“Assessee’s Right to Write Off Bad Debts Affirmed by Court”

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Case Name

Commissioner of Income Tax vs. Vivek Engineering & Casting Ltd. (High Court of Calcutta)

ITA No. 128 of 2006

Date: 11th January 2016

Key Takeaways

• The court confirmed that an assessee is not required to prove a debt became bad in the previous year to claim it as a bad debt.
• The decision emphasized the importance of the assessee’s honest judgment in determining the recoverability of a debt.
• The ruling clarified the application of Section 36(1)(vii) (of Income Tax Act, 1961) and Section 36(2) (of Income Tax Act, 1961), reinforcing that mere writing off in the accounts is sufficient for claiming a bad debt deduction.

Issue

Can an assessee claim a deduction for bad debts without proving the debt became bad in the previous year, based solely on their honest judgment of its irrecoverability?

Facts

Vivek Engineering & Casting Ltd. claimed a deduction for a bad debt amounting to Rs. 2.70 crores, which was not shown as income in previous years. The assessee argued that the debt was irrecoverable, while the Revenue contended that the conditions for claiming a bad debt under the Income Tax Act were not met.

Arguments

• Assessee’s Argument: The assessee maintained that they had the right to write off the debt based on their honest belief that it was irrecoverable, as per the amended Section 36(1)(vii) (of Income Tax Act, 1961).
• Revenue’s Argument: The Revenue argued that the debt was not shown as income in previous years and that the assessee was not engaged in the money lending business, thus not fulfilling the conditions for a bad debt deduction.

Key Legal Precedents

• Girish Bhagwat Prasad (256 ITR 770): The court referenced this case to support the view that writing off a debt in the accounts is sufficient for claiming a deduction.
• Coates of India Ltd. (232 ITR 324): This case was cited to emphasize that the assessee’s judgment on the irrecoverability of a debt must be honest, not merely convenient.

Judgement

The court ruled in favor of Vivek Engineering & Casting Ltd., affirming that the assessee’s honest judgment and the act of writing off the debt in their accounts were sufficient to claim a deduction under Section 36(1)(vii) (of Income Tax Act, 1961). The court dismissed the Revenue’s appeal, reinforcing the assessee’s right to determine the recoverability of debts.

FAQs

Q: What does this judgment mean for other businesses?

A: It clarifies that businesses can claim bad debt deductions based on their honest assessment of recoverability, without needing to prove the debt became bad in the previous year.

Q: Does this mean any debt can be written off?

A: No, the judgment emphasizes that the decision to write off a debt must be based on an honest judgment, not convenience.

Q: How does this affect the application of Section 36(1)(vii) (of Income Tax Act, 1961)?

A: The judgment reinforces that writing off a debt in the accounts is sufficient for claiming a deduction, aligning with the provisions of Section 36(1)(vii) (of Income Tax Act, 1961) as amended.

The appeal was admitted on 16th May, 2006. The questions proposed by the appellant and admitted are as follows:-

“1. Whether, on the facts and in the circumstances of the case, the ld. Tribunal has erred in upholding the order of the Commissioner of Income-tax (Appeals) without considering that the conduct of the assessee towards claiming bad debt was not bonafide and honest as the amount shown as bad debt was never shown as income in the preceeding years and the money was not held as stock in trade as the assessee was not engaged in the business of money lending ?

2. Whether on the facts and in the circumstances of the case, the ld. Tribunal has erred in deleting the disallowance made by the Assessing Officer without considering the conditions stipulated under section 36(i)(vii) (of Income Tax Act, 1961) read with section 36(2) (of Income Tax Act, 1961) and only concentrating on the fact that the loan has become irrecoverable irrespective of the basis of legal requirement for allowing any debt as bad debt ?”

The assessee had shown and/or claimed bad debt in a sum of Rs.2,74,58,660/- out of which Rs.2,70,00,000/- related to the principal amount of loan advanced to one M/s. Dinesh Kumar Singhania and Company. The balance amount of Rs.4,58,660/- was on account of interest. The assessing officer allowed the claim for bad debt insofar as the interest part was concerned amounting to a sum of Rs.4,58,660/- but the claim with regard to bad debt for the principal sum of Rs.2.70 crores was not allowed for the following reasons:-

“(a) The amount of Rs.2,70,00,000/- was not shown as income earlier or even the relevant previous year.

(b) As pointed out earlier the business of the assessee is manufacturing and export goods of cast iron products, C.I. boring. The assessee company is not a banking company and it is also not engaged in the money lending business where the money is held as stock-in-trade.”

