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PETITIONER: COMMISSIONER OF INCOME TAX, A.P.

       Vs.

RESPONDENT: M/S. T.VEERABHADRA RAO, K. KOTESWARA RAO & CO.

DATE OF JUDGMENT08/07/1985

BENCH: PATHAK, R.S. BENCH: PATHAK, R.S. VENKATARAMIAH, E.S. (J)

CITATION:  1985 AIR 1600            1985 SCR  Supl. (2)  20  1985 SCC  Supl.  403     1985 SCALE  (2)1

ACT:      Income Tax  Act, 1961,  Sec. 36(1)(vii)-  Business of a predecessor firm  with assets  and liabilities taken over by the assessee-Assessee  paying income  tax on interest income accruing on  debt - Part of debt written off as a bad debt - Whether it could be allowed as a deduction.

HEADNOTE:      The assessee, a partnership firm, took over the running business  of  an  earlier  firm  with  all  the  assets  and liabilities including a debt of Rs.23,577. The assessee paid income tax  on the interest income accruing on the aforesaid amount of debt for the assessment year 1963-64. On March 31, 1965 the  assessee and  the debtor entered into a settlement whereby a  sum of  Rs.25,000 was accepted by the assessee in satisfaction of  the debt  and the  amount of  interest  due thereon. The  balance of  Rs. 15,100  was written off by the assessee as  irrecoverable. The assessee also incurred a sum of Rs.  6,880 as  legal expenses  on filing  an appeal which arose out  of a  suit already  instituted by the predecessor firm for recovering a sum due from the Central Government.      In assessment proceedings for the assessment year 1965- 66, the  assessee claimed  deduction of  the  aforesaid  two amounts written  off as  bad debts.  The Income  Tax Officer disallowed  both   the  claims.  On  appeal,  the  Appellate Assistant Commissioner  of Income  Tax allowed the claims of the assessee-firm holding that the business transferred from the   predecessor    firm   to    the   assessee   continued uninterrupted, and the change of ownership was no bar to the bad debt  being allowed.  The Income  Tax Appellate Tribunal and the High Court confirmed the view taken by the Appellate Assistant Commissioner. Hence this appeal.      Dismissing the appeal, ^      HELD:  (1)   The  money   owed  by  a  debtor  under  a transaction with  a predecessor  firm can  be written off as irrecoverable  in   the  accounts   of  the  successor,  the assessee, in a subsequent year and could be claimed as a bad debt under  clause (vii)  of sub-s.(1) of s.36 of the Income Tax Act, 1961. [24 A-B] 21      (2)  When   a  business   along  with  its  assets  and

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liabilities is transferred by one owner to another, there is no reason  why a  debt so transferred should not be entitled to the  same treatment  in the  hands to  the successor. The recovery of  the debt  is a right transferred along with the numerous  other   rights  comprising   the  subject  of  the transfer. If  the law  permits the  transferer to  that  the whole or  part of  the debt  as irrecoverable and to claim a deduction on that account, it seems difficult to accept that the same  right should  not be recognized in the transferee. It is  merely an  incident flowing  from the transfer of the business, together with its assets and liabilities, from the previous owner  to the  transferee.  It  is  a  right  which should, on  a proper  appreciation of all that is implied in the transfer  of a business, be regarded as belonging to the new owner. [25 E-H]      (3) Even  if the  debt had  been taken  into account in computing the  income of  the predecessor  firm only and had subsequently  been  written  off  as  irrecoverable  in  the accounts of  the accounts  of the  assessee would still have been entitled  to a deduction of the amount written off as a bad debt. It is not imperative that the assessee referred to in  sub-clause  (a)  must  necessarily  mean  the  identical assessee referred  to in  sub-section(b). A successor to the pertinent interest  of a previous  assessee would be covered within the  terms of  sub-clause (b). the successor assesee, In effect, steps into the shoes of his predecessor. [26 E-F]      In the present case, the debt was taken into account in the income  of the  assessee for the assessment year 1963-64 when the  interest income  accruing thereon was taxed in the hands of  the assessee.  It is  the same  assessee  who  has subsequently,  pursuant   to  a  settlement,  accepted  part payment of the debt in full satisfaction and has written off the balance  of the  debt as  irrecoverable in his accounts. Therefore the  conditions in  both sub-clause (a) and (b) of Clause (1) of sub-s.(2) of s.36 are satisfied. The same test has to  be applied  for acknowledging the claim to deduction of Rs. 6,880. [26 B-D]

