1. Both these appeals by the assessee relate to assessment year 1984-85.
2. The assessee deals in cotton. A return of income declaring income of Rs. 26,233 was submitted on 13-9-1984. Assessment was completed under Section 143(1) on 24-3-1986. Subsequently the ITO found that the sales-tax of Rs. 11,62,958 was debited to the profit & loss account out of which sales-tax amounting to Rs. 9,07,435 was not paid during the year. This was liable to be disallowed under Section 43B of the Income-tax Act, 1961 (the Act). After obtaining the approval of the IAC, assessment was processed for scrutiny under Section 143(2)(6) of the Act. Instructions under Section 144A were issued by the IAC on 6-3-1987 directing the ITO to make an addition of Rs. 9,07,435 in respect of unpaid outstanding sales-tax liability in view of Section 43B. On 19-3-1987, the assessee submitted a revised return of income in which the income was computed in the following manner:Net income as per original return Rs. 26,233Add : Unpaid sales tax added as per Section 43B Rs. 9,07,435Total Rs. 9,33,668Less: Trading loss in respect of irrecoverabledebt Rs. 8,95,277Total Income Rs. 38,391 The assessment under Section 143(3) was completed on 27-3-1987 at an income of Rs. 9,50,020. The assessee preferred an appeal against the said order in which the main grievance of the assessee was that the ITO has erred in not entertaining and considering the revised return submitted prior to completion of the assessment proceedings. Some other disallowances made by the ITO were also challenged in that appeal. The CIT(A), vide his order dated 29th February, 1988 directed the ITO to consider the revised return of the assessee on merits and also sustained certain disallowances made out of travelling, telephone, depreciation etc. The first appeal marked as ITA No. 1157/88 is against that order dated 29-2-1988.
3. Since a fresh assessment was made by the Assessing Officer pursuant to the directions given by the CIT(A) after taking into consideration the revised return, the learned counsel for the assessee stated that he would not like to press this appeal against the order of the CIT(A) dated 29-2-1988.
4. During the course of fresh assessment proceedings, the ITO examined the assessee's claim for grant of deduction in respect of trading loss/bad debt amounting to Rs. 8,95,277 claimed for the first time in the revised return submitted on 19-3-1987. The assessee sold goods to M/s Usha Spinning & Weaving Mills Ltd., Faridabad, U.P. (For short M/s Usha) in the preceding year. The total debits in the account of the said customer in the preceding year was Rs. 21,20,578.34 out of which the assessee realised a total sum of Rs. 13,47,000, leaving an outstanding balance of Rs. 7,73,578.34 as at the beginning of the year under consideration. A sum of Rs. 1,51,698.66 was added as interest on the aforesaid opening balance. Thus the total debit in the account of the said customer was Rs. 9,25,277 out of which a sum of Rs. 30,000 was recovered on 29-1-1983 and the balance amount of Rs. 8,95,277 was shown as outstanding amount at the time when the original return was filed.
At the time of filing the revised return an entry was made in the books of account pertaining to the year under consideration S.Y.2039 by way of supplementary adjustment entries by which the account of M/s Usha was credited by a sum of Rs. 8,95,277 with a corresponding debit to trading loss account with the narration that during the current year the mill was closed on 24-5-1983. The amount of goods sold to M/s Usha cannot possibly be recovered and it is, therefore, debited to trading loss account and credited to the party's account. After obtaining necessary directions from the Dy. CIT under Section 144A, the ITO rejected the assessee's claim for deduction of the aforesaid amount and completed the assessment at a total income of Rs. 9,33,670 vide order dated 25-11-1988. The reasons for such disallowance have been elaborately discussed by the ITO in the assessment order. On further appeal, the learned CIT(A) confirmed the view taken by the ITO and dismissed the assessee's appeal. The second appeal, marked as ITA No.1594/90 is directed against this order of the CIT(A).
