A debt cannot be held to have become bad until the completion of winding up, and messing expenses incurred by an adhatiya are an admissible business expenditure and not entertainment within the meaning of Section 37(2B) of the Income Tax Act.

U.N. Bhachawat, J.

1. This is a reference tinder Section 256(1) of the I.T. Act, 1961 (for short hereinafter referred to as "the Act") at the instance of the Department.

2. The material facts giving rise to the present reference are these :

The relevant assessment year is 1973-74. The assessee is a registered firm and derives income from the adhatiya business. It had claimed messing expenses at Rs. 16,400 as an allowable expense. The claim was disallowed by the ITO on two grounds--

(i) that the expenditure was not proved ; and

(ii) that the expenditure was in the nature of entertainment expenditure which could not be allowed in view of Section 37(2B) of the Act.

3. The assessee had also claimed bad debts amounting to Rs. 27,000. This deduction regarding the bad debts was claimed on the ground that the debtor, who owed the above sum to the assessee, had filed insolvency petition and was adjudicated as insolvent. The claim was disallowed by the ITO on the ground that no dividend was yet declared, the petition had not been finally decided and, therefore, the debt could not be treated as a bad debt.

4. The assessee filed an appeal before the AAC. The AAC allowed the claim of expenses but reduced it from Rs. 16,400 to Rs. 2,600. The AAC also allowed the claim for the bad debt to the tune of Rs. 13,500 as against the amount of Rs. 27,000 claimed by the assessee.

5. The Department as well as the assessee filed appeals against the order of the AAC. The Department claimed that messing expenses could not be allowed in view of the embargo of Section 37(2B) of the Act. It also challenged the allowance of Rs. 13,500 as bad debt out of the claim of Rs. 27,000. The assessee in its appeal claimed allowance of the full amount of Rs. 27,000, claimed as a bad debt. The Tribunal held that assessee being an adhatiya was entitled to claim messing expenses as per the practice prevailing amongst adhatiyas and the AAC properly allowed the messing expenses. As regards the claim for bad debt the Tribunal dismissed the Department's appeal and allowed the assessee's claim as a bad debt, but restricted its disallowance to 10% on the concession made by the assessee himself. The relevant part of the Tribunal's order on this account is extracted hereinbelow :

"In our view since the statement of assets and liabilities was filed by the debtor and on 12-10-1972, i.e., before the close of the accounting year the assessee was justified in claiming the entire bad debt though he himself conceded that 10% of the claim could be rejected as the assets levied were at Rs. 1,48,000 and the liabilities on the debtor of about Rs. 14 lakhs. In the circumstances we restrict the disallowance on account of bad debt to 10% of the total claim and as such the order of the Appellate Assistant Commissioner is modified accordingly."

6. In the setting of the above facts, the following questions have been referred to this court for answer :

"(1) Whether, on the facts and circumstances of the case, the Tribunal was right in law in holding that the assessee is entitled to deduction of bad debt to the extent of 90% of the total claim of Rs. 27,000, even though no dividend had been declared by the appropriate authorities in the insolvency proceedings ?

(2) Whether, on the facts and circumstances of the case, the Appellate Tribunal was right in law in holding that the expenditure claimed by the assessee for providing messing facilities to the trade clients is an admissible business expenditure and that such expenses are not in the nature of entertainment within the meaning of Section 37(2B) of the Income Tax Act?"

7. We shall first take question No. 1. It is an admitted position as the question itself indicates that the insolvency proceedings are yet pending and no dividend has been declared. It is only when the official assignee or receiver would declare a final dividend, then the portion of the debt which would remain outstanding after deducting the final amount of dividend payabl