Commissioner of Income Tax vs S.M. Syed Mohammed Saheb and Bros.

K. Sreedharan, J.—The question referred to us is ; "Whether, on the facts and in the circumstances of the case and also in view of the fact that the debts have not been taken into account in computing the income of the assessee at any time, the bad debt of Rs. 65,026 was an allowable deduction in the assessment of the assessee-firm u/s 36(5) of the Income Tax Act, 1961 ?" The assessment year to which this question relates is 1975-76.

A firm by name Messrs. S.M. Syed Mohammed Saheb and Brothers, was carrying on the business of purchase and sale of cloth at Calicut. It had branches at Cannanore and Mangalore. On account of differences of opinion between the partners, the firm was dissolved on January 17, 1973. Business carried on at Calicut was allotted to S. M. Syed Abdulkhader and his five daughters. They constituted a firm and it is the assessee with which we are concerned in these proceedings.

During the previous year ending March 31, 1975, it wrote off Rs. 6,743 in the profit and loss account and Rs. 58,283 in the "general reserve" as bad debts. The assessee-firm a filed return for the assessment year 1975-76 claiming a net loss of Rs. 27,970. In doing so, it claimed deduction of the aforementioned amounts of Rs. 6,743 and Rs. 58,283 u/s 36(2)(i)(b) of the Income Tax Act, 1961. The Income Tax Officer rejected the claim. The assessee took up the matter before the Appellate Assistant Commissioner without success. On second appeal before the Tribunal, the assessee contended that the fact that the debts were due to the predecessor firm would not debar the assessee from deduction in respect thereof on the ground of their having become bad and irrecoverable since the assessee had taken over the business from the predecessor firm. The Department disputed this contention. But the Tribunal decided in favour of the assessee. Hence, the question for our consideration.

It is the common case that the outstandings, namely, Rs. 6,743 and Rs. 58,283, aggregating to Rs. 65,026, had become bad during the relevant previous year. It is also not disputed that the said amount had been written off as irrecoverable in the books of account of the assessee in the relevant previous year.

Section 36(2)(i)(b) in so far as it is relevant for the purpose of this proceeding is as follows :

"36. (2) In making any deduction for a bad debt or part thereof, the following provisions shall apply :--

(i) no such deduction shall be allowed unless such debt or part thereof-

(a) has been taken into account in computing the income of the assessee of that previous year, or of an earlier previous year, or ....

(b) has been written off as irrecoverable in the accounts of the assessee for that previous year. "

In the instant case, since it is not disputed that the outstandings aggregating to Rs. 65,026 have been written off as irrecoverable in the books of account of the assessee in the relevant previous year, the requirement of Sub-clause (b) of Section 36(2)(i) has been satisfied. The question to be considered is whether an assessee who succeeds to the business carried on by another person could claim deduction of a business debt which come into existence in the course of the business carried on by such other person in an earlier year, on its becoming irrecoverable after the assessee had taken over the business. In Commissioner of Income Tax, Bombay City-II Vs. Bombay Hing Supply Co., , the High Court of Bombay had to consider a similar issue. The Department contended that the loss, if any, was a capital loss in the hands of the assessee. He is not entitled to have that amount deducted. This contention was negatived. The court observed that ( at page 680) :

"The argument (debt in question had been taken into account in computing the income of the predecessor firm and not of the assessee-firm) overlooks the fact that the assessee has purchased the business of the old partnership as a going concern. The identity of the business has not undergone any change. The continuity of business has not in any manner been interrupted. The business has been carried on in the name of the Bombay Hing Supply Co. before as well as even now. The only change that has taken place is that formerly four persons were partners of the business concern and now only three out of the four have remained as partners of the firm. To the old business, the three partners of the assessee-firm were not strangers. The trading debts of the old partnership have become the trading debts of the business of the assessee. Some of those debts have now become bad, some of the customers having failed to pay the same. In the circumstances, in our opinion, the condition ''debts due to the assessee in respect of that part of his business'' also has been satisfied."

It is also worthwhile to note that the same question was considered by the Andhra Pradesh High Court in Commissioner of Income Tax Vs. T. Veerabhadra Rao, K. Koteswara Rao and Co., . The court observed that what was necessary was that the fact that the debt should have been written off as irrecoverable and the fact that the predecessor-firm had written off the debt as irrecoverable was sufficient. The view taken by the Andhra Pradesh High Court in this case has been confirmed by the Supreme Court in Commissioner of Income Tax, A.P. Vs. T. Veerabhadra Rao, K Koteswara Rao and Co.,

According to learned counsel representing the Revenue since Rs. 58,283 was credited to a "general reserve", the assessee cannot claim deduction even if the said amount has become irrecoverable and consequently a bad debt. The argument is that the amount which become irrecoverable from the category of "general reserve" is not entitled to deduction while computing the profit and loss in the trading account, since the loss is not a trading loss. When the assessee has credited the amount of Rs. 58,283 as "general reserve" it can only amount to a capital loss and not a trading loss. It is worthwhile to note that reserve has not been defined. The meaning of the word "reserve" is to be understood with reference to the context. So also the true nature and character of the disputed sum must be determined with reference to the substance of the matter. The issue is not to be approached in a pedantic manner.

It is true that the assessee entered Rs. 6,743 in the profit and loss account and Rs. 58,283 in the "general reserve" as bad debts. The fact remains that these amounts have become irrecoverable and it was so entered in the books of the assessee in the relevant previous year as it is conceded that both amounts have become bad during the relevant previous year. We are of the view that the assessee is entitled to claim deduction of that amount. Merely on the ground that Rs. 58,285 has been characterised as "general reserve" and other amount of Rs. 6,743 entered in the profit and loss account will not in our considered view change its character when both amounts have become bad and irrecoverable. In this view of the matter, we find no error in the decision rendered by the Tribunal. Consequently, we answer the question in the affirmative in favour of the assessee and against the Revenue.

A copy of this judgment signed by the Registrar under the seal of the High Court will be forwarded to the Income Tax Appellate Tribunal, Cochin.