Associated Banking Corporation of
India Ltd. Vs. Commissioner of Income-Tax, Bombay  INSC 231 (22 October
22/10/1964 SHAH, J.C.
CITATION: 1965 AIR 1188 1965 SCR (1) 788
Income Tax Act (11 of 1922), ss. 10(1) and
10(2) (xi) and (xv)--Scope of-Bad debts-If should be written off before claim
is allowed Bank-Embezzlement by officer-If trading loss-Time of occurrence.
The assessee was a Bank in liquidation. The
official liquidator submitted a return for the assessment year 194849 and
claimed as 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.
10(2)(xv), certain amounts embezzled by one of its officers and which the bank
had to pay to its constituents. The income-tax authorities and the Appellate
Tribunal rejected the claim for allowance of bad debts on the ground that the
bad debts had not been written off in the books of account of the bank. They also
rejected the claim for allowance of the embezzled amounts on the grounds that
those amounts did not relate to the business of the bank and that, in any
event, the loss, not having been ascertained in the year of account was not
suffered in that year. When the matters were referred to the High Court, the
Court asked for a report from the Tribunal as to : (i) whether any debts had
actually become irrecoverable, and (ii) the year in which loss was suffered by
the bank in consequence of the embezzlements. The Tribunal reported that debts
aggregating to Rs. 15,00,000 at least, had become irrecoverable in the year of
account, and that the defalcations by the bank's officer 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 assessee holding that (i) the bad debts were not
admissible deductions because they were never written off, and (ii) the loss to
the bank on account of the defalcations occurred later than the year of
account. The assesses appealed to the Supreme Court.
HELD : (i) The bank was entitled to claim Rs.
15,00,000 as bad debts in the year of account. [802 F-G] Section 10(2) (xi)
does not say that the income-tax officer cannot allow a bad or doubtful debt unless
it is written off in the books of account; it merely states that he shall not
allow any amount in excess of the amount actually written off as irrecoverable.
If there is a reasonable explanation for the absence of an entry writing off
the amount of a debt, such absence by itself is not a ground for denying to the
officer, jurisdiction to estimate the amounts of debts which have become
irrecoverable and to allow them as proper deductions in the computation of
profits. The officer's power is restricted 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 assessee. That does not mean that an assessee who chooses
not to post an entry is in a better position than one who has actually posted
entries, because, he always runs the risk of the income-tax officer coming to
the conclusion that the fact that he had hot chosen to post an entry is
consistent with the finding that no part of the debt due to him has become
irrecoverable. [794 E-F; 796 D-F; 797 G-H; 798 B-C] Begg Dunlop and Co. Ltd. v.
Commissioner of Excess Profits Tax, West Bengal. (1954) 25 I.T.R. 276,
789 (ii) The bank was not entitled to claim
as a business loss or deduction the amount embezzled by the officer. L802 G]
Loss had been suffered by the bank as a result of the defalcations by its
officer, but the withdrawal and misapplication of the funds came to the
liquidator's knowledge only after the accounting year, and so, 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 liquidator, a trading loss could not be deemed
to have resulted. A trading loss 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 reasonable prospect of recovering the amounts, trading
loss, in a commercial sense, would not be deemed to have resulted.
L800 D; 801 G-H] M. P. Venkatachalapathy Iyer
v. Commissioner of Incometax, 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'
A. V. Viswanatha Sastri, J. B. Dadachanji, O.
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 5, 1945 Javeri was appointed a Director of the Bank.
On April 21, 1947 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
9,71,664, after debiting against the gross
profits in the profit & loss account an amount exceeding Rs. 12,00,000 as
debts which became irrecoverable. On 790 February 26, 1953 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
Secretary amounted to Rs. 48,50,952.
It is common ground that entries adjusting
the books of account and writing off the amounts claimed to be irrecoverable
were not posted in the books of account either before the return was filed, or
even till the proceeding reached the Tribunal. The departmental authorities and
the Tribunal rejected the claim for allowance of bad debts on the ground that
the bad debts were not written 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.
