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TMI Blog2008 (9) TMI 613X X X X Extracts X X X X X X X X Extracts X X X X ..... nished the party-wise details of bad debt which are as under : Name of the Party Amount Ranjatkaur P. Hora 354,780 Inderjithsingh Hora 171,821.17 Ramesh Rungta 185,249.55 Navnit Daghi 2,135.26 Nimesh Patel 220,171.83 4. Through the note, it was explained with regard to the compliance of requirement of section 36(2) of the Income-tax Act that assessee had to write off the said amount in its P & L account of NSE broking business as the same could not be recovered from the said parties after putting lot of efforts. These parties have lost heavily in the stock market, therefore, they do not have the funds to pay to the assessee and assessee had no other alternative except to write off the said amount as a bad debt. 5. The assessee was again asked to state about the stocks which were not transferred to the clients and the status of such shares. He was also asked to submit the details of margin money collected from the above parties. The assessee has furnished the copy of the ledger account of the bad debt parties which showed no balance after transfer of the closing balance to the bad debt accounts. It was also intimated that brokerage earned from these parties could not b ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... o tax on its brokerage income subject to allowance of expenses and other income. The value of purchase or sale on behalf of the clients, is not credited or debited to the P & L account. 8. Thus the moment the broker purchases shares on behalf of the client from stock exchange a debt is credited in the books of account in the name of the client. The part of debit balance which does not pertain to brokerage and pertains to value of shares purchased by client is not covered by section 36(2) of the Act. It is thus amply clear that amounts not required or treated as not recoverable from clients in the case of share brokers cannot be allowed under section 36(1)(vii) as bad debt unless the debt is only in respect of un-recovered brokerage. Since the assessee is a broker, the income which has taken into consideration is only the brokerage and if at all there is any bad debt, it should be limited to the unrealized bad debt component. Thus in case a client does not pay in the future, the whole debt cannot partake the nature of bad debt allowable under section 36(1)(vii) as this amount of debt has not been included in the computation of income as required under section 36(2) of the Act. Sinc ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... amendment the assessee was to prove that the debt has become bad in the relevant previous year. Requirement of proving that the debt has become bad thus stays as it was earlier. 3.10 The allowability of claim under section 36(1)(vii) is further governed by the section 36(2) of the Income-tax Act. Section 36(2) provides that unless such debt or part thereof have been included in the computation of income of previous year or earlier previous years, it cannot be allowed as bad debt under section 36(1)(vii). This has significant implications in the case of shares and stock-brokers. The broker act as an agent and facilitate transactions between the principals. In the case of share and stock brokers what is credited to the P & L account, is the brokerage income arising from purchase or sale on behalf of the clients. The share and stock broker buys and sells on behalf of the client from the stock-exchange for which it earns brokerage income of say 0.25 per cent to 2 per cent of purchase/sale value. The share-broker is liable to tax on its brokerage income subject to allowance of expenses and other income. The value of purchase or sale on behalf of the clients, is not credited or debited ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... (1)(vii), deduction of bad debt would not be allowable while computing the income chargeable under the head "Profits & Gains of Business" as the general provisions of the Act is not applicable where specific provisions are enacted. Hence claim of bad debt as such is rejected. 4. Bad debt as Business loss : 4.1 The assessee is a Stock broker and is a listed member of recognized Stock Exchange under section 4 of Securities Contract Regulation Act, 1956, being BSE/NSE. The foreword of the said Act is "An Act to provide for the establishment of a Board to protect the interests of investors in securities and to promote the development of, and to regulate, the securities market and for matters connected therewith or incidental thereto." The said Act is notified with effect from 20-2-1957. 4.2 The section 9 of the said Act empowers the Exchange to make bye laws for regulation and control of Contracts. Accordingly, BSE/NSE has formulated bye laws with the approval of SEBI. The said bye laws, the business of Exchange were not regulated properly and investor suffered badly. Hence, an Act was passed to provide for the establishment of a Board to protect the interests of investors in securi ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... es or regulations made thereunder. 4.6 Thus the conduct of business of assessee in Securities is fully regulated by SEBI (Stock-Broker and Sub-Brokers) Regulation, 1992 and circulars and guidelines thereunder. As per Chapter II, Regulation 9, no business of buying, selling and dealing in securities can be made without registration and such an act would be an offence as per section 24 of SEBI Act. Any default of regulation or abetting violation regulation is separately penalable as per Regulation 25 appearing in Chapter VI. Schedule I of the said SEBI (Stock-Broker and Sub-Brokers) Regulation, 1992 states methods of registration of Brokers and sub-brokers. It clearly states that no sub-broker shall be registered except with the recommendation letter of a registered Broker. Schedule II narrates code of conduct for Stock-brokers. The relevant portion is reproduced as below : B. Duty to the Investor. (1) Execution of orders - A stock-broker, in his dealing with the clients and the general investing public, shall faithfully execute the orders for buying and selling of securities at the best available market price and not refuse to deal with a small investor merely on the ground of ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ligence in completing the settlement of transactions with them. (5) Agreement between sub-broker, clients of the sub-broker and main broker - A sub-broker shall enter into a triplicate agreement with his client and with the main stock broker specifying the scope of rights and obligations of the stock-broker, sub-broker and such client of the sub- broker. 