M/S.george Maijo & Co., (Vizag), Madras v. The Commissioner Of Income-Tax, Madras

IN THE HIGH COURT OF JUDICATURE AT MADRAS DATED: 18/09/2002 CORAM THE HONOURABLE MR.JUSTICE V.S.SIRPURKARandTHE HONOURABLE MR.JUSTICE N.V.BALASUBRAMANIAN T.C.No.1270 of 1988 M/s.George Maijo & Co., (Vizag),Madras. ..... Applicant -Vs- The Commissioner of Income-tax,Madras. ..... Respondent Reference arising out of the order of the Income-tax AppellateTribunal, Madras Bench-A, dated 15.12.1987 in ITA No.2867/Mds/85, at theinstance of the assessee. !For applicant :: Mr.P.P.S.Janarthana Raja ^For respondent :: Mr.T.C.A. Ramanujam, Sr.St.Counsel for IT. :ORDER N.V.BALASUBRAMANIAN,J. The assessee is a firm consisting of five partners. Theassessee with another firm, by name, M/s.George Maijo Associates formed aconsortium and constituted a partnership firm, called M/s.United Exports. TheUnited Exports is also a firm consisting of two partners, viz., AndrewG.Pattamana and Rita Joseph representing the assessee herein. The assessmentyear with which we are co ncerned is 1981-82 and the relevant previous yearfor the said assessment year ended on 30.6.198 0. In the accounts of theconsortium, United Exports for the year ending 30.6.1980 the assessee wasdebited with the share of expenditure incurred which included the cost ofcertain goods which was claimed to have been lost at high sea. Thetransaction relating to the loss of goods arose out of the import of P.V.C.Resin suspension Grade. The United Exports entered into a C.I.F. (cost,insurance, freight) contract on 11.6.1979 with M/s.Palmex Enterprises,Singapore for the import of 800 Metric tonnes (M.T.) of P.V.C. Resin at therate of 780 U.S. Dollar per M.T. The shipment was to be made by 30thSeptember,197 9 and payment was to be made by way of an irrevocable letter ofcredit. 2. The United Exports requested the Bank of India, Bombay to 2. The United Exports requested the Bank of India, Bombay to open a letter of credit and the bank issued a letter of credit for a sum ofRs.51,18,950/-. The United Exports took an insurance policy from the NewIndia Assurance Co. Ltd. for Rs.55 lakhs in respect of the goods as percover note No.25556 dated 29.6.1979 valid up to 29.9.1979 . On 17.8.1979,United Exports took another cover note for Rs.22 lakhs with New IndiaAssurance Co. Ltd. for profit insurance. The foreign seller, M/s.PalmexEnterprises presented the bills along with the copy of invoice, packing listand certificate of origin to the Bank of India for payment and the bank madethe payment on 21.8.1979. The United Exports then received a presentationmemo on 22.8.1979 from the bank informing the arrival of the documents. On12.9.1979, United Exports received a cable from M/s.Palmex Enterprises statingthat it was understood from the owners/agents of the vessel 'Averilla' thatthe vessel sank with cargoes on 8th September,1979 150 miles off Colombo.Therefore the United Exports did not retire the documents from the bank andinstead, the United Exports made a claim with New India Assurance Co. Ltd.and also filed a Summary suit No.800 of 1980 on the file of the High Court ofJudicature at Bombay against New India Assurance Co. Ltd. Since the amountwas not paid by the United Exports, the Bank of India also filed a Summarysuit No.1677 of 1981 on the file of the High Court, Bombay against the UnitedExports for recovery of the amount due to it. In the accounts of the UnitedExports for the year ending 30.6.1980, the value of the goods lost in transitamounting to Rs.51,18,950/- was reduced from the value of the closing stock.3. Subsequently, there was a C.B.I. enquiry and it was foundthat the ship, Averilla had sunk under mysterious circumstances and thepartners of M/s.Palmex Enterprises were prosecuted for an act of conspiracyalong with a partner of another concern, called M/s.Orient Enterprises beforethe Sessions Judge, Singapore and they were convicted. It is relevant tomention here that the import of P.V.C. Resin was undertaken at the instanceof Imperial Industrial Corporation which was a dummy for Orient Enterprises,though no concluded written agreement existed between United Exports andImperial Industrial Corporation. A sum of Rs.5 lakhs paid as advance byImperial Industrial Corporation was taken into account by United Exports sinceit was not demanded back by Imperial Industrial Corporation. The report ofthe C.B. I. revealed that the accused had conspired to obtain a second-handvessel in which they had loaded drums containing coloured water to pass it offas oil and packed rice-bran as other goods such as cloves and arranged withthe Captain to scuttle the ship in the high seas. In other words, inpursuance of the conspiracy, the United Exports was induced on behalf of adummy firm, M/s.Imperial Industrial Corporation showing it to be the actualuser of P.V.C. Resin for opening the letter of credit in favour of theSingapore firm. There were number of parties who were victims of theconspiracy and one of them was the United Exports.4. The assessee, on the basis of debit entry made by United Exports, claimed that a sum of Rs.51,18,232/- should be allowed as businessexpenditure. The Income-tax Officer rejected the claim of the assessee on theground that United Exports obtained the licence and it was only United Exportswho entered into an agreement with M/s.Orient Enterprises, New Delhi andM/s.Siraj & Co., Bombay for the import of P. V.C. Resin and Palm Oil. Healso found that only the United Exports opened the letter of credit with theBank of India and United Exports arranged for the insurance of goods and filedsuit against the insurance company. Accordingly, the Income-tax Officer was Exports, claimed that a sum of Rs.51,18,232/- should be allowed as