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Commissioner Of Income-Tax v. Dunlop India Ltd.
Factual and Procedural Background
The reference arises under section 256(2) of the Income-tax Act, 1961, concerning the assessment year 1980–81 (previous year ending 31 December 1979). The assessee is a limited company engaged in the manufacture of tyres and tubes. Between November 1976 and September 1977 the assessee exported goods to various parties in Turkey amounting to Rs. 2,72,19,587. The Turkish purchasers were to pay in U.S. dollars and had deposited an equivalent amount in Turkish lira with the Central Bank of Turkey. Due to an acute foreign exchange shortage, the Government of Turkey imposed a ban on remittances and the Central Bank did not transfer the deposited amounts to India. The normal 90-day realisation period lapsed without receipt by the assessee. The Turkish lira was devalued successively five times between 27 October 1976 and 10 April 1979, reducing the lira's value to 30.66% of its pre-first-devaluation level.
During the calendar year 1979 the assessee received a letter dated 6 March 1979 from the Indian Embassy in Turkey indicating that realisation of the Turkish debts was unlikely in the foreseeable future. While finalising accounts for 1979, the assessee's directors wrote off Rs. 121 lakhs as bad debts: according to the opinion, Rs. 95 lakhs was written off from the current profit and loss account and a stated balance (variously recorded in the record) was written off from the provision for bad and doubtful debts account. The assessee claimed deduction for the bad debts written off and took them into account in the audited accounts for the year.
The Income-tax Officer (ITO) rejected the claim on the ground that recovery was still possible — reference was made to a decree of the Government of Turkey dated 25 January 1980 under which foreigners would be paid only after 54 months, in small instalments over a further period of 10 years, and negotiations by the Indian Embassy were ongoing. The assessee appealed to the Commissioner of Income-tax (Appeals) who allowed Rs. 95 lakhs as a bad debt. The Revenue appealed to the Tribunal, which allowed the full claim (Rs. 121 lakhs) as bad debt. The Revenue then referred a question to this Court challenging the Tribunal's treatment of the Rs. 95 lakhs under section 36 of the Income-tax Act.
Legal Issues Presented
- “Whether, on the facts and in the circumstances of the case, the Appellate Tribunal was justified in law in holding that the conditions laid down under section 36 of the Income-tax Act, 1961, were satisfied with regard to the debt of Rs. 95 lakhs and in that view of the matter directing the Income-tax Officer to allow deduction of Rs. 95 lakhs as bad debts?”
Arguments of the Parties
Revenue's Arguments
- The debt could be valued only in May 1981, and therefore it could not be said to have become bad or that any loss had arisen in the calendar year 1979.
- The onus of proving deductibility as a bad debt rests on the assessee, and that onus was not discharged in this case.
- The decree of 25 January 1980 of the Government of Turkey indicated that recovery was possible (payment after 54 months in instalments over 10 years) and negotiations by the Indian Embassy were ongoing — so there remained at least a slight ray of hope of realisation; hence the debt could not be held irrecoverable.
- Section 36(1)(vii) does not permit allowance of bad debt where the conclusion of irrecoverability is premature or hasty; the standard for allowing a deduction should not be unduly relaxed.
Assessee's Arguments
- The sales to the Turkish purchasers had been brought into the profit and loss account for the relevant year and the provision for bad and doubtful debts was subjected to tax in the year it was created.
- The total claimed bad debts (stated as Rs. 121 lakhs) were arrived at after valuing the Turkish lira deposits in terms of rupees as on 31 December 1979; the assessee had its bankers value the debts as of that date.
- The fact that the bankers' valuation was completed after the end of the previous year is immaterial; the write-off decision was taken by the board while finalising the accounts for the previous year.
- The decree relied upon by the Revenue was not promulgated during the previous year, and therefore could not affect the bona fide assessment made in 1979.
- The bankers' valuation indicated a drastically reduced realisable value (bankers opined that after discounting the value as on 31 December 1979 the recoverable amount would be Rs. 28,85,284), demonstrating the substantial diminution in value compared to the billed amount.
