A. vs Thomas And Co. Ltd. vs Commissioner of Income Tax
Rewritten Version Notice: This is a rewritten version of the original judgment.
Court: Supreme Court of India
Case Number: Not extracted
Decision Date: 25 October, 1962
Coram: Hidayatullah J.
In this matter, the Court recorded that the appeal arose from a dispute concerning a deduction claimed by the assessee, A. V. Thomas and Co. Ltd., a company incorporated at Alleppey in 1935. The company sought to deduct an amount of Rs 4,05,072‑8‑6 for the assessment year 1952‑53 on the ground that the sum represented a bad debt which had been written off in its books on 31 December 1951. The assessing authority disallowed the deduction. Subsequently, after various procedural steps, the High Court of Kerala framed the principal issue for determination as follows: whether, on the facts and in the circumstances of the case, the Tribunal was correct in holding that the amount of Rs 4,05,071‑8‑6 claimed as a deduction was not admissible under either section 10(2)(xi) or section 10(2)(xv) of the Income‑Tax Act. The High Court found the matter suitable for appeal to this Court, and the appeal was lodged by the assessee. The respondent in the appeal was the Commissioner of Income‑Tax (Bangalore), Kerala. The judgment was delivered by Justice Hidayatullah. The Court noted that the memorandum of association of A. V. Thomas and Co. Ltd. authorized the company to engage in a variety of businesses. Specifically, clauses 1, 5, 18 and 23 of the memorandum permitted the company to be interested in, to promote and to undertake the formation and establishment of other companies, to make investments and to render financial or other assistance to any company. At the material time, the board of A. V. Thomas and Co. Ltd. comprised three directors: A. V. Thomas, S. Sankaranarayana Iyer and J. Thomas. The Court further identified another private limited company, Southern Agencies Ltd., situated in Pondicherry, whose directors were A. V. Thomas, S. S. Natarajan and C. S. Ramakrishnan Karayalar. In addition, the Court described the existence of a mill in Pondicherry known as Rodier Textile Mills, which was owned by Anglo‑French Textiles Ltd., Pondicherry.
The Court then recounted the factual background presented by the assessee. It was asserted that Southern Agencies Ltd. had, in 1948, undertaken the promotion of a new limited company to be called Rodier Textile Mills Ltd., Pondicherry, with the purpose of acquiring and developing the Rodier Textile Mills. To finance this promotional activity, the assessee claimed to have transferred sums totaling Rs 6,05,071‑8‑6 to Southern Agencies Ltd. The Court emphasized that the money was not supplied directly from the coffers of A. V. Thomas and Co. Ltd.; rather, it was advanced at the request of the assessee by India Coffee and Tea Distributors Ltd., a firm based in Madras. According to the assessee, although an entry in its own books dated 31 December 1948 recorded the amount as an advance for the purchase of 6,000 shares of Rs 100 each in the proposed Rodier Textile Mills Ltd., the principal intention behind the transaction was to assist and finance Southern Agencies Ltd. in accordance with the powers conferred on the assessee by its memorandum of association. The Court noted that the subscription list for Rodier Textile Mills Ltd. remained open from 5 January to 20 January 1949, but that no application for shares was made on behalf of A. V. Thomas and Co. Ltd., and consequently the shares were not acquired.
The shares in the new company were never obtained because the public showed no interest in the promotion and the entire venture collapsed. On 1 September 1950 the assessee company formally approved the actions of Mr A V Thomas in providing the advance, and subsequently, on 18 September 1950, its board of directors resolved that Rs 6,00,000 of the amount should be recorded as an advance for the purchase of shares in Rodier Textile Mills Ltd., which at that time was still being formed, while the remaining balance of Rs 5,072‑8‑5 should be entered under sundry advances due from the promoters of the new company. The promoter, Southern Agencies Ltd., failed to return the whole sum; it repaid Rs 2,00,000 on 7 December 1951, a payment that appears to have been accepted as full satisfaction of that portion. Although the advance was still considered good and recoverable as late as 12 June 1951, the balance was written off on 31 December 1951, the closing date of the assessee company’s financial year. That written‑off amount was subsequently claimed in the assessment year 1952‑53 as either a bad debt actually written off or, alternatively, as an expenditure that was wholly and exclusively incurred for the purpose of the assessee company’s business and was not of a capital nature. The Income‑Tax Officer of Alleppey held that the debt had been written off when it was neither bad nor doubtful, deeming the claim premature and therefore disallowing the deduction. An appeal to the Appellate Assistant Commissioner affirmed the officer’s order, albeit on a different basis: the Commissioner observed that the advance had been made for the purpose of acquiring shares in a company then in formation, which constituted the acquisition of a capital asset, either by gaining control of the new company or by obtaining its goodwill that might lead to agency rights for the assessee company. Consequently, any loss was characterized as capital in nature, rendering the question of premature bad‑debt deduction irrelevant, and the Commissioner further held that the deduction could not be claimed under section 10(2)(xv) of the Income‑Tax Act. The assessee company then appealed to the Tribunal, which upheld the Appellate Assistant Commissioner’s decision on a third ground. The Tribunal accepted that although one of the assessee company’s objectives was to promote and finance other companies for profit, the Rs 6,00,000 advance was not made in the ordinary course of its business but was driven by personal motives. In reaching this conclusion, the Tribunal noted that the advance was given to Southern Agencies Ltd., a firm not promoted by the assessee company, that there was no prior business relationship between the two entities, and that the assessee company held no expectation of a financial benefit from the transaction.
