TMI Blog1980 (8) TMI 40X X X X Extracts X X X X X X X X Extracts X X X X ..... For the relevant assessment years 1967-68 and 1969-70, the assessee-firm had claimed allowance on account of bad debts. An amount of Rs. 54,145 was due to the assessee from one Mansukhlal Nathulal on account of sale of ghamelas to him by the assessee-firm. The said party lost heavily in forward business and became a pauper. The amount of Rs. 54,145 which was due from him was, therefore, written off by the assessee-firm by debiting the said amount to the profit and loss account and crediting to bad debt reserve account without any entry in the debtor's account in the books of the assessee-firm. So far as the amount of Rs. 54,145 which was claimed by the assesseefirm for the bad debt allowance for the year 1967-68 was concerned, the ITO disallowed the claim on the ground that the assessee-firm had dealings with the said party up to July 30, 1965, and that no efforts to recover the amount by filing a suit were made. On the other hand, the AAC on appreciating the evidence and the material produced before him, came to the conclusion that the said party was absolutely ruined and the debt had really become bad. The AAC also considered the fact that the conduct of the assessee-firm showe ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... te Tribunal. By a common order, five revenue appeals were disposed of. So far as the present controversy between the parties is concerned, the Tribunal took the view that four conditions were required to be fulfilled before allowance for bad debt can be granted under s. 36 and those four conditions according to the Tribunal were as under : (1) The debt or loan should be in respect of a business which is carried on by the assessee in the relevant accounting year. (2) The debt should have been taken into account in computing the income of the assessee of the accounting year or of an earlier accounting year or should represent money lent in the ordinary course of the business of banking or money-lending. (3) The amount of the debt or loss, or part, thereof, which is claimed as a deduction, should be established to have become bad in the accounting year. (4) The amount should be written off as irrecoverable in the accounts of the assessee for that accounting year in which the claim for a deduction is made for the first time. The Tribunal found that so far as the first two conditions were concerned, there was no dispute between the parties that such conditions were fulfil ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... he view, which it did, against the assessee. Now, in order to appreciate the short controversy between the parties, it is necessary to keep in view certain proved facts on the record of the case. It has been held by the Tribunal itself that the debts in question had become bad debts during the relevant accounting years. 'The narrow question which has remained for consideration is as to whether the condition of s. 36(2)(i)(b) has been satisfied or not by the assessee when it posted certain entries in its account books regarding these bad debts. In order to appreciate the said controversy in its correct perspective, it is necessary to have a look at the relevant statutory provisions. Section 36(1) of the I.T. Act, 1961, provides that "the deductions provided for in the following clauses shall be allowed in respect of the matters dealt with therein in computing the income referred to in section 28 ". Clause (vii) of s. 36(1) states that subject to the provisions of sub-s. (2), the amount of any debt or part thereof, which is established to have become a bad debt in the previous year, can be allowed as permissible deduction. Sub-s. (2) of s. 36, so far as it is relevant for our pres ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... corresponding provision of the Indian I.T. Act, 1922. In S. 10(1) of the said Act, it was provided that " the tax shall be payable by an assessee under the head ' Profits and gains of business, profession or vocation ' in respect of the profits or gains of any business, profession or vocation carried on by him ". Certain allowances were contemplated to be given while computing the profits and gains for the concerned years and for that purpose, s. 10(2) provided that " such profits or gains shall be computed after making the following allowances, namely..." Clause (xi) of S. 10(2) reads as under : " (xi) 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 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 : Provided that ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ar as the present provisions of s. 36 under the 1961 Act are concerned, it is clear that before any claim for allowance as bad debt is held established by the ITO it must appear that the concerned bad debt was written off as irrecoverable in the account books of the assessee for the relevant previous years. This requirement has become a condition for the grant of a claim for bad debt allowance. To that extent, there is a clear departure from the scheme in the earlier Act. Still, so far as the exact requirement of the writing off of the concerned debt as irrecoverable in the account books of the assessee is