Kerala State Industrial Development Corporation Ltd. vs Commissioner of Income Tax

K.S. Radhakrishnan, J.—Tribunal, Cochin Bench, has referred the following question of law u/s 256(1) of the IT Act, 1961, for the decision of this Court:

Whether, on the facts and in the circumstances of the case, the Tribunal is justified in holding that the claim of bad debts in respect of Vanchinad Leathers Ltd. was not legally sustainable and allowable ?

Abovementioned question arises out of the order passed by the Tribunal in ITA No. 831/Coch/1991, dt. 13th June, 1997 in the case of Kerala State Industrial Development Corporation Ltd., Trivandrum, for the asst. yr. 1988-89.

Assessee, the Kerala State Industrial Development Corporation Ltd., is a limited company wholly owned by the Government of Kerala. It was incorporated with the object of promotion of industries and advancement of industrial development in the State of Kerala. Vanchinad Leathers Ltd. was a joint sector company promoted by the assessee in the year 1974 for processing hides and skins. The company started commercial production in the year 1977. However, it was closed down in 1980. Later it was reopened in September, 1982 and again closed down in January, 1983. Assessee had advanced large amounts to the company. Assessee claimed deduction of Rs. 55,70,949 as provision for bad debts. Claim for deduction of bad debts was not allowed on the ground that no reasonable steps had been taken for recovering the debts and further no part of the outstanding amount had been assessed as the income of the earlier years. Further, it was also noticed that the amount was not written off in the assessee''s accounts in claiming bad debt. Assessee took up the matter in appeal before the CIT(A) and the CIT(A) confirmed the disallowance. Matter was taken up before the Tribunal. It was contended before the Tribunal that the board of directors of the assessee in July, 1988 had recommended to write off the debt as bad debt since there was no possibility of recovering the said amount. Further, it was also pointed out that posting of debit entries in the P&L a/c and credit entries in the bad debt recovery amount would be sufficient compliance of the condition in Section 36(2)(i)(b). Before the Tribunal it was contended by the Revenue that before treating the debt as bad debt the assessee had not taken any serious steps to recover the debt. Reference was also made to the auditor''s report and stated that as per the report, recovery steps would be initiated only after the Corporation was satisfied that the unit could not be operated economically. Further, it was also pointed out that a decision was taken by the BIFR recommending winding up of the debtor company on 16th Dec, 1988, that is, after the accounting period relevant for the asst. yr. 1988-89. It was further pointed out that there was no evidence to show that the debt had become irrecoverable during the year in question. The Tribunal took the view that the assessee could not prove that the debt had become irrecoverable during the previous year. Conditions for claiming deduction u/s 36(2)(i)(b) were not satisfied and hence the appeal was dismissed. Against the order of the Tribunal dismissing the appeal on 13th June, 1997 assessee made an application u/s 256(1) of the IT Act for referring following question of law to this Court:

Whether, on the facts and in the circumstances of the case, the Tribunal is justified in holding that the sum of Rs. 55,70,949 due from Vanchinad Leathers Ltd. has not been proved to have become irrecoverable during the previous year?

Later assessee filed OP No. 5528 of 1999 before this Court seeking a direction u/s 256(2) of the Act. Accordingly reference was made by the Tribunal by its order dt. 14th March, 2000 which was later numbered as IT Ref. No. 25 of 2000.

Senior counsel appearing for the assessee Sri M. Pathrose Matthai submitted that Vanchinad Leathers Ltd. from which amount was due to the assessee was closed down in the year 1980, reopened in September, 1982 and again closed down in January, 1983. Performance in the business of the company had all along been discouraging and it had been incurring loss year after year. Subsequently BIFR has taken steps to wind up the company. An amount of Rs. 55,70,949 was due to the assessee which the assessee had debited as bad debts in the P&L a/c for the year ended 31st March, 1988. Counsel placed reliance on the decision of the Gujarat High Court in SARANGPUR COTTON MANUFACTURING CO. LTD. Vs. COMMISSIONER OF Income Tax, GUJARAT-I., and contended that the assessee had advanced money to the debtor in the course of its business in financing and there was sufficient compliance with Section 36(2)(i)(b) of the Act. Counsel submitted that once the assessee had posted the (debit) entries in the P&L a/c and credit entries in the bad debt recovery account that would be sufficient compliance with the provisions of Section 36(2)(i)(b). Counsel also submitted that from the report of IDBI and BIFR the assessee came to know that there was no possibility of realising the loans given to the defaulter. Consequently, assessee satisfied the requirements of Section 36(2)(i)(b) of the Act.

