TMI Blog2010 (7) TMI 455X X X X Extracts X X X X X X X X Extracts X X X X ..... ooks of account as irrecoverable. - Decided in favor of assessee. - ITA No. 3374/Mum/2004 - - - Dated:- 16-7-2010 - R.V. EASWAR PRESIDENT D.K. AGARWAL JUDICIAL MEMBER J. P.M. JAGTAP ACCOUNTANT MEMBER J. Appellant by : Shri Ajit Kumar Sinha Respondent by: Shri Hiro Rai ORDER PER P.M. JAGTAP, AM. This Special Bench has been constituted u/s 255(3) of the Income Tax Act, 1961 to decide the following question which is arising out of the present appeal:- Whether on the facts and circumstances of the case and in law, the assessee, who is a share broker, is entitled to deduction by way of bad debts under section 36(1)(vii) read with section 36(2) of the Income Tax Act, 1961 in respect of the amount which could not be recovered from its clients in respect of transactions effected by him on behalf of his client apart from the commission earned by him. 2. The relevant facts of the case giving rise to the question which has been referred to the Special Bench are that the assessee is a share broker. The return of income for the year under consideration was filed by him on 2.11.1998 declaring total income of Rs. 67,797/-. In the said return, deduction ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... in section 36(2) thus was not satisfied and the assessee was not entitled to claim deduction in respect of the said bad debts u/s 36(1)(vii). It was noted by the Division Bench that this stand of the Revenue was accepted by the co-ordinate Bench of the Tribunal in the case of India Infoline Securities Pvt. Ltd. Vs. A.C.I.T. 25 SOT 123 (Mum) and in the case of ACIT vs. B.N. Khandelwal 101 TTJ 717. It was also noted by the Division Bench that there was however a contrary view taken by the co-ordinate Bench in the cases of ACIT vs. Olympia Securities Ltd. (ITA No. 4053/Mum/02 dtd. 21.12.2006), ACIT vs. PRS Shares and Finance Ltd. (ITA 4280/Mum/07 dtd. 20.5.2008) and Shri Somen P. Sangani vs. ITO (ITA No. 3410/Mum/05 dtd. 5.6.08). It was held by the co-ordinate Benches in the said cases that the condition u/s 36(2) stands satisfied where the assessee has taken into consideration the brokerage income connected with the transaction effected by it on behalf of his clients. It was held that the claim of the assessee in respect of deduction on account of bad debts u/s 36(1)(vii) therefore cannot be denied on the ground that the amount of bad debts has not been taken into consideratio ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... n computation of income by virtue of brokerage being credited in the P L account in the case of share broker. 6. The ld. D.R. also contended that in the case of the broker, the accrual of brokerage income and accrual of debt against client in respect of share purchase are two different events which happen at two different times. He submitted that the income on account of brokerage accrues to the broker the moment he conducts the transaction on behalf of his client, but the client does not become a debtor of the broker at this point of time. He submitted that it is only on the settlement day which is later in point of time that the client becomes debtor of the broker in case the former fails to pay the amount against purchase of shares and the broker has to make the said payment on behalf of the client. He contended that in such a situation also the broker has underlined security in the form of shares purchased against the amount receivable from client and there is hardly any possibility of the said debts becoming bad if the broker has ensured receipt of prescribed 20% margin money from the client. He contended that it cannot therefore be said that by virtue of brokerage being ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... clients and not the share broker himself. He submitted that the transactions of trading in shares are governed by rules and regulations of stock exchange and the broker has a limited specified role in such transactions as prescribed by SEBI. He invited our attention to the relevant circular issued by SEBI in this context and took us through the various guidelines laid down therein to show the restrictions imposed on brokers and safeguards provided to protect the interest of the broker. He submitted that if the said guidelines are strictly followed, a broker would never put him in a situation where he has an irrecoverable debts from his clients and there will be no occasion for him to claim deduction on account of bad debts. He contended that only when the said guidelines are violated by a broker that he may have the risk of suffering loss as a result of bad debts and such loss would rise only when there is infraction of law laid down by SEBI under SEBI Act. He contended that this aspect therefore needs to be taken into consideration while examining the claim of the share broker for deduction on account of bad debts. 