In its findings the Tribunal concluded that Rodier Textile Mills Ltd., Pondicherry, was neither financed nor promoted by the assessee company and that the company’s claim of acquiring any agency right was not supported by any evidence. The Tribunal expressed the view that the advance of Rs 4,05,072‑8‑5 was probably made because the assessee company and Southern Agencies Ltd. were substantially commonly owned by two persons, namely A V Thomas and S S Natarajan. Consequently, the Tribunal held that the deduction could not be allowed because the advance had been made out of personal motives rather than as part of the ordinary business of the assessee company. The assessee company sought a full‑scale case on the matter, but the Tribunal refused to grant it.
In its application for a case the assessee company formulated three specific questions: first, whether, based on the facts and circumstances, the sum of Rs 4,05,072‑8‑5 could be claimed as a bad debt written off under section 10(2)(xi) of the Income‑tax Act; second, whether the same sum could be claimed as a permissible deduction under section 10(2)(xv) of the Act; and third, whether the sum could be allowed as a proper debit and charged to the profit and loss account of the assessee company. These questions demonstrate that the assessee attempted to claim the amount in three distinct ways: as a loss in the ordinary course of business under section 10(i), as a bad debt written off under section 10(2)(xi), and as an expenditure wholly and exclusively incurred for business purposes under section 10(2)(xv).
The assessee company appealed to the High Court, which issued a reference on a single question that had been quoted. That single question indicated that the High Court did not direct the matter to be decided under section 10(1) of the Act. While the Tribunal had examined the advance from a business perspective and concluded that it was not an ordinary business advance but one motivated personally, the High Court apparently declined to consider the issue under section 10(1) and instead framed the reference under clauses (xi) and (xv) of section 10(2). The reference therefore concerned only those two clauses. An attempt was later made before this Court to raise the issue under section 10(1) and to claim the deduction as an ordinary business loss; that argument was rejected because, in our view, the question framed by the High Court did not encompass a discussion of section 10(1). The assessee company should, at the same stage, have asked the High Court to frame a question that included that possibility.
The Court observed that the Tribunal possessed no material on which it could form the conclusion that the transaction in question was not a business transaction but rather an advance made for personal motives. It was submitted before the Court that, when the High Court had sought a reference on the single question, it had declared that the question would encompass three matters. The first two matters were expressly set out in the question, while the third, described as implicit, concerned whether the Tribunal was competent to determine a case that the department had not previously established at an earlier stage. The Court clarified that this implicit aspect was not equivalent to a statement that the Tribunal lacked any material to reach the conclusion that the advance was not made in the ordinary course of the assessee’s business. The Court further noted that the High Court, in its order calling for a statement of the case, had observed that there was no dispute at any earlier stage that the transaction was not in the ordinary course of business; however, the High Court’s conclusion in the order made under section 66(2) could not be regarded as having any relevance or binding effect. The Court held that the High Court had erred in forming its own finding and that it was unsurprising that the Tribunal had protested against that finding. The Court explained that the High Court could have framed a question asking whether any material existed to support the Tribunal’s finding and could have invited the Tribunal to state its case on that basis. By not doing so, the question as framed required the assessee company to prove its case either under section 10(2)(xi) or under section 10(2)(xv), and the Court indicated that the matter would be examined from these two perspectives. The Court then reproduced clauses (xi) and (xv) of section 10(2), which read as follows: “(2) such profits or gains shall be computed after making the following allowances, namely: … (xi) When the assessee’s accounts in respect of any part of his business, profession or vocation are not kept on a 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 assessee carrying on a banking or money‑lending 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 amount actually written off as irrecoverable in the books of the assessee: … (xv) any expenditure (not being an allowance of the nature described in any of the clauses (i) to (xiv) inclusive, and not being in the nature of capital expenditure or personal expenses of the assessee) laid out or expended wholly and exclusively for the purpose of such business, profession or vocation.” In support of its position, the assessee company asserted that, since there was no dispute regarding the facts that the transaction constituted an advance made in the ordinary course of business, it should be treated accordingly.
