K PARAMASIVAN & SONS,CHENNAI vs. DCIT, NON CORP. CIRCLR-19(1), CHENNAI

The grounds raised by the assessee read as follows:- 1. The CIT(A) erred in disallowing ₹16,84,761 on the sole ground that customer account balances and ledgers were not available, ignoring the fact that employees had tampered with records, rendering such reconciliation impossible.

The loss was incurred in the course of business and is allowable under Section 37(1) of the Act as a genuine business loss arising from employee fraud, substantiated by police complaint and journal records. :- 3 -: 3. Alternatively, the loss is allowable as bad debt u/s 36(1)(vii), as the income was offered in earlier years and the irrecoverability was conclusively established and written off in the books, in line with the decision in:

The partial allowance by CIT(A) and disallowance of the rest is inconsistent, given that the accounting method and nature of transactions were uniform.

The disallowance amounts to denial of relief for a genuine loss suffered by the assessee due to criminal misappropriation, and contradicts the settled judicial position that loss should be allowed in the year of crystallization.

Brief facts of the case are as follows: The assessee is a partnership firm, which is a dealer of petroleum products of BPCL. For the assessment year 2012-13, return of income was filed on 10.09.2012 declaring total income of Rs.7,31,473/-. In the return of income, assessee had claimed a sum amounting to Rs.23,10,549/- u/s.36(1)(vii) of the Act as bad debts. The assessment was completed u/s.143(3) of the Act vide order dated 13.03.2015. In the said assessment order, the AO disallowed Rs.23,10,549/- claimed as bad debts. The relevant finding of the AO in denying the claim of deduction u/s.36(1)(vii) of the Act reads as follows:- “During the course of assessment proceedings the assessee’s Authorized Representative was asked to furnish the details of bad debts written off. For which he had furnished the list of debtors and stated that except the debts pertains to HDFC Credit Card Group and :- 4 -: Petro Card Reload cash or cheque amounting to Rs.12,55,738/- and Rs.4,29,023/- respectively were outstanding for more than a year as bad debts and the chances of getting back the money is remote hence the same was written off in the books of accounts as irrecoverable. When the AR was asked to justify the claim, since most of the debtors are Government and ongoing concerns, he has accepted for disallowance of the above sum to the tune of Rs. 6,25.788/-, as he could not furnish any justification that these amounts are irrecoverable.

Aggrieved by the order of the AO, denying the claim of deduction u/s.36(1)(vii) of the Act, assessee preferred appeal :- 5 -: before the First Appellate Authority (FAA). The FAA partly-allowed the appeal of the assessee. The FAA, for a sum of Rs.6,25,788/- held the same as allowable as bad debts written off u/s.36(1)(vii) of the Act. As regards balance sum of Rs.16,84,761/-, the FAA held that it is not clear how these amounts written off has become bad debts. Therefore, to the extent of Rs.16,84,761/-, claimed as bad debts from HDFC credit card and petro card reload were not allowed as deduction u/s.36(1)(vii) of the Act. The relevant finding of the FAA denying the benefit of deduction u/s.36(1)(vii) of the Act for an amount of Rs.16,84,761/- reads as follows:- “5.1 However, the appellant has not uploaded ledgers pertaining to HDFC credit card (Rs.12,55,738) and Petro Card Reload (Rs.4,29,023). It is not clear how these amounts became bad debts. Merchants get paid from credit card transactions through a system involving payment processors, card networks, and acquiring banks, where the funds are eventually deposited into the merchant's bank account, minus processing fees. When a customer uses their credit card or petro card to make a purchase, the appellant’s point-of-sale (POS) system or online payment gateway initiates the transaction. The amounts are invariably credited to appellant’s bank account by the end of the day. If by any technical glitch these amounts were not received, the merchant can take it up with banks and get it resolved. Bad debts arising from credit card business can be part of banking business and not any other business receiving payments through cards. Petro cards are loaded and used by customers, not sellers. In case of incentives receivable from credit cards, they are offered to customers, not merchants. The merchant only pays a small percentage of the transaction amount as a fee to the credit card company. In the absence of further details, it is held that total amount of Rs.16,84,761 claimed as bad debts from HDFC credit card and Petro Card Reload are not allowable as bad debts. The balance amount of Rs.6,25,788 is :- 6 -: allowable as bad debts written off u/s Section 36(1)(vii). As a result, the appeal is partly allowed.”