5. The assessee has raised as many as 19 grounds in this appeal. During the course of hearing the grounds challenging the validity of reopening of assessment already completed under Section 143(1), the challenge to the proceedings under Section 144 A and the addition made in respect of outstanding sales-tax liability added in view of Section 43B were not pressed. The only effective ground on which the learned counsel addressed his arguments relate to the deduction claimed in respect of the aforesaid sum of Rs. 8,95,277, which, according to him, ought to have been fully allowed under Section 28 read with Section 37 and for 36 of the Act either as a trading loss or as bad debt. The only other ground pressed before us relate to levy of interest under Section 139(8) and under Section 217 of the Act.
6. The learned counsel for the assessee vehemently contended that the amount outstanding against M/s Usha became irrecoverable in the previous year under consideration and represents a trading loss which was genuinely suffered by the assessee in this year and ought to have been allowed as a trading loss under Section 28. A declaration for lock out of the factory of M/s Usha was announced on 24-5-1983 which falls in the year under consideration. During this year the assessee could recover only a sum of Rs. 30,000 despite all efforts. Several cheques given by the said trade customer were dishonoured in the last few months of the preceding accounting year relating to assessment year 1983-84. The subsequent events also confirm that the said debtor had no capacity to repay any amount out of the outstanding balance. The debtor company went into liquidation in the year 1985. Our attention was also invited towards a letter dated 16th April, 1987 from one Shri Vallabhdas Damodardas Bhansali, the agent through whom goods were sold, saying that the mill of the debtor company is closed since 24th May, 1983. They have declared lock out due to their weak financial conditions and, there is no possibility of reopening of the mill and there is also no possibility of getting any collection and interest from them. In view of these facts, the assessee was fully justified in writing off the said outstanding amount as a trading loss by way of supplementary adjustment entries and was entitled to grant of deduction in respect thereof as a trading loss. He placed reliance on judgments in CIT v. Motor Credit Co. (P.) Ltd. [1981] 127ITR 572 (Mad.), Lord's Dairy Farm Ltd. v. CIT [1955] 27 ITR 700 (Bom.), Sarangpur Cotton. Mfg.
Co. Ltd. v. CIT [1983] 143 ITO 166 (Guj.), CIT v. Abdul Razak & Co.
[1982] 136 ITR 825 (Guj.), CIT v. Equitorial (P.) Ltd. [1974] Tax.
37(3)-82 (Guj.) and also submitted synopsis of various decisions to support his contention. In the alternative it was submitted that the said deduction is also allowable as a bad debt and it fulfills all the conditions prescribed under Sections 36(1)(vj7) and 36(2). The debt in question became irrecoverable during the year under consideration and the same has duly been written off in the books of account through the supplementary adjustment entries made at the time of filing of the revised return. He, therefore, urged that the said deduction should be allowed either as a trading loss under Section 28 or as a bad debt under Section 36 or as a necessary outgoing for ascertaining the true amount of taxable income under Section 37.
7. The learned D.R. submitted that the ITO as well as the CIT(A) has rightly denied the grant of deduction in respect of the aforesaid amount. The assessee had himself shown this amount as outstanding against M/s Usha in the balance sheet submitted along with the original return of income. He had also added the amount of interest on the principal amount of outstanding balance which clearly shows that the assessee had every hope of recovering the said amount till the end of the accounting year and till the date of furnishing the original return of income. The IAC gave directions under Section 144A on 6-3-1987 directing the ITO to make an addition of Rs. 9,07,435 on account of outstanding unpaid amount of sales-tax liability in view of Section 43B. At this stage the assessee realised that this addition of outstanding unpaid sales-tax liability is bound to be sustained in view of Section 43B. Therefore it tried to somehow claim some deduction to offset this addition of sales-tax liability. Accordingly he filed a revised return on 19-3-1987 in which this claim for deduction of trade loss/bad debt amounting to Rs. 8,95,277 was made for the first time.