Table of Precedents Cited
| Precedent | Rule or Principle Cited For | Application by the Court |
|---|---|---|
| Devi Films Ltd. v. Commissioner Of Income-Tax, Madras, [1963] 49 ITR 874 | The assessment of whether a debt has become bad must be made with regard to the circumstances prevailing at the time the decision to write off is taken; later happenings are generally irrelevant. The standard is that of a reasonably prudent businessman or director making a bona fide assessment. | The Court applied this principle to hold that the critical inquiry is the state of affairs at the time the assessee wrote off the debt (calendar year 1979). The Court relied on the precedent to affirm that the Tribunal's fact-finding about irrecoverability in 1979 was to be respected unless shown to be perverse. |
Court's Reasoning and Analysis
The Court reviewed the rival contentions and articulated the legal standard for allowing a deduction under section 36(1)(vii): mere book write-off is not by itself conclusive, but whether a debt has become bad must be judged from the possibility of realisation at the time the decision to write off is taken. That assessment must be bona fide and guided by the reality of events up to that time; subsequent events are not generally relevant. The appropriate standard is that of a reasonably prudent businessman or company director, not an unreasonably stringent standard imposed by the Revenue.
The Court relied on the Madras High Court decision in Devi Films Ltd. to support the proposition that the inquiry centres on circumstances at the date of write-off. Applying that principle, the Court examined the Tribunal's factual finding that the letter dated 6 March 1979 from the Indian Embassy demonstrated that at least part of the amount due had become irrecoverable and bad in the calendar year 1979. The Tribunal also accepted expert quantification and found the writing off from current profits (and from provision) to be genuine.
Because the issue of whether a debt is bad is a question of fact, the Court emphasised deference to the Tribunal's factual findings: the Tribunal had found that the debt had become bad in the previous year and the Revenue had not challenged that finding as perverse or as being unsupported by evidence. The Court therefore declined to interfere with the Tribunal's fact-finding and conclusions.
Holding and Implications
Holding: The Court answered the referred question in the affirmative and against the Revenue — it upheld the Tribunal's conclusion that the conditions under section 36 of the Income-tax Act were satisfied with regard to the claimed bad debt and that the Income-tax Officer should allow the deduction (as to the Rs. 95 lakhs in question in the referred question).
Implications:
- Direct effect on the parties: The High Court upheld the Tribunal's allowance of the bad debt deduction (answering the specific question regarding Rs. 95 lakhs in favour of the taxpayer). The Court recorded that there would be no order as to costs.
- Broader implications: The Court reiterated the established factual inquiry — that the bona fide assessment of recoverability at the time of write-off governs the question of whether a debt is bad, and later events are generally not decisive. The opinion does not purport to set aside or create a new legal precedent beyond applying and following the existing principle from Devi Films Ltd.
Disposition as recorded in the opinion: The question was answered in the affirmative and against the Revenue. There will be no order as to costs. (Shyamal Kumar Sen, J. concurred.)
Ajit K. Sengupta, J.:— This reference under section 256(2) of the Income-tax Act, 1961, relates to the assessment year 1980–81, the previous year ending December 31, 1979. The assessee is a limited company deriving income from business in the manufacture of tyres, tubes, etc.
2. The assessee exported goods to several parties in Turkey between November, 1976, and September, 1977, amounting to Rs. 2,72,19,587. The parties in Turkey were to pay for the goods in U.S dollars and deposited an equivalent amount in lira in the Central Bank of Turkey. The Central Bank of Turkey, however, did not transfer the amount deposited by the purchasers in Turkey to India. In view of the extremely critical foreign exchange reserve position, the Government of Turkey imposed a ban on all remittances out of Turkey. As a result, the amount deposited in the Central Bank of Turkey remained there. The normal period of 90 days within which the sale proceeds should have been realised expired without any receipt by the assessee on account of the aforesaid ban. The assessee entered into correspondence with the Government of Turkey through the Indian Embassy there. In the meantime, the Turkish currency was devalued successively on five occasions between October 27, 1976, and April 10, 1979, with the result that the value of lira came down to 30.66 per cent. of its value prior to the first devaluation. As a result, the value of lira deposited by the purchasers came down in terms of U.S dollars and also, as a consequence, in terms of rupees. During the calendar year 1979, which is the previous year under consideration, the assessee received a letter dated March 6, 1979, from the Indian Embassy in Turkey saying that there was no chance of realising the Turkish debts in the foreseeable future due to acute foreign exchange shortage. The directors of the assessee-company, while finalising the accounts for the calendar year 1979, took note of the above fact and wrote off a sum of Rs. 121 lakhs as bad debt. A sum of Rs. 95 lakhs was written off from the current profit and loss account and the balance of Rs. 20 lakhs was written off from the provision for bad and doubtful debts account. The assessee claimed deduction for bad debt of Rs. 121 lakhs which was actually written off from the books and taken into account in the audited profit and loss account and balance-sheet of the year under consideration. The Income-tax Officer rejected the claim on the ground that there was a chance of recovery of the amount because of the decree dated January 25, 1980, of the Government of Turkey under which the debts of the foreigners would be paid only after 54 months, and that too, in small instalments over a period of further 10 years and that negotiations were being carried on by the Indian Embassy in Turkey.
