ASSOCIATED CANKING CORPORATION OF INDIA Lm. A v. COllMISSIO:"iER OF INCOME-TAX, BOMBAY-1. October 22, 1964 (K. SUBBA RAO, J.C. SHAH A1'D S. M. S!KRI JJ.) lneome Tax Act (11 of 1922), ss. 10(1) and 10(2) (xi) and (xv)- Scope ,,f-Bad debts-If should be written off before claim is al/owed- Bank-1~·,nbczzlement by officer-I/ trad,ing loss-T;nie of occurrence. The :tsscsscc was a Bank in liquidation.
The official Jiquidator sub- mitted ;1 return for the assessment year 194849 and claimed ao;; deductions : (i) under s. 10(2)(xi) of the Indian Income-tax Act, 1922, debts due to the Bank which had become irrecoverable. and (ii) under s. I0(2)(x•'), certain arnounts embezzled by one of its otliccrs and v.·hich the bank had to pay to its constitucnLs. ·rhc income-tax authorities and the Appellate Tribun:U rejected the claim for aUowance of. bad debts on tho cround that the b::id debts h:id not been v.·rittcn off in the books of account of the bank. ·rhey also rcjcc1c<l 1hc claim for allo\\'ance of the embezzled amounts on the grounds that those amour.ts did not relate to the business of the bank and that, in any event, the Joss, not having been ascertained in the year of account w;is not suffered in that year.
\Vhcn the matt~rs \Vere referred to lhc High (~ourt, rhc Court asked for a report from the ·rribUna] as to: (i) "hc•hcr any de!11s had ac1ually hecome irrec.overable, and (ii) the year in which lo~~' \va~ suffered by the ht1nk in consequence of the cmbc1zlcmcnts. The Tribunal reported that debls ag~regating to Rs. 15,00.000 at least, had l>cwmc irrecoverable in the year of aocount, and that the defalcations by the h:mk's ofiicer became known to the liquidator only after the ending of the year of account.
After the receipt of the report, the High Court decided against the asscsscc holding that (i) the bad debts were not admis- iiblc deductions because they were never written off, and (ii) the loss to the hank on account of the dcfalcation.s occurred later than the year of account. The as.sc-;scc appealed to the Supreme Court.
HELD: (i) The hank was entitled to claim Rs. 15,00,000 as bad debts in the yc;ir o( account. [802 F-G] Section 10(2) (xi) does not say that the income-tax officer cannot allow a bad or doubt(ul debt unless it is written off in the hooks of account; it merely stales that he •hall not allow any amount in excess of the amount actually \vrittcn off as irrecoverable.
If .there is a reasonabJe explanation for the ahscnce of an entry writing off the amount of a debt, such absence hy its~lf is not a ground fOr denying to the officer, jurisdiction to estimate the an1ounrs of dehls \\rhich have become irrecoverable and to allow them as proper deductions in the computation of profits.
The officer's power is rC"Strictcd only in one direction, namely, that, when the assessee has posted an entry or entries in his books of account, the amount to be estimated as irrecoverable is not to exceed the amount actually written off by the asses.see. Thal dncs not mean that an assessee who chooses not to post an entry is in a helter position than one who has actually posted entries, because, h1: :ilv.:;1vs nins the risk of the inc.omc-tax officer coming to the conclusion that the fact thot he had not chosen to post an entry i• consistent with the lindin1: that no port of the debt due to him has become irre"..<>verable. (794 ff
E-F; 796 D-f; 797 G-H; 798 n-CJ Brgg Dunlop n11d c·o. Lril. v. Con1missioner oj Excess Profits Tax, West Brngal. ( 1954) c5 J.T.R c76, approved. ASSOCIATED BANKING CORP. V. C.I.T. (Shah /.)
(ii) The bank was not entitled to claim as a business losa or deduction c the amount embezzled by the officer. [802 G] Loss had been suffered by the bank as a result of the defalcations by ill officer, but the withdrawal and misapplication of the funds came to the liquidator's knowledge only after the accounting year, and &o, the amount would not be a permissible deduction under s. 10 (2) (xv) of the Act. Though the embezzlements took place in 1946, they were then unknown to the bank; and even after they became known to the liquida- tor, a tra\)ing loss could not be deemed to have resulted. A trading los• does not occur. to a bank as soon as embezzlement takes place of its funds, whether or not. the bank was aware of it.
