Itxa/70/2004 Of M/S. L.k.p. Merchant Fincing Ltd v. Dy. Commissioner Of Income-Tax, Special Range

Digitallysigned byNIKITANIKITAYOGESHYOGESHGADGILGADGILDate:2022.07.1815:31:41+0530 ITXA-70-2004-Judgment.odt IN THE HIGH COURT OF JUDICATURE AT BOMBAY ORDINARY ORIGINAL CIVIL JURISDICTION INCOME TAX APPEAL NO. 70 OF 2004 M/s. L.K.P. Merchant Financing Ltd.203, Embassy Center, Nariman Point,Mumbai – 400 021. …Appellant V/s.The Dy. Commissioner of Income Tax,Special Range – 34, Mumbai. …Respondent ------- Ms.Dinkle Hariya a/w Ms.Rashmi Vyas i/b. Mr.Vipul B. Joshi for theAppellant.Mr.Vikas T. Khanchandani for the Respondent. ------- CORAM : DHIRAJ SINGH THAKUR &ABHAY AHUJA, JJ. RESERVED ON : 6[th] JULY 2022 PRONOUNCED ON : 18[th] JULY 2022 JUDGMENT : (PER ABHAY AHUJA, J.) 1.This is an Appeal, filed under Section 260A of theIncome Tax Act, 1961 (“the Act”) by M/s. L.K.P. MerchantFinancing Ltd., being aggrieved by an order dated 28[th] July, 2003,passed by the Income Tax Appellate Tribunal, Mumbai in IncomeTax Appeal No.5403/M/97 for Assessment Year 1991-92. 1 of 16 2.The Appeal came to be admitted on 29[th] November, 2004 on the following substantial question of law: “Whether, in the facts and circumstances of the case andin law, the order of the Tribunal confirming the action ofthe Assessing Officer in rejecting the claim of theappellant for deduction of bad debt written off u/s. 36(i)(vii) of the Act, is bad in law?” 3.The Appellant statedly is a Public Limited Company registered as a Non Banking Finance Company engaged in thebusiness inter alia of lease finance. 4.For the Assessment Year 1991-92, the AppellantCompany filed a return showing “nil” income. The return wasprocessed under Section 143(1)(a) of the Act. Subsequently,proceedings under Section 147 of the Act were initiated by issuanceof a notice under Section 148 of the Act as the Assessing Officer hadreason to believe that income chargeable to tax had escapedassessment. In the re-assessment proceedings, the assessee wasassessed to a sum of Rs.20,69,805/- which is the dispute havinggiven rise to the question of law in this Appeal. 5.Earlier, on December 19[th], 1987, a lease agreement wasentered into between the Appellant and one M/s.Orson Electronics 2 of 16 ITXA-70-2004-Judgment.odt Ltd., as lessee to transfer the right to use of certain equipments byway of lease. As per the terms of the lease deed, order formanufacturing and supply of the equipment was placed on threeconcerns to whom, the Appellant-assessee made payments on behalfof lessee. The first installment of lease amount was received by theAssessee. Further installments due were also accounted for asincome in the respective years, as per the mercantile system ofaccounting although the lessee defaulted in payment of furtherinstallments. The following lease incomes were offered forassessment: 6.It is the case of the Appellant that in view of the defaults in payment of the balance installments, the assessee approachedthis Court seeking winding up of M/s.Orson Electronics Ltd., andappointment of Official Liquidator to safeguard the interest of thecreditors. That in view of the dispute that arose, the assessee 3 of 16 ITXA-70-2004-Judgment.odt company wrote off the amount of Rs.20,69,805.30 (23,62,875.10minus 2,93,069.80) asbad debt during the previous year relevantto A.Y.1991-92. 7.In the re-assessment, the Assessing Officer held that asper the mercantile system of accounting followed by the assessee,the accrued lease incomes were taxable in the respective years. Thewriting off was not allowed by the Assessing Officer observing thatin view of the pendency of the dispute of the assessee before theHigh Court, the assessee had not foregone its right to claim the leaserentals and that the write off was premature. 3 of 16 ITXA-70-2004-Judgment.odt company wrote off the amount of Rs.20,69,805.30 (23,62,875.10minus 2,93,069.80) asbad debt during the previous year relevantto A.Y.1991-92. 7.In the re-assessment, the Assessing Officer held that asper the mercantile system of accounting followed by the assessee,the accrued lease incomes were taxable in the respective years. Thewriting off was not allowed by the Assessing Officer observing thatin view of the pendency of the dispute of the assessee before theHigh Court, the assessee had not foregone its right to claim the leaserentals and that the write off was premature. 8.The assessee filed an Appeal before the Commissioner ofIncome Tax (Appeals) and vide order dated 21[st] May, 1997, theCommissioner of Income Tax (Appeals) partly allowed the Appeal ofthe assessee directing the Assessing Officer to allow deduction of anamount of Rs.20,69,805/- to be written off by the assessee in itsbooks of account for the Assessment Year 1991-92 observing thatthe lease rentals offered as income on mercantile basis can bedefinitely said to have become bad from the business point of view ofthe assessee and the assessee’s subsisting right to recover the 4 of 16 ITXA-70-2004-Judgment.odt amount and the pendency of the matter before the High Court werenot valid grounds to postpone writing off of the amounts in questionwhich had been offered for taxation in the earlier years. 