Full Judgment Text
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PETITIONER:
ASSOCIATED BANKING CORPORATION OF INDIA LTD.
Vs.
RESPONDENT:
COMMISSIONER OF INCOME-TAX, BOMBAY-1.
DATE OF JUDGMENT:
22/10/1964
BENCH:
SHAH, J.C.
BENCH:
SHAH, J.C.
SUBBARAO, K.
SIKRI, S.M.
CITATION:
1965 AIR 1188 1965 SCR (1) 788
ACT:
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.
HEADNOTE:
The assessee was a Bank in liquidation. The official
liquidator submitted a return for the assessment year 1948-
49 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
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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, approved.
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 Income-
tax, Madras. (1951) 20 I.T.R. 363, approved.
JUDGMENT:
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.
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
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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 Rs.
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 ques-
tions 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,
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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, profe
ssion 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
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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 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 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
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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
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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. Commis-
sioner 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
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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 of profits.
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 res-
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(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 Income-
tax 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
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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 assessee.
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 exten-
sive 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
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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 sometime
thereafter.
There is another amount of Rs. 98,892 which 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 unnecessary for the purpose of this
appeal to set
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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
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,
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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
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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 Bank.
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. 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. 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.
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