Associated Banking Corporation Of... vs Commissioner Of Income-Tax, Bombay-1

Rewritten Version Notice: This is a rewritten version of the original judgment.

Court: Supreme Court of India

Case Number: Civil Appeal No. 956 of 1963

Decision Date: 22 October 1964

Coram: J.C. Shah, S.M. Sikri

In this matter, the Supreme Court of India considered an appeal filed by Associated Banking Corporation of India Limited against the Commissioner of Income‑Tax, Bombay‑1. The appeal was decided on 22 October 1964. The judgment was authored by Justice J. C. Shah, who was joined by Justices S. M. Sikri and Subbarao K. Sikri. The case is reported in the 1965 volumes of the All India Reporter at page 1188 and in the Supreme Court Reports (First Series) at page 788. The statutory provisions that were examined were sections 10(1) and 10(2) of the Income Tax Act, 1922, specifically sub‑clauses (xi) and (xv), which relate to the scope of deductions for bad debts, embezzlement by an officer of a bank, and the timing of the loss.

The assessee was a bank that had entered into liquidation. The official liquidator filed a return for the assessment year 1948‑49, seeking deductions under two heads. First, a deduction under section 10(2)(xi) was claimed for debts that had become irrecoverable, amounting to at least Rs 15,00,000. Second, a deduction under section 10(2)(xv) was sought for amounts that had been embezzled by one of the bank’s officers, amounts which the bank had subsequently had to pay to its depositors. The assessing authority and the Income‑Tax Appellate Tribunal rejected both claims. The tribunal held that the bad‑debt deduction could not be allowed because the debts had not been written off in the bank’s books of account. Likewise, the embezzlement deduction was rejected on the basis that the loss did not arise out of the bank’s business and, even if it did, the loss had not been incurred in the year of account in question.

The matters were then taken up by the High Court, which asked the tribunal to prepare a report answering two specific questions: whether any of the debts had actually become irrecoverable, and in which year the loss due to the officer’s embezzlement was suffered by the bank. The tribunal reported that debts amounting to at least Rs 15,00,000 had indeed become irrecoverable during the year of account, and that the defalcations by the bank’s officer became known to the liquidator only after the close of that year. After receiving this report, the High Court ruled against the bank, holding that the bad‑debts could not be deducted because they had never been written off, and that the loss arising from the embezzlement occurred after the year of account and therefore could not be allowed as a deduction.

The bank appealed this decision to the Supreme Court. The Court held that the bank was entitled to claim the Rs 15,00,000 as a deduction for bad debts in the relevant year of account. The Court explained that section 10(2)(xi) does not forbid an income‑tax officer from allowing a bad or doubtful debt merely because the assessee has not entered a write‑off in its books. The provision merely requires that the officer not allow an amount exceeding that which has actually been written off as irrecoverable. When a reasonable explanation exists for the absence of a written‑off entry, that absence alone cannot be considered a sufficient ground for denying the deduction.

