MANKAD J. - The question that arises in this reference is whether the assessee, a public limited company, is entitled to a deduction of Rs. 2,37,537 in the computation of its income for the assessment year 1971-72, the year of account being the calendar year 1970.
The above question arises in the background of the following facts. The assessee-company entered into a contract with one Madhu Wool Spinning Mills, a partnership firm (hereinafter referred to as 'the firm'), for the purchase of a right to import staple fibre of non-viscose origin. Under the terms of the contract, it paid Rs. 1,68,000 to the firm by way of premium for the purchase of the said right. Out of this premium paid to the firm, the firm paid back Rs. 18,140 to the assessee-company. Thus after deducting the amount paid back by the firm, the premium paid by the assessee-company to the firm in round figures came to Rs. 1,50,000. The above contract came to be cancelled or terminated and the firm gave three cheques of Rs. 50,000 each to the assessee-company for the repayment of the balance of the premium received by it in March, 1965. All the three cheques were dishonoured and it appears that after the cheques were dishonoured, no payment was received by the assessee-company from the firm towards the dishonoured cheques or the balance of the premium which the firm was required to pay back to the assessee-company. The assessee-company, therefore, filed a suit being Summary Suit No. 532 of 1966 in the Bombay High Court for the recovery of Rs. 1,50,000, the amount due under the dishonoured cheques and interest. It appears that there was a compromise between the assessee-company and the firm and a consent decree was passed in the suit. Under the consent terms, the assessee-company had agreed not to execute the decree for a period of one year. The firm, however, failed to pay the decretal amount after the expiry of the period of one year and, therefore, the assessee-company took out Chamber Summons on July 13, 1968, seeking permission of the court to execute the decree. The decree, however, could not be executed till the end of the calendar year 1970, which is the year of account relevant to the assessment year under reference.
In the year 1965, in addition to the payment of premium of Rs. 1,68,000 as stated above, the assessee-company paid Rs. 2,73,000 to the firm by way of advance for the purchase of staple fibre for which it had entered into a contract with the firm. The assessee-company received goods worth Rs. 1,85,313 towards the advance payment made by it to the firm. After given credit for this amount which represented the price of the goods received, Rs. 87,687 remained with the firm. The firm failed to pay this amount back to the assessee-company. The assessee-company, therefore, filed a suit being Summary Suit No. 1129 of 1969 in the Bombay High Court for recovery of this amount of Rs. 87,687 from the firm. This suit, we are told, was decreed on October 30, 1970.
It will be seen from the above facts that the total principal amount which remained due and payable by the firm to the assessee-company came to Rs. 2,37,537. This debit balance of Rs. 2,37,537 in the firms account was carried forward from year to year up to the end of the calendar year 1970. While finalising the account for the calandar year 1970, the assessee-company decided to write off this amount of Rs. 2,37,537 due from the firm. It appears that there was a credit balance of Rs. 33,208 in the Doubtful or Bad Debt Reserve Account at the end of the calendar year 1969. Having regard to this credit balance of Rs. 33,208 in the Bad Debt Reserve Account, the board of directors of the assessee-company by a resolution passed as its meeting held on March 30 1971, resolved to make a provision of Rs. 2,35,000 against doubtful debts and advances by crediting the said amount to the Bad Debt Reserve Account and debiting it to the profit and loss account of the company for the year 1970. This decision, it appears, was taken in pursuance of the decision to write off the aforesaid amount of Rs. 2,37,537 due from the firm. As a result of the credit entry of Rs. 2,35,000 made in the Bad Debt Reserve Account, the total credit balance in that account came to Rs. 2,68,028 to Rs. 2,60,918, which included Rs. 2,37,537 written off as stated above, were debited to the said account leaving a credit balance of Rs. 7,110 in the said account at the end of the account year 1970. Rs. 2,35,000, provision made against doubtful debts and advances were debited to the profit and loss account for the year 1970.