businessexpenditure. The Income-tax Officer rejected the claim of the assessee on theground that United Exports obtained the licence and it was only United Exportswho entered into an agreement with M/s.Orient Enterprises, New Delhi andM/s.Siraj & Co., Bombay for the import of P. V.C. Resin and Palm Oil. Healso found that only the United Exports opened the letter of credit with theBank of India and United Exports arranged for the insurance of goods and filedsuit against the insurance company. Accordingly, the Income-tax Officer was of the opinion that the loss could be claimed only in the hands of M/s.UnitedExports and not in the hands of the assessee. He was also of the opinion thateven in the hands of United Exports the liability was not crystallised. TheInspecting Assistant Commissioner, who was associated in the assessmentproceedings, was also of the opinion that the consortium was nothing but agroup of certain parties with the object of achieving certain results forearning income. He was of the opinion that the United Exports did not act asan agent for the constituent units. He agreed with the Income-tax Officerthat it was the United Exports which had imported the goods and the loss sooccurred had to be considered in the hands of the United Exports. In otherwords, according to the Inspecting Assistant Commissioner, there was no directnexus between the loss occurred and the activities of the assessee. In thisview of the matter, the claim of the assessee for deduction for a sum ofRs.51,18,950/- was rejected. However, the Inspecting Assistant Commissionerin his order refer red to a figure of Rs.55,06 ,706/- instead ofRs.51,18,950/-. 5. The assessee filed an appeal against the order of assessment before the Commissioner of Income-tax (Appeals). The Commissionerof Income-tax (Appeals) found that the loss of Rs.55,06,706/- consisted of theactual loss on import of Rs.54,26,268/- and a sum of Rs.80,438/- beingexpenses incurred by the United Exports on behalf of the assessee. He heldthat the assessee entered into an agreement with the United Exports and theUnited Exports acted as a medium to channelise the export activities of themember units with the permission of the Government of India. He was of theview that after obtaining import entitlements on behalf of the member units,the goods were shipped and if any loss arose, the loss would be a loss ofstock-in-trade as far as the member units are concerned. He therefore heldthat the loss arose out of a completed transaction. He held that as far asBank of India is concerned, the transaction with regard to import wascompleted at the moment when it negotiated the letter of credit and paid theamount covered by the letter of credit and thereafter made a claim against theUnited Exports for full value despite the fact that the goods did not reachthe United Exports. He held that the loss in the transit has to be borne bythe importer. He held that the fact that goods never reached the assesseeshowed that the assessee could be deemed to have sustained the loss. As faras the liability of the Bank of India is concerned, the reason for non-arrivalof the goods is immaterial. He also found that the insurance claim wasrejected and therefore he held that the entire sum of Rs.55,06,706/- would beallowed as a deduction. The Commissioner of Income-tax (Appeals) allowed theappeal preferred by the assessee on this point. 6. The Revenue preferred an appeal challenging the order of 6. The Revenue preferred an appeal challenging the order of the Commissioner of Income-tax (Appeals) before the Income-tax AppellateTribunal. The Appellate Tribunal found that the report of the C.B.I. couldnot be ignored and the goods contracted to be purchased by the United Exportswere not actually put on board 'Averilla'. The Appellate Tribunal held thatthe bill of lading did not refer to the actual goods and hence, it is notpossible to accept the claim of the assessee that the closing account of theUnited Exports should be reduced by an amount equivalent to the value of thegoods. The Appellate Tribunal also found that the bank filed a suit and theUnited Exports also filed a suit against the Insurance Company. The AppellateTribunal was of the view that the right of the bank to receive payment is itself a dispute and consequently the liability cannot be said to have accruedin the previous year relevant to the assessment year in question. In thisview of the matter, the Appellate Tribunal felt that it is not necessary todecide the question whether the United Exports had actually suffered any realloss in the previous year by cheating and as long as the United Exports has arecourse both against the bank and the Insurance Company, it could not be saidthat the United Exports had actually incurred any loss. The AppellateTribunal also rejected the contention made on behalf of the Revenue that theloss incurred by the United Exports could not be allowed in computing theincome of the assessee. The Appellate Tribunal held that the United Exportsacted only as an agent and carried on the transaction for and on behalf of theconstituent units and all expenses or losses incurred by the United Exportshave to be borne by the principals, viz., the units. The Appellate Tribunaltherefore held that the admissible loss properly apportioned between the twoconstituent units has to be allowed in the hands of the assessee in computingthe income. The Appellate Tribunal therefore allowed the appeal preferred bythe Revenue. Dissatisfied with the order of the Appellate Tribunal, theassessee sought for a reference and the Appellate Tribunal has stated a caseand referred the following question of law for our consideration:-" Whether on the facts and circumstances of the case, the assessee isentitled to deduction of the sum of Rs.51,18,950/- being amount debited to itsaccount by United Exports and allocated to the assessee?" 