1. The assessee is a co-operative society and it is being assessed under the Income-tax Act as an association of persons. For the accounting year ending June 30, 1966, corresponding to the assessment year 1967-68, the Income-tax Officer disallowed the deduction claimed by the assessee on the following two sums :
(1) Reserve for deficit in jail supply disallowed on Rs.the ground that it is a provision 4,803(2) Reserve for deficit stock disallowed on the groundthat it is a provision as in earlier years 1,13,589
2. Aggrieved by the disallowance, the assessee went before the Appellate Assistant Commissioner who held that under the Income-tax Act, no reserve can be allowed as a deduction. The assessee took the matter in appeal to the Income-tax Appellate Tribunal contending that the sum of Rs. 1,13,589 represented the deficit stocks in various items and they were in the nature of handling losses, that usually the purchases are made in bags of different weights and they are rebagged and standardised, that the loss occurring at that stage as well as at the stage of handling should be taken to be handling losses and that at any rate they are only contra entries and did not affect the profit and the society is entitled to create a non-statutory reserve in view of section 62 of the Co-operative Societies Act. As regards the sum of Rs. 4,803, it was contended before the Tribunal that during the supply of goods to the jail authorities, a shortage has occurred and, therefore, a reserve has been created in that regard as it could not be written off without due sanction from the higher authorities during the year of account.
3. As against these contentions, the Revenue contended before the Tribunal that the stock deficit has not been entered then and there in the books and that the deficiency in stocks arising out of physical verification is credited towards the reserve account which is neither an outgoing nor has been treated as a loss during the year of account.
4. The Tribunal held that during the year of account goods of the value of Rs. 1,13,589 have been shown as deficit in stocks, that instead of writing it off as a loss it has been shown as a reserve, that according to the stock books the value of the goods to this extent were in stock but in fact they were not available, that they were handling losses or any other type of loss during the year of account were not proved, that the assessee's employees and ex-employees were proceeded against for the loss of the deficiency in stocks and a sum of Rs. 41,000 odd had in fact been recovered, that the loss arising out of the deficiency in stocks and should be taken to be a loss in the nature of embezzlement of stocks and that only when the matter is finally settled, the assessee can be allowed to write off the loss. Thus, the Tribunal held that the assessee has not established that the loss has occurred in the year of account in which case alone the assessee could get a deduction and the recoveries, if any, later, could be brought to tax under section 41. Regarding the sum of Rs. 4,803, the Tribunal found that the nature of the loss and whether it has arisen in this year has not been established.
5. Aggrieved by the order of the Tribunal, the assessee sought and obtained a reference to this court on the following two questions :
'(1) Whether, on the facts and in the circumstances of the case, a sum of Rs. 4,803 representing the reserve for deficit in jail stock was includible in the income of the assessee society for the assessment year 1967-68
(2) Whether, on the facts and in the circumstances of the case, a sum of Rs. 1,13,589 or any part thereof, representing a reserve for deficit stock was includible in the income of the society for its assessment year 1967-68 ?'
6. As already stated, the sum of Rs. 4,803 in respect of which deduction was claimed by the assessee during the assessment year is a reserve created for deficit in jail supply. Before the Tribunal, the assessee has filed certain statements giving details of the deficit in the supplies made to the Central Jail and the total amount of such deficit during the relevant assessment year came to Rs. 4,803. According to the assessee, the Tribunal has proceeded on the basis that the deficiency has not been caused by the co-operative audit and the matter is under investigation and, therefore, whether there was loss to the extent of Rs. 4,803 and whether it has arisen during the assessment year has not been established. Admittedly, the assessee has not shown the said sum of Rs. 4,803 as a loss during the year of account or that the deficiency has been written off. The assessee merely created a reserve for the said sum of Rs. 4,803 out of the profits and claimed a deduction therefor on the basis that it is a deficiency in the stock which occurred in the course of the business. The stand taken by the Revenue which has been accepted by the Tribunal is that so long as the deficiency in stock is not written off and treated as a loss, it can never the treated as an outgoing during the accounting year and, therefore, the deduction claimed cannot be allowed. As regards the sum of Rs. 1,13,589 which is a reserve for deficit in stocks, the Tribunal has found that goods worth that sum have been treated in the stock books as stocks but they were shown as not available. The fact that they are handling losses or any other type of loss has not been proved and that in any event, since the deficiency has not been written off and treated as a loss of stocks, no deduction could be claimed for the said sum. According to the Tribunal, it is only when the actual loss in stocks is determined in the year of account that the assessee could get a deduction for the said sum treating it as a loss. The Tribunal has proceeded on the basis that the assessee has not established that the loss has occurred during the accounting year.