concerned, as we have noted above, the language used in both the Acts, viz., the Act of 1922 and the Act of 1961, is almost identical. Now, we may note a salient feature which has been well established on the record of this case. The AAC has found on evidence that the assessee was following a particular method of account-keeping and whenever he found that the debt had become bad, the profit and loss account was debited to that extent and a corresponding credit entry was made in the bad debt reserve account. Of course, the assessee did not carry out the entries further by posti ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... , contended in this connection that the aforesaid definition of the word " write-off " shows that the balance under an account previously regarded as an asset must be transferred to another account before it can be said that the said account is written off. It is not possible to agree with the said submission of Mr. Raval. All that the definition mentioned by Kohler shows, is that an account which was previously shown as an asset must be transferred to an expense account or the profit and loss account. In the present case, it is not in dispute that the assessee did post the relevant entries debiting the profit and loss account for the concerned previous year, clearly indicating the amounts which were due from the concerned debtors and which had become irrecoverable and these amounts had been then credited to the bad debt reserve account. Thus, the relevant debts effected in the profit and loss account can clearly amount to a notional transfer of the balance under the concerned bad debt account. In the Dictionary of Business and Management by K. C. Parikh, 1972 Edn., at p. 348, is mentioned the meaning of the word " write-off " as under: " In book-keeping, to transfer a bad debt ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... or's (by name) account. The debtor's account is then closed and the bad debts account is transferred at the end of the year, to the profit and loss account (debit side). " Mr. Raval then drew our attention to Book Keeping and Accounts by Spicer and Pegler, 16th Edn., at p. 39. In the said book, it has been mentioned : " When a debt is found to be irrecoverable, it should be written off as a loss by means of a journal entry debiting Bad Debts Account and crediting the account of the defaulting debtor. At the end of the accounting period, the Bad Debts Account is closed by transfer to the Profit and Loss Account. Should a debt which has been written off as bad be subsequently recovered, in whole or in part, the debtor's personal account should be debited and Bad Debts Account credited, the cash received then being credited to the debtor's account. This is preferable to posting the amount recovered direct from the Cash Book to the credit of the Bad Debts Account without making any entry in the debtor's personal account, since it is desirable, for future reference, that this account should contain a full history of the occurrence. " Mr. Raval also drew our attention to cert ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... at this amount is not credited to Debtors' Control Account or to any individual debtor's accounts in the subsidiary ledger, because, in contrast with the previous entry, no debts are actually written off. " Thus, Mr. Raval wanted to pinpoint the difference between the writing off of an actual debt and making a provision for the same. Mr. Raval also invited, in this connection, our attention to the observations made by the learned author at p. 103 of the said book to the effect: If the debt is bad it should be written off; if it is not bad, but collection in full is not regarded as certain, the provision created is against a doubtful debt. " Mr. Raval also invited our attention to Principles and Practice of Book Keeping and Accounts by B.G. Vickery, 16th Edn., at pp. 96 and 97, of the said book, in which observations regarding Personal Accounts Bad Debts are found. It has been observed therein : " When it becomes known that a debtor's balance is irrecoverable, and that it no longer represents an asset, the personal account must be closed by transferring the loss to the debit of a Bad Debts Account, in which all the bad debts are collected pending their transfer to the de ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... o be made. The Bad Debts provision would be 5 per cent. of pounds 2,500, and not 5 per cent. of 2,560. In the balance sheet, therefore, we should have- pounds pounds Sundry Debtors 2,500 Less Bad Debts provision 125 2,375 ---------- Instead of Sundry Debtors 2,560 Less Bad Debts provision 128 2,432 When the Bad Debts are written off, the Sundry Debtors will be reduced to pounds2,500 and this point seems to be quite unnoticed by the majority of students, who are greatly surprised when the Balance Sheet totals do not agree. " Mr. Raval also invited our attention to p. 609 of A Desk Book of Business Management Terms by Leon A. Wortman, 1979 Ed., wherein the term " write off " is defined to mean " the transfer of the remainder of the value of an asset to an expense account ; the act of reducing book value. " The aforesaid text books to