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Case Number

Tax Case (Appeal) No. 6 of 2007

Attorney(S)

For the Appellant: J. Narayanaswamy, Advocate.

Judges

P.D Dinakaran
Chitra Venkataraman, JJ.

Acts

Amending Act, 1987, has amended clause (vii) of sub-section (1) and clause (i) of sub section (2) of the section
provisions of clause (vii) of sub-section (1) read with subsection (2) of the section
Tribunal.7. Section 36(1)(vii)
provisions of sub-section (2),
Laws (Amendment) Act 1987,

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Smart Summary

Summary of Judgment: Tax Case (Appeal) No. 6 of 2007 (Decided January 29, 2007)

Factual and Procedural Background

This appeal arises from an assessment for the year 2002-03. The assessee is a company running tutorial classes for professional entrance examinations. On March 28, 2000 the assessee took over the business of First Computers. The assessee claimed a deduction of Rs. 51,57,365 as bad debts, said to be amounts due from franchisees of First Computers. The assessee explained that the franchisees' business declined substantially (attributed to the events in the USA in September 2001), many franchisees closed, and the assessee therefore wrote off the dues after adjusting security deposits. The Assessing Officer disallowed the bad-debt claim, treating the write-off as a unilateral decision without sufficient proof, and added Rs. 51,57,365 to the assessee's income.

The assessee appealed to the Commissioner of Income-tax (Appeals) (CIT(A)), who confirmed the assessing officer's order. The assessee then appealed to the Income Tax Tribunal (Tribunal). The Tribunal examined authorities relied upon by the Revenue, considered the fall in receipts (noting receipts from franchisees fell from Rs. 51,47,980 in 2000-01 to Rs. 11,63,247 in 2001-02), and allowed the bad-debt claim. The Tribunal also considered two connected issues: (a) whether advertisement expenditure could be claimed in one year while the fee receipts were spread over subsequent years, and (b) whether the assessee could follow a system of accounting that did not conform to a strict matching principle. The Tribunal allowed the advertisement expenditure under section 37 and rejected the Revenue's challenge on the accounting system.

Aggrieved, the Revenue appealed to this Court. The Court considered the questions of law raised and dismissed the appeal.

Legal Issues Presented

Whether, on the facts and circumstances of the case, the Tribunal was right in holding that as long as the assessee writes off a debt as bad debt, the question whether it was indeed a bad debt should not be gone into?
Whether, on the facts and circumstances of the case, after the amendment of section 36, an assessee is entitled to claim deduction in respect of any debt written off as bad?
Whether, on the facts and circumstances of the case, the Tribunal was right in permitting the assessee to claim expenditure on advertisement in one year, while the matching fee receipts were spread over more years?
Whether, on the facts and circumstances of the case, the assessee is entitled to follow a system of accounting which is not in accordance with the matching principle?

Arguments of the Parties

Revenue's Arguments (Appellant)

The Tribunal's view that mere writing off a debt suffices for deduction is unsustainable in law; the mere act of writing off, without evidentiary support that the debt had become irrecoverable, cannot be treated as sufficient for allowance.
The amendment to section 36 does not permit the assessee to write off any amount and claim an automatic deduction; the amendment does not remove the requirement to show that the debt had become irrecoverable.
On the advertisement-expenditure issue: the assessee spread receipts over years but claimed the full deduction in the year of payment; the deduction should be allowed in the year when related receipts are booked to match income and expenditure.
The assessee neither followed a proper mercantile system nor a cash system of accounting; post 1997-98 the option available is either cash or mercantile; the hybrid approach is not permissible.

Assessee's Arguments (Respondent)

The assessee explained that First Computers' franchise business had materially declined (noting a large fall in receipts) and many franchisees closed; in those circumstances the assessee wrote off dues after adjusting security deposits and filed detailed statements showing names, amounts, and adjustments.
The assessee relied on the amendment to section 36(1)(vii) (effective April 1, 1989) and the position that writing off as irrecoverable in the accounts in the previous year entitles deduction; the assessee asserted that an honest commercial judgment to write off suffices.
On advertisement expenditure, the assessee pointed out the expenditure was incurred wholly and exclusively for the purpose of business; the fact that fee receipts were collected in advance and spread over the course does not preclude deduction under section 37.
The assessee stated it had been following a cash system earlier and had justified the accounting practice in the Tribunal; it relied on section 37 to claim revenue expenditure.

