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The Commissioner Of Income Tax v. General Insurance Corporation Of India
Factual and Procedural Background
In the Assessment Year 1989–1990, the assessee claimed expenses related to bank commission and salaries for staff of the Investment Department as deductible expenses for earning dividend income under section 80-M of the Income Tax Act. The assessing officer (AO) increased the deductible expenses by including apportioned salary, allowances, and investment expenses, resulting in a higher expense figure. Additionally, the AO rejected the assessee's claim of a deduction for an amount of Rs. 1.18 crores credited to a reserve for doubtful debts, on the basis that the conditions under section 36(1)(vii) and section 36(2) were not met, particularly that the debts were not actually written off the books. The First Appellate Authority decided both issues in favor of the assessee. The department appealed to the Tribunal, which dismissed the appeal. The department then filed the present appeal under section 260A of the Income Tax Act.
Legal Issues Presented
- Whether expenses incurred by the assessee on account of salary paid to the staff of the Investment Department could be said to be directly relatable to the earning of dividend income for the purposes of computing deduction under section 80-M of the Income Tax Act?
- Whether the assessee has violated rule 5 of the First Schedule to the Act read with section 36(1)(vii) by debiting an amount of Rs. 1.18 crores to the profit and loss account under the head “reserve for doubtful debts”?
Arguments of the Parties
Department's Arguments
- Section 36(1)(vii) permits deduction only for bad debts written off as irrecoverable in the accounts for the previous year, a provision introduced by the Direct Tax Law Amendment Act, 1987 effective from 1.4.1989.
- Prior to 1.4.1989, the condition for bad debt deduction was that the debt be established as bad in the previous year; the new wording introduced a stricter requirement of actual writing off.
- Rule 5 of the First Schedule, which relates to insurance business other than life insurance, requires that any inadmissible expenditure or allowance debited to profit and loss account, including reserves, be added back when computing profits.
- The assessee’s transfer of Rs. 1.18 crores to reserve for doubtful debts should be disallowed and added back as per rule 5, since it was not admissible under section 36(1)(vii).
- Judgments cited by the assessee pertain to periods before 1.4.1989 and do not interpret rule 5 as amended by the Finance Act, 1998; hence, they are inapplicable.
Assessee's Arguments
- Section 36(1) deals with deductions allowed in computing income under section 28, while section 36(2) sets conditions for claiming deduction for bad debts.
- Before 1.4.1989, section 36(2)(i) required debts to be written off as irrecoverable; post 1.4.1989, this condition was shifted to section 36(1)(vii) without substantive change in law.
- The Tribunal correctly relied on Bombay High Court and Gujarat High Court judgments holding that transferring an amount to a bad debt reserve account constitutes writing off the bad debt, even if the debt is not removed from the books.
- Rule 5(a) of the First Schedule applies only where amounts debited to profit and loss account are inadmissible under sections 30 to 43B; the burden is on the department to prove inadmissibility under section 36(1)(vii).
- The department failed to raise the factual issue whether the debt had become irrecoverable; thus, the reserve transfer complies with statutory requirements.
Table of Precedents Cited
| Precedent | Rule or Principle Cited For | Application by the Court |
|---|---|---|
| C.I.T, Mumbai v. General Insurance Corporation of India (I.T.A No. 457 of 2000) | Interpretation of expenses relatable to dividend income under section 80-M | Supported the finding that salary expenses of investment staff are not directly relatable to earning dividend income, favoring the assessee. |
| C.I.T v. Jwala Prasad Tiwari (Bombay High Court) | Meaning of "writing off" bad debts for deduction under section 36(1)(vii) | Held that transferring amounts to bad debt reserve accounts constitutes writing off, supporting assessee's compliance with statutory requirements. |
| Sarangpur Cotton Mfg. Co. v. C.I.T (Gujarat High Court) | Interpretation of writing off bad debts in accounts | Affirmed that writing off can be by debit to bad debt reserve account without removal from books, supporting assessee’s position. |
| Vithaldas H. Dhanjibhai Bardanwala v. C.I.T (Gujarat High Court, Division Bench) | Condition for allowance of bad debt deduction under section 36 | Confirmed that bad debt must be written off as irrecoverable in accounts; debit entries to profit and loss account and corresponding credit to bad debt reserve satisfy this condition. |
Court's Reasoning and Analysis
The court first considered whether salary expenses of the investment department staff were directly relatable to dividend income under section 80-M. Relying on a prior judgment, it concluded these expenses are not directly relatable and thus not deductible under section 80-M, ruling in favor of the assessee.