9.Aggrieved by the said order, the Revenue carried theorder of the Commissioner of Income - Tax (Appeals) – II, Mumbaiin appeal, before the Income Tax Appellate Tribunal, Mumbai. TheIncome Tax Appellate Tribunal allowed the Revenue’s Appeal andreversed the order of the Commissioner of Income – Tax (Appeals).It was held that the assessee’s attempt to reverse the entry to claimbad debt, was against the established principle of accountancy.Further, it was observed that since the assessee was maintainingmercantile system of accounting and if such reversal was allowed,then it would be a clear violation of the method of accountingadopted by the assessee and even if the claim of the assessee inrespect of bad debt may be correct, the same could not beconsidered as the assessee had accounted for lease rentals and hasalso claimed depreciation. 10.Aggrieved by the aforesaid order of the Tribunal, theassessee has approached this Court by filing this Appeal impugning 5 of 16 ITXA-70-2004-Judgment.odt the Tribunal order on inter alia the aforementioned substantialquestion of law. 11.Ms.Dinkle Hariya, learned Counsel for the Appellantsubmits that since the Assessment Year in question is 1991-92 andas per the amended Section 36(1)(vii), after 1[st] April, 1989, it is notnecessary for the assessee to establish that the debt has in factbecome irrecoverable, it is enough if the bad debt is written off asirrecoverable in the accounts of the assessee. Learned Counseldraws the attention of this Court to the decision of the Hon’bleSupreme Court in the case of T.R.F. Ltd. V/s. Commissioner ofIncome-tax [(2010) 190 Taxman 391 (SC)] in support of hercontentions. 12.On the other hand, Mr.Vikas Khanchandani–learnedStanding Counsel for the Revenue would submit that the very factthat the assessee has reversed the entry to the claim of bad debt ascan be seen from Note – 5 to the Notes to the Accounts in Schedule –17 forming part of the accounts as on 31[st] March, 1991 of theassessee, there has been a violation of the mercantile method ofaccounting adopted by the assessee and therefore, the Tribunal has 6 of 16 ITXA-70-2004-Judgment.odt 12.On the other hand, Mr.Vikas Khanchandani–learnedStanding Counsel for the Revenue would submit that the very factthat the assessee has reversed the entry to the claim of bad debt ascan be seen from Note – 5 to the Notes to the Accounts in Schedule –17 forming part of the accounts as on 31[st] March, 1991 of theassessee, there has been a violation of the mercantile method ofaccounting adopted by the assessee and therefore, the Tribunal has 6 of 16 ITXA-70-2004-Judgment.odt rightly rejected the assessee’s claim. He submits that the AssessingOfficer has disallowed the debt as a bad debt after arriving at aconclusion that the decision of the assessee to write off the debt asirrecoverable was not bona fide inasmuch as the assessee hadsought to reverse the entry to the claim of bad debt. He submits thatthe Tribunal has also rightly set aside the decision of theCommissioner (Appeals). He further submits that the written offdebt has to be a bad debt and not any kind of debt can be written offas can be seen from the language of the said provision. In support ofhis contention, learned Standing Counsel refers to a decision of thisCourt in the case of Director of Income Tax V/s. Oman InternationalBank SOAG [2009(5) Bom.C.R.416]. He however fairly states thatnotwithstanding the aforesaid objection, the requirement of Section36(1)(vii) of the Act after the amendment only requires the writingoff of the bad debt as irrecoverable as it is not necessary for theassessee to establish that in fact the debt has become irrecoverable. 13.We have heard Ms.Dinkle Hariya, learned Counsel forthe Appellant and Mr.Vikas Khanchandani learned StandingCounsel for the Revenue and with their able assistance, we haveperused the papers and proceedings in the matter. 7 of 16 ITXA-70-2004-Judgment.odt 14.Facts being undisputed, the only issue that arises for ourconsideration is whether the Tribunal was right in rejecting theclaim of the assessee for deduction of bad debt written off under Section 36 (1)(vii) of the Act. 15.Section 36(1)(vii) of the Act is quoted as under: Other deductions. 36.