1965-VIL-187-MAD-DT
Equivalent Citation: [1966] 61 ITR 418 (Mad)
MADRAS HIGH COURT
REF NO 57/63, TC NO 194/63
Date: 06.12.1965
COMMISSIONER OF INCOME-TAX
Vs
CITY MOTOR SERVICE LTD.
BENCH
VEERASWAMI K. and KUNHAMED KUTTI JJ.
JUDGMENT
The judgment of the court was delivered by VEERASWAMI J.-Whether a sum of Rs. 55,040 is allowable as a deduc-tion under section 10(2)(xi) or 10(2)(xv) of the Income-tax Act, 1922, is thequestion referred to us under section 66(2) of the Act. The assessee is aprivate company, which originally was engaged as a transport operator instage carriages; but during the accounting year relevant to the assessmentyear 1957-58 with which we are concerned, it diverted itself to the businessof 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 a private firm which had directors common to itand the assessee. The assessee had transactions with Sungo Limited from1942 and was financing the latter from time to time with various sums oninterest. The interest which the assessee was entitled to receive on thefinancing transactions was assessed to tax under the head "businessincome", except for the year 1956-57, when a sum of Rs. 5,000 represent-ing interest was added as income under the head "other sources". Buteven this was later changed by an order under section 35 and this amountwas 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 bya resolution the assessee waived interest from Sungo Limited for 1951-52,1953-54 and 1956-57, during the relevant assessment years, the total sumof Rs. 14,500 was estimated to be the interest which the assessee wasentitled to and this was added to the chargeable income of the assessee inthose years. As on April 1, 1956, the amount due to the assessee fromSungo 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 thedebts due, and the balance, namely, Rs. 55,040, was written off by the asses-see as on March 31, 1957, as an irrecoverable debt. The claim for reductionof 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 wereoutside the course of its business.
On the former occasion, when on account of the resolution of theassessee-company, interest due from Sungo Limited was waived during theassessment year 1952-53 and when the Income-tax Officer found that ther was no justification for the waiver and on that basis sought to estimate theinterest and add it to the chargeable income, the question whether therevenue was right in doing so came up to this court by a reference undersection 66(2). In dealing with that question, this court had observed (1) :
"Apparently Sungo Limited was not the only firm to which the asses-see lent money from out of its cash which included amounts the assesseehad borrowed... Though the assessee borrowed moneys, the advances itmade to others, including Sungo Limited, were obviously in the course of the assessee's business."
There was also a further observation by this court in that judgment:
"We are referring to this aspect only to emphasise that advance to Sungo Limited and to others also were in the ordinary course of the busi-ness 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 advancesmade by the assessee to Sungo Limited should be taken to have been madein the course of the assessee's business and it cannot be said that they didnot amount to a trade debt. The Tribunal also pointed out that theassessee and Sungo Limited were both carrying on the business of dealersin 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 thedepartment had held to have accrued to the assessee have also gone to swellthe profits of the assessee. On that view, the Tribunal allowed deductionof 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, thedebt of Rs. 55,040 is an allowable deduction under section 10(2)(xi) or10(2)(xv)?"
At no stage before the revenue or the Tribunal would the applicabilityof 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 relyon that provision. In the circumstances, therefore, we have to concentrateonly on section 10(2)(xi).
The argument before us for the revenue is that while we may take thefinding of the Tribunal as correct, namely, that the advances to SungoLimited were made by the assessee in the course of carrying on its busi-ness, a further requisite should be satisfied in order that the assessee maybe entitled to the benefit of the first part of clause (xi) of section 10(2), thatis, the bad debt should be such as when it is realised it must go to swell theprofits of the assessee. In other words, it is said that not only should the
(1) See Appendix infra.
bad debt be one incurred in the course of carrying on of the business, but itshould be such that if it were not a bad debt, it should have come in as arevenue receipt which would go to swell the profits. This, according to thecontention for the revenue, is in contra-distinction with a money-lendingbusiness, where what is laid out in lending is itself part of the stock-in-trade of the money-lending and it is, therefore, not necessary, when deduc-tion is claimed on the ground of bad debt, to see whether if it had beenrealised 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 debthad been realised. Section 10(2)(xi) is as follows:
"When the assessee's accounts in respect of any part of his business,profession or vocation are not kept on the cash basis, such sum, in respectof bad and doubtful debts, due to the assessee in respect of that part ofhis business, profession or vocation, and in the case of an assessee carryingon a banking or money-lending business, such sum in respect of loansmade in the ordinary course of such business as the Income-tax Officermay estimate to be irrecoverable but not exceeding the amount actuallywritten off as irrecoverable in the books of the assessee."
