Unrecoverable out of pocket expenses allowable u/s 37(1) as business loss though not admissible as bad debts written off u/s s 36(1)(vii) – ITAT

Unrecoverable out of pocket expenses allowable u/s 37(1) as business loss though not admissible as bad debts written off u/s s 36(1)(vii) – ITAT

ABCAUS Case Law Citation:
973 2016 (07) ITAT
Assessment Year: 2010-11
Date/Month of Judgment: July 2016

Brief Facts of the Case:
The assessee firm was engaged in rendering legal services including corporate services for incorporation of companies. During the course of the scrutiny assessment u/s 143(3) of the Income-tax Act, 1961 the AO noticed that the assessee had claimed out of pocket expense incurred on incorporation of company on behalf of a client as bad debts u/s 36(1)(vii). The Assessing Officer disallowed the expense on the basis that there was nothing on record to show that these debtors were financially not in a position to pay the debts. 

On appeal, Commissioner of Income-tax (Appeals) confirmed the additions on the ground that the assessee failed to show that the debt in question formed part of the income in relevant assessment year. He further opined that the as incorporation of company was not a trading debt of the appellant the write off did not qualify as a debt as it was not incidental to the business carried on by the appellant. The business/profession of the appellant was providing legal advice and not making payments on behalf of the clients. 

Observation made by ITAT:

The ITAT noted that the out of pocket expenses (ROC fees, professional fees etc ) had been incurred by the assessee which were reimbursable from the client. The assessee firm was engaged in rendering legal services including corporate services for incorporation of companies and out of pocket expenses incurred were incidental to the carrying on the business of the assessee. The assessee written off the expenses as the likelihood of the recovery of the expenses became remote as the partner who introduced the client, retired from the firm and according to the assessee, it was not commercially viable to claim expenses through litigation.

The Tribunal observed that though the expenses written off could not be allowed as bad debt written off under section 36(1)(vii), however, the claim of the assessee as business loss, if justified, was allowable. The Tribunal placed reliance on the judgment of Bombay High Court in the case of Harshad J Choksi V. CIT 349 ITR 250 (Bom) , wherein it was held as under:

“11. On the basis of the aforesaid decisions, it can be concluded that even if the deduction is not allowable as bad debts, the Tribunal ought to have considered the assessee’s claim for deduction as business loss. This is particularly so as there is no bar in claiming a loss as a business loss, if the same is incidental to carrying on of a business. The fact that condition of bad debts were not satisfied by the assessee would not prevent him from claiming deduction as a business loss incurred in the course of carrying on business as share broker.

12. In fact this court in the matter of Commissioner of Income Tax v. R.B. Rungta& Co. (Supra) upheld the finding of the Tribunal that the loss could be allowed on general principles governing computation of profits under Section 10 of the Indian Income Tax Act, 1922 which is similar/identical to Section 28 of the Act. The revenue in that case urged that the assessee having claimed deduction as a bad debt the benefit of the general principle of law that all expenditure incurred in carrying on the business must be deducted to arrive at a profit cannot be extended. This submission was negatived by this court and it was held that even where the debt is not held to be allowable as bad debts yet the same would be allowable as a deduction as a revenue loss in computing profits of the business under Section 10(1) of the Indian Income Tax Act, 1922.”

Unrecoverable out of pocket expenses

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