FINQUEST SECURITIES PVT LTD., MUMBAI V. DCIT, CC-3(4), MUMBAI

ITA 623/MUM/2023

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The case involves Finquest Securities Pvt Ltd, a share broker, which faced a loss due to fraudulent activities by an employee who transferred shares from clients' accounts to unknown accounts and sold them, siphoning the proceeds. The assessee claimed a deduction for the loss incurred, which was initially disallowed by the Assessing Officer and upheld by the CIT(A). The Tribunal, after hearing the arguments and examining the evidence, decided to remit the case back to the Assessing Officer for further investigation into the fraudulent transactions and the recoverability of the losses.

• Counselvise Citation: [2023] 140 COUNSELVISE.COM (IT) 108450 (ITAT-MUMBAI)
• Duration Of Justice: 3 month(s) 29 day(s)
• Appeal Type: Income Tax Appeal
• Pronouncement Date: 26-06-2023
• Appeal Filed By: Assessee
• Order Result: Allowed
• Bench Allotted: F
• Next Hearing Date: 13-06-2023
• Assessment Year: 2015-2016
• Appeal Filed On: 28-02-2023
• Other Referred Cases: Badridas Daga vs. CIT, Lord's Dairy Farm Ltd. vs. CIT, Bharat Earth Movers vs. CIT
• Laws Referred To: Income-tax Act, 1961
• Result in Favour of: Assessee
• Court: TRIBUNAL
• Section: 115JB; 250

Judgement Text

1 ITA 623/Mum/2023 Finquest Securities Pvt Ltd IN THE INCOME TAX APPELLATE TRIBUNAL MUMBAI BENCH “F”, MUMBAI BEFORE SHRI ABY T. VARKEY (JUDICIAL MEMBER) AND MS. PADMAVATHY S. (ACCOUNTANT MEMBER) I.T.A. No.623/Mum/2023 (Assessment year 2015-16) Finquest Securities Pvt Ltd 602, 6 th Floor, Boston House Suren Road, Andheri (E) Mumbai-400 093 PAN : AABCB7028F vs Deputy Commissioner of Income-tax Central Circle-3(4), Mumbai Room No.1915,19 th Floor, Air India Building, Nariman Point, Mumbai- 400 021 APPELLANT RESPONDENT Assessee represented by Shri V G Ginde Adv / Kumar Kale Adv Department represented by Vrunda V Matkari – Sr AR Date of hearing 14-06-2023 Date of pronouncement 27 -06-2023 O R D E R PER : MS PADMAVATHY S. (AM) This appeal is against the order of the Commissioner of Income-tax (Appeals)-51, Mumbai [hereinafter ‘Ld.CIT(A)’] dated 16/01/2023 for the assessment year 2015-16. The assessee raised the following grounds of appeal:- “Being aggrieved by the order dated 16.01.2023 passed by the learned Commissioner of Income Tax (Appeals) - 51, Mumbai. ["Ld. CIT(A)"] u/s 250 of the Income-tax Act, 1961 ("Act"), your appellant prefers this appeal, among others, on the following grounds of appeal, each of which is without prejudice to, and independent of, the other: 1. On the facts and in the circumstances of the case, and in law, the Ld. CIT(A) erred in confirming the disallowance made by the Ld. AO of the trading loss of 2 ITA 623/Mum/2023 Finquest Securities Pvt Ltd Rs.l,06,00,000/- incurred by the appellant due to fraud committed by one of its employees. The Ld. CIT(A) failed to appreciate, and ought to have held, that the said loss arose during the relevant previous year, and hence, it was deductible in that year itself. Your appellant, therefore, prays that said loss be allowed as a deduction. 2. On the facts and in the circumstances of the case, and in law, the Ld. CIT(A) erred in confirming the addition of Rs.l,06,00,OOO/- made to the book profit u/s. 115JB of the Act. The Ld. CIT(A) erred in holding the aforesaid sum as a provision for unascertained liability. Your appellant, therefore, prays that the aforesaid addition of Rs.1,06,00,000/- be deleted from the book profit computed u/s. 115JB of the Act.” 2. The assessee is a share broker and maintains a D-mat account on behalf of its clients wherein the purchases and sales are routed through a pool in the beneficiary account and settled accordingly. The assessee filed the return of income for A.Y. 2015-16 on 30/09/2015 declaring a total income of Rs.1,12,04,720/- under normal provisions of the Act and Rs. 87,27,423/- under section 115JB of the Act. The case was selected for scrutiny and the statutory notices were duly served on the assessee. The Assessing Officer, during the course of assessment noticed that the assessee has debited an amount of Rs.1,06,00,000/- in its P&L Account under the head “bad debts” and claimed the same as deduction under section 36(2) of the Act. The assessee submitted before the Assessing Officer that the amount debited per se is not bad debt but a loss on account of fraud. The assessee explained that an employee of the assessee company fraudulently transferred shares of the Scrip “Kewal Kiran Clothing Ltd (KKCL)” purchased by one of the clients of the assessee to various unknown accounts who were not clients of the assessee which were subsequently sold in the open market and the sale proceeds were siphoned. The assessee further submitted