COMMISSIONER OF INCOME-TAX VS COATES OF INDIA LTD, 2000 PTD-CALCUTTA-HIGH-COURT-INDIA 598 (1998)

Income-tax---

----Bad debt--Deduction---Conditions precedent for claiming deduction-- Assessee must arrive at honest judgment that on facts and circumstances debt not realisable for some fault or supervening impossibility on part of debtor to pay but not possible difficulties or hurdles assessee may have to incur to compel recalcitrant debtor to pay---Judgment of assessment should reveal irrecoverability of debt from angle of debtor and not on ability of assessee to recover same---Amounts due to assessee from S & A---Amount payable by A to assessee not small---No legal action taken by assessee against A---I.T.O. disallowing claim for deduction of bad debt ---C.I.T. (Appeals) and Tribunal deleting disallowance of bad bebt---C.I.T. (Appeals) and Tribunal taking into consideration feasibility of recovery of debt from angle of assessee and not of debtor---Tribunal not justified in deleting disallowance of bad debt---Indian Income Tax Act, 1961; S. 36(1)(vii).

In order to claim deduction under section 36(l)(vii) of the Income Tax Act, 1961, as it stood at the relevant time, the assessee is required to show that, on the facts and circumstances pertaining to a particular debt, he has taken an honest judgment that the said debt has become a bad debt. If the judgment is an honest judgment and not a convenient judgment, then the Department would be able to insist on demonstrative or infallible proof.

The judgment of the assessee must be established to have been taken on relevant facts and circumstances, which should show that the debt is not realisable for some fault on the part of the debtor or some supervening impossibility on the part of the debtor to pay, but not the possible difficulties or hurdles the assessee may have to incur to compel the recalcitrant debtor to pay. The assessee for his convenience may decide that the debt is too small and it is not worthwhile to pursue the debtor but that judgment will not be an honest judgment which would establish that the debt has become a bad debt.

During the previous year relevant to the assessment year 1986-87, the assessee wrote off a sutra of Rs.12,439 and a sum of Rs.1,23,277 payable by S and A, respectively, treating the same to be bad debts on the grounds that in spite of the best efforts of the assessee, the payments were not forthcoming and that due to the smallness of the amounts it was not considered worthwhile to take legal action to recover the debts. The Income tax Officer found that S had informed the assessee that it was ready and would start sending the payments from the month of April, 1985, that A had confirmed the balance due and payable by it to the assessee and had also made certain payments, that the amount payable by A to the assessee could not be said to be a small amount and since no legal action had been taken by the assessee against A, the claim of the assessee that the debts could not be recovered from S and A could not be accepted and, therefore, he disallowed the claim for deduction. The Commissioner of Income-tax (Appeals) allowed the claim of the assessee for deduction of the bad debts. On further appeal, the Tribunal affirmed the order of the Commissioner of Income-tax (Appeals). On a reference:

Held, that what had been taken into consideration by the Commissioner of Income-tax (Appeals) and the Tribunal was the ability or feasibility of the recovery of the debt from the angle of the assessee and not of the debtor and in those circumstances both of, them erred in law. Therefore, the Tribunal was not justified in law in deleting the disallowance of the bad debts.

Bank of Bihar Ltd. v. CIT (1962) 45 ITR 427 (SC); CIT v. Dunlop India Ltd. (1994) 209 ITR 987 (Cal); Devi Films Ltd. v. CIT (1963) 49 ITR 874 (Mad.); Jethabhai Hirji and Jethabhai Ramdas v. CIT (1979) 120 ITR 792 (Bom.) and Kamla Cotton Co. v. CIT (1997) 226 ITR 605 (Guj.) ref.

JUDGMENT

BARIN GHOSH, J.---The following question as framed under section 256(2) of the Income Tax Act, 1961, is the subject-matter of this reference:

"Whether, on the facts and .in the circumstances of the case, the Tribunal was justified in law in deleting the disallowance of the bad debts for the assessment year 1986-87 in respect of two debts, amounting to Rs.12,439 and Rs.1,23,277?"

The assessment year involved is 1986-87. The concerned previous year ended on October 30, 1985.

During the concerned previous year, the assessee wrote off, amongst others, a sum of Rs.12,439 and a sum of Rs.1,23,277, payable by Sarada Press, Bhagalpur, and Amit Agencies, Allahabad, respectively, treating the same to be bad debts and claimed deduction under section 36(1)(vii) of the Income Tax Act, 1961.