So long as there was a realion- able prosp~ct of recovering the amounts, trading loss, in a commercial .ense, would not be deemed to h.-·e resulted. [800 D; 801 <{-HJ M. P. Venkatachalapathy lyt!r v. Commissioner of Incom~~ta.x, Madras. (1951) 20 I.T.R. 363, approved.
CIVIL APPELLATE JURISDICTION : Civil Appeal No. 956 of 1963. Appeals from the judgment and order dated April 22, 1960, of the Bombay High Court in Income-tax Reference No. 72 of 1957.
:r A. V. Viswanatha Sastri, J. B. Dadachanjl, 0. C. Mathur and Ravinder Narain for the appellant. C. K. Daphtary, Attorney-General, K. N. Rajagopala Sastri, R. H. Dhebar and R. N. Sachthey, for the respondent.
The Judgment of the Court was delivered by Shah J. One M. C. Javeri was appointed Secretary to the Associated Banking Corporation of India Ltd., and under a power of attorney dated August 14, 1943 he was entrusted with powers, amongst others, to supervise, manage and conduct the business, to lend and make at. such rate or rates or interest as he thought fit with or without security to any person, and to receive and give good discharge for repayment of any moneys so lent or advanced and all interest thereon and to borrow money upon the security of any securities, assets or property of the Bank and upon such terms as he thought fit for the benefit. of the Bank.
On March C: 5, 1945 Javeri was appointed a Director of the Bank. On April 21, 194 7 by order of the High Court of Bombay the Bank was ordered to be compulsorily wound up and an Official Liquidator was appointed to liquidate the business of the Bank.
On August 23, 1949 the liquidator submitted a return for the assessment year 1948-49 disclosing for the previous year ending June 30, 1947 business loss computed at Rs. 9, 71,664, after debiting against the gross profits in the profit & loss acwount an amount exceed- ing Rs. 12,00,000 as debts which became irrecoverable.
On SUPREMI! COURT REPORTS [19651 I S.C.R. February 26, 19 5 3 the liquidator informed the Income-tax Officer that in the course of investigations it was found that the bad debts of the Bank including the amounts embezzled by the Secre- tary amounted to Rs. 48,50,952.
It is common ground that entries adjusting the books of accc"mt and writing off the amounts claimed to be irrecoverable were not posted in the books of account .either before the return was tiled, or eve)\ till the proceeding reached the Tribunal. The departmental authorities and the Tribunal rejected the claim for allowance of brd debts on the ground that the bad debts were not wrillen off in the books of account of the Bank as required by s. 10(2) (xi) of the Income-tax Act.
The claim for allowance of Rs. I0, 15,000 and Rs. 98,892 being the loss resulting from embezzlements by the Secretary was rejected by the departmental authorities on the grounds, that the embezzlements did not relate to the business of the Bank and could not be treated as loss suffer- ed by the Bank in the course of the buSincss, and in any event the loss was not suffered in the year of account because it was not D ascertained in that year.
The Income-tax Appellate Tribunal agreed with the departmental authorities for the second of the t:ivo reasons. The Tribunal referred unde'r s. 66 (I ) of the Act, two ques- tions which were later modified by the High Court to read as follOWli :-
( I ) Whether on the facts and in the circumstance' of the case the assessee is entitled to claim bad debts amounting to Rs. 38,35,654 or any lesser sum ? ( 2) Whether on the facts and in the circumstances of
the case the assessee is entitled to claim two sums of Rs. 10,15,000 and Rs. 98,892 as a business loss or as a deduction under &. 10(2) (xv) of the Income-tax Act? The High Court agreed with the Tribunal that the claim for allowance of bad dehts could not be sustained under s. 10(2) (xi) ali the debts had not been written off in the books of account of the Bank.
But at the request of counsel for ti.e liquiuator they called upon the Tribunal to submit a supplementary statement on the question whether the debts had actually become irrecover- able during the year of account, and whether they were debts arising in the course of the business of the Bank.
The Hiih Court being of the opinion that the facts set out in the statement of case were not sufficient to enable them to record an answer on ,_ ASSOCIATED BANKING CORP. V. C.!.T. (Shah /.)
