Illegal payments under foreign exchange law are not deductible as business expenditure or business loss for tax purposes.

Amounts paid under an arrangement that contravened foreign exchange law were not allowable as business expenditure or business loss under the Income-tax Act, 1961. Expenditure incurred to facilitate or continue an unlawful transaction is not laid out wholly and exclusively for business purposes, even if the arrangement is said to be commercially convenient or intended to reduce loss. The principle that illegal receipts or losses may sometimes be considered in tax computation does not extend to deductions for outgoings incurred in violation of another statute, where the underlying arrangement is unlawful and opposed to public policy. The claimed reduction of taxable income on the basis of the illegal payment was therefore rejected.

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Issues: Whether amounts paid in violation of foreign exchange law could be treated as business expenditure or business loss under the Income-tax Act, 1961, and whether the assessee could reduce its taxable receipts by the amount repatriated through an illegal arrangement.

Analysis: The payment was found to have been made as part of an arrangement that contravened the foreign exchange law. Expenditure incurred to evade the law or to facilitate an illegal transaction is not expenditure laid out wholly and exclusively for the purposes of business. A trader cannot rely on the plea that the arrangement was commercially convenient or necessary to mitigate loss, because contravention of law is not a normal incident of lawful business. The principle that illegal business receipts and losses may be considered for tax computation does not extend to allowing deductions for penalties or outgoings incurred for violation of another statute, where the underlying transaction itself is unlawful and opposed to public policy.

Conclusion: The claim for deduction or reduction of taxable income on account of the illegal payment failed and the contention based on real income was rejected.

Ratio Decidendi: Expenditure incurred for the purpose of violating another law, or in pursuance of an illegal arrangement, is not deductible as business expenditure or business loss under the Income-tax Act because the statutory test requires a lawful purpose connected with the business.

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