Mumbai ITAT: Once Bad Debt Is Written Off, AO Cannot Demand Proof of Irrecoverability; Transitional Four-Year Rule Inapplicable

Anita Medical Systems Pvt Ltd Vs ITO (ITAT Mumbai)

Mumbai ITAT: Once Bad Debt Is Written Off, AO Cannot Demand Proof of Irrecoverability; Transitional Four-Year Rule Inapplicable

The Mumbai ITAT held that the assessee was entitled to deduction of bad debts under Section 36(1)(vii) once the debts were written off as irrecoverable in its books of account and the amounts had already been taken into account in computing income in earlier years, thereby satisfying the requirements of Section 36(2). The Tribunal observed that, after the amendment effective from 1 April 1989, an assessee is not required to prove that the debt has actually become irrecoverable, reiterating the law laid down by the Supreme Court in TRF Ltd. v. CIT.

The Tribunal further held that the Assessing Officer and the CIT(A) had erroneously invoked Section 36(2)(iv) by applying a four-year limitation for writing off debts. It clarified that Section 36(2)(iv) is merely a transitional provision applicable only to debts relating to Assessment Year 1988-89 or earlier and has no application to subsequent assessment years. The Tribunal also observed that, once the Revenue had accepted the debtor balances in earlier years and the assessee had produced ledger accounts and legal notices issued for recovery, it could not insist upon further proof of irrecoverability or question the genuineness of the debts without any contrary material. Accordingly, the disallowance of ₹37.02 lakh was deleted and the assessee’s appeal was allowed.

Cases Discussed:

• Anita Medical Systems Pvt. Ltd. Vs ITO (ITAT Mumbai)
• TRF Ltd. v. CIT (2010) 323 ITR 397 (SC)
• DCIT v. Oman International Bank (2006) 286 ITR 8 (Bom.)
• Pr. CIT v. Khyati Realtors Pvt. Ltd.

FULL TEXT OF THE ORDER OF ITAT MUMBAI

The present appeal filed by the assessee arises out of order dated 04.11.2025 passed by the NFAC, Delhi for Assessment Year 2023-24 on following grounds of appeal:

1. The Ld. Commissioner of Income Tax (Appeals) – NFAC erred in not appreciating the fact that the notice u/ s. 143(2) of the Income Tax Act, 1961, was issued without adhering to the CBDT Circular F. no. 225/ 157/ 2017/ HAI’ dated 23/06/2017, which is binding on the Assessing Officer. That the said notice is invalid, and the assessment framed pursuant thereto is void ab initio and ought to be quashed.

2. The Ld. Commissioner of Income Tax (Appeals)-NFAC erred in confirming the disallowance of bad debts u/ s. 36(1)(vii) of the Income Tax Act 1961 amounting to Rs. 37,01,707/ -, without appreciating the factual matrix of the case. That the addition made is illegal, unwarranted and ought to be deleted.

3. Without Prejudice to the above ground, the Ld. Commissioner of Income Tax (Appeals) NFAC erred in confirming the addition to the tune of Rs. 12,72,874/ – by erroneously applying the provisions of section 36(2)(iv) of the Income Tax Act, 1961 and ignoring that the said provision is not applicable to the relevant assessment year. That the addition made is completely illegal.

4. All of the above grounds are without prejudice to each other. The appellant craves leave to add, amend, alter, or delete any of the above grounds of appeal.

Brief Facts of the case is as under:

The assessee is a private limited company and filed return of income for the year under consideration. The case was selected for scrutiny under cash for the reason to verify the business expenses. It was observed by the Ld.AO that assessee has shown bad debt aggregating to Rs.37,01,707/- in its profit and loss account for the year under consideration. The Ld.AO accordingly issued notice under section 143(2) r.w.s. 142(1) calling upon assessee to furnish relevant documents including financial statement, audit reports and ledger accounts.

2.1. The assessee provided details of bad debts along with copies of legal notice in some of the cases. It was submitted that the amounts were written off in the books of accounts after fulfilling necessary criteria established by various judicial precedents including the decision of the Hon’ble Supreme Court in the case of TRF v. CIT reported in (2010) 323 ITR 397,wherein it is held that once a bad debt is written off in the books of accounts, it is an allowable deduction.

2.2. The Ld.AO however, disallowed the claim of the assessee by stating that assessee failed to establish the irrecoverablity and thus did not complied with the requirement under section 36(2) of the Act. It was also observed by the Ld.AO that legal actions were not pursued in all cases and some debts were not beyond the stipulated period as per section 36(2)(iv) of the Act.

