1958 (3) TMI 100 - HC - Income Tax

Ruling on Bad Debts: Importance of Accurate Bookkeeping for Tax Deductions

Associated Banking Corporation of India Ltd. Versus Commissioner of Income Tax, Bombay City I

The court ruled that bad debts must be written off in the books for deduction under section 10(2)(xi) of the Indian Income Tax Act. It emphasized the ... - Issues Involved:1. Entitlement to claim bad debts not written off in the books of the assessee.2. Entitlement to claim defalcation amounts as business expenses or losses.Detailed Analysis:1. Entitlement to Claim Bad Debts Not Written Off in the Books of the Assessee:The primary issue revolves around whether the assessee, a bank in liquidation, can claim bad debts as deductions under section 10(2)(xi) of the Indian Income Tax Act, despite not having written them off in the books. The liquidator claimed bad debts amounting to Rs. 38,35,689. The Tribunal denied these deductions, stating that the debts were not written off in the bank's books.The court examined section 10(2)(xi) which stipulates that bad debts must be written off in the books to be deductible. The section reads, '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.' The court emphasized that the legislative intent was to ensure that the assessee's accounts reflect true profits or losses, which necessitates writing off bad debts in the books.The court rejected Mr. Kolah's argument that the absence of a book entry should not prevent the claim if the debts are proven irrecoverable. The court maintained that the requirement to write off bad debts in the books is a condition precedent for claiming them as deductions. This view aligns with previous decisions, such as in Commissioner of Income Tax and Excess Profits Tax v. Jwala Prasad Tiwari and Karamsey Govindji v. Commissioner of Income Tax, where it was established that debts must be written off to be deductible.The court also addressed the Calcutta High Court's decision in Begg Dunlop and Co. Ltd v. Commissioner of Excess Profits Tax, which suggested that writing off debts is not imperative. However, the court adhered to its settled practice and previous decisions, emphasizing uniformity in interpreting all-India statutes.The court concluded that if the assessee seeks to challenge this interpretation, the Tribunal must find whether the debts were irrecoverable in the year of account. The Tribunal's current findings were unclear, necessitating a supplementary statement to determine if the debts became irrecoverable in the relevant year.2. Entitlement to Claim Defalcation Amounts as Business Expenses or Losses:The second issue concerns whether the assessee can claim amounts of Rs. 10,15,000 and Rs. 98,892, representing defalcations by the bank's secretary, as business expenses or losses. The Tribunal applied the test from Curtis v. J. & G. Oldfield Ltd., which distinguishes between defalcations occurring before and after money reaches the till. The court, however, preferred the test from Lord's Dairy Farm Ltd. v. Commissioner of Income Tax, which considers whether the loss sprang directly from the necessity of delegating duties to an employee.The court directed the Tribunal to reassess the facts using the Lord's Dairy Farm test, not the Curtis test. Additionally, the Tribunal erred in suggesting that defalcations are deductible in the year they are discovered. The correct approach, as stated in Lord's Dairy Farm, is that the loss is deductible in the year it becomes irrecoverable, not necessarily when discovered.The court reframed the question to determine whether the defalcation amounts could be claimed as business losses under section 10(2)(xv) or as trading losses. The Tribunal must also clarify the secretary's powers and whether the losses occurred in the year of account.The court amended question No. 1 to reflect the correct amount of Rs. 38,35,689, excluding the defalcation amounts.The court will answer the questions after receiving the supplementary statement from the Tribunal, which should include findings on the irrecoverability of debts and the circumstances of the defalcations.Conclusion:The judgment addresses two critical issues: the necessity of writing off bad debts in the books to claim them as deductions and the conditions under which defalcation amounts can be claimed as business losses. The court emphasized adherence to legislative intent and previous decisions, directing the Tribunal to provide further findings to resolve these issues comprehensively.