Advocate Akhilesh Kumar Sah
The Delhi High Court, has held in CIT vs. Samara India(P) Ltd. (2013) 216 Taxman 93 , following the decision of Supreme Court in T.R.F. Ltd. Vs. CIT(2010) 323 ITR 397:190 Taxman 391(SC), that for an assessee to claim deduction in relation to bad debts it is, now, no longer necessary to establish that debt had become irrecoverable and it is sufficient if assessee forms such an opinion and writes off debt as irrecoverable in its accounts.
The Supreme Court in T.R.F. Case (Supra) has held that 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.
Analysis Of Section 36(1)(vii):
Section 36(1) (vii) subject to its proviso, Explanation and subject to the provisions of section 36(2), allows deduction for the amount of any bad debt or part thereof which is written off as irrecoverable in the account of the for the previous year while computing total income of assessee for that previous year. Following basic conditions govern the grant of deduction in respect of bad debt under clause (vii) of section 36(1):
(i) the debt or loan should be in respect of business which is carried on by the assessee in the relevant accounting year;
(ii) the debt should have been taken into account in computing the income of the assessee for the accounting year or for an earlier accounting year or should represent money lent in the ordinary course of his business of banking or money-lending;
(iii) the amount should be written off as irrecoverable in the accounts of the assessee for that accounting year in which the claim for deduction is made for the first time [See Sarangpur Cotton Manufacturing Co. Ltd. v. CIT (1983) 143 ITR 166 (Guj)
Under section 36(1)(vii) deduction is not allowed in respect of doubtful debts. Question under section 10(2)(xi) of Income Tax Act, 1922 [corresponding to section 36(1) (vii) of Income tax Act, 1961] can arise only if there is a bad or doubtful debt. What is meant by debt in this connection was laid down by Rowlatt J. in Courtis v. J & G Oilfield Ltd. (1925) 9 Tax Cas 319 (At page 330) as follows:
“When the rule speaks of a bad debt it means a debt which is a debt that would have come into the balance sheet as a trading debt in the trade that is in question and that it is bad. It does not really mean any bad debt which, when it was a good debt, would not have come in to swell the profits”. In the section 10(2)(xi) of 1922 Act, a debt means something, more than a mere advance, It means something which is related to business or results from it. To be claimable as a bad doubtful debt it must first be shown as a proper debt [A.V. Thomas & Co. Ltd. v. CIT (1963) 48 ITR 67 (SC)]. The expression “bad and doubtful debt” is descriptive of a debt which cannot reasonably be expected to be realized. It is not sufficient for the assessee to say that he became pessimistic about the prospects of recovery of the debt in question. He must feel honestly convinced that the financial position of the debtor was so precarious and shaky that it would be impossible to collect any money from him.
There is no acid test to ascertain whether a debt has become bad and doubtful, and if so, when. The question is really one of fact depending upon congeries of facts and diverse circumstances bearing on the debtor’s pecuniary position, his commitments and obligations, and the natural apprehensions that would be caused in the minds of the creditors regarding recovery of their dues. It cannot be laid down as an inflexible rule of law that a waiver by a creditor of a portion of his debt would amount to proof positive of the debt, or any portion thereof, having become bad and doubtful [Devi Films Ltd. v. CIT (1963) 49 ITR 874 (Mad)].
A debt may be either written off as irrecoverable in the individual accounts of the debtor in the assessee’s books or by making appropriate entries in the profit & loss account [CIT V. Srivinayaga Pictures (1986) 161 ITR 65 (Mad)]. Once the assessee has posted entries in the profit and loss account and corresponding entries are posted in the Bad Debt Reserve Account, that would be sufficient compliance with the provisions of the statutory requirement for writing off as irrecoverable the concerned debt in the books of the assessee. When a businessman writes off an amount, there is primafacie evidence that the amount is irrecoverable. Undoubtedly, the department can rebut the prima facie inference by drawing attention to circumstances or by leading some evidence to suggest that the position taken up by the assessee was not correct [Sarangpur Cotton Manufacturing Co. Ltd. v. CIT (supra) . Under section 10(2)(xi) of the Income Tax Act, 1922) [which corresponds to section 36 (1) (vii) of the Income Tax Act, 1961] a debt was only allowable when it was a debt and arose out of and as an incident to the trade. Except in money-lending trade, debts could only be so described if they were due from customers for goods supplied or loans to constituents or transactions of a similar kind. In every case the test was; was the debt due as an incident to the business? If it was not of that character it would be capital loss [CIT v. Abdullabhai AbdulKadar (1961) 41 ITR 545 (SC).