(1) The deductions provided for in the followingclauses shall be allowed in respect of the matters dealtwith therein, in computing the income referred to insection 28- (i) to (vi)….. (vii) subject to the provisions of sub-section (2), theamount of any bad debt or part thereof which is writtenoff as irrecoverable in the accounts of the assessee forthe previous year: Provided that in the case of an assessee to which clause (viia) applies, the amount of the deduction relating toany such debt or part thereof shall be limited to theamount by which such debt or part thereof exceeds thecredit balance in the provision for bad and doubtfuldebts account made under that clause: Provided further that where the amount of such debt orpart thereof has been taken into account in computingthe income of the assessee of the previous year in whichthe amount of such debt or part thereof becomesirrecoverable or of an earlier previous year on the basisof income computation and disclosure standards notifiedunder sub-section (2) of section 145 without recordingthe same in the accounts, then, such debt or part thereofshall be allowed in the previous year in which such debtor part thereof becomes irrecoverable and it shall bedeemed that such debt or part thereof has been writtenoff as irrecoverable in the accounts for the purposes ofthis clause. [Explanation 1.]—For the purposes of this clause, anybad debt or part thereof written off as irrecoverable in 8 of 16 ITXA-70-2004-Judgment.odt the accounts of the assessee shall not include anyprovision for bad and doubtful debts made in theaccounts of the assessee. [Explanation 1.]—For the purposes of this clause, anybad debt or part thereof written off as irrecoverable in 8 of 16 ITXA-70-2004-Judgment.odt the accounts of the assessee shall not include anyprovision for bad and doubtful debts made in theaccounts of the assessee. [Explanation 2.]—For the removal of doubts, it is herebyclarified that for the purposes of the proviso to clause(vii) of this sub-section and clause (v) of sub-section (2),the account referred to therein shall be only one accountin respect of provision for bad and doubtful debts underclause (viia) and such account shall relate to all types ofadvances, including advances made by rural branches;” 16.The above provision was brought into effect from 1[st]April, 1989 by the Direct Tax Laws (Amendment) Act, 1987. Priorto the amendment, any debt which is established to have become abad debt in the previous year could be allowed as a deduction.However, after 1[st] April, 1989, it is not necessary for an assessee toestablish that the debt has become irrecoverable. Paragraph 4 ofthe decision of the Hon’ble Supreme Court in the case of T.R.F. Ltd.V/s. Commissioner of Income-tax (supra)is apt and is quoted asunder: “4. This position in law is well-settled. After 1-4-1989, itis not necessary for the assessee to establish that thedebt, in fact, has become irrecoverable. It is enough ifthe bad debt is written off as irrecoverable in theaccounts of the assessee. However, in the present case,the Assessing Officer has not examined whether the debthas, in fact, been written off in accounts of the assessee.When bad debt occurs, the bad debt account is debitedand the customer's account is credited, thus, closing theaccount of the customer. In the case of companies, theprovision is deducted from sundry debtors. As statedabove, the Assessing Officer has not examined whether, 9 of 16 ITXA-70-2004-Judgment.odt in fact, the bad debt or part thereof is written off in theaccounts of the assessee. This exercise has not beenundertaken by the Assessing Officer. Hence, the matteris remitted to the Assessing Officer for de novoconsideration of the above-mentioned aspect only andthat too only to the extent of the write off.” 17.This Court in the case of Director of Income Tax V/s.Oman International Bank SOAG (supra) had the occasion toconsider what is ‘bad debt’. Paragraph 10 of the said decisiondescribes bad debt to be a debt that cannot be recovered. A debtbecomes bad debt when the creditor has no reasonable chance ofrecovering it from the debtor. It is a debt which cannot reasonablybe collected nor is there any reasonable expectation of recovery.Expanding further with respect to the provisions of Section 36(1)(vii), in Paragraph 11, this Court observed that when the assesseetreats the debt as a bad debt in his books, the decision has to be abusiness or a commercial decision and cannot be whimsical orfanciful. The decision must be based on material that the debt is notrecoverable. The decision must be bona fide. This Court observedthat the difference between the position, pre-amendment and postamendment would be that the burden is no longer on the assesseeand can be claimed in the year it is written off in the books ofaccount as irrecoverable. If the A.O. is to disallow a debt as a bad 10 of 16 ITXA-70-2004-Judgment.odt debt, he must arrive at a conclusion that the decision to treat a debtas bad debt was not bona fide. The obligation on the assessee is thathe must be prima facie satisfied based on information available thatthe debt is bad and that would be sufficient requirement