Full Judgment Text
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PETITIONER:
COMMISSIONER OF INCOME TAX, GUJARAT
Vs.
RESPONDENT:
M/S. S. C. KOTHARI
DATE OF JUDGMENT05/10/1971
BENCH:
GROVER, A.N.
BENCH:
GROVER, A.N.
HEGDE, K.S.
CITATION:
1972 AIR 391 1972 SCR (1) 950
CITATOR INFO :
RF 1977 SC1142 (8)
F 1980 SC1271 (6)
ACT:
Income tax act (11 of 1922) ss 10 (1) and (2) and s. 24
(1)--Scope of.
Forward Contracts (Regulation) Act, 1952 s. 15(4)-Contract
in violation of-If illegal
HEADNOTE:
Section 15(4) of the Forward Contracts (Regulation) Act,
1952 is conceived in the larger interest of the public to
protect them against the malpractices indulged in by members
of recognised associations in respect of transactions in
which their duties as agents come into conflict with their
personal interest. Parliament had made a writing,
evidencing or confirming the consent or authority of a non-
member, as a condition of the contract if the member has
entered into a contract on his own account. So long as
there was no such writing there was no enforceable contract.
Under the Act, there is not only an express prohibition but
also punishment for contravention of that prohibition.
The assessee, a registered firm, was a member of the
Saurashtra Oil and Oilseeds Association, and was carrying on
the business of commission agency and general merchants. It
was also doing forward business. During the assessment year
1958-59 it incurred a loss in certain transactions. Those
transactions were in contravention of the provisions of s.
15(4) of the Forward Contracts (Regulation) Act. The
assessee claimed that the loss was allowable under s. 10(1)
of the Income-tax Act, 1922, as a deduction against its
other business income even if the losses were incurred in
illegal transactions. The Income-tax Officer rejected the
contention of the assessee, and also held that the losses
incurred in illegal business could not be deducted from
speculative profits under s. 24 of the Income-tax Act. The
Appellate Assistant Commissioner confirmed the order. The
Tribunal held that the assessee could not set off the loss
against the other income under s. 10(1) of the Income-tax
Act but was entitled to do so under s. 24.
On the questions referred to the High Court namely : (1)
Whether the loss was in respect of illegal contracts, (2)
Whether the loss was a result of speculative transactions
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and therefore could be set off under s. 24 of the
Income-tax Act, and (3) whether even if the loss was as a
result of illegal transactions the assessee was entitled to
set off the loss under s. 10(1) of the Income-tax Act,
the High Court did not answer the first question but held
that the losses could be set off both under s. 10 and s. 24
of the Income-tax Act.
In appeal to this Court,
HELD:(1) It is well settled that contracts which are
prohibited by statute, the prohibition being either express
or implied, would be illegal and unenforceable if they are
entered into in contravention of the statute. Therefore,
the contracts in the present case, were illegal contracts
and the loss was in respect of such illegal contracts. [955
C-D]
Sunder Lal v. Bharat Handicrafts [1968] 1 S.C.R. 608,
followed.
951
(2)Under Explanation 2 of s. 24 a speculative transaction
means a transaction in which a contract for purchase and
sale of any commodity is periodically or ultimately settled
otherwise than by actual delivery etc.; but the contract has
to be an enforceable contract and not an unenforceable one
by reason of any taint or illegality. In the present case,
the contracts were illegal and unenforceable on account of
the contravention of s. 15(4) of the Forward Contracts
(Regulation) Act. The High Court was therefore in error in
considering that set off could be allowed under s. 24(1)
of the Income-tax Act. [959 D-F]
(3)While s. 10(1) of the Income-tax Act imposes a charge
on profits or gains of a business it does not provide how
those profits are to be computed. Section 10(2) enumerates
various items which are admissible as deductions but they
are not exhaustive. The profits and gains which are liable
to tax under s. 10(1) are what are understood to be such
under ordinary commercial practice. The loss for which the
deduction is claimed must be one that springs directly from
the carrying on of the business and is incidental to it,
that is, the profit was earned and the loss was sustained in
the same business. If this is established the deduction
must be allowed provided that there is no provision against
it. 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. Simi-
larly, the taint of illegality of the business cannot
detract from the loss being taken into account for
computation of the amount which can BE subjected to tax as
profits. Cases which deal with payment of a penalty for
infraction of law or the execution of some illegal activity
stand on a different footing, because, an expenditure is not
deductible unless it is a commercial loss in trade and such
a penalty cannot be described as such. [956 G-H. 957 A-B, D-
E, G-H; 959 H; 960 A-B]
[Since in the present case no finding was given by the High
Court that the two businesses in which profits were made and
losses were sustained were the same, the matter was remanded
to the High Court for decision on this point.]
