The judgment of the court was delivered by
VENKATADRI J. - On a requisition made by this court under sub-section (2) of section 66 of the Indian Income-tax Act, the Tribunal has drawn up a statement of the case raising the followin :
'Whether, on the facts and in the circumstances of the case, the disallowance of the assessees claim, that Rs. 4,681 was a bad debt, it was entitled to write off under section 10(2)(xi) of the Act, was justifie ?'
The assessee is a firm carrying on business in purchase and sale of cotton in Coimbatore. Originally, the firm consisting of 4 partners commenced business in the year 1944. There were changes in the constitution of the firm from time to time. On January 1, 1956, one of the four partners retired from the partnership, and on the same day, three more persons were taken in as partners; accordingly, a fresh deed of partnership was drawn up recording the changes in the firm. Before they entered into the fresh partnership in the year 1956, a limited company called the Aron Spinning and Weaving Mills, having its registered office in Kerala State, which was one of their customers, went into liquidation, with the result there was an amount due to the assessee-firm on the date of the liquidation in a sum of Rs. 4,681. The assessee-firm made enquiries with regard to the resources of the said mills to repay the amount; and finding that the chances of recovery were remote, the sum of Rs. 4,681 was written off in the assessees account for the year ended December 31, 1955, as a bad and doubtful debt. When the assessee claimed that sum as deduction under the provisions of section 10(2)(xi) of the Act for the assessment year 1956-57, relevant to the accounting period ending on December 31, 1955, the Income-tax Officer, holding that the claim for allowance was premature, disallowed the claim of the assessee. The assessee-firm accepted the decision of the officer for that year. Subsequently, the official liquidator of the Kerala High Court, with whom the assessee-firm had filed its claim for the said sum, informed the assessee during the year 1957 that there was absolutely no chance of any declaration of dividend in the liquidation of the mills. In pursuance of this communication, the assessee, for the assessment year 1958-59, relevant to the accounting year ended December 31, 1957, claimed the amount again as a deduction under section 10(2)(xi) of the Act. In support of the claim, the firm also filed a copy of the letter addressed to Indian Overseas Trading Corporation by the official liquidator stating that there was no prospect of any dividend declaration to the ordinary creditors. This time, the Income-tax Officer rejected the claim, on the ground that the debt had been written off on December 31, 1955, by the firm consisting of four partners, that there were changes in its constitution on January 1, 1956, when one of the partners retired and three more persons were taken in as partners and that since the bad debt had been written off by the firm as previously constituted. But on appeal the Appellate Assistant Commissioner held that the firm consisting of six partners was only a continuation of the firm consisting of four partners, that the changes were only changes in the constitution of the firm and that the business continued uninterruptedly. Accordingly, he held that the debt continued to be an asset of the same firm, and there was no question of any new firm of six partners taking over the debt. He further held that the assessee had written off the amount in the earlier year in good faith, and that, when the Income-tax Officer disallowed the claim on the ground that it was premature, the officer was not justified in rejecting the claim when the debt became bad and irrecoverable.
Aggrieved with this order, the department preferred an appeal to the Income-tax Appellate Tribunal. The department contended that the amount in question represented a debt due to the predecessor of the assessee-firm which was an entity different from it. It was also contended that at the time of the taking over of the business by the present partnership, there was no arrangement in regard to this debt and lastly that it was not a business debt of the assessee-firm. The Tribunal, agreeing with the contentions of the department held that the assessee was an entity different from the old firm to which alone the debt in question belonged, and since the debt was already written off in its own books, it could never have become the property of the assessee-firm. The Tribunal allowed the appeal of the department, upholding the disallowance.
The assessee then moved the Tribunal to refer the question of law to this court, and the Tribunal declining to do so, the assessee moved this court, and, on the directions of this court, the question set out earlier stands referred for determination.
It is usual commercial practice to write off the debts which are regarded as bad in the making up of annual accounts maintained on the mercantile system. The assessee has to satisfy, before allowance could be made, that the amount had become bad and irrecoverable and it had been written off in the accounts and it was incidental to the business.