7. Mr.P.P.S.Janarthana Raja, learned counsel for the assesseesubmitted that the Appellate Tribunal was not correct in holding that theassessee did not incur any liability during the previous year relevant to theassessment year in question. According to him, when the Appellate Tribunalhas accepted that there was a valid consortium and United Exports acted onlyas agent of the consortium, the assessee as a constituent of the consortium isentitled to the allowance of the amount debited to its account by the UnitedExports, that is, the share of expenditure incurred towards the goods whichwere lost at high sea. His submission was that the goods were stock-in-tradeof the assessee and so long as the assessee was not a party to the conspiracythat might have been entertained between the foreign seller, viz., PalmexEnterprises, Singapore and another concern, by name, Orient Enterprises, theassessee is entitled to get deduction of the share of expenses incurred inrelation to the loss of the goods. His submission was that the bank hasalready paid money and though the liability to the bank is disputed, theliability was incurred by the assessee during the previous year in questionand therefore the assessee is entitled to deduction. Learned counsel reliedupon the decision of the Supreme Court in KEDARNATH JUTE MFG. CO. LTD. v.C.I.T. (82 ITR 363) and submitted that the liability does not cease to be aliability because the assessee had taken proceedings before higher authoritiesfor getting it reduced or wiped out. Learned counsel also submitted thatduring the previous year, the bank paid the money and the bona fide of thetransaction is not disputed and when the Appellate Tribunal has accepted thatthe assessee's title to the goods transferred by delivery of document, viz.,bill of lading, it erred in applying the exception where there is nomisrepresentation or fraud on the facts of the case. Learned counselsubmitted that the assessee was cheated and when the loss occurred due to theloss of stock-in-trade to the assessee and when the liability arose during the previous year relevant to the accounting year in question, the assessee isentitled to claim the amount as deduction. He also relied upon the decisionof the Delhi High Court in C.I.T. v. BHARAT CARBON AND RIBBON MFT. CO.(239 ITR 505). 8. Mr.T.C.A.Ramanujam, learned counsel appearing for the department submitted that the department should have proceeded on the basisthat there was no consortium and the assessment should have been made on theassociation of persons. He submitted that the loss did not arise during theprevious year and accordingly, the debit is premature and since there was noascertained loss, the assessee is not entitled to get deduction. Learnedcounsel submitted that the debit entry is not helpful and since the loss hasto be ascertained, the assessee is not entitled to claim the deduction.Learned counsel relied upon the decision of this Court in VENKATACHALAPATHYIYER v. COMMR. OF INC.-TAX (20 ITR 363) and submitted that unless the lossis actual and certain, there could not be an accrual of loss. He thereforesubmitted that until settlement of the case by compromise, there is no loss atall and it is only then, that the loss would come into existence. Learnedcounsel also relied upon the following decisions:- 1. ASSOCIATED CLOTHIERS LTD. v. COMMR. OF INC.-TAX (63 ITR 224) 2. C.I.T. v. HINDUSTAN HOUSNG & LAND DEVPT. TRUST (161 ITR 524) 3. HOPKIN & WILLIAMS (TRAVANCORE) LTD. v. COMMR. OF INC.-TAX (64 ITR 76) 4. U.P.VANASPATI AGENCY v. COMMR. OF INC.-TAX (68 ITR 120) 5. COMMR. OF INC.-TAX v. SHEWBUX JAHURILAL (46 ITR 688) 9. At the outset, we mention that though Mr.P.P.S.Janarthana 1. ASSOCIATED CLOTHIERS LTD. v. COMMR. OF INC.-TAX (63 ITR 224) 2. C.I.T. v. HINDUSTAN HOUSNG & LAND DEVPT. TRUST (161 ITR 524) 3. HOPKIN & WILLIAMS (TRAVANCORE) LTD. v. COMMR. OF INC.-TAX (64 ITR 76) 4. U.P.VANASPATI AGENCY v. COMMR. OF INC.-TAX (68 ITR 120) 5. COMMR. OF INC.-TAX v. SHEWBUX JAHURILAL (46 ITR 688) 9. At the outset, we mention that though Mr.P.P.S.Janarthana Raja, learned counsel produced before us a copy of the letter of the AssistantGeneral Manager, Bank of India addressed to the United Exports, Chennaiconfirming that the suit instituted by the bank has been settled by payment,we are not referring to or placing any reliance on the said letter as theletter was not considered and could not have been considered by the AppellateTribunal as the settlement seems to have taken place subsequent to the orderof the Appellate Tribunal. We are of the view that in view of the decision inASSOCIATED CLOTHIERS LTD. v. COMMR. OF INC.-TAX (63 ITR 224), this Court ina reference under section 256 of the Income-tax Act has no power to admit orrecord additional evidence which has not been placed before the Tribunal andto consider that evidence. Hence, we ignore the letter produced by thelearned counsel for the assessee. 10. We also like to clear another matter also before proceeding further. The submission of Mr.T.C.A.Ramanujam, learned counsel forthe Revenue is that the department has committed an error in not proceedingagainst the United Exports and the assessee herein as well as the otherconstituent unit, and should have made an assessment on the consortium as anassociation of persons. We are not expressing any opinion as to what thedepartment should have done. We are also not expressing any opinion on thesubmission of the learned counsel for the Revenue and we are not inclined togive any direction also for making such an assessment. 