The entry of writing off the debt in question as a trading loss at the time of filing of the revised return cannot be considered to be a bonafide entry and it is merely an after-thought and cooked up entry made with a view to nullify the effect of addition made under Section 43B. This amount cannot be considered as a trade loss as it is squarely covered by the provisions dealing with bad debts contained in Section 36(1)(vi7) and 36(2). Any items which are expressly covered or prohibited by Sections 30 to 43C cannot be allowed as a deduction under Section 28. The CIT(A) has rightly held that this amount cannot be considered and allowed as a trading loss. The said amount also cannot be allowed as a bad debt. There are pre-conditions for grant of deduction in respect of bad debt. The assessee has to establish that the debt in question became bad in the year under consideration. There is ample evidence on record that there was every hope of recovery of this amount as the assessee had not only shown this amount as outstanding in the balance-sheet submitted along with the original return but had also added interest in the year under consideration.
Furthermore, the assessee had not written off this amount as bad debt at the time of filing of the original return. The subsequent entries made at the time of filing the revised return cannot be treated as bonafide entries. These preconditions for grant of deduction in respect of bad debts are not at all fulfilled in the present case. The company had gone into liquidation in the year 1985. The letter of the agent relied upon by the learned counsel for the assessee is also dated 16th April, 1987. Both these events took place much after the end of the relevant accounting year. It cannot, therefore, be said that the debt in question became bad in the previous year under consideration. An amount of so called doubtful debt which is not allowable under Section 36 can never be regarded as an allowable deduction under Section 37 as the various conditions for grant of deduction prescribed in Section 36 have not been fulfilled in the present case. The reliance placed on extracts from the minutes of a meeting of ABDTAC held on 2nd June, 1972 published in Taxman's Direct Taxes Circulars, Vol. I, 1980 edition at page 212 by the learned counsel for the assessee does not in any manner help him as the assessee has not brought any evidence on record that the factory of M/s Usha was taken over by the State Textile Corporation for which alone the said instructions were to be issued by the Board.
In any event the amount did not become irrecoverable in the year under consideration. More than 13 lakhs were recovered from this debtor in the immediately preceding year. A further recovery of Rs. 30,000 was made in this year. Interest was added by the assessee in the accounting year and the total amount was shown as outstanding in the balance-sheet submitted along with the original return. All these facts conclusively prove that the assessee had every hope of recovery of the said amount and it cannot be allowed as deduction under any provisions of the IT Act. He relied upon the detailed reasons mentioned in the assessment order, in the directions given under Section 144A and in the order of the CIT(A).
8. We have carefully considered the rival submissions and have also gone through the orders of the departmental authorities as well as all other documents to which our attention was drawn during the course of hearing. We have also gone through the various judgments which were relied upon by the parties at the time of hearing.
8.1 The issues which require our consideration can be broadly classified as under: (a) Whether under the facts and circumstances of the assessee's case the desired deduction of Rs. 8,95,277 can be allowed as a trading loss u/s 28? (b) Whether deduction in respect of the said amount can be allowed as a bad debt under Section 36(1)(vii) read with Section 36(2)? If so, whether the various conditions prescribed for grant of deduction in respect to debts can be said to have been fulfilled in the present case? 8.2 The provisions of Section 28 provides that profits and gains of any business or profession which was carried on by the assessee during the previous year will be chargeable to tax under the head profits and gains of business or profession. Section 29 provides that income referred to in Section 28 shall be computed in accordance with the provisions contained in Sections 30 to 43C. The scheme of these Sections is that profits and gains must be computed subject to certain express allowance and to certain express or implied prohibitions of deductions. But deduction which is neither within the terms of the prohibition nor such that the specific allowance must be taken as the exclusive definition of its area, must be allowed if it is, on the facts of the case, a proper debt item chargeable against the income of that year. Once a particular item of expenditure or deduction is of the nature specifically described in any of the statutory provisions contained in Sections 30 to 43C of the Act, the allowability of the said expenditure will have to be considered in the light of that specific provision. More so when the said specific