4.7 As per the Notification No. SO 855(E), dated 29-11-2001 issued by SEBI for Regulation of transactions between member brokers and their clients, the relevant portions of which are reproduced below, the member broker is supposed to follow the said Regulations for effective carrying of regulated business of brokerage. 1.It shall be compulsory for all member brokers to keep the money of the clients in a separate account and their own money in a separate account. No payment for transactions in which the Member broker is taking a position as a principal will be allowed to be made from the client's account. The above principles and the circumstances under which transfer from client's account to Member broker's account would be allowed are enumerated below : (1) (2) (3) B. Obligation to pay money into clients account Every mem ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... Stock Exchange shall issue a Press Release immediately after the pay out. 4.Member brokers shall buy securities on behalf of client only on receipt of margin of minimum 20 per cent on the price of the securities proposed to be purchased, unless the client already has an equivalent credit with the broker. Members may not, if they so desire collect such a margin from Financial Institutions, Mutual Funds and FIIs. 5.Member brokers shall sell securities on behalf of client only on receipt of minimum margin of 20 per cent on the price of securities proposed to be sold, unless the member has received the securities to be sold with valid transfer documents to his satisfaction prior to such sale. Members may not, if they so desire, collect such a margin from Financial Institutions, Mutual Funds and FIIs. 6.Member brokers shall issue the contract note for purchase/sale of securities to a client within 24 hours of the execution of the contract. 7.In case of purchases on behalf of clients, Member Brokers shall be at liberty to close out the transactions by selling the securities, in case the client fails to make the full payment to the Member Broker for the execution of the contract with ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... f bad debt is nothing but value of shares appropriated by the guaranteed seller i.e., Exchange for purchasing the shares in violation of the business regulation. Since this purchase is not for self, debt owed to Exchange is on account of counter guarantee offered by broker to the exchange for violating the business Regulations, circulars and guidelines. Even in case of sales on behalf of the clients, if the clients do not transfer the shares, the amount forfeited by Exchange for bad delivery, takes the same colour and hence should be dealt identically as it is due to the failure of assessee to carry on the business in the regulated mode as required by law. Thus for assessee the amount paid to Exchange is a penalty paid for violating the business Regulations, circulars and guidelines which the assessee did with violation and not out of compulsion. The only difference is that assessee chose to account for such loss in this year. 4.8 The rules and regulations by SEBI are framed to public interest. Any violation of such rules and regulations attract penalties and fines for the reason that the acts of the assessee are against public policy. Hence amount paid for action against public p ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... -90. The old provision as it existed prior to 1-4-1989 provided that the debt must be established to have become bad in the previous year. This led to a litigation on the question of year of allowability of bad debt in the particular year. In order to eliminate the dispute relating to year of its allowability and also to rationalize the provision, it has now been provided that claim for bad debt will be allowed in the year in which such a bad debt has been written off as irrecoverable in the accounts of the assessee. But such a liberal approach about the year of allowability cannot be extended to deduction allowable in respect of trading loss under section 28 and/or under section 37. ...In this regard, it will also be worthwhile to state that the burden lies on the assessee to prove that a particular amount is allowable as a trading loss or as an expenditure under section 28 and/or under section 37(1). The assessee has to prove that such a deduction claimed by him satisfies all the ingredients of the aforesaid provisions of law. The assessee will, therefore, have to prove and submit all the required material to support the allowability of the said amount as a deduction under sectio ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... show that assessee had not collected any margin money from clients. The amount of recovery from this client is only on account of sale of shares not transferred to the clients. Further assessee could not correlate the money received from the client's account as pertaining to brokerage outstanding. He also could not furnish the exact breakup of value of shares included therein with any evidence despite repeated direction in this regard. 