Also, a statute barred debt is not necessarily bad neither is a debt which is not statute barred necessarily good [Kantilal Chimanlal Shah v. CIT (1954) 26 ITR 303 (Bom). The practice of regarding a debt as prima facie bad when it is barred by limitation and no longer recoverable is not, however, unreasonable but this presumption is rebuttable according to the circumstances of the case [Bansidar Poddar v. CIT (1934) 2 ITR 20 (Pat)].
Whether debt turned bad is question of fact?
In Essen Private Ltd. v. CIT (1967) 65 ITR 625 (SC) the appellant, which carried on business as managing agent of several concerns, pursuant to the agreement with one of the companies managed by it, advanced large sums of moneys amounting to Rs. 3,40,956 to the managed company from time to time on current account. It also guaranteed along with a director of the managed-company a loan of Rs. 2 lakh obtained from a bank. The managed company failed in its business and upon the bank pressing for payment, the appellant, in accordance with its guarantee, paid the bank Rs. 81,593 and out of the goods of the managed-company released by the bank it realized Rs. 44,905. Even thereafter the managed-company did not improve and there was no prospect of receiving any moneys from it. The appellant wrote off the sum of Rs. 4,03,203 in its book and claimed allowances of that sum as a bad debt. The Tribunal found that the advances to the managed-company were in pursuance of its objects and were made in the course of its business and allowed the claim. On a reference of the question whether the debt was incurred in the course of its business so as to make it a loss deductible under section 10(2)(xi) of the Indian Income Tax Act, 1922 [Corresponding to section 36(1)(vii) of Income Tax Act, 1961], the High Court held that the appellant acquired the managing agency on condition of giving loans and making advances and the loss arising out of such advances was only a capital loss. On appeal to the Supreme Court it held by reversing the decision of the High Court that there was proper material before the Appellate Tribunal in support of its finding that the debt was incurred in the course of its business so as to make it deductible under section 10(2)(xi) and that the High Court exceeded its jurisdiction in traversing into findings of fact reached by the Appellate Tribunals. See Also CIT v. Ram Nand Ram Kishan (1975) 101 ITR 98 (All). InBank of Bihar Ltd. v. CIT (1962) 45 ITR 427 (SC),the Supreme Court made the following observations (at page 429) :
“The question whether a debt is a bad one of fact, and if there is some evidence to justify the conclusion, it is not open to the High Court in a reference to re-appreciate the evidence.”.
Burden of proof:
Before amendment of section 36(1)(vii) and 36(2) of the Income Tax Act, 1961 [by the Direct Tax Laws (Amendment) Act, 1987 (part III)], it was necessary for an assessee to establish that the debt became bad in the previous year in question. Now bad debts are straightway allowed in the year of write off [See CBDT Circular No. 551 dated 23-1-1990].
At present, for claiming deduction of an amount as irrecoverable as per terms of section 36(1)(vii) the assessee has to actually write off in the accounts that amount (which has been claimed as bad debt) in the previous year (in question).Also the debt claimed as bad debt should be related to the business of the assessee [See ClT v. Birla Bros. (P) ltd. (1970) 77 ITR 751 (SC)]. A bad debt presupposes the existence of a debt [National Petroleum Co. Ltd. vs. ClT (1945) 13 ITR 336(Bom)]. Bad debts are legacies of years that have gone before but they become bad debt which have to be wiped out in a particular year when all hopes of their recovery are gone [Hulasilal Ramdayal, In re (1941) 9 1TR 635 (All)]. The word “bad” used in conjunction with the word “debt” means worthless. Therefore, a “bad debt” is a worthless debt [CIT vs. Coates of India Ltd. (1998) 6 DTC 224(Cal-HC) : (1998) 232 ITR 324 (Cal)].
