Conditions to be fulfilled for bad and doubtful debts to be claimed for deduction under Section 36(1)(vii) of IT Act

Cause Title : Pr. Commissioner Of Income Tax vs Khyati Realtors Pvt. Ltd., SLP (Civil) No. 672 Of 2020)

Date of Judgment/Order : 25.08.2022

Corum : S. Ravindra Bhat, Uday Umesh Lalit, Sudhanshu Dhulia

Citied: 

1. Southern Technologies Ltd. v. Joint Commissioner of Income Tax, Coimbatore
2. Commissioner of Income Tax v. Mysore Sugar Co. Ltd.
3. Mohan Meakin Ltd. v. Commissioner of Income Tax
4. Harshad J. Choksi v. Commissioner of Income Tax
5. IBM World Trade Corporation v. Commissioner of Income Tax
6. T.R.F. Limited v. Commissioner of Income Tax, Ranchi
7. Catholic Syrian Bank Ltd. v. Commissioner of Income Tax, Thrissur

Background

The assessee carries on real estate development business, trading in transferable development rights (TDR) and finance. ₹ 10 crores was advanced on 06.03.2007 to M/s C. Bhansali Developers Pvt. Ltd. to acquire certain commercial premises and for reservation by way of bookings in their upcoming project on the Old Mumbai-Pune Highway in Khopoli. It was contended by the Assesee that the project did not appear to make any progress, and consequently, the assessee sought return of the amounts from the builder. However, the latter did not respond. As a result, the assessee’s Board of Directors resolved to write off the amount as a bad debt in 2009. It was also contended that the amount could also be construed as a loan, since the assessee had ‘financing’ as one of its objects. The AO disallowed the sum of ₹ 10 crores claimed as a bad debt in determining its income under “Profits and Gains of Business or Profession”. Aggrieved, the assessee appealed. The CIT(A) confirmed the disallowance on account of bad debts and interest. A further appeal was preferred to the ITAT, which allowed the assessee’s plea. The Revenue sought an appeal to the Bombay High Court. The Bombay High Court ruled that no question of law requiring a decision arose in the appeal and consequently declined to entertain the Revenue’s plea.

The Revenue has appealed a decision of the Bombay High Court1 which affirmed an order2 of the Income Tax Appellate Tribunal which had upheld a claim by the respondent for writing off ₹ 10 crores as a bad debt.

Judgment

Section 36 of the Income Tax Act 1961 occurs under the heading ‘other deductions’. The income of every assessee has to be assessed according to the statutory framework laid out Chapter IV, Part D of the Act. That chapter deals with heads of income. Section 28 of the Act deals with the chargeability of income to tax under the head ‘Profits and Gains of Business or Profession’.

For the purposes of computing income chargeable to tax, therefore, besides specific deductions, ‘other deductions’ enumerated in different clauses of Section 36 can be allowed by the AO. Each of the deductions must relate to the business carried out by the assessee. If the assessee carries on a business and writes off a debt relating to the business as irrecoverable, it would without doubt be entitled to a corresponding deduction under clause (vii) of sub-section (1) of Section 36 subject to the fulfilment of the conditions set forth in sub-section (2) of Section 36 of the IT Act.

With effect from 1 April 1989, with the insertion of the new Explanation under Section 36(1)(vii), any bad debt written-off as irrecoverable in the account of the assessee would not include any ‘provision’ for bad and doubtful debt made in the accounts of the assessee. In other words, before this date, even a provision could be treated as a write off. However, after this date, the Explanation to Section 36(1)(vii) brought about a change. As a result, a mere provision for bad debt per se was not entitled to deduction under Section 36(1)(vii). 

It is thus evident that merely stating a bad and doubtful debt as an irrecoverable write off without the appropriate treatment in the accounts, as well as non-compliance with the conditions in Section 36(1)(vii), 36(2), and Explanation to Section 36(1)(vii) would not entitle the assessee to claim a deduction. 

It is evident from the various rulings of the Supreme court, that:

(i) The amount of any bad debt or part thereof has to be written-off as irrecoverable in the accounts of the assessee for the previous year;

(ii) Such bad debt or part of it written-off as irrecoverable in the accounts of the assessee cannot include any provision for bad and doubtful debts made in the accounts of the assessee;

(iii) No deduction is allowable unless the debt or part of it “has been taken into account in computing the income of the assessee of the previous year in which the amount of such debt or part thereof is written off or of an earlier previous year”, or represents money lent in the ordinary course of the business of banking or money-lending which is carried on by the assessee;

(iv) The assessee is obliged to prove to the AO that the case satisfies the ingredients of Section 36(1)(vii) as well as Section 36(2) of the Act.

The Supreme Court observed that the accounts of the assessee nowhere showed that the advance was made by it to M/s C. Bhansali Developers Pvt. Ltd. in the ordinary course of business. Its primary argument was that the amount of ₹ 10 crores was given for the purpose of purchasing constructed premises but no material to substantiate this submission there is nothing on record to suggest that the requirement of the law that the bad debt was written-off as irrecoverable in the assessee’s accounts for the previous year had been satisfied. 

In view of the above discussion, it is held that the assessee’s claim for deduction of ₹ 10 crore as a bad and doubtful debt could not have been allowed. The findings of the ITAT and the High Court, to the contrary, are therefore, insubstantial and have to be set aside.

Further, on the issue of admissibility of an expenditure as a deduction, which does not fall within the provisions of Sections 28 to 43, and is not capital in nature, but is laid out or spent exclusively for the purpose of business, under Section 37 of the Act, the court held that test should be to decide whether the expense was incurred for business, or whether it fell into the capital stream and the same should be admitted only if the disallowance of the amount, on account of bad and doubtful debt, did not preclude a claim for deduction, on the ground that the expenditure was exclusively laid out for the purpose of business.