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Associated Banking Corporation of India Ltd. Vs. Commissioner of Income-tax, Bombay-1 - Court Judgment

LegalCrystal Citation
SubjectDirect Taxation
CourtSupreme Court of India
Decided On
Judge
Reported inAIR1965SC1188; [1965]35CompCas308(SC); [1965]56ITR1(SC); [1965]1SCR788
ActsIncome-tax Act, 1922 - Sections 10(2) and 66(1); Indian Income-tax (Amendment) Act, 1939 - Sections 11; Income-tax Act, 1961 - Sections 28 and 36(1)
AppellantAssociated Banking Corporation of India Ltd.
RespondentCommissioner of Income-tax, Bombay-1
Cases ReferredIn M. P. Venkatachalapathy Iyer and Anr. v. Commissioner of Income
Excerpt:
the case dealt with the scope of the sections 10(1) and 10(2) (xi) and (xv) of the income tax act, 1922 - it further questioned whether the bad debts should be written off before the claim was allowed - it was held that the bank was entitled to claim rs. 15, 00,000 as bad debts in the year of account - section 10 (2) (xi) of the act did not say the income tax officer could not allow a bad or doubtful debt unless it was written off in the books of accounts; it merely stated that he should not allow any amount in excess of the amount actually written off as irrecoverable - further, the bank was not entitled to claim as a business loss or deduction the amount embezzled by the officer. - indian penal code, 1890.section 375 & 376 & 417: [tarun chatterjee & v.s. sirpurkar, jj] rape inference.....shah, j.1. one m. c. javeri was appointed secretary of the associated banking corporation of india ltd., and under a power of attorney dated august, 14, 1943, he was entrusted with powers, amongst others, to supervise, manage and conduct the business, to lend and make at such rate or rates of interest as he thought fit with or without security to any person, and to receive and give good discharge for repayment of any moneys so lent or advanced and all interest thereon and to borrow money upon the security of any securities, assets or property of the bank and upon such terms as he thought fit for the benefit of the bank. on march 5, 1945, javeri was appointed a director of the bank. on april 21, 1947, by order of the high court of bombay the bank was ordered to be compulsorily wound up and.....
Judgment:

Shah, J.

1. One M. C. Javeri was appointed secretary of the Associated Banking Corporation of India Ltd., and under a power of attorney dated August, 14, 1943, he was entrusted with powers, amongst others, to supervise, manage and conduct the business, to lend and make at such rate or rates of interest as he thought fit with or without security to any person, and to receive and give good discharge for repayment of any moneys so lent or advanced and all interest thereon and to borrow money upon the security of any securities, assets or property of the bank and upon such terms as he thought fit for the benefit of the bank. On March 5, 1945, Javeri was appointed a director of the bank. On April 21, 1947, by order of the High Court of Bombay the bank was ordered to be compulsorily wound up and an official Liquidator was appointed to liquidate the business of the bank. On August 23, 1949, the liquidate submitted a return for the assessment year 1948-49 disclosing for the previous year ending June 30, 1947, business loss computed at Rs. 9,71,664 after debiting against the gross profits in the profit and loss account an amount exceeding Rs. 12,00,000 as debts which became irrecoverable. On February 26, 1953, the liquidator informed the Income-tax Officer that in the course of investigations it was found that the bad debts of the bank including the amounts embezzled by the secretary amounted to Rs. 48,50,952.

2. It is common ground that entries adjusting the books of account and writing off the amounts claimed to be irrecoverable were not posted in the books of account either before the return was filed, or even till the proceeding reached the Tribunal. The departmental authorities and the Tribunal rejected the claim for allowance of bad debts on the ground that the bad debts were not written off in the books of account of the Bank as required by section 10(2)(xi) of the Income-tax Act. The claim for allowance of Rs. 10,15,000 and Rs. 99,892 being the loss resulting from embezzlements by the secretary was rejected by the department authorities on the grounds, that the embezzlements did not relate to the business of the Bank and could not be treated as loss suffered by the Bank in the course of the business, and in any event the loss was not suffered in the year of accounts because it was not ascertained in that year. The Income-tax Appellate Tribunal agreed with the departmental authorities for the second of the two reason.