The Court explained that the income‑tax officer possessed jurisdiction to estimate the amounts of debts that had become irrecoverable and to allow those amounts as proper deductions in the computation of profits. However, the officer’s power was limited in only one direction: when the assessee had recorded an entry or entries in its books of account, the amount estimated as irrecoverable could not exceed the amount that the assessee had actually written off. The Court stressed that this limitation did not place an assessee who refrained from making a written‑off entry in a more advantageous position than one who had made such entries. The reason, the Court said, was that the assessee who chose not to record a write‑off constantly faced the risk that the income‑tax officer might conclude that the very absence of a write‑off entry indicated that no portion of the debt owed to the assessee had become irrecoverable. The Court cited authorities, referring to the passages at pages 794 E‑F, 796 D‑F, 797 G‑H and 798 B‑C, and approved the decision in Begg Dunlop and Co. Ltd. v. Commissioner of Excess Profits Tax, West Bengal (1954) 25 I.T.R. 276. The Court then turned to the second point, namely that the bank could not claim as a business loss or deduction the amount embezzled by its officer. It observed that although the bank had suffered a loss due to the officer’s defalcations, the withdrawal and misapplication of the funds only became known to the Official Liquidator after the close of the accounting year. Consequently, the amount could not be allowed as a permissible deduction under section 10(2)(xv) of the Income‑Tax Act. The Court noted that the embezzlements took place in 1946 but were unknown to the bank at that time; even after the liquidator discovered them, a trading loss could not be said to have arisen. The Court clarified that a trading loss does not arise for a bank immediately upon the occurrence of embezzlement, whether or not the bank is aware of it. As long as there existed a reasonable prospect of recovering the amounts, a commercial trading loss would not be deemed to have occurred. The Court supported this proposition with references to pages 800 D and 801 G‑H, and approved the decision in M. P. Venkatachalapathy Iyer v. Commissioner of Income‑Tax, Madras (1951) 20 I.T.R. 363. The judgment concerned Civil Appeal No. 956 of 1963, which arose from the Bombay High Court’s judgment and order dated 22 April 1960 in Income‑Tax Reference No. 72 of 1957. The appellant was represented by counsel for the Associated Banking Corporation of India Ltd., while the respondent was represented by counsel for the Commissioner of Income‑Tax. The judgment was delivered by Justice Shah. In the factual background, the Court noted that one M. C. Javeri had been appointed Secretary to the Associated Banking Corporation of India Ltd. Under a power of attorney dated 14 August 1943, Javeri was entrusted, among other powers, to supervise, manage and conduct the business of the bank, to lend money at such rates of interest as he deemed fit, with or without security, to receive repayment of any monies advanced together with interest, and to borrow money on the security of any securities, assets or property of the bank in a manner he considered beneficial to the bank.

In this case the Court recorded that M. C. Javeri, who had been given a power of attorney on 14 August 1943, was authorised to borrow money against any securities, assets or property of the Bank and to do so on such terms as he thought would benefit the Bank. Subsequently, on 5 March 1945, Javeri was also appointed a Director of the Bank. Two years later, on 21 April 1947, the High Court of Bombay issued an order directing that the Bank be compulsorily wound up and that an Official Liquidator be appointed to wind up its business. The Liquidator, on 23 August 1949, filed a return for the assessment year 1948‑49 in which he disclosed that for the preceding financial year ending 30 June 1947 the Bank had suffered a business loss of Rs 9,71,664. In arriving at that figure the Liquidator had debited, against the gross profits shown in the profit and loss account, an amount of more than Rs 12,00,000 as debts which had become irrecoverable. Later, on 26 February 1953, the Liquidator informed the Income‑Tax Officer that investigations had revealed that the total bad debts of the Bank, including amounts embezzled by the Secretary, amounted to Rs 48,50,952. Both parties accepted that the entries required to adjust the books of account and to write off the amounts claimed as irrecoverable had never been posted in the Bank’s books, neither at the time the return was filed nor even by the time the proceedings reached the Tribunal.

The departmental tax authorities and the Income‑Tax Appellate Tribunal rejected the Liquidator’s claim for an allowance of bad debts on the ground that, as required by section 10(2)(xi) of the Income‑Tax Act, the bad debts had not been written off in the Bank’s books of account. The Liquidator also sought an allowance of Rs 10,15,000 and Rs 98,892 as losses resulting from the Secretary’s embezzlement. The departmental authorities dismissed these claims on two grounds: first, that the embezzlement did not arise in the ordinary course of the Bank’s business and therefore could not be treated as a business loss; second, that the loss had not been incurred in the relevant year of account because it had not been ascertained during that year. The Tribunal concurred with the departmental authorities on the second ground.

Under section 66(1) of the Act, the Tribunal framed two questions for consideration, which the High Court later modified as follows: (1) whether, on the facts and circumstances of the case, the assessee was entitled to claim bad debts amounting to Rs 38,35,654 or any lesser sum; and (2) whether, on the facts and circumstances, the assessee was entitled to claim the two sums of Rs 10,15,000 and Rs 98,892 as a business loss or as a deduction under section 10(2)(xv) of the Income‑Tax Act. The High Court agreed with the Tribunal that the claim for an allowance of bad debts could not be sustained under section 10(2)(xi), because the debts had not been written off in the Bank’s books of account. At the request of counsel for the Liquidator, the Court then invited the Tribunal to submit a supplementary statement concerning the powers that had been entrusted to the Secretary and the year in which the loss due to the Secretary’s embezzlement was suffered by the Bank.