which our attention was drawn by Mr. Raval for the revenue show that in the double entry book-keeping as and when debtor's account is squared off, it can be demonstrated that the debt is irrecoverably written off. But the short question which has been posed for our consideration in the present proceeding is this : In the abs ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... development rebate. The grant of this rebate was a concession subject to the fulfilment of the conditions prescribed under the proviso, and the creation of a reserve fund under section 17 of the Banking Companies Act was not sufficient compliance with the proviso, even though the amount so carried to the reserve fund might be large enough to cover both requirements. " Thus, it was laid down by the Supreme Court in the aforesaid decision that before an assessee can claim development rebate, he must strictly comply with the condition for the grant of such rebate as prescribed by the relevant statutory provisions of the Act. Mr. Raval also invited our attention to a decision of this court in the case of Addl. CIT v. Shri Subhlaxmi Mills Ltd. [1975] 100 ITR 188. That was also a case pertaining to development rebate. It has been observed in the aforesaid decision of this court (headnote): " The debiting of the profit and loss account must be done before the profit and loss account is closed, that is, entries should be made regarding the reserve at the time of making up the profit and loss account. The Legislature has clearly indicated that the assessee must ordinarily be allowed ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... everse way. As we have already stated above, the only requirement of s. 36(2)(iXb) is that the concerned bad debt must have been written off as irrecoverable in the account of the assessee. Once the debit entries posted by the concerned assessee with the relevant corresponding entries clearly indicated the said fact, the requisite statutory condition has got to be treated as fully complied with. Mr. Raval for the revenue drew our attention in support of his submission to s. 36(2)(iv), which reads as under: "In making any deduction for a bad debt or part thereof, the following provisions shall apply:- ......... (iv) where any such debt or part of debt is written off as irrecoverable in the accounts of the previous year and the Income-tax Officer is satisfied that such debt or part became a bad debt in any earlier previous year not falling beyond a period of four previous years immediately preceding the previous year in which such debt or part is written off, the provisions of sub-section (6) of section 155 shall apply. " Mr. Raval contended that if in a given year, the debt is written off as irrecoverable by the concerned assessee and if the ITO finds that the debt became ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... n a doubtful debt. Our attention was also invited to a copy of instruction No. 370 (Circular letter No. F. No. 205/15/71, dated January 13, 1972, issued by the Secretary, Central Board of Direct Taxes, Government of India, New Delhi). The said circular was with reference to the provisions of bad debt allowance in the hands of assessees who had sold goods to sick textile mills. While dealing with the aforesaid subject, the said circular referred to the provisions for bad and doubtful debts as made in s. 10(2)(xi) of the 1922 Act and the similar provision made in s. 36(1)(vii) of the 1961 Act. The circular on this aspect observed as under: " The Law Commission had replaced the words'bad and doubtful debts' occurring in section 10(2)(xi) of the I.T. Act, 1922, by the words 'debts or parts thereof that are established to have become bad debts ' as the Commission was of the view that the word ' doubtful ' was unnecessary and did not add anything to what was covered by a word ' bad'. It is, therefore, obvious that there was no intention to reduce the scope of the earlier provisions contained in section 10(2)(xi) of the I.T. Act, 1922 ; it is considered that the provision in section 36( ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... n ideal 'mode of book keeping is not adopted and if what the assessee has done reflects a clear intention to treat the concerned debts as irrecoverable and he has written them off as irrecoverable by not treating them as existing assets and if such an intention is clearly reflected by the debit entries in the profit and loss account and the corresponding credit entries in the bad debts reserve account, the strict requirement of S. 36(2)(i)(b) can be said to have been complied with. Not following an ideal mode of book-keeping or not posting all the detailed, exhaustive and scientific entries does not necessarily mean that the requirements of S. 36(2)(i)(b) are not complied with. Absence of an ideal state of maintenance of accounts is not necessarily an absence of compliance with the minimum requirement of s. 36(2)(i)(b). We may now turn to a couple of decisions on the point. The first decision is of the Supreme Court in Associated Banking Corporation of India Ltd. v. CIT [1965] 56 ITR 1. The said decision arose out of a case which was covered by the earlier provisions of ss. 10(1), 