Deduction of Bad Debts and Legal Expenses Upheld for Assessee-Firm

Commissioner Of Income-Tax, AP Versus T. Veerabhadra Rao, K. Koteswara Rao And Co.

Commissioner Of Income-Tax, AP Versus T. Veerabhadra Rao, K. Koteswara Rao And Co. - [1976] 102 ITR 604 Issues Involved:
1. Deduction of bad debts amounting to Rs. 15,100.
2. Deduction of legal expenses amounting to Rs. 6,880.

Detailed Analysis:

1. Deduction of Bad Debts Amounting to Rs. 15,100:

The assessee-firm claimed a deduction of Rs. 15,100 as bad debts, which were initially owed by Lakshmi Trading Company to the predecessor-firm. The Income-tax Officer disallowed the claim, arguing that the debt was originally due to the predecessor-firm and that there was no justification for the assessee-firm to take over the loan or prove the debtor's inability to pay.

The Appellate Assistant Commissioner allowed the claim, noting that the business taken over by the assessee-firm continued uninterrupted and that the change of ownership did not bar the allowance of bad debts. It was also found that the assessee-firm had paid income-tax on the interest of Rs. 11,349, thus proving the assessee's bona fides.

The Tribunal upheld this decision, stating that when a business is succeeded as a whole and as a running concern, the assets and liabilities taken over become those of the successor. The assessee-firm was therefore entitled to write off the bad debts. The Tribunal noted that the interest accrued on the debt was assessed in the hands of the assessee-firm, satisfying the conditions of section 36(2)(i).

The High Court examined section 36(2)(i) and found no indication that both requirements (clauses (a) and (b)) must be satisfied by the same assessee. The court emphasized that the relief of deduction is related to business transactions and not to personal qualifications of an assessee. The court rejected the argument that the word 'the' in clause (b) refers back to the assessee in clause (a), stating that the legislature did not explicitly require the two assessees to be the same.

The court cited precedents under the 1922 Act, which allowed successors to write off bad debts. The court concluded that the 1961 Act did not change this position, allowing the successor-firm to write off bad debts and claim deductions.

2. Deduction of Legal Expenses Amounting to Rs. 6,880:

The assessee-firm also claimed a deduction for legal expenses incurred in connection with an appeal filed in the Supreme Court to recover amounts from the Central Government. The Income-tax Officer disallowed this claim for the same reasons as the bad debt claim.

The Appellate Assistant Commissioner allowed the claim, citing the same reasons for allowing the bad debt claim.

The Tribunal upheld this decision, noting that the legal expenses were related to the business taken over by the assessee-firm, which continued uninterrupted.

The High Court, in its analysis, found that section 36(2)(i) does not prohibit the successor-firm from writing off bad debts or claiming deductions for legal expenses related to the predecessor-firm's business. The court concluded that the 1961 Act did not change the position of the law under the 1922 Act, allowing the successor-firm to claim deductions for legal expenses.

Conclusion:

The High Court answered the question in the affirmative, allowing both the bad debt of Rs. 15,100 and the legal expenses of Rs. 6,880 as allowable deductions in the assessment of the assessee-firm for the assessment year 1965-66. The court ruled against the department and awarded costs to the assessee, with an advocate's fee of Rs. 250.