Aggrieved by the order of the Ld.AO, the assessee filed appeal before the Ld.CIT(A).

3. The Ld.CIT(A) after considering the submissions of the assessee observed and held as under:

“6.1 I have carefully considered the assessment order passed under section 143(3) read with section 144B of the Income-tax Act, 1961, the grounds of appeal raised, the written submissions filed by the appellant, and the material available on record. The only issue involved in the present appeal pertains to the disallowance of Rs. 37,01,707/ – on account of bad debts written off during the year.

6.2 The brief facts of the case are that the appellant, a company engaged in the business of trading and distribution of medical equipment, filed its return of income declaring a loss of Rs. 2,68,04,440/ -. During scrutiny assessment, it was noticed thatthe appellant had claimed bad debts aggregating to Rs. 37,01,707/ -. On examination, the Assessing Officer observed that the appellant had failed to establish that the said debts had become bad in accordance with the provisions of section 36(1)(vii) read with section 36(2) of the Act. Accordingly, the Assessing Officer disallowed the same and assessed the total loss at Rs. 2,31,02,733/ -.

6.3 In present appeal, the appellant contended that the Assessing Officer erred in disallowing the claim of bad debts even though the amounts had been written off in the books of account. The appellant relied upon various judicial pronouncements including the decisions of the Hon’ble Supreme Court in TRF Ltd. v. CIT [(2010) 323 ITR 397 (SC)] and the Hon’ble Bombay High Court in DCIT v. Oman International Bank [(2006) 286 ITR 8 (Bom.)], arguing that once the debt is written off in the books, the deduction must be allowed without further proof of irrecoverability. The appellant also contended that the Assessing Officer wrongly interpreted section 36(2)(iv), which in its view does not apply to the current assessment year.

6.4 The submissions of the appellant have been duly considered. It is evident from the assessment records that the appellant failed to furnish any documentary evidence to establish the nature of each debt, the year in which the corresponding income was offered, or the steps taken for recovery. In several cases, the appellant merely produced ledger copies or internal records without supporting correspondence, confirmations, or evidence of write-off as irrecoverable in the regular course of business. Further, in certain cases, part payments were received from the concerned parties, and the balances were written off without demonstrating that recovery had become impossible. These facts clearly indicate that the claim of bad debts was not substantiated in accordance with section 36(1)(vii) read with section 36(2) of the Act.

The contention that a mere write-off entry is sufficient, irrespective of the facts. cannot be accepted in the appellant’s favour. The decision of the Hon’ble Supreme Court in TRF Ltd. (supra) does not dispense with the requirement that the debt must. genuinely arise in the course of business and must have been taken into account in computing income in earlier years. The appellant has not demonstrated that these conditions are satisfied. Mere book entries, unsupported by factual and documentary evidence, cannot convert doubtful recoveries or unverified balances into allowable bad debts.

The Assessing Officer, after detailed verification, has given specific observations in respect of each debtor, noting that the appellant failed to substantiate the claim with credible evidence such as correspondence, confirmation, or proof of cessation of business relationship. I concur with the Assessing Officer’s finding that the appellant has not proved the genuineness of the write-off or compliance with section 36(2). The reasoning adopted in the assessment order is in consonance with the statutory provisions and supported by the decision of the Hon’ble Supreme Court in Pr. CIT v. Khyati Realtors Pvt. Ltd. wherein it was held that mere write-off without demonstrating that the debt had actually become bad would not entitle the assessee to deduction.

6.5 In view of the above facts and circumstances, and considering that the appellant has failed to discharge the onus of proving that the debts written off had actually become bad or were taken into account in computing income of the earlier years, the disallowance of Rs. 37,01,707/- made by the Assessing Officer under section 36(1)(vii) read with section 36(2) is found to be justified and is accordingly confirmed.”

Aggrieved by the order of the Ld.CIT(A) assessee is an appeal before this Tribunal.

4. At the outset, the Ld.AR submitted that all the grounds raised in the present appeal relate to a solitary issue, namely, the disallowance of bad debts amounting to Rs.37,01,707/- claimed under section 36(1)(vii) of the Act.

4.1. The Ld.AR submitted that the assessee had written off the impugned bad debts in its books of account during the relevant previous year. It was contended that the corresponding amounts had already been taken into account while computing the income of the assessee in the preceding assessment years. Accordingly, it was submitted that the conditions prescribed under section 36(1)(vii) read with section 36(2) of the Act stood fully satisfied.