Aggrieved by the order of the FAA, the assessee has filed the present appeal before the Tribunal. The Ld. AR submitted that the FAA has erred in sustaining the disallowance of Rs.16,84,761/- solely on the ground that customer account balances and ledgers were not available, ignoring the fact that the employees of the assessee had tampered with the records, thereby rendering reconciliation impossible. The Ld.AR further contended that the loss was incurred wholly and exclusively in the course of business and is allowable under Section 37(1) of the Act, being a genuine business loss arising out of employee fraud, which has been duly substantiated by lodging of a police complaint and by supporting journal entries. The Ld. AR submitted that the said loss is also allowable as bad debt under Section 36(1)(vii) of the Act, since the income had already been offered to tax in earlier years and the irrecoverability of the amount stood conclusively established. The assessee has also written off the same in its books of account, in line with the ratio laid down by the Hon’ble Supreme Court in the case of TRF Ltd. v. CIT reported in (2010) 323 ITR 397 (SC). The Ld. AR also pointed out that the approach of the FAA in partly allowing the claim while disallowing the balance is inconsistent, :- 7 -: especially when the method of accounting and the nature of transactions remain uniform. Finally, the Ld. AR submitted that the disallowance effectively results in denial of relief for a genuine business loss suffered by the assessee on account of criminal misappropriation, which is contrary to the settled judicial position that such loss ought to be allowed in the year in which it crystallizes.

The Ld.DR supported the findings of the FAA.

I have read rival submissions and perused the material on record. The FAA had disallowed the bad debts claimed to the tune of Rs.16,84,761/- while allowing the claim of bad debts to the tune of Rs.6,25,788/- from the total addition made by the AO to the tune of Rs.23,10,549/-. The bad debts written off to the tune of Rs.16,84,761/- relates to two components namely HDFC credit card group to the tune of Rs.12,55,738/- and petro card reload to the tune of Rs.4,29,023/-. The above amount is irrecoverable on account of a fraud involving certain contract employees who manipulated petro card transactions records and customer ledger accounts thereby misappropriating a portion of the collections. The fraud conducted by the employees caused an actual financial :- 8 -: loss, wherein the receivables could not be traced or recovered due to the tampering of statements and account mismatches. Therefore, on account of the above incident, the sum of Rs.23,10,549/- was written off as bad debts through journal entries dated 31.03.2012. 9. The loss incurred by the assessee on account of the fraud conducted by the employees is also supported by the FIR filed on 22.07.2011 (refer page 27 to 323 of the appeal set). The police compliant filed by the assessee before the Assistant Commissioner is enclosed at page No.49 of the appeal (part of FIR) and the Remand Report submitted before the Hon’ble Metropolitan Magistrate Court, Saidapet, Chennai is also enclosed at page No.51 of appeal set followed by the detailed record of the complaint capturing the modus operandi of the fraud conducted by the employees.

Admittedly bad debts written off by the assessee during the assessment year under consideration i.e., AY 2012-13, remains unpaid to the assessee thereby fortifying the action of the assessee in claiming such bad debts. Hence, on the cumulative consideration of facts and circumstances of the case, I allow the :- 9 -: grounds of appeal filed by the assessee. Hence, the disallowance sustained by the FAA is deleted.

In the result, the appeal filed by the assessee is allowed.

Ĥ×यथȸ/Respondent 3. आयकर आयुÈत /CIT, Chennai 4. ͪवभागीय ĤǓतǓनͬध/DR

गाड[ फाईल/GF.