3. The assessee filed an appeal to the Commissioner of Income-tax (Appeals) who allowed the sum of Rs. 95 lakhs as bad debt which had arisen in the calendar year 1979 and had been written off from the books.
4. Being aggrieved, the Revenue went in appeal before the Tribunal. The Tribunal observed that the conditions for allowing the bad debt as deduction had been fulfilled in this case. It was the letter dated March 6, 1979, that convinced the assessee that at least a part of the amount due from the Central Bank of Turkey had become irrecoverable and bad. This event occurred in the calendar year 1979. The quantification had been properly made by an expert and no flaw had been found therein. Further, the sum of Rs. 95 lakhs had been written off from the current profits. It, therefore, upheld the allowance of Rs. 95 lakhs as bad debt given by the Commissioner of Income-tax (Appeals).
5. It is in this context, the following question has been referred to this court at the instance of the Revenue.
“Whether, on the facts and in the circumstances of the case, the Appellate Tribunal was justified in law in holding that the conditions laid down under section 36 of the Income-tax Act, 1961, were satisfied with regard to the debt of Rs. 95 lakhs and in that view of the matter directing the Income-tax Officer to allow deduction of Rs. 95 lakhs as bad debts?”
6. Counsel for the parties repeated their contentions urged before the Tribunal. On behalf of the Revenue, it was pointed out that the debt could be valued by the assessee only in May, 1981. Therefore, the debt could not become bad nor could any loss be said to have arisen during the calendar year 1979. It has further been urged that the onus of proving the deductibility of debt as bad debt rests on the assessee and in this case the onus has not been discharged. The circumstances rather show that the recovery did not really prove to be chanceless because a decree dated January 25, 1980, of the Government of Turkey could be taken out. Under the decree the foreigners are entitled to be paid only after 54 months over a period of further 10 years in small instalments and negotiations were still being carried on by the Indian Embassy in Turkey during the previous year for salvaging the assessee's dues. So long as there is a slight ray of hope of realising the debt, the debt could not be said to have become bad. The law as envisaged in section 36(1)(vii) does not contemplate the admissibility of a claim of bad debt even where the conclusion as to irrecoverability of the debt is manifestly premature and hasty.
7. Dr. Pal appearing for the assessee on the other hand has contended that there was no dispute that the sales made by the assessee-company to the Turkish purchaser formed part of the sale proceeds of the relevant year and thus entered into the profit and loss account nor is there any dispute over the fact that the provision made for bad and doubtful debts was subjected to tax in the year in which the provision was created. Thus, the entire sum of Rs. 121 lakhs which the assessee claims as having become bad was arrived at after valuing the lira deposited in the bank in Turkey in terms of rupees on December 31, 1979. The assessee got the debts as on December 31, 1979, valued by its bankers. It is an immaterial consideration that the said valuation was arrived at subsequent to the expiry of the previous year. The decision for the write off of the debt as bad debt was taken by the board of directors while finalising the accounts. The decree referred to by the Revenue is of no bearing as during the previous year there was no decree promulgated by the Government of Turkey. He further pointed out that the assessee got the debts as on December 31, 1979, valued by its bankers who opined that after discounting the value as on December 31, 1979, the same would be only Rs. 28,85,284 which was less than the billed amount of Rs. 2,72,19,587 by Rs. 2,43,34,303.
