Advance amount irrecoverable is deductible as loss
Advance amount irrecoverable is deductible as loss

During the course of assessment proceedings disputes do arise between the Income-tax payers and the Income-tax Department about the deductibility or otherwise of business loss.  Sometimes the dispute focuses on the question whether the amount claimed as deductible is business loss or otherwise. Fortunately the Delhi High Court in the case of Mohan Meakin Ltd. v. CIT (2012) 348 ITR 109 has held that the amount of advance in the course of business becoming irrecoverable is deductible as business loss even if it is claimed otherwise as bad debt.  As this is an important judgment for the taxpayers in general and business in particular, the facts and the judgment are analysed in this article below.

The assessee established an export division for the export of various items including leather products. After exploring the market abroad, it established business contacts with C of the USA.  In order to maintain its commitment for the supply of hand-made leather shoes, it entered into an agreement with a sole proprietary concern of B for carrying out the necessary manufacturing of hand-made leather shoes.  As the quantity and the value involved in the transaction was substantial and to ensure regular supplies, it had to advance from time to time different amounts to B.

Since it could not realise Rs.25.32 lakhs from C, it had to suspend the supplies to C and ultimately had to suspend the orders placed by it on B.  In view of this development, B showed its inability to refund the advances and pleaded inability stating that it had in turn given substantial advances to the workers engaged by it. It also stated that a lot of amount was also invested on the wooden blocks made for the types of shoes ordered by the assessee.  It was also pleaded by B that all these wooden blocks were of no use and value in case further orders were to be cancelled.  In the meantime, B was diagnosed with cancer and ultimately died on 19.10.1985.

The assessee stated that it could not take legal action against B or his legal heirs in view of the fact that they would have made counter-claims on account of the firm orders placed having been cancelled.  Since it also failed to recover the outstanding amount of Rs. 25.32 lakhs from C, despite all efforts through the Embassy of India in Washington, Consulate General of India, New York and other debt collection agencies, this amount had to be written off in consultation with and after approval from the Reserve Bank of India. This amount was claimed by the assessee as bad debt but this was disallowed by the Assessing Officer as also the Income-tax Appellate Tribunal.

 Then an appeal was filed to the High Court.  The High Court allowed the appeal holding that continuity of supply was essential to honour the agreement with C and it was to continue the business without any break that the advances were made to B. It was only on account of non-recovery of the huge amount from C that the work had to be cancelled and the supplies had to be abruptly stopped by the assessee and consequently the production had necessarily to be stopped.

Usually a manufacturer gives advances to the workers, which are adjusted or carried forward against the works done by them. This was not an unusual practice. The advances made by the assessee in this case were certainly of a type, which would be within the contemplation of the words “laid out or expended wholly and exclusively for the purposes of the business”. As no portion of the advances could be stated to be loss of capital expenditure, and it being a plain case of business loss, the Delhi High Court held that it would certainly be allowable to be deducted under the provisions of section 37 of the IT Act.

Then the Delhi High Court gave its considered view that it was in the totality of overall situation of the matter that the assessee decided to write off the advances made to M/s. KBH as bad debt. The reason as given by the assessee was apparently well-founded and was abruptly rejected by the Assessing Officer and the Tribunal.

According to the Delhi High Court these authorities did not appreciate the fact that the continuaion of supply was essential to honour the agreement with the corporation and it was to continue the business without any break that the advances were made to the manufacturer, M/s. KBH.

It was only on account of non-recovery of the huge amount from the corporation that the work had to be cancelled and the supplies had to be abruptly stopped by the assessee and consequently the production was necessarily required to be stopped.  It was further held by the Delhi High Court that it is a known practice that usually manufacturer gives advances to the workers which are adjusted or carried forward in the coming times against the works done by them. This was not an unusual practice which was liable to be outrightly rejected by the IT Department.

When the assessee had written off the dues recoverable from the corporation and the same were accepted by the Department and it had also so written off, the advances made to M/s. KBH in its books of account, what else could be the proof with the assessee for its being unable to recover the same. Besides, the other reason for writing off was the demise of the proprietor, BD of M/s. KBH and the assessee in its wisdom did not choose to take the matter to the court apprehending counter-claim and this decision, according to the Delhi High Court, appeared to be well reasoned.

In any case, the Revenue could not compel the assessee to have recourse to litigation to recover the amount against the dead person or his legal heirs when in the given circumstances, the same may not be recoverable.  It was rightly recorded by the CIT (Appeals) that the debt had become bad and not recoverable and it would be a futile exercise to take any action against the legal heirs of the deceased.

The counsel for the Revenue also half-heartedly submitted that this alternative plea of the applicability of section 28 and section 37 was not raised by the assessee before the IT authorities earlier and so it could not be raised before the High Court in this appeal.  The counsel for the assessee submitted otherwise and relied upon the Supreme Court judgment in the case of CIT v. Mahalakshmi Textile Mills Ltd. (1967) 66 ITR 710 (SC).

In this case, it was held that the right of the assessee to relief was not restricted to the pleas raised by him before the Departmental authorities or before the Tribunal. It was held that if for reasons recorded by the departmental authorities in respect of the contention raised by the assessee, grant of relief to him on another ground is justified, it would be open to the departmental authorities and the Tribunal and indeed they would be under a duty to grant that relief.

It was also held that there was nothing in the Income-tax Act which restricted the Tribunal to determine all questions before the Departmental authorities and all questions, whether on law or facts, which related to the assessment of the assessee might be raised before the Tribunal.  It was further held that because the claim was not made under one particular provision of the IT Act, but was so made out under another provision of law, the High Court failed to understand as to how the assessee could be debarred to raise such a legal question.  Having regard to all this, the High Court was of the view that it was legally permissible to raise question of deduction under section 37 of the IT Act even if it was not raised before the authorities below.  In view of the discussion as made out above, the High Court answered the question in the affirmative and allowed the appeal.

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