section is so worded as to prohibit expressly or impliedly any allowance apart from that section and except on the fulfilment of the conditions prescribed in that specific section. The debt in question admittedly represents a trade debt. It is a part of the debt representing cost of goods sold to the debtor company which had been taken into account in computing the income of the assessee of the preceding year when sales were made to the aforesaid company. Therefore, deduction in respect of this item will be solely governed by the provisions of Section 36(1)(vii) read with Section 36(2). The provisions contained in Section 36(1 )(vi7) and 36(2) lays down fulfilment of various conditions for grant of deduction in respect of bad debts. Therefore, we are of the view that the provisions of Section 36(1)(vii) and 36(2) covers the entire field regarding grant of deduction in respect of bad debts relating to such trade debts. The allowability or otherwise of this deduction, therefore, cannot be considered under Section 28 or under Section 37 on the general principles in arriving at the true profits and gains of business as the same is governed by the specific provisions contained in Sections 36(1)(vii) and 36(2). Reliance placed by the learned counsel for the assessee on the judgment of Hon'ble Gujarat High Court in the case of Equitorial (P.) Ltd. (supra) does not support the assessee's contention, as the facts of that case are clearly distinguishable. It is true that the Hon'ble Gujarat High Court in that case held that an irrecoverable debt can be allowed a trading loss under Section 28. However, while giving this finding the Hon'ble High Court had clearly observed that a claim for bad debt under Section 36(1)(vii) can be made only in respect of a trade debt which is due from customers for goods supplied or in respect of advances given in the normal course of money lending business of an assessee. In the case before the Hon'ble High Court the amount of advance given to the debtor concern did not represent an item of trade debt. It was, therefore, considered as not governed by the provisions of Section 36(1)(vii) read with Section 36(2) but was held to be a trading loss allowable under Section 28 as the loss in question was incidental to trading transactions.
8.3 The only question, therefore, remains to be considered is whether deduction can be allowed as bad debt under the provisions of Section 36(1)(vii) read with Section 36(2) under the facts and circumstances of the present case. A perusal of the said Sections clearly reveals that the following conditions will have to be fulfilled for grant of deduction in respect of bad debt under Section 36: (i) the debt or loan should be in respect of a business, which should be carried on by the assessee in the relevant year under consideration; (ii) 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; (iii) the amount of debt should have really become bad in the year under consideration; and (iv) the amount should have been written off as irrecoverable in the accounts of the assessee for the accounting year in which such a claim for deduction is made.
So far as condition Nos. (i) &(ii) are concerned it admittedly stands fulfilled in the case of the assessee, The controversy relates to the remaining two conditions.
8.4 The first controversial aspect is whether the debt in question can be said to have really become bad in the accounting year or not. The points which favour the revenue's contention are that the assessee had recovered a sum of more than Rs. 13 lakhs in the preceding year, he made further recovery of Rs. 30,000 in the year under consideration, he himself had added interest on the principal amount in this year and had shown the entire amount of outstanding balance along with interest accrued thereon as a debt at the time of filing of the original return and the events of winding up proceedings of the debtor company had taken place in the year 1985 pertaining to subsequent year. These facts, according to the revenue support the findings given by the CIT(A) that the debt in question did not become bad in the year under consideration and the assessee had every hope of its recovery. The subsequent writing off of the said debt as a trading loss is an attempt to nullify the addition of sales-tax made under Section 43B which cannot justify grant of deduction in the facts of the present case.
8.5 The points which support the assessee's contention are that the declaration of lock out of the factory of the debtor company occurred in the year under consideration, several cheques given by the said debtor were dishonoured in the preceding year, recovery of only Rs. 30,000 could be made in the year under consideration and the subsequent events of winding up of the company and the letter of the agent showing that nothing can be recovered from the said debtor are material evidence which establishes that the debt in question had really become bad in the year under consideration. The further fact that the assessee has not been able to recover from the said debtor till to date or from the official liquidator also proves beyond doubt that the debt in question had really become irrecoverable and bad in the year under consideration.
