1. Two questions have been referred for our decision under section 66(2) of the Indian Income-tax Act, They are as follows :
'1. Whether on the facts and the circumstances of the case, the amount of Rs. 2,00,000 (Rupees two lakhs) or any part thereof should have been allowed as a valid deductions either under the provisions of section 10(2) (xi) or otherwise under section 10(1) of the Indian Income-tax Act, 1922
2. Whether there is any material whatever to support the finding that the sum of Rs. 2,00,000 (Rupees two lakhs) or any part thereof did not become bad or irrecoverable during the previous year relevant for the assessment year 1953-54 ?'
As stated in the second question itself we are concerned with the assessment year 1953-54, the corresponding year of account being the Divali year October 31, 1951, to October, 18, 1952. This corresponds to Samvat year 2008. We state his this here because accounts of the two companies with which we are concerned in this case - one is according to the English calendar and the other (of the assessee-company) is according to the Samvat year.
2. The assessee is a private limited company, M. L. Dhanukar & Co. Private Limited. This company is, so to say, the central organisation of a number of companies which one M. L. Dhanukar and his sons own and control. In all the group of companies the controlling interest is that of the Dhanukar family. It will be convenient therefore to refer to this group of companies as the Dhanukars.
3. In 1948, the Dhanukar promoted the Worli Chemical Works Ltd. (hereinafter referred to as the Worli Company) and in that company the assessee-company owned 662 shares, M. L. Dhanukar owned 11 shares and his son, D. M. Dahanukar, owned 330 shares, thus making a total of 1,003, shares. Of the shares capital of this company, only 50% has been called up. The directors of the assessee-company and the Worli company are common. From time to time the assessee company used to finance the Worli company. It is not dispute that the assessee-company carries on the business not merely of managing agents but from time finances all the other companies of the family and is engaged in leading moneys to them and borrowing moneys from the members of the family. Whether that was done as a matter of business was one of the points raised before the Appellants Assistant Commissioner but it is not in dispute before us that the transactions between the assessee-company and the Worli company were transactions in the course of the business of the assessee.
4. The Worli company is engaged in the manufacture of chemical products including chemical medicinal products. In the course of their business they required finance and the assessee-company from time to time used to finance the Worli company. At the commencement of Samvat year 2008 the Worli Company owed to the assessee-company a sum of Rs. 5,85,413-1-3. There were several transactions during this year between the two companies to which we shall a presentably refer but on October 17, 1952, i.e., one day before the close of the Divali year S. Y. 2008 the assessee-company wrote off a sum of Rs. 2 lakhs out of the indebtedness of the Worli company to them. Taking into account the other transaction the books of the assessee-company showed that the Worli company was indebted to them in the sum of Rs. 4,97,200-14-6.
5. In the assessment year 1953-54, the Income-tax Officer allowed the sum of Rs. 2 lakhs as a bad debt to the assessee. He held that this amount represented a part of the amount advanced to the Worli company, which company had been suffering continuous losses on account of which the available assets were insufficient to meet the liability of the losses. Looking to the financial status of the company he allowed a deduction of Rs. 2 lakhs as a bad debt by his order dated 20th December 1956.
6. When the matter came under the scrutiny of the Commissioner, he felt that the order passed by the Income-tax Officer was erroneous and prejudicial to the interests of the revenue. Therefore, after hearing the assessee, the Commissioner took action under his revisional powers under section 33B of the Income-tax Act. The Commissioner in his order held in favour of the assessee that the transactions were in the course of the money-lending business of the assessee-company and to that extent the lending of moneys by assessee-company was justified. Then he considered the question whether the debt to the extent of Rs. 2 lakhs was bad in the particular year in which the same was written off and he pointed out a number of circumstances upon which he came to the conclusion that it could not be said that there was no reasonable expectation of recovering the whole debt on the date on which it was written off by the assessee-company. He pointed to several transactions which the assessee-company continued to have with the Worli company even after the sum of Rs. 2 lakhs was written off and observed that 'the position in fact is that the assessee-company continues to finance its sister concern without allowing that company to reduce its own indebtedness, and at the same time reduces its own profits by writing off a part of the debt and thus saves substantial tax. In other words, a apart of its own profits is diverted to the Worli Chemical Works and that escapes taxation.'
