PETITIONER:
COMMISSIONER OF INCOME TAX, A.P.
Vs.
RESPONDENT:
M/S. T.VEERABHADRA RAO, K. KOTESWARA RAO & CO.
DATE OF JUDGMENT08/07/1985
BENCH:
PATHAK, R.S.
BENCH:
PATHAK, R.S.
VENKATARAMIAH, E.S. (J)
CITATION:
1985 AIR 1600 1985 SCR Supl. (2) 20
1985 SCC Supl. 403 1985 SCALE (2)1
ACT:
Income Tax Act, 1961, Sec. 36(1)(vii)- Business of a
predecessor firm with assets and liabilities taken over by
the assessee-Assessee paying income tax on interest income
accruing on debt - Part of debt written off as a bad debt -
Whether it could be allowed as a deduction.
HEADNOTE:
The assessee, a partnership firm, took over the running
business of an earlier firm with all the assets and
liabilities including a debt of Rs.23,577. The assessee paid
income tax on the interest income accruing on the aforesaid
amount of debt for the assessment year 1963-64. On March 31,
1965 the assessee and the debtor entered into a settlement
whereby a sum of Rs.25,000 was accepted by the assessee in
satisfaction of the debt and the amount of interest due
thereon. The balance of Rs. 15,100 was written off by the
assessee as irrecoverable. The assessee also incurred a sum
of Rs. 6,880 as legal expenses on filing an appeal which
arose out of a suit already instituted by the predecessor
firm for recovering a sum due from the Central Government.
In assessment proceedings for the assessment year 1965-
66, the assessee claimed deduction of the aforesaid two
amounts written off as bad debts. The Income Tax Officer
disallowed both the claims. On appeal, the Appellate
Assistant Commissioner of Income Tax allowed the claims of
the assessee-firm holding that the business transferred from
the predecessor firm to the assessee continued
uninterrupted, and the change of ownership was no bar to the
bad debt being allowed. The Income Tax Appellate Tribunal
and the High Court confirmed the view taken by the Appellate
Assistant Commissioner. Hence this appeal.
Dismissing the appeal,
^
HELD: (1) The money owed by a debtor under a
transaction with a predecessor firm can be written off as
irrecoverable in the accounts of the successor, the
assessee, in a subsequent year and could be claimed as a bad
debt under clause (vii) of sub-s.(1) of s.36 of the Income
Tax Act, 1961. [24 A-B]
21
(2) When a business along with its assets and
liabilities is transferred by one owner to another, there is
no reason why a debt so transferred should not be entitled
to the same treatment in the hands to the successor. The
recovery of the debt is a right transferred along with the
numerous other rights comprising the subject of the
transfer. If the law permits the transferer to that the
whole or part of the debt as irrecoverable and to claim a
deduction on that account, it seems difficult to accept that
the same right should not be recognized in the transferee.
It is merely an incident flowing from the transfer of the
business, together with its assets and liabilities, from the
previous owner to the transferee. It is a right which
should, on a proper appreciation of all that is implied in
the transfer of a business, be regarded as belonging to the
new owner. [25 E-H]
(3) 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 accounts of 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-clause (a) must necessarily mean the identical
assessee referred to in sub-section(b). A successor to the
pertinent interest of a previous assessee would be covered
within the terms of sub-clause (b). the successor assesee,
In effect, steps into the shoes of his predecessor. [26 E-F]
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. 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.
Therefore the conditions in both sub-clause (a) and (b) of
Clause (1) of sub-s.(2) of s.36 are satisfied. The same test
has to be applied for acknowledging the claim to deduction
of Rs. 6,880. [26 B-D]
JUDGMENT:
CIVIL APPELLATE JURISDICTION : Civil Appeal No. 114
(NT) of 1975.
From the Judgment and Order dated 16.1.1974 of the
Andhra Pradesh High Court in Case Referred No. 9 of 1972.
B.B. Ahuja and Miss A. Subhashini for the Appellant.
22
A. Subba Rao for the Respondent.
The Judgment of the Court was delivered by
PATHAK, J. This appeal by special leave is directed
against the judgment of the High Court of Andhra Pradesh
disposing of a reference made under sub-s.(1) of s.256 of
the Indian Income Tax Act, 1961 for its opinion on the
following question of law.