11. Another point sought by Mr.T.C.A.Ramanujam, learned counsel for the Revenue is that the loss occurred is that of the United 10. We also like to clear another matter also before proceeding further. The submission of Mr.T.C.A.Ramanujam, learned counsel forthe Revenue is that the department has committed an error in not proceedingagainst the United Exports and the assessee herein as well as the otherconstituent unit, and should have made an assessment on the consortium as anassociation of persons. We are not expressing any opinion as to what thedepartment should have done. We are also not expressing any opinion on thesubmission of the learned counsel for the Revenue and we are not inclined togive any direction also for making such an assessment. 11. Another point sought by Mr.T.C.A.Ramanujam, learned counsel for the Revenue is that the loss occurred is that of the United Exports and it is not open to the assessee to claim the same in thecomputation of its income. We are of the view that it is not open to theRevenue to raise such a contention. We have already set out the facts. TheIncome-tax Officer as well as the Inspecting Assistant Commissioner in the taxassessment proceedings proceeded on the basis that the loss is that of theUnited Exports and if there is any loss, that could be claimed by the UnitedExports. The assessee preferred an appeal before the Commissioner ofIncome-tax (Appeals) and the Commissioner of Income-tax (Appeals) did notaccept that view and held that the Income-tax Officer and the InspectingAssistant Commissioner had not properly appreciated the circumstances in whichthe consortium was formed in order to get the benefit given by the Governmentfor the customers. The Commissioner of Income-tax (Appeals) held that theUnited Exports acted only as a medium to channelise the export activities ofthe member units and after the goods were shipped, if any loss arose, that wasa loss of stock-in- trade of the member units. The Commissioner of Income-tax(Appeals) therefore held that the assessee would be entitled to get deductionof the trading loss and allowed the appeal preferred by the assessee. TheRevenue has challenged the deduction in the hands of the assessee before theAppellate Tribunal and the Appellate Tribunal rejected the contention urged onbehalf of the Revenue that it was not the loss of the assessee, but that ofthe United Exports. The Appellate Tribunal found that the United Exportsacted only as an agent and the rules also permitted the United Exports tocarry on the transactions. The Appellate Tribunal also found that the profitson transactions were assessed in the hands of the constituent members andequally the loss should also be allowed as deduction in the hands of themembers. The Appellate Tribunal therefore held that the proportionate lossshould be divided between the two constituents and allowable in the hands ofthe assessee in the computation of its income. The finding of the AppellateTribunal has become final as the Revenue has not challenged the finding byfiling an independent reference application. Before the Appellate Tribunalthe Revenue lost its case on the question whether the business loss wasallowable in the hands of the assessee or not, and it is an independentquestion. Though the Appellate Tribunal decided that the loss is not abusiness loss in the previous year relevant to the assessment year inquestion, the Revenue could have asked for a reference on the question whetherit was a loss of the assessee or that of the United Exports. Further, therewas no application at all by the Revenue requesting the Appellate Tribunal torefer a question on the issue whether the loss is that of the assessee or thatof the United Exports. In the absence of any such question of law referred bythe Appellate Tribunal, we hold that it is impermissible for the Revenue toraise the question that the loss could not be claimed by the assessee at alland that the finding rendered by the Appellate Tribunal that it is open to theconstituent units to claim the loss has become final. 12. In this connection, we would also like to mention thatthere were two transactions and the Appellate Tribunal held that as regardsone transaction the loss was allowable in the hands of the assessee and in thecase of other transaction, which is subject matter of the present tax casereference, the Tribunal held that the loss did not accrue in the previousyear. The Appellate Tribunal independently went into the question and decidedthat the loss is that of the assessee and the United Exports acted only as anagent. Since the finding of the Appellate Tribunal has not been challenged by filing an independent reference application requesting the Tribunal to referthe question, in the absence of any question before us, it is not open to thelearned counsel for the Revenue to urge the point. This Court in E.I.D.PARRY LIMITED v. C.I.T. (174 ITR 11) has held that the Tribunal was notcompetent to refer a question suo motu and there must be an application eitheroral or written before the Tribunal. On the facts of the case, we find thatthere was neither an oral request, nor a written application before theTribunal and the Tribunal has also not referred a question as sought to becanvassed by the learned counsel for the Revenue. In the absence of anyapplication or reference by the Tribunal, we hold that it is not open to thelearned counsel for the Revenue to raise such a point in the reference at theinstance of the assessee. Accordingly, we decline to entertain the plea ofthe learned counsel for the Revenue. 13. Mr.T.C.A.Ramanujam, learned counsel for the Revenue strongly relied upon the decision of this Court in VENKATACHALAPATHY IYER v.COMMR. OF INC.