Raj Woollen Industries v. C.I.T., Simla, 43 I.T.R. 36,
Chandrika Prasad Ram Swarup v. C.I.T., U.P. & C.P., 7 I.T.R.
269, Badridas Daga v. Commissioner of Income-tax, 34 I.T.R.
10, Haji Aziz & Abdul Shakhor Bros v. C.I.T., Bombay City,
41 I.T.R. 350 and Allen v. Fraquharson Bros. 17 T.C. 59,
referred to.
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JUDGMENT:
CIVIL APPFLLATE JURISDICTION: Civil Appeals Nos. 1993 of
1968 and 1173 of 1971.
Appeals by certificate/special leave from the judgment and
order dated August 3, 4, 1967 of the Gujarat High Court in
Income-tax Reference No. 18 of 1966.
S. T. Desai, R. N. Sachthey and B. D. Sharma, for the
appellant (in both the appeals).
V.S. Desai, K. L. Hathi and P. C. Kapur, for the
respondent (in both the appeals).
The Judgment of the Court was delivered by
Grover, J. This is ,in appeal from a judgment of the
Gujarat High Court. Originally an appeal (C.A. 1993/68) had
952
been brought by certificate but that certificate was found
to be defective as no reasons were stated therein for
granting it. A Petition for special leave, was, therefore,
filed and the same has been granted. Both the appeals shall
stand disposed of by this judgment. The assessee is a
registered firm and carried on the business of commission
agency and general merchants. It also does forward
business. It is a member of the Saurashtra Oil and Oilseeds
Association Ltd., Rajkot. During the assessment year 1958-
59 the corresponding accounting period being the samvat year
2013 the assessee claimed to have incurred a loss of Rs. 3
40,443/- in certain transactions entered into with different
people for the supply of groundnut oil. The transactions,
according to the assessee, were non-transferable ready
delivery contracts entered into with non-members of the
Association. It was expected that these contracts would be
performed but owing to certain reasons some of the contracts
could not be performed and differences had to be paid.
According to the assessee it had acted as a Pucca Artia.
The assessee claimed that the aforesaid loss was allowable
under s. 10(1) of the Income Tax Act, 1922 as a deduction
against its other business income. The Income tax Officer
came to the conclusion that the transactions in question
were hit by the provisions of the Forward Contracts
Regulation Act, 1952, hereinafter called the ’Act’ and the
Rules and Regulations of the Saurashtra Oil and Oilseeds
Association Ltd. In particular the transactions were hit by
the provisions of sub-ss. (1) and (4) of s. 15 of the Act
and were not saved by s. 18. The losses were held to have
been incurred in illegal transactions. He rejected the
contention of the assessee that even on the assumption that
the losses were incurred in illegal transactions they could
be allowed in the computation of the income. The Income tax
Officer further held that the losses incurred in illegal
business could not be deducted from the speculative profits
under s. 24 of the Indian Income tax Act, 1922, hereinafter
called the "Act of 1922". The Appellate Assistant
Commissioner confirmed the order of the Income-tax Officer.
In the appeal before the Tribunal it was held that the
transactions in question were not illegal contracts but were
contracts which had been, validly entered into under the Act
and the bye-laws etc. The Tribunal thereafter proceeded to
examine the question whether the losses incurred could be
allowed on the assumption that the transactions were
illegal. It was of the view that the assessee would be
entitled to a set off under s. 24 even if the losses were
incurred in illegal transactions. The Tribunal remanded the
matter for a report from the Appellate Assistant
Commissioner as to the applicability of the proviso to s.
