Holding

A loss arising from seizure of stock in trade, even if the stock consists of illegal goods, is allowable as a business loss and Section 37, which governs business expenditure, does not preclude such deduction.

Summary

The appellant, a medical practitioner, was arrested for manufacturing and selling heroin, and the seized heroin was claimed as a loss in his income‑tax return on the ground that it formed part of his stock in trade. The assessing officer disallowed the claim, treating the amount as income from undisclosed sources, and the revenue upheld this view in the appellate tribunal. The Income Tax Appellate Tribunal, after a procedural correction, held that the seized heroin constituted stock in trade and allowed a deduction of Rs 2 lakh as a business loss. The High Court set aside the tribunal’s order, relying on the explanation to Section 37 of the Income Tax Act that expenses incurred in illegal activities are not deductible, and rejected the deduction on moral grounds. The Supreme Court, however, held that once a factual finding establishes that the seized heroin was stock in trade, the loss is a business loss allowable under ordinary commercial principles, and that Section 37, which deals with business expenditure, does not apply. Consequently, the Court restored the tribunal’s order and allowed the appeal.

Issues considered

Whether possession of heroin in contravention of the NDPS Act can be treated as stock in trade possessed by a medical practitioner
Whether such a medical practitioner is entitled to deduct the value of the seized heroin as a business loss
Whether the order of the Income Tax Appellate Tribunal is perverse and illegal
Whether Section 37 of the Income Tax Act, 1961 bars deduction of loss arising from illegal stock

Legislation cited

Income Tax Act, 1961s. 254(2), s. 37
Narcotic Drugs and Psychotropic Substances (NDPS) Act, 1985

Subjects

business lossstock in tradetax deductionillegal businessIncome Tax ActSection 37heroin seizuremoral vs legal considerationsNDPS Act

Judgment

....
DR. T. A. QUERESHI A
v.
COMMISSIONER OF INCOME TAX, BHOPAL

DECEMBER 6, 2006

[S.B. SINHA AND MARKANDEY KATJU, JJ.] B

Income Tax Act, 1961-Computation of profits and gains of business/
profession-Assessee engaged in manufacture and selling of heroin-Seizure
of heroin-Deduction, claim of-Applicability of section 37-Held: Seizure C
of heroin formed part of stock in trade of assessee-Thus, entitled to claim
deduction as a business loss on account of seizure-Section 37 relates to
business expenditure, thus not applicable-Section 37.

Jurisprudence-Legal principles vis-a-vis morality-Held: Law is
different from morality-Court has to decide cases on legal principles and D
not on one's own moral views.

The question which arose for consideration in this appeal was whether
the assessee could claim that the heroin seized from him formed part of his
stock in trade and hence its loss on account of seizure is an allowable
deduction as a business loss while computing his profits and gains of E
business/profession.

Allowing the appeal, the Court

HELD: 1.1. The Income Tax authorities recorded a finding that the
assessee was engaged in manufacture and selling of heroin. Once such a F
finding of fact is recorded, it follows that any loss from such a business is a
business loss. The tribunal recorded a finding that the assessee was doing
the business of manufacture and sale of heroin and that the heroin seized
was the assessee's stock in trade. In view of this finding, the tribunal rightly
allowed the assessee's claim of deducting the loss of heroin as a business G
loss. (314-G-H; 315-A)

1.2. Section 37 of the Income Tax Act, 1961 has no application to the
instant case since section 37 relates to business expenditure, and the instant
311
H
312 SUPREME COURT REPORTS [2006) SUPP. 10 S.C.R.
-
A case does not deal with business expenditure but with business loss. Business
losses are allowable on ordinary commercial principles in computing profits.
Once it is found that the heroin seized formed part of the stock in trade of
the assessee, it follows that the seizure and confiscation of such stock in trade
has to be allowed as a business loss. Loss of stock in trade has to be considered
B as a trading loss. Thus, the judgment of High Court cannot be sustained and
is set aside and the order of tribunal is restored. (315-G-H; 316-A-B)

C/Tv. Piara Singh, AIR (1980) SC 1271 and Commissioner of Jncome-
Tax v. S.N.A.S.A. Annamalai Chettiar, AIR (1973) SC 1032, relied on.

