22 October 1964
Supreme Court


Case number: Appeal (civil) 956 of 1963






DATE OF JUDGMENT: 22/10/1964


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



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



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,



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



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



             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.  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



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



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



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 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 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,



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 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. 803