24(1) (read with the Explanation) of the Act of 1922. After
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the remand report was received the Tribunal gave the
following two findings : (1) the contracts under
consideration were all
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non-transferable specific delivery contracts where the
intention ab initio was either to give or take delivery (2)
the contracts were entered into either for the purchase or
sale and later on the same quantity was either sold or
purchased back by the assessee on behalf of the same
constituents at the market rates prevailing at the material
time i.e. they were squared up by corresponding sales or
purchases as the case might be. After referring to certain
decisions of High Courts the Tribunal held that the loss of
Rs. 3,40,443 had been incurred in speculative transactions.
The Tribunal next proceeded to consider whether
notwithstanding that the losses had been incurred in
speculative transactions the assessee could set off those
against the other income under s. 10(1) of the Act of 1922.
Purporting to follow the view of the majority of the High
Courts, the Tribunal held that such a loss could not be set
off against the other income. But according to the Tribunal
the assessee was certainly entitled to set off the loss
against the profits in speculative transactions and to that
extent the contention of the assessee was accepted. Both
the assessee and the Commissioner of Income tax moved the
Tribunal for submitting a case and referring certain
questions of law to the High Court. Thus in all the
following four questions were referred by the Tribunal
(1) Whether on the facts and in the
circumstances of the case the contracts in
respect of which the loss of Rs. 3,40,443 was
claimed were illegal contracts and were not
validly entered into under the Forward
Contracts Regulation Act 1952 ?
(2) Whether even assuming the transactions
in which the loss of Rs. 3,40,443/- was
incurred, were illegal transactions, the
assessee would be entitled to the set off of
the said loss ?
(3) Whether on the facts and in the
circumstances of the case the transactions
resulting in a loss of Rs. 3,40,443 were
speculative transactions for the purpose of s.
24 of the Indian Income tax Act 1922 merely on
the ground that The assesses had not performed
the contracts by giving delivery and had paid
damages in settlement of the obligations
contracted for ?
(4) Whether on the facts and in the
circumstances of the case the assessee is
entitled to set off the balance of the loss
of Rs. 1,21,397/- against the assessee’s other
income ?"
The High Court did not consider that it was necessary to
answer the first question. The answer to the second
question was that
954
even though the disputed contracts were not validly entered
into in accordance with the provisions of S. 15(4) of the
Act the loss ,of Rs. 3,40,443/- was liable to be taken into
account in computing the business income, of the assessee
under S. IO of the Act of 1922 and the assessee was entitled
to set it off against the profits fro other speculative
transactions. The third question was answered in the
affirmative with the result that the transactions resulting
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in the loss of Rs. 3,40,443/- were held to be speculative
for the purpose of s. 24 of the Act of 1922. The fourth
question was answered in the negative and against the
assessee. It is the Commissioner of Income tax alone who
has appealed.
So far as the first question is concerned we are unable to
comprehend why the High Court did not decide it. A lot of
debate took place before us on the question whether the
contravention of S. 15 (4) of the Act would render the
contracts illegal. According to that provision no member of
a recognised Association shall, in respect of any goods
specified in the notification under sub-s. (1), enter into
any contract on his own account with any person other than,
a member of the recognised Association unless he has secured
the, consent or authority of such person and disclosed in
the note memorandum or agreement of sale or purchase that he
has bought or sold the goods as the case may be on his own
account. It is not necessary to refer to the proviso. It
is common ground and has been admitted before us that there
was a clear contravention of the provisions of S. 15(4) so
far as the transactions in question were concerned.
According to S. 20(e) any person who enters into any
contract in contravention of the provisions of S. 15(4)
among other sections shall on conviction be punishable for
the first offence with imprisonment which may extend to one
year or with fine of not less than Rs. 1,000/- or with both.