3. The Tribunal referred under section 66(1) of the Act, two questions which were later modified by the High Court to read as follows :-

'(1) Whether on the facts and in the circumstances of the case the assessee is entitled to claim bad debts amounting to Rs. 38,35,654 or any lesser sum

(2) Whether on the facts and in circumstances of the case the assessee is entitled to claim two sums of Rs. 10,15,000 and Rs. 98,892 as a business loss or as a deduction under section 10(2)(xv) of the Income-tax Act

4. The High Court agreed with the Tribunal that the claim for allowance of bad debts could not be sustained under 10(2)(xi) as the debts had not been written off in the books of account of the Bank. But at the request of counsel for the liquidator they called upon the Tribunal to submit a supplementary statement on the question whether the debts had actually become irrecoverable during the year of account, and whether they were debts arising in the course of the business of the Bank. The High Court being of the opinion that the facts set out in the statement of case were not sufficient to enable them to record an answer on the second question, called upon the Tribunal to submit a supplementary statement about the powers entrusted to the Secretary, and the year in which loss was suffered by the Bank in consequence of embezzlements by the Secretary. The Tribunal reported that debts aggregating to 'Rs. 15,00,000 at least' had become irrecoverable in the year of account, and that the Secretary had misused powers entrusted to him under the power of attorney (a copy of which was annexed to the report) after posting fictitious entries in the books of account, but the defalcations of Rs. 18,00,000 and Rs. 98,892 by the Secretary became known to the liquidator only after the year of account ending June 30, 1947.

5. At the further hearing of the reference the High Court observed that they were bound by the finding recorded at the earlier hearing that bad debts were not admissible deductions because the debts were never written off in the books of account of the Bank, and that the time when loss resulting from embezzlement or defalcation by a servant or agent of the assessee occurs must be decided on the facts and circumstances of each case, and no general rule could be laid down in that behalf. In the view of the High Court loss of Rs. 10,15,000 did not occur when factious entries had been posted at the instance of the Secretary in the books of account of the Bank, but much later. The item of Rs. 98,892 was also not admissible as a business loss in the year of account for the same reason. With certificate granted by the High Court, this appeal is preferred by the liquidator of the Bank.

6. In considering whether writing off in the books of account is a condition precedent to the admissibility of allowance for bad debts, attention must first be directed to the terms of section 10(2)(xi). The clause provides :

'(2) Such profits or gains shall be computed after making the following allowances, namely :-

(xi) When the assessee's accounts in respect of any part of his business, profession or vocation are not kept on the cash basis, such sum, in respect of bad and doubtful debts, due to the assessee in respect of that part of his business, profession or vocation, and in the case of an assessee carrying on a banking or money-lending business, such sum in respect of loans made in the ordinary course of such 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 :

Provided . . . . . . . . . . . . . . . . . . . . . . .'

7. The assessee is a Banking Company : it has in the ordinary course of its business granted loans and on the finding of the Tribunal, debts of the value of Rs. 15,00,000 are estimated to be irrecoverable in the year of account. Could this amount be allowed as a deduction in the computation of taxable income, when it is not written off as irrecoverable in the books of account

8. It is for the assessee to claim allowance in respect of debts which have become irrecoverable either in his return or in the statement accompanying the return. By his supplementary statement, the liquidator claimed that an amount of Rs. 48,50,952 should be treated as bad debts in the year of account. It was, therefore, clear that the claim was made by the liquidator for treating as bad debts the amounts which were claimed to be irrecoverable in the year of account. But it is contended that it is a condition of admissibility of allowance of bad debts that an entry or entries must be posted in the books of account writing off the debts as irrecoverable.