The assessee had filed a statement alongwith the return where it was contended that in spite of the best efforts made by the assessee, the aforementioned payments were not forthcoming. As appears from the assessment order, the assessee was requested to prove that the said sums had become bad debt during the relevant previous year. The assessee, therefore, produced certain correspondence made with the aforementioned debtors. During the course of hearing before the Assessing Officer, the assessee submitted that due to the smallness of the amounts, it was not considered worthwhile to take legal action to recover the subject debts.

The Assessing Officer found that the amount due and payable by Sarada Press, Bhagalpur, pertained to the period 1983-84. By a letter, dated April 1, 1985, addressed to the assessee, Sarada Press, Bhagalpur, contended that they would start sending the payments month by month from the month of April, 1985. The fact remained, however, that no payment was made by Sarada Press, Bhagalpur, to the assessee until the end of the previous year, that is to say, until October 30, 1985.

In so far as Amit Agencies, Allahabad, is concerned, the Assessing Officer found that it had confirmed the balance due and payable by it to the assessee by a letter, dated December 31, 1983, and subsequent thereto made certain payments. The Assessing Officer also noted that the assessee has discontinued business with the Amit Agencies, Allahabad and the said debtor had in writing regretted dishonor of some of its post, dated cheques. The Assessing Officer also took note of the extract of the minutes of the meeting held between the officers of the assessee and of Amit Agencies, Allahabad.

The Assessing Officer concluded that from the proposal of Sarada Press, Bhagalpur, contained in its letter, dated April 1, 1985, it appears that Sarada Press; Bhagalpur, is ready to make payments and, therefore, it is difficult to accept the contention of the assessee that the amount payable by the Sarada Press, Bhagalpur, has become bad during the relevant previous car.

In so far as Amit Agencies, Allahabad, is concerned; the Assessing Officer was of the view that the amount payable by it to the assessee cannot be said to be a small amount and since no legal action has been taken by the assessee that the amount due and payable to it by Amit Agencies, Allahabad, has become bad debt, cannot be accepted.

Before the Commissioner of Income-tax (Appeals), the assessee contended that considering the comparative smallness of the amount and the costs which would have to be incurred, the appellant did trot take recourse to legal action for recovery. It was also contended that the Department cannot insist on demonstrative proof that a debt has become bad which must satisfy the test of infallibility. It was also suggested by the assessee that it was required to make an honest judgment and on the facts as found by the Assessing Officer, it cannot be said that its judgment was not hottest. The Commissioner of Income-tax (Appeals) accepting those submissions of the assessee, accepted that the amount payable by Sarada Press, Bhagalpur, was a bad debt during the relevant previous year.

In so far as Amit Agencies. Allahabad, is concerned it was urged by the assessee before the Commissioner of Income-tax (Appeals) that it was fed up with false promises made from time to time by Amit Agencies, Allahabad, and that numerous cheques issued by the said debtor from time to time were dishonored. The Commissioner of Income-tax (Appeals) considered a letter of Amit Agencies, Ailahabad, dated June 22, 1982, the minutes of the meeting between the officers of the assessee and Amit Agencies, Allahabad, held on July 6, 1983, and letters of the assessee dated

July 24, 1984, and September 22, 1984, whereupon he held that the assessee made an honest judgment in writing off the amount due to it by Amit Agencies, Allahabad, as irrecoverable.

The Tribunal dealt with the matter in the manner as follows:

"After hearing both the parties and perusing the material on. Record we are of the opinion that the Commissioner of Income-tax, (Appeals) was justified in directing the deletion of the bad debts. In doing so, the Commissioner of Income-tax (Appeals) has relied upon the judgment of the Bombay High Court in 'the case of Jethabhai Hirji and Jethabhai Ramdas v. CIT (1979) 120 ITR 792. We agree with the reasoning and conclusion of the Commissioner of Income-tax (Appeals) in deleting the disallowance of the bad debts in respect of two parties, Sarada Press and Amit Agencies, aggregating to Rs.1,35,666. His order is, therefore, upheld in this regard."

Section 36(1)(vii) of the Income Tax Act, 1961, as it stood at the relevant time, is as follows:

"(vii) Subject to the provisions of subsection (2), the amount of any debt, or part thereof, which is established to have become a bad debt in the previous year. "

The word "bad." used in conjunction with the word "debt" means worthless. Therefore, a "bad debt" is a "worthless debt".

