Whether writing of bad debts in accounts sufficient to claim deduction u/s 36(1)(vii) of IT Act 1961

QUESTION

Whether writing of bad debts in accounts sufficient to claim deduction u/s 36(1)(vii) of the Income-tax Act, 1961?

APPLICABLE PROVISIONS

SECTION 36(1)(vii) - Other deductions

(1) The deductions provided for in the following clauses shall be allowed in respect of the matters dealt with therein, in computing the income referred to in section 28-

(vii) subject to the provisions of sub- section (2), the amount of any bad debt or part thereof which is written off as irrecoverable in the accounts of the assessee for the previous year:

Provided that in the case of a bank to which clause (viia) applies, the amount of the deduction relating to any such debt or part thereof shall be limited to the amount by which such debt or part thereof exceeds the credit balance in the provision for bad and doubtful debts account made under that clause.

SECTION 36(2) OF INCOME TAX ACT, 1961

In making any deduction for a bad debt or part thereof, the following provisions shall apply-

(i) no such deduction shall be allowed unless such debt or part thereof has been taken into account in computing the income of the assessee of the previous year in which the amount of such debt or part thereof is written off or of an earlier previous year, or represents money lent in the ordinary course of the business of banking or money- lending which is carried on by the assessee;

(ii) if the amount ultimately recovered on any such debt or part of debt is less than the difference between the debt or part and the amount so deducted, the deficiency shall be deductible in the previous year in which the ultimate recovery is made;

(iii) any such debt or part of debt may be deducted if it has already been written off as irrecoverable in the accounts of an earlier previous year being a previous year relevant to the assessment year commencing on the 1st day of April, 1988, or any earlier assessment year, but the Assessing Officer had not allowed it to be deducted on the ground that it had not been established to have become a bad debt in that year;

(iv) where any- such debt or part of debt is written off as irrecoverable in the accounts of the previous year being a previous year relevant to the assessment year commencing on the 1st day of April, 1988 , or any earlier assessment year and the Assessing Officer is satisfied that such debt or part became a bad debt in any earlier previous year not falling beyond a period of four previous years immediately preceding the previous year in which such debt or part is written off, the provisions of sub- section (6) of section 155 shall apply;

(v) where such debt or part of debt relates to advances made by a bank to which clause (viia) of sub- section (1) applies, no such deduction shall be allowed unless the bank has debited the amount of such debt or part of debt in that previous year to the provisions for bad and doubtful debts account made under that clause.The trust deeds containing such a provision should therefore not be refused recognition if the other conditions prescribed under the rules are satisfied.

(vi) Winding up of superannuation fund. - An approved superannuation fund cannot be wound up unless necessitated by the winding up or discontinuance of the employer' s trade or under- taking.

(vii) A superannuation fund where rules provide for pension benefits in the form of' annuity certain' is not entitled for approval, as the same is not covered under rule 89 of the Income- tax Rules.

(viii) The limit mentioned in rule 80 is in respect of the salary of each employee taken separately and also in respect of each year of his service taken separately.

(ix) Approval of superannuation funds which provide for payment of annuities to an employee or transfer of equitable interest to another approved superannuation fund when the employee leaves the services voluntarily before he attains the specified age of retirement may not be refused merely on the ground that he left the service voluntarily before he reached the age of normal retirement.

(x) The words' pay' and' salary' should be interpreted alike for all purposes of the PF Rules since the word' salary' has been defined in the Act and since contributions to the fund are also being made by the employee members on this basis, the word pays occurring in the Rules relating to withdrawals should also be interpreted to have the same meaning as salary.

(xi) Gratuity funds. - Initial contributions to approved gratuity funds may be permitted to be made in not more than five annual instalments commencing from the year in which the employee has been admitted to the benefits of the fund. An application for approval of Gratuity Fund may be made three years after the establishment of the gratuity fund. In order that the benefits of approval for the intervening period may not be denied to bona fide funds Commissioners may after considering all the relevant facts of the case accord approval with effect from the date from which it satisfies the conditions laid down in rule 3 of Part C of the Fourth Schedule.

(xii) Bad debts. - The suggestion of Chambers of Commerce and the Indian Banks Association that in the case of Banks the bad debts claimed should be automatically allowed in their entirety in the assessments of the banks was not acceptable. Where accounts are kept on mercantile basis, interest thereon is taxable irrespective of whether the interest is credited to suspense account or to interest account. The amount of such interest is therefore includible in the taxable income.

LET'S ANSWER ABOVE QUESTION ON THE BASIS OF THE DECISION OF THE DELHI HIGH COURT IN-
CIT (Appellant) vs. Samara India (P) Ltd. (Respondents)
DEHLI HIGH COURT
Dated: 10/05/2013

BRIEF FACTS

1. Assessee, a private limited company, is engaged in the business of dealing and servicing motor vehicles and had taken certain property on lease from three landowners for a period of three years renewable for two further periods of 3 years each.

2. The property consisted of a plot of land whereupon the lessors were required to build a warehouse cum workshop and hand over the same to the assessee.

3. In this regard, the assessee advanced certain sums to the lessors which were liable to be adjusted against monthly rent. The monthly rent for the property in question was agreed at Rs. 32,400/- and the assessee was entitled to adjust a sum of Rs. 17,400/- per month from the advance paid by the assessee to the lessors. In addition to the advance paid by the assessee to the lessors, the assessee also incurred substantial expenditure on the development and interiors of the property.

4. However, the workshop was demolished by the DDA on 01.06.2000 as the land which was subject matter of the lease agreement, in fact, belonged to the DDA and not the lessors.

5. The assessee, thereafter, filed a suit in HC being suit titled as Samara India Pvt. Ltd. v. UOI & Ors.: CS(OS) No.2467/2001. The said suit was still pending before HC for recovery of the sums advanced by the assesse to the lessors and the amount expended by the assessee on development and interiors of the property.

6. Assessee had written off a sum of Rs. 64,60,707/- as irrecoverable in the previous year, which was an aggregate of two components, namely, advance rent of Rs. 33,82,289/- paid by the assessee to the lessors and Rs. 30,78,418/- spent by the assessee on the property.

7. During assessment, AO had disallowed such write offs on the basis that the amount represented capital expenditure.

8. It was relevant to state that the genuineness of the expenditure was not doubted by the AO and it had disallowed the amount written off on the ground that the amount incurred by the assesse was on development and improvement of the leasehold property and was of an enduring nature and thus could not be considered as revenue expenditure.

9. The AO held that in view of the explanation to Section 32(1), capital expenditure incurred by an assessee in respect of a building not owned by him, was required to be treated in the same manner as if the expenditure had been incurred on a building owned by the assessee.

ORDER / JUDGEMENT

10. The Delhi High Court has held, following the decision of Supreme Court in T.R.F. Ltd. vs. CIT (2010), 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.

TRF Limited vs. CIT (Supreme Court)

The Supreme Court had to consider whether after the amendment to Section 36 (1) (vii) w.e.f. 1.4.1989, an assessee had to establish, as a matter of fact, that the debt advanced by the assessee had, in fact, become irrecoverable or whether writing off the debt as irrecoverable in the accounts was sufficient.

HELD deciding in favour of the assessee

(i) The position in law is well-settled. 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. When a bad debt occurs, 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.

(ii) As the AO has not examined whether the debt has, in fact, been written off in accounts of the assessee. the matter is remitted to the AO for de novo consideration of the above-mentioned aspect only and that too only to the extent of the write off.

11. The Supreme Court 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.