9. The Income-tax Officer is by the Act entrusted with the power to estimate as irrecoverable the debts which are claimed as bad or doubtful, but the power is subject to the restriction that the allowance will not exceed the amounts actually written off as irrecoverable in the books of the assessee. If the assessee in his books of account has written off a certain amount as irrecoverable, the Income-tax Officer may not, even if his estimate exceeds the amount written off, allow the amount exceeding the amount actually written off. Can it be said that when the assessee has not posted entries in the books of account writing off any amount representing bad or doubtful debts, there is no restriction upon the power of the Income-tax Officer to allow a permissible deduction under the head 'bad debt' On his question there is conflict of opinion in the High Courts. Chagala C.J., in the judgment under appeal, held that the view that writing off in the books of account was a condition precedent to the admissibility of a bad or doubtful debt was in conformity with the view which the courts had consistently taken for many years in interpreting section (10)(2)(xi). The learned chief Justice observed :

'We are not aware of any single case where either the department or the assessee ever contended in this court that an assessee is entitled to a certain amount as a bad debt which amount has in fact not been written off in his books of account. But apart from the settled practice, there are decisions of this Court which have also proceeded on that view of the section.'

10. The Calcutta High Court in Begg Dunlop and Co. Ltd. v. Commissioner of Excess Profits Tax, west Bengal : [1954]25ITR276(Cal) has expressed an equally emphatic opinion to the contrary. Chakravartti C.J., Who delivered the judgment of the court observed that by the last clause of section 10(2)(xi) the Income-tax Officer is given a discretion to allow such amount as he himself may estimate to be irrecoverable, a maximum limit or rather a ceiling is at the same time set, beyond or higher than which he may not go. It is necessary in resolving the conflict to examine carefully the provisions relating to the allowance of bad debts in computing the profits or gains of a business carried on in the year of account.

11. Under the Income-tax Act, 1922 as originally enacted there was no provision in sub-section (2) of section 10 for allowance of bad or doubtful debts in the computation of profits or gains of a business carried on by the assessee. But bad or doubtful debts could properly by allowed as necessary business deductions under section 10(1). In Commissioner of Income-tax, Central Provinces and Bear v. Sir S. M. Chitnavis (1932) L.R. 59 IndAp 290 the Judicial Committee held that a debt which has become a bad debt during the year of account can properly be treated as a loss and deducted from profits. The Judicial Committee observed at page 296 :

'Although the Act nowhere in terms authorizes the deduction of bad debts of a business, such a deduction is necessarily allowable. What are chargeable to income-tax in respect of a business are the profits and gains of a year; and in assessing the amount of the profits and gains of a year account must necessarily by taken of all losses incurred, otherwise you would not arrive at the true profits and gains. But the losses must be losses incurred in that year. You may not, when setting out to ascertain the profits and gains of one year, deduct a loss which has in fact been incurred before the commencement of that year. If you did, you would not arrive at the true profits and gains of the year .... If thus follows that a debt, which had in fact become a bad debt before the commencement of a particular year, could not properly be deducted in ascertaining the profits of that year, because the loss had not been sustained in that year.'

12. The Judicial Committee however did not regard the entries writing off the debts as irrecoverable as a condition precedent to admissibility of the claim for allowance. It is true that in any recognised system of accounting, if the claim is made that a debt has become barred, where the accounts are maintained according to the commercial method of accounting, an entry or entries - if not in the account of the debtor - at some appropriate place or place in the books would be posted recording that in the view of the assessee the debt had become irrecoverable, and without such an entry or entries it would, in normal cases, be difficult to make up a profits and loss account of the year. But the entries need not be in respect of each individual debt regarded by the assessee as bad or doubtful : a composite entry relating to the debts regarded as bad or doubtful may suffice.

13. After the judgment of the Privy Council in Chitnavis's case (1932) L.R. 59 IndAp 290 the Legislature has inserted by section 11 to Indian Income-tax (Amendment) Act 7 of 1939 clause (xi) in sub-section (2) of section 10, which expressly deals with the admissibility of bad or doubtful debts as allowances in the computation of profits and gains. In cases governed by the amended Act undoubtedly the question of admissibility of bad or doubtful debt as allowance must be adjudged in the light of the express provision of the statute, and not on general considerations of commercial accountancy, or business necessity. It is pertinent to bear in mind the language used by the Legislature : the clause does not say that the Income-tax Officer cannot allow a bad or doubtful debt, unless it is written off in the books of account; it merely states that the Income-tax Officer shall not allow any amounts in excess of the amount actually written off as irrecoverable. It is, therefore, for the Income-tax Officer to ascertain what debts have become bad or doubtful in the year of account. This would require an investigation by the Income-tax Officer whether any debts claimed to be bad or doubtful have become irrecoverably, and for what amount. If the assessee has posted a composite entry debts exceeding in value the amount entered may not be allowed as irrecoverable by the assessing authority. If he has posted entries in respect of individual debts, the restriction on the power of the assessing authority must operate in respect of each such debt written off. This much is however clear that in respect of any individual debt, writing off in the books of account is not a condition of its allowance in the computation of profits.