Whether on the facts and in the circumstances of
the case the bad debt of Rs.15,100 and the legal
expense of Rs.6,880 were allowable deductions in
the assessment of the assessee firm for the
assessment year 1965-66?
The assessee is a partnership firm. It took over the
business of an earlier firm. All the assets and liabilities
of the predecessor firm passed on to the assessee firm.
These included a debt of Rs.23,577 due from Laxmi Trading
Company to the predecessor firm. The total amount due in the
account relating to Laxmi Trading Company was Rs.40,549
comprising an outstanding amount of Rs. 29,200 and interest
thereon in the sum of Rs. 11,349 for the period April 31,
1960 to March 31, 1961. The amount of interest was taxed in
the hands of the assessee for the assessment year 1963-64.
On March 31, 1965 the parties effected a settlement under
which a sum of Rs.25,000 was accepted by the assessee in
full settlement of the said debt. The balance of Rs.15,100
was written off as irrecoverable.
In assessment proceedings for the assessment year 1965-
66, for which the previous year was the year ending March
31, 1965 the assessee claimed a deduction of the aforesaid
sum of Rs. 15,100 written off as a bad debt. The Income-tax
Officer disallowed the claim on the ground that the debt was
due originally to the predecessor firm, that there was no
reason to take over the loan by the assessee firm and
further that it was not proved that the debtor was so
financially embarrassed that he was unable to pay the debt.
On appeal, the Appellate Assistant Commissioner of Income
Tax held that the business transferred from the predecessor
firm to the assessee continued uninterrupted, and the change
of ownership was no bar to the bad debt being allowed. He
also noted that the assessee had paid income-tax on the
interest of Rs.11,349, in an earlier assessment year, and
held that the assessee’s bonafides stood established.
Holding that there was
23
justification for writing off the bad debt in the measure
claimed by the assessee, the Appellate Assistant
Commissioner allowed the appeal.
It may be mentioned that the assessee had also claimed
a deduction of a sum of Rs. 6,880 before the Income-tax
Officer on the ground that the assessee had incurred legal
expenses in that amount in connection with an appeal filed
in the Supreme Court for the purpose of recovering a sum due
from the Central Government. The transaction related to the
predecessor firm and the suit instituted by it had been
continued by the assessee on taking over the assets and
liabilities of the predecessor firm. The Income Tax Officer
disallowed this claim also, but in appeal the Appellate
Assistant Commissioner upheld the claim.
The Income-tax Department appealed to the Income-tax
Appellate Tribunal against the order of the Appellate
Assistant Commissioner and urged that cl.(i) of sub-s.(2) of
s.36 of the Income Tax Act, 1961 did not permit such an
allowance because it did not satisfy the requirement
mentioned in cl.(a) and cl.(b) of that provision, and
therefore it was not open to the assessee to claim a
deduction of Rs.15,100 as a bad debt nor the legal expenses
of Rs.6,880. The Appellate Tribunal dismissed the appeal,
holding that where a business was succeeded to by an
assessee, it was entitled to write off the bad debts of the
business taken over. The Appellate Tribunal observed that
whenever a business was succeeded to as a whole and as a
running enterprise the assets and liabilities so taken over
became the assets and liabilities of the successor and,
therefore, the assessee was entitled to write off the bad
debts. It noted that the assessee had not only treated the
amount a debt owed to it but had allowed the interest
accrued thereon to be assessed in its hand as the interest
constituted part of the debt. At the instance of the
Commissioner of Income-tax, a reference was made to the High
Court of Andhra Pradesh for its opinion on the question set
forth earlier. The High Court answered the question in the
affirmative and against the Department.
It is not disputed that the assessee succeeded to the
business of the predecessor firm and took over all its
assets and liabilities, including the debt due from Laxmi
Trading Company. The business carried on by the predecessor
firm was now carried on by the assessee. The facts also show
that the assessee paid income tax on the interest income
accruing on the debt for the assessment year 1963-64. It is
also not disputed that the parties effected a settlement on
March 31, 1965 whereby a sum of
24
Rs. 25,000 was accepted by the assessee in satisfaction of
the debt and that the balance of Rs.15,100 was written off
by the assessee as irrecoverable. The question is whether
money owed by a debtor under a transaction with a
predecessor firm can be written off as irrecoverable in the
accounts of its successor, the assessee, in a subsequent
year and could be claimed as a bad debt under cl.(vii) of
sub-s.(1) of s.36 of the Income Tax Act, 1961.