In the reference the Tribunal was asked to answer two questions: first, whether the debts in dispute had actually become unrecoverable during the relevant year of account, and second, whether those debts had arisen in the ordinary course of the Bank’s business. The High Court held that the material placed before it in the original statement of case did not permit a definitive answer to the second question. Consequently, the Court directed the Tribunal to file a supplementary statement that would disclose the scope of authority that had been entrusted to the Secretary and indicate the year in which the Bank suffered loss as a result of the Secretary’s embezzlement.

The Tribunal’s supplementary statement disclosed that debts amounting to at least Rs 15,00,000 had become irrecoverable in the year of account under consideration. It further reported that the Secretary had abused the powers conferred on him by a power of attorney— a copy of which was attached to the Tribunal’s report—by entering fictitious entries in the Bank’s books of account. However, the Tribunal noted that the specific defalcations of Rs 18,00,000 and Rs 98,892 committed by the Secretary did not become known to the liquidator until after the close of the year of account, which ended on 30 June 1947.

When the matter was heard again, the High Court observed that it was bound by its earlier finding that bad debts could not be allowed as deductions because those debts had never been written off in the Bank’s books of account. The Court further explained that the moment at which a loss arising from embezzlement or defalcation by an employee or agent of the assessee occurs must be determined on the facts and circumstances of each individual case, and that no universal rule could be laid down on the issue. In the Court’s view, the loss of Rs 10,15,000 did not arise at the time the Secretary caused the fictitious entries to be posted, but only at a later date. Similarly, the amount of Rs 98,892 could not be treated as a business loss for the year of account for the same reason.

Having obtained a certificate from the High Court, the liquidator of the Bank filed the present appeal. In order to decide whether a written‑off entry in the books of account is a condition precedent to the allowance of bad debts, the Court turned to the language of section 10(2)(xi) of the Income‑Tax Act. That provision states that where an assessee’s accounts are not maintained on a cash basis, an allowance may be made for bad and doubtful debts due to the assessee in respect of that part of the business, and, in the case of a banking or money‑lending business, for loans made in the ordinary course of business that the Income‑Tax Officer may estimate to be irrecoverable, provided that the amount of the allowance does not exceed the sum actually written off as irrecoverable in the assessee’s books, assuming the assessee is a banking company and has complied with the conditions set forth in the statute.

In the present matter, the Tribunal observed that the bank, in the ordinary course of its business, had granted loans and that debts amounting to Rs 15,00,000 were estimated to be irrecoverable for the relevant year of account. The central issue therefore was whether such an amount could be allowed as a deduction in computing the taxable income when the same sum had not been written off as irrecoverable in the bank’s books of account. The law provides that an assessee may claim a deduction for debts that have become irrecoverable either in the income‑tax return itself or in the statement that accompanies the return. In the supplementary statement filed by the liquidator, a claim was made that Rs 48,50,952 should be treated as bad debts for that year of account. This claim clearly indicated that the liquidator was seeking to have regarded as bad debts those amounts that were asserted to be irrecoverable in the same financial year. Nevertheless, it was contended that a prerequisite for allowing a deduction for bad debts was that the assessee must have entered in its books of account an entry, or entries, that wrote off the debts as irrecoverable. Under the statute, the Income‑Tax Officer is empowered to estimate certain debts as irrecoverable, but that power is limited by the condition that the allowance granted may not exceed the amount actually written off as irrecoverable in the assessee’s books. Consequently, if the assessee has written off a specific sum as irrecoverable, the Officer, even when his estimate of loss is higher, cannot allow a deduction that exceeds the amount actually written off. The question that arose was whether, in the absence of any such entries in the books of account, the Officer’s discretion to permit a deduction under the head “bad debt” would be unrestricted. This point of law was the subject of a divergence of opinion among the High Courts.