14. Our attention has not been invited to any decision (except the judgment under appeal) in which it has been ruled that the power of the Income-tax Officer to allow deductions of debts which are regarded as bad or irrecoverable, can only be exercised when there is an entry posted in the books of account of the assessee that a certain amount has become irrecoverable. Two case to which Chagla C.J. referred in the course of his judgment as illustrative of a settled practice of the Bombay High Court do not support that view. In commissioner of Income-tax and Excess Profits Tax, Central Bombay v. Jwala Prasad Tiwari : [1953]24ITR537(Bom) the assessee had claimed in the course of assessment of his profits and gains that certain debts had become doubtful of recovery in the year of account. The assessee had in fact debited the two sums in the profits and loss account and credited them under the head 'doubtful debts' in the suspense account. The income-tax authorities held that as the individual accounts of the debtors in the books of the assessee had not been credited with the amounts, the debts had not been written off as required by the section. The High Court held that the amount of the debts had in fact been written off in the assessee's books. The court held in that case that section 10(2)(xi) did not demand that individual ledger entires writing off debts claimed to be bad or doubtful should be posted. The court was not called upon in that case to consider whether absence of an entry writing off the amounts deprived the Income-tax Officer of his power to allow bad or doubtful debts to the extent estimated by the officer to be irrecoverable. This case does not lay down that to the admissibility of a bad debt as an allowance under section 10(2)(xi) writing off of the debt is a condition precedent.

15. The other case in Karamsey Govindji v. Commissioner of Income-tax, Bombay City : [1957]31ITR953(Bom) . In that case the assessee had advanced in 1945 and 1946 without security certain loans a film producer and had written off the loans as bad debts in November, 1947. On the evidence in the case the income-tax authorities held that the loans had not become irrecoverable in 1947, and the High Court of Bombay in a reference under section 66(2) held that the finding of the Income-tax authorities that the debts had not become bad in 1947 could not be regarded as not justified on the evidence. The case evidently did not directly deal with the writing off of a debt in the books of account of the assessee being a condition precedent allowance under section 10(2)(xi).

16. It was conceded by counsel for the revenue that the allowance of a bad debt may be granted even if the entry writing off the amounts as irrecoverable is posted during the course of the hearing before the Income-tax Officer. The Department therefore submits that though and entry writing off the amount of a debt claimed to be bad or doubtful is a condition precedent to the allowance, the entry need not be posted before the return is submitted, or even before the hearing of the assessment proceeding by the Income-tax Officer is concluded. The Legislature has not made an express provision that an entry in books of account writing off a debt as irrecoverable is a condition of its admissibility as an allowance under section 10(2)(xi), and the language used in the clause examined in the light of the scheme of the Act does not compel such an interpretation. On the power of the Income-tax Officer and therefore of all superior authorities - undoubtedly a restriction is placed. It is not open to the Income-tax Officer to estimate the debts as irrecoverable in excess of the amounts which the taxpayer regards as irrecoverable. But it for some adequate reason the tax-payer has not posted an entry and there is a reasonable explanation for that default, absence of an entry writing off the amounts of a debt which has become bad or doubtful which may be posted at any time in the appropriate place in the books of account before the proceedings are concluded before the authority is by itself not a ground for denying to the Income-tax Officer jurisdiction to estimate the debts as irrecoverable, and to allow it as proper deduction in the computation of profits. It might at first sight appear somewhat paradoxical that if the assessee has actually written off as irrecoverable in his books of account individual debts or a collective sum as debts irrecoverable, the power of the Income-tax Officer is restricted and the amount he may allow as irrecoverable debts cannot exceed the amount actually written off : where the amount is not written off in the books of account, the Income-tax Officer's jurisdiction is at large and he may allow amounts as irrecoverable. But the provisions of the statute should not be construed in a narrow spirit of technicality. It may be noticed that clause (xi) does not restrict the power to estimate bad debts : it limits the power to grant allowance under the head of bad and doubtful debts, any amount in excess of the amount actually written off by the assessee in his books of account. It would therefore by reasonable to hold that if after estimating the bad debts, there is no express statutory restrains on the exercise of the power to grant allowance, no implication of a restraint on the exercise of the power may be evolved, unless such implication is on the scheme of the Act intended and in the scheme of the Act we find no such restraint imperatively intended, for it cannot be assumed in all cases that absence of an entry writing off the amount of bad debts necessarily implies that no debts become irrecoverable in the year of account.