A the second question, called upon the Tribunal to submit a supple- mentary statement about the powers entrusted to the Secretary, and the year in which loss was suffered by the-Bank in consequence of embezzlements by the Secretary. The Tribunal reported that debts aggregating to "Rs. 15,00,000. at least" had become irre- coverable fa the year of account, and that. the Secretary had B misused powers entrusted to. him under the power of attomey (a copy of which was annexed to the report) after posting fictitious entries in the books of · account, but tire defalcations of Rs. 18,00,000 and Rs. 98,892 by the Secretary became known to the liquidator only after the year 9f account ending June 30, 1947.
c At the further hearing of the reference the High Court. observ- ed that they were_ bound by the finding recorded at the earlier hearing that ·.bad debts were not admissible deductions because the debts were never written oll in the books of account of th• -Bank, and that the· time when loss resulting from embezzlement D or defalcation. by a servant or· agent of the · assessee occurs must be decided on the facts and circUinstances of each case, and no generel rule could be laid· down in that behalf.
In the view of the High Court loss of Rs. 10,15,000 did not .occur when ficti- tious entries had been posted . at the instance of the Secretary in E the books of account of the Bank, but much later. The item of Rs .. 98,892 was also not admissible as a business loss in the year of account for the same reas<>n.
With certificate granted by the High Court, this appeal is preferred by the liquidator of the Bank. In considering whether writing off in the books of account is a condition precedent to the admissibility of allo~ance for bad debts, attention must first be directed to the terms of s. 10(2) (xi). The clause provides :
"( 2) Such profits or gains shall be computed after making the following allowances, namely :- (xi) When the assessee's accounts in respect of any part of his business, profession or vocation are not kept on the cash basis, such sum, Jn respect of bad and doubtful
debts, due to the assessee in respect of that part of his business, profession or vocation, and in the case of an assessee carrying on a banking or money-lending busi- ness, such sum in respect of loans made in the ordinary
course of such business as the Income-tax Officer may estima~ to be irrecoverable but not exceeding the (1965) I S.C.R. amount actually written off as irrecoverable in the books of the asscssce :
Provided The assessee is a Banking Company : it has in the ordinary course of its business granted loans and on the finding of the Tribunal, debts of the value of Rs. I 5,00,000 are estimated to be irre- coverable in the year of account.
Could this amount be allowed as a deduction in lhe computation of taxable income, when it iJ not written off as irrecoverable in the books of account ? It is for the assessce to claim allowance in respect of debta which have become irrecoverable either in his return or in the c statement accompanying the return.
By his supplementary state- ment, the liquidator claimed that an amount of Rs. 48,50,952 should be treated as bad debts in the year of account. It waJ, therefore, clear that the claim was made by the liquidator for treating as bad debts the amounts which were claimed to be irrecoverable in the year of account.
But it is contended that it D is a condition of admissibility of allowance of bad debts that an entry or entries must be posted in the books of account writing off the debts as irrecoverable.
The Income-tax Officer is by the Act entrusted with the power to estimate as irrecoverable the debts which are claimed as bad or doubtful, but th~ power is subject to the restriction that the allowance will not exceed the amount actually written off u irrecoverable in the books of the assessee.
If the assessee in his books of account has· written off a certain amount as irrecoverable, the Income-tax Offi~er may not, even if his estimate exceeds the amount written off, allow the amount exceeding the amount F actually written off.
Can it be said that when the assessee has not posted entries in the books of account writing off any amount representing bad or doubtful debts, there is no restriction upon the power of the Income-tax Officer to .allow a permissible deduc- tion under the head "bad debt" ? On this question there is conflict of opinion in the High Courts.
Chagla C.J., in the judgment G under appeal held that the view that writing off in the books of account was a condition precedent to the admissibility of a bad or doubtful debt was in conformity with the view which the Courts had consistently taken for many years in interpreting s. (IO){i)(xi). The learned Chief Justice observed :
"We are not aware of any single case where either the Department or the assessee ever contended in this Court that an assessee is entitled to a certain amount as a bad c ASSOCIATED BANKING CORP. v. C.I.T. (Shah J.)
debt which amount has in fact not been written off in his books of account. But apart from the settled prac- tice, there are decisions of this Court which have also proceeded on that view of the section."
The Calcutta High Court in Begg Dunlop and Co. Ltd. v. Com- mislsoner of Excess Profits Tax, West Bengal(') has expressed an equally emphatic opinion to the contrary. Chakravartti C.J., who delivered the judgment of the Court observed that by the last clause of s. 10(2) (xi) the Income-tax Officer is given a dis- cretion to allow such amount as he himself may estimate to be irrecoverable, a maximum limit or rather a ceiling is at the same time set, beyond or higher than which he may not go.