Table of Precedents Cited

Precedent	Rule or Principle Cited For	Application by the Court
Commissioner Of Income-Tax v. Micromax Systems P. Ltd., [2005] 277 ITR 409 (Mad)	Interpreted amendment to section 36: after April 1, 1989 deduction is allowed for amount actually written off (not merely provision); emphasized that deduction is allowable in the year it is written off.	The Court noted this decision (relied on by Revenue) but, on the facts here (fall in receipts and commercial decision to close accounts), held that the assessee's honest judgment in writing off the debts could not be faulted and the claim under section 36(1)(vii) could not be rejected.
South India Surgical Co. Ltd. v. ACIT, [2006] 287 ITR 62 (Mad)	Cited by the Tribunal as a decision relied on by the Revenue (specific principle as relied upon by Revenue is not elaborated in the opinion beyond being considered alongside Micromax).	The Tribunal considered this decision in the context of the Revenue's contentions; the Tribunal nevertheless allowed the bad-debt claim on the facts. The High Court did not find cause to disturb the Tribunal's factual conclusion.
Madras Industrial Investment Corporation Ltd. v. CIT, [1997] 225 ITR 802	Decision involving application of matching principle to certain expenditures (the opinion notes the decision of the apex court on matching doctrine).	The Tribunal held that Madras Industrial Investment Corporation Ltd. v. CIT could not be applied to the facts of the present case; the Court accepted the Tribunal's approach and allowed the advertisement expenditure under section 37.
Commissioner Of Income-Tax v. Southern Roadways Ltd., [2006] 282 ITR 379 (and earlier Division Bench decision [2004] 265 ITR 404 (Mad))	Explained the scope of section 37: expenditure not being capital or personal but laid out wholly and exclusively for the purpose of business should be allowed.	The Court relied on this line of authority to hold that advertisement expenditure, being revenue in nature and incurred exclusively for business, should be allowed despite the assessee deriving benefit in future years.

Court's Reasoning and Analysis

The Court's analysis proceeds from statutory text, factual enquiry, and administrative guidance:

Statutory text and amendment: The Court examined section 36(1)(vii) as amended effective April 1, 1989, which provides that 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 is to be allowed (subject to subsection (2)).
Factual inquiry: The Court reviewed the Assessing Officer's and Tribunal's findings about the facts. The material factual backdrop included a sharp fall in receipts from franchisees (from Rs. 51,47,980 in 2000-01 to Rs. 11,63,247 in 2001-02), the commercial downturn after the events in the USA in September 2001, and the franchisees' closures. The Court observed that the Revenue did not deny these factual findings and that there was nothing to suspect the motive for the write-off.
Effect of the amendment and administrative interpretation: The Court referred to the Direct Tax Laws (Amendment) Act, 1987 and the Board's Circular No. 551 (dated January 23, 1990) which explained that the amendment was intended to rationalise allowance of bad debts by permitting the claim in the year the debt is written off as irrecoverable in the accounts. The Court read the amendment and the Circular to mean that, while the deduction is not an automatic concomitant of writing off if there were contrary evidence, an honest judgment by the assessee at the time of writing off—viewed in the factual context—cannot be lightly disturbed.
Application to present facts: Applying the above, the Court concluded that the assessee made a bona fide commercial decision to write off the dues in light of the fall in business and closure of franchisees; therefore the claim under section 36(1)(vii) could not be rejected. The Court found no question of law requiring admission of the appeal on this point.
Advertisement expenditure and section 37: Turning to the advertisement-expenditure issue, the Court analysed section 37 and the matching principle advanced by the Revenue. The Court accepted the Tribunal's reasoning that if expenditure is revenue in nature and incurred wholly and exclusively for the purpose of business, the mere fact that the expenditure yields benefit in future years does not defeat the expenditure claim. Relying on precedents interpreting section 37, the Court held the expenditure should be allowed.
Accounting-system objection: The Revenue's contention that the assessee was following a hybrid system (claiming expenditure in one year while spreading income) was not specifically pressed before the Tribunal; in any event, having accepted the character of the expenditure under section 37, the Court found no justification to permit the appeal on this ground.
Conclusion on legal questions: In light of the statutory amendment, Board guidance, and factual findings about the commercial downturn and the assessee's honest judgment, the Court concluded the Tribunal's orders raised no substantial question of law meriting interference and therefore dismissed the appeal.

