The Income Tax law allows a
taxpayer in business a choice to follow either the cash system or the
mercantile system of accounting. In case the taxpayer chooses to maintain the
accounts on mercantile basis, he has to account for credit sales as revenue
receipts. He is then faced with incidental losses of business in the form of
non-realisation of such credit sales, which he needs to write off as bad debts
to the profit and loss account. The amount of bad debts written off, which may
range from a few thousands to crores of rupees, is generally a soft target for
disallowance at the time of assessment with the tax authorities insisting upon
the taxpayer to prove that the ‘debt’ had actually become ‘bad’ during the year
in which the deduction is claimed. Specific provisions dealing with the
deductibility of bad debts in computing the income for tax purposes have been
enacted in the Indian Income-Tax Act by way of Section 36(1) (vii) and Section
36(2) of the Act. Section 36(1) (vii), as amended by the Direct Tax Laws
(Amendment) Act 1987 with effect from Assessment Year 1989-90, provides that
the amount of any bad debt or part thereof which is written off as
irrecoverable in the accounts of the taxpayer for the previous year would be
allowed as a deduction in computing the business income. As per the pre-amended
law, it was obligatory for the taxpayer to prove that the debt had actually
become bad in the year under consideration. This is subject to the provisions
of Section 36(2), which requires that the debt, which is claimed as bad, should
have been taken into account in computing the income of the taxpayer in that
year or in an earlier year. The CBDT Circular No 551 dated 23-01-1990 explained
the scope of the amendment. As per the circular, the old provisions which
required that the debt must be established to have become bad in the year under
consideration led to enormous litigation. Therefore, in order to eliminate the
disputes in the matter of determining the year in which a bad debt can be
allowed, the Section had been amended to provide that the claim for bad debt
will be allowed in the year in which such a bad debt has been written off as
irrecoverable in the accounts of the taxpayer. However, it is often experienced
that in spite of the above-referred crystal clear position in law, revenue
authorities still mandate the taxpayer to establish that the debt had actually
become bad in the year of claim. The special bench decision of the tribunal in
the case of Oman International Bank (2006) (100 ITD 285) (Mum) specifically
analysed in detail the position of law after the amendment and observed that it
is clear from the substitution that the intention of the legislature was to
leave it to the prudence of the business man to judge himself as to whether a
particular debt has become irrecoverable or not. If he writes it off as
irrecoverable in his accounts of the previous year, it is sufficient compliance
for claiming debt as bad debt under Section 36 (1) (vii) of the Act. This
position of law is also supported by the decisions of the Delhi High Court in
the cases of Morgan Securities and Credits P Ltd (2006) (292 ITR 339) and
Global Capital Ltd. (2007) (201 Taxation 210). In these cases, the Delhi High
Court has held that a conjoint reading of Section 36(2) and Section 36 (1)
(vii) makes it clear that the taxpayer would be entitled to a deduction of any
bad debt which has been written off as irrecoverable in its accounts for the
previous year. With the rendering of these decisions, the tax authorities will
hopefully stop impressing upon the taxpayer to prove that the debt had actually
become bad and allow the taxpayer the necessary deduction as long as he can
prove that it has been written off as irrecoverable in its books and had been
offered to tax in an earlier year. In case not, the issue can be strongly
challenged with the appellate authorities. – www.financialexpress.com