Regarding the second question on the deduction of Rs. 1.18 crores credited to reserve for doubtful debts, the court analyzed the statutory provisions in section 36(1)(vii) and rule 5 of the First Schedule. It noted that the key condition for deduction is that the bad debt must be written off as irrecoverable in the accounts. The court found that the legislature shifted the requirement of writing off from section 36(2)(i) to section 36(1)(vii) without substantive change in the law.
The court examined authoritative judgments explaining that writing off a bad debt includes posting debit entries to the profit and loss account and corresponding credit entries to bad debt reserve accounts. This method complies with the statutory requirement even if the debt remains on the books. The court observed that the department did not raise the factual issue whether the debt had become irrecoverable, a necessary condition for disallowance.
Consequently, the court held that the assessee complied with section 36(1)(vii) and that rule 5(a) of the First Schedule, which requires adding back inadmissible reserves, did not apply as the reserve was admissible under the statute. The court thus answered the second question in favor of the assessee.
Holding and Implications
The appeal is disposed of in favor of the assessee on both questions.
The court held that (1) salary expenses of investment department staff are not directly relatable to dividend income for deduction under section 80-M, and (2) the assessee complied with the requirements of section 36(1)(vii) by transferring Rs. 1.18 crores to reserve for doubtful debts, thereby justifying the deduction. The department’s appeal was dismissed with no order as to costs.
The decision directly affects the parties by affirming the assessee’s claims and rejecting the department’s disallowances. No new precedent beyond the application of existing interpretations was established.
S.H Kapadia, J.:— Two questions of law arise for determination in this appeal in respect of the Assessment Year 1989–1990.
(1) Whether expenses incurred by the assessee on account of salary paid to the staff of the Investment Department could be said to be directly relatable to the earning of dividend income for the purposes of computing deduction under section 80-M of the Income Tax Act?
(2) Whether the assessee has violated rule 5 of the First Schedule to the Act read with section 36(1)(vii) by debiting an amount of Rs. 1.18 crores to the profit and loss account under the head “reserve for doubtful debts”?
FACTS:
2. In the Assessment Year in question, the assessee took bank commission of Rs. 6.01 lacs (approximately) as expenses for earning dividend income. The department made upward revision by including apportioned cost of salary, allowances and investment expenses for earning dividend income. Accordingly, the total expenses pertaining to dividend income for section 80-M was computed at Rs. 13.56 lacs (approximately). Similarly, the AO rejected the claim of the assessee under the head “reserve for doubtful debts” on the ground that the assessee had not fulfilled the conditions laid down in section 36(1)(vii) as also the conditions laid down in section 36(2) since the debts were not actually written off the books of accounts. The matter was carried in appeal. Both the above questions were decided in favour of the assessee by the First Appellate Authority. Being aggrieved, the department carried the matter in appeal to the Tribunal. The Tribunal dismissed the appeal. Hence, the department has come in appeal under section 260A of the Income Tax Act.
FINDINGS ON QUESTION NO. (1):
3. In view of our judgment in I.T.A No. 457 of 2000 decided on 18th September, 2000 in the case of C.I.T, Mumbai v. General Insurance Corporation of India, question No. 1 is answered in the negative i.e in favour of the assessee and against the department. On this point, it may also be added that the grounds of appeal are totally vague. The grounds do not indicate the investment expenses which are alleged to be relatable to the earning of dividend income.