-TAX (XX ITR 363). In that case, the assessee was a firmcarrying on business as yarn merchants and the assessee employed a clerk whowrote account books as well as acted as salesman. He also received anddisbursed cash in the absence of the managing partner and collected bills.The clerk noted the amounts received and spent by him in the course of the dayon slips of paper and handed over the slips with cash balance in his hands tothe managing partner at the close of the day. The clerk embezzled certainmoney and he entered the transactions in the books maintained by him, but heshort-totalled the receipts and over-totalled the payments and prepared astatement of daily cash balance on the basis of such wrong totals and handedover to the managing partner at the end of the day only the cash as per thatstatement. A criminal complaint was filed against him and a civil suit wasalso filed for recovery of the amount and the matter was compromised in themonth of August, 1941. The assessee claimed deduction of the amount embezzledin the assessment proceedings for the assessment year 1942-43. This Courtheld that though the misappropriation was found in 1941, the amount wasentered in the accounts as a debit against the clerk at the end of theprevious accounting year and until the settlement of the case by way ofcompromise, there was no loss at all. 14. Mr.T.C.A.Ramanujam, learned counsel also referred to the 14. Mr.T.C.A.Ramanujam, learned counsel also referred to the decision of the Supreme Court in ASSOCIATED BANKING CORPORATION OF INDIA LTD.v. C.I.T. (56 ITR 1) wherein it was held that so long as there is a prospectof recovery of the moneys embezzled, trading loss in the commercial sensecannot be deemed to have resulted with. In this connection he also relied onthe decision of the Kerala High Court in HOPKIN & WILLIAMS (TRAVANCORE) LTD.v. COMMR. OF INC.-TAX (LXIV ITR 7 6) and the decision of the Allahabad HighCourt in U.P.VANASPATI AGENCY v. COMMR. OF INC.-TAX (68 ITR 120) wherein itwas held that if the assessee made necessary attempts to recover the loss fromthe persons, but failed or if the assessee did not make such attempts becauseit was useless to make them in view of the financial position of the personconcerned, then and then alone the loss could be allowed. Learned counselrelied on those decisions and submitted that the assessee has not taken anystep to recover the money lost either from the United Exports or from theforeign seller and since the assessee has not taken steps to recover the loss,the loss could not be said to have occurred enabling the assessee to claimdeduction. 15. We are unable to accept the submission of the learned counsel for the Revenue. There is no dispute that the contract entered intowas a C.I.F. contract for the purchase of certain articles and the shipmentwas to be made on 30.9.1979 and payments were required to be made by anirrevocable letter of credit. The foreign seller issued sixteen bills oflading dated 6.8.1979 and presented the bills along with a copy of invoice,packing list and certificate of origin to the Bank of India for payment andthe bank made payment on 21.8.1979 and the united Exports also received apresentation memo on 22.8.1979 from the bank informing the arrival of thedocuments. Though we are not concerned with the question whether the bank wasright in making payment but for deciding the issues that arise in the case, weare of the opinion that the question of legal effect of opening letters ofcredit has to be considered. 16. The Supreme Court in number ofcases considered the legal effect of opening letters of credit and paymentsmade by the bank in pursuance of letters of credit. The followingobservations in U.P.C.F. LTD. v. SINGH CONSULTANTS AND ENGINEERS (P) LTD.(1988) I SCC 174) are relevant for the purpose of this case:- " 29. In Tarapore & Co., Madras v. M/s.V/O Tractors Export, Mascow (1969) 2 SCR 920: (1969) 1 SCC 233: AIR 1970 SC 891), this Court observedthat irrevocable letter of credit had a definite implication. It wasindependent of and unqualified by the contract of sale or other underlyingtransactions. It was a mechanism of great importance in international tradeand any interference with that mechanism was bound to have seriousrepercussions on the international trade of this country. The courtreiterated that the autonomy of an irrevocable letter of credit was entitledto protection and except in very exceptional circumstances courts should notinterfere with that autonomy. 31.The Court however observed that the opening of a confirmedletter of credit constituted a bargain between the banker and the seller ofthe goods which imposed on the banker an absolute obligation to pay. Thebanker was not bound or entitled to honour the bills of exchange drawn by theseller unless they and such accompanying documents as might be requiredthereunder, were in exact compliance with the terms of the credit. 44. The modern documentary credit had its origin from letters of credit. We may, therefore, begin the discussion with the traditionalletter of credit. Paul R.Verkuil in an article ('Bank Solvency and GuarantyLetters of Credit', Stanford Law Review, V.25 1972-73 at p.719 ) explains thesalient features of a letter of credit in these terms:The letter of credit is a contract. The issuing party – 44. The modern documentary credit had its origin from letters of credit. We may, therefore, begin the discussion with the traditionalletter of credit. Paul R.Verkuil in an article ('Bank Solvency and GuarantyLetters of Credit', Stanford Law Review, V.25 1972-73 at p.719 ) explains thesalient features of a letter of credit in these terms:The letter of credit is a contract. The issuing party – usually a bank – promises to pay the 'beneficiary' - traditionally a seller ofgoods – on demand if the beneficiary presents whatever documents may berequired by the letter. They are normally the only two parties involved inthe contract. The bank which issues a letter of credit acts as a principal,not as agent for its customer, and engages its own credit. The letter ofcredit thus evidences – irrevocable obligation to honour the draft presentedby the beneficiary upon compliance with the terms of the credit. 