2024 (11) TMI 1097 - AT - Income Tax

Employee embezzlement loss qualifies as allowable deduction under Section 28(i) despite incorrect initial classification under Section 37(1)

ITAT Mumbai held that embezzlement loss by employee is allowable deduction under Section 28(i) rather than Section 37(1). Assessee initially claimed ... Reopening of assessment u/s 147 - misappropriation of funds by one of the employees of the assessee - HELD THAT:- We note that the assessee claimed the expenses which was not related to the business, but the amount was utilized by the employee in fraudulent way. The assessee suffered the embezzlement of the fund by the employee. The assessee claimed these expenses u/s 37(1) of the Act But on later stage, assessee came to know that these expenses are not a genuine expense, but it is an embezzlement of the fund by one of the employees. AR referred the CBDT Circular No 35-D (XLVII-20) [F.No. 10/48/65-IT(A-I)] dated 24/11/1965 where it is stated that loss arising due to embezzlement is allowable loss U/s 28(i) of the Act. The grievance of the revenue is that the claim of expenses is not under section 37(1), but it will come under section 28 of the Act considering the embezzlement. The assessee had never rectified the head during filing of return of Income in pursuance of notice U/s 148 of the Act. We note that the assessee offered the sum of Rs. 229 lakhs to tax, after recovery of the funds. We find that it is a justified claim for assessee that after receiving all the recovery, the same will be offered to tax. But the impugned amount was not recovered during impugned assessment year. It is only detected in the bank account of employee’s wife. Only on the basis of the assumption the addition is unjustified. The debited amount is not fulfilling the purpose of expenses claimed U/s 37(1) of the Act but after all this expense is related to loss due to embezzlement which is allowable expenditure. The assessee is in process of recovery and after recovering the same the realized amount was offered for tax. We respectfully relied on the order of Bombay Forgings Pvt Ltd [1993 (9) TMI 99 - BOMBAY HIGH COURT] and G.G. Dandekar Machine Works Ltd [1993 (1) TMI 40 - BOMBAY HIGH COURT] In this issue, the assessee is eligible for the deduction due to loss of fund in embezzlement. AO unable to bring any evidence the impugned amount was recovered during impugned assessment year, in our considered view, the addition is unjustified - Decided in favour of assessee. Issues Involved:1. Validity of reopening assessment under Section 148 of the Income-tax Act, 1961.2. Legitimacy of disallowing Rs. 30,62,000 under Section 37(1) of the Income-tax Act.3. Applicability of Section 28(i) for claiming deduction due to embezzlement loss.Detailed Analysis:1. Validity of Reopening Assessment under Section 148:The primary issue was whether the reopening of the assessment under Section 148 was justified. The assessee challenged the reopening, arguing that the assessment was initially completed under Section 143(3), and the reopening was based on the information regarding the misappropriation of funds by an employee. The Assessing Officer (AO) reopened the case after discovering a cash deposit in the employee's wife's bank account, which was linked to the embezzled funds. The assessee contended that the reopening was invalid as the recovery process was ongoing, and the amount was already acknowledged as pending recovery. However, the appellate tribunal did not express a definitive view on the legal grounds of reopening, focusing instead on the substantive issues of the case.2. Legitimacy of Disallowing Rs. 30,62,000 under Section 37(1):The core issue was whether the disallowance of Rs. 30,62,000 as a business expense under Section 37(1) was justified. The AO disallowed the amount, asserting that it represented bogus expenditure claimed through fraudulent vouchers raised by the employee. The tribunal examined whether the expense was incurred wholly and exclusively for business purposes. It concluded that since the expenditure was linked to embezzlement, it could not qualify as a legitimate business expense under Section 37(1). The tribunal upheld the AO's action, emphasizing that expenses related to fraudulent activities do not meet the criteria for business deductions under this section.3. Applicability of Section 28(i) for Claiming Deduction Due to Embezzlement Loss:The tribunal considered whether the loss due to embezzlement could be claimed as a deduction under Section 28(i) of the Act. The assessee argued that the embezzlement loss was incidental to the business and should be deductible as a trading loss. The tribunal relied on precedents, including the Bombay High Court's decisions in Bombay Forgings Pvt Ltd and G.G. Dandekar Machine Works Ltd, which recognized embezzlement losses as deductible when incidental to business operations. The tribunal noted that the assessee had already offered the recovered amount to tax and was in the process of recovering the remaining funds. It found the assessee's claim justified, stating that the loss was incidental to the business and allowable under Section 28(i). Consequently, the tribunal deleted the addition of Rs. 30,62,000, ruling in favor of the assessee.Conclusion:The appellate tribunal allowed the appeal, concluding that the addition of Rs. 30,62,000 was unjustified. It recognized the embezzlement loss as a deductible business expense under Section 28(i), provided the loss was incidental to the business. The tribunal's decision was based on the principle that detection of embezzlement is not relevant for claiming deductions, aligning with established precedents. The appeal was allowed, and the addition was deleted, with the tribunal setting aside the impugned appeal order.