In order to take advantage of section 36(1)(vii) of the Income Tax Act, 1961, the assessee is required to establish that a debt due to it has become a worthless debt.

In order to establish the same, as held in Jethabhai Hirji and Jethabhai Ramdas v. CIT (1979) 120 ITR 792 (Bom.), it is not necessary for the assessee to show that he has failed to recover the debt despite taking legal action. What he is required to show, as held in CIT v. Dunlop India Ltd. (1994) 209 ITR 987 (Cal), that having regard to the facts and circumstances of the case a bona fide assessment has been made by the assessee to the effect that the realization of the debt is not possible.

The assessee cannot say, as held in Devi Films Ltd. v. CIT (1963) 49 ITR 874 (Mad), that he become pessimistic about the prospect of recovery of the debt in question. At the same time, the Department, as held in Kamla Cotton Co. v. CIT (1997) 226 ITR 605 (Guj), cannot insist upon demonstrative and infallible proof that the debt become bad.

In the case of Jethabhai Hirji and Jethabhai Ramdas (1979) 120 ITR 792 (Bom.), the assessee wrote off the debt and then filed a suit. for recovering it and ultimately obtained a decree on admission. The Court noted that there were materials on record to show that at the time when the loss was crystallized, the financial position of the debtor was weak and the same was becoming weaker. That aspect of the matter was ignored by the Tribunal and, therefore, there was nothing to show that the decision taken by the assessee to write off the debt was a dishonest decision.

In the case of CIT v. Dunlop India Ltd. (1994) 209 ITR 987 (Cal), the assessee had exported goods to Turkey. The importer of the goods deposited the price of the goods with the Central Bank of that country, but by reason of the decision taken by the Government of that country, that money was not remitted. Ultimately, the currency of that country was devalued, with the result the same came down to 30.6 percent. During the relevant previous year, the assessee received a letter from' the Indian Embassy situate in that country, saying there was no chance of realising the Turkish debts in the foreseeable future due to acute foreign exchange shortage. The Assessing Officer refused to accept the said debt to be a bad debt on the ground that there is a chance for recovery of the debt inasmuch as the Government of Turkey has subsequently declared that the debt due to foreigners would be paid after 54 months in small installments over a period of 10 years. The Court pointed out that as on the date of taking the decision to write off, it cannot be said that the said decision was not an honest decision and that later happenings would not be relevant.

In Devi Films Ltd. v. CIT (1963) 49 ITR 874 (Mad), the Court found that the debtor is still active in the pursuit of his business, profession or vocation; the debtor owned immovable properties both in Madras and Ootacamund; he is holding shares in a film producing concern. To the outside world, the debtor was found certainly not a person without credit verging on insolvency. His indebtedness to others under decrees of Court, it was observed, is only one side of the picture. The Court, therefore, concluded, that it is impossible to assume that the assessee in the circumstances could have reasonable thought that the sum became a bad debt at the relevant time.

In Kamla Cotton Co. v. CIT (1997) 226 ITR 605(Guj), the cheques issued by the debtor to the assessee were dishonoured and the debtor -company had closed' down its business due to financial difficulties and thereupon its management was taken over under the Industries (Development and Regulation) Act. The debtor-company was also declared a relief undertaking under the Bombay Relief Undertakings (Special Provisions) Act. It was shown that the liability of the debtor-company far exceeded it assets and the chance of the assessee to recover the amount due-was bleak. The Court held in those circumstances that it cannot be said that there was any dishonesty on the part of assessee to treat the debt due by the said debtor company as a bad debt.

Therefore, in order to claim deduction under section 36(1)(vii) of the Income Tax Act, 1961, as it stood at the relevant time, the assessee was required to show that on the facts and circumstances pertaining to a particular debt, he has taken an honest judgment that the said debt has become a bad debt and if he could show that he has taken an honest judgment, the same would establish that the debt in question is a bad debt. The relevant considerations; therefore, would be honesty of the judgment, on the facts and circumstances pertaining to the concerned debt. If, on the facts and circumstances it could be established that the judgment was an honest judgment and not a convenient judgment, then the Department would not be able to insist on demonstrative or infallible proof.