JUDGMENT:      CIVIL APPELLATE  JURISDICTION :  Civil Appeal  No.  114 (NT) of 1975.      From the  Judgment and  Order dated  16.1.1974  of  the Andhra Pradesh High Court in Case Referred No. 9 of 1972.      B.B. Ahuja and Miss A. Subhashini for the Appellant. 22      A. Subba Rao for the Respondent.      The Judgment of the Court was delivered by      PATHAK, J.  This appeal  by special  leave is  directed against the  judgment of  the High  Court of  Andhra Pradesh disposing of  a reference  made under  sub-s.(1) of s.256 of the Indian  Income Tax  Act, 1961  for its  opinion  on  the following question of law.           Whether on  the facts  and in the circumstances of           the case  the bad  debt of Rs.15,100 and the legal           expense   of Rs.6,880 were allowable deductions in           the  assessment  of  the  assessee  firm  for  the           assessment year 1965-66? The assessee  is  a  partnership  firm.  It  took  over  the business of  an earlier firm. All the assets and liabilities of the  predecessor firm  passed on  to the  assessee  firm. These included  a debt  of Rs.23,577  due from Laxmi Trading Company to the predecessor firm. The total amount due in the account relating  to Laxmi  Trading  Company  was  Rs.40,549

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comprising an  outstanding amount of Rs. 29,200 and interest thereon in  the sum  of Rs.  11,349 for the period April 31, 1960 to  March 31, 1961. The amount of interest was taxed in the hands  of the  assessee for the assessment year 1963-64. On March  31, 1965  the parties  effected a settlement under which a  sum of  Rs.25,000 was  accepted by  the assessee in full settlement  of the  said debt. The balance of Rs.15,100 was written off as irrecoverable.      In assessment proceedings for the assessment year 1965- 66, for  which the  previous year  was the year ending March 31, 1965  the assessee  claimed a deduction of the aforesaid sum of  Rs. 15,100 written off as a bad debt. The Income-tax Officer disallowed the claim on the ground that the debt was due originally  to the  predecessor firm,  that there was no reason to  take over  the loan  by  the  assessee  firm  and further that  it was  not proved  that  the  debtor  was  so financially embarrassed  that he was unable to pay the debt. On appeal,  the Appellate  Assistant Commissioner  of Income Tax held  that the business transferred from the predecessor firm to the assessee continued uninterrupted, and the change of ownership  was no  bar to  the bad debt being allowed. He also noted  that the  assessee had  paid income-tax  on  the interest of  Rs.11,349, in  an earlier  assessment year, and held  that   the  assessee’s  bonafides  stood  established. Holding that there was 23 justification for  writing off  the bad  debt in the measure claimed   by   the   assessee,   the   Appellate   Assistant Commissioner allowed the appeal.      It may  be mentioned that the assessee had also claimed a deduction  of a  sum of  Rs. 6,880  before the  Income-tax Officer on  the ground  that the assessee had incurred legal expenses in  that amount  in connection with an appeal filed in the Supreme Court for the purpose of recovering a sum due from the  Central Government. The transaction related to the predecessor firm  and the  suit instituted  by it  had  been continued by  the assessee  on taking  over the  assets  and liabilities of  the predecessor firm. The Income Tax Officer disallowed this  claim also,  but in  appeal  the  Appellate Assistant Commissioner upheld the claim.      The Income-tax  Department appealed  to the  Income-tax Appellate  Tribunal  against  the  order  of  the  Appellate Assistant Commissioner and urged that cl.(i) of sub-s.(2) of s.36 of  the Income  Tax Act,  1961 did  not permit  such an allowance  because   it  did  not  satisfy  the  requirement mentioned in  cl.(a)  and  cl.(b)  of  that  provision,  and therefore it  was not  open  to  the  assessee  to  claim  a deduction of  Rs.15,100 as a bad debt nor the legal expenses of Rs.6,880.  The Appellate  Tribunal dismissed  the appeal, holding that  where  a  business  was  succeeded  to  by  an assessee, it  was entitled to write off the bad debts of the business taken  over. The  Appellate Tribunal  observed that whenever a  business was  succeeded to  as a  whole and as a running enterprise  the assets and liabilities so taken over became the  assets and  liabilities of  the  successor  and, therefore, the  assessee was  entitled to  write off the bad debts. It  noted that  the assessee had not only treated the amount a  debt owed  to it  but  had  allowed  the  interest accrued thereon  to be  assessed in its hand as the interest constituted part  of  the  debt.  At  the  instance  of  the Commissioner of Income-tax, a reference was made to the High Court of  Andhra Pradesh for its opinion on the question set forth earlier.  The High  Court answered the question in the affirmative and against the Department.      It is  not disputed  that the assessee succeeded to the

