Illegal transaction payments are not deductible, while ordinary customer refreshments may still qualify as business expenditure.

A payment made to carry out an unlawful foreign exchange remittance and export arrangement was treated as non-deductible business outgo, because illegality cannot be converted into a deductible loss or expense by describing the arrangement as integrated or by relying on section 28, business expenditure principles, or rule 6DD(j) read with section 40A(3). Ordinary customer refreshments, however, were treated differently: expenditure on tea, coffee, food and similar hospitality was regarded as an allowable business deduction and not equivalent to entertainment or banquet spending. The principal disallowance favoured the Revenue, while the hospitality claim succeeded for the assessee.

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Issues: (i) Whether the sum of Rs. 2,95,000 paid in connection with an illegal foreign exchange remittance and export arrangement was deductible in computing business income under section 28 of the Income-tax Act, 1961, or otherwise allowable, including under rule 6DD(j) read with section 40A(3) of the Income-tax Act, 1961; (ii) Whether the sum of Rs. 19,659 spent on tea, coffee, food and similar customer hospitality was allowable as a deduction.

Issue (i): Whether the sum of Rs. 2,95,000 paid in connection with an illegal foreign exchange remittance and export arrangement was deductible in computing business income under section 28 of the Income-tax Act, 1961, or otherwise allowable, including under rule 6DD(j) read with section 40A(3) of the Income-tax Act, 1961.

Analysis: The payment was made in furtherance of a transaction that contravened foreign exchange law. A lawful business may be taxed on its profits, but a payment made to carry out an unlawful arrangement is not a normal incident of that business and cannot be treated as a commercial loss or allowable business expenditure. The character of the transaction as an integrated arrangement did not alter its illegality. The same principle applied whether the claim was advanced as real income computation under section 28, as business expenditure, or as a deduction claimed under the exception in rule 6DD(j).

Conclusion: The amount of Rs. 2,95,000 was not deductible. The answer was against the assessee and in favour of the Revenue. The alternative claim under rule 6DD(j) also failed.

Issue (ii): Whether the sum of Rs. 19,659 spent on tea, coffee, food and similar customer hospitality was allowable as a deduction.

Analysis: Amounts spent on supplying ordinary refreshments and food to customers were treated as distinguishable from entertainment or banquet expenditure. Applying the binding view previously taken by the Court on similar facts, such expenditure was regarded as an allowable business outgoing.

Conclusion: The amount of Rs. 19,659 was deductible. The answer was in favour of the assessee and against the Revenue.

Final Conclusion: The reference was answered on the principal disallowance in favour of the Revenue, but the hospitality expenditure claim succeeded, so the overall result was mixed.

Ratio Decidendi: A payment made in furtherance of an unlawful transaction connected with a lawful business is not a deductible business loss or expenditure, and illegality cannot be converted into a deductible outgoing by characterising the arrangement as an integrated transaction or by invoking the real income theory; ordinary customer refreshments are not to be treated as entertainment expenditure in the same manner as banquets or amusement.

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