The judgment must be established to have been taken on relevant facts and circumstances, which facts and circumstances should show that the debt is not realisable for some fault on the part of the debtor or some supervening impossibility on the part of the debtor to pay, but not the possible difficulties or hurdles the assessee may have to incur to compel the recalcitrant debtor to pay. The assessee for his convenience may decide that the debt is too small and it is not worthwhile to pursue the debtor but that judgment will not be an honest judgment which would establish that the debt has become a bad debt or a worthless debt.

The facts on which the judgment has to be taken by the assessee should reveal the irrecoverability of the debt from the angle of the debtor and not of the ability of the assessee to recover the same.

In the present case what was taken into consideration by the Commissioner of Income-tax (Appeals) as well as by the Tribunal, was the ability or feasibility of recovery of the debt from, the angle of the assessee and not of the debtor. In those circumstance both of them erred in law.

We, therefore, answer the question in the negative and in favour of the Department.

There is, however, a residuary matter. Learned counsel appearing on behalf of the assessee relying on the judgment of the Supreme Court in the case of Bank of Bihar Ltd. v. CIT (1962) 45 ITR 427, contended that whether a debt is a bad debt or not, is a question of fact and the Tribunal having founded its conclusion on facts, it is not open to the High Court in a reference to reopen, the fact for the purpose of re-appreciating the evidence. In the case of Bank of Bihar Ltd. v. CIT (1962) 45 ITR 427, the Supreme Court made the following observation (page 429):

"The question whether a debt is a bad debt is one of fact, and if there is some evidence to justify the conclusion it is not open to the High Court in a reference under section 66 of the Indian Income-tax Act, to re-appreciate the evidence."

The Supreme Court, therefore, said that if there is some evidence to justify the conclusion that a debt is a bad debt then the High Court in a reference cannot re-appreciate the evidence.

The evidence in the instant case does not justify the conclusion. In that view of the matter, there is no substance in the submissions of learned counsel appearing on behalf of the assessee.

SHYAMAL KUMAR SEN, J.--While agreeingwith the finding of my learned brother, I would like to make the following observation.

The question for consideration really is when a debt becomes bad or irrecoverable. It is. not always necessary to institute recovery proceedings by way of suit or other procedure. What is required is to find out if there was any chance of recovery of the dues from the debtor. For example, when the liability of the debtor far exceeds its assets and the assessee's chance of recovery of the amount appears to be bleak, that alone is sufficient to justify the action of the assessee in writing off the debt as a bad debt.

In the instant case, there is nothing on record to show that there is no chance of recovery or that liability of the debtor exceeds its assets. There being no such as aforesaid evidence before the Tribunal, the Tribunal was not justified in deleting the disallowance and confirming the order of the Commissioner of Income-tax (Appeals) to that effect.

It is quite true that it is not compulsory for the assessee to take legal proceedings against the debtor for recovery of the claim before writing it off as a bad debt and accordingly when a creditor bona fide writes off the debt because it appears that there is no chance of its recovery in the foreseeable future or where the recovery proceedings would be so cumbersome and expensive as to outweigh any advantage of instituting any recovery proceedings, the assessee discharges the onus and would be entitled to claim deduction of the bad debt under clause (vii) of section 36(1) of the Income Tax Act, 1961.

It is a necessary requirement under the statute that the debt has become a bad debt and irrecoverable. Whether a debt becomes a bad debt is an objective fact to be determined objectively. In the instant case, there was no evidence before the Tribunal to hold that the debt had become bad or the same had been established to be irrecoverable. Merely because the amount payable by the debtor is small or the debtor has acknowledged its liability to make payment but fails to keep up its promises, does not mean that the debt has become bad or irrecoverable for the purpose of allowance of deduction under the Income-tax Act.

In the case of Jethabhai Hirji and Jethabhai Ramdas v. CIT (1979) 120 ITR 792 (Bom.) it was held, inter alia, that the Tribunal misdirected itself in ignoring from consideration the very relevant statement of 'the managing director of the. debtor-company (New Era) which indicated that even at the time when the loss was crystallised, the position of the debtor was weak and becoming weaker. When the Income-tax Officer recorded the statement of the managing director, not in the presence of the assessee and failed to examine and elicit a clear answer from the debtor about the financial position of the debtor in the year 1957 or early 1958, it would not lie in the mouth of the Revenue to complain that the assessee had not discharged the onus of showing that the debt was bad and irrecoverable in the year of account, especially when the opportunity was available to the Income-tax Department and was not availed of by it when all these were done behind the back of the assessee. The failure of the Tribunal to consider the inferences flowing from this statement bf the debtor was reprehensible. It was a very material circumstance to be considered and ignorance thereof must be regarded as an error of the nature which would vitiate the conclusion and which would permit the Court to substitute a proper conclusion for the conclusion somewhat cavalierly arrived at by the Tribunal.

