2010 (9) TMI 26 - HC - Income Tax

Unrealized assets written off loss of 12.58 crores security deposit written off advance given to various employees were written off AO disallowed written off - The reason for denying these deductions given by the AO was that security deposits and employees balance written off did not spring directly from carrying on of the business and were not incidental thereto though it was admitted that the same may have some connection with the business. CIT(A) and ITAT allowed the deduction Held that - Insofar as deduction of advances given to the employees are concerned which had become unrecoverable that may not pose much of a problem. Advances were given to the persons who had been employed by the assessee-company and if they became unrecoverable it would clearly be treated as business loss. Security deposits were not in the form of rent. The question would be when such a security deposit has become non-recoverable for some reasons whether it can be allowable as deduction under Section 28 of the Act. The deposits were not given in the ordinary course of business either. These were given for securing the premises on rent; albeit for the purpose of carrying on business therein. - the amount of 15, 34, 951/- (towards security) was not a revenue loss and therefore not allowable as deduction.

Issues Involved:
1. Deductibility of security deposit written off.
2. Deductibility of advances to employees written off.
3. Applicability of Section 28 and Section 37(1)(vii) of the Income Tax Act.
4. Nature of security deposits and advances in the context of business loss.

Detailed Analysis:

1. Deductibility of Security Deposit Written Off:

The respondent-assessee claimed a deduction for a security deposit of Rs. 15,34,951 written off as unrealizable. The Assessing Officer (AO) disallowed this amount, arguing that such deposits did not spring directly from carrying on the business and were not incidental thereto. The CIT (A) and the Tribunal, however, allowed the deduction, treating it as a business loss under Section 28 of the Income Tax Act. The High Court, upon review, held that the security deposits were given to landlords for obtaining business premises and were refundable. Since these deposits were not in the form of rent and were not given in the ordinary course of business, the Court concluded that they could not be allowed as a revenue loss. The appeal was thus partly allowed, disallowing the deduction of Rs. 15,34,951.

2. Deductibility of Advances to Employees Written Off:

The respondent-assessee also claimed a deduction for advances amounting to Rs. 5,18,380 given to employees, which were written off as unrealizable. The AO disallowed this amount, but the CIT (A) and the Tribunal allowed it, considering it a business loss under Section 28 of the Act. The High Court upheld this view, noting that advances to employees were given in the ordinary course of business and their non-recovery was directly linked to the business operations. The Court referenced the judgment of the Bombay High Court in CIT, Panaji, Goa vs. Maina Ore Transport (P) Ltd., which supported the deductibility of such advances as business losses.

3. Applicability of Section 28 and Section 37(1)(vii) of the Income Tax Act:

The AO initially rejected the deductions under Section 37(1)(vii), stating that the amounts were not written off by debiting the Profit and Loss Accounts but were charged to the amalgamation reserve account. The AO also argued that these amounts were not considered income in the previous years. The High Court, however, focused on Section 28, which pertains to deductions for trading losses incidental to business. The Court clarified that the loss must arise from the carrying on of business and be incidental to it, aligning with the principles laid down in the Supreme Court case of Badri Dass Daga.

4. Nature of Security Deposits and Advances in the Context of Business Loss:

The High Court examined whether the security deposits and advances were capital or revenue in nature. For the security deposits, the Court concluded that they were capital in nature as they were given to secure tenancy rights, which are considered capital assets. On the other hand, advances to employees were deemed revenue in nature since they were given in the ordinary course of business and their non-recovery was incidental to business operations.

Conclusion:

The High Court's judgment clarified the treatment of security deposits and advances written off as business losses. The security deposit of Rs. 15,34,951 was not allowed as a revenue loss, while the employee advances of Rs. 5,18,380 were allowed as a business loss under Section 28 of the Income Tax Act. The judgment emphasized the importance of the nature and purpose of the expenditure in determining its deductibility.

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