In the present case, the assessee corporation submitted that the amount in question should be treated either as a loss arising from trade, as a bad debt, or as an expenditure that could be claimed under section 10(2)(xv) of the Income‑tax Act. To support this submission, the corporation relied heavily on certain ledger entries that related to Rodier Textile Mills Ltd. and were recorded in its own books. These entries were identified in the record as annexures “A‑1” to “A‑3”. The High Court also examined these accounts and interpreted them as indicating that the corporation had attempted to acquire a capital asset. The ledger entries covered a period beginning in 1948 and terminating on 31 December 1951, and each page bore the heading “personal ledger”. In December 1948, the ledger showed sundry amounts totalling Rs 6,05,071‑8‑5 described as amounts “paid to you by Indian Coffee and Tea Distributors Ltd., Madras, towards purchase of shares.” On 1 January 1949 the same sum opened with a debit balance of Rs 6,05,071‑8‑5. The entries did not identify the person or entity referred to as “you”. Subsequently, a series of reversing entries were made concerning various amounts. By 31 December 1949 the ledger presented the balance as follows: an advance for sundry expenses due from the promoters of a new company, amounting to Rs 5,071‑8‑5, together with a balance of Rs 6,00,000‑0‑0. The year 1950 opened on 1 January with an entry that transferred the balance of Rs 6,00,000‑0‑0, which was then credited to an amount paid to Southern Agencies Ltd. The same balance of Rs 6,00,000‑0‑0 appeared as the opening balance on 1 January 1951. On 7 December a payment of Rs 2,00,000 was recorded and Rs 4,00,000 was transferred for the purpose of writing it off. On 31 December 1951, Rs 4,00,000 was written off together with the amount of Rs 5,072‑8‑5. The latter sum included a charge of Rs 1 for carriage hire, which was also written off after the corresponding entry had been reversed. From these entries it was evident that, at the outset, the amount had been entered as an advance for the purchase of shares in Rodier Textile Mills Ltd.; consequently, if the purpose was to acquire shares, the amount could not be characterised as revenue expenditure.
The High Court correctly observed that acquiring agencies and reselling them was not a business activity of the assessee corporation. The corporation’s intention, as shown by the ledger entries, was to acquire shares so that it could later obtain the lucrative business of selling agencies and related undertakings of Rodier Textile Mills Ltd. This intention was reinforced by a statement made by the corporation’s chairman on 15 December 1952, in which he explained, “You are aware that an advance was made to the Southern Agencies (Pondicherry) Ltd. to acquire for us shares in Rodier Textile Mills Ltd. It was felt that when the promotion and working of Rodier Textile Mills Ltd. became a fait accompli, our company stood considerably to gain by securing their agency for handling their goods.” The chairman’s remarks clearly demonstrated that the corporation intended to acquire a capital asset for its own benefit. Because the purpose was to obtain a capital asset, the claim could not be placed within the ambit of section 10(2)(xv) of the Income‑tax Act, as no expenditure of a capital nature is allowable under that provision.