9. The ld. D.R. then took us through the various decisions ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... n indicates that the same is held to be not allowable u/s 36(1)(vii). He relied on the decision of Hon ble Supreme Court in the case of A.V. Thomas Co. Ltd. Vs. CIT 48 ITR 67 (SC) wherein it was held in a similar context that a debt means something which is related to the business or results from it and it is an outstanding which if recovered would have swelled the profits. He contended that if this concept of debt explained by the Hon ble Apex Court is taken into consideration, the amount receivable by the assessee as share broker from his clients against purchase of shares cannot be described as a debt and deduction u/s 36(1)(vii) cannot be allowed on account of bad debts. 11. In reply, the learned counsel for the assessee submitted that the fundamental issue involved for the consideration of the Special Bench relates to the satisfaction of condition prescribed in section 36(2) in the case of a broker where only the brokerage income is credited to the P L account and not the value of purchase of shares made on behalf of the clients. Referring to the provisions of section 36(2), he submitted that the expression used therein is taken into account in computing the income ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... curities Ltd.(supra) and submitted that as held therein, the amount receivable by the assessee as a broker from his clients against purchase of shares made on their behalf represent his debts and the brokerage which was received in the said transactions having been shown as income by the assessee in the previous year and it was taxed as such by the assessing authority, he was entitled to deduction u/s 36(1)(vii) for the said debts after having written off the same as bad or irrecoverable. He also relied on the decision of Hon ble Delhi High Court in another case CIT vs. Bonanza Portfolio Ltd. (supra) wherein it was held while dealing with a similar issue that the money receivable by the share broker from his clients against purchase of shares had to be treated as debt and since it became bad, it was rightly considered as bad debt and claimed as such by the assessee in the books of account. It was also held that since the brokerage payable by the client was a part of the debt and that debt had been taken into account in the computation of income of the assessee, the conditions stipulated in section 36 (1)(vii) and 36(2) stood satisfied. 14. The ld. Counsel for the assessee su ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... s whether he has actually suffered such loss or not. He has contended that this is not the case even of the A.O. that there was no loss actually suffered by the assessee on account of non-recovery of debt representing amount receivable by the assessee from his clients against purchase of shares. 16. As regards the submission of the ld. D.R. that it is not very clear either from the order of the A.O. or that of the ld. CIT(A) that the amount in question claimed as bad debts was written off by the assessee as irrecoverable from its books of account, the ld. Counsel for the assessee filed a copy of ledger account of one of the clients of the assessee to show that the amount receivable from the said party was written off from the books of account of the assessee as irrecoverable. He submitted that such copies of ledger account of all the concerned parties were filed by the assessee before the A.O. during the course of assessment proceedings to show that the amounts receivable from them were duly written off as irrecoverable. 17. As regards the other objection raised by the ld. D.R. as to whether the brokerage income in respect of transactions in question claimed as bad debts wer ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ess carried on by the assessee and therefore the second limb of clause (i) of sub-section (2) of section 36 is not relevant in the present case atleast at this stage. We may, however, have to consider the same at appropriate stage while dealing with the arguments raised by the ld. D.R. referring to the said limb. What we are concerned at this stage is whether the condition stipulated in the first limb of section 36(2)(i) is satisfied in the case of the assessee in as much as whether the debt representing amount receivable by the assessee as share broker from his clients against purchase of shares on their behalf or part thereof can be said to have been taken into account in computing the income of the assessee. The stand of the assessee in this regard is that the brokerage receivable by the assessee on the transactions of purchase of shares made on behalf of the clients is part of the debt receivable from the clients on account of the said transaction and the amount of brokerage having been taken into account in computing the income of the assessee, the condition stipulated in the first limb of section 36(2)(i) stands satisfied. In support of this contention, reliance has been p ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... g the income of the assessee. At the time of hearing before us, even the ld. D.R. has not disputed this proposition clearly propounded by the Hon ble Supreme Court in the case of T. Veerabhadra Rao K. Koteshwar Rao Co (supra). 