The Supreme Court has ruled that provisioning for bad debt cannot be considered for deduction against the taxable income & Provision for bad and doubtful debts cannot be added to the ‘book profits’ for purposes of section 115JA because they merely represent the dimunition in the value of an asset and are not a provision for an unascertained liability.
The Supreme Court, in its recent ruling in the case between the Income Tax Department (hereafter referred to as revenue) and HCL Comnet Systems and Services, was of the view that bad debt was not a liability. It added that provisioning would only be eligible for deduction if it was for a liability and not an asset. Accounting norms define an asset as money that a company or an entity is entitled to receive from its investments or loans and advances. The norms specify liability as dues that a company has to pay in the future. Bad debt refers to those loans, where a party, which has lent money to another party, may see slim chances of retrieving the loan, necessitating the lender party to make a provision. According to banking experts, the decision will have a detrimental effect on banks and other lending institutions as loans and advances are their main business. They will end up taking a hit on their profits if they are not allowed to seek tax deduction on the provision they make for loans. While the Supreme Court’s decision pertains to a company following the Minimum Alternate Tax (MAT) under Section 115JA of the Income Tax Act, 1961, the court has clarified that the definition of bad debt remains the same even for companies filing returns under Section 349 of the Companies Act, said tax experts.
Under Section 115JA of MAT, which came into force in 1996-97, a company was required to pay a 30 per cent tax if its total income was less than 30 per cent of its book profit. In 2001, Section 115JA was replaced by Section 115JB, which mandates a company with a total income less than 7.5 per cent of its book profit to pay a 7.5 per cent tax. Under Section 349 of the Companies Act, a company pays normal tax. According to the judgement, a provision for liability will be eligible for deduction from the taxable income and not a provision for bad debt, which is an asset. “A provision for bad debt is not a provision for liability because if the assessee does not receive its dues, no liability could be fixed. Therefore any provision made towards irrecoverability of the debt cannot be said to be a provision for liability and thus cannot claim deduction from the taxable income,” the SC order said. The decision could have a wider implication on lending institutions and banks, where extending loans and advances are the normal course of business. Thus irrecoverability of dues against loans or debt will affect the normal course of business and may eventually affect depositors, whose money is ultimately lent. Experts said the order may have to be interpreted differently in case of financing institutions.
Note: The judgements in Echjay Forgings 251 ITR 15 (Bom), Amines & Plasticizers 296 ITR 727 (Gau) and Usha Martin 104 ITD 249 (Kol) (SB) stand impliedly approved while that in Beardsell 244 ITR 256 (Mad) stands impliedly overruled.