VEERASWAMI J. - Whether a sum of Rs. 55,040 is allowable as a deduction under section 10(2)(xi) or 10(2)(xv) of the Income-tax Act, 1922, is the question referred to us under section 66(2) of the Act. The assessee is a private company, which originally was engaged as a transport operator in stage carriages; but during the accounting year relevant to the assessment year 1957-58 with which we are concerned, it diverted itself to the business of body-building. For the assessment year it declared a loss of Rs. 638. Among other things, the Income-tax Officer by an order dated December 31, 1957, declined to allow deduction of the sum of Rs. 55,040 and brought it to tax. In his view, this sum could not be treated as a bad debt under section 10(2)(xi) of the Act.
Sungo Limited was private firm which had directors common to it and the assessee. The assessee had transactions with Sungo Limited from 1942 and was financing the latter from time to time with various sums on interest. The interest which the assessee was entitled to receive on the financing transactions was assessed to tax under the head 'business income', except for the year 1956-57, when a sum of Rs. 5,000 representing interest was added as income under the head 'other sources'. But even this was later changed by an order under section 35 and this amount was treated as income under the head 'business income'. Up to March 31, 1950, interest due from Sungo Limited was found at Rs. 30,172. As by a resolution the assessee waived interest from Sungo Limited for 1951-52, 1953-54 and 1956-57, during the relevant assessment years, the total sum of Rs. 14,500 was estimated to be the interest interest which the assessee was entitled to and this was added to the chargeable income of the assessee in those years. As on April 1, 1956, the amount due to the assessee from Sungo Limited came to Rs. 56,300. In the year of account ended March 31, 1957, the assets of Sungo Limited were sold away and adjusted against the debts due, and the balance, namely, Rs. 55,040 was written off by the assessee as on March 31, 1957, as an irrecoverable debt. The claim for reduction of this amount under section 10(2)(xi) was disallowed, the revenue being of the view that the advances made to Sungo Limited by the assessee were outside the course of its business.
On the former occasion, when on account of the resolution of the assessee-company, interest due from Sungo Limited was waived during the assessment year 1952-53 and when the Income-tax Officer found that there was no justification for the waiver and on that basis sought to estimate the interest and add it to the chargeable income, the question whether the revenue was right in doing so came up to this court by a reference under section 66(2). In dealing with that question, this court had observed :
'Apparently Sungo Limited was not the only firm to which the assessee lent money from out of its cash which included amounts the assessee had borrowed.... Though the assessee borrowed moneys, the advances it made to others, including Sungo Limited, were obviously in the course of the assessees business.'
There was also a further observation by this court in that judgment :
'We are referring to this aspect only to emphasised that advance to Sungo Limited and to others also were in the ordinary course of the business of the assessee, though it was by no means money-lending business'.
In view of the above observations of this court, the Tribunal in its order out of which the present reference arises, stated that the advances made by the assessee to Sungo Limited should be taken to have been made in the course of the assessees business and it cannot be said that they did not amount to a trade debt. The Tribunal also pointed out that the assessee and Sungo Limited were both carrying on the business of dealers in shares and the advances had been made in the course of such business. Further, that the interest charged in the past and the interest which the department had held to have accrued to the assessed have also gone to swell the profits of the assessee. On that view, the Tribunal allowed deduction of the entire amount of Rs. 55,040 as a bad debt under section 10(2)(xi).
The question actually referred to us, as apparently framed by this court reads :
'Whether on the facts and in the circumstances of the case, the debt of Rs. 55,040 is an allowable deduction under section 10(2)(xi) or 10(2)(xv) ?'
At no stage before the revenue or the Tribunal would the applicability of section 10(2)(xv) appear to have been taken, argued or considered. Even before us, no attempt has been made on behalf of the assessee to rely on that provision. In the circumstances, therefore, we have to concentrate only on section 10(2)(xi).
The argument before us for the revenue is that while we may take the finding of the Tribunal as correct, namely, that the advances to Sungo Limited were made by the assessee in the course of carrying on it s business, a further requisite should be satisfied in order that the assessee may be entitled to the benefit of the first part of clauses (xi) of section 10(2), that is, the bad debt should be such as when it is realised it must go to swell the profits of the assessee. In other words, it is said that not only should the bad debt be one incurred in the course of carrying on of the business, but it should be such that if it were not a bad debt, it should have come in as a revenue receipt which would go to swell the profits, This, according to the contention for the revenue, is in contra-distinction with a money-lending business, where what is laid out in lending is itself part of the stock-in-trade of the money-leanding and it is, therefore, not necessary, when deduction is claimed on the ground of bad debt, to see whether if it had been realised it would have gone to swell the profits. Obviously, in such a case, it would have gone to swell the profits of the money-lender, if the bad debt had been realised. Section 10(2)(xi) is as follows :
'When the assessees 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.'