8. The assessee claimed the aforesaid sum of Rs. 2,43,45,303 as business loss arising in the calendar year 1979. Alternatively, it claimed deduction for bad debt of Rs. 121 lakhs which was actually written off from the books and taken into account in the profit and loss account and balance-sheet of the year under consideration.
9. The Income-tax Officer rejected both the claims of the assessee on the ground that proper quantification of the loss was not made and that there was a chance of recovery of the amount because of the decree dated January 25, 1980, of the Government of Turkey and the negotiations which were being carried on by the Indian Embassy in Turkey.
10. The Commissioner of Income-tax (Appeals) found that no trading loss could be claimed in the calendar year 1979 because the transactions were made in the calendar years 1976 and 1977. However, coming to the alternative claim for bad debt, the Commissioner of Income-tax (Appeals) allowed the sum of Rs. 95 lakhs as bad debt which had arisen in the calendar year 1979 and had been written off from the books. Regarding the balance sum of Rs. 26 lakhs, the Commissioner of Income-tax (Appeals) disallowed the same on the ground that the assessee did not write off the same from the books of account and so one of the essential conditions for allowing deduction for bad debt was not satisfied in respect of the said amount of Rs. 26 lakhs.
11. The Tribunal by a consolidated order allowed the ientire claim of Rs. 121 lakhs as bad debt. The Tribunal did not allow the claim of the assessee as a trading loss, as according to the Tribunal, there is no provision in the Income-tax Act to allow the business loss part by part in a piecemeal way. However, the Tribunal allowed the claim for bad debt as a deduction as, according to the Tribunal, all the conditions for allowing such bad debt have been fulfilled. It was the letter dated March 6, 1979, that convinced the assessee that at least a part of the amount due from the Central Bank of Turkey had become irrecoverable and bad. This event occurred in the calendar year 1979. The quantification has been properly made by an expert and no flaw has been made therein. The sum of Rs. 26 lakhs had also been written off from the books of the assessee and it is apparent from Note No. 12 in the printed accounts appearing at page 28 thereof. The only difference is that while a sum of Rs. 95 lakhs has been written off from the current profit, the balance of Rs. 26 lakhs had been written off from the taxed provision for bad and doubtful debts made in the calendar year. Hence, the Tribunal accepted the alternative contention of the assessee. In other words, the Tribunal did not uphold the disallowance of business loss but upheld the allowance of Rs. 95 lakhs as bad debt given by the Commissioner of Income-tax (Appeals) and in addition also upheld the allowance of a further sum of Rs. 26 lakhs as a deduction for bad debts.
12. We have considered the rival contentions. True, the assessee must establish that the debt in question has become in fact a: bad debt. It is not that the mere fact of the debt having been written off in the books by the assessee is sufficient for the claim that deduction under the provisions of section 36(1)(vii) as bad debt is allowable. But the question whether a debt has become bad or not must be decided from the point of view of the possibility of the realisation of the debt and the assessment of such possibility has to be first a bona fide assessment and the decision to write off being dictated by the reality in the light of the events till the time the decision is taken. Later happenings would not be relevant. This principle is laid down by the Madras High Court in the case of Devi Films Ltd. v. Commissioner Of Income-Tax, Madras., [1963] 49 ITR 874. Therefore, we shall have to direct our attention to the true state of circumstances that obtained at the time the trader wrote off the debt. But the standard with which the assessment with regard to recoverability of the debt is to be made cannot be too rigid a standard as the Revenue may adopt; the standard has to be the standard of a reasonably prudent businessman or director of a company coming to the conclusion that the debt is irrecoverable depending on the facts and circumstances of each case.
13. In any case, whether a debt has become bad in a particular year is purely a question of fact and the Tribunal has found as fact that the amount of debt for which the deduction has been claimed as bad debt has really become bad during the previous year and we do not feel called upon to interfere with that fact-finding which has not been challenged by the Revenue as perverse. The Tribunal's finding has not been assailed as based on no evidence or on considerations partly relevant or partly irrelevant. Unless it is specifically assailed to be a finding of fact vitiated by perversity, that finding has to be accepted as final.
14. In that view of the matter, we answer the question in the affirmative and against the Revenue. There will be no order as to costs.
Shyamal Kumar Sen, J.:— I agree.
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