10(2)(xi) of the Indian I.T. Act, 1922. The question in that case was as to whether absence of entri ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... e hearing that some or all debts had become bad or doubtful." In the aforesaid decision, the Supreme Court did note the change brought about by the present Act by s. 36(1)(vi). After quoting that section, the Supreme Court observed that the material clause has been wholly redrafted and the Legislature has expressed its intention clearly. As we have indicated above, the material change which has been brought about by the present provision of s. 36(1)(vii) read with s. 36(2) is that before any allowance can be granted for any bad debt, the assessee under the Act has got to show that he has written off the concerned debt as irrecoverable in his books of account for the previous year. In the earlier Act, no such condition precedent existed. But still the question will remain as to whether the assessee can be said to have written off the bad debt as irrecoverable in his books of account by debiting his profit and loss account and by crediting the bad debt account but not the ledger account of the concerned debtor in the assessee's books. The aforesaid question which has been posed for our consideration has been squarely answered against the revenue by an earlier decision of the Bombay ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... books and if that was not done, the amount could not be said to have been written off as required by that section and, therefore, it was not permissible. The aforesaid argument of Mr. N. P. Engineer in Jwala Prasad's case [1953] 24 ITR 537 (Bom) was in terms turned down by the Division Bench of the High Court. Chagla C.J., speaking for the, Division Bench, observed (p. 539): " The whole of the argument of Sir Nusserwanji is that writing-off can only be achieved by the accounts of the respective debtors in the books of the assessee being credited with the amount in respect of which they have been indebted to the assessee. Sir Nusserwanji says that the accounts do not show that the amounts have been written off because these amounts were still shown in the account as being due to the assessee. " The Division Bench also noted the other submission of Mr. Nusserwanji for the revenue that it was not enough that the profit and loss account should be debited, but it was essential that the accounts of the debtors should be adjusted by writing off the amounts. The aforesaid contention of Mr. Nusserwanji for the revenue was in terms negatived by the Division Bench in the said decision. It ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... o the facts of the present case. As we have already stated above, provisions of section 10(2)(xi) of the earlier Act of 1922, in so far as they required actual writing off of the concerned debts as irrecoverable in the books of account of the assessee, are in pari materia with the present provisions of sections 36(2)(i)(b). The only difference is that in the earlier provisions, entries were to be found in the books of the assessee while in S. 36(2)(i)(b), entries are to be found in the accounts of the assessee. Mr. Raval fairly conceded that, in substance, this difference of phraseology makes no real difference. It is, therefore, clear that the Division Bench of the Bombay High Court in the aforesaid case clearly took the view that once the assessee has posted entries in the profit and loss account showing a particular debt to have become bad and once corresponding entries are posted in the suspense account, that would be enough compliance with the provisions of the statutory requirement for writing off as irrecoverable the concerned debt in the books of the assessee. No further requirement can be spelt out from this express language used by the Legislature and it cannot be insiste ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... rovisions of s. 36(2)(i)(b). The learned Advocate-General has adopted the said reasoning of the Tribunal as part of his argument. But even apart from the later decision of the Tribunal, as we have already indicated above, on the language of s. 36(2)(i)(b), it appears clear to us that once the assessee, following a particular simple system of accounts, has posted the relevant debit entries in his profit and loss account and the corresponding credit entries in the bad debt reserve account, thereby clearly expressing his intention to treat the concerned debt as irrecoverable bad debt, he is said to have done what is required of him by the aforesaid statutory provision and no further duty can be foisted upon him requiring him to also close the existing ledger accounts of the concerned parties in his books of account. The net work of statute as indicated by the Legislature by enacting s. 36(2)(i)(b) does not spread its tentacles that far as Mr. Raval would like to have for the revenue. In that view of the matter, it must be held that the Tribunal in the present case was in error when it took the view that the assessee had not written off as irrecoverable in its accounts, the debts in qu ..... X X X X Extracts X X X X X X X X Extracts X X X X
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