Chief Justice Chagla, delivering the judgment under appeal, held that the requirement that a debt be written off in the books of account before a deduction could be allowed was consistent with the longstanding judicial interpretation of section 10(2)(xi). He observed that, to his knowledge, no case had ever been presented before the Court in which either the Revenue Department or the assessee claimed a deduction for a bad debt that had not been written off in the books. He further noted that, apart from the settled practice, several decisions of this Court had also applied the same view of the statutory provision. In contrast, the Calcutta High Court, in the case of Begg Dunlop and Co. Ltd. v. Commissioner of Excess Profits Tax, West Bengal, expressed an emphatic opinion to the opposite effect. Chief Justice Chakravartti, who authored the judgment of that Court, observed that the last clause of the section gave the Income‑Tax Officer a discretion to estimate an amount as irrecoverable, subject to a ceiling beyond which the Officer could not go. This contrast highlighted the conflicting approaches that required clarification.

In this case, the Court observed that section 10(2)(xi) of the Income‑tax Act confers a discretionary power on the Income‑tax Officer to permit an amount that he personally estimates to be irrecoverable, but that this discretion is limited by a ceiling beyond which the Officer may not exceed his allowance. The Court stressed that, in order to resolve the apparent conflict, it was essential to examine with care the statutory provisions that govern the allowance of bad debts when computing the profits or gains of a business carried on during the relevant accounting year. The Court explained that, when the Income‑tax Act of 1922 was first enacted, sub‑section (2) of section 10 contained no express provision for permitting the allowance of bad or doubtful debts in the computation of a taxpayer’s profits or gains. Nevertheless, the Court noted that bad or doubtful debts could still be treated as legitimate business deductions under the general provision of section 10(1). The Court then referred to the decision in Commissioner of Income‑tax, Central Provinces and Berar v. Sir S. M. Chitnavis, where the Judicial Committee held that a debt which becomes a bad debt during the accounting year may be regarded as a loss and may be deducted from profits. The Committee’s judgment, quoted at page 296, was set out in full: “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.” The Court further explained that, although the Judicial Committee recognized the deduction of such losses, it did not treat the act of writing off the debts in the books as a prerequisite condition for the claim to be allowed. The Court acknowledged that, in any recognized system of commercial accounting, where accounts are maintained on a commercial basis, the assessment that a debt has become barred would normally be reflected by an entry or entries in the books of account—either in the debtor’s account or in an appropriate section of the books—indicating that, in the taxpayer’s view, the debt was irrecoverable. The Court noted, however, that such entries need not be made for each individual debt; a composite entry covering a group of debts considered bad or doubtful may be sufficient for the preparation of the profit and loss account for the year.

The Court observed that when a taxpayer treats certain debts as bad or doubtful, it is sufficient for the taxpayer to make a single aggregate entry covering all such debts, rather than recording each debt individually. After the Privy Council’s decision in the Chitnavis case, Parliament responded by amending the Indian Income‑tax Act through section 11 of the Income‑tax (Amendment) Act 7 of 1939, inserting clause (xi) into subsection (2) of section 10. This amendment expressly governs the allowance of bad or doubtful debts in computing taxable profits and gains. Consequently, in matters governed by the amended statute, the question of whether a bad or doubtful debt may be allowed as a deduction must be decided according to the clear wording of the statute, and not on the basis of general commercial accounting principles or considerations of business necessity. The Court noted the precise language used by the legislature: the provision does not forbid an Income‑tax Officer from allowing a bad or doubtful debt unless the debt has been written off in the taxpayer’s books; rather, it stipulates that the Officer may not allow an amount exceeding the amount that has actually been written off as irrecoverable. Accordingly, it is the responsibility of the Income‑tax Officer to determine which debts have become bad or doubtful during the relevant accounting year, a task that requires the Officer to investigate whether the debts claimed to be bad or doubtful are in fact irrecoverable and to ascertain the exact amount involved. If the taxpayer records a composite entry for debts whose total value exceeds the amount entered as written off, the assessing authority may not permit a deduction greater than the amount actually written off. Conversely, where the taxpayer makes individual entries for each debt, the statutory restriction applies separately to each such debt that has been written off. Nevertheless, the Court made clear that the mere act of writing off an individual debt in the books of account is not a condition precedent for its allowance as a deduction in the profit computation. The Court added that, apart from the judgment presently under appeal, no decision has been cited that holds the Income‑tax Officer’s power to allow deductions for bad or irrecoverable debts depends on the existence of a specific entry in the taxpayer’s books showing that a particular amount has become irrecoverable. The two cases referenced by Chief Justice Chagla as illustrative of established Bombay High Court practice do not support that restrictive view. In Commissioner of Income‑tax and Excess Profits Tax, Central Bombay v. Jwala Prasad Tiwari, the assessee claimed that certain debts had become doubtful in the relevant year and had debited the amounts in the profit and loss account while crediting them under a “doubtful debts” heading in a suspense account. The tax authorities argued that because the individual debtor ledgers were not credited, the debts had not been written off as required by the statute. The High Court, however, held that the debts had indeed been written off in the assessee’s books and concluded that section 10(2)(xi) does not obligate the taxpayer to make individual ledger entries for each bad or doubtful debt. The Court further noted that it was not required in that case to determine whether the absence of a specific entry would deprive the Income‑tax Officer of the power to allow the estimated irrecoverable amount. Accordingly, the decision does not establish that writing off a debt is a prerequisite for its allowance under section 10(2)(xi). The Court also referred to another case, Karamsey Govindji, Bombay v. Commissioner of Income‑tax, Bombay City, in which the assessee had advanced unsecured loans to a film producer in 1945 and 1946 and had written off those loans.