It is necessary in resolving the conflict to examine carefully the pro- visions relating to the allowance of bad debts in computing the profits or gains of a business carried on in the year of account. Under the Income-tax Act, 1922 as originally enacted there was ·no provision in sub-s. ( 2) of s. 10 for allowance of bad or doubtful debts in the computation of profits or gains of a business carried on by the assessee.
But bad or doubtful debts could pro- perly be allowed as necessary business deductions under s. _10(1). In Commissioner of Income-tax, Central Provinces and Berar v. Sir S. M. Chitnavis( 2 ) the Judicial Committee held that a debt which has become a bad debt during the year of account can pro- perly be treated as a loss and deducted from profits.
The Judicial Committee observed at p. 296 : "Although the Act nowhere in terms authorizes the deduction of bad debts of a business, such a deduction is necessarily allowable. What are chargeable to income-
tax in respect of a business are the profits and gains of a year; and in assessing the amount of the profits and gains of a year account must necessarily be taken of all losses incurred, otherwise you would not arrive at the true profits and gains. But the losses must be losses incurred in that year. You may not, when setting out to ascertain
the profits and gains of one year, deduct a Joss which had in fact been incurred before the commencement of that year. If you did, you would not arrive at the true profits and gains of the year. …. It thus follows
that a debt, which had in fact become a bad debt before the commencement of a particular year, could not pro- perly be deducted in ascertaining the profits of that year because the loss had not been sustained in that year."
– ·—- —- .(I) (1954) 25 l.T.R. 276, 284. (2) (1932) L.R. 59 I.A. 290 . SUPREME COURT REPORTS [1965) l S.C.R. The Judicial Committee however, did not regard the entries writing off the debts as irrecoverable as a condition precedent to admissibility of the claim for allowance. It is true that in any recognised system of accounting, the claim made that a debt has become barred, where the accounts are maintained according to the commercial method of accounting, an entry or entries-if not in the account of the debtor-at some appropriate place or place~ B in the books would be posted recording that in the view of the assessec the debt had become irrecoverable, and without such an entry or entries it would, in normal cases, be difficult to make up a profit and .loss account of the year.
But the entries need not be in respect of each individual debt regarded by the asscssce u bad or doubtful : a composite entry relating to the debts re- garded as bad or doubtful may suffice.
After the judgment of the Privy Council in Chitnavls's case( 1 ) the Legislature has inserted by s. 11 of the Indian Income- tax (Amendment) Act 7 of 1939 cl. (xi) in sub-s. (2) of s; 10, o which expressly deals with the admissibility of bad or doubtful debts as allowances in the computation of profits and gains. In
cases governed by the amended Act undoubtedly the question of admissibility of bad or doubtful debt as allowance must be adjudg- ed in the light of the express provision of the statute; and not on aeneral considerations of commercial accountancy, or busin~ E necessity.
It is pertinent to bear in mind the language .used by the Legislature : the clause does not say that the Income-tax Olli- cer cannot allow a bad or doubtful debt, unless it is written off in the books of account; it merely states that the Income-tax Officer shall not allow any amount in excess of the amount actually written off as irrecoverable.
It is, therefore, for the Income-tax F Officer to ascertain what debts have become bad or doubtful in the year of account. This would require an investigation by the Income-tax Officer whether any debt~ claimed to be bad or doubt- ful have become irrecoverable, and for what amount. If the assessce has posted a composite entry debts exceeding in value the amount entered may not be allowed as irrecoverable by the assessing authority.
If he has posted entries in respect of indi- vidual debts, the restriction on the power of the assessing authority must operate in respect of each such debt written off. This much
is however, clear that in respect of any individual debt, writing off in the books of account is not a condition of its allowance in H the computation of profits. ———- (t) (1932) L.R. S9 I.A. 290.
ASSOCIATED BANIGNG CORP. V. C.I.T. (Shah J.) 79 5 Our attention has not been invited to any decision (except the judgment under appeal) in which it has been ruled that the power of the Income-tax Officer to allow deductions of debts which are regarded as bad or irrecoverable, can only be exercised when there is an entry posted in the books of account of the assessee that a certain amount has become irrecoverable.
