COMMISSIONER OF INCOME TAX, A.P.versusM/S. T.VEERABHADRA RAO, K. KOTESWARA RAO & CO.

        20


A                         WIMISSIONER OF INCQIE TAX, A.P.
                                         v.
                   M/S. T.VEERABllADRA RAO, K. KmESWARA RAO & CO.

                                    JULY 8, 1985

B                   [R.S. PATHAK AND E.S. VENKATARAMIAH JJ.J
                                                                              ·-
              Income Tax Act, 1961, Sec. 36(l)(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.
c
              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 asseasment year 1963-64. On March 31, 1965 the assessee and
        the debtor entered into a settlement whereby a sum of Rs.25,000
D       was accepted by the aasessee 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.
E
              In assessment proceedings for the assessment year 1965-66,
        the aaseasee 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 Comnissioner of
        Income Tax allowed the claims of the assessee-firm holding that
F       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 Comnissioner. Hence this appeal.

    G         Dismissing the appeal,

            HELD: (l) 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-11.(l) of
    H   s.36 of the Income Tax Act, 1961. [24 A-BJ
•                      c.I.T. ,A.P. v. M/S. T.VEERBllADRA RAO


           (2) When a business along with its assets and liabilities is
       transferred by one owner to another, there is no reason why a
                                                                        21




       debt so transferred should not be entitled to the same treatlllent
                                                                              A


       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         B
 j     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      C
       business, be regarded as belonging to the new owner. [25 E-11]

           (3) Even i f the debt had been taken in::o account in computing
. _,   the income of the predeceasor'firm.only and had subsequently been
       written off as irrecoverabie in the accounts of the assessee, the
       assessee would still have been entitled to a deduction of the          D
       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-clause (b). A successor to
       the pertinent interest of a previous assessee would be covered
       within the terms of sub-clause (b). The successor assessee, in
       effect, steps into the shoes of his predecessor. [26 E-F)
                                                                              E
             In the present case,· the debt was taken into account in the
       income of the assessee for the assessment year 1963~4 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 satis-
       faction and has written-off the balance of the debt as irrecover-      F
       able in his accounts. Therefore the conditions in both sub-clause
       (a) and (b) of Clause (i) of sub-s.(2) of a.36 are satisfied.
       The same test has to be applied for acknowledging the ciaim to
       deduction of Rs. 6,880. [26 B-D]

               CIVIL APPELLATE JURISDICTION    Civil Appeal No. 114 (NT) of       G
       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.               H
    A
         22              SUPREME COURT REPORTS


              A. Subea Rao for the Respondent.
                                                         [1985] SUPP.2 s.c.R.
                                                                                 ••
              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
    B    reference made under sub-s.(l) 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 expenses
                     ,'of Rs.6,880 were allowable deductions in the assess~
                     · ment of the assessee firm for the assessment year
    c                 1965-66?"

         The assessee is a partnership firm. It took over the business of
         an earlier firm. All the assets and liabilities of the prede-
         cessor f i~ passed On to the assessee firm.. These included a
         debt of Rs.23,577 due from Laxmi Trading Company to the prede-
         cessor     firm. The total amount due in the account relating to
    I)   Laxmi Trading Company was ·Rs.40,549 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
         asses see in fl\11 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.
    F
         15,100 written off as a bad debt. The Income-tax Officer dis-
         allowed the claim on the ground that the debt was due originally
         to the predecessor finn, 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
    G
         of Income Tax held that the business transferred from the prede-
         cessor 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
        C.I.T.,A.P. v. M/S. T.VEERBllADRA RAO [PATHAK, J.]     23


justification for writing off the bad debt in the measure claim-     A
ed 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     I!
amount in connection with an appeal filed in the Supreme Court
for the purpose of recovering a sum due from the Central Govern-
ment. 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     D
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 when-
                                                                     E
ever a business wat; 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
                                                                     F
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 ques-
tion set forth earlier. The High Court answered the question in
the affirmative and against the Department.
                                                                     G
      It is not disputed that the assessee succeeded to the
business of the predecessor firm and took over all its assets and
liabilites, 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 t.he debt for the
                                                                     H,
assessment year 1963-64. It is also ·not disputed that the
parties effected a settlement on March 31, 1965 whereby a sum of
          24           SUPREME COURI REPORTS           [1985] SUPP.2 s.c.R.


A         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 predecesor 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
B         debt under cl.(vii) of sub-s.(l) of s.36 of the Income Tax Act,
          1961.

                Cl.(vii) of sub-s.(l) of s.36 of the Income Tax Act, 1961
          provides :

                     "36.(1). The deductions provided for in the following
c                    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 estab-
ll                   lished 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
    I!               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
    F                 incane of the assessee of the previous year or of an
                     .earlier previous year, or represents money lent J.n 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
     G               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
     II              year in which the ultimate recovery is made;
           C.I.T.,A.P. v. M/S. T.VEERBHADRA RAO [PATHAK, J,]      25


              (iii) any such debt or part of debt may be deducted if    A
              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;
                                                                        B
              (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 preceeding the previous        c
              year in which such debt or part is written off, the
              provisions of sub-section (6) of section 155 shall
              apply".

    S.28, referred to in sub-s.(l) of s.36, provides that income
                                                                        j)
    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 with-
    out doubt be entitled to a corresponding deduction under cl.(vii)   E
    of sub-s.(l) 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 liabilites, 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       F
    rights comprising the subject of the transfer. If the law permits
    the transferor to treat the whole or part of the debt as irre-
    coverable 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 liabili-     G
    ties, 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       H
    sub-s.(2) of s.36 declares that a deduction can be allowed only
        26             SUPREME COURT REPORTS          [1985) SUPP.2 s.c.R.


A       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 yea 1963-64 when
B       the interest income accruing thereon was truced in the hands of
        the assessee. The interest was truced as income because it repre-
        sented 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
c       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 satisfac-
        tion 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 satis-
        fied in the present case, and the High Court as well as the
u       Appellate Tribunal and the Appellate Assistant Commissioner are
        right in. the view which they took.

               It seems to us that even: i f 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
E       accounts of the assessee, the assessee would Still have been
        entitled to a dedution of the amount written off as a bad debt.
        It is not imperative that the assessee referred to in sub-cl.(a)
        must neeessarily mean the identical assessee referred to in
        sub-cl (b). A successor to the pertinent J.nterest of a previous
        assessee would be covered within the terms of sub-cl. (b). The
F       successor assessee, in effect,     steps into the shoes of his
        predecesSor.

              Accordingly, we hold that the assess~e 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
G       iri'ecoverable.

              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.

    H
        C.I.T. ,A.P., v. M/S. T.VEERBHADRA RAO [PATHAK, J.]     27


      As regards the sum of Rs.6,880 claimed by the assessee as      A
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 institued by it was continued by the assessee on taking
over the assets and iiabilities of the predecessor firm. The
Income Tax Officer, the Appellate Assistant Commissioner, the        B
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.
                                                                     c



                                                 Appeal dismissed.