ITAT upheld deduction on account of embezzlement of funds unearthed during year

ITAT upheld claim of deduction on account of embezzlement of funds unearthed during the relevant assessment year

In a recent judgment, ITAT Mumbai has upheld claim of deduction on account of embezzlement of funds unearthed during assessment year following the ratio laid down by the Hon’ble Supreme Court

ABCAUS Case Law Citation:
4692 (2025) (08) abcaus.in ITAT

In the instant case, the Income Tax Department (Revenue) had challenged the order passed by the CIT(A)/National Faceless Appeal Center (NFAC) in deleting the addition on account of embezzlement of funds.

The respondent assessee was engaged in the business of manufacturing. The case was selected for complete scrutiny under the Computer Aided Scrutiny Selection (CASS).

The Assessing Officer (AO) completed the assessment under section 143(3) of the Act, by inter alia disallowing the deduction claimed by the assessee in its Profit & Loss Account on account of embezzlement of funds.

The CIT(A) observed that as per CBDT Circular No. 35D (XLVII 20) of 1965, F. No. 10/48/65-IT(AI) dated 24, November, 1965, the loss by embezzlement by employees should be treated as incidental to a business and this loss should be allowed as deduction in the year which it is discovered.

The CIT(A) further observed that Hon’ble Supreme Court has held that human nature being what it is, it is impossible to rule out the possibility of an employee taking advantage of his position as such employee and misappropriating the funds of his employer, and the loss arising from such misappropriation must be held to arise out of the carrying on of business and to be incidental to it. And that is how it would be dealt with according to ordinary commercial principles of trading.

Similarly, the Hon’ble Madras High Court while examining the allowability of the loss arising on the embezzlement of cash as Bad Debt, upheld the Tribunal decision holding it to be a business loss. Also, the Hon’ble Delhi High Court upheld the ITAT decision following Apex Curt decision that embezzlement by an employee was allowable as a deduction in computing the business income. It was further observed in the CBDT circular that this loss should be allowed as a deduction in the year in which it is discovered.

The CIT(A) observed that in this case the embezzlement was discovered in the FY 2017-18 relevant to AY 2018-19 and that too made by employee of the Company during the course of carrying out their responsibilities.

Following the CBDT Circular, the CIT(A) deleted the addition.

Before the Tribunal the assessee submitted that the detection of the said embezzlement was made during this impugned assessment year.  The payment in question was accounted for in assessee’s books of account as payment related to sales-tax.  These amounts were not actually paid to sales-tax authorities and were rather embezzled. 

It was submitted that the newly appointed CFO during the course of finalization of the annual accounts for the relevant year noticed unusually huge debit balances in ledger account of “Local Sales Tax Payable”, “Central Sales Tax Payable” etc. The entries were initially passed by debiting the account titled “balance with excise, customs & sales-tax”.  Part of the amounts were transferred to the ‘cost of goods sold from time to time’.  The amount of funds embezzled were debited to ‘cost of goods’ head was consequently claimed as deductible expenses from year to year.  However, balance lying in the head “balance with excise, customs, sales-tax, etc.” was never claimed as deduction. 

It was stated that the assessee immediately made public disclosure of the embezzlement fraud on the Bombay Stock Exchange (‘BSE’) and informed BSE that an independent investigating firm – PricewaterhouseCoopers (‘PwC) had been appointed as forensic auditors to investigate the possibility of embezzlement fraud. The assessee also filed a complaint with Economic Offences Wing (EOW), Mumbai in relation to the embezzlement fraud.

The Tribunal observed that the assessee had furnished sufficient evidence demonstrating that the said embezzlement occurred during the impugned assessment year. The CIT(A) had called for a remand report from the Assessing Officer and, upon receipt thereof, passed the impugned appellate order. While adjudicating the matter, the CIT(A) relied on CBDT Circular as well as the judgment of the Hon’ble Supreme Court.

The Tribunal further noted that the assessee had submitted all necessary evidence both during the assessment proceedings and the appellate stage, and these were not disputed or rejected by the AO.

Accordingly, following the ratio laid down by the Hon’ble Supreme Court the Tribunal held that the conclusion reached by the CIT(A) was justified. Accordingly, the grounds raised by the revenue on this issue were dismissed.

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