It is wholly incomprehensible how such a contract would not
fall directly within the ambit of the first part of s. 23 of
the Indian Contract Act which deals with consideration or
object of an agreement which is forbidden by law. Such
consideration or object would be unlawful according to the
provisions of that section and the agreement would
consequently be ’void. The High Court did not decide the
point whether the contracts which contravened the provisions
of S. 15(4) of the Act were illegal. It did not consider it
material to decide whether the impugned contracts were
illegal. In its opinion what was material was that the
impugned contracts had been entered into unlawfully and the
question was whether the loss sustained in the unlawful
business could be taken into account in computing the
business income of the assessee. We consider that the first
question which was referred to the High Court stands
concluded by the law laid down by this Court in Sunderlal &
Son v.
955
Bharat Handicrafts (P) Ltd..(1) It was laid down that the
prohibition imposed by s. 15 (4) of the Act was not imposed
in the interest of revenue. That provision was conceived in
the larger interest of the public to protect them against
the malpractices indulged in by members of recognised
associations in respect of transactions in which their
duties as agents came into conflict with their personal
interest. Parliament had made a writing, evidencing or
confirming the consent or authority of a non-member, as a
condition of the contract if the member has entered into a
contract on his own account. So long as there was no
writing as was contemplated by s. 15 (4) or its proviso
there was no enforceable contracts
It is well settled that contracts which are prohibited by
statute the prohibition being either express or implied
would be illegal and unenforceable if they are entered into
in contravention of the statute. Under the provisions of
the Act there is not only an express prohibition (s., 15 (4)
) but punishment is also provided for contravention of that
prohibition, (s’ 20). Such contracts could not possibly be
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regarded as having been validly entered into under the Act.
The answer ’to the first question, therefore, should have
been in the affirmative and against the assessee.
Coming to the second question, the language thereof is some-
what ambiguous and the question was not framed properly. It
appears that there were two aspects which had come up for
consideration before the departmental authorities the
Tribunal and the High Court. The first aspect related to
the deduction of the loss of Rs. 3.40,443/- incurred in the
aforesaid illegal transactions while computing the profits
of the assessee’s speculative business under s. 10(1). The
other was the set off which can be allowed within the
relevant parts of s. 24 of the, Act of 1922. The High Court
referred to various English decisions as also to Wheat
croft’s Law of Income tax and Simon’s Income tax for
supporting the ’View that even where a trade is illegal it
would still be a trade within the meaning of income tax law
and if any profits are derives from such trade they would be
assessable to tax. The High Court did not accept the
contention urged on behalf of the Revenue that although the
profits from an, illegal I trade or business would be
exigible to tax the losses from such business could not be
taken Court observed
"There is in principle no distinction between
profits and losses of a business and if the
profits of an illegal business are assessable
to tax, equally the losses arising
(1) [1968] 1 S.C.R. 608.
956
from illegal business must be held to be
liable to be taken into account in computing
the income of the assessee’.
The High Court was not inclined to accede to the submission
on behalf of the Revenue that the same principle would be
applicable as has been applied in certain cases in which the
question which came up for determination was whether an
expenditure, incurred on an illegal activity would be
deductible under S. 10 (2) (xv) of the Act of 1922. One of
such cases, is a decision of the Punjab High Court in Raj
Woollen Industries v. Commissioner of Income tax, Simla(1).
In that case the real question was whether a certain amount
which was paid to achieve what was prohibited by law, viz.,
the export of wool without having the requisite export
licence was an amount which the assessee was entitled to
deduct under S. 10 (2) (xv) of the Act of 1922. It was held
that according to principle and authority such a deduction
could not be claimed. It was also observed that such a
deduction would not be permissible even under S. 10(1).
Following observations may be referred to :
.lm15
"Profits had to be ascertained according to the accepted
principles of commercial accountancy and if S. 10(2) (xv)
did not permit deduction of an item of expenditure which was
laid out or expended for carrying on the business in
contravention of the law, then such an outgoing though
otherwise properly admissible, as set off against the gross
receipts on the principles of commercial accountancy could
not be taken into consideration in computing the profits".
On the other hand according to the decision of a full bench
of the, Allahabad High Court in Chandrika Prasad Ram Swarup
v. Commissioner of Income tax, U.P. & C.P. (2) income
assessable to tax is the actual income of an individual or a
firm irrespective of the manner in which the income was
derived. Legality or illegality of the transaction
culminating in profits or losses, was, therefore, foreign to
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the scope of an inquiry into the income of an individual or
a firm for the purpose of income tax.