Two B cases to which Chagla C.J., referred in the course cif his judgment M illustrative of a settled practiee of the Bombay High Court do not support that view. In Commissioner C'f Income-tax and
Excess Profits Tax, Central Bombay v. Jwala Prasad Tiwari(') the assessee had claimed in the course of assessment of his profits C and gains that certain debts had become doubtful of recovery in the year of account.
The assessee had in fact debited the two sums in the profit and loss account and credited them under the head "doubtful debts" in .the suspense account. The Income-tax authorities held that as the individual accounts of the debtors in the bOoks of the assessee had not been credited with the amounts, D the debts had not been written off as required by the section. The High Court held that the amount of· the debts had in fact been written off in the assessee's books; The Court held in that case that s. 10(2 )(xi) did not demand that individual ledger entries writing off debts claimed to be bad or doubtful should be posted. The Court was not called upon in that case to consider whether E absence of an entry writing· off the amount deprived the Income- tax Officer of his power to allow bad or doubtful debts to the extent estimated by the Officer to be irrecoverable.
This case does not lay down that to the admissibility of a bad debt as an allowance under s. 10(2 )(xi) writing off of the debt is a condi- tion precedent. The other case is Karamsey Govindji, Bombay v. Comml!-
sioner of Income-tax, Bombay City( 2 ). In that caSe the assessee had advanced in 1945 and 1946 without security certain loallll to a film producer and had written off the loans as bad debts in G November 1947. On the evidence ,in ,the case the Income-tax authorities held that the loans had not become irrecoverable in 194 7, and the High Court of Bombay in a reference under
s. 66(2) held that the finding of the Income-tax authorities that the debts had not become bad in 194 7 could not be regarded as not justified on the evidence. The case evidently did not directly deal
H with the writing off a debt in the books of account of the assessee being a condition precedent to allowance under s. 10(2) (xi) (I) (1953) 2-4 l.T.R. 537. (2) (1957) 31 I.T.R. 953.
79p [ 1965] l S.C . .ll. It was conceded by Counsel for -the revenue that the allowance 2f a b;!d debt may be granted eyen if the entry writing off t)le amo(l]n-as-irrccoverable is poste,;1 during the course of the hearing befcre the Income-tax office.
The l;)epartment "therefore submits that though an entry writi!"!g off the amounr of a debt claimed to be bad or .doubtful -is a condition precedent to ihe allowance, the entry need not be posted before the return is submitted, or even before tlic hearing of th~ assessment proceeding by the Income-tax Officer 'is concluded.
The· Legislature has .not made an eKpress provision that an entry in the books of account writing off a debt as irrccoverabic is a condition. of its admissibility as an allowance under s. 10(2) (xi), and the language used in the clause examined in the light of the scherne of the Act does not compel such an inter, , C pretation. ' On the power of the Income-tax Officer-and there- , fore a!l superior authorities-uudoubtedly a restriction is placed. lt is not open to the Income-tax Officer to estimate. the cfebts as irrecoverable in excess of the amount which the tax-payer regards as irrecoverable.
I3ut if for some adequate reason the tax-payer D. has not posted an.entry and' there is a reasonable explanation _for that default, absence of entry writing oif the amount of a debt which has become. bad,· or doubtful
which may be posted at any time. in tne appropriate place in the bool<:s of account before the proceedings arc, concluded before the autho- rity is by· itself not a ground .for denying to the Income-tax Officer E jurisdiction to estimate tile debts as irrecoverable, and to allow it as proper· deduction in the .computation of profits.
It might at first sight appear somewhat· paradoxical that if the assessee has act~al!y written off as irrecoverable b his books of accou11t individual debts or a collective sum as debts irrecoverable, ·the power' of the Income-tax Officer is restricted and the amou,nt he F may allow as irrecov,erable debts cannot exceed the amount actually written of!' : where the amount is not written off in the pooks of account, aie ~ncome-~ax Officer's jurisdiction is at large and he may allow any amount as irrecoverable: But the pro- visions of Lie statute should' not be construed in a narrow spirit of technicality.
It may t>e ~oticed that cl. (xi) does not restrict G the power to estimate bad debts : it limits the power to grant allowance under the heaa of bad and doubtful debts, any amount in excess of the amount actually written off by the. asi;essee in his, books of account.