7. When the matter was taken in appeal by the assessee to the Income-tax Appellate Tribunal in Bombay, the Tribunal confined the findings of the Appellate Assistant Commissioner and dismissed the appeal. The Tribunal dealt with all the circumstances and came to the conclusion that 'a prudent businessman would not have considered the debts as bad' on the date on which it was written off. In fact they went further and held that 'there was no material to justify the write-off of Rs. 2 lakhs by the assessee-company on 17th October, 1952. In other words, we hold that the write-off was premature.'
8. The two questions framed for our decision, in substances, fall to be determined upon the same facts and circumstances. The short question is whether, on the date on which the debt was written off, that is to say, on 17th October, 1952, the circumstances were such that a reasonable and prudent businessman would have consider it a bad debt.
9. Having heard Mr. Rajgopal at length, we think that, upon the circumstances established in the present case, answers to the question referred, can only be against the assessee. All that is necessary is to set forth these circumstances as they have been found and they speak for themselves.
10. First, it has to be remembered that the Worli company was promoted by the Dhanukar and that the assessee-company owns 662 shares in the Worli company and that the remaining shares are owned also by M. L. Dhanukar and his son, D. M. Dahanukar, with the result that the Dhanukar family owns cent. per cent. of the share capital of the Worli company. It is in every sense a controlled company; since it has been held that the advance were made from time to time by the assessee-company to the Worli Company in the course of their business, we shall proceed on that basis. Now the position as in the accounting year, in which the date on which the debt was written off falls (i.e., the 17th October, 1952), was briefly as follows : The opening balance of the debit account of the Worli company in the books of the assessee-company showed that the Worli company were indebted to the assessee in the sum of Rs. 5,85,413-1-3. Then there is shown an amount paid to the Worli company Rs. 16,600 and the total amount due from the Worli company was further augmented by a sum of Rs. 1,05,384-5-3. This sum consists of two items. The exact date of the advance is not known. But it is not in dispute before us and that is a finding of fact given by the Tribunal and mentioned in the statement of the case that this amount related to advances made in the earlier years out of the profits of the assessee-company, which were subsequently found to be concealed profits. In November, 1951, it appears that the assessee had made a disclosure of their true income to the income-tax department taking advantage of the disclosure scheme then announced. The assessee-company disclosed an income of Rs. 31,56,774 as profits which had not been disclosed before. This sum was credited to the 'disclosure suspense account' and the sum of Rs. 86,249-11-3 was debited to the Worli company. The balance of Rs. 19,134 out of the sum of Rs. 1,05,384 represents the interest on Rs. 86,249. This amount alleged to have been advanced to the Worli company has not been disclosed but since the Worli company was promoted only in the year 1948, and disclosure of the concealed income was made in the year 1951, obviously the advance to the Worli company must have been some time between 1948 and 1951. Thus, the total indebtedness of the Worli company to the assessee-company came to Rs. 7,07,397-6-6. As against that, the account of the Worli company in the books of the assessee shows that the Worli Company were paid a sum of Rs. 10,100. Then there was a credit given to the Worli company for the amount of Rs. 2 lakhs and a small sum of Rs. 96.
11. Out of the amounts advanced to the Worli company we have already mentioned the sum of Rs. 16,000 said to have been paid to the Worli company during the year. As to this amount the finding given is that the cash advance was made on various dated from November 5, 1951, to June 2, 1952, in small amounts.