4.2. The Ld.AR further submitted that the Assessing Officer as well as the Ld.CIT(A) erred in invoking section 36(2)(iv) of the Act to deny the deduction on the ground that the debts had been written off beyond four years from the year in which the corresponding income had been offered to tax. It was contended that such an interpretation is legally untenable, as section 36(2)(iv) applies only to debts relating to the assessment year 1988-89 or any earlier assessment year and has no application to the impugned assessment year.

4.3. The Ld.AR submitted that, in support of the claim, the assessee had furnished the details of the four bad debts written off, the corresponding ledger accounts, and copies of the legal notices issued to the respective debtors for recovery of the outstanding amounts. According to the Ld.AR, these documents demonstrate that reasonable efforts had been made by the assessee to recover the dues and, upon failure of such recovery efforts, the debts were bona fide written off in the books of account.

4.4. Placing reliance on the decision of Hon’ble Supreme Court in TRF Ltd. v. CIT (supra) and the decision of Hon’ble Bombay High Court in DCIT v. Oman International Bank reported in (2006) 286 ITR 8, the Ld.AR submitted that after the amendment to section 36(1)(vii) with effect from 1/04/1989, it is no longer necessary for the assessee to establish that the debt has become irrecoverable. It was contended that once the debt is written off as irrecoverable in the books of account and the conditions of section 36(2) are fulfilled, the deduction is required to be allowed, and no further proof regarding the irrecoverability of the debt can be insisted upon.

4.3. On the contrary the Ld.DR placed reliance on the observations of the Ld.CIT(A) reproduced herein above.

We have perused the submissions advanced by both sides in the light of the records placed before us.

5. For claiming deduction under section 36(1)(vii) read with section 36(2) of the Act, the primary conditions that are required to be satisfied are that the debt or part thereof should be written off as irrecoverable in the books of account during the relevant previous year and that such debt should have either been taken into account in computing the income of the assessee of the relevant previous year or of an earlier previous year, or should represent money lent in the ordinary course of the business of banking or money-lending. In the present case, admittedly, the assessee is neither engaged in the business of banking nor in the business of money-lending. Therefore, the latter limb of section 36(2) has no application. It is, however, an undisputed fact that the debts claimed as bad debts had been taken into account in computing the income of the assessee in the preceding assessment years. Accordingly, the statutory requirement prescribed under section 36(2) stands duly satisfied.

5.1. We further find that the authorities below have denied the claim by invoking section 36(2)(iv) of the Act on the premise that the bad debts had been written off beyond four years from the year in which the corresponding income had been offered to tax. In our considered view, such an approach is legally unsustainable. Section 36(2)(iv) is a transitional provision applicable only to debts relating to the assessment year 1988-89 or any earlier assessment year and has no application to the year under consideration. After the amendment brought about by the Finance Act, 1987 with effect from 1 April 1989, section 36(1)(vii) merely requires that the bad debt should be written off as irrecoverable in the books of account of the assessee. It is no longer incumbent upon the assessee to establish that the debt has in fact become irrecoverable. This legal position stands authoritatively settled by Hon’ble Supreme Court in TRF Ltd. v. CIT (supra).

5.2. The Ld. CIT(A) has observed that mere book entries, even when supported by certain documentary evidence, cannot convert doubtful recoveries or unverified balances into allowable bad debts. We are unable to subscribe to the aforesaid reasoning. The assessee has placed on record the ledger accounts of the debtors, details of the amounts written off and copies of legal notices issued for recovery, evidencing that reasonable steps had been undertaken before the debts were written off. Once the statutory conditions prescribed under sections 36(1)(vii) and 36(2) stand fulfilled, no further requirement survives in law to establish the actual irrecoverability of the debt. The observations of the Ld. CIT(A), therefore, travel beyond the mandate of the statute as interpreted by the Hon’ble Supreme Court.

5.3. We also find merit in the submission of the Ld. AR that the opening balances of the debtor accounts for the year under consideration are nothing but the closing balances of the immediately preceding year. In the absence of any dispute regarding the genuineness of such balances in the earlier years, the Revenue cannot, while considering the claim of bad debts in the year of write-off, question the existence of the very debts without bringing any material on record to establish that the balances were fictitious or non-genuine. In the present case, no such material has been brought on record by the Revenue.

5.4. In view of the foregoing discussion, we hold that the assessee has duly satisfied the conditions prescribed under sections 36(1)(vii) and 36(2) of the Act. We thus direct the Ld.AO to allow the deduction of Rs.37,01,707/- claimed by the assessee towards bad debts.

Accordingly the grounds raised by the assessee stands allowed.

In the result, appeal filed by the Assessee stands allowed.

Order pronounced in the open court on 14.07.2026