Now while s. 10(1) of the Act of 1922 imposes a charge on
the profits or gains of a business it does not provide how
these profits are to be computed. Section 10(2) enumerates
various items which are admissible as deductions. They are,
however, not exhaustive of all allowances which can be made
in ascertaining the profits of a business taxable under S.
10(1). It is undoubtedly true that profits and gains which
are liable to be taxed under
(1) 43 I.T.R. 36. (2) 7 I.T.R. 269.
957
s.10(1) are what are understood to be such under ordinary
commercial principles. The loss for which the deduction is
claimed must be one that springs directly from the carrying
on of the business and is incidental to it. If this is
established the deduction must be allowed provided that
there is no provision against it express or implied in the
Act : (See Badridas Daga V. Commissioner of Income tax(1).
In that case loss sustained by the business by reason of
embezzlement by an employee was held to be an admissible
deduction under s. 10(1) although it did not fall within s.
10(2) (xi) of the Act of 1922. Indeed profits cannot be
computed without deducting the loss and permissible expenses
incurred for-the purpose of the business.
The approach of the high Court in the present case has been
that in order to arrive at the figure of profits even of an
illegal business the loss must be deducted if it has
actually been incurred in the carrying on of that business.
It is the net profit after deducting the out goings that can
be brought to tax. It certainly seems to have been held and
that view has not been shown to be incorrect that so far as
the admissible deductions under s. 10(2) are concerned they
cannot be claimed by the, assessee if such expenses have
been incurred in either payment of a penalty for infraction
of law or the execution of some illegal activity. This,
however, is based on the principle that an expenditure is
not deductible unless it is a commercial loss in trade and a
penalty imposed for breach of the law during the course of
the trade cannot be described as such. Penalties which are
incurred for infraction of the law is not a normal incident
of business and they fall on the assessee in some character
other than that of a trader; (See Haji Aziz & Abdul Shakoor
Bros v. Commissioner of Income tax, Bombay City(2). In that
case this Court said quite clearly that a disbursement is
deductible only if it falls within s. 10(2) (xv) of the Act
of 1922 and a penalty cannot be regarded as an expenditure
wholly and exclusively laid for the purpose of the business.
Moreover disbursement or expense of a trader is something
"which comes out of his pocket. , A loss is something
different. That is not a thing which he expends or
disburses. That is a thing which comes upon him abextra"
(Finlay J., in Allen v. Farquharson Brothers & Co.) (3). If
the ’business is illegal neither the profits earned nor the
losses incur-red 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 into account for computation of the
amount which can be subjected to tax as "profits" under s. 1
0 ( 1 ) of the Act of
(1)34 I.T.R. 10.
(3) 17 T.C. 59.
(2) 41 I.T.R. 350.
958
1922. The tax collector cannot be heard to say that he will
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bring the gross receipts to tax. He can only tax profits of
a trade or business. That cannot be done without deducting
the losses and the legitimate expenses of the business. We
concur in the view of the High Court that for the purpose of
s.10(1) the losses which have actually been incurred in
carrying on a particular illegal business must be deducted
before the true figure relating to profits which have to be
brought to tax can be computed or determined. This will,
however, not conclude the answer to question No. 2 because
it seems to have been framed with the other aspect relating
to "set off" under s.24 of the Act.
The High Court found that the transactions were of a
speculative nature. It was thus held that the loss of Rs.
3,40,443/- sustained in the impugned contracts was liable to
be set off against ,the profit of Rs. 2,19,046/- which was
admittedly a profit from speculative, transactions. The
concluding portion of the judgment of the High Court may be
reproduced because to Our mind it creates a certain amount
of difficulty.
"The loss of Rs. 3,40,443/- sustained in the
impugned contracts was, therefore, liable to
be set off only against the profit of Rs.