12. Now, no doubt, therefore, the position of the Worli company on the date on which the amount of Rs. 2 lakhs was written off was that it had total liabilities of Rs. 7,98,000 and assets of RS. 6,22,000. This is what is founded by the Tribunal. Even so, it has been held by the Tribunal that there was no scope for writing off a sum of Rs. 2 lakhs. Both the Appellate Assistant Commissioner and the Tribunal have found that of the total capital of the company a sum of Rs. 50,000 could have been always called up by the company and, therefore, the company cannot be said to be in a position where it could not pay the whole of Rs. 2 lakhs. But apart from that an important finding has been given that the assessee-company continued to have transactions with the Worli company and continued to make fresh advanced to the Worli company although of a small amount. Out of the amount of Rs. 16,600 which was advanced, it has been found as a fact that Rs. 1,500 were advanced to the Worli company on the 2nd June, 1952. Thus, upon the accounts themselves the position is clear that on the date on which the amount of Rs. 2 lakhs was written off, that is to say, 17th October, 1952, the position of the Worli company was not so bad that any reasonable person would have said that it was not in a position at all to repay the sum of Rs. 2 lakhs. On the other hands, the facts showed that the assessee-company conditioned to make advances to the Worli company till June, 1952, and yet a little more than six months later on the 17th October, 1952, it wrote off Rs. 2 lakhs of the indebtedness of the Worli company as a bad debt. There was no circumstances which transpired between June and October, 1952, which can be said to have altered the position of the Worli company so as to make its financial position worse that it was in June, 1952. These are therefore two principal circumstances upon which the conclusion was reached by the income-tax authorities that the assessee could not as a reasonably prudent business man have come to the conclusion that the amount of Rs. 2 lakhs was indeed a bad debt.
13. But there are further important circumstances which have been found by the authorities. They are that the Worli company continued to negotiate for more and more business with several parties including foreign collaborators which would show that the assessee-company must have known that the Worli company was not in such a bad way that it could not have repaid its indebtedness. It has been found that in October, 1950, negotiations were started with the American Products Ltd., Bombay, for some sort of collaboration with an American company known as Sigma Laboratories. NO doubt, these negotiations fell through some time in 1951, but soon after negotiations were commenced in December, 1952, with U. S Vitamin Corporation, New York, though the common director, M. L. Dahanukar. These negotiations fell through some time in 1956, and thereafter further negotiations were commenced with Fomos Laboratories Inc., New York, which materialised in substantial business. As a result of this business the Dhanukar were enabled to import several millions of tablets which were supplied by Worli company to the Government of India for a sum of Rs. 2 1/2 lakhs which amount was to be recovered from the Government of India. The assessee-company, it is said, considered the Worli company as being unable to pay its debts, but one cannot understand why the directors in charge of the Worli company who are the directors of the assessee-company also still continued to carry on business of the Worli Company. That is a further indication that on the 17th October, 1952, the position of the Worli company was not so hopeless as was sought to be made out, and a creditor of the Worli company would not have come to the conclusion that the debt could not be repaid by the Worli company.
14. The Worli company in the subsequent years 1955-57, continued business relations and had several transactions with different companies of the Dhanukar group. The three transactions mentioned in the order of reference are as follows :
By Dhanukar & Sons Ltd. on 14-11-55 9,126
By the assessee-company in July & August, 1956 30,000
By Amrit Oil Mills Ltd. in October, 1957. 1,777
15. Now, no doubt, by the letter dated December 9, 1958, which counsel read out in extenso, the assessee has explained how these transactions were effected, particularly as regards the loan of Rs. 30,000 made in two amounts of Rs. 20,000 and Rs. 10,000. He has explained this letter that when the consignment of Fomos tablets from the Fomos Laboratories of New York arrived the Worli Company had not liquid funds to clear the consignment and also to repack the same in accordance with the requirement of the Government of India before their supply to the Government and therefore the assessee-company advanced this amount, as 'a temporary loan'. The letter upon which counsel placed strong reliance itself states 'We though that there was a bright future for the Worli Chemical Works Ltd.... We though that by lending the small amount, necessitated in the special circumstances narrated above, it would enable the Worli Chemical Work Ltd. to fulfil their contract with the Government and realise a large sum of money.... '. Even from the balance-sheets for the year 1952 and 1953, which were also referred to in the argument before, us, it seems that though no doubt the Worli company was suffering losses, its losses increased up to the year 1952, but for the year ended 31st March, 1953, the loss had decreased showing that in about 4 years after its promotion was doing better than in the earlier years of its existence. These are circumstances which have been referred to by the Tribunal in its own order and in the reference and as have been referred to by counsel in the argument before us.