17. In our view Chakravartti C.J. was right when he observed in Begg Dunlop and Co. Ltd's case : [1954]25ITR276(Cal) at page 284 :

'I am entirely unable to hold that section 10(2)(xi) of the Income-tax Act imperatively requires that in order that any amounts may be allowed as irrecoverable in any particular year, such amounts or a larger amount must be 'actually written off as irrecoverable in the books of the assessee'. The relevant language of the section, if I may recall its terms, is 'such sum as the Income-tax Officer may estimate to be irrecoverable but not exceeding the amounts actually written off'. What that language means, to my mind, clearly is that while the Income-tax Officer is given a discretion to allow such amounts as he himself may estimate to be irrecoverable, a maximum limit or rather a ceiling is at the same time set, beyond or higher than which he may not go. It does not seem to be even a requirement of the section that a debt which the Income-tax Officer may treat as irrecoverable must be written off at all. All that the section seems to mean, in my view, is that if a debt has actually been written off by the assessee in his books as irrecoverable in a particular year, then the Income-tax Officer, in making an allowance in respect of bad debts for that year, must not allow anything in excess of the amount which the assessee has himself written off.'

18. But this does not mean that an assessee who chooses not to post an entry in the books of account about bad or doubtful debts places himself in a better position than an assessee who has actually posted entries writing off amounts as irrecoverable in his books of account. On the materials placed before him, it is always open to the Income-tax Officer to come to the conclusion that the fact that the assessee has not chosen to post an entry is consistent with the circumstance that no part of the due to him in the year of account has become bad or doubtful and therefore irrecoverable, and on that account to disallow the claim which may be made at the hearing that some or all debts had become bad or doubtful. Even when no entry has been posted in the books of account, the question is one of power to be exercised on the facts and circumstances on the record by the Income-tax Officer to allow deductions in the computation of profits and gains. If the Income-tax Officer estimates certain debts to be irrecoverable, it would be within his power under section 10(2)(xi) to allow the same in computing the profits. The power is only restricted in one direction, namely, that where the assessee has posted an entry or entries in the book of account the amount to be estimated irrecoverable is not to exceed the amount actually written off as irrecoverable by the assessee.

19. Under the Income-tax Act 43 of 1961, by section 36(1)(vi) the amount of any debt or part thereof which is established to have become a bad debt in the previous year has to be allowed in computing the income under section 28 : but that allowance is subject to Sub-section (2) which provides insofar as it is material that 'in making any deduction for a bad debt or a part therefore the following provisions shall apply :

(i) no such deduction shall be allowed unless such debt or part thereof -

(a) had been taken into account in computing the income of the assessee of that previous year or of an earlier previous year, or represents money lent in the ordinary course of the business of banking or money-lending which is carried on by the assessee, and

(b) has been written off as irrecoverable in the accounts of the assessee for that previous year. (ii) . . . . . . .(iii) . . . . . . .(iv) . . . . . . .'

20. It is manifest that the material clause has been wholly reflected and the Legislature has expressed its intention clearly.