In the course of the assessment for the assessment year 1971-72, the assessee-company claimed deduction of Rs. 2,37,537 as bad debt. While furnishing details of the above claim, the assessee-company by its letter dated March 5, 1974, addressed to the ITO stated that the claim for the bad debt was made as it could not recover any amount till the end of the calendar year 1970. It was further stated : 'even after several years, we do not find any chance of recovery'. In other words, according to the assessee-company, it was not able to recover anything from the firm up to the date of the letter, that is, March 5, 1974. The ITO, while framing the assessment, rejected this claim holding that the assessee-company had failed to prove that the debt had become bad and that it was not recoverable. The ITO was of the opinion that the claim made by the assessee-company was premature. In the appeal preferred by the assessee-company, the AAC confirmed the view taken by the ITO (i) holding that the debt did not relate to the previous year relevant to the assessment year under reference; (ii) that it was not proved to have become bad in the said previous year; and (iii) that the debt was time-barred. In short, the AAC agreed with the view taken by the ITO that the assessee-company had failed to prove that the debt had become irrecoverable in the previous year relevant to the assessment year under reference. The assessee carried the matter in further appeal to the Income-tax Appellate Tribunal (hereinafter referred to as 'the Tribunal'). The Tribunal was of the view that no event had taken place in the year of account relevant to the assessment year 1971-72 which would justify the claim for deduction made by the assessee-company. The Tribunal took the view to the effect that since the proceedings for the recovery of the amount due from the firm were pending, the assessee-companys claim was not sustainable. In the result, the assessee-companys claim for deduction came to be rejected by the Tribunal also. The assessee-company has challenged the view taken by the Tribunal and at the instance of the assessee-company, the following question has been referred to us for our opinion under s. 256(1) of the I.T. Act, 1961 (hereinafter referred to as 'the Act') :
'Whether, on the facts and in the circumstances of the case, the Tribunal was right in law in holding that the assessee was not entitled to deduction of Rs. 2,37,537 for A. Y. 1971-72 ?'
Section 36(1)(vii) provides that subject to the provisions of sub-s. (2), the amount of any debt, or part thereof, which is established to have become a bad debt in the previous year, shall be allowed as deduction in computing the income referred to in s. 28. Sub-section (2) of s. 36 reads as under :
'In making any deduction for a bad debt or part thereof, the following provisions shall apply :-
(i) No such deduction shall be allowed unless such debt or part thereof -
(a) has 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 of that previous year;
(ii) If the amount ultimately recovered on any such debt or part of debt is less than the difference between the debt or part and the amount as deducted, the deficiency shall be deductible in the previous year in which the ultimate recovery is made;
(iii) any such debt or part of debt may be deducted if it has already been written off as irrecoverable in the accounts of an earlier previous year, but the Income-tax Officer had not allowed it to be deducted on the ground that it had not been established to have become a bad debt in that year;
(iv) where any such debt or part of debt is written off as irrecoverable in the accounts of the previous year and the Income-tax Officer is satisfied that such debt or part became a bad debt in any earlier previous year not falling beyond a period of four previous years immediately preceding the previous year in which such debt or part is written off, the provisions of sub-section (6) of section 155 shall apply.'
Four conditions govern the grant of deduction under cl. (vii) of s. 36(1), namely :
(i) the debt or loan should be in respect of a business which is carried on by the assessee in the relevant accounting year;
(ii) the debt should have been taken into account in computing the income of the assessee for the accounting year or for an earlier accounting year or should represent money lent in the ordinary course of his business of banking or money-lending;
(iii) the amount of debt or loan, or part thereof which is claimed as a deduction should be established to have become bad in the accounting year; and
(iv) the amount should be written off as irrecoverable in the accounts of the assessee for that accounting year in which the claim for deduction is made for the first time.
It is not in dispute that out of these four conditions two conditions, namely, conditions Nos. (i) and (ii) are satisfied in the instant case. The Revenue, however, contends that the last two conditions, namely, conditions Nos. (iii) and (iv) are not satisfied and, therefore, the assessee-company is not entitled to claim deduction of the debt in question. Before we deal with the question whether or not the assessee-company has succeeded in establishing that the debt has become bad in the year of account relevant to the assessment year under reference, we will first consider the question whether the assessee-company has fulfilled condition No. (iv). As pointed out above, in order to claim deduction of the amount of the debt in question, one of the requirements of sub-s. (2) of s. 36 is that the amount should be written off as irrecoverable in the accounts of the assessee-company in the relevant accounting year. We have already set out in detail the manner in which the assessee-company wrote off the debt of Rs. 2,37,537 due from the firm. We have gathered the relevant facts from the annual report of the assessee-company for the calendar year 1970 produced before us with the consent of the learned counsel for the Revenue. The balance-sheet discloses that Rs. 2,37,537 were written off. Under the resolution of the board of directors passed at the meeting held on March 30, 1971, Rs. 2,35,000 were credited to the Doubtful Debt Reserve Account and debited to the profit and loss account. The learned counsel for the Revenue contended that though the debt in question was for Rs. 2,37,537, Rs. 2,35,000 only were credited to the