2,19,046/- which was admittedly profit from
speculative transactions and the balance of
Rs. 1,21,397/- after such set off was not
liable to be set off against the other income
of the assessee in view of the first proviso
to s. 24(1). We may make it clear that in
taking this view we have proceeded upon the
basis (that the impugned contracts which
resulted in the loss of Rs. 3,40,443
constituted a separate business distinct from
the business of forward contracts resulting in
the profit of Rs. 2,19,046/-. The result
would, however, be the same even if the
impugned contracts which resulted in the loss
of Rs. 3,40,443/- did not constitute a
separate business but were part of the same
business of forward contracts which resulted
in the profit of Rs. 2,19,046/- for in that
event the loss of Rs. 3,40,443 would be liable
to be taken into account in determining the
profits from such business under section 10".
Section 24, to the extent it is material for
our purposes, is set out below :
"Set off of loss in computing aggregate income
(1)Where any assessee sustains a loss of
profits or gains in any year under any of the
heads mentioned in section 6, he shall be
entitled to have the amount of the
959
loss set off against his income, profits or
gains under any other head in that year
Provided that in computing the profits and
gains. chargeable under the head "profits and
gains of business, profession or vocation" any
loss sustained in speculative transactions
which are in the nature of a business shall
not be taken into account except to the extent
of the amount of profits and gains, if any, in
any other business consisting of speculative
transactions;
Explanation 1. Where the speculative
transactions carried on are of such a nature
as to constitute a business, the business
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shall be deemed to be distinct and separate
from any other business.
Explanation 2. A speculative transaction means
a, transaction in which a contract for
purchase and sale of any commodity including
stocks and shares is periodically or
ultimately settled otherwise than by actual
delivery or. transfer of the commodity or
scripts;"
In order to claim the set off the meaning of the speculative
transaction has to be first looked at. Under Explanation 2
such a transaction means a transaction in which a contract
for the purchase and sale of any commodity is periodically
or ultimately settled otherwise than by actual delivery etc.
Now the contract has to be an enforceable contract and not
an unenforceable one by reason of any taint of illegality
resulting in its invalidity. It has already been found by
us that the contracts in question were illegal and
unenforceable on account of contravention of s. 15(4) of the
Act. The High Court was in error in considering that any
set off could be allowed in the present case under the first
proviso to s. 24(1) which must be read with Explanation 2.
There would have been no difficulty in disposing of the
matter finally after the above discussion. But enough
attention was not devoted to the business which the assessee
was doing and in which the profit of Rs. 2,19,046 was made
and the loss of Rs. 3,40,443 was sustained. It has been
found to be of a speculative nature but the High Court has
not clearly found that it was the same business in which the
amount of the profit and the loss mentioned above was earned
and sustained in which case alone a deduction will be
possible of the loss under s. 10(1). The High Court
proceeded on the basis that if the business in which the
profit was made and the business in which the loss was
incurred were separate a set off could be claimed by the
assessee under s. 24(1). If, however, the business was the
same then the loss would be liable to be taken
960
into account while computing the profits under s.10(1). As
we have come to the conclusion that no set off could be
allowed under S. 24(1) of the Act of 1922 it will have to be
determined whether the profits and losses were incurred in’
the same business even though that business involved the
entering into contracts some of which were, in the eye of
the law, illegal. If the trade or the business, for
instance, the business of commission agency or forward
business was the same in which the profits were made and the
loss was incurred then in order to arrive at the figure
which can be subjected to tax the loss will have to be
deducted from the profit. For this purpose we shall have to
remit the matter to the High Court to decide this point and
if necessary, after calling for a supplementary statement of
the case.
In the result our answer to the first question is that the
contracts were illegal. on the third and the fourth
questions there is no dispute nor has- any appeal been
preferred by the assessee relating to them that the answers
returned by the High Court in the affirmative and in the
negative respectively were not correctly answered. As
regards question No. 2 the High Court will have to answer
the same in the light of our judgment. Th.-, appeal by
special leave (i.e. C.A. 1173/71) shall stand disposed of
accordingly and the other appeal by certificate (i.e. C.A.
1993/68) is hereby dismissed. There will be no order as to
costs.
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V.P.S. Appeal partly
allowed.
961