7. Before us learned counsel for the assessee contends that though normally a deduction can be claimed only when the deficiency in the stocks is written off during the year of account and treated as a loss in stocks, the position in the case of a co-operative society is different. In a co-operative society, before the loss in stocks is written off, sanction of the higher authorities has to be obtained and since obtaining of the sanction takes considerable time, the actual writing off of the loss in stocks during the accounting year should not be insisted upon. According to learned counsel for the assessee, it is because of the delay in getting the sanction from the higher authorities for writing off of the loss in stocks that the co-operative audit has suggested creation of a reserve towards such a loss that the deduction can be claimed in respect of the said reserve in the year in which the loss in stocks had occurred. Learned counsel has referred to the following passage occurring on pages 91-92 of the Tamil Nadu Co-operative Audit Manual :
'Administrative sanction is necessary only when the society wants to write off the deficit on the assets side of the balance-sheet by adjustment from the reserve. But when the society actually recovers a part or whole of the deficit from the those responsible, the auditor is bound to release a corresponding amount from the specific reserve. There is no point in asking the society to produce administrative sanction when it produces solid proof of recovery in its own accounts.....
The above are the types of non-statutory reserve which may be called as authorised. There are innumerable other reserves in the balance-sheets of almost every big society which have been created by auditors in the past. As already explained, some of them are not covered by corresponding assets to be recovered. They were, no doubt, created with the best of intentions to prevent the inflation or divisible profits and to provide for irrecoverable assets or doubtful cases under suspense transactions. They had also to be created to prevent an increase in profit when expenditure was objected to in audit and shown as recoverable from those responsible. It is not possible to list out all possible reserves of this type and to deal with the procedure for their disposal or recoupment. Enough has been said above to make it possible for the present auditor to understand the implications and advise the societies as to the correct mode of wiping off such non-statutory reserves. This is problem not only for auditors but also for those in administrative charge of societies. They must make a move, examine all such cases and take urgent steps either to recover the assets concerned or write them off by adjustment from the specific reserves. Sustained and patient work is necessary in this direction. It is the duty of the district co-operative audit officers to ensure that auditors do not, as for as possible, increase the number of such reserves by prevailing on the societies to avoid the situations which render the creation of such reserves necessary. The problem bristles with difficulties. A concerted effort on the part of all concerned is called for to get over it.'
8. Learned counsel for the assessee states that the purpose of creating such a non-statutory reserve is to prevent the inflation of divisible profits, to provide for irrecoverable assets or doubtful cases under suspense transactions and to prevent an increase in profit when the expenditure was objected to in audit and shown as recoverable from those responsible.
9. We do not, however, see how, merely because a co-operative society has to obtain the sanction of the higher authorities for writing off the stock deficiency in the year of account, it could create a reserve towards that loss and claim a deduction of the amount as reserve. It has been found by the Tribunal that, according to the stock books of the assessee, the goods covered were available in stocks. As a matter of fact, the stocks available as per the stock register of the society on the closing day of the previous year have been shown as the opening stock of the current year though with a clarification that the goods to the extent of the deficiency are not available. Whatever be the difficulties that may be felt by the co-operative society in writing off the deficiency in stocks, the legal position is that unless it is shown that there is loss by way of deficiency in stocks in the year of account and that a reserve has been created for that loss, deduction cannot be claimed for that reserve. If the deficiency has been written off in the year of account, it can be taken to be a loss in stocks and the reserve created for the purpose should be allowed as a deduction to the extent of the deficiency written off.