Holding and Implications

HOLDING: The appeal by the Revenue is DISMISSED. The Tribunal's decision allowing the assessee's bad-debt claim under section 36(1)(vii) and allowing the advertisement expenditure under section 37 is upheld.

Implications (as stated in the opinion):

Direct effect on the parties: The assessing officer's disallowance of Rs. 51,57,365 as bad debts is set aside; the assessee's claim for that amount under section 36(1)(vii) is sustained. The assessee's claim for advertisement expenditure is likewise allowed under section 37.
On legal doctrine and precedent: The Court treated the statutory amendment to section 36(1)(vii) and the Board's explanatory circular as decisive; the Court did not find a question of law for admission and therefore did not formulate a new legal principle beyond applying existing statutory interpretation and authority to the facts. The opinion does not state that it lays down a novel precedent beyond affirming the Tribunal's factual and legal conclusions in this case.

This summary is based exclusively on the contents of the provided judgment text. No information that is not present in the opinion has been introduced.

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Commissioner Of Income-Tax v. Brilliant Tutorials P. Ltd.

Tax Case (Appeal) No. 6 of 2007

Decided on January 29, 2007

The Judgment of the Court was delivered by

Mrs. Chitra Venkataraman, J.:— The Revenue is on appeal against the order of the Tribunal. The appeal relates to the assessment year 2002-03.

2. Following are the questions of law raised in this appeal:

“(1) Whether, on the facts and circumstances of the case, the Tribunal was right in holding that as long as the assessee writes off a debt as bad debt, the question whether it was indeed a bad debt should not be gone into?

(2) Whether, on the facts and circumstances of the case, after the amendment of section 36, an assessee is entitled to claim deduction in respect of any debt written off as bad?

(3) Whether, on the facts and circumstances of the case, the Tribunal was right in permitting the assessee to claim expenditure on advertisement in one year, while the matching fee receipts were spread over more years ? and

(4) Whether, on the facts and circumstances of the case, the assessee is entitled to follow a system of accounting which is not in accordance with the matching principle ?”

3. The assessee is a company engaged in the business of running a tutorial for professional entrance examinations. On March 28, 2000, it took over the business of the company, First Computers. The assessee claimed a sum of Rs. 51,57,365 as bad debt, being the amount due from the franchisee of First Computers. It is stated that the main business of First Computers was to impart computer education and it had collected security deposits from various franchisees. It is stated that the business, however, slowed down and worsened due to the tragic incidents in the USA in September, 2001. Faced with this situation, and that the franchisees had closed down their business, the assessee was left with no other option except to write off the dues from the franchisees. The assessee filed a detailed statement, showing the names of the franchisees, the amount due from them, the security deposit adjusted and the net amount written off. Such course was adopted by the assessee, on the contention that there had been a serious fall in the income earned by these franchisees. They also felt that the closure of the business by the franchisees had also motivated them to write it off as bad debt. The assessing authority took the view that the assessee-company had taken a unilateral decision of closing the accounts of the franchisees and thereby claimed the debts as bad. Hence, the assessing authority rejected the plea and disallowed the claim of bad debts, thus resulting in addition of a sum of Rs. 51,57,365 to the assessee's total income.

4. Aggrieved by the above, the assessee preferred an appeal before the Commissioner of Income-tax (Appeals)-III. In the course of hearing before the first appellate authority, the Commissioner of Income-tax called for a report from the Assessing Officer, wherein it was stated that mere writing off of the amount from the assessee's books of accounts as a bad debt was not acceptable and, hence, unless and until the assessee proved that the debt really became a bad debt and in the absence of any satisfactory proof to that extent, the claim, as such, could not be granted. The first appellate authority, by his order, dated November 24, 2005, confirmed the order of the assessing authority, stating that there was no considerable force in the submission of the assessee.

