Principles for writing off bad debts u/s 36(2) as laid down by Courts-ITAT explains. Writing off & claiming deduction are two different things and it is not sweet will of the assessee.
ABCAUS Case Law Citation:
ABCAUS 1233 (2017) (05) ITAT
The appellant assessee was aggrieved by the order passed by the CIT(A) inter alia confirming disallowance of bad debts u/s 36 of Income Tax Act, 1961 (‘the Act’).
Assessment Year : 2007-08, 2008-09, 2009-10
Date/Month of Pronouncement: May, 2017
Important Case Laws Cited relied upon:
Nilofor I Singh
Brief Facts of the Case:
During the assessment proceedings, the Assessing Officer (‘the AO’) found that the assessee had claimed bad debts, including the bad debts pertaining to seven overseas parties, that it had claimed bad debts in respect AY.s 1994-95 to 1999-2000. The AO directed the assessee to furnish evidence to prove that these amounts were taken into account in computing its income in the relevant years. The AO was of the view that it was a legal requirement for claiming a deduction of some a bad debt u/s. 36 of the Act.
The assessee showed its inability to prove the fact by stating that records and accounts prior to the period of 01/04/2001 were no longer available with it. However, it furnished a copy of letter, dated 28/09/1999, written to the CIT seeking therein an extension for a period of six months a payment on account of certain export bills was not received till 28/09/1999.
The AO observed that the assessee had claimed deduction u/s 80HHC at the rate of 100%, that normally in export business a consignment was exported to of overseas party against opening of a letter of credit with the bank, that once payment against export was released by the bank the exporter would become aware of the fact of actual realisation against the particular sale, that if the amount was not received the assessee should have revised its claim u/s 80HHC because it had availed 100% deduction under that section on accrual basis, that the deduction u/s 80HHC was available to an assessee only on receipt of foreign exchange on actual basis.
The AO noted that the assessee could not furnish any evidence that the claim u/s 80HHC was revised for non-receipt of amount from the overseas parties and that it had offered the amount in question for taxation in the relevant year for non-fulfilment of condition u/s 80HHC. Further, the assessee had claimed impugned amounts as bad debts after 10 years and there was no bona fides and to claimed impugned amounts as bad debts after ten years and more.
The AO concluded that the claim for deduction on account of bad debts made by the assessee was not bonafide as no evidence was produced to establish the conditions laid down in section 36 and disallowed the bad debts.
Aggrieved by the order of the AO, the assessee preferred an appeal before the First Appellate Authority (FAA). Before CIT(A) it was argued that the assessee was entitled to claim bad debts according to its sweet will, that if the income was exempt by virtue of section 80HHC it could not be held that conditions laid down u/s. 36 were not fulfilled It was also stated that it was the discretion of the assessee to claim bad debts in the year in which it found them irrecoverable.
Contentions of the appellant assessee:
It was stated that as per section 36(1), no period had been prescribed for writing off of bad debts and the same could be claimed at any time. He relied upon few decisions also.
Contention of the Respondent Revenue:
It was argued that there was no evidence that the assessee had offered the disputed amounts for taxation in the earlier years and no justification was offered for claiming the bad debts after a period of roughly 10 years.
Observations made by the Tribunal:
The Tribunal observed the provisions of section 36(2) of the Act and also referred to several case laws on the subject as under:
Bombay High Court
After April 1, 1989, it is not necessary for the assessee to establish that the debt has in fact become irrecoverable and it would be sufficient if the bad debt is written off as irrecoverable in the accounts of the assessee. Sub-section (2) of section 36 of the Act, stipulates that a deduction for a bad debt or part thereof shall not be allowed unless (a) the debt 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 (b) the debt represents money lent in the ordinary course of business of banking or money lending which is carried on by the assessee.
Lal Wollen and Silk Mills Pvt. Ltd
Punjab & Haryana High Court
Before claiming deduction u/s.36(2)(i) of the Act, the following essential ingredients must be fulfilled : (i) the assessee ought to have depicted the debt as his income, during the previous year or any other earlier previous year, (ii) the assessee ought to have shown the debt as irrecoverable or as a bad debt, and ought to have written it off during the previous year, and (iii) the deduction for such a debt which has been written off, can be claimed in the previous year during which the assessee has written off the debt
Kerala Transport Company
Kerala High Court
We find no error in the reasoning of the authorities below. This is a case where the assessee’ s accounts were subjected to audit u/s.142(2A) of the Income-tax Act. In the report, it has been specifically stated that the goods had been dispatched by KSDC in the year 1983 and that if at all there was damage caused to the goods it was in the year 1983 and the matter was also settled later in January, 1986. However, the assessee claimed deduction for the AY. 1988-89 for a liability which had arisen in an earlier year. Further, it may also be noted that the goods never belonged to the assessee and the value of the goods was not credited in the assessee’ s books. It cannot, therefore, be said that there was a bad debt. Further, the amount was also not due from KSDCL to the assessee, but claimed as payable by the assessee to them. Therefore, it cannot be considered as bad debt due to the assessee within the meaning of section 36(2) of the Act
Kanchanjunga Advertising P Ltd.
Delhi High Court
It was open to the assessee to show that the debt had been taken into account in computing the income of the earlier year or years or of the year under consideration, even in the penalty proceedings.However, no material was brought by the assessee in the course of the penalty proceedings or in the course of the hearing of the appeal to show that the debt had been taken into account in the manner required by section 36(2)(i) of the Act.