21. In dealing with the second question some more facts may be stated. The secretary, M. C. Javeri, was invested with extensive powers of management and the directors of the Bank appeared to have remained supine. The secretary helped himself to large amounts out of the assets of the Bank. On November 1, 1946, the Bank entered into an underwriting agreement with the Government of Bhopal underwriting a loan of the value of Rs. 2 crores issued by the Government of Bhopal. On December 3, 1946, V. R. Ranade and Sons applied to the bank for purchasing Bhopal Government loan and remitted in full the amounts of Rs. 15 lakhs to the Bank. This amounts was in the first instance credited in the sundry deposit account, but at the instance of the Secretary the entry in the sundry deposit account was reversed and the sum of Rs. 15 lakhs was broken up into smaller amounts and credited in the account books in different names. V. R. Ranade and Sons pressed for delivery of the loan certificates and the Secretary delivered to them a forged allotment letter for certificates of the value of Rs. 15 lakhs purported to have been received from the Bank of Bhopal Ltd. After the Bank was ordered to be would up, V. R. Ranade and sons made a claim on December 5, 1947, For preferential payment of Rs. 15 lakhs out of the assets of the Bank. On February 28, 1949, the liquidator submitted to an order that V. R. Ranade and Sons be paid Rs. 8,80,000 as preferential creditors within on month of the date of the order. This amounts was, under the direction of the Court, actually paid some time later by the Official Liquidator to V. R. Ranade and Sons.

22. Early in 1947, the Bank of Bhopal had instructed their broker, Shantilal L. That, to purchase on its behalf Bhopal Government loan of the face value of Rs. 3,00,000, and Thar contracted to purchase of Bhopal Government loan from the assessee Bank. On February 11, 1947, an amount of Rs. 3,00,000 was paid to the Bank, but no letter of allotment was issued. Loan certificates were never delivered to the Bank of Bhopal Ltd. and Rs. 3,00,000 paid to the assessee Bank were transferred to the account of Haroon Haji Abdul Satar to Bantwa in the Jetpur branch of the Bank showing as if that person had sold bonds of the value of Rs. 3,00,000. This amount was withdrawn by the Secretary and misappropriated. The Bank of Bhopal Ltd. filed a suit against the assessee bank in the Bombay High Court for an order for delivery of the Bhopal Government bonds and in the alternative for a decree for Rs. 3,00,000. A settlement was arrived at in the suit and the assessee Bank agreed to pay to the Bank of Bhopal Ltd. Rs. 1,35,000 in full and final settlement. A consent decree was passed on September 20, 1951, and was satisfied by the liquidator sometime thereafter.

23. There is another amount of Rs. 98,892 which it was claimed by the liquidator was embezzled by the Secretary. At the hearing counsel for the liquidator has given up this part of the claim and it is unnecessary for the purpose of this appeal to set out the details in respect of this amount. The claim under the second question must therefore be restricted to Rs. 10,15,000. The Income-tax authorities disallowed this claim. In their view it was not suffered by the Bank in the course of its business and therefore could not be treated as a loss by the Bank, and in any event the loss was not suffered in the year of account because it was ascertained in the year 1949 or later and could be taken into account in the assessment relating to that period alone. The embezzlements undoubtedly took place in the year of account ending June 30, 1947. The Secretary misused the powers conferred upon him under the power of attorney and withdrew Rs. 18,00,000 by posting entries in the names of persons who did not exist, or who had no dealings with the Bank. But until an investigation of the dealings of the bank was made, the embezzlements could not come to the knowledge of the Directors of the Bank or the liquidator. The Bank had to pay Rs. 10,15,000 to its constituents to satisfy the liability arising out of the Secretary's dealings with the funds of the Bank. Loss has, therefore, been suffered by the Bank as a result of the withdrawals made by the Secretary, and the only question relevant for the purpose of the appeal is whether the loss occurred in the year of account ending June 30, 1947.

24. It was urged by counsel for the liquidator that loss occurs to a Banking institution when funds are withdrawn or misapplied by an agent or servant and misappropriated, and therefore the withdrawals or misapplication by the Secretary having taken place in the year of account, the loss was admissible as an allowance in the year of account against the profits of that year. We are unable to agree with that contention. A claim to deduct an amount lost to the assessee because of embezzlement by his agent does not fall within the description of any allowance under clauses (i) to (xv) of sub-section (2) : to be admissible it must, if at all, fall within sub-section (1). This position was conceded in the High Court, in our judgment properly, by counsel for the Bank. The problem as to when loss resulting from misapplication of funds by an agent occurs must be viewed like many other problems arising under the Income-tax Act on a conspectus of all the facts and circumstances in the context of principles of commercial trading. Embezzlement of funds by an agent, like a speculative adventure, does not necessarily result in loss immediately when the embezzlement takes place, or the adventure is commenced. Embezzlement may remain unknown to the principal, and the assets embezzlement may be restored by the agent or servant.