It would therefore be reasonable to ·hold that if after estima!ing tbe bad debts, there is no express st;itu- tory restraint on the exercise of the power to grant allowance, no impiication of a restraint on- the exercise of the power may be evolved, unle~s such implication is on the scheme of the Act c
ASSOCIATED BANKING CORP. V, C.J.T. (Shah J.) intended. And in the scheme of the Act we find no such rea· traint imperatively intended, for it cannot be assumed in all cases that absence of an entry writing off the amount of bad debts necessarily implies that no debts have become irrecoverable in the year of account.
In our view Chakravartti C.J., was right when he observed in Begg Dunlop and Co. Ltd.'s case(') at p. 284 : "I am entirely unable to hold that Section 10 ( 2) (xi) of the Income-tax Act imperatively requires that in
order that any amount may be allowed as irrecoverable in any particular year, such amount or a larger amount must be "actually written off as irrecoverable in the books of the assessee".
The relevant language of the Section, if I may recall its terms, is "such sum as the Income-tax Officer may estimate to be irrecoverable but not exceeding the' amount actually written off".
What that language means, to my mind, clearly is that while the lncome-tax Officer is 2iven a di,cretion to allow such amount as he himself may estimate to be irrecoverable, a maximum limit or rather a ceiling is
at the same time set, beyond or higher than which he may not go. It does not seem to be even a require- ment of the Section that a debt which the Income-tax Officer may treat as irrecoverable must be written ofl
at all. All that the Section seems to mean, in my view, is that if a debt has actually been written off by the assessee in his books as irrecoverable in a particular year, then the Income-tax Officer, in making an allow-
ance in respect of bad debts for that year, must not allow anything in excess of the amount which the asses- see has himself written off." But this does not mean that an assessee who chooses not to post an entry in the books of account about bad or doubtful debts o places himself in a better position than an assessee who has actually posted entries writing off amounts as irrecoverable in his books of account.
On the materials placed before him, it is always open to the Income-tax O.fficer to come to the conclusion that the fact that the assessee has not chosen to post an entry is consistent with the circumstance that no part of the t:lebt due to him in the year of account has become bad or doubtful and therefore irrecoverable, and on that account to disallow
the (1) (1954) 25 I.T.R. 276. SUPREME COURT REPO;ns [1965] I S.C.R. claim which may be made at the hearing that some or all debt~ bd hcccmc bad er doubtful. Even when no entry has been
posted in the books of account, the question is one of power to be exercised on the facts and circumstances on the record by the Income-tax Officer to allow deductions in the computation of :'ro!!ts um! gains. If the Income-tax Offic~r estimates cer- tain dc!:>ts to be irrecoverable. it would be wi•hin his power under s. I 0(2)(xi) to nllow the same in computing the profits.
That p0wer is only restricted in one dircctio;i, namely, jhat where the assesS"'..c has posted an entry or entries in the books of account the amount to be estimated as irrecoverable is not to exceed the amount actually written off as irrecoverable by the asscssce. Under the Income-tax Act 43 of 1961, bv s. 36(J)(vi) the
amoum of any debt or part thereof which is established to have become a bad debt in the previous year has to be allowed in com- puting the income under s. 28 : but that allowance is subject to subs-s. (2) which provides insofar as it is ma!erial that "in making any deduction for a bad debt or a part thereof the following pro- vi,!ons shall apply :
(i) no such deduction shall be allowed unless sud1 debt or part thereof (a) has been taken into account in computing the JI c income of the assessee of that 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) (iii) (iv) It is manifest that the material clause h~; hccn wh"llY rcdr~·f1eJ and the Legislature has expressed its inten<ion clc:irly.
In dealing with the second question son:c more facts may be stated. The Secretary M.C. Javeri was invested with e~ten- 11ive powers of management and the Directors of the Bank appear- ed to have remained supine.
The Secretary helped l1imself to large amounts out of t1u: a.>sets of the Bank. On November l, 1946, the Bank entered into an underwriting agreement with the Government of Bhopal underwriting a loan of the value of Rs. 2 crores issued by the Government of Bhopal.
On December 3, ASSOCIATED BANKING CORP. V. C.l.T. (Shah J.) A 1946 V. R. Ranade and Sons applied to the Bank for purchasing Bhopal Government loan and remitted in full the amount of
R~. 15 Jakhs to the Bank. This amount was in the first instance credited in the sundry deposit account, but at the instance of the Secretary the entry in the sundry deposit account was revers- ed and the sum of Rs. 15 lakhs. was broken up into smaller amounts and credited in the account books in different names. V. R. Ranade and Sons pressed for delivery of the loan certifi- cates and the Secretary delivered to them a ·forged allotment Jetter for certifi~a.tes of the value of Rs. 15 lakhs purported to have been received from the Bank of Bhopal Ltd.