The said decision, however, cannot assist the assessee in any manner.

In this context, the Bombay High Court held that the Department cannot insist on demonstrative proof of the fact which must satisfy the test of infallibility. All that is required is an honest judgment on the part of the assessee at the time when he makes the write off.

There is no material, however, in the instant case to arrive at the conclusion that the debt has become irrecoverable or bad and as such the writing off of the debt for the purpose of claiming deduction cannot be said to be an honest judgment on the part of the assessee.

For the purpose of ascertaining if a debt has become bad and doubtful, and if so when, the categories of acts and diverse circumstances bearing on the debtor s pecuniary position, his commitments and obligations and the natural apprehensions that would be caused in the minds of the creditors regarding recoverability of the dues, should be considered. In this connection, the judgment and decision in the case of Devi Films Ltd. v. CIT (1963) 49 ITR 874 (Mad) may also be taken note of. In the aforesaid decision, Devi Films Ltd., the assessee was carrying on business as financier of production of motion pictures and as dealer in cinematographic machines and spare parts. The assessee entered into an agreement on July, 1955, with a certain Dinshaw K. Tehrani who had ventured upon the production of a cinema film called "Raja Rani". Under this agreement, the assessee agreed to lend Tehrani a sum of Rs.3,80,000. The money was lent as per the terms of the agreement, but Tehrani could not complete the production due to lack of funds. The assessee entered into a further agreement with Tehrani on January 31, 1956, and agreed to provide him with further funds to the extent of Rs.1,50,000. In all, the assessee advanced to Tehrani the sum of Rs.5,57,022-10-1 in pursuance of the two agreements aforesaid. The picture, after release, proved to be a flop and the expectations of the assessee to make profit out of the financing agreements failed. The assessee was, however, able to realise by collections from exhibitions and by sale of distribution rights, in all a sum of Rs.4,91,001-12-3. There remained a balance of Rs.65,950-13-10 due and payable by Tehrani to the assessee. It ,appears that this Tehrani was not a person of large means. He had a house in the city of Madras, purchased in the name of his wife. He held 100 shares is Newton Studios Ltd. of the face value of Rs.10,000. Notwithstanding the indebtedness of Tehrani to the assessee, it entered into an arrangement with Tehrani on April 1, 1957, by which Tehrani pledged his shares in Newton Studios as security for a sum of Rs.10,000 on condition of the assessee waiving the balance of Rs.55,950-13-10. As stated already, Tehrani's liability to the assessee on that date was Rs.65,950-19-10. In the year of assessment 1957-58, in respect of the previous year ended April 12, 1957, the assessee wrote off this sum of Rs.55,950-13-10 as bad and doubtful debts and claimed it as a proper deduction under section 10(2)(xi) of the Indian Income-tax Act in computing its income. The Income-tax Officer rejected the assessee's claim holding that the assessee had not taken any legal proceedings for the recovery of the amount, that it had not exhausted his remedies for the recovery of the debt and that it was premature to write off the debt as a bad debt. The assessee, nevertheless, reiterated its claim for deduction of this amount as a bad debt for the subsequent assessment year 1958-59. Again the Officer rejected its claim.

The claim of the assessee was rejected up to the stage of the Tribunal. Thereafter, the matter came up on reference to the Madras High Court. The Division Bench of the Madras High Court held (head note) that the expression "bad and doubtful debt" is descriptive of a debt, which cannot reasonably be expected to be realised. It is not sufficient for the assessee to say that he became pessimistic about the prospects of recovery of the debt in question. He must feel honestly convinced that the financial position of the debtor was so precarious and shaky, that it would be impossible to collect any money from him.

As already observed there is no material on record, in the instant case, on the basis of which it can be held that the debt is "a bad and doubtful debt" and as such the act of the assessee in writing off the said debt cannot be said to be an exercise of honest judgment.

With the observation as above, I agree with the finding of my learned brother.

M.B.A./3231/FCOrder accordingly