Madras H.C : Whether, on the facts and in the circumstances of the case, the Tribunal was right in holding that the claim of Rs. 2,10,000 as bad debt is an admissible deduction for the asst. yr. 1968-69?

Counsel Appeared

C.V. Rajan, for the Revenue : K.R. Ramamani & P.P.S. Janarthana Raja, for the Assessee

M.N. CHANDURKAR, C.J.:

Two questions which have been referred at the instance of the Revenue in this reference are as follows :

“1. Whether, on the facts and in the circumstances of the case, the Tribunal was right in holding that the claim of Rs. 2,10,000 as bad debt is an admissible deduction for the asst. yr. 1968-69?

2. Whether the Tribunal’s conclusion that the assessee incurred the loss of Rs. 2,10,000 and that that should be allowed as a deduction is a reasonable view to take on the facts and in the circumstances of the case?”

2. The assessment in question is for the asst. yr. 1968-69. The accounting year of the assessee, as an individual, ended on 12th April, 1968. Among the sources of income of the assessee, there are two with which we are concerned, namely, money-lending business and Shanmuga Pictures. The business of film financing was carried on by the assessee under the name of “Shanmuga Pictures”. In the asst. yr. 1968-69, the assessee claimed business loss to the extent of Rs. 2,10,000. The said amount was also claimed as bad debt due from one RM. Ramanathan Chettiar of Uma Pictures, Madras, which amount was advanced by the assessee to Uma Pictures under an agreement dt. 16th Sept., 1957. The total advances up to 5th Sept., 1961, which is the date of the agreement which is relevant, came to a little over Rs. 2,18,000.

The first agreement dt. 16th Sept., 1957, between the assessee and Uma Pictures, provided for an advance of Rs. 1 lakh to be made by the assessee according to the requirements of Uma Pictures for producing a film, the name of which was later given as “Chittoor Rani Padmini”. As security for the due repayment of this advance together with a commission of Rs. 25,000 which is described as finance commission to be paid to Shanmuga Pictures, the agreement provided that the financiers shall have a first and permanent charge and control over the entire “World negative rights” of the picture and all realisations therefrom. The agreement also fixes the time for repayment of the amount of Rs. 1,25,000 as ten months from the date of the first shooting day of the picture or before the date of first release of the picture whichever is earlier. There is a further clause in the agreement which provides that the financiers shall be entitled to the exclusive control of the distribution, exhibition and exploitation of the picture and to receive all advances, proceeds and realisations payable in respect of all transactions of distribution, lease or sale of rights of the picture with effect from the date of the agreement. This clause required that the relevant agreement with the direction for payment shall be executed by the producers duly confirmed by the financiers who shall, however, have no responsibility or liability for the repayment of any of the advances raised from distribution.

3. The producers of Uma Pictures were running short of finances and on 25th Oct., 1958, the producers, Messrs. Uma Pictures, entered into an agreement with one Mr. C.T. Arunachalam representing Messrs. South India Films with regard to the distribution rights of the said picture in the districts of Madurai, Ramnad, Tirunelveli and Kanyakumari. It is enough to mention that under this agreement, Messrs. South India Films agreed to pay Rs. 1,90,000 to the producers. The distribution rights assigned were for a period of five years from the date of delivery of the films. The agreement also provided that in the event of the sum of Rs. 1,90,000 not being fully adjusted and wiped off within a period of one year from the date of release of the picture in respect of the territories, the producers shall refund to the distributors immediately such unrecouped portion of the said amount.

4. The producers entered into a further agreement on 5th Sept., 1961, with one Sri N. SM. Adaikkappa Chettiar under which Adaikkappa Chettiar was to advance a sum of Rs. 1,80,000 to the producer in the manner provided for in the agreement. The agreement further provided that Adaikkappa Chettiar was entitled to repay himself from out of the amounts to be received from the several distributors. Under this agreement, Adaikkappa Chettiar was to pay Messrs. Shanmuga Pictures all such amounts as he may receive from parties in excess of the amounts due to him.

