Supreme Court disallows confiscation loss incurred while carrying on legal business

This tax alert summarizes a recent two-judge bench Supreme Court (SC) decision in the case of Prakash Chand Lunia (D) Thr.Lrs. & Anr  (Taxpayer) wherein the issue before the SC was whether loss incurred on account of confiscation of silver bars, owned by the Taxpayer who was engaged in legitimate jewelry business, is allowable as deduction.

The SC set aside the underlying Rajasthan High Court ruling which allowed such loss by placing reliance on the SC decision of CIT v Piara Singh  (three-judge bench). Both judges held that the confiscation loss incurred by the Taxpayer while carrying on legal business is not allowable. However, both judges passed separate judgements providing separate reasons for arriving at such conclusion.

The first judge held that the present case is distinguishable from ratio of Piara Singh ruling since the Taxpayer, in the present case, incurred confiscation loss while carrying on legal business whereas in Piara Singh ruling the taxpayer incurred confiscation loss while carrying on illegal business of smuggling. Hence, the loss is not allowable in the present case.

However, the second judge charted a different path of reasoning to disallow the loss. He held that insertion of an Explanation in 1998 with retrospective effect from inception of the current income tax law and amendment in 2016 to deny set off of loss against undisclosed incomes are significant developments. The Explanation denies deduction in respect of any expenditure incurred by a taxpayer for any purpose which is an offence or prohibited by law. This reflects the position that loss incurred by confiscation or penalties/fines for infraction of law is not allowable whether incurred while carrying on legal business or illegal business. To that extent, the three-Judge Bench SC ruling in Piara Singh’s case and two-judge bench SC ruling in Dr. T. A. Quereshi v. CIT  (rendered after noticing the Explanation) which allowed such loss where taxpayers were carrying on illegal business are per incuriam and not binding precedents.