Doubtful Debts Reserve Account and debited to the profit and loss account. According to the learned counsel, the said credit entry of Rs. 2,35,000 in the Doubtful Debts Reserve Account and debit of the same to the profit and loss account was not linked up with the debt in question. In other words, according to the learned counsel, there was nothing on record to prove that the assessee-company had written off the debt in question. The question now raised by the learned counsel was not raised before the lower authorities. The fact that the assessee-company had written off the debt in question was never questioned before the lower authorities. It is, therefore, not open to the learned counsel for the Revenue to agitate this point for the first time in this reference. But, apart from that, the assessee-company has produced sufficient material to link up the aforesaid amount of Rs. 2,35,000 credited to the Doubtful or Bad Debt Reserve Account and debited to the profit and loss account with the debt in question. As discussed above, there was a credit balance of Rs. 33,028 in the Bad Debt Reserve Account at the end of the calendar year 1969, and it was, therefore, that the board of directors decided to credit Rs. 2,35,000 to this account to bring the total credit balance to Rs. 2,65,028. The debt of Rs. 2,37,537 due from the firm, that is, the debt in question and another bad debt of Rs. 23,381 were adjusted against the total credit balance of Rs. 2,68,028 in the Bad Debts Reserve Account. As a result of this adjustment, credit balance of Rs. 7,110 was left in the Bad Debt Reserve Account. As held by this court in Vithaldas H. Dhanjibhai Bardanwala v. CIT : 130ITR95(Guj) if the debit entries posted by the assessee in his accounts indicate that the concerned debt is written off, the requisite statutory condition has got to be treated as fully complied with. Once the assessee has posted entries in the profit and loss account and corresponding entries are posted in the Bad Debt Reserve Account, that would be sufficient compliance with the provisions of the statutory requirement for writing off as irrecoverable the concerned debt in the books of the assessee. In the instant case, the assessee-company has posted entries in the profit and loss account and corresponding entries are posted in the Bad Debt Reserve Account. These entries coupled with deduction of Rs. 2,37,537 from advances in the balance-sheet of the assessee-company would be compliance with the condition with regard to writing off of the debt in question in its books of account for the relevant year of account.
The question, however, which still remains to be answered is whether the assessee-company has established that the debt in question became bad in the previous year or year of account relevant to the assessment year under reference. It is contended on behalf of the assessee-company that they had placed sufficient material and evidence before the lower authorities to establish its claim. According to the learned counsel for the assessee-company, having regard to the evidence, the decision of the Tribunal was not only erroneous, but one which no reasonable authority could have arrived at. It was contended that the Tribunal has failed to take into consideration the evidence and material placed on record by the assessee. The Tribunal had rejected the assessees claim on the grounds that no event had taken place in the previous year and that the proceedings for recovery of the debt were pending. On the other hand, the learned counsel for the Revenue contended that the finding recorded by the Tribunal was a finding of fact which could be supported by evidence on record and if that were so, it would not be proper for this court in its reference jurisdiction to reappreciate the evidence on record and reverse this finding of fact recorded by the Tribunal. It was submitted that the Tribunals finding that the assessee-company had failed to establish that the debt had become irrecoverable in the previous year, was correct and, in any case, it was a possible view which cannot be interfered with by this court in exercise of its referance jurisdiction under s. 256 of the Act.
There are a number of decisions having a bearing on the question raised before us. We, however, do not consider it necessary to refer to them, since in Jethabhai Hirji and Jethabhai Ramdas v. CIT : 120ITR792(Bom) the Bombay High Court while dealing with a similar question has discussed these decisions and succinctly called out the principles which govern the determination of the question. The Bombay High Court has summarised these principles as follows at p. 811 of the report :
'It is clear that a debt cannot be written off as bad and irrecoverable if on the material available it could be shown that there was a possibility of recovering the same or which is not yet taken into liquidation, will not by itself establish such a possibility. That the assessee wrote off the debt at a particular point of time or in a particular year is not conclusive of the matter, but is not wholly or totally irrelevant. This will be a material circumstance unless it can be shown or established from the materials on record that the write-off was not proper or bona fide. That this was so can be established even by reference to the subsequent conduct of the assessee from which it is possible to infer definitely that the assessee still considered the debt or at least a part thereof as recoverable or regarded the debtor as financially solvent. It is now well settled that the fact that the assessee has not taken steps by way of legal proceedings against the debtor would not automatically justify the finding that he was entitled to write off the amount as a bad debt. In our opinion, the fact that an assessee, subsequent to the write-off of the debt, continues with legal proceedings against the debt need not necessarily lead to the conclusion that the write-off was improper or lacked bona fides but would be a factor to be taken into account in order to arrive at a proper determination of the question. It is, however, clear to us that mere notices served for taking up a debtor-company into winding up or launching criminal prosecution or inducing other authorities to launch criminal prosecution against the debtor company or its directors cannot be regarded as equivalent to taking steps for recovery of the amount.'