ARGUMENTS ON QUESTION NO. (2):
4. Mr. Desai, learned Senior Counsel appearing on behalf of the department, contended that section 36(1) refers to deductions required to be allowed in computing income referred to in section 28. He invited our attention to section 36(1)(vii) which refers to writing off bad debt or any part thereof as irrecoverable in the accounts of the assessee for the previous year. He pointed out that the words “any bad debt or part thereof which is written off as irrecoverable in the accounts of the assessee for the previous year”, were introduced by Direct Tax Law Amendment Act, 1987 with effect from 1.4.1989 He contended that prior to 1.4.1989, the words were as follows: “Any debt or part thereof which is established to have become a bad debt in the previous year.” He also invited our attention to the First Schedule to the Act and, in particular, clause 5. The First Schedule refers to insurance business. It is required to be read with section 44. He contended that, in the present case, we are not concerned with Life Insurance business. He contended that under rule 5, profits from business of insurance other them life insurance was required to be determined by taking into account balance of the profits disclosed by the annual accounts subject to adjustments viz. any expenditure or allowance including any amount debited to profit and loss account by way of dividend, reserve, or provision for any tax which is not admissible under sections 30 to 43B, shall be added back. He contended that, in the present case, the assessee has transferred the amount to Reserves for doubtful debts. Therefore, the AO was right in adding back the aforestated amount of Rs. 1.18 crores. He contended that rule 5 was amended by Finance Act, 1998 with effect from 1.4.1989 He contended that the judgments relied upon by the assessee have no application as they pertain to the period before 1.4.1989 He contended that none of the judgments have interpreted rule 5 in the First Schedule as amended by Finance Act, 1998. Therefore, the judgments cited by the assessee did not apply to the facts of this case. On the other hand, it was urged on behalf of the assessee by Mr. Irani, learned Counsel for the assessee, that section 36(1) provides for deductions to be allowed in computing the income referred to in section 28. He pointed out that section 36(2), however, lays down the conditions which an assessee is required to satisfy before claiming deduction for a bad debt or a part thereof. He contended that prior to 1.4.1989, clause (i) in section 36(2) stipulated that no deduction shall be allowed unless any debt or part thereof has been written off as irrecoverable in the accounts of the assessee. He pointed out that after 1.4.1989, however, the Legislature has removed the above condition from section 36(2) and has transferred it under section 36(1)(vii). Therefore, he contended that there is no basic change brought about by the Legislature and the law, as it stood before 1.4.1989, remains the same. He, therefore, contended that the Tribunal has rightly relied upon the judgments of the Bombay High Court in the case of C.I.T v. Jwala Prasad Tiwari,1. He also relied upon the judgment of the Gujarat High Court in case of Sarangpur Cotton Mfg. Co. v. C.I.T,2 Both these judgments have laid down that if an amount is transferred to a bad debt reserve account in the books of an assessee, it would amount to writing off the bad debt and it was not necessary that the amount should be altogether taken off from the books of the assessee. Mr. Irani further invited our attention to rule 5(a) of the First Schedule to the Act. He pointed out that the said rule has no application. He contended that rule 5(a) applied to cases where an expenditure or allowance including any amount debited to profit and loss account either by way of reserve is not admissible under provisions of sections 30 to 43b then, in computing the profits, the said amount shall be added back. In this case, however, he contended that the burden was on the department to prove that the amount debited by the assessee to profit and loss account was not admissible under section 36(1)(vii). Hence, rule 5(a) was not applicable to the facts of this case. He contended that, in the present matter, the only contention raised by the department was that the assessee did not fulfill the condition of writing off bad debt under section 36(1)(vii) by crediting the said amount of Rs. 1.18 crores to the reserve account for doubtful debt by debiting profit and loss account. Mr. Irani vehemently urged that, in this case, the department has failed to raise the pertinent question as to whether the debt had become irrecoverable in terms of section 36(1)(vii).
FINDINGS ON QUESTION NO. (2):
5. To decide question No. (2) the relevant sections are quoted herein below.
section 36(1)(vii)
“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—
(i) ——————
(ia) —————
(ib) —————
(ii) —————
(iia) —————
(iii) —————
(iv) —————
(v) —————
(va) ——————
(vi) ——————
(vii) subject to the provisions of sub-section (2), the amount of [any bad debt or part thereof which is written off as irrecoverable in the accounts of the assessee for the previous year]:”
Rule 5(a) and (c) of the First Schedule under sub-heading B.
