1980 (5) TMI 56 - AT - Income Tax

Issues Involved:
1. Whether the bad debts written off by the assessee-firm, which were originally due to the predecessor firm, can be claimed as a deduction under Section 36(2)(i)(b) of the IT Act, 1961.

Detailed Analysis:

1. Background of the Case:
A firm named M/s. S.M. Syed Mohamed Saheb & Bros., constituted under a deed dated 1st April 1970, consisting of fourteen partners, was dissolved following disputes. The business at Calicut was taken over by S.M. Syed Abdul Kader Saheb and his five daughters, forming a new assessee-firm under a deed dated 1st April 1973. The net asset of the business was worth Rs. 8 lakhs, acquired for Rs. 1,50,000, with Rs. 6,50,000 credited as "general reserve."

2. Claim for Deduction:
During the previous year ending 31st March 1975, the assessee-firm wrote off Rs. 6,743 in the profit and loss account and Rs. 58,283 in the "general reserve" as bad debts, claiming a net loss of Rs. 27,970. The ITO rejected the claim, stating that the bad debts related to the predecessor firm, not the assessee-firm, and assessed the income as Rs. 36,620.

3. Appeal to AAC:
The assessee appealed, reiterating the claim for deduction of Rs. 65,026. The AAC held that the outstanding dues were capital assets and the loss was capital loss, not deductible under Section 36(2)(i)(b) of the IT Act, 1961. The assessment was confirmed, leading to this appeal.

4. Assessee's Argument:
The assessee's representative argued that the debts, though due to the predecessor firm, should be deductible as they were taken over by the assessee. Citing various High Court decisions, it was contended that the trading debts retained their character and were not capital assets.

5. Department's Argument:
The Department contended that since the debts were due to the predecessor firm, they could not be deducted by the assessee. The Supreme Court decision in CIT, M.P. vs. Hukumchand Mohanlal was cited, asserting that the principle applied to Section 41(1) should apply to Section 36(2)(i)(b) as well.

6. Legal Provisions:
Section 36(2)(i)(b) requires that the debt must have been taken into account in computing the income of the assessee in the relevant or earlier previous year and written off as irrecoverable in the accounts of the assessee for the relevant previous year. It was undisputed that the debts had become bad and were written off in the relevant year.

7. Precedents:
- Bombay High Court in CIT vs. Bombay Hing Supply Co.: The Court allowed the deduction, emphasizing the continuity of the business and the trading nature of the debts.
- Andhra Pradesh High Court in CIT vs. T. Veerabadra Rao: The Court held that the trading debts of the predecessor firm retained their character and were deductible by the successor firm.
- Madras High Court in Addl. CIT vs. S.RM. PL. Subramaniam Chettiar: The Court allowed the deduction, noting that the debt written off by the predecessor firm was sufficient.
- Allahabad High Court in T.N. Shah (Pvt.) Ltd. vs. Addl. CIT: The Court followed the principles from the Bombay and Andhra Pradesh High Courts, allowing the deduction.

8. Supreme Court Decision:
The Supreme Court in CIT vs. Hukumchand Mohanlal held that Section 41(1) did not apply to successors, but this principle was not applicable to Section 36(2)(i)(b) as the debts retained their trading nature.

9. Conclusion:
The Tribunal held that the lower authorities were incorrect in treating the debts as capital assets. The trading nature of the debts was retained, and the assessee was entitled to the deduction of Rs. 65,026, as the debts had become irrecoverable during the relevant previous year.

Result:
The appeal was allowed, modifying the assessment in accordance with the findings.

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