For a debt to be classified as bad, assessee has only to write it off as irrecoverable in its accounts

For claiming any debt as a bad debt, one has to satisfy following two conditions:

(1) Debt is written off as bad debt in the Profit and Loss Account by making corresponding entry in the party account.

(2) Debt is taken in to account in computing the income of the assessee of the previous year in which debt is written off or in earlier previous year.

It is crystal clear from the amended provisions of Section 36(1)(vii) that there is no requirement that the income in respect of which bad debts is written off has to be recognised as income in earlier previous year and not in the year in which bad debt is written off, in fact Section 36(2) itself permits that the income could be of the same previous year in which the debt has been written off or it could have been recognised in the earlier previous year.

IN THE INCOME TAX APPELLATE TRIBUNAL
DELHI BENCH ‘B’ : NEW DELHI

BEFORE SHRI R.P.TOLANI, JM AND SHRI R.C.SHARMA, AM

ITA No. 971/Del/2009

Assessment Year: 1998- 99

Appellant by : Shri S.C. Vasudeva and Shri Sachin Vasudeva, CAs.
Respondent by : Ms.Y.S.Kakkar, DR.

Date of Judgement: 17th November, 2009. 

O R D E R

PER R.C. SHARMA, AM :

This is an appeal filed by the assessee against the order of CIT(A) dated 10.12.2008 for the AY 1998-99, in the matter of order passed u/s 143(3) of the IT Act.

2. Rival contentions have been heard and record perused. Facts in brief are that assessee’s claim for bad debts written off in the books of account amounting to Rs.47,48,426/- and difference in exchange debited to profit & loss account amounting to Rs. 2,33,625/- was disallowed by the AO in the course of assessment u/s 143(3). In an appeal filed by the assessee, the dis allowance was confirmed. In the further appeal filed before the Tribunal vide order dated 28.10.2005, issue with regard to allowing claim of bad debts was allowed for statistical purposes in favour of assessee with the following directions to the AO:-

“We have heard the parties and perused the record of the case. It may be mentioned that prior to the amendment to section 36(1)(vii), the assessee was required to satisfy that debt which is written off is established to have become bad. While in view of amended provisions, it would be sufficient to allow the claim for write off of bad debts, if in the opinion of the assessee, a particular debt has become bad and the same has been written off in the books of accounts as irrecoverable. The amended provisions have left to the prudence or the judgement of the businessman to consider whether a particular debt has become bad and the same should be written off in the books of accounts as irrecoverable. The Honourable High Court of Gujarat in the case of CIT Vs Girish Bhagwat Prasad 256 ITR 772 has held that in order to claim deduction u/s 36(1)(vii) all that is required by assessee is to show that the bad debt has been written off as irrecoverable, of course, subject to the genuineness of the claim.

It may be mentioned that the assessee is not only to write off the bad debt in Profit & Loss A/c but he has to make corresponding credit entry in the account of debtor. It may further mentioned that the provisions of section 36(1)(vii) are subject to the condition in section 36(2), viz., that such debt have been taken into account in computing the income of the assessee of the previous year or it represents money lent in the ordinary course of business of business being carried out by the assessee. Since the necessary details are not on record, we set aside the impugned order and restore the same to the file of the Assessing Officer to examine and consider the matter afresh in the light of the above observations after affording a reasonable opportunity of being heard.”

3. Without obeying the directions given by the Tribunal, the AO again confirmed the addition vide order dated 30.11.2006 by observing that assessee has not fulfilled condition laid down u/s 36(2) that such debt should have been taken into account in computing the income of the assessee. The AO also observed that the nature of write off appears to be that of trade discount, rather than the amount having become bad. By the impugned order, the CIT(A) confirmed the action of the AO by observing that nothing has been brought on record either before the AO or during the appellate proceedings to indicate that debts have become “bad debts” so as to be written off for being claimed as deductible u/s 36(1)(vii). The CIT(A) concluded that looking to the nature that it being a case of the outstanding balance of debtors, the same cannot be allowed as a deduction u/s 36(1)(vii) of the Act.

4. In respect of the loss claimed on account of foreign exchange fluctuation which was disallowed by the AO and the CIT(A), in an appeal filed before the Tribunal, the Tribunal allowed assessee’s claim for statistical purposes after having the following observation:-

“We have heard the parties and perused the records of the case. It is seen that neither the Assessing Officer nor the CIT(A) has discussed as to how this foreign exchange loss has accrued, whether this was a trading loss or capital loss nor it has been discussed as to what method of accounting the assessee has been following viz. mercantile system of accounting or cash system of accounting. Thus it would depend upon the answer whether additional liability, which the assessee had incurred on account of foreign exchange fluctuation, was on account of trading asset or capital asset and which method of accounting the assessee has been followed. It may be mentioned that the system of accounting followed by the assessee would be a crucial factor for allow ability of expenditure/  losses and for taxation of receipts. In the facts and circumstances of the case, the impugned order passed in this regard is set aside and restored to the file of the Assessing Officer, who may examine the matter afresh in accordance with the law after affording a reasonable opportunity of being heard to the assessee.”