20. The ld. D.R.has contended that the ratio laid down in the case of T. Veerabhadra Rao K. Koteshwar Rao Co (supra), however, is not applicable in the case of assessee who is a share broker. According to him, even though section 36(2)(i) does not require that the whole amount of bad debt claimed u/s 36(1)(vii) should have been taxed as income, such amount atleast should have been reflected on the credit side of the P L account so that the net amount after deducting the corresponding expenses is included in the total income of the assessee chargeable to tax. He has contended that in the case of a share broker, only the brokerage amount is credited to the P L account and not the value of shares purchased on behalf of the clients. He has also contended that the transaction of sale/purchase of shares actually belong to the clients of the share broker and it is not necessary that brokerage is always relatable to the value of share transactions. He ha ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... me on account of interest accrues to the lender only after a specified period of interval as agreed between the parties. As held by the Hon ble Supreme Court in the case of T. Veerabhadra Rao K. Koteshwar Rao Co (supra), interest is taxed as income because it represents an accretion accruing during the relevant year on money owed to the assessee by the debtor and the nature of such income indicates the transaction from which it emerges. It therefore follows that even if accrual of brokerage income and accrual of debt against client in respect of share purchase are two different events which happen at two different times, brokerage income accrues to the share broker as a result of transaction of purchase of shares on behalf of the clients and this nature of brokerage income indicates that it emerges from the transaction of purchase of shares by the assessee on behalf of his clients in the capacity of share broker. The amount receivable by the assessee on account of brokerage thus is a part of debt receivable by the share broker from his clients against purchase of shares and once such brokerage is credited to the P L account of the broker and the same is taken into account in co ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... us, where the assessee broker has actually suffered a loss as a result of non-recovery of the amount receivable from his clients against purchase of shares on their behalf, the allowability thereof is required to be considered in accordance with the relevant provisions of the Income Tax Act and it is irrelevant whether such loss has been suffered by the assessee as a result of not following the said rules and regulations and guidelines or even after following the same. Moreover, even if it is assumed that such loss has been incurred by the assessee as a result of not following the rules and regulations and guidelines issued by the SEBI, the same cannot be equated to expenditure incurred by the assessee for any purpose which is an offence or which is prohibited by law. The reliance of the ld. D.R. on the said rules and regulations of stock exchange and guidelines issued by SEBI thus is clearly misplaced and the arguments raised by him relying thereon cannot be accepted being devoid of merits. In the case of CIT vs. Pranlal Kesurdas 49 ITR 931, the claim of the assessee for bad debts was disallowed by the A.O. on the ground that the said debt was arising out of forbidden wayada t ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ituation, however, is altogether different because the money itself constitutes stock in trade of the said business and any debt representing money lent in the ordinary course of banking or money lending business clearly constitutes the trading debt of that business. It is therefore not necessary to apply the test laid down in first limb of section 36(2)(i) to ascertain whether the debt representing money lent in the ordinary course of banking or money lending business is trading debt or not since the said debt going by the very nature of banking/money lending business itself is a trading debt. In our opinion, this is the rationale behind the exception provided in the second limb of section 36(2)(i) in respect of banking/money lending business and therefore no adverse inference on the basis of the said exception can be drawn against the assessee carrying on the business of share broking as sought by the ld. D.R. 25. At the time of hearing before us, the ld. D.R. has relied, inter alia, on the decisions of the tribunal in the case of India Infoline Securities (P) Ltd. Vs. ACIT (supra), Addl. CIT vs. B.N. Khandelwal (supra) and Mahesh J. Patel vs. ACIT 109 ITD 35 (TM) in support ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ch business. Moreover, the said debt if good would have swelled a taxable profit of the assessee broker in the form of brokerage income. 