The proviso to the section is unnecessary for present purposes. If theaccounts are kept on cash basis, then of course the first part of the sectionwill have no application. In this case it is not in dispute that the assessee followed the mercantile system. As we mentioned, it is not controvertedbefore us for the revenue that the debt in respect of which deduction isclaimed was lent by the assessee in the course of carrying on its business.In addition to these facts, the question is whether it is necessary for theassessee to show, in order that it may be eligible for the deduction underthe first part of the clause, that the bad debt, if realised, would have goneto 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 tous 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 theprofits or gains of business and sub-section (2) says that such profits shallbe computed after making the allowances mentioned therein. It is appar-ent from that scheme of the section that loss of a purely capital charactercannot come in for deduction in the computation of profits undersection 10. Logically, it follows from the context that what is deductibleis such a computation must be a loss of a revenue character. In thatsense, 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, ifrealised, would have gone to increase the profits. It is no doubt true thatthe 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 ofincome. To illustrate our meaning, take, for example, the sale by an assesseeof 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 abad debt for the purpose of clause (xi), because it does not go to produce orswell 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), seemsto be supported by authority. Commissioner of Income-tax v. S. R. Subra-manya Pillai (1) though not directly in point, contains observations whichreflect the view we have taken. The learned judges in that case stated:
"Under the mercantile accountancy system referred to in section10(2)(xi), an entry is made on the receipt side of the account when a sale isconcluded 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 asreceipts and the tax is levied on what has sometimes been called as 'bookprofits'. It may later on be found that some of these 'book profits' arein fact irrecoverable. They are then written off as bad debts and sincesuch 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 commercialpractice has taken a statutory form in the first part of section 10(2)(xi) ofthe Act as amended in 1939."
We may incidentally observe that in this case too the interest chargedby the assessee on Sungo Limited was brought to tax in the previous assess-ment years and, indeed, even when the assessee, by a resolution, decidednot to charge interest, the revenue insisted that because Sungo Limitedwas in sound financial position, interest should have been charged and onthat basis interest estimated by the revenue, as should have been charged by the assessee, was taxed. When it comes to a matter of deduction ofbad debt, as we mentioned, the revenue now urges that it is not a trade orbusiness debt within the meaning of section 10(2)(xi). There is a furtherobservation in that case which too may be read:
"When section 10(2)(xi) speaks of a bad debt, it means a debt whichwould have come into the balance-sheet as a trading debt in the businessor trade that is in question in this case-the book-seller's trade-and whichhas become a bad debt. It does not refer to any debt due to the traderwhich, when it was good, would not have come to swell the profits of thebook-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 reallylosses 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, jointlywith another, certain sums of money, the joint borrowing having beennecessitated by the business needs of both. The other failing in hisbusiness, the entire debt was recovered from the assessee. The assesseeclaimed to deduct from his income a sum equivalent to what he had paidon 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 extent wasnot incurred by him as incidental to the carrying on of his business.Commissioner of Income-tax v. Abdullabhai Abdulkadar (1) was concerned withthe 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 adebt was only allowable when it was a debt and arose out of and as anincident to the trade. Except in money-lending trade, debts could only beso described if they were due from customers for goods supplied or loans toconstituents 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 notallowable under section 10(2)(xi) as a bad debt as it did not arise out of andwas not an incident to the respondent's business."
The Supreme Court quoted with approval the well-known observa-tion of Rowlatt J. in Curtis v. J. & G. Oldfield Ltd. (3)
"'When the rule speaks of a bad debt it means a debt which is a debtthat would have come into the balance-sheet as a trading debt in the tradethat is in question and that it is bad. It does not really mean any baddebt which, when it was a good debt, would not have come in to swell theprofits'."
Disallowance of the sum claimed by the assessee was on account of thefact that his firm was not an agent within the meaning of section 42(1) andthe liability was imposed because of the deeming provision in sub-section (2)of section 42 of the Act. In the premises, therefore, the liability imposedupon the firm was not a business debt arising out of the business of thefirm and that it did not spring directly from the carrying on of the businessand was not incidental to it. Lehnu Mal Asa Ram v. Commissioner of
(3) (1925) 9 Tax Cas. 319.
