Facts of the Case

The assessee, M/s DLF Universal Ltd., claimed a loss of Rs. 2,08,774/- in its return for Assessment Year 1982-83 on account of embezzlement committed by an employee posted at its Ahmedabad Branch.

The Assessing Officer disallowed the claim on the ground that the loss was not connected with normal business activities.

In appeal, the Commissioner of Income Tax (Appeals) disagreed with the Assessing Officer and held that embezzlement of business funds by an employee while discharging official duties constituted a business loss and was generally allowable as a deduction.

However, the Commissioner (Appeals) further held that the deduction could not be allowed in Assessment Year 1982-83 because the assessee had failed to establish that all possible efforts for recovery of the embezzled amount had been exhausted and that recovery was no longer possible.

The Income Tax Appellate Tribunal affirmed the view of the Commissioner (Appeals), relying upon the Supreme Court judgment in Associated Banking Corporation of India Ltd. v. CIT (56 ITR 1).

The matter was thereafter referred to the Delhi High Court.

Issues involved

  1. Whether the Income Tax Appellate Tribunal was correct in holding that the embezzlement loss of Rs. 2,08,774/- was not allowable in Assessment Year 1982-83 merely because the loss was discovered during that year.
  2. Whether an embezzlement loss can be claimed as a deduction before the assessee establishes that recovery of the embezzled amount is no longer reasonably possible.
  3. In which assessment year should a business loss arising from embezzlement be allowed under the Income-tax Act.

Petitioner’s Arguments

The assessee contended that:

  • The loss arose due to embezzlement committed by its employee while handling business funds.
  • Such loss was directly connected with the conduct of business and therefore constituted an allowable business loss.
  • Since the embezzlement was discovered during Assessment Year 1982-83, the deduction ought to be allowed in that year itself.
  • The loss had effectively crystallized upon discovery of the embezzlement.

Respondent’s Arguments

The Revenue argued that:

  • Mere discovery of embezzlement does not automatically result in an allowable business loss.
  • The assessee must establish that all reasonable and possible steps for recovery have been taken.
  • So long as there remains a reasonable prospect of recovery from the defaulting employee, the loss cannot be treated as having finally occurred in the commercial sense.
  • Reliance was placed on the Supreme Court decision in Associated Banking Corporation of India Ltd. v. CIT (56 ITR 1), which laid down that such loss becomes deductible only when it is established that recovery is not possible despite all recovery efforts.

Court Findings

The Delhi High Court observed that the Supreme Court in Associated Banking Corporation of India Ltd. v. CIT (56 ITR 1) had clearly held that embezzlement does not automatically result in a deductible trading loss at the moment it occurs or even when it is discovered.

The Court emphasized that:

  • A business loss due to embezzlement can be recognized only when there is no reasonable prospect of recovery.
  • If there remains any reasonable possibility of restitution from the employee, the loss cannot be regarded as final in the commercial sense.
  • The burden lies upon the assessee to demonstrate that all possible measures for recovery have been exhausted.

The Tribunal had recorded a factual finding that the assessee had failed to prove that recovery efforts had been exhausted and that there was no possibility of recovering the embezzled amount.

Since this factual finding remained unchallenged, the High Court held that the loss was not allowable in Assessment Year 1982-83.

Court Order

The Delhi High Court answered the reference:

In favour of the Revenue and against the Assessee.

The Court held that the claim for deduction of embezzlement loss was rightly disallowed in Assessment Year 1982-83 because the assessee had not established that recovery of the embezzled amount had become impossible despite exhausting all available remedies.

Important Clarification

This judgment reiterates the settled principle that:

  • Embezzlement loss is a permissible business loss.
  • However, deduction is not available merely because the embezzlement occurred or was discovered.
  • The relevant year for claiming deduction is the year in which the assessee establishes that recovery of the amount is no longer reasonably possible.
  • The existence of a reasonable chance of recovery postpones recognition of the loss for tax purposes.
  • The burden of proving irrecoverability rests upon the assessee.

Sections Involved

  • Section 28 of the Income-tax Act, 1961 (Profits and Gains of Business or Profession)
  • Principles governing deduction of business losses under the Income-tax Act
  • Judicial principles laid down in Associated Banking Corporation of India Ltd. v. CIT (56 ITR 1, Supreme Court)

Link to download the order -https://delhihighcourt.nic.in/app/case_number_pdf/2010:DHC:4332-DB/AKS01092010ITR4951992.pdf

Disclaimer

This content is shared strictly for general information and knowledge purposes only. Readers should independently verify the information from reliable sources. It is not intended to provide legal, professional, or advisory guidance. The author and the organisation disclaim all liability arising from the use of this content. The material has been prepared with the assistance of AI tools.