Employee embezzlement loss as trading loss: deductible where incidental to business and written off as irrecoverable.

Loss from employee embezzlement is not a bad debt unless a debt in law first existed and later became irrecoverable, and it is not business expenditure because it is an involuntary loss rather than a voluntary outgoing. It is nevertheless deductible as a trading loss where the defalcation is incidental to the business, arises from duties necessarily entrusted to staff, and is written off as irrecoverable. On the facts, the cashier handled the company's money in the ordinary course of business, the loss occurred during those duties, and no contrary evidence showed recovery was possible, so the amount was allowable in the relevant assessment year.

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Issues: Whether the amount lost by embezzlement of an employee was deductible as a bad debt or as business expenditure under section 10(2)(xi) or section 10(2)(xv) of the Income-tax Act, 1922, and, if not, whether it was nevertheless an allowable trading loss deductible in the year in which it was written off.

Analysis: A loss caused by defalcation does not constitute a bad debt unless there is a debt in law due to the assessee and later becoming irrecoverable. It is also not expenditure laid out wholly and exclusively for business, because embezzlement is an involuntary loss and not a voluntary outgoing. However, section 10 is directed to computation of true commercial profits, and losses which are incidental to the business and spring directly from the necessity of entrusting duties to employees are deductible as trading losses. On the facts, the cashier was necessarily entrusted with handling the company's money, the defalcations occurred in the course of those duties, and the amount was written off with no contrary evidence to show recoverability.

Conclusion: The embezzled sum was an allowable trading loss and was deductible by the assessee in the relevant assessment year.

Final Conclusion: The reference was answered in favour of the assessee, and the amount lost through employee defalcation was held deductible as part of the business loss.

Ratio Decidendi: A loss arising from employee embezzlement is deductible as a trading loss where it is incidental to the business, necessarily connected with the employment of staff for business operations, and becomes irrecoverable so that true commercial profits can be ascertained.

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