8.6 As regards fulfilment of the fourth condition the revenue's contention is that the amount was not written off as trading loss or as bad debt and no such entry was made in the books of account at the time of filing the original return. The subsequent supplementary adjustment entries made by the assessee at the time of filing the revised return is an after-thought and was made merely with a view to nullify the addition of outstanding unpaid sales-tax liability made under Section 43B and cannot be treated as bonafide entry of writing off of the debt in question.
8.7 The assessee's contention in this regard is that the supplementary adjustment entries made by him at the time of filing the revised return is valid. The requirement of law is that the amount should be written off in the books of account of the accounting year in question.
Subsequent to the furnishing of the original return, the assessee realised that the amount due from M/s Usha is irrecoverable and, therefore, decided to write off the same as a trading loss by making supplementary adjustment entries in the accounting year under consideration itself, which is perfectly valid as the reality of the bad debt in question is not in dispute.
8.8 The decision as to fulfilment of these two controversial aspects was indeed difficult. After a thoughtful consideration of the various facets of this controversy and after examining the principles of law as deduced in the various judgments referred to above, we are inclined to accept the assessee's contention that the said deduction is allowable as bad debt under Section 36(1)(vii) read with Section 36(2). The reality of the bad debt has not been disputed by the revenue. But what has been disputed is only the year of its becoming bad and irrecoverable. There is no doubt about the fact that the assessee has not recovered any amount out of the outstanding balance of Rs. 8,95,277 from M/s Usha. It is also apparent from the copies of accounts of the debtor company that in the previous year relating to assessment year 1983-84 the assessee had supplied goods to the said company aggregating to about Rs. 21 lakhs out of which Rs. 13,47,000 were recovered in the preceding year. During this year the assessee has not sold any material to this company. The very fact that the assessee stopped making credit sales to the aforesaid debtor company clearly proves that the financial position of the debtor company was extremely doubtful and weak at the beginning of the year itself. This is corroborated by the fact that several cheques given by the said debtor were dishonoured in the preceding year. The only transaction in this account in the year under consideration is a further recovery of Rs. 30,000 against the opening outstanding balance of more than Rs. 7 lakhs. It is also an admitted fact that the factory of the debtor company was closed and there was a lock out of that factory in the year under consideration. The Hon'ble Gujarat High Court in the case of Sarangpur Cotton Mfg. Co. Ltd. (supra) at page 176 observed that subsequent events clearly show that the assessee company was justified in concluding that the amount was not recoverable in the year in question. On the strength of this judgment we can validly take into consideration the subsequent events.
In the present case, the debtor company subsequently went into liquidation and the assessee till to date has not received any amount from the debtor company or from the official liquidator. In the accounting year under consideration the credit sales discontinued right from the beginning and no recoveries could be made beyond a meager sum of Rs. 30,000. All these facts, in our view, adequately establish the fact that the debt in question really became bad and irrecoverable in the accounting year itself. The mere fact that the assessee had in a routine manner made adjustment of accrued interest will not alter this basic fact that the debt in question had become bad in the accounting year itself in view of the various circumstances mentioned hereinbefore.
8.9 The other condition of writing off of the amount as bad debt in the accounting year can also be said to have been fulfilled after the assessee had written off the said debt by making supplementary adjustment entry by which the amount in question was debited as a trading loss with a corresponding credit in the account of the debtor company. It is true that the assessee realised the necessity of writing off of the said amount only after the IAC in the first directions under Section 144 A had directed the ITO to make addition of the outstanding amount of sales-tax liability in view of Section 43B. But whether such subsequent writing off of the entry as trade loss or bad debt is bonafide or not will again depend on the question whether the debt in issue had really become bad in the accounting year itself. We have already discussed the various aspects and evidence brought on records which, in our view, clearly establishes that the debt became bad in the accounting year itself. At the time of filing the original return the assessee perhaps did not give serious attention in respect of the said outstanding amount. However, when the question of addition of unpaid sales-tax arose in view of Section 43B, the assessee, or any one, would naturally examine the reasons as to why the sales-tax could not be paid. One such reason for non-payment of sales tax resulting in an addition under Section 43B could be non-realisation of sale proceeds from the trade debtors. The unpaid sales tax has been disallowed in view of Section 43B while the amount of irrecoverable sale proceeds from trade debtors was not written off. This mistake was realised by the assessee after the IAC gave directions under Section 144 A. At that point of time the assessee seriously applied his mind and came to the conclusion that the amount recoverable from the trade debtor had in fact become bad in that very year and the entry should have been written off which in fact was subsequently written off in the accounting year itself by passing the supplementary adjustment tries.