that a police compliant has been filed in this regard and therefore, a provision is made in the books of account towards the shares fraudulently transferred. The 3 ITA 623/Mum/2023 Finquest Securities Pvt Ltd Assessing Officer, after considering the submissions of the assessee was of the view that the occurrence of the fraud has not been classified / established and that the amount cannot be held as irrecoverable. Also the Assessing Officer noticed that the amount mentioned by the assessee in the police complaint being Rs.92,24,800/- does not reconcile to the amount actually debited to the P&L Account. Accordingly, the Assessing Officer disallowed the claim and also made adjustment to the book profits. Aggrieved, the assessee filed appeal before the CIT(A). 3. Before the CIT(A), the assessee submitted a detailed note explaining the modus operandi of the fraud committed by the employee, the extract of which is given below:- “AY 2015-16 1. This note explains the modus operandi adopted by Mr. Jignesh Desai ('JD"), one of the employees of the appellant in perpetrating fraud on the appellant. JD was one of the authorized signatories of the appellant, who could transact for the appellant's D-mat A/c (Beneficiary A/c), wherein delivery of client's shares is received and wherefrom delivery of client's shares is given; it is pool A/c in the name of the appellant [Client ID 10680733]. This D-mat A/c could be operated by any two joint signatories, JD being one them. 2. Firstly, JD used to add an entry in a blank row of client's Instruction Slip signed by them for giving delivery of other shares, to bring shares in Kewal Kiran Clothing Ltd. (KKCL 1 ) in the Beneficiary D-mat A/c with mala fide intention to take them out to his accomplices' D-mat A/cs. 3. Later, JD used to make additional entry in the Instruction Slip in the blank row after the slip was signed by the joint signatories, to effect transfer of shares from Beneficiary D-mat A/c [Client ID 10680733] to the D-mat A/c of one of his accomplices. Please see p.29 of the PB, which is one such slip dated 03.01.2015, wherein the second entry is for transfer of 200 shares of KKCL in favour of D-mat A/c No. 120400000014815, which was made by him after the slip was signed by the other joint signatory. 4. To illustrate, for example, on 24.07.2013, from one of our clients D-mat A/c. [No. 120400000002975] 2,000 shares in KKCL were first transferred by JD to the 4 ITA 623/Mum/2023 Finquest Securities Pvt Ltd aforesaid Beneficiary D-mat A/c [Client ID 10680733].Later, JD fraudulently transferred 1,300 shares out of the above on various dates to his accomplice's D- mat A/c [No. 1204000000140815] as under: Date No. of shares 24.07.2013 600 10.09.2013 200 08.10.2013 300 14.10.2013 200 5. Between the period 24.07.2013 to 03.01.2015, JD thus unauthorizedly transferred following shares out of appellant's client's D-mat A/c to three D-mat A/cs, pertaining to the persons who were not the appellant's clients. During this period JD transferred 5,200 shares in KKCL from the aforesaid D-mat A/c. From Client's D-mat A/c. fNo. 1204000000029751 Date No. of shares JD's accomplices' s D- mat A/c No. 24.07.2013 600 1204000000140815 10.09.2013 200 1204000000140815 08.10.2013 300 1204000000140815 14.10.2013 200 1204000000140815 06.06.2014 250 1204000000232047 03.07.2014 200 1204000000232047 02.08.2014 200 1204000000140815 5 ITA 623/Mum/2023 Finquest Securities Pvt Ltd 10.09.2014 200 1204000000140815 29.09.2014 200 1204000000140815 09.10.2014 200 1204000000232047 27.11.2014 250 1204000000232047 11.12.2014 200 1204000000232047 03.01.2015 200 1204000000140815 TOTAL 3200 From Client's D-mat A/c. [No. 105170461 Date No. of shares JD's accomplices's D-mat A/c No. 12.11.2013 300 1203320003995099 09.12.2013 300 1204000000140815 08.01.2014 200 1203320003995099 01.02.2014 200 1204000000140815 26.02.2014 300 1204000000232047 01.03.2014 200 1204000000232047 07.04.2014 300 1204000000232047 29.04.2014 200 1204000000232047 6 ITA 623/Mum/2023 Finquest Securities Pvt Ltd TOTAL 2000 6. The client FFSPL had purchased 15,500 shares in KKCL on 30.09.2013, and its D-mat A/c [No. 1204800000038326] was credited on .03/10/2013. Out of these shares, JD fraudulently transferred 5,900 shares to D-mat A/c No. 1204800000030561 of the appellant maintained for shares held for clients in margin/as collateral on 18.02.2015, for which JD had no authority. To cover up the previous fraudulent transfers made from the above referred two clients' D-mat A/cs. viz., 1204800000002975 & 10517046, on the same day, i.e. 18.02.2015, JD transferred 5,200 shares in KKCL from aforesaid margin D-mat A/c. [No. 1204800000030561] to these two D-mat A/cs so that his earlier fraud could go undetected. He, therefore, transferred 3200 shares to clients' D-mat A/c. No. 1204800000002975 & 2000 shares to client's D-mat , A/c. No. 10517046. 