5. The aggrieved assessee preferred a further appeal before the Tribunal. The Tribunal considered the decision relied on by the Revenue in the case of Commissioner Of Income-Tax v. Micromax Systems P. Ltd., [2005] 277 ITR 409 (Mad) and South India Surgical Co. Ltd. v. ACIT, [2006] 287 ITR 62 (Mad), and pointed out that as against the total receipts from the franchisees at Rs. 51,47,980 in the year 2000-01, there was a considerable fall in the year 2001-02 at Rs. 11,63,247; that considering such a huge fall in the business, there was a clear cut case of bad debts and after the amendment of section 36(1)(vii), writing off such bad debt would entitle the assessee to claim deduction; that an assessee was not required to prove anything beyond except the honest judgment on the part of the assessee to sustain the claim. Under the circumstances, the Tribunal allowed the plea of the assessee. On the second aspect regarding the expenditure incurred on advertisement in one year and the matching fee spread over for more than one year as well as the question of the system of accounting, which is not in accordance with the matching principle, the Tribunal noted that the assessee was collecting the fee in advance and the receipts were split over the duration of the entire course. The Assessing Officer observed that the entire expenditure relating to advertisement expenses should be allowed only in the year, in which the receipts had been booked, which should be in accordance with the matching principle. The Tribunal held that the decision of the apex court in the case of Madras Industrial Investment Corporation Ltd. v. CIT, [1997] 225 ITR 802, could not be applied to the facts herein and the benefit of expenditure on advertisement would not be available on a specified future period. The Tribunal further held that the benefit would be available for a long period of time, but such period of time could not be defined by any method. The Tribunal also rejected the reliance placed on the asses-see's own case for the earlier years, on the ground that the assessee was following the cash system then. Going by the language of section 37(1) it is clear that it does not impose any condition except those that are explicitly set out in the provision that the expenditure is laid out exclusively for the purpose of business and that the expenditure being revenue in character, the mere fact that the assessee might have derived benefit in future years could not stand in the way of granting the relief on the expenditure incurred on advertisement. The Revenue has preferred this appeal on this ground also.

6. Learned standing counsel appearing for the Revenue submitted that the view of the Tribunal that the assessee would be entitled to the relief on the claim of bad debt by a mere writing off without any evidence to support the same would be totally unsustainable in law. He further submitted that amendment to section 36 does not empower the assessee to write off any amount to claim it as an automatic deduction as a bad debt. He also submitted that while the assessee had been spreading the income over the years, the deduction is claimed in the year of expenditure itself. It is also stated that the assessee neither followed the mercantile system nor cash system of accounting and that after 1997-98, the option is only either cash system or mercantile system. Under the circumstances, learned standing counsel prayed for rejection of the view of the Tribunal.

7. Section 36(1)(vii) was amended with effect from April 1, 1989. The relevant provision reads as follows:

“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.”

(emphasis1 supplied)

8. A perusal of the order of the assessing authority shows that as a matter of fact there had been a fall in the receipts of income through franchisees. Referring to the details of the income, it was stated that the assessee had been receiving sufficient amount by way of advance in the form of security deposits and, hence, there was no reason for the assessee to have bad debts for the assessment year 2002-03 of such a huge magnitude. It was further stated that after the take over of First Computers, the assessee-company had withdrawn from the business and taken a unilateral decision of closing their accounts and claimed it as bad debts.

9. A perusal of the details given before the Assessing Officer shows that there had been an actual fall in the receipts, which is said to be due to the crash in the USA having a serious impact on the business carried on. A commercial decision to close down the business was taken and thereby the account closed as part of the decision. There is no denial of this fact from the Revenue. As such, factually there is nothing for the Revenue to suspect the motive for writing off the debt. Quite apart from this, by reason of the Direct Tax Laws (Amendment) Act 1987, the question as to whether the debt has become bad or doubtful is a factual one. With the amendment that is brought in with effect from April 1, 1989, even taking the view that the benefit could not be claimed as an automatic concomitant of writing off, an honest judgment made at that time when the assessee wrote off the debt, in the light of the events leading to that stage, could not be found fault with. Under the circumstances, the claim made in terms of section 36(1)(vii) cannot be rejected.