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business of  the predecessor  firm and  took  over  all  its assets and  liabilities, including  the debt  due from Laxmi Trading Company.  The business carried on by the predecessor firm was now carried on by the assessee. The facts also show that the  assessee paid  income tax  on the  interest income accruing on  the debt for the assessment year 1963-64. It is also not  disputed that the parties effected a settlement on March 31, 1965 whereby a sum of 24 Rs. 25,000  was accepted  by the assessee in satisfaction of the debt  and that  the balance of Rs.15,100 was written off by the  assessee as  irrecoverable. The  question is whether money  owed   by  a   debtor  under  a  transaction  with  a predecessor firm  can be written off as irrecoverable in the accounts of  its successor,  the assessee,  in a  subsequent year and  could be  claimed as  a bad debt under cl.(vii) of sub-s.(1) of s.36 of the Income Tax Act, 1961.      Cl.(vii) of  sub-s.(1) of  s.36 of  the Income Tax Act, 1961 provides :           "36.(1).  The   deductions  provided  for  in  the           following clauses  shall be  allowed in respect of           the matters  dealt with  therein, in computing the           income referred to in section 28 -           .................................................           (vii) subject  to the provisions of sub-s.(2), the           amount of  any debt,  or part  thereof,  which  is           established to  have become  a  bad  debt  in  the           previous year".           Sub-s.(2) of s.36 declares :-           "(2). In  making any  deduction for  a bad debt or           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 the 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) if  the amount  ultimately recovered  on  any           such debt  or  part  of  debt  is  less  than  the           difference between the debt or part and the amount           so deducted, the deficiency shall be deductible in           the previous  year in  which the ultimate recovery           is made; 25           (iii) any  such  debt  or  part  of  debt  may  be           deducted if  it has  already been  written off  as           irrecoverable  in   the  accounts  of  an  earlier           previous year,  but the Income-tax Officer had not           allowed it  to be  deducted on  the ground that it           had not been established to have become a bad debt           in that year;           (iv) where  any such  debt  or  part  of  debt  is           written off  as irrecoverable  in the  accounts of           the previous  year and  the Income-tax  Officer is           satisfied that such debt or part became a bad debt           in any  earlier previous year not falling beyond a           period  of   four   previous   years   immediately           preceding the  previous year in which such debt or           part is written off, the provisions of sub-section           (6) of section 155 shall apply".