5. While giving effect to the order of the Tribunal, the AO again made the addition by observing that it is a contingent liability, the true import of which can be determined only on actual payment of the amount. He further stated that debit entry in the profit & loss account for foreign exchange notional loss is in the nature of provision or reserve, hence the same cannot be allowed as a deduction. The dis allowance so made was confirmed by the CIT(A) and the assessee is in further appeal before us in respect of both the issues and following grounds have been taken by the assessee :-

“1. (a) That on the facts and circumstances of the case the learned CIT(A) was most unjustified in not following the directions given by Honourable ITAT vide its order dated 28.10.2005 regarding the matters to be considered for the purpose of allowing the deduction of bad debts written off by the appellant.

(b) That in this connection the learned CIT(A) has erred both on facts and in law in sustaining the dis allowance made by learned assessing officer amounting to Rs. 47,48,426/- on account of bad debts written off by the appellant in its books of accounts.

2. (a) That the learned CIT(A) was not justified in disallowing the claim of the appellant with regard to the foreign exchange loss amounting to Rs. 2,36,625/- on the alleged contention that the said amount does not represent a liability required to be met by the branch office in India.

(b) That on facts and circumstances of the learned CIT(A) has erred in this case also is not conforming to the directions of the Honourable ITAT contained in paragraph 6 of the order dated 28.10.2005.

3. That the learned CIT(A) was not justified in restricting certain expenditures like commission, insurance, subscription to journals, advertisement, courier etc. to 5% of the adjustable total income as per section 44C of the Act, without giving credence to the contention of the appellant that the revenue expenditure incurred by the assessee under various heads is not in the nature of head office expenditure as per section 44C of the Act and that these expenses are not even payable to head office of the assessee company.

4. That in any case and without prejudice to the contention in (3) above, the learned CIT(A) was not justified in not accepting the contention that the appellant is entitled to the benefit under India Mauritius Treaty on the basis of which the expenditure incurred in India is allowable in its entirety for computing the profits and gains from business and therefore provisions of section 44C would be inapplicable in the case of the appellant.

5. That the appellant craves leave to add, amend and/ or alter the grounds at a later stage.”

6. We have considered the rival contentions, carefully gone through the orders of the authorities below and found from the record that assessee is engaged in service industry where payment becomes due immediately on rendering of services. As per normal practice after raising of bill for services, 30 days credit is allowed after which follow up action is started. Thereafter having regard to the facts and circumstances of each individual case, a bona-fide assessment is made by the management to the effect of its realisation and thereafter if the management is satisfied with possibility of its recover ability the same is written off as bad debts in the books of account. During the relevant year under consideration the assessee had shown income of Rs. 6.88 crores on account of services rendered. Out of it, in the profit & loss account the assessee has claimed bad debts of Rs. 47.48 lakhs in respect of 22 parties, full details of which along with the date of entering the transaction, the amount outstanding, date and value of invoice, age of debtor, the amount written off and the date of writing off was furnished before the AO. The copy of accounts of all these parties have also been filed. As the assessee was unable to recover the outstanding balance in their account, after making reasonable and bona-fide efforts for recovering, the same was written off as bad debt in the profit & loss account. There is no dispute to the fact that all the amounts were written off by debiting in the profit & loss account. There is also no dispute that corresponding entry in the respective account of parties were also passed. In the assessment order, the AO has wrongly observed that bad debts written off were in the nature of trade discount. In case of trade discount, there is no reason to write off the debt and claim the same u/s 36(1)(vii), since the amount of trade discount is firstly reduced from the gross receipts, and only net receipt is taken as income.

The trade discount can be claimed as an expenditure as and when the same is given. The assessee has duly explained the accounting policy followed by it. As per the accounting policy followed by the assessee company, we found that when the services are rendered, the Revenue is recognised by debiting the party account and crediting the income account. In case where money is not recoverable from the party after doing reasonable efforts, the outstanding balance in the account is being written off as bad debts by debiting the profit & loss account and a corresponding entry in the debtor account is also being passed. Even if in the very same year the assessee is unable to recover the amount of bill raised on account of services rendered and which has already been accounted for as income, the assessee wrote off the same in the books of account and claimed it as bad debts. As per the amended provisions of Section 36(1)(vii) if a debt has been written off as irrecoverable in the accounts of the assessee, it will be sufficient for claiming it as bad debts, subject to the condition that the amount so written of has already been accounted for as income in the year or in the earlier years. Thus for claiming any debt as a bad debt, one has to satisfy following two conditions:-

“(1) Debt is written off as bad debt in the Profit and Loss Account by making corresponding entry in the party account.

(2) Debt is taken in to account in computing the income of the assessee of the previous year in which debt is written off or in earlier previous year.”