Income-tax (1) followed the principle of Commissioner of Income-tax v. Abdulla-bhai Abdulkadar (2) and does not take us further. In Commissioner of Income-tax v. Mysore Sugar Co. Ltd. (3), the assessee was carrying on business in themanufacture of sugar and, for that purpose, he used to advance money tosugarcane growers under an agreement to have the advances adjustedtowards the price of the sugarcane to be delivered to the assessee. The advances became irrecoverable and the assessee claimed a certain amounton that account as a deduction under section 10(2)(xi). The Supreme Courtheld that this was a case of merely making a forward arrangement for thenext year's crops and paying an amount in advance out of the price and there was no element of a capital investment in making the advance andthe loss incurred by the assessee was, therefore, a loss on the revenue sideand was deductible. A. V. Thomas & Co. v. Commissioner of Income-tax (4)related to a company advancing for purchase of shares in a new companywith 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, whileholding that it could not be so treated and allowed to be deducted undersection 10(2)(xi), observed:
"A debt, for the purposes of section 10(2)(xi), was something more thana mere advance and meant something which was related to the business orresulted from it. It was an outstanding which, if recovered, would haveswelled the profits, and not merely money handed over to some one forpurchasing a thing which that person failed to return even though no pur-chase 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 haveswelled the taxable profits."
This principle was applied in Commissioner of Income-tax v. EssenPrivate Ltd. (5) Learned counsel for the assessee contends that the principle could beapplied only to the extent of the profits produced by a fund and not the principal fund itself covered by a debt. In other words, he says that moneywhich has been given out by a financier by itself cannot swell the profits.Nevertheless, according to his argument, the entire debt should be takeninto account, provided it has been incurred in the course of the business.He relies on the following observation of the Supreme Court in IndoreMalwa United Mills Ltd. v. State of Madhya Pradesh (6):
"Under the memorandum of association as well as under the expresspower conferred by the said resolution, the company, through the managing agents, could invest its funds by way of loans. If there was no mishap themanaging agents would have paid the entire amount and if they did not,the company could have recovered the entire amount from them. Theresult, therefore, was that both the borrowing by the managing agents onbehalf of the company from third parties and the lending to themselvescreated legal obligations. They were obligations created in the course ofthe business. The money lent would be a debit item in the accounts of thecompany in accordance with the accepted commercial practice and if theamount was realised it would be a credit item. Both would be proper items of accounts for ascertaining the profit and loss of the company. If the debtbecame irrecoverable, it would be a bad debt."
These observations were not made by the Supreme Court in relationto section 10(2)(xi). All that is necessary to say in the present case is thata debt may be treated as a bad debt for purposes of section 10(2)(xi), ifthere is a debt in point of fact, it is incurred in the course of carrying onand as incidental to the business of the assessee, it is irrecoverable and if itwere realised it would have gone to swell the profits. If these indicia aresatisfied, we think the assessee would be entitled to the benefit of the firstpart of section 10(2)(xi).
Learned counsel appearing for the revenue contends that the requisitethat the debt if realised should have gone to swell the profits of the busi-ness is not satisfied. We are unable to accept this contention. The factthat in the previous assessment years the revenue brought to charge theinterest due from advances made by the assessee to Sungo Limited demon-strates that the debt did go to swell the business profits of the assessee. Aswe mentioned earlier, the interest so due to the assessee was treated by therevenue itself throughout as business income. It cannot, therefore, be pre-tended that the debt was not one which if realised would not have gone toswell the business profits of the assessee. The memorandum of associationof the assessee-company empowered it to carry on business as financiers andalso to lend, deposit or advance monies on such terms as might seemexpedient, the financing of the monies being confined to the parties doingbusiness similar to that of the assessee. When the assessee made advancesto Sungo Limited, which was dealing in shares, it was within the power of the assessee-company and it could well be described as in the course of carry-ing on its business. When monies are so advanced as incidental to and inthe course of its business, often the advances would constitute a debt which,when realised, would go to swell the profits of the business. Actually, inthis 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 thedebt, if realised, would have gone to swell the business profits of the assesseewas not specifically mooted before the Tribunal. But it is clear from the 's 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 toswell the profits of the assessee. Further, it is only one aspect of the ques-tion whether deduction of the amount in question could or could not beallowed under section 10(2)(xi).
The question under reference is answered against the department withcosts. Counsel's fee Rs. 250.
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