7. Since JD had no authority to transfer shares from FFSPL's D-mat A/c [No. 120480000038328] or the appellant's margin/collateral D-mat A/c. [1204800000030561], this fraud came to the notice of the appellant and a detailed internal enquiry made against JD revealed that he had done this to cover up his earlier fraud of transferring 5,200 shares to his accomplices, referred to in para (5) above. Accordingly, the appellant filed a written complaint to the Inspector of Police, MIDC Police Station, Mumbai on 20.02.2015. 8. It may be noted that since JD restored 5,200 shares to the D-mat A/cs of the two clients out of the shares fraudulently transferred from FFSPL's D-mat A/c, the appellant had to restore those many shares to FFSPL by purchasing the same from market. By this way, the shares were fraudulently transferred to his accomplices and later sold from their account in the market to encash them. ...,.' 9. Summarizing, JD in all transferred 5,200 shares in KKCL from the Beneficiary D-mat A/c [Client ID 10680733] out of the shares received from two clients in this D-mat A/c to his accomplices' three D-mat A/cs.” 4. The assessee also submitted that while filing the police complaint, the amount of Rs.92,24,800/- was quantified based on the value on the said date and the provision as on 31/03/2015 was made based on the value on the said date and accordingly, the amount of Rs.1,06,00,000/- was arrived at. The CIT(A), after considering the submissions of the assessee held that – 7 ITA 623/Mum/2023 Finquest Securities Pvt Ltd “7.3 The contentions of the appellant and the facts mentioned in the assessment order have been considered. The first fact which emerges is that the fraud or embezzlement took place in the D-mat account of the client and not the assessee in the first place. While the assessee claims that it was under statutory obligation to "compensate" the client for the fraud, the actual loss can be booked by the assessee only when it actually compensates the client by way of replacing the shares. In the instant case, the~appellant has itself subTrTitted in Para 2.3.6 or its submissions dated 22.04.2019 that upto 31.03.2015, it had not actually purchased these shares to compensate the client. The relevant extracts from the appellant's reply are reproduced below: Thirdly, the fraud amount was quantified at Rs.92,24,800/- in the police complaint filed on 20.02.2015 based on the market price of KKCL shares as on that date, i.e. Rs.1774/- for 5,200 shares. However, by 31.3.2015, the appellant had not actually purchased these shares to compensate the client, and therefore, while finalising the accounts, the loss was quantified at Rs. 1,06,00,000/- based on the market price of shares as at 31.03.2015. Hence, there was a difference between these two sums. It may be appreciated that the actual loss in the present case could be quantified only when the appellant purchased the share and compensated the client; and until then, the loss was based on the fluctuating market price of those shares. However, merely because loss could be precisely compensated later, its deductibility is not affected thereby, if the liability to compensate the client was crystallised in the year under reference. 7.4 From the above it is clear that when the fraud was detected, the loss, if any, was caused to the relevant client and not to the assessee as the embezzlement had taken place in the D-mat account of the client and not the assessee. The question of loss in the hands of the assessee would arise only on the date when the assessee actually compensates the client. The assessee has himself made it clear that upto 31.03.2015 i.e in AY 2015-16 no such compensation had been made. So the question of allowing any loss in AY 2015-16 does not arise. 7.5 The case laws relied upon by the appellant, namely, Badridas Daga vs. CIT[1958] 34 ITR 10 (SC) and Lord's Dairy Farm Ltd. vs. CIT [1955] 27 ITR 700 (Bom) also cannot be applied to the facts of the present case as here the fraud has been committed by the employee in respect of the client/customer by embezzling shares from the client's D-mat account. The loss to the assessee will only arise when it actually compensates such client. It is clear no such compensation has been made 8 ITA 623/Mum/2023 Finquest Securities Pvt Ltd in AY 2015-16. Accordingly, the computation of this loss in future will also depend on the manner in which the client has been compensated in the future. It is interesting to note that the appellant has nowhere mentioned in its submissions as to how and when the client has been actually compensated. Thus even at this stage it cannot be said as to how and when this compensation, if any, has been made. In any case no such loss can be allowed in the present AY 2015-16. In view of the above, the claim of the assessee regarding the so called loss of Rs. 1,06,00,000/- is rejected. This ground of appeal is dismissed.” 