In R. B. Seth Ganga Sagar v. Income-tax Appellate Tribunal, the Allahabad High Court has held that the questions whether a particular debt has become bad or not and at what time it became bad are questions of fact, that the decisions of these questions would depend mainly upon the state of mind of the assessee and although the time when the assessee writes off the debt in question may be a relevant circumstance, yet it is not conclusive upon the question when the debt became bad, that the finding arrived at by the Income-tax Tribunal upon this matter is not open to challenge unless it is clear that finding has been arrived at through any error of law. In Alagananda Mudaliar v. Commissioner of Income-tax, this court held on the facts of the case that the income-tax authorities would not be justified in holding that the assessee should have written off the debt before the final decision was given in the case then pending in the Privy Council. In the same case, Mockett J. observed that it might well be a matter of greatest difficulty for any creditor to know whether he was or was not going to get a dividend or whether his debt became bad or not. A debt becomes irrecoverable, only when it becomes patent that the debtor has not the means to pay and therefore the debt cannot be recovered. It is impossible accurately to say that a bad debt has been incurred by a creditor until the debtor has died without estate or has gone insolvent and his estate has been distributed. The assessee is, therefore, entitled to wait till the official liquidator declares the dividend or the final result of the liquidation proceedings.
When the assessee claimed a deduction of the said amount for the assessment year 1956-57, relevant to the accounting period during December 31, 1955, the Income-tax Officer rejected the claim as premature. The decision of the officer operated only for the particular year under assessment; it would be open to the assessee to repeat the claim in respect of the particular debt in any subsequent year, provided it had not been recovered during the interva : vide Rulia Mal Raunak Ram v. Commissioner of Income-tax. In the instant case, the assessee again claimed a deduction of the amount, when it was finally known that there was no chance of any declaration of dividend. This time, the Income-tax Officer rejected the claim mainly on the ground that there was a change in the constitution of the firm and as such the present partnership was not entitled to claim any deduction under section 10(2)(xi) of the Act. The question, therefore, for consideration is whether the present partnership firm is entitled to the benefit of that provision of the Act.
On similar facts, this court in Hanumanthappa and Sons v. Commissioner of Income-tax, to which one of us was a party, after reviewing the relevant provisions of the Partnership Act, hel :
'What is clear from all of these provisions is that, since a partnership is the creature of a contract, it is open to the partners to agree that the firm shall not stand dissolved on the occurrence of any particular contingency, which, without such a safeguard, would in law result in the dissolution of the firm. If, therefore, the partners have agreed to that effect viz., that the firm shall not stand dissolved by the taking of new partners, the firm as an entity, in so far as the Income-tax Act is concerned must necessarily be regarded as continuing for the purposes of that Act.'
The present deed of partnership dated January 1, 1956, states, after referring to the previous history of the firm from the commencement of the partnership, that the firm shall continue to carry on business under the name and style of Lakshmi Nivas & Company, that the business of the partnership shall continue to be that of dealing in oil seeds, oil cakes, oil products... and that the business of the firm shall continue to be carried on at Coimbatore and - or at other place or places.... This will clearly show that, when one of the partners retired from the firm and when new partners were taken into the firm, the business of the firm was for all practical purposes carried on in the same way and under the same name as before. Business may change hands; a partner may cease to be a partner, the business being carried on by his co-partners; but even so it does not amount to a discontinuance of the business. It is only a change in the ownership of the business. Once it is held that the business is being carried on as usual, the assessee will be entitled to claim the allowance as provided for under section 10(2)(xi) of the Act, irrespective of the change in the constitution of the firm. It is further proved that the assets and liabilities of the business of the new set of partners. Therefore, the Tribunal is not right in holding that the writing off of the debt should be in the books of the present firm and that the assessee was an entity different from the old firm to which alone the debt in question belonged. The assessee had also established that the debt has become bad and irrecoverable and that it became bad in the accounting year. Chagla C.J. in Karamsey Govindji v. Commissioner of Income-tax observed that it is the duty of the department to take a sympathetic view of the matter, if, in fact, the debt was never recovered, and that, if the debt was not allowed to the assessee in the year of account, there is no reason why the department should not consider allowing him this debt in the next year when admittedly the debt became irrecoverable, although the assessee may not have written it off in that year. As already observed, we are of the view that the Tribunal was not justified in disallowing the claim of the assessee in the circumstances of the case.
In the result, the question is answered in favour of the assessee. The assessee will be entitled to costs. Counsels fee Rs. 250.
Question answered in favour of the assessee.