In that case the Court observed that because the individual debtor accounts had not been credited with the disputed amounts, the debts had not been written off in accordance with the statutory requirement, yet the High Court found that the amounts had, in fact, been written off in the assessee’s books. The Court further held that section 10(2)(xi) did not obligate the taxpayer to make separate ledger entries for each debt that was claimed to be bad or doubtful, and that the provision did not stipulate that such entries must be posted. Moreover, the Court noted that it was not asked to decide whether the lack of a specific entry removing the amount from the books would strip the Income‑Tax Officer of the authority to allow a deduction for debts that the Officer considered irrecoverable. Consequently, the decision did not establish that a written‑off entry is a mandatory condition for a bad‑debt allowance under section 10(2)(xi). The Court then referred to another decision, Karamsey Govindji, Bombay v. Commissioner of Income‑Tax, Bombay City, in which the assessee had advanced unsecured loans in 1945 and 1946 to a film producer and subsequently wrote off those loans as bad debts in November 1947. The Income‑Tax authorities, based on the evidence, contended that the loans had not become irrecoverable in 1947, but the Bombay High Court, on a reference under section 66(2), held that the authorities’ finding could not be considered unjustified on the evidence. That judgment, reported in (1953) 24 I.T.R. 537 and (1957) 31 I.T.R. 953, did not directly address whether writing off a debt in the taxpayer’s books is a prerequisite for allowance under section 10(2)(xi). The revenue counsel conceded that a bad‑debt allowance could be granted even if the entry writing off the amount as irrecoverable was entered during the hearing before the Income‑Tax Officer. Accordingly, the Department submitted that, although an entry writing off the amount of a debt claimed to be bad or doubtful may be regarded as a condition precedent to the allowance, the entry need not be posted before the tax return is filed, nor before the assessment hearing is concluded. The Legislature, the Department argued, has not expressly provided that a bookkeeping entry writing off a debt as irrecoverable is a condition for its admissibility as an allowance under section 10(2)(xi), and the language of the clause, when read in the context of the Act’s scheme, does not force such an interpretation. Regarding the power of the Income‑Tax Officer and other superior authorities, the Department acknowledged that a clear limitation exists: the Officer may not estimate debts as irrecoverable in excess of the amount that the taxpayer himself regards as irrecoverable. However, if the taxpayer, for a satisfactory reason, has not posted an entry and provides a reasonable explanation, the absence of such an entry should not by itself deprive the Officer of jurisdiction to assess the debt as irrecoverable and to allow it as a proper deduction in the computation of profits.

In the present case, the Court observed that the mere absence of an entry in the books of account writing off the amount of a debt that had become bad or doubtful was not, by itself, a reason to refuse the Income‑tax Officer the authority to estimate that debt as irrecoverable and to permit a deduction of that amount in the computation of profits. The Court noted that, at first glance, the rule could appear paradoxical. When a taxpayer had actually written off individual debts or a collective sum as irrecoverable, the Officer’s power was limited; the amount that could be allowed as an irrecoverable debt could not exceed the amount that the taxpayer had recorded as written off. Conversely, where no entry had been made in the books, the Officer’s jurisdiction was broad, and the Officer could allow any amount he deemed irrecoverable.