5. Aggrieved, the assessee is in appeal before the Tribunal. 6. The Ld.AR submitted that the fraudulent transaction carried out by the employee is a loss incurred in the normal course of business and, therefore, should be allowed as a deduction. The Ld.AR drew our attention to the observations of the CIT(A) which is extracted as above to submit that the CIT(A) has acknowledged the fact that there has been a fraud and that he had upheld the disallowance for the reason that the loss was not crystallised during the year under consideration. The Ld.AR also submitted that though the police complaint (page 17 of paper book) was filed, the assessee did not pursue the compliant for the reason that the concerned employee has died in November, 2017 (death certificate at page 38 of the paper book). The Ld.AR also submitted that the employee was earning only Rs.19,000/- p.m. as salary and that the assessee even otherwise would not have recovered the huge amount of liability from the deceased employee. Therefore, the Ld.AR submitted that the liability has crystallised to the assessee when the loss was identified and, therefore, should be allowed in the year under consideration. The Ld.AR relied on the decision of Lord's Dairy Farm Ltd vs CIT (1955) 27 ITR 700 (Bom) and also the decision of the Supreme Court in the case of Bharat Earth Movers vs CIT (2000) 245 ITR 428 (SC). 9 ITA 623/Mum/2023 Finquest Securities Pvt Ltd 7. The Ld.DR vehemently argued that the assessee has not provided enough evidences to show that the loss / fraudulent transaction have indeed happened. The Ld.DR drew our attention to the modus operandi of the fraudulent transaction as submitted by the assessee where it has been stated that there are two signatures to the share transfer form whereas in the copy of transfer form submitted by the assessee, there is only one signature of the deceased employee. It is therefore submitted by the Ld.DR that whether the other signatory is party to the fraudulent transaction or not has not been clearly established by the assessee, the Ld.DR submitted that as per the said note, there are other parties, who are involved in the impugned fraudulent transactions and they have not been brought into the picture and whether the amount is recoverable from these persons is not factually evidenced by the assessee. The ld DR further submitted that the assessee without establishing these facts has suo motu concluded that the amount cannot be recovered. The Ld.DR also submitted that the assessee has considered 5,900 shares of KKCL while making the provision, whereas as per the submissions made before the lower authorities, the number of shares involved is 5,200 and no explanation has been provided for the difference. The Ld.DR, therefore, submitted that the entire provision is based on what has been declared by the assessee as a fraudulent transaction and cannot be allowed without proper verification of facts and evidence. 8. We heard the parties and perused the material on record. One of the employees of the assessee (who is deceased now) has fraudulently transferred the shares purchased by a client through the assessee to various parties with whom he had colluded to sell these shares through another broker firm and the money thus realised was siphoned. The assessee has made a provision of Rs.1,06,00,000/- 10 ITA 623/Mum/2023 Finquest Securities Pvt Ltd towards the shares fraudulently sold based on the market value of the shares as on 31/03/2015 for the reason that the amount is not recoverable since the concerned employee was not in a position to repay the amount siphoned and later deceased. The assessee's further contention is that the loss is incurred in the normal course of business and hence to allowed as a deduction. The contention of the revenue on the other hand, is that the assessee has not evidenced that the amount has become irrecoverable given that there are external parties, who have been cohorts to the entire transaction and that the loss can be claimed only in the year in which the assessee would compensate the client. Since the CIT(A) has disallowed the claim for the reason that the fraud has not crystallized during the year under consideration a query was raised by the bench as to when the shares KKCL are purchased to compensate the client. In response the ld AR submitted a contract note where the trade date is mentioned as 31.03.2016 and submitted that though the settlement to the client happened in the subsequent year, the liability has cristalised as and when the fraudulent event occurred