Loss of investment not allowable as business loss and for claiming an amount as bad debt conditions specified in section 36(2)(i) are required to be fulfilled

3. Against the order passed by the CIT under section 263, the assessee filed an appeal to the Tribunal in ITA No. 1233/Mum/2006. This appeal was disposed of by the Tribunal by order dated 24.06.2008. A perusal thereof shows that the Tribunal took the view that in the course of the assessment proceedings the Assessing Officer had no occasion to examine the issue of bad debt in detail and therefore the Assessing Officer had no occasion to form an opinion as to the allow-ability of the same. It would appear that before the Tribunal the assessee put forth an argument that the amount written off as bad debt should be allowed alternatively as business loss. The Tribunal in paragraph 9 of its order opined that though it may be true that the assessee was in the business of investment in shares as also trading in shares but its conduct as far as the sale of shares to M/s. Potlurri Lease & Hiring Purchase Pvt. Ltd. is concerned, it was treated in the books of account as investment and loss arising from the sale of shares was treated under the head “long term capital loss” and set off against the long term capital gains in the later years. After making these observations the Tribunal eventually held that the CIT was correct in acquiring jurisdiction to revise the assessment order under section 263 of the Act.

4. We may also notice one more aspect of the matter. In the same paragraph, the Tribunal in its order also observed that prima-facie the claim of bad debt cannot be considered under section 36(1)(vii) and from the facts on record and submissions made “it can be concluded that the assessee has wrongly claimed the amount not recoverable from M/s. Potlurri Lease & Hiring Purchase Pvt. Ltd. as bad debt under the section 36(1)(vii) and as allowable deduction under the head “business” and the Assessing Officer allowed the same without examining the facts on record”. Having made these observations the Tribunal in para 11 of its order hastened to add that these observations are limited to the issue of acquiring jurisdiction under section 263 and are in no way relatable to the allow-ability or non-allow-ability of the claim of bad debt which may come up for consideration separately.

5. In the assessment order passed on 17.03.2006 under section 143(3) read with section 263 of the Act, the Assessing Officer examined the assessee’s claim of bad debt of Rs. 95 lakhs. After considering the detailed reply filed by the assessee, the Assessing Officer rejected the claim as under:-

“4.3 I have perused the arguments of the assessee company and am not in agreement with the same. It is seen on perusal of the assessment records of assessment year 1999-2000 that the loss on sale of shares on SMS Pharmaceuticals has been declared as long term capital loss. This shows that the transaction in respect of the purchase and sale of shares of SMS Pharmaceuticals are nothing but transfer of capital asset and not part of the business of the assessee company. This fact is evident from the assessment records of previous assessment years wherein the shares have been shown as investments. In view of the above, the claim of the assessee company that the said loss of Rs. 95,00,000/- should be allowed as a business loss and thereby writing it off as bad debt under section 36(1)(vii) of the Income Tax Act cannot be allowable as the conditions laid down by section 36(1)(vii) of the Income Tax Act, 1961 are not satisfied by the assessee company.

4.4 Hence, the aforesaid claim of bad debts of Rs.95,00,000/- is disallowed as business loss and treated as capital loss of the earlier year and are allowed to be c/f as per law”.

6. On appeal the CIT(A) recorded the following findings:-

a) Merely because the shares of SMS Pharmaceuticals Ltd. were shown in the assessee’s balance sheet as non-trade investments, it cannot be said that they were not held for trading purposes. The nomenclature described only the type of investments made vis-a-vis other business activities of the company.

b) The assessee is engaged in investment activities which is in the nature of financing business and the profit or loss arising from such activities is in the nature of business profit or loss. In fact for the assessment years 1995-96 to 1998-99 profit on sale of such investments have been shown as business profits and also assessed as such.

c) Though the shares were purchased in the financial year 1996-97, the assessee did not ask for the benefit of indexation of cost while computing the long term capital gain or loss on the sale of the shares and the difference between the sale proceeds and the purchase price was claimed as capital loss for the year ended 31.03.1999. This shows that the shares were treated as business asset and not as capital asset.

d) The Assessing Officer had enquired into the claim of bad debts in detail and the assessee had also submitted all the facts in relation thereto in its letters dated 10.02.2005, 14.02.2005 and 21.02.2005. The Assessing Officer in the original assessment proceedings had accepted the assessee’s claim of bad debt only after examining the facts placed on record.

e) Thus the transaction was an ordinary business transaction carried out in the course of business of financing and investments and the sale proceeds receivable from M/s. Potlurri Lease & Hiring Purchase Pvt. Ltd. was a business debt and since the same could not be recovered and was written off as bad debt in the assessee’s books, it is allowable as bad debt under section 36(1)(vii) of the Act.