C 2. High Court has adopted an emotional and moral approach rather than
a legal approach. The High Court's order that the assessee was committing
a highly immoral act in illegally manufacturing and selling heroin is upheld.
However, cases are to be decided by Court on legal principles and not on one's
own moral views. Law is different from morality. 1315-F-G)

D CIVIL APPELLATE JURISDICTION : Civil Appeal No. 5635 of2006.

From the final Judgment and Order dated 29.11.2004 of the High Court
of Madhya Pradesh (Indore Bench) in LT.A. No. 33/l999.

M.L. Verma, Indu Malhotra and Vikas Mehta and Satya Mitra for the
E Appellant.

K.P. Pathak, A.S.G., T.A. Khan and B.V. Balaram Das for the Respondent.

The Judgment of the Court was delivered by
F
MARKANDEY KA TJU, J. Leave granted.

This appeal has been filed against the impugned judgment dated
29.11.2004 passed by the Madhya Pradesh High Court in LT.A. No. 33 of 1999.

G Heard learned counsel for the parties and perused the record.

The appellant is an assessee. He is a doctor by profession at a place
called 'Garoth' in District Mandsaur. On 18.7.1985, CBI sleuths arrested the
appellant while transporting a huge quantity of contraband article (the narcotic
H drugs heroin) in a Jeep (Jonga) RSO 3592. This led to further raid in his
T. A. QUERESHI '" COMMNR. OF INCOME TAX. BHOPAL [MARKANDEY KATJU,J.] 3 13
residential premises. In this raid, one clandestine laboratory to manufacture A
heroin powder along with several contraband drugs was recovered. All these
contraband articles were seized and proceedings under the NDPS Act were
initiated against the assessee. We are not concerned with these proceedings.

So far as proceedings under the Income Tax Act ~re concerned, with
which we are concerned, the assessee-appellant filed his return for the B
Assessment Year 1986-87. In this assessment the assessee claimed that since
the heroin seized from him forms part of his stock in trade hence its loss on
account of seizure is an allowable deduction while computing his profits and
gains of business/profession. The Assessment Officer by order dated 28.3.1989
did not accept the contention of the assessee and added a sum of Rs. C
5,50,0001-, being the assessed value of the heroin seized, as an income from
undisclosed source. In appeal filed by assessee the CIT (Appeal) upheld the
order of Assessment Officer by his order dated 1.2.1990. The assessee then
filed a second appeal before the Tribunal. By its order dated 31.3 .1993 the
Tribunal reduced the value of the heroin seized to Rs.2 lacs, but refused to
deduct this amount from the assessee's income as a business loss, since D
according to the Tribunal the assessee had not claimed it as a business loss.
However, subsequently on an application under Section 254(2) the Tribunal
by order dated 26.4.1994 accepted that the assessee had in fact claimed it as.
a loss, and consequently it recalled its order dated 31.3.1993. Ultimately, the
Tribunal by order dated 14, l 0.1998 allowed the appeal and held that the E
assessee is entitled to claim the deduction as a business loss. In other words,
the Tribunal was of the view that since the seizure has resulted in loss in trade
hence, relying upon the law laid down by this Court in CIT v. Piara Singh,
124 ITR 40, the Tribunal allowed the deduction of Rs.2 lacs out of the gross
total income of the assessee. It is against this view of the Tribunal that the
revenue felt aggrieved and filed the appeal before the High Court which, as F
stated above, was admitted for final hearing on the following questions of
law:

1. Whether possession of heroin in contravention of provision of
the NDPS Act, 1985 can be treated to be stock and trade possessed
by a Medical Practitioner ? G
2. Whether such Medical Practitioner can be permitted to deduct
Rs. 2 lacs from such stock of heroin as loss during the trade ?

3. Whether the order passed by the Income Tax Appellate Tribunal,
Indore Bench in IT-272/89-90 for Assessment Year 1986-87 is
H
314 SUPREME COURT REPORTS [2006) SUPP. 10 S.C.R.

A perverse and illegal ?

By the impugned order the High Court allowed the appeal and set aside
the order of the Tribunal. Hence, this appeal.

In paragraph 7 of its judgment, the High Court has relied on the
B explanation to Section 37 of the Income T~x Act which states :

"S.37-Explanation - For the removal of doubts, it is hereby declared
that any expenditure incurred by an assessee for any purpose which
is an offence or which is prohibited by law shall not be deemed to
have been incurred for the purpose of business or profession and no
C deduction or allowance shall be made in respect of such expenditure".

