1995 PLP 1204 (PTD)

DR. B.P. SARAF, J.

By this reference under section 256(1) of the Income Tax Act, 1961 read with section 18 of the Companies (Profits) Surtax Act, 1964, the Income-tax Appellate Tribunal has referred the following question of law at the instance of the assessee for opinion: "Whether, on the facts and in the circumstances of the case, the Tribunal was right in holding that the provision for doubtful debts and the provision for doubtful advances cannot be treated as free reserves and cannot be included for the purpose of computing the capital of the company for the purposes of surtax?" The facts of the case are brief. The assessee is a limited company. During the previous year relevant to the assessment year 1975-76 the assessee made a provision for doubtful debts amounting to Rs.19,56,668 and also a provision for doubtful advances amounting to Rs.1,20,

933. In the course of the assessment of the assessee under the Companies (Profits) Surtax Act, 1964, it was contended by the assessee that these two amounts, though named as provision, were in fact reserves and were part of the capital of the assessee and, therefore, those amounts should not be deducted in the computation of the capital of the assessee-company for the purpose of surtax: This contention of the assessee was not accepted by the Income Tax Officer On appeal, the order of the Income-tax Officer was confirmed by the Commissioner of Income-tax (Appeals) and the Income-tax Appellate Tribunal. Hence this reference at the instance of the assessee. The controversy in this case is in a very narrow compass. The question is whether under the facts and circumstances of the case, the provision for doubtful debts and the provision for doubtful advances are provisions having the effect of reducing the capital of the assessee or whether in reality they are "reserves", though termed as "provisions". We have heard learned counsel for the assessee, Mr. Mistry, and learned counsel for the Revenue, Mr. Jetly. We have carefully considered the rival submissions. It is a well-settled legal position that for determination of the question whether a particular amount kept apart by the assessee for a particular purpose will be a provision or a reserve will not depend upon the nomenclature given by the assessee in his books of account. What is shown in the books as a provision may, in reality, turn out to be a reserve and what is shown as 'reserve may in fact be a provision. The answer depends upon the true nature and character of the provision. A particular amount set apart by the assessee can be termed as a provision if it is so kept apart for providing for any known or existing liability. But, if such provision is made in excess of the amount that would be reasonably necessary for such purpose, the excess would be treated as a "reserve". In the instant case, the "provision for doubtful debts" and "provision for doubtful advances" are not provisions for any known or existing liability. These amounts are also not deductible in computing the income of the assessee as is evident from section 36 of the Income-tax Act which deals with allowability of deduction for bad debts in computation of income from business. Section 36, as it stood at the material time and so far as relevant, reads as under: "36.???? Other deductions.

(1) The deductions provided for in the following 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 subsection (2), the amount of any debt, or part thereof, which is established to have become a bad debt in the previous year; .... (2)??????? In making any deduction for a bad debt or part 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 income of the assessee of that previous year, or of an earlier previous year, or represents money lent in 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 accounts of the assessee for that previous year;... Section 36(1)(vii) read with subsection (2) thereof clearly goes to show that any amount kept apart by the assessee for meeting future losses on account of bad debts is not taken into consideration for-computation of the income. What is allowed, as a deduction is only the amount of bad debts which are written off as irrecoverable in the account of the assessee and established to have become bad debts in the previous year in question. This section supports the view that a provision for bad debts, though named as a provision, is in effect a reserve because it is the assessee who has decided to keep aside part of its capital or income which forms part of the capital to meet future contingencies arising out of losses caused by bad debts. This amount remains at all times and for all purposes the capital of the assessee till any debt actually becomes bad and part of it is utilized in writing off that amount in the books of account. In that view of the matter, it is clear that a provision for doubtful debts or doubtful advances is nothing but a reserve, and it is a part of the capital of the assessee. The Tribunal was, therefore, not right in refusing to treat the same as a reserve for computing the capital of the company for the purpose of surtax. In the light of the above discussion, we answer the question referred to us in the negative, i.e. in favour of the assessee and against the Revenue. No order as to costs M.BA./804/TF???????????????????????????????????????????????????????????? ?????????? Reference answered.