The Judgment of the Court was delivered by
CHAKRAVARTTI, J. - This is a reference under Section 66(1) of the Indian Income-tax Act at the instant of the Commissioner of Income-tax, West Bengal, in respect of a deduction of Rs. 55,030 from the business profits of the assessee on the ground that the amount constituted a bad debt. The relevant facts are as follows :-
The assessee is a timber merchant. On February 5, 1930, he obtained a loan of Rupees one lakh from the Bank of India, Bombay, on the joint security of himself and another man called Mamraj Rambhagat. On the same day Mamraj Rambhagat obtained a loan of Rupees one lakh from the Imperial Bank of India, Bombay, on the joint security of himself and the assessee. The assessee paid off his debt to the Bank of India in due time, but Mamraj Rambhagat failed to pay his. It appears that on March 24, 1930, the Imperial Bank realised from the assessee the debt owing jointly by him and Mamraj Rambhagat the amount recovered being Rupees one lakh six thousand and twenty six. Exactly a month later on April 24, 1931, Mamraj Rambhagat failed in his business and his estate went into the hands of Receivers. What kind of Receivers they were and in the what proceedings the appointment of Receivers was made does not appear.
After he had paid the debt to the Imperial Bank of India the assessee opened a ledger account in his own books in the name of Mamraj Rambhagat and debited against him the sum of Rs. 1,06,026 which he had paid to the Bank. The assessee received dividends from the Receivers of the estate of Mamraj Rambhagat from time to time. The total amount he received was Rs. 45,596 and the last payment was made on May 17, 1938. Apparently no payment was received thereafter and in the year of account 1997 R.N. relevant to the assessment year 1941-42, the assessee wrote off the balance of Rs. 55,030. It was this amount which he claimed in his assessment for the year 1941-42 as an allowable deduction.
The Income-tax Officer declined to allow the deduction claimed on the ground that the loss was a capital loss. On appeal his decision was confirmed by the Appellate Assistant Commissioner. On further appeal, however, the Appellate Tribunal allowed the deduction relying chiefly on the decision of the Madras High Court in the case of Commissioner of Income-tax, Madras v. S. A. S Ramaswamy Chettiar.
The Commissioner of Income-tax thereupon made an application for a reference to this court and in due course the Tribunal referred the following question of law : 'Whether on the facts found the sum of Rs. 55,030 is allowable as a bad debt under the provisions of Section 10(2)(xi) of the Indian Income-tax Act ?'
The ground upon which the Tribunal based its decision was that before the Appellate Assistant Commissioner the assessee had stated that it was the usual custom in Bombay to secure loans on joint security and the Appellate Assistant Commissioner had not held that such custom had not been proved. In the opinion of the Tribunal, if such a custom existed it would be sufficient to make the loss which the assessee had suffered an allowable deduction in the computation of his profits. It was said that although the Madras case had been distinguished by the Appellate Assistant Commissioner on the ground that the parties in that case were money-lenders whereas the assessee in the present case was a timber merchant that difference in facts did not affect the applicability of the principle laid down. 'In one case' observed the Tribunal, 'money was taken from the Bank to carry on a money-lending business whereas in the other case money is taken from the Bank to carry on the timber trade.'
In my opinion the ground on which the Tribunal proceeded is erroneous both in fact and in law. It seems to have been overlooked that no part of the loan which had been taken from the Imperial Bank on the joint security of the assessee and Mamraj Rambhagat was applied to the assessees own business. What had been applied to the assessees business was the other sum of Rupees one lakh which had been borrowed from the Bank of India. The Tribunal therefore seems to have proceeded on an erroneous assumption as to the facts of the case and the application of the money.
But this error of fact apart the decision in my view is also bad in law. It is important to remember what the deduction contemplated by Section 10(2) are and what is the computation to which they are relevant. The second sub-section of Section 10 lays down the method of computing the profits and gains of business and to that end provides for a number of allowances which may be made in arriving at the assessable amount. The operation contemplated by Section 10(2) or indeed by the whole of the section is an operation of the computation of the profits of a business and the allowances which are permitted are all allowances as they must need be of sums which can properly be set off against such profits. In order that any expenditure or loss may properly be set off against business profits, it is elementary that the expenditure must be one laid out in the course of the trade or business concerned for the purpose of earning the profits thereof and similarly the loss must be one incurred in the course of carrying on the operations of the same business. That is emphasised by the language of clause (xi) of Section 10(2) itself under which the deduction was claimed in the present case for it speaks of 'bad and doubtful debts due to the assessee in respect of his business.' The debt must therefore be one which can properly be called a trading debt and a debt of the trade, the profits of which are being computed. Judged by that test it is difficult to see how the debt in the present case can be said to be a debt in respect of the business of the assessee. The assessee is not a person carrying on a business of standing surety for other persons. Nor is he a money-lender. He is simply a timber merchant. There seems to have been some evidence before the Appellate Assistant Commissioner that he had from time to time obtained finances for his business by procuring loans on the joint security of himself and some other person. But it is not established, nor does it seem to have been alleged that he in his turn was in the habit of standing surety for other alleged that be in his turn was in the habit of standing surety for other persons along with them for the purpose of securing loans for their use and benefit. Even if such had been the case any loss suffered by reason of having to pay a debt borrowed for the benefit of another, would have been a capital loss to him and not a business loss at all. In the present case the facts are most weak. All that has been proved is that the assessee accommodate another person by making himself jointly responsible with him to a Bank advanced a loan to that person and he had to pay a portion of that debt out of his own pocket. I am entirely unable to see how that loss can be connected with the assessees timber trade or even if it can be connected, how it is a trading loss.