10,15,000 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 suffered by the Bank in the course of the business, and in any
event the loss was not suffered in the year of account because it was not
ascertained in that year. The Income-tax Appellate Tribunal agreed with the
departmental authorities for the second of the two reasons.
The Tribunal referred under s. 66(1) of the
Act, two questions which were later modified by the High Court to read as
follows :(1) Whether on the facts and in the circumstances 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 s. 10 (2) (xv) of the Income tax Act ?
The High Court agreed with the Tribunal that the claim for allowance of bad
debts could not be sustained under s. 10(2) (xi) as the debts had not been
written off in the books of account of the Bank. But at the request of counsel
for the liquidator they called upon the Tribunal to submit a supplementary
statement on the question whether the debts had actually become irrecoverable
during the year of account, and whether they were debts arising in the course
of the business of the Bank. The High 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 791 the second question, called upon the Tribunal to submit a
supplementary 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 irrecoverable in the year 'of account, and
that the Secretary had misused powers entrusted to him under the power of
attorney (a copy of which was annexed to the report) after posting fictitious
entries in the books of account, but the defalcations of Rs. 18,00,000 and Rs.
98,892 by the Secretary became known to the
liquidator only after the year of account ending June 30, 1947.
At the further hearing of the reference the
High Court observed 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 off in the books of account of the Bank, and that the time when
loss resulting from embezzlement or defalcation by a servant or agent of the
assessee occurs must be decided on the facts and circumstances of each case,
and no general 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 fictitious entries had been
posted at the instance of the Secretary in 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 reason. 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 allowance 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 assesse's
accounts in respect of any part of his business, profession or vocation are not
kept on the cash basis, such sum, in 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 assesee carrying on a banking or money-leading business,
such sum in respect of loans made in the ordinary course of such business as
the Income-tax Officer may estimate to be irrecoverable but not exceeding the
792 amount actually written off as irrecoverable in the books of the assessee
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. 15,00,000 are estimated to be irrecoverable in the year of account.
Could this amount be allowed as a deduction in the computation of taxable
income, when it is not written off as irrecoverable in the books of account ?
It is for the assessee to claim allowance in respect of debts which have become
irrecoverable either in his return or in the statement accompanying the return.
By his supplementary statement, the liquidator claimed that an amount of Rs.
48,50,952 should be treated as bad debts in the year of account. It was,
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 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 the power is subject to the restriction that
the allowance will not exceed the amount actually written off as 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 Officer may not,
even if his estimate exceeds the amount written off, allow the amount exceeding
the amount 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 deduction under the head "bad debt" ?
On this question there is conflict of opinion in the High Courts. Chagla C.J..
in the judgment 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. (10) (2) (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 793 debt which amount has in fact not
been written off in his books of account. But apart from the settled practice,
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.
Commissioner 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 discretion 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 provisions 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 properly 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
properly 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 loss 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 properly be deducted in ascertaining the profits of
that year because the loss had not been sustained in that year." (1)(1954)
25 I.T.R. 276, 284.
(2) (1932) L.R. 59 I.A. 290.
794 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 places in the books would be posted recording that in the
view of the assessee 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 assessee as bad or doubtful : a composite entry
relating to the debts regarded as bad or doubtful may suffice.
After the judgment of the Privy Council in
Chitnavis'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, 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 adjudged in the light of the express provision of the statute, and not
on general considerations of commercial accountancy, or business necessity. It
is pertinent to bear in mind the language used by the Legislature : the clause
does not say that the Income-tax Officer 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 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 debts
claimed to be bad or doubtful have become irrecoverable, and for what' amount.
If the assessee 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 individual
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 the computation of profits.
(1) (1932) L.R. 59 I.A. 290.
