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Quiz for the week (14 Jul 2025): Smith a resident individual was a partner of a firm by name Lamb & Co which was dissolved on 31st March, 2022 and he took over all the assets and liabilities of the firm w.e.f. 1st April,2022 and continued the same business. However, he discontinued the business w.e.f. 1st July,2024 and claimed Rs.3 lakhs due from the supplies made by the erstwhile firm as bad debt. In August, 2024, he had sold the only plant of the business for Rs.5 lakhs plus GST @18% to Xavier on credit basis who became insolvent subsequently and could recover only Rs.1 lakh from him. Discuss the validity of deduction claimed for the assessment year 2025-26. Best Answer : Section 36(1)(vii) says that 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 is eligible for deduction. Section 36(2) provides the conditions for allowance of bad debt. It is deductible where it is taken into account in computing the income of the assessee of the previous year in which it 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. If the amount ultimately recovered on any such debt or part thereof is less than the 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. There are two claims made by Smith which is given in the query. The first one is about the debt representing amount due from a customer who had to pay Rs.3 lakhs to him since Smith has taken over the business of the firm. The claim of bad debt is deductible since Smith is the successor to the business of the firm. However, if the business was discontinued by him after takeover, then the claim of bad debt is not permissible. Smith had discontinued the business w.e.f. 1.7.2024 and hence, he can claim bad debt of the erstwhile firm in the previous year 2024-25 and it is admissible. Refer CIT v. Jagat Ram Om Prakash 1979 TaxPub(DT) 0486 (P&H-HC) / CIT v. Veerbhadra Rao 1985 TaxPub(DT) 1300 (SC). The apex court in Veerbhadra Rao’s case (supra) referred as under: "It seems to us that even if the debt had been taken into account in computing the income of the predecessor-firm only and had subsequently been written off as irrecoverable in the accounts of the assessee, the asses-see would still have been entitled to a deduction of the amount written off as a bad debt. It is not imperative that the assessee referred to in sub-clause (a) must necessarily mean the identical assessee referred to in sub-clause (b). A successor to the pertinent interest of a previous assessee would be covered within the terms of sub-clause (b). The successor assessee, in effect, steps into the shoes of his predecessor". As regards sale of plant owned by Smith sold for Rs.5 lakhs, it is not in the regular course of business and it is a capital loss. Only a debt which is ‘revenue’ in nature could be claimed as bad debt. Therefore, Smith cannot claim Rs.5 lakhs as bad debt for the plant sold.

Quiz for the week (14 Jul 2025):

Smith a resident individual was a partner of a firm by name Lamb & Co which was dissolved on 31st March, 2022 and he took over all the assets and liabilities of the firm w.e.f. 1st April,2022 and continued the same business. However, he discontinued the business w.e.f. 1st July,2024 and claimed Rs.3 lakhs due from the supplies made by the erstwhile firm as bad debt. In August, 2024, he had sold the only plant of the business for Rs.5 lakhs plus GST @18% to Xavier on credit basis who became insolvent subsequently and could recover only Rs.1 lakh from him. Discuss the validity of deduction claimed for the assessment year 2025-26.

Best Answer :

Section 36(1)(vii) says that 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 is eligible for deduction. Section 36(2) provides the conditions for allowance of bad debt. It is deductible where it is taken into account in computing the income of the assessee of the previous year in which it 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. If the amount ultimately recovered on any such debt or part thereof is less than the 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.

There are two claims made by Smith which is given in the query. The first one is about the debt representing amount due from a customer who had to pay Rs.3 lakhs to him since Smith has taken over the business of the firm. The claim of bad debt is deductible since Smith is the successor to the business of the firm. However, if the business was discontinued by him after takeover, then the claim of bad debt is not permissible. Smith had discontinued the business w.e.f. 1.7.2024 and hence, he can claim bad debt of the erstwhile firm in the previous year 2024-25 and it is admissible. Refer CIT v. Jagat Ram Om Prakash 1979 TaxPub(DT) 0486 (P&H-HC) / CIT v. Veerbhadra Rao 1985 TaxPub(DT) 1300 (SC).

The apex court in Veerbhadra Rao’s case (supra) referred as under:

"It seems to us that even if the debt had been taken into account in computing the income of the predecessor-firm only and had subsequently been written off as irrecoverable in the accounts of the assessee, the asses-see would still have been entitled to a deduction of the amount written off as a bad debt. It is not imperative that the assessee referred to in sub-clause (a) must necessarily mean the identical assessee referred to in sub-clause (b). A successor to the pertinent interest of a previous assessee would be covered within the terms of sub-clause (b). The successor assessee, in effect, steps into the shoes of his predecessor".

As regards sale of plant owned by Smith sold for Rs.5 lakhs, it is not in the regular course of business and it is a capital loss. Only a debt which is ‘revenue’ in nature could be claimed as bad debt. Therefore, Smith cannot claim Rs.5 lakhs as bad debt for the plant sold.