27. Here, we may also refer to the case of CIT vs. City Motor Service Ltd. 61 ITR 418 wherein Hon ble Madras High court was concerned with section 10(2)(xi) of the 1922 Act. This section is the forerunner of section 36(2)(i) of the 1961 Act, but there was no condition that the debt should have been taken into account in computing the income of the assessee for the relevant assessment year or any earlier year. Despite this, Hon ble Madras High Court held that such a condition must be read into the section. The relevant portion of the judgment in this context is extracted below from page 421 of the report:- .the question is 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 realized, 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 b ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... f shares on their behalf must be held allowable as a bad debt. 29. At the time of hearing before us, the ld. Counsel for the assessee has strongly relied on the decisions of Hon ble Delhi High Court in the case of CIT vs. DB (India) Securities Ltd.(supra) and in the case of CIT vs. Bonanza Portfolio Ltd. (supra) stating that the same are directly on the point in issue and there being no contrary decision of the Hon ble jurisdictional High Court or any other High Courts, this Special Bench has to follow the same. We have carefully perused the said decisions of the Hon ble Delhi High Court. In the case of DB (India) Securities Ltd.(supra), the assessee was a member of Delhi Stock Exchange and was carrying on the business of shares and stock broking. The assessee had purchased shares on behalf of his client for the total value of Rs. 1.06 crores at an average price of Rs. 55 per share. The said client made a payment to the extent of Rs. 65 lacs only to the assessee and the remaining amount of Rs. 41 lacs had remained unpaid. The brokerage income earned by the assessee in respect of the said transaction of purchase of shares was duly declared in its return of income and was as ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... rt of that debt and that part had been taken into account in computation of his income, the conditions stipulated in section 36(1)(vii) and 36(2) stood satisfied and the assessee was entitled for deduction in respect of the said amount since it had become bad. In our opinion, the ratio of these decisions of the Hon ble Delhi High Court in the case of CIT vs. DB (India) Securities Ltd.(supra) and in the case of CIT vs. Bonanza Portfolio Ltd. (supra) is squarely applicable to the issue which is under consideration in the present case before this Special Bench. 30. The learned D.R. has contended before us that the rules and regulations of stock exchange governing relations between broker and his clients as well as the guidelines issued by the SEBI from time to time protecting the interest of share broker were not brought to the notice of the Hon ble Delhi High Court in the cases of CIT vs. DB (India) Securities Ltd.(supra) and CIT vs. Bonanza Portfolio Ltd. (supra) and Their Lordships thus had no occasion to consider the issue in the light of the same. However, as already held by us, the said rules and regulations as well as guidelines are not relevant in the context of issue refe ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... re broker, from his clients against the transactions of purchase of shares on their behalf constitutes debt which is a trading debt. The brokerage/commission income arising from such transactions very much forms part of the said debt and when the amount of such brokerage/commission has been taken into account in computation of income of the assessee of the relevant previous year or any earlier year, it satisfies the condition stipulated in section 36(2)(i) and the assessee is entitled to deduction u/s 36(1)(vii) by way of bad debts after having written of the said debts from his books of account as irrecoverable. We, therefore, answer the question referred to this Special Bench in the affirmative that is in favour of the assessee. 33.The matter will now go before the regular Bench for disposing of the appeal keeping in view our decision rendered hereinabove. 34. Before parting, we may recapitulate that there are certain arguments which have been raised by the ld. D.R. for the first time before this Special Bench relating to quantification of the amount of bad debts and verification of some factual aspects. As already observed by us in this context, the Department is at l ..... X X X X Extracts X X X X X X X X Extracts X X X X
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