Business-connected payment to non-resident principal can qualify as a deduction when recovery becomes irrecoverable.

Amounts compulsorily paid by an assessee under section 42(1) on behalf of a non-resident principal, where the liability arose only because of the assessee's business connection and the recovery later proved irrecoverable, were held to have a direct nexus with the assessee's trading operations. The payment was not treated as an unrelated discharge of another person's liability; it was connected with the assessee's own business and the resulting claim had sufficient business linkage. Even if the amount did not strictly constitute a debt, it remained a loss incidental to business and had to be considered in computing true profits. The deduction was therefore admissible either as a bad debt or as a business loss.

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Issues: Whether the amount paid by the assessee under section 42(1) on behalf of the non-resident principal, and found irrecoverable, was an allowable deduction either as a bad debt under section 10(2)(xi) or as a business loss.

Analysis: The liability arose because the assessee carried on business with the non-resident and was therefore statutorily treated as his agent. The payment was not a voluntary discharge of another's liability unrelated to the business, but one directly connected with the assessee's own business operations. The statutory obligation attached only by reason of the business connection, so the resulting claim against the non-resident had the requisite nexus with the business. Even if the item did not strictly answer the description of a debt, it was still a loss incidental to the trading activity and had to be taken into account in computing true ? profits.

Conclusion: The amount was an admissible deduction under the Income-tax Act, either as a bad debt or as a business loss, and the answer to the reference was in the affirmative.

Ratio Decidendi: A liability compulsorily discharged by an assessee because of a business connection with a non-resident has sufficient nexus with the assessee's business to qualify as an allowable deduction when the corresponding recovery becomes irrecoverable.

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