Senior standing counsel appearing for the Revenue Sri P.K. Ravindranatha Menon referred to the P&L a/c and submitted that the assessee had never made provision for doubtful debts and that debt had not been written off. Further, it is also pointed out that BIFR had taken a decision to wind up the company only on 16th Dec, 1988 after the accounting year relevant for the asst. yr. 1988-89. Further, counsel also contended that burden is entirely on the part of the assessee to establish that the debt had become irrecoverable during the previous year relevant for the assessment year. Counsel also placed reliance on the decision of this Court in Travancore Tea Estates Co. Ltd. Vs. Commissioner of Income Tax, which was confirmed by the apex Court in Travancore Tea Estates Co. Ltd. Vs. Commissioner of Income Tax, Cochin, .

We may refer to the relevant provision of the IT Act before we examine the various contentions raised on either side :

(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 the previous year in which the amount of such debt or part thereof is written off or of an earlier previous year, or represents money lent in the ordinary course of the business of banking or moneylending which is carried on by the assessee;

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

The expression "bad debt" relates to debt of which chance of recovery is remote, but still efforts can be made to recover the bad debts. When efforts are on to recover the bad debt, it cannot be said that the debt has become irrecoverable. A debt may be written off as irrecoverable in the individual accounts of the debtors in the assessee''s books or by making appropriate entries in other accounts, by debiting in the P&L a/c and crediting in the doubtful debts account. Burden is always on the assessee to prove that a debt or portion of it has become irrecoverable in the accounting year. Gujarat High Court in Sarangpur Cotton Manufacturing Co. Ltd.''s case (supra) has taken the view that the assessee has posted the entries in the P&L a/c and corresponding entries are posted in the bad debt reserve account and that would be sufficient-compliance with the provisions of the statutory requirement for writing off as irrecoverable the concerned debt in the books of the assessee. The Court held when a businessman writes off an amount, there is prima facie evidence that the amount is irrecoverable. Undoubtedly, the Department can rebut the prima facie inference by drawing attention to circumstances or by leading some evidence to suggest that the position taken up by the assessee was not correct. The above decision was followed by the Gujarat High Court in Kamla Cotton Company Vs. Commissioner of Income Tax, where the Court has taken the view that if the assessee had written off its claim as a bad debt it could not be said that it had not acted in a bona fide manner. Events and circumstances subsequent to the stage of writing off which are relevant also would justify the action of the assessee.

Be that as it may, abovementioned principle laid down by the Gujarat High Court, in our view, would not advance the case of the assessee so far as this case is concerned. We have perused the P&L a/c of the assessee ending on 31st March, 1987 and 31st March, 1988. Balance sheet has made only provision for doubtful debts. The expression "provision for bad and doubtful debts" cannot be construed as writing off bad debts. Above narration may give a ray of hope of recovery even though there is only a remote possibility. Assessee may retain a ray of hope but it cannot be said that the assessee has written off the debts. Counsel referred to several circumstances prior to and subsequent to the accounting year stating that those circumstances would justify that there was no possibility of recovering the amount but we find it difficult to agree. Counsel also pointed out that even though the assessee has made an honest attempt, it was not possible to recover the amount. Whatever be the attendant circumstances, unless and until debt has been written off "as irrecoverable amounts (sic-in the accounts) of the assessee" as provided u/s 36(2)(i)(b), assessee cannot claim any deduction for bad debts. "Irrecoverable" in Section 36(2)(i)(b) means the amount that is not recoverable. Assessee, as we have already indicated, in the P&L a/c has made a provision for bad and doubtful debts. Such a provision will not fall within the meaning of Section 36(2)(i)(b).

We may in this connection refer to the decision of this Court in Travancore Tea Estates Co.''s case (supra) wherein this Court has taken the view that in order to claim a deduction u/s 36(1)(vii) of the IT Act, 1961, the debt should be proved to be bad in the previous year and it should have been written off by the assessee in the relevant previous year. The Court further held that the debt may become bad when it is proved to be irrecoverable on account of the fact that the debtor is in a bad financial position or that it had become irrecoverable. So long as there is a ray of hope to recover the debt and so long as the debt is in the process of realisation, it cannot be said that it has become irrecoverable. The burden of proof that there is a debt owing to the assessee, that it has been taxed in the earlier years, that the debt arose in the course of business of the assessee and finally it has become bad in the year of account, are all on the assessee. The question whether it has become bad during the year of account is a question of fact. If the finding of the Tribunal is based on admissible evidence, the finding would not be disturbed. Above mentioned decision was later affirmed by the apex Court in Travancore Tea Estates Co.''s case (supra). Reference may also be made to the decision of the Calcutta High Court in Commissioner of Income Tax Vs. Coates of India Ltd., wherein the Court held that in order to claim deduction u/s 36(1)(vii) of the IT 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 debt has become a bad debt.

We have already indicated that so far as this case is concerned, the P&L a/c of the assessee had made only a provision for bad debt and doubtful debt had not been written off as bad debt. Consequently, the Tribunal is justified in holding that the claim of bad debt was not legally sustainable and allowable. We, therefore, answer the question in favour of the Revenue and against the assessee.