Business expense deduction for liabilities arising from negligent servants found deductible when liability is incidental to trade.

Whether compensation and legal costs paid for damage caused by the assessee's employees in the course of timber hauling are deductible under the Income-tax Act was addressed by applying the principle that only losses incidental to and incurred for the purpose of earning business profits are allowable. The court treated liabilities arising from risks inherent in the timber business (including negligence of servants while engaged in hauling) as part of the cost of operations and held the compensation and costs to be deductible in the relevant year.

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Issues: Whether the assessee is entitled to deduct Rs. 9,020-12-6 paid as compensation and costs in the relevant accounting year under the Income-tax Act.

Analysis: The reference under Section 66(1) of the Income-tax Act, 1961 raises the question whether damages paid for injury to a bailor's property, found to have resulted from negligence of the assessee's servants while employed in the business, are deductible. Applying the accepted principle that only losses really incidental to the trade and incurred for the purpose of earning business profits are deductible, the court examined whether the liability arose out of carrying on the timber business and was incidental thereto. Authorities and comparative decisions recognising that liabilities arising from risks inherent in the business (whether contractual or delictual) constitute part of the cost of operations where the risk of negligence is incidental to the trade were applied to the facts where the elephant and its mahouts were engaged for timber hauling as an integral part of the business.

Conclusion: The compensation and costs paid arose out of the carrying on of the assessee's timber business and were incidental thereto; therefore the deduction of Rs. 9,020-12-6 is allowable. The question is answered in the affirmative in favour of the assessee.

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