Bad and doubtful debts reserve does not form part of capital base unless it is an unreasonably unnecessary excess which the company did not reasonably need to provide for its bad and doubtful debts.

Ajoy Nath Ray, Maharaj Sinha

( 1 ) FIVE assessment years are involved in this reference but we deal with the question with reference to only one of those as a representative and prototype assessment year.

( 2 ) THAT one is the assessment year 1976-77.

( 3 ) THE question referred to us is as follows :"whether, on the facts and in the circumstances of the case, the Tribunal was justified in law in not confirming the order of the Commissioner of Income-tax (Appeals) in respect of bad and doubtful debt reserves ?"

( 4 ) THE point whether bad and doubtful debts were correctly classed as reserves by the Tribunal becomes relevant in view of the Companies (Profits) Surtax Act, 1964.

( 5 ) UNDER that Act the capital base of the company has an effect on the incidence of the liability of surtax. The profit remaining the same, the surtax would become lessened as the capital base of the company became broadened.

( 6 ) IT was thus in the interest of the assessee-respondent to emphasize that the bad and doubtful debts also form reserves in the true sense of the term. This is because a reserve true and proper, and not merely so-called by the accountant of the company, is, without doubt a part of the capital base.

( 7 ) UNDER the Second Schedule to the said Act the computation of the company's capital is to be made. The first clause of the said Schedule provides that the capital of a company shall be taken as on the first day of the previous year relevant to the assessment year.

( 8 ) IN the said clause under Sub-clause (ii) the reserves of a company are included. The Explanation to the said clause mentions some items, in relation to standard corporate accounts, which are not to be regarded as reserve or capital for the computation of corporate surtax.

( 9 ) THE facts of this case, set out in a very brief compass are as follows.

( 10 ) THE opening balance for the assessment year under review showed an amount of Rs. 18,09,370 as the carried forward reserve for bad and doubtful debts.

( 11 ) DURING the said year, a fresh amount of Rs. 1,49,398 was added to the said opening balance. The bad and doubtful debts thus aggregated Rs. 19,58,768 taking the entire year into consideration.

( 12 ) IT is also an admitted fact that a sum of Rs. 15,40,400 was written back or charged to the profit and loss account during the year in question leaving a balance amount of Rs. 4,18,368.

( 13 ) THIS amount of Rs. 4,18,368 is the amount in question before us. The company would have us answer that this is a part of the company's capital base but the Revenue contends otherwise, may be, the requirement that the capital as on the first day of the year is material was not given proper importance at any stage, but we do not want to enter into this extra side issue entirely on our own.

( 14 ) IT is also an admitted fact that in regard to the writing back of the said amount of Rs. 15,40,400, the company had followed its usual practice of charging an ad hoc percentage of the bad and doubtful debts to its profit and loss account in every different previous year. It is the clear contention of the asses-see that this writing back of the ad hoc percentage of the sum total of bad and doubtful debts did not bear any particular relation to any specified debt owed to the company.

( 15 ) THE Commissioner of Income-tax (Appeals) had found in favour of the Revenue. From the decision of the Tribunal, we find (specially from page 77 of the paper book) that the bad and doubtful debt reserve of Rs. 18,09,370 as the opening balance on January 1, 1975, was noted by the Tribunal ; it further noted that identical contentions as raised by the assessee before the Tribunal were accepted by the Commissioner of Income-tax (Appeals) for the assessment year 1975-76. The Tribunal noted that the order for the assessment year 1975-76 had become final and the Department had not contested it. In that order the bad and doubtful debts reserve of Rs. 18,09,370 was mentioned. The Tribunal thereaf

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