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December 3, 2020

It is not necessary for the assessee to establish that bad debts have become irrecoverable to claim deduction

by CA Shivam Jaiswal in Income Tax

It is not necessary for the assessee to establish that bad debts have become irrecoverable to claim deduction

An entity may not be able to recover its balances outstanding in respect of certain receivables. In accountancy such receivables are referred as Irrecoverable Debts or Bad Debts. Bad debts could arise for a number of reasons such as customer going bankrupt, trade dispute or fraud. Every time an entity realizes that it unlikely to recover its debt from a receivable, it must ‘write off’ the bad debt from its books. This ensures that the entity’s assets (i.e. receivables) are not stated above the amount it can reasonably expect to recover which is in line with the concept of prudence. However, are such bad debts allowed as a deduction while computing business income under the provisions of Income Tax?

While computing the profit and gains from business or profession, there are certain expenditures which are disallowed. This means that the income tax department does not allow the benefit of such expenditures and the assesses are required to pay taxes on such expenditures by adding it back to the net profits. Section 36 of the Income Tax Act illustrates various expenses that are allowed as a deduction from the income earned from business and profession. Let us look at what expenses are covered under this section. Can irrevocable bad debts be allowed as a deduction then?

Let us refer to the case of T. R. F. Ltd. v. CIT (2010), where the main issue under consideration was whether the assessee has to establish that the debt has become irrecoverable to claim deduction under section 36(1)(vii) or a mere write off of such debt in the books of Account is sufficient.

Facts of the Case:

The assessee had claimed a deduction of bad debt under section 36(1)(vii). The ITO disallowed the claim of bad debts on the ground that the assessee was unable to establish that the facts that the debt had become irrecoverable.

Observations of the Supreme Court (SC)

  • Prior to 1st April, 1989, every assessee had to establish, as a matter of fact, that the debt advanced by the assessee had, in fact, become irrecoverable.
  • That position got altered by deletion of the word “established”, which earlier existed in Section 36(1)(vii) of the Income Tax Act, 1961
  • Prior to April 1989, Section 36(1)(vii) stated that, the amount of any debt, or part thereof, which was established to have become a bad debt in the previous year shall be allowed in respect of the matters dealt with therein, in computing the income referred to in section 28
  • Post April 1989, Section 36(1)(vii) stated that, the amount of any bad debt or part thereof which was written off as irrecoverable in the accounts of the assessee for the previous year shall be allowed in respect of the matters dealt with therein, in computing the income referred to in section 28
  • This position in law is well-settled.
  • After 1st April, 1989, it was not necessary for the assessee to establish that the debt, in fact, became irrecoverable.
  • It was enough if the bad debt was written off as irrecoverable in the accounts of the assessee.
  • However, in the present case, the Assessing Officer had not examined whether the debt had, in fact, been written off in accounts of the assessee.
  • When bad debt occurred, the bad debt account is debited and the customer’s account is credited, thus, closing the account of the customer.
  • In the case of Companies, the provision is deducted from Sundry Debtors.
  • As stated above, the Assessing Officer had not examined whether, in fact, the bad debt or part thereof was written off in the accounts of the assessee.
  • This exercise was not undertaken by the Assessing Officer.
  • Hence, the matter was remitted to the Assessing Officer for de novo consideration of the above-mentioned aspect only and that too only to the extent of the write off.

In conclusion, subsequent to 1-4-1989 it is not necessary for the assessee to establish that the debts have become irrecoverable. It is sufficient if they were written off as irrecoverable in the accounts of the assessee.

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