795 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 cases to which Chagla C.J., referred in the course of his
judgment as illustrative of a settled practice of the Bombay High Court do not
support that view. In Commissioner of Income-tax and Excess Profits Tax,
Central Bombay v. Jwala Prasad Tiwari(1) the assessee had claimed in the course
of assessment of his profits 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, 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 absence of an entry writing
off the amount deprived the Incometax 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 condition precedent.
The other case is Karamsey Govindji, Bombay
v. Commissioner of Income-tax, Bombay City(1). In that case the assessee had
advanced in 1945 and 1946 without security certain loans to a film producer and
had written off the loans is bad debts in November 1947. On the evidence in the
case the Income-tax authorities held that the loans had not become
irrecoverable in 1947, and the High Court of Bombay in a reference under s.
66(2) held that the finding of the Income-tax authoritics that the debts had
not become bad in 1947 could -not be regarded as not justified on the evidence.
The case evidently did not directly deal with the writing off a debt in the
books of account of the assesee being a condition precedent to allowance under
s. 10 (2) (xi).
(1) (1953) 24 I.T.R. 537.
(2) (1957) 31 I.T.R. 953.
796 It was conceded by Counsel for the
revenue that the allowance of a bad debt may be granted even if the entry
writing off the amount as irrecoverable is posted during the course of the
hearing before the Income-tax office. The Department therefore submit& that
though an entry writing off the amount of a debt claimed to be bad or doubtful
is a condition precedent to the allowance, the entry need not be posted before
the return is submitted, or even before the hearing of the assessment
proceeding by the Income-tax Officer is concluded. The Legislature has not made
an express provision that an entry in the books of account writing off a debt
as irrecoverable 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
scheme of the Act does not compel such an interpretation.
On the power of the Income-tax Officer-and
therefore all superior authorities-undoubtedly a restriction is placed.
It is not open to the Income-tax Officer to
estimate the debts as irrecoverable in excess of the amount which the tax-payer
regards as irrecoverable. But if for some adequate reason the tax-payer has not
posted an entry and there is a reasonable explanation for that default, absence
of entry writing off the amount of a debt which has become bad or doubtful
which may be posted at any time in the appropriate place in the books of
account before the proceedings are concluded before the authority is by itself
not a ground for denying to the Income-tax Officer jurisdiction to estimate the
debts as irrecoverable, and to allow it as proper deduction in the computation
It might at first sight appear somewhat
paradoxical that if the assessee has actually written off as irrecoverable in
his books of account individual debts or a collective sum as debts
irrecoverable, the power of the Income-tax Officer is restricted and the amount
he may allow as irrecoverable debts cannot exceed the amount actually written
off : where the amount is not written off in the books of account, the
Income-tax Officer's jurisdiction is at large and he may allow any amount as
irrecoverable. But the provisions of the statute should not be construed in a
narrow spirit of technicality. It may be noticed that cl. (xi) does not
restrict the power to estimate bad debts : it limits the 'power to grant
allowance under the head of bad and doubtful debts, any amount in excess of the
amount actually written off by the assessee in his books of account. It would
therefore be reasonable to hold that if after estimating the bad debts, there
is no express statutory restraint on the exercise of the power to grant
allowance, no implication of a restraint on the exercise of the power may be
evolved, unless such implication is on the scheme of the Act 797 intended. And
in the scheme of the Act we find no such restraint 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(1) 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 Income-tax
Officer is given a discretion 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
requirement of the Section that a debt which the Incometax Officer may treat as
irrecoverable must be written off 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 allowance in respect of bad debts for that year, must not allow anything
in excess of the amount which the assessee 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 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 Officer 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 debt 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.