On the basis of the above findings, the CIT(A) allowed the claim of the debt.

7. The revenue is aggrieved by the aforesaid decision of the CIT(A) and has come in appeal before the Tribunal. In our opinion, their grievance is fully justified. There is no dispute that the shares of M/s. SMS Pharmaceuticals Ltd. were shown under the head “investments – non-trade” in Schedule 5 to the balance sheet. Even if it is assumed that this is only to describe the type of investments made vis-a-vis the other business activities of the company and it does not mean that these shares were not held for trading as held by the CIT(A), it cannot be overlooked that the assessee had declared the loss arising on the sale of the shares under the head “capital gains” in the return filed in the assessment year 1999-2000. A copy of the return and the statements accompanying the return is filed as  part of the paper book. The shares of M/s. SMS Pharmaceuticals Ltd. are shown under the head “long term investments [non-trade]” in the balance sheet. The shares were sold to M/s. M/s. Potlurri Lease & Hiring Purchase Pvt. Ltd. on 10.06.1998 for an agreed price of Rs. 3,37,50,000/-. In the return filed for the assessment year 1999-2000, the loss on sale of investment was shown under the head capital gains at Rs. 7,19,81,622/- which included the loss of Rs. 1,96,59,041/- on the sale of shares of M/s. SMS Pharmaceuticals Ltd. Thus it is undisputed that the loss on the sale of shares were shown and assessed as long term capital loss. The net long term capital loss declared for the assessment year 1999-2000 was carried forward to the subsequent years and it was set off partly in the assessment year 2000-01 and partly in the assessment year 2003-04 against the long term capital gains for these years. Thus despite claiming before the CIT(A) which claim has also been accepted by him, that the fact that the shares were shown as long term investments (non-trade) in the balance sheet does not mean that they were not held for the purpose of the business in shares said to have been carried on by the assessee, the assessee’s conduct in claiming the loss on the sale of the same shares as capital loss in the return filed for the assessment year 1999-2000 clearly indicates that the claim is untenable and it should not have been accepted by the CIT(A). The assessee also claimed to carry forward the long term capital loss, which included the loss on the sale of shares of M/s. SMS Pharmaceuticals Ltd. and set it off against the long term capital gains for the subsequent assessment years. Having thus claimed that the loss on the sale of shares was a capital loss (long term), the assessee is now taking a completely contradictory position by claiming that the unrecoverable amount of Rs. 95 lakhs from the sale proceeds due from M/s.Potlurri Lease & Hiring Purchase Pvt. Ltd. is a bad debt. It is indeed surprising that the assessee has chosen to make such a claim when one of the basic conditions for allowance of bad debt has not been satisfied by him. We are referring to section 36(2)(i) of the Act which requires that the amount claimed as bad debt should have been taken into account in computing the business income of the assessee in any of the earlier years or in the year in which the bad debt is claimed as a deduction. In the course of the arguments before us we specifically asked the learned representative for the assessee to tell us whether this condition is satisfied in the present case. He stated in response that the condition has not been satisfied. If this basic condition is not satisfied there is no way the claim can be allowed as a bad debt quite apart from the fact that it cannot be claimed as a trade debt because the loss on sale of the shares was shown as a loss on sale of investment and consequently a long term capital loss. If the shares were held as long term investments and described as non-trade investments, we fail to see how the same shares can be claimed to be stock-in-trade or a business asset. The conduct of the assessee in exhibiting the shares as long term investments (non-trade) in the balance sheet and its consistent claim that the loss on the sale of shares represented long term capital loss to be set off against the long term capital gains expose the fallacy in the assessee’s stand before us and before the Assessing Officer in the second round of proceedings taken under section 143(3) read with section 263. The CIT(A), with respect, does not appear to have appreciated the gravity of the facts and the contradictory stand taken by the assessee. He was also not justified in accepting the assessee’s claim that because it did not claim the benefit of cost indexation while computing the long term capital loss on the sale of shares, it shows that the assessee treated the sale of shares as sale of business asset. There is no basis for this conclusion. It may be an omission to claim the particular benefit available to the assessee while computing the capital gains and merely from the omission, the CIT(A) was not justified in inferring that the entire nature of the shares changed from a capital asset/investment to business asset/stock-in-trade. The CIT(A) also appears to have lost sight of the fact that the condition prescribed by section 36(2)(j) of the Act was not satisfied in the present case.