“THE FIRST SCHEDULE
INSURANCE BUSINESS
[See section 44)
B.- Other insurance business.
Computation of profits and gains of other insurance business.
5. The profits and gains of any business of Insurance other than life insurance shall be taken to be the balance of the profits disclosed by the annual accounts, copies of which are required under the Insurance Act, 1938 (4 of 1938), to be furnished to the Controller of Insurance, subject to the following adjustments:—
(a) subject to the other provisions of this rule, any expenditure or allowance [including any amount debited to the profit and loss account either by way of a provision for any tax, dividend, reserve or any other provision as may be prescribed] which is not admissible under the provisions of sections 30 to (43B) in computing the profits and gains of a business shall be added back;
(b) [***]
(c) such amount carried over to a reserve for unexpired risks as may be prescribed in this behalf shall be allowed as a deduction.”
6. At the outset, we may mention that the question as to whether the debt has become irrecoverable has not been raised in the appeal.
7. It is a factual dispute which ought to have been raised. The only dispute which has been raised is, whether rule 5(a) of the First Schedule to the Act is attracted by the mode in which the amount of Rs. 1.18 crores has been transferred to “reserve account for doubtful debts”. In the case of Jwala Prasad Tiwari (supra) Bombay High Court had held that the expression “writing off is a technical term used by the Auditors. That, there are two methods of dealing with a debt which has been written off in the books of account viz. by giving corresponding credit to the debtor's account or by giving corresponding credit to the bad and doubtful debts account. The first method is only employed where it is desired to close the account of the debtor. The second method is employed where there are some chances of recovery. That, when we talk of “writing off” we are not concerned with the credit to be given to an account. That, “writing off means the raising a debit entry. This can only be to the debit of the profit and loss account. That, this is the only debit which can be raised as a result of writing off a bad debt. To the same effect is the judgment of the Gujarat High Court in the case of Sarangpur Cotton (supra). In the case of Vithaldas H. Dhanjibhai Bardanwala v. C.I.T, the Division Bench of the Gujarat High Court has held that under section 36 of the Act, before any claim for allowance for a bad debt is established by the AO, it must appear that the concerned bad debt was written off as irrecoverable in the account books of the assessee. This requirement is a condition for grant of claim for bad debt allowance. To that extent, there is a departure from the earlier Act. However, so far as the exact requirements of writing off is concerned, the language used in the Act of 1922 and the Act of 1961 is identical. If the debit entries posted by the assessee indicate that bad debt has been written off as irrecoverable in the accounts of the assessee then the statutory condition stands fully complied with. That, if the assessee has posted entries in the profit and loss account and the corresponding entries are posted in the bad debt reserve account, it 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. These Judgments squarely apply to the facts of our case. In the present matter, the assessee has posted entries in the profit and loss account and has made corresponding entries in the bad debt reserve account. Therefore, there is compliance of section 36(1)(vii). It may be noted that prior to 1.4.1989, this statutory requirement existed under section 36(2)(i). That entry has been shifted and brought to section 36(1)(vii). Therefore, to the extent of the exact requirement of writing off of the concerned debt as irrecoverable is concerned, the law remains the same even after 1.4.1989 Hence, there is compliance of section 36(1)(vii). Rule 5(a) of the First Schedule, inter alia, lays down that where any expenditure or allowance is debited to profit and loss account by way of reserve which is not admissible under the provisions of section 36(1) then the amount shall be added back in computing the profits of the business. However, in the present case, as stated hereinabove, there is full compliance of section 36(1)(vii). The manner of writing off is as per the statutory requirement. The department has not raised the relevant factual dispute as to whether the debt has not become irrecoverable or not. In the circumstances, question No. 2 is answered in the negative i.e in favour of the assessee and against the department.
8. Accordingly, the appeal is disposed of with no order as to costs.
9. Certified Copy expedited.
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