45. The letter of credit has been developed over hundreds of years of international trade. It was most commonly used in conjunction withthe sale of goods between geographically distant parties. It was intended tofacilitate the transfer of goods between distant and unfamiliar buyer and seller. it was found difficult for the seller to rely upon the credit of anunknown customer. It was also found difficult for a buyer to pay for goodsprior to their delivery. The bank's letter of credit came into existence tobridge this gap. In such transactions, the seller (beneficiary) receivespayment from issuing bank when he presents a demand as per terms of thedocuments. The bank must pay if the documents are in order and the terms ofcredit are satisfied. The bank, however, was not allowed to determine whetherthe seller had actually shipped the goods or whether the goods conformed tothe requirements of the contract. Any dispute between the buyer and theseller must be settled between themselves. The courts, however, carved out anexception to this rule of absolute independence. The courts held that ifthere has been 'fraud in the transaction' the bank could dishonourbeneficiary's demand for payment. The courts have generally permitteddishonour only on the fraud of the beneficiary, not the fraud of somebodyelse. 53. Whether it is a traditional letter of credit or a new device like performance bond or performance guarantee, the obligation of banksappears to be the same. If the documentary credits are irrevocable andindependent, the banks must pay when demand is made. Since the bank pledgesits own credit involving its reputation, it has no defence except in the caseof fraud. The bank's obligations of course should not be extended to protectthe unscrupulous seller, that is, the seller who is responsible for the fraud.But, the banker must be sure of his ground before declining to pay. Thenature of the fraud that the courts talk about is fraud of an 'egregiousnature as to vitiate the entire underlying transaction'. It is fraud of thebeneficiary, not the fraud of somebody else. If the bank detects with aminimal investigation the fraudulent action of the seller, the payment couldbe refused. The bank cannot be compelled to honour the credit in such cases.But it may be very difficult for the bank to take a decision on the allegedfraudulent action. In such cases, it would be proper for the bank to ask thebuyer to approach the court for an injunction." 17. We have quoted the judgment in extenso to clarify the 17. We have quoted the judgment in extenso to clarify the role of a bank in honouring a letter of credit. The Bank of India has dulymade payment on presentation of documents. The bank has also informed theUnited Exports about the arrival of the documents. Though the ship sank inhigh seas, the consortium, United Exports claimed the amount on the basis ofthe accounts maintained by it wherein the assessee was debited with the sharein the expenditure which includes the cost of the goods which had been claimedas lost in high sea. The report of the C.B.I. is dated 6.8.1994 and theassessment year with which we are concerned is 1981-82 with the relevantprevious year ending 30.6.1980. We are of the view that the fact that thebank had made payment to the foreign seller in honouring the letter of credittaken out by the United Exports and the fact that the ship sank in high seaduring the relevant previous year and the further fact that there was a debitentry in the accounts of the United Exports because of the loss of goodscannot be overlooked in determining the question whether the loss had occurredduring the previous year ended on 30.6.1980. Though it is permissible to lookinto the subsequent events, yet, it is difficult to visualise that theassessee should wait for the finalisation of its accounts till the C.B.I.investigation is over and the C.B.I. submits its report. It is also relevantto notice that in the report of the C.B.I. there was no indictment either against the assessee or against the United Exports and it was only against theforeign seller and another firm, called Oriental Enterprises the indictmentwas made. It is not the case of the Revenue that the assessee or the UnitedExports was a party to the fraud committed by the foreign seller. In ourview, when the ship was alleged to have sunk in high sea, it is open to theassessee to take note of the actual payment by the bank in honouring theletter of credit taken out by the United Exports and the actual sinking of theship for claiming the amount as a trading loss. Though the United Exportsresisted the suit instituted the bank, the mere fact that the liability wasdisputed is not a ground to hold that the loss did not accrue. 18. We are of the view that the decisions relied on by Mr.T.C.A. Ramanujam, learned counsel for the Revenue have no application as in thosecases, there was embezzlement and the courts have taken the view that unlessaccounts were settled, the assessee could not claim any loss. On the otherhand, on the facts of the case, when the assessee bona fide thought that therewas no prospect of recovery of value of the goods which had sunk in the seafor which the bank had already made payment and debit entry was made by theUnited Exports against the assessee, we hold that the loss arose during theprevious year relevant to the accounting year in question. As alreadyobserved by us, the mere fact that the United Exports contested the liabilityis not a ground to hold that there was no accrual of liability. 