The principles on which amount of bad debt are allowed to be deducted in the computation of taxable profits are now well-settled. The principle is that where accounts are kept on a mercantile basis the expected profits or expected receipts are also entered on the credit side and the book-profits resulting from the inclusion of such expected profits or receipts are offered for taxation. If in the ultimate event any of these expected receipts fails to materialise or to take the specific case if any debt becomes irrecoverable that amount is allowed to be deducted because having been included in the profits it now transpires that it had been wrongly included. Nothing therefore can be allowed to be deducted as a bad debt unless, if recoverable or recovered, it could be taken as a profit of the business. As Mr. Justice Rowlatt put it in the case of Curtis v. J. & G. Oldfield, 'a bad debt 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.' It is clear that in the present case if the amount of Rs. 55,030 had been recovered it could not in any event have gone to swell the profits of the assessees timber business. If it could not count for profit, it is impossible to see how it could count for loss.
The question referred to this Court is of an extremely limited scope and is confined to Section 10(2)(xi) of the Act. But I might add that even if this amount had been claimed as expenses of the business it could not have been allowed as a deduction. It has not been proved nor does it seem to have been alleged that it was necessary for the assessee in order that he might carry on his timber business to oblige others from time to time by standing surety for them and that liabilities that might arise out of such transactions were among the normal and unavoidable risks involved in the very carrying on of the business. Even if that fact had been established, I should think that the risk would have been so remote that it could not have been regarded as a risk so closely attached to the business that any liability arising out of it could be properly regarded as a business expenditure.
Another test by which the matter can be judged will make the invalidity of the assessees claim even clearer. I have already pointed out that by the transaction which ultimately caused him the loss of Rs. 55,030 he did not procure any capital for his own business but supposing that he had done so and some part of the borrowed capital had been lost it would be impossible for him to contend that such loss should be allowed to him as a deduction under Section 10. As has been pointed out when a person borrows for the purpose of his business the only allowance to which he is entitled is the interest he pays on it. No allowance is permissible in respect of the capital. If a man who invests his own money cannot claim any loss if the money so invested should be lost it is not easy to see why he should be in a better position if the loss occurs in respect of borrowed money.
Judged by all the tests that can be thought of it appears to me that the loss of Rs. 55,030 which the assessee has suffered is in no way connected with his timber business at any rate with the carrying on of it and I can see no principle on which it could be set off against the trading profit of that business or claimed as a revenue loss at all.
It remains only to refer to the two cases mentioned in the Statement of Case. The first is the case of Commissioner of Income-tax, Madras v. Ramaswami Chettiar, the decision on which the Tribunal has relied. That is a case of money-lenders and the finding in that case is that it was the custom of the particular class of money-lender there concerned to borrow from Banks for the purposes of lending out the sums so obtained at a higher rate of interest and that they borrowed on the security of one another. On that finding it is quite clear that even the borrowing from the Bank, which was a borrowing similar in form to that in the present case, was a part of the money-lending business of the assessee and the loss he suffered by reason of that transaction was clearly a business loss. The case was considered and distinguished on that and other grounds in a later decision of the same High Court in the case of Commissioner of Income-tax, Madras v. S. R. Subramanya Pillai and the Court held that the earlier decision must be read as confined to its own peculiar facts and not applicable to business other than money-lending business of Nattukottai Chetties. A well reasoned exposition of the principle upon which a bad debt can be allowed as a deduction will be found in the later case. It appears from the statement of case submitted by the Tribunal that when at the hearing of the application for a reference the later case of the Madras High Court was cited on behalf of the Commissioner of Income-tax the Tribunal felt pressed by its reasoning and authority.
I have said enough to indicate the reasons on which the claim of deduction made by the assessee in the present case must be disallowed. In my opinion the question referred to this Court must be answered in the negative.
The assessee had not entered appearance and did not appear at the hearing. We do not think that the non-appearance of the assessee is any reason for departing from the ordinary rule that costs will follow the event. The Commissioner of Income-tax is entitled to the costs of this reference and will have them.
DAS GUPTA, J. - agree.
Reference answered in the negative.