5. Then, we come to the more crucial agreement dt. 5th Sept., 1961, which happens to be the same date on which the producers entered into an agreement with Adaikkappa Chettiar. Since this agreement is of some importance for the purpose of the decision of the question raised, we shall refer to it in some detail. This is an agreement for leasing out to Messrs. Shanmuga Pictures by the producers the rights of exploitation of the film for the rgvenue districts of Madurai, Ramnad and Tirunelveli including Kanyakumari for a period of ten years. In lieu of these rights, Shanmuga Pictures agreed to pay a sum of Rs. 3,25,000 to the producer. This amount of Rs. 3,25,000 was to be accounted for in two parts. Rs. 1,15,000 and sales commission were to be paid to Messrs. South India Films in whose favour there was already an agreement dt. 25th Oct., 1958, with regard to the distribution rights. The balance amount was to be credited in the account of the producer. The material part of this clause is as follows: “The party of the Second Part (Shanmuga Pictures) agree to pay to the party of the First Part (producer) as consideration for the exploitation, distribution and exhibition rights of the said picture a sum of Rs. 3,25,000 (Three lakhs and twenty-five thousand only) in the manner set out below. Rs. 1,15,000 and sales commission to be paid to Messrs. South India Films immediately and the balance amount to be credited in the account of the party of the First Part. The party of the First Part hereby agrees to print and supply five prints and six sets of loan publicities such as photo cards, enlargements, slides, blocks, seographs, etc….” Clause 4 of the agreement reads as follows: “…..All realisations from the said picture in the said territory for the said period of ten years shall belong to and be the property of the party of the Second Part and the party of the First Part shall have no right or claim in respect of the same.” Clause 8 of the agreement provided that all disputes arising out of the agreement shall be settled at Madras and the Courts of Madras alone shall have the jurisdiction over all matters arising from the agreement.

6. One more agreement requires to be referred to. That agreement is dt. 5th Feb., 1963. That was the date on which the picture was released. Messrs. Shanmuga Pictures who were described as principals under this agreement appointed Messrs. Mahalakshmi Films, represented by their sole proprietor, K.T. Subbiah, as the sole and exclusive distributors for the area in respect of which Shanmuga Pictures had acquired rights under the agreement dt. 5th Sept., 1961. The financial relationship between the financier, i.e., the assessee, and Subbiah was governed by this agreement. Under this agreement, Subbiah was to pay Rs. 2 lakhs as distribution advance to the assessee. The assessee, described as principals, had the right to scrutinise the documents connected with the distribution of the said film at any time at the distributors’ office. Under cl. 12, it was provided that out of the net film hire realisations of the said film received from the distribution area, the distributors shall first deduct their commission due to them, then any other expenses incurred by them on behalf of the principals under the latter’s prior sanction and then adjust the balance of the realisations towards the advance amount paid by them and after the entire advance amounts were fully recovered by the distributors, the distributors were to remit to the principals the net film hire realisations after deducting their distribution commission and other expenses, if any, on or before the 15th of the succeeding month. Clause 13 provided that if any amount of the advance remained unrecovered from out of the net film hire realisations within a period of one year from the date of release of the film in the distribution area, the unrecovered portion of the advance amount and other expenses due to the distributors together with interest thereon at the rate of 12% until the date of payment shall be paid by the principals to the distributors within a week from the date of expiry of one year from the date of release of the film. The distributors could exercise rights under this agreement for a period of five years. It appears that K.T. Subbiah filed a suit claiming a sum of Rs. 1,68,504 from the assessee because the picture had failed. The matter was, however, amicably settled. Under these circumstances, the assessee claimed to have written off a sum of Rs. 2,10,000 due from the producer.

The ITO disallowed this claim on the ground that when the assessee credited the accounts of the producer with Rs. 2,10,000 and debited the film purchase account, the debit was extinguished. The ITO took the view that the assessee having exploited the film, if he had incurred any loss in the process of exploitation, that was undoubtedly a loss; but, then, the ITO took the view that the claim made by the assessee was premature because the assessee had made certain claims before the official receiver who was dealing with the assets of the producer who had, in the meantime, become insolvent. This has, however, been found to be incorrect because, admittedly, the assessee had not made any claim before the official receiver. According to the ITO, it was not explained how the purchase price of Rs. 3,25,000 was fixed when a sum of Rs. 1,15,000 was paid to South India Films by the assessee. Holding that the loss claimed was excessive, the ITO found that the sum of Rs. 85,000 received from the sub- distributor was not taken into account.

The AAC, in the appeal filed by the assessee, took the same view and held that when, as a consequence of the agreement dt. 5th Sept., 1961, a sum of Rs. 2,10,000 was credited to the debtor’s account, there was no question of any further debt due to the assessee from the debtor. According to the AAC, since the assessee had purchased the rights for a period of ten years and that period had not expired, there was no question of writing off any loss. The claim was also, according to him, premature.

The Tribunal, in an appeal filed by the assessee, took the view that the assessee had obtained distribution rights for four districts, so that the moneys advanced by him may be salvaged and that in the circumstances of the case, the fact that Rs. 2,10,000 was credited to the account of the debtor would not go to show that the money-lending transaction came to an end. According to the Tribunal, the assessee had lost a sum of Rs. 2,10,000 in the year of account and the distribution rights had not brought any money to the assessee, but, on the other hand, he had to make compensatory payments to Subbiah. The Tribunal thus allowed the appeal and deleted the addition. Arising out of this order of the Tribunal, the two questions reproduced above have been raised at the instance of the Revenue.