19. In our view, it is profitable to view the transaction Ramanujam, learned counsel for the Revenue have no application as in thosecases, there was embezzlement and the courts have taken the view that unlessaccounts were settled, the assessee could not claim any loss. On the otherhand, on the facts of the case, when the assessee bona fide thought that therewas no prospect of recovery of value of the goods which had sunk in the seafor which the bank had already made payment and debit entry was made by theUnited Exports against the assessee, we hold that the loss arose during theprevious year relevant to the accounting year in question. As alreadyobserved by us, the mere fact that the United Exports contested the liabilityis not a ground to hold that there was no accrual of liability. 19. In our view, it is profitable to view the transaction from another angle as well. Let us assume, the assessee had placed directorders with the foreign seller and the letter of credit was also opened at therequest of the foreign seller and after making payment by the bank inhonouring the letter of credit, the vessel which carried the goods sank in thehigh sea. In such a situa tion, it is not expected that the assessee shouldfile a suit against the foreign seller and depend upon the outcome of the suitwhether the amount should be written off or not. Equally, it cannot be statedthat the loss would occur in the year in which final decree was passed in thesuit. The fact that the goods loaded in the ship had lost in the high sea forwhich the assessee had to make payment to the bank would show that theliability to make payment had fallen on the assessee and in the absence of anypossibility for the assessee to get back the stock-in-trade lost in the highsea, the assessee would be justified in claiming the same as a trading loss inthe year in which the ship had sunk in the high sea. Therefore the mere factthat the United Exports acting on behalf of the assessee resisted the suitinstituted by the bank is not relevant when the ship had sunk in the high sea.Further, neither the assessee, nor the United Exports was a party to the fraudcommitted by the foreign seller. 20. We are of the view that it is also permissible to look the matter from another angle. The assessee was a member of the consortiumand on the basis of the agreement with the United Exports, it was found thatthe United Exports was acting as a medium to channelise the export activitiesof the member units. The assessee requested the United Exports to importgoods and had the assessee paid the full value of the goods, there would havebeen a credit entry in favour of the assessee in the book of the UnitedExports. Had the goods been received by the United Exports and delivered tothe assessee, corresponding entry cancelling the credit entry would also havebeen made in the delivery account and the United Exports might at least beentitled to commission as agreed upon in the agreement. The assessee 20. We are of the view that it is also permissible to look the matter from another angle. The assessee was a member of the consortiumand on the basis of the agreement with the United Exports, it was found thatthe United Exports was acting as a medium to channelise the export activitiesof the member units. The assessee requested the United Exports to importgoods and had the assessee paid the full value of the goods, there would havebeen a credit entry in favour of the assessee in the book of the UnitedExports. Had the goods been received by the United Exports and delivered tothe assessee, corresponding entry cancelling the credit entry would also havebeen made in the delivery account and the United Exports might at least beentitled to commission as agreed upon in the agreement. The assessee apparently had not paid the value of the goods at the time of placing ordersto import goods. Since it was an international trade, letter of credit wasopened with the Bank of India by the United Exports and the bank also paid themoney on presentation of documents by the seller. Consequently, the UnitedExports became liable to pay money to the bank, even though it was disputingthe liability. In the meantime, the goods lost in the high sea with theresult, the United Exports had made debit entry against the assessee and madea claim against the assessee for the full value of the goods. As far as theassessee is concerned, even in the absence of receipt of goods, the liabilityhas fallen on it to pay the value of the goods and in that sense, the loss hasoccurred to the assessee. The United Exports claimed the money from theassessee and the assessee also accepted the same and that would constitute aprima facie evidence that the loss had occurred during the previous yearrelevant to the assessment year. The assessee has admittedly maintained itsbooks on mercantile basis. We are of the view that the assessee is entitledto claim deduction of the loss irrespective of the fact that the UnitedExports had contested the suit filed by the bank or the money was not paid tothe bank by the United Exports. 21. The Supreme Court in RAMCHANDAR SHIVNARAYAN v. C.I.T.(111 ITR 263) held that it is open to the assessee to claim the loss if it hasa proximate connection with its business. Hence, it is settled that the lossarising by embezzlement of money by a stranger to the business is also atrading loss and the loss is liable to be allowed as deduction provided theloss is incidental to the normal operation of the business. 