of theamended provisions. Paragraphs 10 and 11 of the said decision are usefully quoted as under: 10 of 16 ITXA-70-2004-Judgment.odt debt, he must arrive at a conclusion that the decision to treat a debtas bad debt was not bona fide. The obligation on the assessee is thathe must be prima facie satisfied based on information available thatthe debt is bad and that would be sufficient requirement of theamended provisions. Paragraphs 10 and 11 of the said decision are usefully quoted as under: 10.Let us refer to some Dictionary meanings of theword "bad debt". Chambers 20[th] Century Dictionaryrefers to bad debt as "A debt that cannot be recovered".Mitra’s Legal & Commercial Dictionary refers to baddebt as "A debt becomes bad debt when the Creditor hasno reasonable chance of recovering it from the debtor asheld in (Deoniti Prasad Vs. Commissioner of IncomeTax), A.I.R. 1953 Pat. 360. The Law Lexicon refers tobad debt as “Debt which cannot reasonably be collected.A debt about which there is no reasonable expectation ofrecovery; A debt believed to be unrecoverable.”Reference may also be made to page 878 of the "Law andPractice of Income Tax Law by Kanga, Palkhiwala andVyas, 9[th] Edition, where the learned Jurist opined asunder:- "Under the amended clause, the requirement of"establishing" that the debt had become bad in therelevant accounting year is dispensed with; all thatthe assessee has to show is that the bad debt has beenwritten off as irrecoverable. But the subject-matter ofthe Clause is still “any bad debt” and “not any debt”.The consequences of the amendment are mainlythree: (ii) The assessee cannot arbitrarily, irrationally ormala fide treat a good debt as bad write it off in hisaccounts.,(iii) Where the assessee has acted bona fideand reasonable, the Assessing Officer cannotsubstitute his own subjective judgment, but must 11 of 16 ITXA-70-2004-Judgment.odt accept the assessee’s decision, as to the quality of thedebt. (iv) The assessee is not obliged to write off and claimthe debt in the very year in which it becomes bad. Hecan write it off and claim it in a subsequent year inwhich the debt continues to remain bad. 11.All this would indicate that when the assesseetreats the debt as a bad debt in his books the decisionwhich has to be a business ors commercial decision andnot whimsical or fanciful. The decision must be based onmaterial that the debt is not recoverable. The decisionmust be bona fide. The difference between the position,pre-amendment and post amendment would be that theburden is no longer on the assessee and can be claimedin the year it is written off in the books of accountirrecoverable. The A.O. if he is to disallow the debt as abad debt must arrive at a conclusion that the decisionwas not bona fide. The A.O. only in those circumstancesand to that extent may interfere. All that the assesseemust do is to be prima facie satisfied based on theinformation available that the debt is bad and that wouldbe sufficient requirement of the amended provisions.” 18.With the above prefatory discussion on the settledprinciples with regard to Section 36(1)(vii), post amendment, let usexamine the facts of this case with reference to these principles. 19.The assessee had entered into a lease agreement withM/s.Orson Electronics Ltd., the lessee, to transfer the right to use byway of lease of certain equipment for which, it had already madepayments to the suppliers. It received one installment from thelessee but did not receive payment of the further installments on 12 of 16 ITXA-70-2004-Judgment.odt 18.With the above prefatory discussion on the settledprinciples with regard to Section 36(1)(vii), post amendment, let usexamine the facts of this case with reference to these principles. 19.The assessee had entered into a lease agreement withM/s.Orson Electronics Ltd., the lessee, to transfer the right to use byway of lease of certain equipment for which, it had already madepayments to the suppliers. It received one installment from thelessee but did not receive payment of the further installments on 12 of 16 ITXA-70-2004-Judgment.odt which, lessee had defaulted. The assessee following the mercantilesystem of accounting offered these incomes totaling toRs.23,62,815.10 as set out earlier in the Assessment Years 1987-88, 1988-89 and 1989-90. However, in view of the dispute with thelessee, the assessee filed a winding up petition against the lessee inthe Bombay High Court. It is not in dispute that the assessee hadentered into a bona fide lease agreement with the lessee or that ithad paid amounts to the suppliers of the equipment on behalf of thelessee. The first installment of the lease amount was received by theassessee. Further installments due were also accounted for in viewof the mercantile system of accounting followed by the assessee.The depreciation was also claimed by the assessee