25. In such a case in commercial sense no real loss has occurred. Again it cannot be said that in all cases when the principal obtains knowledge of the embezzlement the loss results. The erring servant may be persuaded or compelled by process of law or otherwise to restore wholly or partially his ill-gotten gains. Therefore so long as a reasonable chance of obtaining restitution exists, loss may not in a commercial sense be said to have resulted.

26. In M. P. Venkatachalapathy Iyer and Anr. v. Commissioner of Income-tax, Madras : [1951]20ITR363(Mad) it was held by the Madras High Court that profits and gains of a business must be ascertained by ordinary commercial principles of trading, and a working rule is that until the loss resulting from misappropriation 'becomes actual and certain' there can be no accrual of loss. In Venkatachalapathy's case : [1951]20ITR363(Mad) the assessee employed a clerk who wrote books of account of a business, acted as salesman, received and disbursed cash in the absence of the managing partner and collect bills. By manipulation of accounts the clerk misappropriated large amounts at diverse times. In May, 1941, it was discovered that the clerk had Embezzled Rs. 36,298-3-6 during the period between October 17, 1939 and October 24, 1940. In June, 1941, a criminal prosecution was launched against the clerk and about the same time a civil suit for recovery of the amounts was also instituted. The claim was compromised in August, 1941 and the clerk paid the assessee Rs. 16,250 in full settlement of his liability. The assessee claimed in the assessment year 1942-43 (accounting year ending with April 12, 1942) a deduction of Rs. 21,372 being the difference of the sum embezzled by the clerk and the amount recovered from him, and it was rightly held that the sum could be treated as a loss in the accounting period deductible from the profits of that period.

27. In the case under discussion the embezzlements of funds of the bank took Place in 1946. They were then unknown to the Bank. Even after the embezzlements came to the knowledge of the Liquidator, trading loss cannot be deemed to have resulted. We are unable to countenance the proposition that irrespective of other considerations, as soon as the embezzlement takes place of the employer's funds, whether the employer is aware or not of the embezzlement, there results a trading loss. So long as there was a reasonable prospect of recovering the amounts embezzled by the bank, trading loss in a commercial sense may not be deemed to have resulted.

28. There is no evidence that in the year of account Javeri the secretary could not have met the obligations either wholly or partially if he was called upon to refund the amounts embezzled. The embezzled amounts did not come to the knowledge of the liquidator even from the report dated April 1, 1947, of Messrs. M. N. Raiji & Co. who were appointed auditors to investigate the affairs of the bank by the Registrar of Joint Stock Companies. The embezzlements came to the knowledge of the liquidator very much later, only when the liquidator made demands from the various persons in whose names the amounts were debited in the books of account of the Bank, and the demands were made upon the liquidator for preferential payment by V. R. Ranade and Sons any by the Bank Of Bhopal Ltd. for repayment of the amounts or in the alternative for delivery of the stock purchased by them through the Bank.

29. The Tribunal has found in its supplementary report that the withdrawals and misapplication of funds by the Secretary came to the knowledge of the liquidator after the accounting year under reference, because no one suspected that the entries posted in the books of account were false entries to cover up his dealings by the Secretary. That conclusion in based on evidence and the loss must, in the circumstances of the case, be deemed to have occurred to the bank after the liquidator came to know about the embezzlements and came to know that the amounts embezzled could not be recovered. One of the prime conditions inviting the deduction of a trading loss under section 10(1) is therefore absent. We accordingly agree with the High Court that the amount of Rs. 10,15,000 was not a permissible deduction under section 10(1).

30. The appeal will therefore be partially allowed. The answer to the first question recorded by the High Court will be discharged, and it will be recorded that the bank is entitled to claim under section 10(2)(xi) Rs. 15,00,000 as bad debts in the year of account ending June 30, 1947. On the second question, the answer will be in the negative. There will be no order as to costs in this appeal.

31. Appeal partly allowed.


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