10. Learned counsel relies on the decision of the Supreme Court in Association Banking Corporation of India Ltd. v. CIT : 56ITR1(SC) , in support of his contention and contends that an entry in the books of account writing off a debt as irrecoverable is not a condition precedent for its admissibility as an allowance under section 37 of the Income-tax Act, 1961, and, therefore, the Revenue cannot insist on the writing off the deficiency in the year of account as a condition for allowing the deduction of the amount set apart as a reserve. In that case, the secretary of a bank misused his powers under a power of attorney and withdrew Rs. 18 lakhs by posting false entries in the books of the bank in the accounting year ending June 30, 1947. The withdrawals for the first time came to the knowledge of the liquidator of the bank after the end of the accounting year and the liquidator had to pay to the constituents of the bank Rs. 10,15,000 pursuant to an order of the court made in 1949 and a settlement in 1951. On those facts, the Supreme Court held that the loss must be taken to have occurred to the bank after the liquidator came to know about the embezzlement and realised that the amounts embezzled could not be recovered and that the sum of Rs. 10,15,000 which the liquidator was constrained to pay to the constituents was not a permissible deduction in the accounting year. The Supreme Court also held that it cannot be said that irrespective of other considerations, as soon as an embezzlement of the employer's funds takes place, whether the employer is aware or not of the embezzlement, of the emplorer,s funds takes place, whether the employer is aware or not of the embezzlement, there results a trading loss and that so long as there is a reasonable prospect of recovery of the amounts embezzled, trading loss in commercial sense cannot be deemed to have resulted. Embezzlement of funds by an agent does not necessarily result in loss immediately when the embezzlement takes place and the embezzlement may remain unknown to the principal and the assets embezzled may be restored by the agent or servant and that in such a case, there is no real loss in a commercial sense, that even in cases where the principal obtains knowledge of the embezzlement, loss does not really result and the erring servant may be persuaded or compelled by process of law or otherwise, to restore wholly or partly his ill-gotten gains and, therefore, so long as a reasonable chance of obtaining restitution exists, loss may not in a commercial sense be said to have resulted. In this case, the deficiency in stocks is said to have been found on physical verification of the stocks during the year of account. There was an investigation on the question of deficiency of stocks and that was continued beyond the continued beyond the accounting year. Therefore, so long as there is a possibility of tracing at least a portion of stocks found short, the loss cannot be said to have occurred. This decision, instead of helping the assessee, in fact helps the Revenue. In that case, the Supreme Court has in fact pointed out that the embezzlement of monies by an employee can be treated as a loss during the year in which the employer actually realised that the amounts embezzled could not be recovered.
11. Learned counsel for the assessee would state that the assessee's case which is one of deficiency of stock cannot be treated as an embezzlement by the employees so as to attract the principle laid down by the Supreme Court in the above case and the Tribunal is also in error in treating the goods on hand as goods of embezzlement. Whether the case is one of embezzlement or not, the fact remains that the stocks have not been shown to have been lost completely. It is no doubt true that physical verification indicated a deficiency in stocks. But as there was a possibility of the stocks being miscarried, the deficiency was not debited during the year of account. Therefore, so long as the deficiency in stocks has not been once and for all written off from the books of account of the assessee, the deficiency cannot be claimed to be a loss in stocks. That will arise only at a time when the deficiency in stocks is actually written off. Though the case before us is not a case of embezzlement, still the principle laid down in that decision has to apply to this case as well.
12. Learned counsel for the assessee then refers to the decision in Dasaprakash Bottling Co. v. CIT : 122ITR9(Mad) . That was a case where the Income-tax Appellate Tribunal had allowed depreciation even though the particular were not furnished in the proper part of the return of income by the assessee. But they were furnished in the course of the proceedings before the Income-tax Officer at the latter's request. The question arose as to whether the Tribunal was justified in doing so. This court held that a conjoint reading of sections 32 and 34 of the Income-tax Act, 1961, showed that the allowance of depreciation is available to the assessee in all cases, that it will be open to the officer to grant depreciation even if the assessee had not furnished the prescribed particulars as the computation of income under the Act is the computation of the real and proper statutory income and that this income could be arrived at only after allowing the deduction available under the law. The above decision has been relied on by the assessee in support of his contention that even without the actual writing off of the loss during the year of account, the assessee is entitled to claim deduction of the amount created as a reserve towards such loss in stocks, for that alone will indicate the real or proper statutory income and that if the deduction is not allowed, the computation of income will not be real. We do not see how the observations made in that case while dealing with depreciation allowance could be used in this case. In the case of a claim for depreciation, the allowance of depreciation is available in all cases as per sections 32 and 34. But on the other hand in respect of a claim for deduction towards loss of stocks, the assessee who makes the claim should prove that there was in fact loss in stocks and such a loss should be reflected in the books of account for the accounting year. If the books of account do not indicate any loss of stocks, then the assessee's claim for deduction towards that loss cannot be allowed in the year of account. The books of account not disclosing the loss during the accounting year and the mere creation of a reserve out of the profits will not entitled the assessee to claim the benefit of deduction. Therefore, the decision in Associated Banking Corporation of India Ltd. v. CIT : 56ITR1(SC) , is not helpful to the assessee.
13. On a due consideration of the matter, we are of the view that unless the assessee writes off the deficiency in stocks in the year of account, it cannot be treated as a loss in stocks and deduction claimed to the extent of the reserve created for that purpose. We are, therefore, in entire agreement with the view taken by the Tribunal in this case.
14. The questions referred are, therefore, answered in the affirmative and against the assessee. The assessee will pay the costs of the Revenue. Counsel's fee Rs. 500.
15. Learned counsel for the assessee makes an oral request for leave to appeal to the Supreme Court against the judgment just now pronounced. Since our decision is based on the particular facts of the case and on the basis of the factual findings rendered by the Tribunal, we do not see that this is fit case for the grant of leave to the Supreme Court. Hence, the request for leave is rejected.