10. Having regard to the scope of section 36(1)(vii) and the commercial decision which persuaded the assessee to write off, we do not find any question of law arising from the order of the Tribunal, for admission.

11. Learned counsel appearing for the Revenue placed reliance on CUT v. Micromax Systems P. Ltd., [2005] 277 ITR 409 (Mad) a decision of this court, relating to the assessment year 1997-98. While considering the amendment, this court held that after April 1, 1989, it is a mandatory condition that deduction actually written off and not just made as a provision, would be allowed as a bad debt.

12. Explaining the amendment, the Board issued a Circular No. 551, dated January 23, 1990 (see [1990] 183 ITR (St.) 7), which read as follows (page 37):

“The old provisions of clause (vii) of sub-section (1) read with subsection (2) of the section laid down conditions necessary for allowability of bad debts. It was provided that the debt must be established to have become bad in the previous year. This led to enormous litigation on the question of allowability of bad debt in a particular year, because the bad debt was not necessarily allowed by the Assessing Officer in the year in which the same had been written off on the ground that the debt was not established to have become bad in that year. In order to eliminate the disputes in the matter of determining the year in which a bad debt can be allowed and also to rationalise the provisions, the Amending Act, 1987, has amended clause (vii) of sub-section (1) and clause (i) of sub section (2) of the section to provide that the claim for bad debt will be allowed in the year in which such a bad debt has been written off as irrecoverable in the accounts of the assessee.”

13. Hence, given the understanding by the Board to the provisions also, this appeal fails.

14. On the second issue regarding the advertisement charges, it is seen that the assessee had changed its accounts maintenance from cash system to mercantile system. The Assessing Officer rejected the claim, on the ground that the advertisement expenses claimed by the assessee did not match the receipts. Hence, he took the view that a portion of the expenditure relating to the advertisement expenses should be allowed only in the year in which the receipts had been booked. Such method would be a perfect match of accounting the income and expenditure.

15. The first appellate authority, however, held that the stand of the assessee did not fit into the matching concept of income and expenditure and, hence, confirmed the disallowance. As far as this claim is concerned, it is not denied that the expenditure incurred was for the purpose of business and the possible benefit in future does not militate against the claim for expenditure in the present time. Hence, considering the scope of section 37, the Tribunal correctly held that the assessee was entitled to the deduction sought for.

16. When once it is admitted that the expenditure is of revenue nature and incurred fully and exclusively in the business, a further enquiry as to whether the income has flowed thereon from the expenditure, would not be a justifiable ground for rejection. On the other hand, an expenditure satisfying the character as revenue expenditure should be allowed in the assessment. In the decision in Commissioner Of Income-Tax v. Southern Roadways Ltd. reported in [2006] 282 ITR 379, this court, to which one of us was a party (Justice P.D.D), referring to a decision of the Division Bench in Commissioner Of Income-Tax v. Southern Roadways Ltd. reported in [2004] 265 ITR 404 (Mad), considered the scope of section 37 and held that any expenditure not being in the nature of capital expenditure or personal expenses but laid out or expended wholly and exclusively for the purpose of the business or profession, should be allowed.

17. As to the third question raised, the Revenue had not made a specific issue before the Tribunal, except to contend that the claim of expenditure in one year and spreading over the income in future years would amount to a hybrid system of accounting not in accordance with the matching principles. However, having regard to our decision as stated above, we do not find any justification to admit this appeal.

18. In view of what is discussed above, this appeal is dismissed at the threshold.

Commissioner Of Income-Tax v. Brilliant Tutorials P. Ltd.

Summary of Judgment: Tax Case (Appeal) No. 6 of 2007 (Decided January 29, 2007)

Factual and Procedural Background

Legal Issues Presented

Arguments of the Parties

Revenue's Arguments (Appellant)

Assessee's Arguments (Respondent)

Table of Precedents Cited

Court's Reasoning and Analysis

Holding and Implications

Commissioner Of Income-Tax v. Brilliant Tutorials P. Ltd.

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