1996 (3) TMI 128 - SC - Income Tax

Banking company's 'bad and doubtful debts' qualify as reserves under tax law, Supreme Court rules

The Supreme Court held that amounts set apart by a banking company for 'bad and doubtful debts' qualified as 'reserves' under the Companies (Profits) ... Whether the amounts set apart by the assessee during each assessment year for 'bad and doubtful debts' in the balance-sheets of the relevant period constitute 'reserve' as contemplated by rule 1(xi)(b) of the First Schedule and rule 1(iii) of the Second Schedule to to the Companies (Profits) Surtax Act, 1964? Held that:- The High Court was in error in surmising that the assessee being a banking company is bound to have bad and doubtful debts. It need not necessarily be so. It is not bound to anticipate on the date of the preparation of the balance-sheet that all or any of its debts 'are bound to be bad and doubtful'. It all depends upon the facts and circumstances. We are of the view that the High Court misunderstood the scope of the observations in Saran Engineering Co.'s case [1986 (7) TMI 88 - SUPREME Court] and surmised that the observations quoted at page 748 will even cover cases, where the liability was not factually anticipated on the date of the preparation of the balance-sheet, but also will apply to cases, where the company 'ought and can' anticipate on the date of the preparation of the balance-sheet. Decided in favour of the assessee Issues Involved:1. Whether the amounts set apart by the assessee for 'bad and doubtful debts' qualify as 'reserves' under rule 1(xi)(b) of the First Schedule and rule 1(iii) of the Second Schedule of the Companies (Profits) Surtax Act, 1964.2. Whether the sums set apart for bad and doubtful debts should be included in the capital of the assessee for surtax relief.Detailed Analysis:1. Qualification of Amounts as 'Reserves':The appellant-assessee, a banking company, set apart amounts as 'reserve' for 'bad and doubtful debts' for the assessment years 1971-72, 1972-73, 1973-74, and 1975-76. The Income-tax Officer rejected the claim that these amounts qualified as reserves. However, the Income-tax Appellate Tribunal allowed the plea, holding that the amounts set apart as reserves were entitled to appropriate relief under rule 1(xi)(b) of the First Schedule and rule 1(iii) of the Second Schedule of the Act.The High Court, however, reversed the Tribunal's decision, stating that such sums were 'provisions' and not 'reserves,' thus not entitled to the relief granted by the Appellate Tribunal. The High Court's judgment was based on the interpretation that sums set apart to meet anticipated liabilities, such as bad and doubtful debts, are provisions and not reserves.The Supreme Court, however, disagreed with the High Court's interpretation. It emphasized that the amounts set apart by the assessee were not written off or adjusted against bad debts, and no claim for deduction was made for bad debts during the relevant years. The funds remained employed in the business as capital and were treated as reserves by the assessee. Therefore, the Supreme Court concluded that these amounts were 'reserves' and not 'provisions,' qualifying for relief under the relevant rules of the Act.2. Inclusion in Capital for Surtax Relief:The Supreme Court analyzed whether the sums set apart for bad and doubtful debts should be included in the capital of the assessee for surtax relief. According to the Companies (Profits) Surtax Act, 1964, statutory deduction is defined as an amount equal to ten percent of the capital of the company as computed in accordance with the Second Schedule.The Tribunal had found that the amounts were not designed to meet any known liability, contingency, commitment, or diminution in the value of assets. Instead, they were treated as reserves, remaining employed in the business as capital. The Supreme Court upheld this finding, stating that the amounts set apart towards bad and doubtful debts were 'reserves' qualifying for appropriate relief under rule 1(xi)(b) of the First Schedule and rule 1(iii) of the Second Schedule of the Act.The Supreme Court criticized the High Court's assumption that a banking company is bound to have bad and doubtful debts, which it must anticipate and make provisions for. The Supreme Court clarified that the liability must be known or anticipated on the date the balance-sheet was prepared, not merely assumed.Conclusion:The Supreme Court set aside the High Court's judgment and restored the order passed by the Appellate Tribunal. It answered the questions referred to the High Court in the affirmative, in favor of the assessee and against the Revenue. The decision applied to all assessment years involved, including 1979-80 to 1987-88, thus granting the assessee the appropriate relief for all relevant years. The appeals were allowed, with no order as to costs.