22. Applying the tests laid down by the Supreme Court, we areof the view that when there is a direct intimate connection between thebusiness operation of the assessee and the loss that has fallen on theassessee, though the loss was occasioned by the act done by the seller, sincethe assessee is not stated to be a party to the fraud committed by the foreignseller, the loss would be allowable as deduction as the loss is incidental tothe business carried on by the assessee. As observed by the Supreme Court inMADRAS INDUSTRIAL INVESTMENT CORPORATION LTD. v. C.I.T. (225 ITR 802),where the liability was incurred which has to be discharged in a future date,it will be a liability, but however, a contingent liability which may have tobe discharged in future cannot be considered as expenditure. In our view, itis not a case of contingent liability as the liability has arisen during theprevious year relevant to the assessment year in question. 23. The Tribunal disallowed the loss only on the ground thatthe loss did not arise during the previous year relevant to the assessmentyear. In our view, the Tribunal has misdirected itself in this matter as ithas focussed its attention only to the suit instituted by the bank and theresistance of the suit by the United Exports. We are of the view thatwhatever may be the stand taken by the United Exports in the suit institutedby the bank, the undisputed facts are that the bank has paid the money to theforeign seller on the basis of the letter of credit and corresponding debitentry has been made against the assessee by the United Exports.24. In this connection, it is also relevant to notice thatthe report of the C.B.I. was filed only on 30.6.1994, and it is not expectedof the assessee to keep its accounts pending till the C.B.I. filed itsreport. The Central Board of Direct Taxes taking note of the ground realitiesof the situation in commercial transactions, has issued a circular dated 24.11.1965 directing the assessing officers to allow the loss arising byembezzlement in the year in which it was discovered and claimed. The circularis applicable to the facts of the case as the assessee had bona fideentertained the view that the loss of stock-in-trade arose during the previousyear in question. In our view, it is a case of cheating by the seller and solong as the assessee was not a party to the cheating, the assessee is entitledto claim the loss. 25. We are also unable to accept the reasonings of theTribunal that the loss had not occurred in the relevant previous year. Wehave already found that the ship had sunk and money was paid by the bank tothe foreign seller and the United Exports made debit entries against theassessee, and in our view, all these factors would establish that the loss hadoccurred during the previous year. As observed by the Supreme Court inRAMCHANDAR SHIVNARAYAN v. C.I.T. (111 ITR 263), when there is a direct andproximate nexus between the loss and the business operations, then the loss isdeductible as the loss is incidental to the carrying on of the business. TheSupreme Court held that the question whether loss has occurred or not has tobe decided from the commercial point of view. The assessee in the normalcourse of business would have imported certain stock-in-trade and had thestock-in-trade arrived and sold by the assessee, the profit or loss on thesale of stock-in-trade would be taken into consideration in the assessment ofthe assessee. Similarly, if the goods were lost in high sea, there is nodifficulty in holding that the assessee is entitled to deduction. Thedifficulty in this case has arisen because the seller had not exported thegoods contracted to be purchased, but cheated the assessee. The positionwould have been different if the liability of the assessee to pay the value ofthe goods had arisen on the sight of the goods. However, on the facts of thecase, since the letter of credit was opened and the bank made payment on thepresentation of documents, the assessee was obliged to pay for the value ofthe goods. We therefore hold that the loss had fallen on the assessee andhence, it is deductible in the computation of the assessee's total income. Inother words, the loss was incidental to the carrying on of the business of theassessee and there is a direct and proximate connection between the businessoperations of the assessee and the loss that occurred. 26. We are of the view that the debit entry made by the 26. We are of the view that the debit entry made by the United Exports is a honest and bona fide one and so long as the debit entry isexisting at the time of finalisation of accounts of the assessee, the assesseewas justified in claiming the same as a business loss. Though the UnitedExports pursued the matter against the Insurance Company and resisted the suitfiled by the bank, that is not relevant in considering the question whetherthe loss has fallen on the assessee. We are therefore of the opinion that theloss incurred by the assessee is a trading loss. In the peculiarcircumstances of the case in which the assessee was not a party to the fraud,the loss occurred during the previous year relevant to the assessment year inquestion. No doubt, it is made clear that if the Insurance Company reimbursesthe money to the assessee, the question whether it is taxable or not wouldarise in the year of reimbursement. However, on the facts of the case, we aresatisfied that the loss occurred because of the loss of goods said to haveexported by the foreign seller in the foreign soil. Accordingly, we do notapprove the view of the Tribunal that the assessee is not entitled to claimthe deduction of the amount as a business loss. Accordingly, we answer the question referred to us in the negative, in favour of the assessee and againstth