798 claim which may be made at the hearing
that some or all debts had become bad or 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 profits and gains. If the Income-tax Officer
estimates certain debts to be irrecoverable, it would be within his power under
S. 10(2)(xi) to allow the same in computing the profits. That power is only
restricted in one direction, namely, that where the assess 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
Under the Income-tax Act 43 of 1961, by s. 36
(1) (vi) the amount of any debt or part thereof which is established to have
become a bad debt in the previous year has to be allowed in computing the
income under S. 28 : but that allowance is subject to sub ss. (2) which
provides insofar as it is material that "in making any deduction for a bad
debt or a part thereof the following provisions shall apply:
(i) no such deduction shall be allowed unless
such debt or part thereof (a) has been taken into account in computing the
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 has
been wholly redrafted and the Legislature has expressed its intention clearly.
In dealing with the second question some more
facts may be stated. The Secretary M.C. Javeri was invested with extensive
powers of management and the Directors of the Bank appeared to have remained
supine. The Secretary helped himself to large amounts out of the assets of the
Bank. On November 1, 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, 799 1946 V. R. Ranade and
Sons applied to the Bank for purchasing Bhopal Government loan and remitted in
full the amount of Rs. 15 lakhs 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 reversed 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 certificates and the Secretary delivered to them a forged allotment letter
for certificates 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 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 of the Court actually paid some time later by the
Official Liquidator to V. R. Ranade and Sons.
Early in 1947 the Bank of Bhopal had
instructed their broker Shantilal L. Thar to purchase on its behalf Bhopal
Government loan of the face value of Rs. 3,00,000 and Thar contracted to
purchase the Bhopal Government loan from the assessee Bank. On February 11,
1947 an amount of Rs. 3,00,000 was paid to the Bank, but no letter of allotment
was issued. Loancertificates were never delivered to the Bank of Bhopal Ltd.
and Rs. 3,00,000 paid to the assessee Bank were transferred to the account of
Haroon Haji Abdul Satar of Bantwa in the Jetpur Branch of the Bank showing as
if that person 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
Bank 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 and the 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
There is another amount of Rs. 98,892 which
it was claimed 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
unnecessary for the purpose of this appeal to set 800 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 conferred 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 embezzlements could not
come to the knowledge of the Directors 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 Secretary's dealings with the funds of the Bank. Loss has, therefore
been suffered by the Bank as a result of the withdrawals made by the Secretary,
and the only question relevant for the purpose 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 a Banking institution when funds are withdrawn or
misapplied by an agent or servant and misappropriated, and therefore the
withdrawals 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 amount lost to the assessee because of embezzlement by his
agent does not fall within the description of any allowance under cls. (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. Embezzlement of funds by an
agent; like a speculative adventure, does not necessarily result in loss
immediately when the embezzlement takes place, or the adventure is commenced.
Embezzlement may remain unknown to the principal, and the assets embezzled may
be restored by the agent or servant.
801 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. Therefore so long as a reasonable
chance of obtaining restitution exists, oss may not in a commercial sense be
said to have resulted.
In M. P. Venkatachalapathy Iyer and Anr. v.
Commissioner of Income-tax, Madras(1) 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 Venkatachalapathy's case(1) 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 partner and collected bills. By manipulation of
accounts the clerk misappropriated large amounts at diverse times. In May 1941
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. The 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 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 embezzled by the
Bank, trading loss in a commercial sense may not be deemed to have resulted.
(1) (1951) 20 I.T.R. 363.
802 There is no evidence that in the year of
account Javeri the 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 1, 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 Companies. The embezzlements came to the knowledge of the liquidator very
much later, only when the liquidator made demands from the various persons in
whose names the amounts were debited in the books of account of the Bank, and
the demands were' made upon the liquidator for preferential payment by V. R.
Ranade and Sons and by the Bank of Bhopal Ltd. for repayment of the amounts or
in the alternative for delivery of the stock purchased by them through the
The Tribunal has found in its supplementary
report that 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 on evidence and the loss must, in the circumstances of the case, be
deemed to have occurred to the Bank after the liquidator came 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 under S.
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. 1 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. There will be
no order as to costs in this appeal.
Appeal partly allowed.