The law does not prescribe any time limit for writing off or making of such entries in the books of account pertaining to the accounting year under consideration. In case such entry for writing off the irrecoverable debt as a bad debt or as a trading loss is made in a bonafide manner and is made in respect of a debt which really became bad in the year of account, there is no justification in holding that the condition relating to writing off the amount as bad debt should not be considered to have been complied with merely because such an entry was not made at the time of filing the original return of income. This view is fortified by the judgment of Hon'ble Rajasthan High Court in the case CIT v. Mazdoor Kisan Sahkari Samiti [1970] 75 ITR 253 in which it was held that the assessee is entitled to grant of development rebate only if he creates a development rebate reserve in the books of account. It was held that such entries may be made at any time till the assessment proceedings are completed and it is not correct to state that they should have been made before the close of the accounting year. In view of aforesaid discussions, the fourth condition for grant of deduction as bad debt, in our view, also stands fulfilled.
8.10 While arriving at the aforesaid conclusions, we have carefully gone through the principles of law laid down by the Hon'ble Bombay High Court in the case of Jethabhai Hirji and Jethabhai Ramdas v. CIT [1979] 120 ITR 792 and by the Hon'ble Gujarat High Court in the case of Sarangpur Cotton Mfg. Co. Ltd. (supra) in which it has held that when a businessman bonafide writes off a debt, it is material circumstance in determining the year in which the debt should be allowed as a bad debt.
It was further held that a debt may be written off and allowed as a bad debt even if the assessee has not taken legal proceedings against the debtor or even if the legal proceedings taken are pending in the year for which the claim for bad debt is made, although subsequently end in a decree in favour of the assessee. Such judicial approach taken in the above referred two judgments have also received legislative acceptance by amendment of Section 36(1)(vii) by the Direct Taxes Laws (Amendment) Act, 1987 w.e.f. 1-4-1989 when the condition relating to establishing of a debt having become bad debt in the previous year has been omitted.
In the present case the allowability of the bad debt in question has not been disputed or doubted by the revenue but what was disputed is only the year of allowability. The said amendment was made only with a view to obviate such wasteful litigation arising merely on account of deciding the year of allowability in cases where the allowability of the deduction is not in dispute. Even if the provisions are capable of two views, the one which is favourable to the assessee should be adopted. In case the assessee recovers any amount on a future date, the same may be brought to tax in the year of realisation in view of Section 41(1) of the Act. This will adequately safeguard the interest of the revenue as and when the assessee recovers any amount out of such irrecoverable debt.
8.11 We, therefore, direct the ITO to allow deduction in respect of the said amount of bad debt.
9. The only other ground pressed before us relates to levy of interest under Sections 139(8) and217. It was the common contention of the learned representatives that this ground will have to be restored back to the CIT(A) as he has not given any finding in relation to this ground. This matter is, therefore, restored back to the learned CIT(A) with the direction to decide the same afresh after providing reasonable opportunity to both the parties.
10. As mentioned earlier, the various other legal grounds taken by the assessee were not pressed and they are, therefore, dismissed as not pressed.
11. In the result ITA No. 1157/Ahd/88 is dismissed as not pressed and ITA No. 1594/Ahd/90 is partly allowed.