The proviso to the section is unnecessary for present purposes. If the accounts are kept on cash basis, then of course the first part of the section will have no application. In this case it is not in dispute that the assessee followed the mercantile system. As we mentioned, it is not controverted before us for the revenue that the debt in respect of which deduction is claimed was lent by the assessee in the course of carrying on its business. In addition to these facts, the questions whether it is necessary for the assessee to show, in order that it may be eligible for the deduction under the first part of the clause, that the bad debt, if realised, would have gone to swell its profits. There is no express indication in the language of the first part of this clause that it should be such a debt. But it is obvious to us that, in the context of the section, the debt, in order to be deductible, must be one which, when realised, would have gone to swell the profits. Sub-section (1) of section 10 is to the effect that tax is payable on the profits or gains of business and sub-section (2) says that such profits shall be computed after making the allowances mentioned therein. It is apparent from that scheme of the section that loss of a purely capital character cannot come in for deduction in the computation of profits under section 10. Logically, it follows from the context that what is deductible in such a computation must be a loss of a revenue character. In that sense, therefore, we think that a bad debt, within the meaning of clause (xi) of section 10(2), should be essentially of a revenue nature which, if realised, would have gone to increase the profits. It is no doubt true that the amount lent as principal will not by itself swell the profits and what is meant is that it is taken into account in the context of computation of income. To illustrate our meaning, take, for example, the sale by an assessee of machinery, which he used in his business for making profits or gains, but fails to realise the proceeds which, as a result, have to be written off. This is clearly a case of capital loss which can in no sense be regarded as a bad debt for the purpose of clause (xi), became it does not go to produce or swell the profits. We are of the view that it is only a debt, as we said, which, when realised, will bear on the profits of the assessee in his business, that can be permitted to be deducted under clause (xi).
This view of ours, as to the effect of the first part of clause (xi), seems to be supported by authority. Commissioner of Income-tax v. S. R. Subramanya Pillai though not directly in point, contains observations which reflect the view we have taken. The learned judges in that case stated :
'Under the mercantile accountancy system referred to in section 10(2)(xi), an entry is made on the receipt side of the account when a sale is concluded although the money on account of such sales has not been paid in. In making up the account at the end of the year such entries are treated as precipitous and the tax is levied on what has sometimes been called as `book profits. It may later on be found that some of these `book profits are in fact irrecoverable. They are then written off as bad debts and since such book profits have been included in the income assessed to tax, the bad debts have been allowed to be written off against the book profits in the year in which they are found to be irrecoverable. This commercial practice has taken a statutory form in] the first part of section 10(2)(xi) of the Act as amended in 1939.'
We may incidentally observe that in this case too the interest charged by the assessee on Sungo Limited was brought to tax in the previous assessment years and, indeed, even when the assessee, by a resolution, decided not to charge interest, the revenue insisted that because Sungo Limited was in sound financial position, interest should have been charged and on that basis interest estimated by the revenue, as should have been charged by the assessee, was taxed. When it comes to a matter of deduction of bad debt, as we mentioned, the revenue now urges that it is not a trade or business debt within the meaning of section 10(2)(xi). There is a further observation in that case which too may be read :
'When section 10(2)(xi) speaks of a bad debt, it means a debt which would have come into the balance-sheet as a trading debt in the business or trade that is in question in this case - the book-sellers trade - and which has become a bad debt. It does not refer to any debt due to the trader which, when it was good, would not have come to swell the profits of the book-selling trade. Debts or losses not connected with a trade or business and not arising out of the operations of the trade or business are really losses of capital and are not admissible deductions under section 10(2)(xi) of the Act.'
On facts, the assessee there was a book-seller who borrowed, jointly with another, certain sums of money, the joint borrowing having been necessitated by the business needs of both. The other failing in his business, the entire debt was recovered from the assessee. The assessee claimed to deduct from his income a sum equivalent to what he had paid on account of the other borrower. The court held that the assessee was not entitled to the deduction on the view that the debt to that the assessee was not entitled to the deduction on the view that the debt to that extent was not incurred by him as incidental to the carrying on of his business. Commissioner of Income-tax v. Abdullabhai Abdulkadar was concerned with the question whether the tax paid by an assessee on behalf of his non-resident principal was deductible as trading loss or as a bad debt. The Supreme Court, while considering the scope of clause (xi) of section 10(2), observed :
'That under clause (xi) of section 10(2) of the Income-tax Act also a debt was only allowable when it was a debt and arose out of and as an incident to the trade. Except in money-lending trade, debts could only be so described if they were due from customers for goods supplied or loans to constituents or transactions of a similar kind. In every case the test was : was the debt due as an incident to the business If it was not of that character, it would be a capital loss. The amount was, therefore, also not allowable under section 10(2)(xi) as a bad debt as it did not arise out of and was not an incident to the respondents business.'
The Supreme Court quoted with approval the well-known observation of Rowlatt J. in Curtis v. J. & G. Oldfield Ltd. :
'When the rule speaks of a bad debt it means a debt which is a debt that would have come into the balance-sheet as a trading debt in the trade that is in question and that it is bad. It does not really mean any bad debt which, when it was a good debt, would not have come in to swell the profits.'
