In the case of South India Surgical Co Ltd v. C.I.T. (287 I.T.R. 62), the facts were that the assessee carried on the business of manufacturing and marketing surgical instruments.
It supplied goods to reputed hospitals and most of them were Government hospitals. While still maintaining the business transactions and making supplies to these hospitals from which amounts were due, the amounts due from them were written-off by the assessee as bad debts. The Assessing Officer disallowed the claim of bad debts in a sum of Rs 65.2 lakh under Section 36(1)(vii) of the Income tax Act, 1961, for the assessment year 1996-97 which was confirmed by the appellate authorities.
Madras High Court judgement
The Madras High Court held that it was clear from the order of the Commissioner (Appeals) that on a perusal of the correspondence produced by the assessee, the hospitals concerned had acknowledged that they were due to pay these amounts to the assessee. It was only paucity of allocated budget to the hospitals that resulted in non-payment.
It would be preposterous to consider that the Government was not in a position to discharge its acknowledged debt. It might be due to certain fund flow problems and priority between different needs that there was postponement in discharging liability by the Government. There was no negation of the claim nor had any Government hospital written that they would not pay any of these amounts.
The other parties to whom huge amounts running into lakhs were due were public and private hospitals with whom the assessee was continuing its business transactions. Except the unilateral act of the assessee to write-off the debts as bad debts in the books of account for the previous year relevant to the assessment year in question, the assessee had not made out any case to regard the debts in question as irrecoverable.
The judgment of the assessee in regarding the debts as bad was not an honest judgment having regard to the financial position of the hospitals. Therefore, the Tribunal was right in law in holding that the debts claimed by the assessee as bad had not become bad and thus were not allowable as deduction under Section 36(1)(vii).
Honest, but not convenient
In conclusion, the Court laid down the proposition that it is not sufficient for the assessee to say that he became pessimistic about the prospect of recovery of the debt in question.
He must feel honestly convinced that the financial position of the debtor was so precarious and shaky and that it would be impossible to collect any money from him. The question is really one of fact depending upon diverse circumstances bearing on the debtor's pecuniary position, his commitments and obligations.
The judgment of the assessee in regarding a debt as a bad debt must be an honest judgment and not a convenient judgment. The judgment of the assessee must be established to have been taken on relevant facts and circumstances which should show that the debt is not realisable for some fault on the part of the debtor or some supervening impossibility on the part of the debtor to pay, but not possible difficulties or hurdles the assessee may have to incur to compel the recalcitrant debtor to pay.
The Court further held that the assessee for his convenience may decide that the debt is too small and it is not worthwhile to pursue the debtor but that judgment would not be an honest one which would establish that the debt has become a bad debt. A time-barred debt can be assumed to be bad, but is not necessarily bad because of expiry of limitation for recovery of the same.
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