After the Bank was ordered to be wound up, V. R. Ranade and Sons made C a claim on December 5, 1947 for preferential payment of Rs. 15 lakhs out of the assets of the Bank. On February 28, 1949 the
liquidator submitted to an order that V. R. Ranade and Sons, be paid Rs. 8,80,000 as preferential creditors within one month of the date of the order. This amount was, under the direction
D of the Court actually paid some time later by the Official Liqui- dator to V. R. Ranade and Sons. Early in 194 7 the Bank of Bhopal bad instructed their broker Shantilal L. Thar to purchase on its behalf Bhopal Gov- ernment loan of the face value of Rs. 3,00,000 and Thar
contracted to purchase the Bhopal Government loan from the Ii: assessee Bank. On February 11, 1947 an amount of Rs. 3,00,000 was paid to the flank, but no letter of allotment was issued.
Loan certificates were never delivered to the Bank of B!lopal Ltd. and .Rs. 3,00,000 paid to the asse\see Ba11k were transferred to the account of Haroon Haji Abdul Satar of Bantwa in the Jetpur Branch of the Bank showing as if that per- F son had sold bonds of the value of Rs. 3,00,000. This amount was withdrawn by the Secretary and misappropriated. The Bank of Bhopal Ltd. filed a suit against the assessee Bani, in the Bombay High Court for an order for. delivery of the Bhopal Government bonds and in the alternative for a decree for
Rs. 3,00,000. A settlement was arrived at in the suit 2nd the G assessee Bank agreed to pay to the Bank of Bhopal Ltd. Rs. 1,35,000 in full and final settlement. A consent decree was passed on September 20, 1951, and was satisfied by the liquidator sometime thereafter.
There is another amount of Rs. 98,892 ?1hich it was claim- ed by the liquidator was embezzled by the Secretary. At the hearing counsel for the liquidator has given up this part of the claim and it is unn~cessary for the purpose of this c:ppeal to set !00
(1965]1 S.C.R. out the details, in respect of this amount. , The claim under the second question must therefore be restricted to Rs. 10,15,000. The Income-tax authorities disallowed this-'claim. In their view it was not suffered by the Bank in the course of its business and therefore could not be treated as a loss. by the· Bank, and in any · event the loss was not suffered in the year of account because it , was ascertained in the year 1949 or later and could be taken into account in the assessment relating to that period alone. The embezzlements_ undoubtedly took place in the year of account ending June 30, 1947. The Secretary misused the powers -con- ferred upon him under the power of attorney and withdrew
Rs. 18,00,000 by posting entries in the names of persons who did not exist, or who had no dealings with the Bank. But until an investigation of the dealings of the Bank was made, the embezzle- ments could not come to the knowledge of the Drrectors of the Bank or the liquidator.· The Bank had to pay· RS. 10,15,000 to its constituents to satisfy the liability arising out of the Secre- tary's dealings with the funds- of the Bank. Loss has, therefore D been suffered by the Bank as a result of the withdrawals made by the Secretary, arid the only question relevant for the purpo~e of the appeal is whether the loss occurred in the year of account ending June 30, 1947.
It was urged by counsel for the liquidator that loss occurs to E a Banking institution when funds are withdrawn or misapplied by an agent or servant and misappropriated, and therefore the with- drawals or misapplication by the Secretary having taken place in the year of account, the loss was admissible as an allowance in the year of account against, the profits, of that year.
We are unable to agree with that contention. A claim to deduct an F , amount lost to the assessee because of embezzlement by his agent does not fall within the description of any allowance under els. (i) to (xv) or sub-s. (2) : to be admissible it must, if at all. – fall within sub-s. ( 1). This position was conceded in the High Court, in our judgment properly, by counsel for the Bank. The problem as to when loss resulting from misapplication of funds by an agent occurs must be viewed like many other problems arising under the Income-tax Act on. a-conspectus of all the facts and circumstances, in the context of principles of commercial trading.