Cl.(vii) of sub-s.(1) of s.36 of the Income Tax Act,
1961 provides :
“36.(1). The deductions provided for in the
following clauses shall be allowed in respect of
the matters dealt with therein, in computing the
income referred to in section 28 –
………………………………………….
(vii) subject to the provisions of sub-s.(2), the
amount of any debt, or part thereof, which is
established to have become a bad debt in the
previous year”.
Sub-s.(2) of s.36 declares :-
“(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 or of
an earlier previous year, or represents money lent
in the ordinary course of the business of banking
or money lending which is carried on by the
assessee, and
(b) has been written off as irrecoverable in the
accounts of the assessee for that previous year;
(ii) if the amount ultimately recovered on any
such debt or part of debt is less than the
difference between the debt or part and the amount
so deducted, the deficiency shall be deductible in
the previous year in which the ultimate recovery
is made;
25
(iii) any such debt or part of debt may be
deducted if it has already been written off as
irrecoverable in the accounts of an earlier
previous year, but the Income-tax Officer had not
allowed it to be deducted on the ground that it
had not been established to have become a bad debt
in that year;
(iv) where any such debt or part of debt is
written off as irrecoverable in the accounts of
the previous year and the Income-tax Officer is
satisfied that such debt or part became a bad debt
in any earlier previous year not falling beyond a
period of four previous years immediately
preceding the previous year in which such debt or
part is written off, the provisions of sub-section
(6) of section 155 shall apply”.
S.28, referred to in sub-s.(1) of s.36, provides that income
under the head “Profits and gains of business or
profession”, shall be chargeable to income-tax. The profits
and gains of a business are charged to income-tax. To
compute the profits and gains so chargeable, s.36 provides
for allowing a number of deductions. Each of the deductions
must relate to the business. If the same assessee was
carrying on a business and he wrote off a debt relating to
the business as irrecoverable, he would without doubt be
entitled to a corresponding deduction under cl.(vii) of sub-
s.(1) of s.36 subject to the fulfilment of the conditions
set forth in sub-s.(2) of s.36. If a business, along with
its assets and liabilities, is transferred by one owner to
another, we see no reason why a debt so transferred should
not be entitled to the same treatment in the hands of the
successor. The recovery of the debt is a right transferred
along with the numerous other rights comprising the subject
of the transfer. If the law permits the transferor to treat
the whole or part of the debt as irrecoverable and to claim
a deduction on that account, it seems difficult to accept
that the same right should not be recognised in the
transferee. It is merely an incident flowing from the
transfer of the business, together with its assets and
liabilities, from the previous owner to the transferee. It
is a right which should, on a proper appreciation of all
that is implied in the transfer of a business, be regarded
as belonging to the new owner. Unless the language of the
statute plainly and clearly compels a construction to the
contrary, the normal rule of the law should be given its
proper play. It is true that cl.(i) of sub-s.(2) of s.36
declares that a deduction can be allowed only
26
if the debt, or part thereof, has been taken into account in
computing the income of the assessee of that previous year
or an earlier previous year and that it has also been
written off as irrecoverable in the accounts of the assessee
for that previous year. 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 Appellate Assistant Commissioner
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 of 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 of the sum
of Rs. 15,100 written off by it in its accounts of the
previous year as irrecoverable.
We may add that although a number of decisions of
various High Courts were cited before us on behalf of the
assessee we consider it unnecessary to refer to them.
27
As regards the sum of Rs.6,880 claimed by the assessee
as 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 Income Tax Officer, the Appellate
Assistant Commissioner, 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. We are satisfied that the
view we are taking in respect of the sum of Rs. 15,100
claimed as a bad debt should also form the basis for
acknowledging the claim to deduction of Rs.6,880.
In the result, the appeal is dismissed with costs.
M.L.A. Appeal dismissed.
28