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S.28, referred to in sub-s.(1) of s.36, provides that income under  the   head  "Profits   and  gains   of  business   or profession", shall  be chargeable to income-tax. The profits and gains  of a  business  are  charged  to  income-tax.  To compute the  profits and  gains so chargeable, s.36 provides for allowing  a number of deductions. Each of the deductions must relate  to the  business.  If  the  same  assessee  was carrying on  a business  and he wrote off a debt relating to the business  as irrecoverable,  he would  without doubt  be entitled to a corresponding deduction under cl.(vii) of sub- s.(1) of  s.36 subject  to the  fulfilment of the conditions set forth  in sub-s.(2)  of s.36.  If a business, along with its assets  and liabilities,  is transferred by one owner to another, we  see no  reason why a debt so transferred should not be  entitled to  the same  treatment in the hands of the successor. The  recovery of  the debt is a right transferred along with  the numerous other rights comprising the subject of the  transfer. If the law permits the transferor to treat the whole  or part of the debt as irrecoverable and to claim a deduction  on that  account, it  seems difficult to accept that  the  same  right  should  not  be  recognised  in  the transferee. It  is  merely  an  incident  flowing  from  the transfer of  the business,  together  with  its  assets  and liabilities, from  the previous  owner to the transferee. It is a  right which  should, on  a proper  appreciation of all that is  implied in  the transfer of a business, be regarded as belonging  to the  new owner.  Unless the language of the statute plainly  and clearly  compels a  construction to the contrary, the  normal rule  of the  law should  be given its proper play.  It is  true that  cl.(i) of  sub-s.(2) of s.36 declares that a deduction can be allowed only 26 if the debt, or part thereof, has been taken into account in computing the  income of  the assessee of that previous year or an  earlier previous  year and  that  it  has  also  been written off as irrecoverable in the accounts of the assessee for that  previous year.  In the  present case, the debt was taken into  account in  the income  of the  assessee for the assessment year  1963-64 when  the interest  income accruing thereon was taxed in the hands of the assessee. The interest was taxed  as income  because it  represented  an  accretion accruing during  the earlier  year  on  money  owed  to  the assessee by  the debtor. The item constituted income because it represented  interest on a loan. The nature of the income indicated  the   transaction  from  which  it  emerged.  The transaction was  the debt,  and that  debt  was  taken  into account in  computing the  income of  the  assessee  of  the relevant previous  year. It  is the  same assessee  who  has subsequently,  pursuant   to  a  settlement,  accepted  part payment of the debt in full satisfaction and has written off the balance of the debt as irrecoverable in his accounts. It appears therefore  that the  conditions in  both sub-clauses (a) and  (b) of cl.(i) of sub-s.(2) of s.36 are satisfied in the present  case,  and  the  High  Court  as  well  as  the Appellate Tribunal  and the Appellate Assistant Commissioner are right in the view which they took.      It seems  to us  that even  if the  debt had been taken into account in computing the income of the predecessor firm only and  had subsequently  been written of as irrecoverable in the  accounts of  the assessee,  the assessee would still have been  entitled to a deduction of the amount written off as a  bad debt.  It is  not  imperative  that  the  assessee referred  to   in  sub-cl.(a)   must  necessarily  mean  the identical assessee referred to in sub-cl (b). A successor to the pertinent  interest of  a  previous  assessee  would  be

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covered  within  the  terms  of  sub-cl.(b).  The  successor assessee,  in   effect,  steps   into  the   shoes  of   his predecessor.      Accordingly, we  hold that  the assessee in the instant case was  entitled to the deduction as a bad debt of the sum of Rs.  15,100 written  off by  it in  its accounts  of  the previous year as irrecoverable.      We may  add that  although a  number  of  decisions  of various High  Courts were  cited before  us on behalf of the assessee we consider it unnecessary to refer to them. 27      As regards  the sum of Rs.6,880 claimed by the assessee as legal expenses in connection with an appeal filed in this Court to  recover an amount due from the Central Government, it  is   apparent  that   the  transaction  related  to  the predecessor firm and the suit instituted by it was continued by the assessee on taking over the assets and liabilities of the predecessor  firm. The Income Tax Officer, the Appellate Assistant Commissioner,  the Appellate Tribunal and the High Court dealt  with this  claim on the same basis as the claim made in  respect of  the bad debt. We are satisfied that the view we  are taking  in respect  of the  sum of  Rs.  15,100 claimed as  a bad  debt  should  also  form  the  basis  for acknowledging the claim to deduction of Rs.6,880.      In the result, the appeal is dismissed with costs. M.L.A.                                     Appeal dismissed. 28