Disallowance of the sum claimed by the assessee was on account of the fact that his firm was not an agent within the meaning of section 42(1) and the liability was imposed because of the deeming provision in sub-section (2) of section 42 of the Act. In the premises, therefore, the liability imposed upon the firm was not a business debt arising out of the business of the firm and that it did not spring directly from the carrying on of the business and was not incidental to it. Lehnu Mal Asa Ram v. Commissioner of Income-tax followed the principle of Commissioner of Income-tax v. Abdullabhai Abdulkadar and does not take us further. In Commissioner of Income-tax v. Mysore Sugar Co. Ltd., the assessee was carrying on business in the manufacture of sugar and, for that purpose, he used to advance money to sugarcane growers under an agreement to have the advances adjusted towards the price of the sugarcane to be delivered to the assessee. The advances became irrecoverable and the assessee claimed a certain amount on that account as a deduction under section 10(2)(xi). The Supreme Court held that this was a case of merely making a forward arrangement for the next years crops and paying an amount in advance out of the price and there was no element of a capital investment in making the advance and the loss incurred by the assessee was, therefore, a loss on the revenue side and was deductible. A. V. Thomas & Co. v. Commissioner of Income-tax related to a company advancing for purchase of shares in a new company with the object of obtaining selling agency. There was a failure of issue of shares in the new company and the question was whether the amount advanced could be treated as a bad debt. The Supreme Court, while holding that it could not be so treated and allowed to be deducted under section 10(2)(xi), observed :
'A debt, for the proposes of section 10(2)(xi), was something more than a mere advance and meant something which was related to the business or resulted from it. It was an outstanding which, if recovered, would have swelled the profits, and not merely money handed over to some one for purchasing a thing which that person failed to return even though no purchase was made...... Since this was not a loan by a banker or money-lender, the debt to be a debt proper had to be one which if good would have swelled the taxable profits.'
This principle was applied in Commissioner of Income-tax v. Essen Private Ltd.
Learned counsel for the assessed contends that the principle could be applied only to the extent of the profits produced by a find and not the principal fund itself covered by a debt. In other words, he says that money which has been given out by a financier by itself cannot swell the profits. Nevertheless, according to his argument, the entire debt should be taken into account, provided it has been incurred in the course of the business. He relies on the following observation of the Supreme Court in Indore Malwa United Mills Ltd. v. State of Madhya Pradesh :
'Under the memorandum of association as well as under the express power conferred by the said resolution, the company, through the managing agents, could invest its funds by way of loans. If there was no mishap the managing agents would have paid the entire amount and if they did not, the company could have recovered the entire amount from them. The result, therefore, was that both the borrowing by the managing agents on behalf of the company from third parties and the lending to themselves created legal obligation. They were obligation created in the course of the business. The money lent would be a debit item in the accounts of the company in accordance with the accepted commercial practice and if the amount was realised it would be a credit item. Both would be proper items of accounts for ascertaining the profits and loss of the company. If the debt became irrecoverable, it would be a bad debt.'
These observations were not made by the Supreme Court in relation to section 10(2)(xi). All that is necessary to say in the present case is that a debt may be treated as a bad for purposes of section 10(2)(xi), if there is a debt in point of fact, it is incurred in the course of carrying on and as incidental to the business of the assessee, it is irrecoverable and if it were realised it would have gone to swell the profits. If these indicia are satisfied, we think the assessee would be entitled to the benefit of the first part of section 10(2)(xi).
Learned counsel appearing for the revenue contends that the requisite that the debt if realised should have gone to swell the profits of the business is not satisfied. We are unable to accept this contention. The fact that in the previous assessment years the revenue brought to charge the interest due from advances made by the assessee to Sungo Limited demonstrates that the debt did go to swell the business profits of the assessee. As we mentioned earlier, the interest so due to the assessee was treated by the revenue itself throughout as business income, It cannot, therefore, be pretended that the debt was not one which if realised would not have gone to swell the business profits of the assessee. The memorandum of association of the assessee-company empowered it to carry on business as financiers and also to lend, deposit or advance monies on such terms as might seem expedient, the financing of the monies being confined to the parties doing business similar to that of the assessee. When the assessee made advances to Sungo Limited, which was dealing in shares, it was within the power of the assessed-company and it could well be described as in the course of carrying on its business. When monies are so advanced as incidental to and in the course of its business, often the advances would constitute a debt which, when realised, would go to swell the profits of the business. Actually, in this case the advances did go to swell the business profits of the assessee.
On behalf of the revenue it was stated that the question whether the debt, if realised, would have gone to swell the business profits of the assessee was not specifically mooted before the Tribunal. But it is clear from the Tribunals order that this aspect was present to its mind and in fact it has given a finding that the interest charged in the past and the interest which the department had held to have accrued to the assessee have all gone to swell the profits of the assessee. Further, it is only one aspect of the question whether deduction of the amount in question could or could not be allowed under section 10(2)(xi).
The question under reference is answered against the department with costs. Counsels fee Rs. 250.