The Court cautioned that the statutory provisions should not be interpreted in an overly technical or narrow manner. It pointed out that clause (xi) of Section 10(2) did not restrict the Officer’s power to estimate bad debts; rather, it limited the power to grant an allowance under the head of bad and doubtful debts to an amount that did not exceed the sum actually written off by the assessee in his books. Accordingly, the Court held that after the Officer had estimated the bad debts, there was no express statutory restraint on his power to grant an allowance, and no implication of such a restraint could be inferred unless the scheme of the Act expressly intended it. The Court further observed that the Act’s scheme did not impose an absolute limitation, because it could not be assumed that a missing entry necessarily meant that no debts had become irrecoverable during the year of account.

Referring to the judgment of Chief Justice Chakravarti in Begg Dunlop and Co. Ltd.’s case, the Court agreed with the earlier observation that Section 10(2)(xi) did not strictly require that an amount be actually written off in the taxpayer’s books before it could be allowed as irrecoverable in a particular year. The Court explained that the language of the provision—“such sum as the Income‑tax Officer may estimate to be irrecoverable but not exceeding the amount actually written off”—conferred discretion on the Officer to estimate the irrecoverable amount, while simultaneously setting a ceiling that could not be surpassed. The Court clarified that the provision did not impose a mandatory requirement that every debt the Officer treated as irrecoverable must be written off in the books, thereby rejecting a literal and restrictive construction of the statute.

In this case, the Court explained that the provision did not require every debt which the Income‑tax Officer might treat as irrecoverable to be formally written off in the taxpayer’s books. The Court held that the essential meaning of the Section was that when a debt had actually been written off by the assessee as irrecoverable in a particular year, the Income‑tax Officer, while allowing a deduction for bad debts for that year, could not permit an amount exceeding what the assessee had written off. However, the Court stressed that this interpretation did not place a taxpayer who omitted to record a doubtful or bad‑debt entry in a more advantageous position than a taxpayer who had made such entries. The Officer could, based on the material before him, conclude that the absence of a written‑off entry reflected the circumstance that no portion of the debt due in the year of account had become bad, doubtful, or irrecoverable, and therefore could reject any claim, such as that cited in (1) (1954) 25 I.T.R. 276, that some or all debts had become doubtful. Even where no entry appeared in the books, the decision remained a matter of the Officer’s power to assess the facts and circumstances on record and to allow deductions in the profit and gains computation. If the Officer estimated certain debts to be irrecoverable, he could, under Section 10(2)(xi), allow the corresponding deduction, subject only to the limitation that when the assessee had actually written off amounts, the estimated deduction could not exceed the amount written off by the assessee. The Court further referred to the Income‑Tax Act of 1961, noting that Section 36(1)(vi) required the amount of any debt or part thereof established as a bad debt in the preceding year to be allowed in computing income under Section 28, but that this allowance was conditioned by Sub‑section (2). Sub‑section (2) stipulated, as a material condition, that no deduction for a bad debt or part thereof could be permitted unless the debt (a) had been taken into account in computing the assessee’s income for that previous year or an earlier year, or represented money lent in the ordinary course of banking or money‑lending business carried on by the assessee, and (b) had been written off as irrecoverable in the assessee’s accounts for that previous year. The remaining sub‑clauses (ii) to (iv) were acknowledged but not reproduced in full.

It was clear that the material clause had been completely rewritten and that the Legislature had expressed its intention in an unambiguous manner. The Secretary, M.C. Javeri, possessed extensive management powers while the Directors of the Bank appeared to remain passive. Using these powers, the Secretary appropriated large sums from the Bank’s assets for his own benefit. On 1 November 1946, the Bank entered into an underwriting agreement with the Government of Bhopal to underwrite a loan valued at Rs 2 crores issued by that Government. Shortly thereafter, on 3 December 1946, V. R. Ranade and Sons applied to purchase the Bhopal Government loan and transferred the full amount of Rs 15 lakhs to the Bank. Initially, this amount was credited to a sundry‑deposit account, but the Secretary ordered the entry to be reversed and broke the Rs 15 lakhs into smaller sums, recording them under different names in the account books. When V. R. Ranade and Sons demanded the loan certificates, the Secretary supplied them with a forged allotment letter purportedly showing certificates valued at Rs 15 lakhs allegedly received from the Bank of Bhopal Ltd. After the Bank was ordered to be wound up, V. R. Ranade and Sons filed a claim on 5 December 1947 seeking preferential payment of Rs 15 lakhs from the Bank’s assets. On 28 February 1949, the liquidator moved for an order directing that V. R. Ranade and Sons be paid Rs 8,80,000 as preferential creditors within one month of the order. Following the Court’s direction, the Official Liquidator eventually paid the specified amount to V. R. Ranade and Sons.