In this case, the Court observed that the declaration made by the chairman of the assessee company demonstrated that the expenditure in question was of a capital nature, which rendered the reliance on section 10(2)(xv) of the Income‑Tax Act untenable. The Court further noted that the amount was not spent in the financial year ending 31 December 1951; rather, the expenditure occurred in 1948, and therefore the matter had to be examined under section 10(2)(xi). In order to assess the applicability of section 10(2)(xi), the Court referred to the memorandum of association of the assessee company, which listed among its objects the promotion of other companies and the financing of such enterprises, and indicated that the amount had been paid to Southern Agencies Ltd. for the purpose of promoting Rodier Textile Mills Ltd. While acknowledging that the memorandum expressly authorized promotion and financing of other companies, the Court held that a memorandum of association is not conclusive evidence of the true character of a transaction; the real nature of the transaction must be inferred from the surrounding circumstances. The Court therefore examined the entries in the books of account of the assessee company, which contradicted the claim that the payment was made to promote Rodier Textile Mills Ltd. The accounts showed that the money was available on 31 December 1948, and that the subscription period for the shares was open from 5 to 20 January 1949, yet the assessee company made no application for even a single share. Up to the end of 1949 the books recorded the amount as laid out for the purchase of shares, and only thereafter was it recharacterised as an advance to Southern Agencies Ltd., with a specific entry appearing at the end of 1950 stating “By amount paid to Southern Agencies Ltd.” The assessee advanced three principal contentions in support of its claim that the sum had become a bad and doubtful debt and should be written off. First, it argued that the High Court was incorrect in holding that a deduction under section 10(2)(xi) required the assessee to demonstrate that it had previously bought and sold agencies. Second, it maintained that the purpose of the company was to acquire shares, and because no share application was made, the transaction with Southern Agencies remained a normal advance in the ordinary course of business. Third, it asserted that since Southern Agencies failed to return the money, the assessee was entitled to write off the amount as a bad doubtful debt. The Court then explained that a claim under section 10(2)(xi) can arise only when there exists a bad or doubtful debt, and that before a debt can be classified as bad or doubtful, it must first be a debt. To clarify the meaning of “debt” in this context, the Court cited the observation of Rowlatt J in Curtis v. J & G Oldfield Ltd, which stated that a bad debt is one that would have appeared on the balance‑sheet as a trading debt in the relevant trade and that, if it were a good debt, it would have increased profits. The Court emphasized that a mere advance of money for a purchase that was never completed does not satisfy the definition of a debt for the purposes of section 10(2)(xi).
The Court explained that the term “bad debt” does not refer to just any loss; rather it means a debt that, if it had been a good debt, would have increased the taxpayer’s profits. In other words, a debt of this kind is an outstanding amount whose recovery would have added to the profit and loss account. It is not, however, money that was handed over merely to enable the purchase of an item when that item was never actually acquired and the money was not returned. The statute therefore requires that a debt be something more substantial than a simple advance. A debt must arise out of, or be closely connected with, the business activity of the assessee and must result from that business. Consequently, before a loss can be claimed under the provision as a “bad or doubtful debt,” the claimant must first prove that the loss represents a genuine debt and not just an advance.
The observations of Rowlatt J. were subsequently endorsed by the Privy Council in Arunachalam Chettiar v. Commissioner of Income‑Tax. The Privy Council held that “their Lordships can give no countenance to a suggestion that, on the dissolution of a partnership, a partner’s share of losses for several preceding years may be accumulated and set off against the income of another partner for a particular year. No principle of writing off a bad debt can justify such a course, whether in the year following the dissolution or, as logic would permit, in some later year when the partner’s insolvency has crystallised. The bad debt would not, if it were a good debt, have come in to swell the taxable profits of the other partner.” The Court also reaffirmed the dictum of Rowlatt J. in Commissioner of Income‑Tax v. Abdullabhai Abdulkadar and referred to the earlier judgment of Venkatarama Aiyar J. in Badridas Daga v. Commissioner of Income‑Tax, where it was observed that a business debt “springs directly from the carrying on of the business and is incidental to it and not any loss sustained by the assessee, even if it has some connection with his business.”
Section 10(2)(xi) of the Income‑Tax Act consists of two limbs. The first limb applies to an assessee who conducts the business of a banker or money‑lender. The second limb applies to all other kinds of business. Because the present case did not involve a loan made by a banker or money‑lender, the debt in question had to satisfy the test that, if it were a good debt, it would have increased the assessee’s taxable profits. Applying this test, the Court found it evident that the amount advanced by the assessee company to another entity for the purpose of purchasing shares could not be characterised as a debt incidental to the assessee’s trading activities. The advance was essentially a pre‑payment for shares that Southern Agencies had the right to allot in Rodier Textile Mills Ltd. Accordingly, it could not be described as a debt.
The Court further observed that the accounting records of the assessee company demonstrated that the company had deliberately altered its books to reclassify the advance as a debt. This reclassification was undertaken so that the company could write off the amount and claim a deduction under Section 10(2)(xi). In the Court’s opinion, the statutory provision was inapplicable to the facts of this case because the transaction did not constitute a proper debt within the meaning of the law.
In this case the Court examined the material placed before it and determined that the appeal could not be sustained on any of the grounds that had been urged. Accordingly the Court ruled that the appeal must fail and therefore dismissed it. In addition, the Court directed that the appellant, identified as the assessee company, should bear the costs incurred by the respondent in these proceedings. By issuing this direction the Court made clear that the financial burden of the litigation would rest upon the appellant. The order expressly stated that the appeal was dismissed and that the respondent’s costs were to be paid by the appellant. No further relief was granted to the appellant, and the dismissal was recorded as final. The judgment therefore concluded that the appeal was dismissed and that the assessee company was liable for the respondent’s costs, thereby bringing the matter to an end.