Employee embezzlement loss deductible as trade loss when it becomes actual and certain, but not as expenditure or bad debt.

Embezzlement by an employee entrusted with collection and disbursement duties was treated as a trade loss incurred in the course of business. The loss was deductible in the relevant accounting year when it became actual and certain, even though the amounts had later been reflected in the books as recoverable. The same amount could not be claimed as business expenditure because misappropriated funds are not sums laid out wholly and exclusively for business purposes, and it could not be treated as a bad debt because it was not shown to be a business loan or trading debt. The reference was answered accordingly in favour of the assessee only on the trade-loss issue.

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Issues: (i) Whether the amount embezzled by the employee was a trade loss deductible in computing the profits of the relevant accounting year. (ii) Whether the same amount could be claimed as an expenditure or as a bad debt under the relevant provisions of the Income-tax Act.

Issue (i): Whether the amount embezzled by the employee was a trade loss deductible in computing the profits of the relevant accounting year.

Analysis: The loss arose in the course of the business because the employee was entrusted with duties connected with collection and disbursement of funds, and the diversion of money occurred while he was acting in the course of that employment. A loss of this kind is to be judged by ordinary commercial principles in ascertaining business profits, and the decisive question is whether the loss is incidental to the business and becomes actual and certain in the relevant year. The mere fact that the amounts were later entered in the books as recoverable from the employee did not prevent the loss from arising when the compromise finally fixed the irrecoverable balance.

Conclusion: Yes. The amount was a trade loss deductible in the relevant accounting year, and the answer to this issue was in favour of the assessee.

Issue (ii): Whether the same amount could be claimed as an expenditure or as a bad debt under the relevant provisions of the Income-tax Act.

Analysis: An amount misappropriated by a clerk is not expenditure laid out wholly and exclusively for business purposes. Nor can it be treated as a bad debt unless it was a loan advanced in the ordinary course of business and had entered the business assets as a trading debt. The amount in question did not answer either description.

Conclusion: No. The claim as expenditure and the claim as bad debt both failed, and the answer to this issue was against the assessee.

Final Conclusion: The reference was answered by holding that the embezzlement loss was deductible as a trade loss in the year when it became actual and certain, but it was not allowable as expenditure or as a bad debt.

Ratio Decidendi: A loss caused by embezzlement by an employee in the course of duties entrusted by the business is deductible as a trade loss when it becomes actual and certain in the relevant accounting year, but it is not deductible as expenditure or as a bad debt unless it satisfies the legal conditions applicable to those allowances.

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