1985 (7) TMI 2 - SC - Income Tax

Taxpayer entitled to deduction for irrecoverable debt write-off and related legal expenses under s.36(2)(i); successor can claim

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

The SC held the assessee was entitled to deduct the amount of a debt written off as irrecoverable and related legal expenses under s.36(2)(i) of the ... Allowability of bad debt and legal expenses as deductions - interpretation of Section 36 of the Income Tax Act, 1961 - HELD THAT:- In the present case, the debt was taken into account in the income of the assessee for the assessment year 1963-64 when the interest income accruing thereon was taxed in the hands of the assessee. The interest was taxed as income because it represented an accretion accruing during the earlier year on money owed to the assessee by the debtor. The item constituted income because it represented interest on a loan. The nature of the income indicated the transaction from which it emerged. The transaction was the debt and that debt was taken into account in computing the income of the assessee of the relevant previous year. It is the same assessee who has subsequently, pursuant to a settlement, accepted part payment of the debt in full satisfaction and has written off the balance of the debt as irrecoverable in his accounts. It appears, therefore, that the conditions in both sub-clauses (a) and (b) of cl. (i) of sub-s. (2) of s. 36 are satisfied in the present case and the High Court as well as the Appellate Tribunal and the AAC are right in the view which they took. It seems to us that even if the debt had been taken into account in computing the income of the predecessor firm only and had subsequently been written off as irrecoverable in the accounts of the assessee, the assessee would still have been entitled to a deduction of the amount written off as a bad debt. It is not imperative that the assessee referred to in sub-cl. (a) must necessarily mean the identical assessee referred to in sub-cl. (b). A successor to the pertinent interest of a previous assessee would be covered within the terms of sub-cl. (b). The successor assessee, in effect, steps into the shoes of his predecessor. Accordingly, we hold that the assessee in the instant case was entitled to the deduction as a bad debt written off by it in its accounts of the previous year as irrecoverable. Legal expenses in connection with an appeal filed in this court to recover an amount due from the Central Government, it is apparent that the transaction related to the predecessor firm and the suit instituted by it was continued by the assessee on taking over the assets and liabilities of the predecessor firm. The ITO, the AAC, the Appellate Tribunal and the High Court dealt with this claim on the same basis as the claim made in respect of the bad debt. In the result, the appeal is dismissed. Issues:1. Allowability of bad debt and legal expenses as deductions in the assessment of the assessee-firm for the assessment year 1965-66.Analysis:The case involved an appeal by special leave against the judgment of the High Court of Andhra Pradesh regarding the allowability of a bad debt of Rs. 15,100 and legal expenses of Rs. 6,880 as deductions in the assessment of the assessee-firm for the assessment year 1965-66. The assessee, a partnership firm, had taken over the business of an earlier firm, including a debt of Rs. 23,577 due from Laxmi Trading Company. A settlement was reached in which Rs. 25,000 was accepted in full settlement of the debt, and the balance of Rs. 15,100 was written off as irrecoverable. The Income Tax Officer disallowed the bad debt claim initially, but the Appellate Assistant Commissioner allowed it, noting the continuity of business and the payment of income tax on interest in a previous year. The Income-tax Appellate Tribunal upheld the claim, emphasizing that the successor of a business is entitled to write off bad debts taken over. The High Court also ruled in favor of the assessee, leading to the appeal to the Supreme Court.The main legal issue revolved around the interpretation of Section 36 of the Income Tax Act, 1961, specifically clauses (vii) and (2) which govern the allowance of bad debts as deductions. The Court analyzed the provisions and concluded that if a business, along with its assets and liabilities, is transferred to a successor, the successor is entitled to the same treatment regarding bad debts as the transferor. The Court held that the conditions for claiming a bad debt deduction were satisfied in this case, as the debt was taken into account in a previous year and subsequently written off as irrecoverable. The Court emphasized that the successor of a previous assessee is covered within the terms of the statute and is entitled to the deduction.Regarding the legal expenses claim, the Court found that the same reasoning applied as for the bad debt deduction. The transaction related to the predecessor firm, and the suit was continued by the assessee upon taking over the assets and liabilities. Therefore, the Court held that the claim for legal expenses should also be acknowledged based on the same grounds as the bad debt deduction. Ultimately, the appeal was dismissed, affirming the allowability of both the bad debt and legal expenses deductions for the assessee-firm for the assessment year 1965-66.The judgment provided a detailed analysis of the statutory provisions, the factual background of the case, and the reasoning behind allowing the deductions claimed by the assessee. It clarified the rights of successors in business transfers and the conditions for claiming bad debt deductions under the Income Tax Act, 1961.