In early 1947, the Bank of Bhopal instructed its broker, Shantilal L. Thar, to purchase on its behalf a Bhopal Government loan having a face value of Rs 3 lakhs, and Thar contracted with the assessee Bank for this purchase. On 11 February 1947, the amount of Rs 3 lakhs was transferred to the Bank, but the Bank never issued a letter of allotment. Consequently, loan certificates were never delivered to the Bank of Bhopal Ltd. The Rs 3 lakhs paid to the assessee Bank was subsequently transferred to the account of Haroon Haji Abdul Satar of Bantwa in the Jetpur Branch, appearing as though that individual had sold bonds valued at Rs 3 lakhs. The Secretary later withdrew this amount and misappropriated it. The Bank of Bhopal Ltd. instituted suit against the assessee Bank in the Bombay High Court seeking an order for delivery of the Bhopal Government bonds and, alternatively, a decree for Rs 3 lakhs. The parties eventually reached a settlement whereby the assessee Bank consented to pay Rs 1,35,000 in full to the Bank of Bhopal Ltd. as a final settlement.

In this case the parties reached a final settlement, and a consent decree was entered on 20 September 1951. The decree was later satisfied by the liquidator. The liquidator also claimed an additional sum of Rs 98,892, alleging that the Secretary had embezzled that amount. However, at the hearing the liquidator’s counsel abandoned this portion of the claim, and the court indicated that it was unnecessary to set out the particulars of that amount for the purposes of the present appeal. Consequently, the claim that formed the second question in the appeal was limited to Rs 10,15,000. The income‑tax authorities disallowed this claim. Their reasoning was that the loss was not incurred in the ordinary course of the Bank’s business and therefore could not be treated as a loss of the Bank; moreover, they said that the loss was not suffered in the year of account because it was only ascertained in 1949 or thereafter, and consequently could be taken into account only in the assessment of that later period. The court noted that the embezzlements had, in fact, taken place in the accounting year that ended on 30 June 1947. The Secretary, who possessed a power of attorney, misused that authority to withdraw Rs 18,00,000 by posting entries in the names of persons who either did not exist or had no relationship with the Bank. Until an inquiry into the Bank’s dealings was conducted, the directors of the Bank and the liquidator were unaware of the embezzlements. As a result of the Secretary’s improper withdrawals, the Bank was compelled to pay Rs 10,15,000 to its constituents in order to satisfy the liability that arose from the Secretary’s handling of the Bank’s funds. Accordingly, a loss had indeed been suffered by the Bank because of the Secretary’s withdrawals. The only question that remained for the appeal was whether that loss occurred in the accounting year that ended on 30 June 1947. Counsel for the liquidator argued that a banking institution suffers loss when an agent or servant withdraws or misapplies funds and that such loss, having occurred in the relevant year of account, should be allowed as a deduction against the profits of that year. The court was unable to accept that argument. It held that a claim to deduct an amount lost through embezzlement by an agent did not fall within any of the specific allowances listed in clauses (i) to (xv) or under sub‑section (2) of the relevant provision; to be admissible, it would have to fall within sub‑section (1). This position had been correctly conceded by counsel for the Bank in the High Court judgment. The court further explained that determining when a loss arising from an agent’s misapplication of funds occurs required a comprehensive examination of all facts and circumstances, applying the principles of commercial trading. Embezzlement, akin to a speculative venture, does not automatically result in an immediate loss; the loss may remain uncertain until the principal becomes aware of the wrongdoing and the assets are either restored or deemed unrecoverable. Consequently, the loss could not be automatically recognized in the year of the unauthorized withdrawal.