Learned counsel appearing on behalf of the Revenue contended that the original loan transaction dt. 16th Sept., 1957, had come to an end by the acquisition of distribution rights under the agreement dt. 5th Sept., 1961. There was, therefore, no question of writing off any debt which had ceased to be due because, according to learned counsel, Rs. 2,10,000 was credited to the account of the debtor on 5th Sept., 1961, and Rs. 3,25,000 was debited to the film purchase account by the assessee. Thus, according to learned counsel, the debt transaction was already squared up and if any loss had been incurred, it was incurred in the process of distribution rights. Learned counsel further contended that film exhibition is not a line of activity of the assessee and if any loss had been incurred in the exploitation of the film, it was really a capital loss.

Learned counsel appearing on behalf of the assessee, however, contended that the subsequent transaction with regard to the acquisition of distribution rights must be referable to the agreement dt. 16th Sept., 1957, itself, and reliance was placed on cl. 12 of the agreement which provided for the exclusive control of the financiers in respect of the distribution, exhibition and exploitation of the picture. The view taken by the Tribunal is sought to be supported by learned counsel for the assessee and it is contended that all the transactions must be considered as part of the scheme to recover the debt owed by Ramanathan Chettiar. It is argued that when, in accordance with the agreement dt. 5th Sept., 1961, book adjustments were made, those were mere book adjustments and did not have the effect of wiping off the liability of the debtor, Ramanathan Chettiar. A case of business loss was sought to be made out on the ground that, alternatively, the distribution rights had not yielded any income at all and, therefore, the assessee was entitled to have a deduction on the ground of revenue loss.

13. At the threshold, it is necessary to bear in mind that we are dealing with the asst. yr. 1968-69 and unless it is established that in that year any loss had occurred or any debt was liable to be written off as bad debt, the view taken by the Tribunal could not be sustained. The Tribunal seems to have taken the view that the assessee took over the distribution rights in order to ensure that the moneys originally advanced to the debtor are recoverable. The Tribunal, however, seems to have overlooked the fact that even the assessee who maintained his accounts on the basis of commercial system, had credited the account of the debtor with a sum of Rs. 2,10,000 and had debited a sum of Rs. 3,25,000 to the film purchase account. The moment the agreement dt. 5th Sept., 1961, was given effect to, it must be traceable to paragraph 12 of the agreement dt. 16th Sept., 1957. It would be difficult to say that on 5th Sept., 1961, the debt which was originally traceable to the agreement dt. 16th Sept., 1957, continued to subsist. The effect of the agreement dt. 5th Sept., 1961, would have fallen for consideration in the asst. yr. 1962- 63. We have no material on record to show how the accounts of the assessee stood in the asst. yr. 1962-63. But it is nobody’s case that even on 5th Sept., 1961, when a sum of Rs. 2,10,000 was credited to the account of the original debtor, Ramanathan Chettiar, there could have been any further occasion to reverse that entry. In any case, that reversal could not take place in the asst. yr. 1968-69. On pure principles of commercial accountancy, the debt must be treated as having been wiped out and substituted by a fresh transaction evidenced by the document dt. 5th Sept., 1961. The agreement dt. 16th Sept., 1957, ceased to be effective because the rights of the parties would now be governed by the agreement dt. 5th Sept., 1961. This was clearly a case, in our view, in which the provisions of s. 62 of the Contract Act would be attracted. Sec. 62 of the Contract Act provided that if the parties to a contract agree to substitute a new contract for it, or to rescind or alter it, the original contract need not be performed.

14. In respect of the amount which was owed by Ramanathan Chettiar to the assessee under the agreement dt. 16th Sept., 1957, a new agreement had taken its place. That debt has been wiped out, with the result that the debtor was not bound to perform or discharge any of his obligations provided under the agreement dt. 16th Sept., 1957. Under the new agreement dt. 5th Sept., 1961, the debtor’s liability was not only wiped out but the assessee had also undertaken to pay a sum of Rs. 1,50,000 to Messrs. South India Films. It is true that Messrs. South India Films is not a party to the agreement but as between the assessee and the previous debtor, the liability which the debtor owed to Messrs. South India Films under the agreement dt. 25th Oct., 1958, was sought to be dealt with as the assessee had taken over the liability also to discharge the debt owed by Uma Pictures to Messrs. South India Films. The agreement dt. 5th Sept., 1961, cannot, therefore, be treated as merely working out the rights under the agreement dt. 16th Sept., 1957. It is entirely a new agreement in substitution of the original agreement. The assessee expected that he would be benefited by taking over the distribution rights. It is nobody’s case that at any stage when the agreement dt. 5th Sept., 1961, was entered into, the assessee was expected to get the exact amount of the debt. The agreement dt. 5th Sept., 1961, as a matter of fact, provides that all receipts consequent upon the exploitation of the firm and exhibition of the film would wholly belong to the assessee. Clause 4 provides as follows: “….All realisations from the said picture in the said territory for the said period of ten years shall belong to, and be the property of, the party of the Second Part and the party of the First Part shall have no right or claim in respect of the same.”