Where the assessee wrote off the debt as bad the same was held to be allowable [CIT vs. IFCI venture capital Funds Ltd.] (2008) 202 Taxation 329 (Del)]. It was held in Jethabhai Hirji and Jethabhai Ramdas v. ClT (1979) 120 ITR 792 (Bom)that it is not necessary for the assessee to show that he has failed to recover that debt despite taking legal action. What he is required to show, as held in ClT v. Dunlop India Ltd. (1994) 2091TR987 (Cal), that having regard to the facts and circumstances of the case a bonafide assessment has been made by the assessee to the effect that the realization of the debt is not possible. Where the assessee claims deduction of an amount as a bad debt but the Tribunal, basing its decision on the facts, allows it as a loss incidental to the, assessee’s business, the Tribunal’s conclusion does not give rise to a question of law [CIT v. Hindustan Times Ltd. (1988) 169 ITR 1 (Del)].Whether a debt is wholly or partly and to what extent, bad or irrecoverable is in every case, and whether the debtor is a human being or a joint-stock company or other entity, a question of fact to be decided by the appropriate Tribunal upon a consideration of the relevant facts of the case[F.E. Dinshaw vs. ClT (1934) 21TR 319 (PC)].
It cannot be said that merely because a debtor has become insolvent, therefore, the debt was irrecoverable or to what extent it was so irrecoverable. This would be a matter which would turn on a variety circumstances which would include the amount of property at the disposal of the insolvent, the skill with which the sale was conducted, which in the case of official auctions might be presumed, and on circumstances which nobody could entirely foreseen in the future, such as the presence of bidders and the amount of property which could be attached and sold in insolvency proceedings which again may be a varying factor [Deokinandan & Sons v. CIT (1941) 9 ITR 202 (Lah)]. Therefore, whether a debt could be considered to be bad debt or not, must depend on the facts and circumstances of each case. Also the question must be looked at from the practical point of view whether the assessee considered that from the business point of view the debt had become irrecoverable and as such bad [V.N. Rajan & Co. v CIT (1983) 142 ITR 545 (Cal)].
It was held in Hong Kong and Shanghai Banking Corporation Ltd. Vs. CIT (1955) 28 ITR 199 (Cal)that the expression “bad and doubtful debts. in section 10(2)(xi) [which corresponds to section 36(1)(vii)] does not contemplate two kinds of debts, but refers to the same class of debt namely, a debt which is bad and doubtful, i.e., a debt, of which the chance of recovery is nil. A doubtful debt does not mean a debt which cannot be held to be irrecoverable, such a debt may also be held to be irrecoverable wholly or in part it was, held inDunlop & Co. Ltd. v. CEPT (1954) 25 ITR 276 (Cal),that if a debt has actually been written off by the assessee in his books as irrecoverable in a particular year, then the Income Tax Officer, in making an allowance in respect of bad debt for that year, must not allow anything in excess of the amount which the assessee himself has written off.
The principal that expiry of period of limitation prescribed under the Limitation Act could not extinguish the debt but it would only prevent the creditor from enforcing the debt has been well-settled. There may be circumstances which may enable the creditor to come with a proceeding for enforcement of debt even after the expiry of the normal period of limitation as provided in the Limitation Act. Mere entry in the books of account of the debtor made unilaterally without any act on the part of the creditor will not enable the debtor to say that the liability has come to an end (CIT vs. Sugauli Sugar Works (P) Ltd. (1999) 149 Taxation 61 (SC).
Debts which have become bad in the course of trade of the assessee are allowable in the year of write-off under Income Tax Act.