The assessee took up the matter before the C.I.T., Appeal. The appeal was allowed by the C.I.T.(A) holding, inter alia, as follows:-

“11. As per Section 36(1)(vii) (of Income Tax Act, 1961) read with Section 36(2) (of Income Tax Act, 1961), bad debt is allowable as deduction if the four conditions therein are fulfilled (i) the debt or loan should be in respect of business carried on by the assessee, (ii) the debt should represent money lent in the Ordinary course of money lending or banking or should have been taken into account in computing the income of the assessee of the accounting year or of an earlier accounting year, (iii) the amount of debt or loan should have become bad and (iv) 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. Considering the facts of the case, I find the appellant company has fulfilled all the conditions laid down in the aforesaid sections. In fact, the A.O. has allowed the interest portion on such loan amounting to Rs.458660/- as bad debt during the relevant previous year. From the Audited accounts of the year it is apparently clear and evident that the appellant company has been carrying on the business of lending and investment and has also earned huge interest on such money lending business as indicated in the above figures. The amendment of Section 36(1)(vii) (of Income Tax Act, 1961) by Finance Act w.e.f. 01-04-89, the assessee is not required to establish that the debt has become bad in the previous year and mere written off of the bad debt in the accounts is sufficient as held by Gujarat High Court in the case of Girish Bhagwat Prasad reported in 256 ITR 770. . .”

The Revenue took the matter to the Tribunal unsuccessfully. The learned Tribunal in dismissing the appeal preferred by the Revenue held, inter alia, as follows:-

“. . .From the details placed at page 38 that more than 50% of the fund is invested in money lending business in all the years right from 1996 – 97 to 2003 – 04. On perusal of papers filed in the paper book at pages 41 to 96, we find that the assessee has received interest and the same has been declared in the return from assessment years 1997 – 98 to 2003 – 04 and the same has been assessed as business income. Thus, it is clear from the facts brought on record that the assessee was also doing money lending business apart from business of manufacturing of iron and steel items. Thus, the basic reason on which the Assessing Officer has disallowed the claim of bad debt fails.

11. Regarding the observation of the Assessing Officer that the debt was already bad in earlier year. We agree with the submission of the Ld. Counsel on this issue that this is not relevant for allowing the claim after the amendment of section in the provisions of the Act with effect from 01-04-89. Hon’ble Gujarat High Court in the case of CIT – Vs – Girish Bhagwatprasad (2002) 256 ITR 772 (Guj.) has held that “Under the provisions of section 36(1)(vii) (of Income Tax Act, 1961) as in force from April, 1989, all that the assessee had to show was that the bad debt was written off as irrecoverable. It is upto the assessee to be satisfied that the debt is not recoverable and once such satisfaction is reached and the amount is written off in the account, the same is to be allowed. Hon’ble Calcutta High Court in the case of CIT –Vs – Coates of India Ltd. (1998) 232 ITR 324 (Cal.) has held that “In order to claim deduction under Section 36(1)(vii) (of Income Tax Act, 1961), as it stood at the relevant time, the assessee is required to show that, on the facts and circumstances pertaining to a particular debt, he has taken an honest judgment that the said debt has become a bad debt. If the judgment is an honest judgment and not a convenient judgment, then the Department would not be able to insist on demonstrative or infallible proof.”

Challenging the order of the learned Tribunal, the aforesaid appeal was preferred.

Mrs. Gutgutia, learned Advocate appearing for the Revenue submitted that there is nothing on the record to show that the assessee is a banking company.

Alternatively, she submitted that the assessee has not disclosed any money lending licence.

Lastly she submitted that the conditions were not fulfilled by the assessee in order to claim deduction under Section 36(1)(vii) (of Income Tax Act, 1961) which reads as follows:-

“36.(1)(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].

This submission is incorrect because without such writing off in the previous year, the matter could not have come up before the assessing officer. She then submitted that the amount remained unrecovered during the years prior to the previous year. At that time the assessee did not treat it as bad debt. To that, the answer is that the assessee is entitled not to treat the amount as bad debt so long as he entertains a belief that the money can be recovered. Law does not require him to treat any amount as bad debt once he becomes apprehensive about recovery thereof. This Court held in Coates of India (Supra) that it has to be an honest judgment of the assessee and not a convenient one.

The next submission advanced by her is that the money could not have been written off unless the money represents the money lent in the ordinary course of business of banking or money lending which is carried on by the assessee. She submitted that the assessee has not disclosed any money lending licence or any document to show that the assessee is engaged in the business of banking.

The assessee, according to her, has also not shown that money lending is carried on by the assessee. This submission made by Mrs. Gutgutia is altogether unmeritorious because the learned Tribunal as the last fact finding authority has come to the conclusion that more than 50% of the capital of the assessee is deployed in money lending. Therefore, the fact that the assessee is in the money lending business cannot be doubted. All the points advanced by Mrs.Gutgutia have thus been rejected. In the result, the questions formulated at the time of admission of the appeal are both answered in the negative.

(GIRISH CHANDRA GUPTA, J.)

(ASHA ARORA, J.)