We would, however, like to refer to a decision of the Division Bench of the Bombay High Court in Lords Dairy Farm Ltd. v. CIT : 27ITR700(Bom) which is binding on us since it has been rendered prior to May 1, 1960 and wherein important observations are made with regard to the evidentiary value to be attached to the entries in the assessees books of account writing off the debt or amount. In that case, the Division Bench of the Bombay High Court was considering the loss caused to the assessee by the defalcation of an employee. The amount was claimed as deduction under the provisions of s. 10(2)(xi) of the Indian I.T. Act, 1922. As regards the first head of the claim it was observed that it was difficult to understand as to how any amount was due by the employee to the assessee-company which amount became irrecoverable, and, therefore, the subject-matter of a deduction under section 10(2)(xi) of the 1922 Act. Even as regards section 10(2)(xv), the Division Bench was not inclined to agree with the view taken by the Tribunal but it observed that it did not follow that the assessee which suffered loss in its business could not get relief because the specific cases of deduction dealt with under s. 10 did not cover its case. According to the Division Bench, this was a trading loss which had to be deducted before arriving at the true profits of a business from a commercial point of view and the assessee would be entitled to deduct that loss although such a loss may not fall within the ambit of any of the deductions mentioned in sub-s. (2) of s. 10. The Bench was then required to consider the question as to when the amount of loss could be allowed to the assessee. It was observed that the material date was not the date on which the embezzlement took place but the date on which the loss is caused. According to the Bench, it is only when it is clear that the money cannot be recovered that the loss is caused. It is in this context of irrecoverability of the amount embezzled that the Division Bench went on to obeserve as follows (p. 708) :
'When a businessman writes off an amount, there is prima facie evidence that that amount is irrecoverable. Undoubtedly, the Department can rebut the prima facie inference by drawing attention to circumstances or by leading some evidence to suggest that the position taken up by the assessee was not correct. In this case there is no evidence whatsoever on the record except the fact that the assessee wrote off this amount in the year of account. In the absence of any evidence we are entitled to presume that the amount became irrecoverable when the assessee wrote it off in its books of account.'
The above observations made by the Bombay High Court, though in connection with trading loss, would apply with equal force to a claim for deduction of bad debt. The Division Bench of the Bombay High Court was considering the point of time at which the amount is considered to be allowable as deduction to the assessee. It was in that context that the Division Bench dealt with the question of recoverability or irrecoverability of the amount. As observed by the Bombay High Court in Jethabhai Hirji and Jethabhai Ramdas case : 120ITR792(Bom) what has been observed with regard to recoverability of the amount and the general principles to be applied to the question will apply irrespective of the nature of the claim of the assessee. As pointed out above, in the instant case, the assessee had written off the amount due from the firm. This, as observed in the case of Lords Dairy Farm Ltd. : 27ITR700(Bom) furnishes prima facie evidence that the amount is irrecoverable. It was open to the Revenue to rebut the prima facie inference by drawing attention to the circumstances or by leading evidence to suggest that the position taken up by the assessee was incorrect. On the contrary, as we shall presently point out, there was sufficient material and evidence on the basis of which the assessee-company could have based its subjective satisfaction that the amount was irrecoverable when it wrote it off. The Tribunal, with respect, has not examined the assessees claim in the light of the principles laid down by the Bombay High Court. The test which the Tribunal should have applied was whether there was sufficient material on record to show that on December 31, 1970, the decision taken by the assessee-company to write off the claim against the firm was or could be demonstrated to be improper or otherwise not bona fide. In our opinion, the Tribunal has failed to apply this test and ignored the relevant circumstances and consequently misdirected itself to reach the conclusion which it did.