16. The principal contention on behalf of the assessee before us is that the tax authorities erred in relying upon events and facts subsequent to the date on which the amount was written off. For instance, it has been urged that the subsequent dealings of the assessee-company with the Worli company ought not to have been relied upon as also the fact that the Worli company continued to trade and improve its position after the date on which amounts was written off. Reference was made in this respect to the proviso to section 10(2), clause (xi), which merely says that if the amount with has been allowed as a bad debt under the parent clause (xi) of the section 10(2) is ultimately recovered on any such debt or loan written off as a bad debt and that amount is greater than the difference between the whole debt or loan and the amount so allowed, 'the excess shall be deemed to be a profit of the year in which it is recovered, and if less, the deficiency shall be deemed to be a business expense of that year'. Counsel pointed out that the proviso itself indicates that even if the debt is ultimately recovered it can only be taxed in that year of account and it does not result in the disturbance of the accounts of that year which have already been settled. If follows, therefore, that the allowance cannot depend upon the subsequent events or the result of the subsequent trading and that would shows that the question whether the debt should be reasonably considered to be bad must be judged only upon the facts and circumstances as they appear on the date on which the debt was written off and not upon either the subsequent facts and circumstances or the subsequent conduct of the assessee or the debtor. In this connection, counsel also referred to the decision in Anbderton and Halstead Ltd. v. Birrell (H. M. Inspector of Taxes) and in Devi Films Ltd. v. Commissioner of Income-tax.
17. So far as the proviso to clause (xi) of section 10(2) is concerned, it does not provide for the manner in which the question whether a debt is bad or not has to be determined. in substance, all that clause (xi) says is that, where the assessee carries on business carries on business had his accounts are not kept on a cash basis, the assessee will be entitled to bad and doubtful debts and where the assessee carries on a banking or money-lending business, the assessee shall be entitled to the allowance of such sum in respect of loans made in the ordinary course of business as the Income-tax Officer may estimate to be irrecoverable, but not exceeding the amount actually written off as irrecoverable in the books of the assessee. The proviso says that if such allowances is granted and subsequently any amount is actually recovered by the assessee then if the amount ultimately recovered is greater than the difference between the whole debt or loan and the amount allowed to be set off, the excess can be charged as a business income or profits during that year and if less, the deficiency shall be deemed to be a business expense of that year. Obviously if an allowance is made in a particular year and the amount allowed or any part of it is subsequently recovered, then it can only be taken into account for purposes of taxation in the year in which the amount is recovered and taut is all that the proviso provides. We do not think that it follows from this proviso that in granting or not granting the allowance contemplated by clause (xi), the Income-tax Officer cannot look at all the surrounding circumstances. In fact, the words in the parent clause are 'as the Income-tax Officer may estimate to be irrecoverable' and that would necessarily include his estimate that the amount is irrecoverable upon all the facts and circumstances of the case. We do not think, therefore, that the provision alters that position or precludes the Income-tax Officer from looking to any subsequent course of business or facts and events which have transpired after the amount has been written off.
18. The case, Devi Films Ltd. v. Commissioner of Income-tax, itself makes this clear. In that case the assessee had entered into an agreement with one Tehrani, who was producing a cinema film, whereby, first, a sum of Rs. 3,80,000 had been advanced by the assessee to Tehrani and later by a separate agreement on 31st January, 1956, a sum of Rs. 1,50,000. In all, the assessee had advanced to Tehrani a sum of Rs. 5,57,022-10-1 in pursuance of the two agreement. The picture, however, did not prove a business success, but the assessee had realised out of the amounts advanced by him from the collections from the exhibition of the picture a sum of Rs. 4,91,071-1-3. Thus there remained a balance of Rs. 65,950-13-10 due and payable by Tehrani to the assessee. A fresh arrangement was entered into with the assessee on 1st April, 1957, in regard to this indebtedness. Tehrani was not a well-to-do person. He had a house in Madras and held 100 shares in a certain studio of the face value of Rs. 10,000. By the agreement of 1st April, 1957, it was agreed between the assessee and Tehrani that the latter should pledge his shares in the studio as security for Rs. 10,000 on condition of the assessee having the balance of Rs. 55,950-13-10 due from Tehrani to him. The assessee claimed the amounts thus waived as a bad debt.