and therefore the provision made as on 31.03.2015 should be allowed a deduction. The basic ingredients for a loss arising due to a fraud committed by an employee to be allowed as a deduction is that the loss should be incurred in the course of business and that the amount embezzled has become irrecoverable. In assessee's case, the loss arises since the assessee needs to buy the shares of KKCL in order to compensate the client. In the case law relied on by the ld AR Lord’s Dairy Farm Ltd (supra) the Hon'ble Bombay High Court has held that "if in any case it is found that it was necessary to deputise certain duties to an employee and it was also found that the loss sprang directly from the necessity of doing so, then the loss would be a trading loss and the assessee would be entitled to claim that amount as a proper deduction". We notice that this case approved by the Supreme Court in the case of Badridas Daga 11 ITA 623/Mum/2023 Finquest Securities Pvt Ltd vs CIT [1958] 34 ITR 10 (SC). The assessee is in the business of trading in shares on behalf of the clients and has delegated the authority to carry out the directions of the client to transact in shares to the deceased and one more employee and the employee fraudulently carried out the sale to siphon the money. Therefore the claim the loss is incurred in the normal course of the business of the assessee holds merit . 9. Now coming to the issue of recoverability, so long as there is a reasonable prospect of recovery of the embezzlement, trading loss in a commercial sense cannot be deemed to have resulted. It is important to establish that it was not possible to recover the loss from the persons responsible for the same and that the assessee has made the necessary attempts to recover the loss from the persons concerned. In the case of Dairy Farm Ltd (supra) the Hon'ble Bombay High Court has considered this issue also and held that – The next question that we have to consider is whether the whole of this amount can be permitted as an allowance to the assessee. If we are right in the view that we have taken that what is claimed as a trading loss is not a permissible deduction under section 10(2)(xv), then the material date obviously is not the date when the embezzlement took place but the material date is when the loss is caused. So long as there is any possibility of the money being recovered from the employee who has embezzled the money, there is no loss to the assessee. It is only when it is clear that the money cannot be recovered that the loss-is caused. 10. We notice from the perusal of the modus operandi of the transaction which is extracted in the earlier part of this order, that there are other parties involved in the transaction besides the deceased employee. However whether any action is taken against the other parties is not coming out clearly from the materials on record. Further the "Inter Depository Delivery Instruction" (page 29 of paper book) 12 ITA 623/Mum/2023 Finquest Securities Pvt Ltd containing the fraudulent transaction is signed by only one employee whereas it is required to be signed by two authorised persons including the deceased employee. Therefore we see merit in the argument of the ld DR that whether the other party was involved in the whole scheme of things and whether any action or enquiry is conducted against the other authorised signatory is not properly evidenced. The ld DR during the course of hearing also brought to our attention the journal entry passed making the provision towards the loss where the number of shares considered are 5900 whereas as per the note of the assessee the fraudulent transaction was conducted for 5200 shares and the assessee has not provided any explanation for the difference. Given these facts, we are of the considered view that the issue should be remitted back to the Assessing Officer for a deno novo verification of the impugned transaction. The assessee is directed to submit the necessary documents to evidence that the amount is no longer recoverable, whether any action is taken against the others involved in the fradulant transaction, the reconciliation for the difference in the number of shares. It is ordered accordingly. 11. In result the appeal of the assessee is allowed for statistical purposes. Order pronounced in the open court on 27/06/2023. Sd/- sd/- (ABY T. VARKEY) (PADMAVATHY S) JUDICIAL MEMBER ACCOUNTANT MEMBER Mumbai, Dt : 27 th June, 2023 Pavanan 13 ITA 623/Mum/2023 Finquest Securities Pvt Ltd प्रतितिति अग्रेतििCopy of the Order forwarded to : 1. अिीिार्थी/The Appellant , 2. प्रतिवादी/ The Respondent. 3. आयकर आयुक्त CIT 4. तवभागीय प्रतितिति, आय.अिी.अति., मुबंई/DR, ITAT, Mumbai 6. गार्ड फाइि/Guard file. BY ORDER, //True Copy// Asstt. Registrar / Senior Private Secretary ITAT, Mumbai