Bad debts are allowable expenses and it is not necessary for the assessee to establish that debt has become irrecoverable

Bad debts are allowable expenses and it is not necessary for the assessee to establish that the debt has become irrecoverable

Gone are the days when the the Assessing Officer would disallow the sum debited in the P&L account as non-recoverable sums written off as bad debts.  The Assessing Officer cannot disallow the sum in the pretext that the assessee didn’t produce any plausible reply . Hence, it can be said that it had  closed all the doors for the AO to conclude that the amount written off as bad debts was done only to reduce the tax liability and nothing more.

The claim for bad debt will be allowed in the year in which the bad debt has been written off as irrecoverable in the accounts of the assessee and the assessee doesn’t requires to establish the debt to have become bad in the relevant previous year.

Reference is this regard invited towards the provisions of section 36 of The Income Tax Act, 1961 [hereinafter referred to as the ‘Act’]. The relevant extracts of the said section reads as under:

“Other deductions.

(1) The deductions provided for in the following clauses shall be allowed in respect of the matters dealt with therein, in computing the income referred to in section 28 –

….

(vii) subject to the provisions of sub-section (2), the amount of any bad debt or part thereof  which is written off as irrecoverable in the accounts of the assessee for the previous year

….

(2) In making any deduction for a bad debt or part thereof, the following provisions shall apply—

(i) no such deduction shall be allowed unless such debt or part thereof 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;”

[Emphasis Added]

On the perusal of the above, it may kindly appreciate that while computing the business profit, an assessee is entitled to avail the deduction with respect to bad debts written off in the books if the following conditions are being fulfilled,

1. The debt in question must be written off as irrecoverable in the books of accounts for the relevant previous year and
2. The amount of the debt must be taken into account while computing the income either during the previous year or during the earlier years.

In the case, when  the assessee had written off the bad debts in its books of accounts during the relevant year, the assessee has fulfilled the condition (1) mentioned above.

Further, the debts must have been taken into account while computing the total income for the earlier year and thereby the assessee has fulfilled the condition (2) mentioned above.

Thereby, when the assessee has fulfilled both the above conditions then the assessee is duly eligible to claim deduction under section 36(1)(vii) of the Act .

The pivotal question, which falls to be considered is whether under the position of law during the current year, the assessee is required to prove before the Assessing Officer that the debt has actually become irrecoverable/bad, so as to be entitled to the deduction under section 36(1)(vii) of the Act with respect to the same.

In this regard, I would like to mention that the provision of section 36(1)(vii) has been amended by the Direct Tax Laws (Amendment) Act, 1987 w.e.f. 01-04-1989. Prior to 01-04-1989 the said provision reads as under:

 “(vii) Subject to the provisions of sub-section (2), the amount of any debt, or part thereof, which is established to have become a bad debt in the previous year”

[Emphasis Added]

Further, I would also like to draw your the kind attention towards the CBDT Circular No. 551, dated 23-01-1990 reported in  (1990)183 ITR(st.) 7 providing the explanatory notes to the Direct Tax Laws (Amendment) Act, 1987. The said circular inter alia reads as under:

“DIRECT TAX LAWS (AMENDMENT) ACT, 1987-IV

Amendments to sections 36(1)(vii) and 36(2) to rationalise provisions regarding allowability of bad debts

6.6 The old provisions of clause (vii) of sub-section (1) read with sub-section (2) of the section laid down conditions necessary for allowability of bad debts. It was provided that the debt must be established to have become bad in the previous year. This led to enormous litigation on the question of allowability of bad debt in a particular year, because the bad debt was not necessarily allowed by the assessing officer in the year in which the same had been written off on the ground that the debt was not established to have become bad in that year. In order to eliminate the disputes in the matter of determining the year in which a bad debt can be allowed and also to rationalise the provisions, the Amending Act, 1987 has amended clause (vii) of sub-section (1) and clause (i) of sub-section (2) of the section to provide that the claim for bad debt will be allowed in the year in which such a bad debt has been written off as irrecoverable in the accounts of the assessee.”