on the equipmentwhich was not disallowed by the Assessing Officer. The legal disputebetween the assessee and the lessee was pending in the BombayHigh Court. It is recorded in the order of the Commissioner ofAppeals that the lessee company had become a sick company.Obviously, the prospects of recovery of lease rentals were quitebleak and the assessee considering that the same could not berecovered in the foreseeable future decided to write off a debt ofRs.20,69,859.30 as bad debt during the previous year relevant tothe Assessment Year 1991-92. It is nobody’s case that the assessee 13 of 16 ITXA-70-2004-Judgment.odt had not complied with the provisions of Section 36(2) of the Act.The assessee took a business decision to write off the debt as a baddebt. Wise businessman would not want to spend good money inlitigating for a bad bargain especially in the light of the facts notedabove. Having taken the commercial decision to write off the debt asa bad debt based on the material, cannot lead to a conclusion thatthe decision was notbona fide. The lease rentals ofRs.20,69,805.30/- offered as income by the Appellant on mercantilebasis had become bad and the Appellant decided to write it off anddid write off the same in its books of accounts in the previous yearin relation to A.Y. 1991-92 in terms of the amended Section 36(1)(vii). In our view, no fault can be found with the same. 20.Coming to the issue of reversal of lease rentals totalingto Rs.20.69 lakhs, that may be a change of the method of accountingby the assessee from mercantile to cash and may even be a breachof the accounting principles. However, that in our view is not arequirement of Section 36(1)(vii) of the Income Tax Act forallowing a debt as a bad debt. In fact, what emerges from Note-5 ofmaking a special mention is that a prudent practice has beenadopted by a limited company of informing its shareholders about 14 of 16 ITXA-70-2004-Judgment.odt the remote possibility of recovery of the said amounts and thedecision to reverse and that the same would be accounted for as andwhen received. 21.The reliance by the Tribunal on the decision ofCommissioner of Income - Tax V/s. Coates of India Ltd. [1998 232ITR 324 Cal], in our view is also misplaced. We observe that the saiddecision was rendered with respect to the facts of a case relating tothe pre-amended Section 36(1)(vii) and not to the post amendedsituation and is therefore distinguishable. Moreover, in view of whatwe have already observed with respect to the bona fide nature of thedecision by the assessee to write off the debt as irrecoverable, thesaid decision would not further the case of the Revenue. 14 of 16 ITXA-70-2004-Judgment.odt the remote possibility of recovery of the said amounts and thedecision to reverse and that the same would be accounted for as andwhen received. 21.The reliance by the Tribunal on the decision ofCommissioner of Income - Tax V/s. Coates of India Ltd. [1998 232ITR 324 Cal], in our view is also misplaced. We observe that the saiddecision was rendered with respect to the facts of a case relating tothe pre-amended Section 36(1)(vii) and not to the post amendedsituation and is therefore distinguishable. Moreover, in view of whatwe have already observed with respect to the bona fide nature of thedecision by the assessee to write off the debt as irrecoverable, thesaid decision would not further the case of the Revenue. 22.In our view, the finding of the Tribunal that the claim ofthe assessee in respect of bad debt cannot be considered, is withoutany basis. Once, a business decision has been taken to write off adebt as a bad debt in its books which decision as discussed above, isbona fide, that in our view, should be sufficient to allow the claim ofthe assessee. The method of accounting has no relevance to theissue. In our view, the Tribunal has misdirected itself in proceedingto give precedence to accounting principles over clear statutory 15 of 16 ITXA-70-2004-Judgment.odt provisions. Evidently, the written off lease rental amount has notbeen reversed from the income entry in Schedule-16. This is a clearcase of writing off a bad debt in accordance with the provision ofSection 36(1)(vii) of the Income Tax Act. The Tribunal has erred inrejecting the claim of the assessee for deduction of bad debt writtenoff under Section 36(1)(vii) of the Act. The substantial question oflaw framed in this Appeal is accordingly answered in favour of theAppellant Assessee and against the Revenue. 23.The order of the Tribunal dated 28[th] July, 2003 passedin Income Tax Appeal No.5403/M/97 is hereby set aside. TheAssessing Officer is directed to allow the claim of bad debt ofRs.20,69,805/- and pass an appropriate Assessment Order inaccordance with the aforesaid decision. 24.The Appeal is allowed in the above terms. No costs. (ABHAY AHUJA, J.) (DHIRAJ SINGH THAKUR J.) 16 of 16