In a recent ruling Delhi High Court (HC) [226 CTR 468] in the case of CIT vs. Bonanza Portfolio (Taxpayer). The HC held that the Taxpayer, who is a share broker, is eligible to claim deduction for bad debts, pursuant to Section 36(1)(vii)of the Indian Tax Law (ITL). The ITL provides that a debt, which is written off in the books of account, is allowable as a bad debt, if the same had been taken into account in computing the income of the financial year in which the debt is written off or in any earlier financial year.
Background and facts of the case
- The Taxpayer, a share broker, purchased shares on its client’s behalf out of its own funds. The brokerage on the said transaction was offered for tax. As the client did not pay for the shares, the Taxpayer wrote off the amount as a bad debt and claimed deduction, pursuant to the ITL.
- As per the ITL, a taxpayer is entitled to claim deduction in respect of any amount of ‘debt or part thereof’ which is written off as bad debt in the books of account, provided that the debt, or part thereof, had been taken into account in the computation of income.
- The Tax Authority rejected the claim for the reason that only the brokerage component of the debt had been considered in computing the income.
- The first appellate authority confirmed the additions made by the Tax Authority. The Taxpayer appealed to the Income Tax Appellate Tribunal (ITAT).
- The ITAT ruled that the Taxpayer was entitled to the deduction as the stipulated conditions of the ITL, for claiming bad debts as a deduction, were satisfied.
Contentions of the Tax Authority
- The shares purchased by the Taxpayer on its client’s behalf (which were not delivered to the client due to non-payment) were the Taxpayer’s investment.
- The amount claimed as bad debt had not been taken into account in computing the income, as stipulated in the ITL.
Contentions of the Taxpayer
- As the transaction for the purchase of shares was made on its client’s behalf, it was not the Taxpayer’s investment.
- The debt due from the client also includes the amount of brokerage income, which is credited to profit and loss account (P&L) and offered for tax. Thus, the stipulated condition of the ITL that ‘debt or part thereof’ should have been taken in computing the income, is satisfied.
Ruling of the HC
The HC held that the Taxpayer was entitled to claim bad debts as a deduction, for the following reasons:
- The Taxpayer is engaged in share broking business. The shares were purchased on its client’s behalf. The brokerage charged for the purchase of shares had been offered for tax in the computation of income. Thus, the said shares were not the Taxpayer’s investment.
- The amount receivable from the client, on account of the shares purchased on its behalf, was a debt. As the Taxpayer had written off the said debt as irrecoverable in his accounts, it was a bad debt.
- The brokerage payable by the client was part of the debt due from the client. Hence, the stipulated condition of the ITL that ‘debt or part thereof’ should have been taken into account, was satisfied.
In the case of a share broker, the amount receivable from a client comprises the cost of shares purchased on its behalf and the brokerage charged to it. Thus, of the total amount of debt, only the brokerage amount is credited to P&L, which is taken into account in the computation of income. Therefore, there were doubts whether irrecoverable debt qualifies for deduction as a bad debt, under the ITL, in the case of a share broker.
The HC ruling clarifies that, in the case of a share broker, brokerage component of the debt credited to P&L satisfies the stipulated condition of the ITL that a ‘part of the debt’ had been taken into account in computing the income.
The HC also reiterated the view that, as per the ITL, deduction of bad debts is allowed upon its write off in the books of account; the Taxpayer is not required to prove that the debt has become bad.
Share brokers are highly exposed to loss on account of bad debts. The ruling would provide relief to the share brokers’ community in the matter of claiming deduction for bad debts.