7. None of the lower authorities have pinpointed any entry in the books of account to show that the debt has not been written off in the books of account by passing a corresponding entry in the party account nor it is a case of any of the lower authorities that the debt was not taken into account in computing the income of the assessee of the previous year in which bad debt is written off or in any of the earlier previous years. Ledger account of all the parties furnished before the lower authorities which have become bad and the genuine efforts were taken by the assessee to recover the same and only thereafter the amount was written off as bad debt. The provisions of Section 36(1)(vii) have been amended by Direct Tax Laws (Amendment) Act, 1987 w.e.f. 1.4.1989, wherein the words “any debt, part thereof” have been substituted by “any bad debt or part thereof which is written off as irrecoverable in the accounts of the assessee for the previous year”. The old provisions of clause (vii) of sub-section (1) read with sub-section (2) of the section laid down conditions necessary for allow ability 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 allow ability 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. Clauses (iii) and (iv) of sub-section (2) of section 36 provided for allowing deduction for a bad debt in an earlier or later previous year, if the Income-tax Officer was satisfied that the debt did not become bad in the year in which it was written off by the assessee. These clauses have become redundant, as the bad debts are now being straightaway allowed in the year of write off. The Amending Act, 1987, has, therefore, amended these clauses to withdraw them after the assessment year 1988-89.

8. It is crystal clear from the amended provisions of Section 36(1)(vii) that there is no requirement that the income in respect of which bad debts is written off has to be recognised as income in earlier previous year and not in the year in which bad debt is written off, in fact Section 36(2) itself permits that the income could be of the same previous year in which the debt has been written off or it could have been recognised in the earlier previous year. Thus, the allegation of AO to the effect that income in respect of bad debts written off was not recognised in earlier previous year but in the previous year itself, therefore assessee is not entitled to claim, is of no substance. After carefully analyzing the full details of debts written off, we found that all the conditions of Section 36(1)(vii) read with Section 36(2) have been satisfied, accordingly there is no merit in the action of the lower authorities for declining the claim of deduction on account of bad debts. Assessee’s case is squarely covered by the verdict of Honourable Jurisdictional High Court in the case of CIT Vs. Morgan Securities & Credits (P) Ltd. – 162 Taxman 124 (Del) and CIT Vs. Auto meters Ltd. – 292 ITR 345 (Del) wherein it was held that assessee would be entitled to deduction of the amount of any bad debts in the year it has been written off as irrecoverable in its accounts as provided u/s 36(2) and Section 36(1)(vii) read with Circular No. 551 dated 23.1.1990. In the case of Auto meters Ltd. (supra), the Honourable Delhi High Court was specifically dealing with amended provisions of the law with regard to claim of bad debts, wherein it was held that prior to 1.4.1989 it was necessary for the assessee to establish that the debt had become bad, whereas after the amendment w.e.f. 1.4.1989 in Section 36(1)(vii), for the debt to be classified as bad, the assessee has only to write it off as irrecoverable in its accounts. It was also observed that as per para 6.6 and 6.7 of Circular No. 551 dated 23.1.1990 that the earlier provision regarding claim of bad debts generated a considerable amount of litigation on the issue whether the assessee had been able to establish that the debt had become bad. It was to overcome this that the amendment was made resulting in a bad debt “now being straightaway allowed in the year of write off”. The amendment made in Section 36(1)(vii) was a conscious decision taken to eliminate litigation with regard to establishing what is bad debt. Case laws cited by learned DR are distinguishable on facts insofar as conditions stipulated in Section 36(2) were not satisfied in respect of accounting of income in earlier years or during the year.

9. In view of the above discussion, we are inclined to agree with learned AR that order passed by lower authorities declining the claim of bad debts written off is devoid of any merit. We are therefore inclined to reverse the finding and conclusion of the lower authorities and allow this ground in favour of assessee.

10. With regard to assessee’s claim for exchange loss fluctuation amounting to Rs. 2,36,625/-, we found that it was on account of trading transactions with group companies. As the group companies have incurred expenditure on behalf of the assessee company, which it has to pay and due to fluctuation in exchange rate the amount payable was more that what was accounted for in terms of the Dollar rate on the date of incurring. Since the transaction was on trading account and not on capital account, in view of the decision of Honourable Delhi High Court in the case of Woodward Governor India Ltd. – 210 CTR 344, which was affirmed by the Honourable Supreme Court and reported at 21 DTR 106, we do not find any merit in the action of the lower authorities for disallowing the claim of foreign exchange fluctuation loss arising out of trading transaction being expenditure incurred by the group companies on behalf of the assessee company. The issue is also concluded in favour of the assessee on the very same issue by ITAT Delhi Bench in the case of Maruti Udyog Ltd.- 101 TTJ 760 and ONGC Vs. DCIT- 83 ITD 151 (Delhi ITAT Special Bench).

11. In the result, the appeal of the assessee is allowed, in terms indicated hereinabove.

Decision pronounced in the open Court on 17th November, 2009.