Embez7Jement of, funds' by an agent, like a specula- tive adventure, does not necessarily result in loss immediately If' when the embezzlement takes place, or the adventure is commenc- ed. Embezzlement may remain unknown to the principal, and
the assets embezzled may be restored by the agent or servant. ASSOCIATED BANKING CORP. V. C.I.T. (Shah J.) 80 l A In such a case in a commercial sense no real loss has occurred. Again it cannot be said that in all cases when the principal obtains knowledge of the embezzlement the loss results.
The erring servant may be persuaded or compelled by process of law or otherwise to restore wholly or partially his ill-gotten gains. There- fore so Jong as a reasonable chance of obtaining restitution exists, B loss may not in a commeccial sense be said to have resulted. c
In M. P. Venkatacha/aparhy Iyer and Anr. v. Commissioner of Income-tax, Madras(') it was held by the Madras High Court that profits and gains of a business must be ascertained by ordinary commercial principles of trading, and a working rule is that until the loss resulting from misappropriation "becomes actual and certain" there can be no accrual of loss.
In Venkata- chalapathy's case(') the assessee employed a clerk who wrote books of account of a business, acted as salesman, received and disbursed cash in the absence of the managing p;,rtner and collected bills.
By manipulation of accounts the clerk mis- appropriated large amounts at diverse times. In May 1'?41 it was discovered that the clerk had embezzled Rs. 36,298-3-6 during the period between October 17, 1939 and October 24, 1940. In June 1941 a criminal prosecution was launched against the clerk and about the same time a civil suit for recovery of the amount was also instituted. 'I'he claim was compromised in August 1941 and the clerk paid the assessee Rs. 16,250 in
full settlement of his liability. The assessee claimed in the assessment year 1942-43 (accounting year ending with April 12, 1942) a deduction Rs. 21,372 being the difference of the sum embezzled by the clerk and the amount recovered from him, and l'I
it was rightly held that the sum could be treated as a loss in the accounting period deductible from the profits of that period. In the case under discussion the embezzlements of funds of the Bank took place in 1946.
They were then unknown to the Bank. Even after the embezzlements came to the knowledge of the Liquidator, trading loss cannot be deemed to have resulted. We are unable to countenance the proposition that irrespective of other considerations, as soon as the 'embezzlement takes place of the employer's funds, whether the employer is aware or not of the embezzlement, there results a trading loss.
So long as there was a reasonable prospect of recovering the amounts em- bezzled by the Bank, trading loss 'in a commercial sense may not be deemed to have resulted. (!) (19511 cO !.T.R. 363.
1>02 ~UPREME COURT REPORTS [1965) I S.C.lt. There is no evidence that in the year of account Javeri the A Secretary could not have met the obligations either wholly or partially if he was called upon to refund the amounts embezzled. The embezzled amounts did not come to the ·knowledge of the liquidator even from the report dated April l, 1947, of Messrs. M. N. Raiji & Co. who were appointed auditors to investigate · the affairs of the Bank by the Registrar of the Joint Stock Com- pa.nies. The embezzlements came to the knowledge of. the· liqui· dator very much later, only when the liquidator made .demands from the various persons in whose names the amounts were debit· ed in the books of account of the Bank, and the demands were made upon the .liquidator for preferential payment by V .. R. · C Ranade and Sons and by the Bank of Bhopal Ltd. for repayment of the amounts or in the alternative for delivery of the stock pur- chased by them through the Bank.
__ The Tribunal has found in its supplementary rep-ort tliat the withdrawals and misapplication of funds by the Secretary came to the knowledge of the liquidator ·after the accounting year under reference, because no one suspected that the entries posted in the books of account were false entries to cover up his dealings by the Secretary.
That conclusion is based oti evidence and the loss must, in the circumstances of the case, be deemed to have occurred to the Bank after the liquidator caine to know· about the embezzlements and came to know that the amounts embezzled could not be recovered.
One of the prime conditions inviting the deduction of a trading loss under s. 10 ( 1) is therefore absent. We accordingly agree with the High Court that the amount of Rs. 10,15,000 was not a permissible deduction unde! s. 10(1). The appeal will therefore be partially. allowed. The answer to the first question recorded by the High Court will be discharged, and it will be recorded that the Bank is entitled to claim under s. 10(2)(xi) Rs. l 5,00,000 as bad· debts in the year of account ending June 30, 1947. On the second question, the answer will be in the negative.
Th~re will be no order as to costs in this 4Ippeal. · G Appeal partly allowed.