO.

Mr. Y. Ratnakar relied upon a circular issued by the CBDT, being Circular No. 220, dt. 31st May, 1977. We have perused the said circular. It only elaborates and illustrates—though not exhaustively—the circumstances in which it is not practicable to comply with the requirements of s. 40A(3). The circular nowhere says that it is not necessary for a person claiming the benefit of r. 6DD(j) to establish the genuineness of the payment and the identity of the payee. On the contrary, the said requirement is repeatedly reiterated. We are, therefore, of the opinion that the said circular cannot in any manner advance the case of the assessee.

The result of the above discussion is that the Tribunal was justified in holding that the disallowance of the said claim for deduction by the ITO with reference to s. 40A(3), is perfectly in order.

Accordingly, we answer the question referred to us in the negative, i.e., in favour of the Revenue and against the assessee. We hold that the payment of Rs. 39,246 by the assessee to persons from whom he is said to have purchased the smuggled goods, is not covered by r. 6DD(j) of the IT Rules, 1962, and cannot, therefore, be deducted in computing his total income for the asst. yr. 1974-75.

9. With respect to the third contention of Mr. Y. Ratnakar, it is necessary to state a few facts: The sum of Rs. 39,246 consists of three items, viz., Rs. 4,498 said to be the cost of 50 kgs. of cloves purchased from Kamala Traders, Madurai; Rs. 16,068 said to be the cost of purchasing 200 kgs. of cloves from South Travancore Plantation Ltd., Nagarcoil, and Rs. 18,680 being the price of 467 cartons of cigarettes purchased from M/s Gulam Abbabhai, Bombay. The record placed before us shows that only 467 cartons of cigarettes have been confiscated, but not the cloves. (Besides cigarettes, a small quantity of textiles also have been confiscated, but no deduction was claimed on that account and, therefore, that aspect does not concern us herein). Now, the contention of Mr. Ratnakar is that by virtue of the confiscation of the cigarettes, the assessee has suffered the loss of their total value, and added to that, the sum of Rs. 18,680 is being added back as the income of the assessee. He says, merely because a deduction claimed is disallowed, it cannot be added back to the income of the assessee. It is not possible to agree with this contention. Indeed, we need not answer this contention. In this case, we are only concerned with the justifiability or otherwise of the disallowance of the deduction claimed by the assessee, in law, and we have upheld the same. What consequence follows in a given case is a matter of law which does not concern us in this reference. However, since the record placed before us shows that 467 cartons of cigarettes were confiscated and, at the same time, the cost price thereof, i.e., Rs. 18,680, appears to have been added back to the income of the assessee, it may be a proper case where the Tribunal, while passing final orders under s. 260 of the Act, may redetermine the assessee’s taxable income, after considering the question whether the value of the cigarettes confiscated can be treated as a business loss. It is, however, evident that the said exercise shall be done by the Tribunal on the basis of the material already on record.

There shall be no order as to costs.

[Citation : 173 ITR 340]