The assessee-company had entered into a contract with the firm in 1965 and paid Rs. 1,68,000 by way of premium for the purchase of the right to import the staple fibres of non-viscose origin. The contract was subsequently cancelled and to repay the balance amount of the premium, the firm gave three cheques of Rs. 50,000 each to the assessee-company. All the three cheques were dishonoured and, therefore, the assessee had to file Summary Suit No. 532 of 1966 in the Bombay High Court to recover Rs. 1,50,000 due under the dishonoured cheques and interest. As pointed out above, a consent decree was passed in the suit and the firm was given one years time to pay up the decretal amount. The firm did not, however, pay the decretal amount even after the expiry of the period of one year. The assessee-company was, therefore, constrained to take out Chamber Summons seeking permission of the court to execute the decree. No amount was, however, recovered till the end of 1970. It was under these circumstances that the company took the decision that the amount was irrecoverable. Mere passing of a decree in favour of the assessee-company does not necessarily indicate that there was a possibility of recovering the debt. Subsequent events clearly show that the assessee-company was justified in concluding that the amount was not recoverable in the year in question. In the letter dated March 5, 1974, addressed to the ITO, the assessee-company has in terms stated the even after the passage of many years, they did not see any chance of recovery. It further appears from the ITOs order that insolvency proceedings were initiated against the firm and its partners. We do not have the date on which these proceedings were initiated but it appears that the said proceedings were initiated subsequent to the year 1970. There is, however, no doubt that they were pending at the time when the ITO framed the assessment. The Chamber Summons taken out by the assessee-company seeking permission to execute the decree was resisted and it appears that the affidavit of Tryambaklal Kuberdas Katakia, a partner of the firm, was filed resisting the Chamber Summons. This affidavit was filed somewhere in February, 1972, and several grounds were raised resisting the execution of the decree. Subsequent suit filed by the assessee-company also did not bear any fruit. A decree was no doubt passed in that suit also, but that decree also remained unexecuted. We may at this stage mention that in Summary Suit No. 532 of 1966, the firm and its partners were granted leave to defend on a condition that Rs. 1,00,000 were deposited in the court. No deposit was made and ultimately, as stated above, the consent decree came to be passed. This circumstance also indicates that the financial circumstances of the firm and its partners were such that they were not in a position to meet their liability. This is clearly stated in the affidavit of Jayantilal Kuberdas Katakia, one of the partners of the firm, filed in support of the application for leave to defend. In para. (v) Jayantilal Kuberdas Katakia has stated :
'Defendants (firm and its partners) were suddenly involved into troubles and extreme financial difficulties............ the business of the said Madhusudan Gordhandas & Co. and their other concerns was completely paralysed. I say that as a direct consequence of the aforesaid situation, which pushed the defendants and their other concerns into stringent financial difficulties......'
In para. (vi) of the said affidavit, Jayantilal Kuberdas Katakia further stated :
'The goods of the said M/s. Madhusudan Gordhandas & Co. detained as aforesaid could not be released for a very long time and over and above the financial difficulties, the said M/s. Madhusudan Gordhandas & Co. and its associates were further involved into numerous civil as well as criminal litigations...... all the activities of the said Madhusudan Gordhandas & Co. and their associates including of the defendants, came to a virtual standstill and their affairs including in respect of their several important matters were in a mess. It was a squeeze on the said firms from all sides and the seizure of the records added further to the confusion that prevailed and to their immense difficulties......'
If in the background of the above facts, the assessee-company came to the conclusion that the amounts due from the firm were not recoverable and wrote off the amounts in its books, in our opinion, the assessee was justified in doing so.
The Tribunal has completely ignored the above circumstances which are clearly brought out on record and harped on only one thing that no event had taken place in the year of account justifying a writing-off of the amount due from the firm. 'No event happened' is, in our opinion, a strong circumstance to justify writing off the amount. In spite of the efforts made by the assessee-company, it was not able to recover a single paisa towards the amount due to it by the end of 1970. That itself was sufficient to justify writing off of the amount due. What is required is honest judgment of the assessee at the time of writing off of the debt in the light of events up to that stage. Having regard to the facts and circumstances of the case, it cannot be said that the decision of the assessee-company was not honest. Events and circumstances subsequent to the stage of writing off which are not irrelevant also amply justify the action of the assessee-company. The assessee-company has satisfied us that the conclusion reached by the Tribunal is vitiated by a gross error or refusal to take into consideration material evidence. In the light of what is discussed in the foregoing paragraphs, we hold that the assessee-company has succeeded in showing that the finding recorded by the Tribunal is unreasonable. Under the circumstances, the court is entitled to answer the question in favour of the assessee, although there may be a clear conclusion of the Tribunal against the assessee-company. As held by us the amount had become irrecoverable and consequently the assessee was justified in writing it off in the year of account relevant to the assessment year under reference.
In the result, we answer the question referred to us in the negative and against the Revenue.
Reference answered accordingly with costs.