[Emphasis Added]

In view of the said amendment, it may kindly noted that the assessee is no more required to establish that his debts have been irrecoverable. Unlike the provisions of section 36(1)(vii) as applicable prior to 01-04-1989, the provisions of the Act during the relevant year doesn’t requires the assessee to establish its debt as bad debts before the Assessing Officer. The amendment made by the Direct Tax Laws (Amendment) Act, 1987 has deleted the condition that the assessee has to establish its debts as bad debt. Instead, the new provision provides that debts have to be written off in the books during the relevant year. Hence, after 01-04-1989, there is no need for the assessee to establish debt has become bad.

Reliance in this regard further placed towards the judgement in the case of TRF Ltd vs. CIT (2010) 323 ITR 397 (SC) wherein the Hon’ble Supreme Court has held that post 01-04-1989, it is not necessary for the assessee to establish that his debt has become bad. If the debt has been written off in the books then it would be sufficient to allow the deduction. The Hon’ble Apex Court inter alia held,

“4. This position in law is well-settled. After 1-4-1989, it is not necessary for the assessee to establish that the debt, in fact, has become irrecoverable. It is enough if the bad debt is written off as irrecoverable in the accounts of the assessee. However, in the present case, the Assessing Officer has not examined whether the debt has, in fact, been written off in accounts of the assessee. When bad debt occurs, the bad debt account is debited and the customer’s account is credited, thus, closing the account of the customer. In the case of companies, the provision is deducted from sundry debtors”

[Emphasis Added]

Similar view has also been taken in the following judgements:

• CIT vs. Times Business Solution Ltd. (2013) 354 ITR 25 (Delhi)
• CIT vs. Essar Teleholdings Ltd. (2015) 228 Taxman 309 (Bombay)(Mag.)
• Onprocess Technology India (P.) Ltd. vs. DCIT (2018) 96 taxmann.com 428(Kol-Tri.)
• Akzo Nobel India Ltd. vs. DCIT (2017) 81 taxmann.com 366(Kol-Tri.)
• DCIT vs. Pricewaterhouse Coopers (P.) Ltd. (2017) 82 taxmann.com 100(Kol-Tri.)
• NLC Nalco (India) Ltd. vs. DCIT (2016) 71 taxmann.com 57 (Kol-Tri.)

It is further submitted that the aforesaid decision of the Hon’ble Apex Court has been accepted by the department with no further amendments. The said is abundantly clear from the CBDT Circular No. 12/2016 dated 30-05-2016. The said circular inter alia states,

“3. The legislative intention behind the amendment was to eliminate litigation on the issue of the allowability of the bad debt by doing away with the requirement for the assessee to establish that the debt, has in fact, become irrecoverable. However, despite the amendment, disputes on the issue of allowability continue, mostly for the reason that the debt has not been established to be irrecoverable. The Hon’ble Supreme Court in the case of TRF Ltd. In CA Nos. 5292 to 5294 of 2003 vide judgment dated 9.2.2010, has stated that the position of law is well settled. “After 1.4.1989, for allowing deduction for the amount of any bad debt or part thereof under section 36(1)(vii) of the Act, it is not necessary for assessee to establish that the debt, in fact has become irrecoverable; it is enough if bad debt is written off as irrecoverable in the books of accounts of assessee.”

4. In view of the above, claim for any debt or part thereof in any previous year, shall be admissible under section 36(1)(vii) of the Act, if it is written off as irrecoverable in the books of accounts of the assessee for that previous year and it fulfills the conditions stipulated in sub section (2) of sub-section 36(2) of the Act.”

[Emphasis Added]

Thereby in light of aforesaid Judicial precedence and CBDT Circulars it can be inferred  that claim for any debt or part thereof in any previous year, shall be admissible under section 36(1)(vii) of the Act, if it is written off as irrecoverable in the books of accounts of the assessee for that previous year and it is not necessary for assessee to establish that the debt, in fact has become irrecoverable. It is enough if bad debt is written off as irrecoverable in the books of accounts of assessee.

In case of any further clarifications, Kindly let me Know at [email protected]

Limitation: The views expressed herein above are based on facts/assumptions as indicated above. No assurance is given that the revenue/judicial authorities will concur with the above views. The views are based on the existing provisions of law and its interpretation, which are subject to change from time to time. No responsibility is assumed to update the views consequent to such changes. The views should not be considered as a legal opinion. Copying the same without consent is not permitted.