19. After taking into account the facts an circumstances found by the income-tax authorities, the Madras High Court pointed out that the expression 'bad and doubtful debt' is descriptive of a debt which cannot reasonably be expected to be realised and it would not do merely for the assessee to say that he became pessimistic about the prospects of recovery of the debt in question. 'He must feel honestly convinced that the financial position of the debtor was so precarious and shaky that it would be impossible to collect any money from him. There is no acid test to ascertain whether a debt has become bad and doubtful, and if so, when. ' In that particular case they pointed out that the debtor was active in the pursuit of his business and the assessee himself did not treat the debtor as one finically unsound as even during the year 1957, six months after writing off of the debt, he thought him creditworthy for being lent a further sum of Rs. 25,000. In that case, therefore, the facts the themselves showed that the Madras High Court took into account circumstances similar to the circumstances were existing subsequent to the writing off of the debt. It was specifically contended before the High Court that the later happening ought not to be taken into account and as to that the Madras High Court observed at page 880 : 'It is true that what all is required is an honest judgment on the part of the assessee at the time when he makes the write-off in the light of events up to that stage and not in the light of later happenings. But it cannot be said that in order to determine the question whether the assessee could have believed that the debt was made (sic 'bad') on a particular date his subsequent conduct, treating the debtor as solvent and sound, would be irrelevant or inadmissible. ' Therefore, undoubtedly a creditor has to come to an honest judgment at the time of the writing off of the debt that it was a bad and irrecoverable debt but that does not mean that when the court is called upon the determine whether as a reasonably prudent man he could have entertained that belief the court can only look at the true circumstances upto the time he wrote off the debt and that it cannot look at the subsequent events or facts or his subsequent conduct. The Madras High Court held that these would not be irrelevant or inadmissible. The decision in Anbderton and Halstead Ltd. v. Birrell was expressly referred to before the Madras High Court and particularly the passage at page 209 from the judgment of Rowlatt J., but even taking into account that passage we do not think that it has been held that the authorities or the court are precluded from looking at the subsequent conduct or the subsequent events in determining the question whether the assessee could have believed that the debt was bad. We cannot, therefore, hold that in the present case the tax authorities have in any way gone wrong in law in looking at the facts and circumstances relating to the business of the Worli company after the date of the writing off of the amount of Rs. 2 lakhs or in looking to the amount of the assessee after that date.
20. Some distinctions was sought to be made by counsel by urging that on the date on which the assessee-company wrote off this amount of Rs. 2 lakhs the concept of commercial insolvency of the Worli Company had to be taken into account and so viewing the position of the Worli company the assessee genuinely felt that it would be commercially impossible to realise Rs. 2 lakhs out of the total indebtedness of the Worli company to the assessee. While there may be a distinction between insolvency for the purpose of the business and insolvency as contemplated by the Insolvency Act we do not think that in judging whether a debt is bad there can be two standards. The standards as has been laid down by the authorities is that of a reasonably prudent businessman or director of a company coming to the conclusion that the debt advanced by him to a particular debtor is wholly irrecoverable. Of course, it is impossible in a given case to define what is the circumstances of each case. We do not think therefore that the concept of commercial insolvency can be imported into a consideration of the question whether and under what circumstances a debt becomes bad.
21. Having considered all the facts and circumstances, we are satisfied that the tax authorities were right in the conclusion reached by them. We, therefore, answer the first question in the negative and the second question in the affirmative. Since the decision is wholly against the assessee, the assessee shall pay the costs of the Commissioner.