Learned senior counsel for the appellant Mr. M. L.Verma, contended
that Section 37 of the Act has no application in this case since Section 37
relates to business expenditure, and in this case we are not concerned with
business expenditure but with business loss. We agree with this contention.
D
No doubt, it was initially contented by the assessee before the Income
Tax authorities that the apparatus for manufacturing heroin from opium did
not belong to the assessee but belonged to one V. T. Madan. However, the
Assessing Officer did not agree with this contention and the Tribunal in its
earlier order dated 3 l.3.1993 has recorded a finding (in paragraph 7 of its
E order) that the assessee was involved in the manufacture and selling of heroin
for material gain. Thus, it has been held by the Income Tax authorities that
the appellant was engaged in manufacture of heroin and selling it for material
gain.

F No doubt, the assessee had contended that he was only earning income
from his medical profession and was not doing any illegal activity of
manufacturing and selling of heroin. However, the finding of fact of the
Tribunal in its order dated 3 l.3.1993 is that the assessee was engaged in
manufacture and selling of heroin. Thus the Income Tax authorities themselves
have recorded a finding that the assessee was engaged in manufacture and
G selling of heroin. No doubt the order of the Tribunal dated 31.3.1993 was
subsequently recalled by the Tribunal, but since with ultimate order dated
14.10.1998 the Tribunal has held that the hero.in seized was the assessee's
stock in trade it is implicit that the Tribunal reiterated to view that the assessee
was doing the business of manufacture and sale of heroin.

H Once the Income Tax authorities records such a finding of fact, it
'· T.A.QUERESHI 1'.COMMNR.OFINCOMETAX,BHOPAL[MARKANDEYKATJU,J.] 315
follows that any loss from such a business is a business loss. A

- The facts of this case are squarely covered by the decision of this Court
in CIT v. Piara Singh, AIR (1980) SC 1271 which was a case of an assessee
carrying on smuggling activity and this Court held that the loss arising out
of confiscation of currency notes must be allowed as a business loss.
B
In the order of the Tribunal dated 14.10.1998 there is a finding of fact
in paragraph 8 to the effect that the heroin forms part of the stock in trade
of the assessee. In view of this finding, the Tribunal allowed the assessee's
claim of deducting the loss of 5 kg. of heroin whose ".alue was assessed by
the Tribunal at Rs. 2 lacs as a business loss.
c
We .fully agree with the view taken by the Tribunal.

The High Court, however, in paragraph 10 of its judgment observed:

"The assessee in this case was engaged in profession of doctor. He
had nothing to do with the contraband article-Heroin for carrying on D
his profession. It is an admitted fact that possession of Heroin is an
offence under NDPS Act. In this view, the rigour of explanation to
Section 37 was fully satisfied and hence the question claiming any
deduction for the value of seized article did not arise nor was an
assessee entitled to claim any such deduction who was bound in
indulging in such heinous and illegal business unconnected with his E
pious professional activity. Indeed, it was disgrace for a doctor
community where one doctor was found indulging in doing such kind
of activities against the humanity".

In our opinion, the High Court has adopted an emotional and moral
F
approach rather than a legal approach. We fully agree with the High Court
that the assessee was committing a highly immoral act in illegally
manufacturing and selling heroin. However, cases are to be decided by Court
on legal principles and not on one's own moral views. Law is different from
morality, as the positivist jurists Bentham and Austin pointed out.
G
As already observed above, the facts of the case are squarely covered
by the decision of this Court in CIT v. Piara Singh (supra).

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. Business
losses are allowable on ordinary commercial principles in computing profits. H
--
316 SUPREME COURT REPORTS [2006] SUPP. JO S.C.R.

A Once it is found that the heroin seized formed part of the stock in trade of
the assessee, it follows that the seizure and confiscation of such stock in
trade has to be allowed as a business loss. Loss of stock in trade has to be
considered as a trading loss vide Commissioner of Income-Tax v. S.N.A.S.A.
Annamalai Chettiar, AIR (1973) SC 1032.

B For the reasons given above, the impugned judgment of the High Court
cannot be sustained and it is hereby set aside and the order of the Tribunal
stands restored. The appeal is allowed. No costs.

N.J. ., Appeal allowed.