Principles for writing off bad debts u/s 36(2) as laid down by Courts
The Tribunal summarised the principles laid down by Hon’ble Courts governing section 36(2) of the Act as under:
(i). There is nothing in section 36(2) to indicate that “assessee” refers to the original creditor and does not include a transferee or assignee of the debt.The condition which has been expressly incorporated in section 36 is that the amount of the debt or part thereof should have been taken into account in computing the income of the assessee in a previous year. The emphasis is not on the assessee being the original creditor but the taking into account of the debt in computing the income of the same business. If, in a given case, the income of a business is computed by taking into account a certain debt, it does not appear reasonable that, in the absence of any statutory prohibition, allowance on account of the debt having become bad should be denied only because the assessee’s identity has changed though the identity of the business continues.
(ii).Whether a debt had become bad or the point of time when it became bad are essentially questions of fact.
(iii). For disentitling an assessee for a deduction by way of bad debt as stipulated u/s.36(2)(i) of the Act, it will have to be shown that such claim was not taken into account in computing the income of the assessee of the previous year or on an earlier previous year, in which the amount of such bad debt was written off.
(iv). Merely because the money-lending business is subsequently discontinued, it cannot not be held that the assessee would be disentitled to claim such a deduction, though such claim as bad debt was, as a matter of fact, not in dispute.
(v). Under sub-section (2) of section 36, merely writing off any amount as a bad debt in the books of account would not ipso facto result in deducting the said sum while computing the taxable income in accordance with the provisions of the Act. The requirement of sub-section (2) is to be established even in a case where a sum is written off in the books of account. The enquiry into the condition required under sub-section (2) is still to be made but such inquiry is to be made only when the debt is written off in the books of account. It is a condition precedent before any claim for deduction on account of debt becoming bad is inquired into. In the absence of such entries made in the books of account, the process of examining the claim with reference to subsection (2) of section 36 would not commence.
(vi). There is a distinction between giving up a claim or waiver of a claim and a failure to recover the claim. In this case, an attempt was made to recover the same but failure to recover it would not amount to waiver or forgoing of the claim itself in view of the provisions contained in the Arbitration Act. If no collusion between the assessee and its debtor is established or found by any of the authorities irrecoverability could not be questioned and as such the irrecoverable part excluded in the award, may satisfy the ingredients of section 36(2) of the Act and can be treated bad debt for claiming deduction u/s.36(1)(vii).
(vii). If shares are not treated as stock-in-trade by an assessee but as investments in the books of account, the writing off made by the assessee of such shares cannot be claimed u/s.36 of the Act.
(viii). Bad debts should be written off when accounts are made up
(ix). If a business, along with its assets and liabilities, is transferred by one owner to another, the debt so transferred by one owner should be entitled to the same treatment in the hands of the successor. The recovery of the debt is a right transferred along with the numerous other rights comprising the subject of the transfer.It is merely an incident flowing from the transfer of the business, together with its assets and liabilities, from the previous owner to the transferee. It is a right which should, on a proper appreciation of all that is implied in the transfer of a business, be regarded as belonging to the new owner.
The Tribunal observed that the assessee had claimed bad debts for the sums outstanding from seven foreign parties and the bad debts pertained to AY. 1994-95 to 99-00. It was also noted that the assessee did not file any documentary evidence about offering the income that represented bad debts before the AO or the FAA.
It was observed that the bad debts claimed by the assessee were for those AY.s., when the export was 100% free and generally the export were made against LCs. The assesse had claimed deduction u/s.80HHC for the exports made. If it had not received money from overseas parties it should have revised the claim made by it. In absence of any documentary evidence to prove non realisation of exports proceeds claim made by it under the head bad debts cannot be accepted. Before becoming bad debt, it should be a debt.
The ITAT opined it is the duty of the assessee to support its claim by documentary evidences whenever it states that certain expenses were incurred for carrying out its normal business or whenever any claim for deduction/rebate/exemption is made. Onus is always on assessee to prove its claim.
It was observed that in the instant case, both the AO and CIT(A) had given a categorical finding of facts that no reliable evidence was produced before them to prove that disputed amounts have turned in to bad debts.
The ITAT observed that there was a long gap between the alleged sums becoming bad debts and their writing off. For more than a decade the assessee sat quietly and suddenly, in the year under appeal, claimed that certain sums should be treated as bad debts.
The ITAT rejected the contention that sweet-will of the assessee decides the issue of time of writing off of bad debts. It opined that ‘will’ of the Sovereign will prevail over the ‘will’ of its subjects. Writing off of bad debts and claiming deduction for it are two different steps and have different consequences. In first situation only assessee is involved. But, in second situation State also has stakes. Legislature in its wisdom has laid down certain conditions u/s 36 of the Act and those provisions govern the writing off of bad debts and not the sweet will of the assessees.
The Tribunal opined that the relevant provisions stipulate that for claiming deduction the assessee should establish that amount in question was not received. On the plea of non availability of the documents prior to AY. 2001-02, the Tribunal opined that nothing prevented assessee to claim deduction in the year 2001-02.
It was held that the genuineness of the claim made by the assessee had not been proved and therefore, the claims made by the assessee could not be allowed.