4.13 The income falling under the head 'Profits and Gains of Business is chargeable to tax under section 28. As per section 29, income chargeable to tax under section 28 is to be computed in accordance with the provisions of sections 30 to 44D. There is no item called business loss allowable under any of the sections from sections 30 to 43D. The interpretation that after amendment bad debt is allowable as and when assessee writes off the debt in the books of account is not acceptable as any assessee who had substantial income as on year end can write off debt from available sundry debtors to the extent of profit and claim deduction of bad debt, thus offering nil income, on the ground that on realization of debt in subsequent year, such income will ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... e parties did not make the further payments, despite repeated requests of the assessee. After a long drawn follow up with the clients, they were not able to make the payments and the assessee has then taken a decision to write-off the bad debt in its books of account in the impugned assessment year. At the time of purchase, the assessee has credited the entire amount i.e., the cost of the shares and the brokerage and made the payment of the same, though he failed to recover from the purchaser. The brokerage amount was already taken into account while preparing the P & L account and as such the condition laid down under section 36(2) was fulfilled. With regard to violation of SEBI Rules and Guidelines, the learned counsel for the assessee has submitted that no action was ever taken by the SEBI or the stock exchange and whatever activities were performed by the assessee, it was in accordance with the Rules and Guidelines laid down in this regard and whatever loss is suffered, it was during the course of normal business. In support of his contention that the assessee was only required to write off the debts in the books of account for claiming the deduction of bad debt from income, th ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... tive on the other hand has placed a heavy reliance upon the assessment order and the Order of the CIT(A). He has contended that Assessing Officer has examined every aspect of the business of a share broker registered with the stock exchange. A share broker arranged the transaction of sales or purchase on behalf of its clients and the source of income is only the brokerage agreed upon or settled by the stock exchange. He has no concern about the profit or losses suffered on sale and purchase of the scrips as it relate to the seller or the buyer. In case of Broker, when transaction of sale and purchase is arranged, a stipulated brokerage accrues to the broker. As per the Rule of the Stock Exchange, broker is required to settle the transactions within a settlement period. No doubt, the broker ensures or stand as guarantor for the seller or the purchaser with regard to the payments and delivery of the scrips and in case the delivery of the scrip is effected, but, payment is not made, the broker has to compensate or to make the payment of its own to the seller and thereafter, the right to recover the amount from the other party i.e., the buyer accrues to the broker. But, the accrual of ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ing the profit and loss account and in computing the income of the assessee, can only be considered as a bad debt for the purpose of deduction under section 36(1)(vii) of the Act and not the remainder. The revenue has also differentiated the share broker from a share trader. 15. Before adjudicating the issue, we prefer to examine the relevant provisions of the Act and the nature of the activities performed by the share trader and share-broker. For the sake of reference, we extract the relevant provisions of section 36(1)(vii) and section 36(2) of the Act. "Section 36(1)(vii) Subject to the provisions of sub-section (2), the amount of (any bad debt or part thereof which is written off as irrecoverable in the accounts of the assessee for the previous year) : (Provided that in the case of (an assessee) to which clause (viia) applies, the amount of the deduction relating to any such debt or part thereof shall be limited to the amount by which such debt or part thereof exceeds the credit balance in the provision for bad and doubtful debts account made under that clause.) (Explanation.--For the purposes of this clause, any bad debt or part thereof written off as irrecoverable in the ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... , then the right to recover the same from the buyer accrues to it. Similar is the position when the broker compensate the buyer on account of non-delivery or the bad delivery. But, this right to recover the said debt on account of discharge of liability, does not accrue to the share broker on the day when the transactions for sale and purchase were arranged, because, as per the SEBI Guidelines, a settlement period is fixed and within the settlement period, the share broker is required to get the transaction settled between the parties. Meaning thereby, in such type of cases, there are two transactions or two different type of debts. One, which is accrued on the day when the transaction of the sale and purchase is arranged and the other on the day when the liability to make the payment of the cost of the scrip or to compensate on account of non-delivery or the bad delivery is discharged. These two transactions cannot be mixed-up together. These are two different debts which accrued to the assessee on different dates and at different point of times for different reasons. Undisputedly, the brokerage which accrued to the assessee on the very first day when the transaction of sale and p ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ess and for these reasons, the trading loss suffered by the assessee, cannot be disallowed on the ground that assessee has not acted or undertaken his business in terms of the Rules and Guidelines laid down by the SEBI. 22. We have also carefully examined the judgments referred to by the assessee and we find that these judgments are rendered on a point of allowing of bad debts on its writing off in its accounts and in this regard, we have no dispute and we are also of the view that debt of brokerage which was not recovered by the assessee, should be termed as a bad debt and its deduction be allowed on its writing off in the books of account. 23. The issue involved before us in the case of share broker was not raised before the Tribunal in the case of Oman International Bank SAOG (supra) and the Madras High Court in the case of Brilliant Tutorials (P.) Ltd. (supra). In the case of Morgan Securities & Credit (P.) Ltd. (supra ), the impugned issue was not examined and the dispute was with regard to the genuineness of the claim of bad debt and it was allowed on its writing off. Similar is the position in the case of Nai Dunia (supra). In the case of Olympia Securities Ltd. (supra) th ..... 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