Embezzlement does not necessarily create a loss at the moment the dishonest act is committed or when the speculative venture begins. The dishonest act may remain concealed from the principal, and the misappropriated assets may later be returned by the agent or servant. In such a circumstance, commercial accounting treats the situation as if no real loss has occurred. Moreover, it cannot be asserted that a loss automatically arises in every case simply because the principal eventually learns of the embezzlement. The erring servant can be persuaded, compelled by legal process, or otherwise induced to restore all or part of the ill‑gotten proceeds. Consequently, as long as there exists a reasonable chance of obtaining restitution, loss cannot be said to have arisen in a commercial sense. The Madras High Court, in M. P. Venkatachalapathy Iyer and Anr. v. Commissioner of Income‑Tax, Madras (1), held that the profits and gains of a business must be measured by ordinary commercial trading principles, and that a practical rule is that loss resulting from misappropriation does not accrue until it becomes “actual and certain.” In the Venkatachalapathy case (1), the assessee had employed a clerk who kept the books of account, acted as a salesman, handled cash in the managing partner’s absence, and collected bills. By manipulating the accounts, the clerk misappropriated substantial sums at various times. In May 1941 the clerk was discovered to have embezzled Rs 36,298‑3‑6 covering the period from 17 October 1939 to 24 October 1940. In June 1941 criminal proceedings were instituted against the clerk, and around the same time a civil suit for recovery of the amount was also filed. The parties reached a compromise in August 1941, whereby the clerk paid Rs 16,250 to the assessee as full settlement of his liability. The assessee, for the assessment year 1942‑43 (the accounting year ending 12 April 1942), claimed a deduction of Rs 21,372, representing the difference between the amount embezzled and the amount recovered. The court correctly treated this amount as a loss deductible in the same accounting period.

In the present matter, the Bank’s funds were embezzled in 1946, and the misappropriations remained unknown to the Bank at that time. Even after the liquidator became aware of the embezzlements, a trading loss could not be said to have occurred. The Court could not accept the proposition that, irrespective of all other considerations, the mere occurrence of embezzlement of an employer’s funds automatically creates a trading loss, whether or not the employer is aware of it. So long as there was a reasonable prospect of recovering the misappropriated amounts, a commercial trading loss should not be presumed. The decision in (1) (1951) 20 I.T.R. 363 was therefore applicable. No evidence was adduced to show that, in the relevant year of account, the Secretary could not have fulfilled his obligations, either wholly or partially, had he been required to refund the embezzled sums. Accordingly, the embezzled amounts did not, in that accounting year, constitute a loss for the Bank.

In this case, the liquidator first learned of the embezzlement from a report dated April 1, 1947 prepared by Messrs M. N. Raiji & Co., who had been appointed by the Registrar of the Joint Stock Companies to audit the Bank’s affairs. The embezzlements, however, did not become known to the liquidator until a later stage, when the liquidator issued demands to the various parties whose names appeared on the bank’s books for the amounts that had been withdrawn. Those demands were made to V. R. Ranade and Sons and to the Bank of Bhopal Ltd., seeking either preferential repayment of the sums or, alternatively, delivery of the stock they had purchased through the Bank. The Tribunal, in its supplementary report, concluded that the withdrawals and misapplication of funds by the Secretary only came to the liquidator’s knowledge after the accounting year in question, because no one at the time suspected that the entries in the books were falsified to conceal the Secretary’s dealings. This conclusion was based on the evidence presented, and the Tribunal held that, under the circumstances, the loss must be regarded as having occurred to the Bank only after the liquidator became aware of the embezzlement and realised that the stolen amounts could not be recovered.

The Court observed that one of the essential conditions for allowing a deduction of a trading loss under section 10(1) was therefore missing. Accordingly, the Court agreed with the High Court that the sum of Rs. 10,15,000 could not be deducted under section 10(1). The appeal was therefore partially allowed. The Court ordered that the answer to the first question recorded by the High Court be discharged and that it be recorded that the Bank is entitled to claim, under section 10(2)(xi), Rs. 1 5,00,000 as bad debts for the accounting year ending 30 June 1947. On the second question, the Court answered in the negative. No order as to costs was made, and the appeal was partly allowed.