It was thus clearly intended by the parties to the agreement that any realisation in excess of Rs. 3,25,000 would belong to the assessee himself and no part of it was to go to the producer. We would have appreciated the contention raised on behalf of the assessee if this agreement contemplated that any amount in excess of Rs. 3,25,000 would be the property of the producer and not of the assessee. It is, therefore, clear that the assessee expected to make a profit and intended to keep the entire profit if the receipts in pursuance of this agreement exceeded the sum of Rs. 3,25,000. The agreement was, therefore, not only a mode of recovery of the loan, but it was also clearly a business venture which the assessee had undertaken after specifically treating the debt of the producer as wiped out. In our view, therefore, the Tribunal was not justified in treating the taking over of the exhibition rights as merely a mode of recovering the money. Clause 4 of the agreement, clearly, is an indication to the contrary.

Learned counsel on behalf of the assessee has referred to a decision of the Mysore High Court in CIT vs. Y.V. Sreenivasa Murthy (1967) 63 ITR 306 (Mys) : TC15R.1413. The assessee in that case was a film distributor who had entered into an agreement with a film producer under which he acquired the rights of distribution of a picture in certain districts. Under the agreement, a sum of Rs. 50,000 was advanced by the assessee to the producer on condition that out of the realisations, the assessee should first reimburse himself to the extent of the sum of Rs. 50,000 which he had advanced, and he will be entitled, further to a commission in respect of the realisations over and above Rs. 50,000. It was also agreed that in the event of the realisations (less the commission) falling short of Rs. 50,000, the producer should pay back the amount advanced to the assessee. The assessee, later, entered into an agreement for sub-distribution on similar conditions. The picture failed and the sub-distributor instituted a suit against the assessee for the recovery of Rs. 44,634 impleading the producer also as a party and a consent decree was passed in that suit under which the assessee agreed to pay Rs. 37,800 to the sub-distributor. A sum of Rs. 41,915 was due to the assessee from the producer and the assessee wrote off this sum as a bad debt in his accounts and claimed deduction of this amount and litigation expenses. The AAC allowed deduction of litigation expenses of Rs. 2,500 and a sum of Rs. 36,300 in computing the assessee’s business income as trade losses. This view was affirmed by the Tribunal. On a reference, at the instance of the Revenue, the Mysore High Court held that as the debt advanced for the acquisition of the right of distribution was advanced in the course of a business which the assessee was conducting as a distributor and exhibitor of pictures, it was a debt due to the assessee in respect of his business within the meaning of s. 10(2)(xi) of the Indian IT Act, 1922, and the sum of Rs. 36,300 which remained unrealised was allowable as a trade loss. The litigation expenses were also held to be allowable.

It was contended by learned counsel appearing on behalf of the assessee that in the light of the ratio of the above aid decision, the amount of debt which remained unrecovered and for the recovery of which the assessee had taken over the distribution rights must be treated as a trade loss. It is necessary to point out that the said decision was considered by this Court in CIT vs. Coimbatore Pictures (P.) Ltd. (1973) 90 ITR 452 (Mad) : TC14R.634. Dissenting from the view taken by the Mysore High Court in the aforesaid decision, this Court took the view that the advances made by the distributors to the film producers, while entering into agreements for distribution rights of pictures, need not necessarily be an advance on revenue account incurred in the course of business and in order to be entitled to a deduction on the ground of business loss, the loss should not only have been incurred in the course of the business, but it should also be in the nature of a revenue loss.

The question as to whether a debt is a bad debt or not and whether the debt is a subsisting one or not has to be decided on the facts of each case. The decision cited on behalf of the assessee is not of any assistance to the assessee because, on facts, we have found that there was no debt existing and that altogether a new agreement had come into being. Consequently, there was no question of the acquisition of distribution rights being a mode of recovery of the loan on the facts of this case.

A natural corollary of the view which we have taken is that since the debt already stood discharged in accordance with the agreement dt. 5th Sept., 1961, there was no question of writing off of the debt in 1968-69 and, further, there was no question of treating the amount equivalent to that debt as a revenue loss in the asst. yr. 1968-69.

18. In the view which we have taken, both the questions raised have to be answered against the assessee. Accordingly, question No. 1 is answered in the negative and in favour of the Revenue and question No. 2 is also answered in the negative and in favour of the Revenue. The assessee will pay the costs of this reference. Costs Rs. 500.

[Citation : 174 ITR 123]