An oft quoted aphorism states that the only two things certain in life are death and taxes. The truth of this statement comes out from the fact that under the Income Tax Act of India, profits derived from illegal activities of an assessee are also taxable. However, this brings to another interesting conundrum – if profits from illegal activities are taxable, are such activities also entitled to the various deductions available to other legal businesses? To answer this question, let’s delve into the case of Dr. T.A. Quereshi vs CIT.
This case has a fascinating factual matrix. The assessee, a doctor by profession, was also engaged in manufacturing and selling heroin, a la Walter White if you will. His contraband operation was busted by the Police and all of his narcotics were seized. The good doctor was not only prosecuted under the NDPS Act in this case, but his income from drug peddling was also sought to be taxed. The doctor however, contended that since his stock in trade of business, i.e. the heroin, had been seized, the same should be categorized as a business loss in order to compute his total income.
Business Loss or Business Expenditure?
Bizarrely enough, when this case wound up before the Supreme Court, the revenue chose to argue a case based on Section 37 of the Income Tax Act, which talks about business expenditure and not business loss. The court also pointed out the same and held that since there is no bar in the Act to claim business loss arising out of an illegal business, the same would be available to the assessee.
The Curious Case of Stock in Trade
In order to determine the tax liability in this case, 3 important questions need to be answered. The first and most basic is whether loss of stock in trade can be claimed as a business loss. The Supreme Court resolved this question by citing the law laid down in CIT vs. S.N.A.S.A. Annamalai Chettiar, which had straightforwardly answered this question in the affirmative.
The second, more convoluted question is whether loss of stock in trade in an illegal activity can also be claimed as a business loss? A quick look at some judicial precedents tells us the answer is yes. In Dr. Quereshi’s case, the Supreme Court leaned on the judgement in the case of CIT vs. Piara Singh, wherein it was held that confiscation of smuggled goods of a person engaging in the business of smuggling would amount to loss of stock in trade which can be taken as a business loss. Justice Grover laid down the rationale behind this while speaking for the court in another case of the same ilk, CIT vs. S.C. Kothari –
“If the business is illegal, neither the profits earned nor the losses incurred would be enforceable in law. But, that does not take the profits out of the taxing statute. Similarly, the taint of illegality of the business cannot detract from the losses being taken in to account for computation of the amount which can be subjected to tax as ‘profit’…”
However, if an assessee is allowed to claim a business loss every time an illegal activity is uncovered, it has the potential to open up a veritable Pandora’s box. The courts seemed to have pre-empted this possibility and have clarified the law in this regard in two judgments mentioned in Piara Singh – Soni Hinduji Kushalji & Co. vs. CIT and J.S. Parkar vs. V.B. Palekar. Both cases related to an assessee who was carrying on a legitimate and legal business, but had engaged in an illegal activity. These two cases laid down that if the illegal activity was not a normal incidence of the assessee’s business, then the loss of stock in trade would not be allowed as a deduction under the head of business loss.
Which brings us to the final question to be considered in this case – is heroin a stock in trade in this particular case? The Revenue had repeatedly argued before the lower courts that the assessee was engaged in the manufacturing and selling of heroin. In fact, the Tribunal even recorded a finding of fact for the same. Once this fact is established, it most naturally leads to the conclusion that since the assessee was engaged in the business of manufacturing and selling heroin, the heroin would be his stock in trade. Once the existence of the business and the stock in trade is established, it is a simple matter of applying Piara Singh to arrive at the conclusion that any loss suffered thereof would be deductible as a business loss.
Illegal Business vs. Infraction of Law
One of the most intriguing aspects of this case was why the Revenue even tried to establish that the manufacture and selling of heroin was the assessee’s business. There was established precedent to show that the moment the illegal activities are categorised as business, then normal rules of profit and loss would apply to the tax calculation of the same. At the same time, if it could be shown that the illegal activity and the income derived from it were not an incident of the normal business of the assessee, then the same could be brought to tax without the associated loss or expenditure being deductible. In the case of Piara Singh, the Revenue perhaps had no option since the assessee was only a smuggler. However, in both Soni Hinduji Kushaji and J.S. Parkar, the illegal activities were not shown as a separate business activity. In fact, J.S. Parkar seems to provide the perfect template for a successful claim by the revenue. In that case, the assessee was engaged in the business of transporting fishes, but chose to also smuggle gold alongside. When caught, the court disallowed the deduction claimed for business loss by stating that the loss befell the assessee on an infraction of the law and not as a businessman or trader. The same could be argued in the case of Dr. Quereshi – said loss would never have befallen him if he did not enagage in an illegal activity.
Hence it would seem fair to assume that if ever illegal activities are to be brought to tax, they should not be brought as a business unto themselves, but as an addition to the normal income of the assessee. After all, crime should never pay. Unless its taxes.
Written by Siddharth P. Sharma, Associate Product Manager @ Riverus