The Tax Publishers

Income Tax--Business Deduction

Advances Made Not in Course of Business Cannot be Claimed as Bad Debt or Business Expenditure

CA. Manoj Gupta

Recently the Supreme Court in PCIT v. Khyati Realtors Private Limited dtd. 25-08-2022 [2022 TaxPub(DT) 5867 (SC)] examined a claim for deduction towards bad debt wherein the assessee did not make advance in the course of business and was in the capital field. On these facts the Court held that the advance written off cannot be allowed as deduction under section 36(1)(vii) and also as business expenditure under section 37(1). The learned author discusses the case in detail.

1. Prologue

The income of every assessee has to be assessed according to the statutory framework laid out Chapter IV, Part D of the Act. That chapter deals with heads of income. Section 28 of the Act deals with the chargeability of income to tax under the head 'Profits and Gains of Business or Profession'. The other deductions that an assessee can claim are elaborated under Section 36 of the Act, which opens with the phrase 'the deductions provided for in the following clauses shall be allowed in respect of the matters dealt with therein, in computing the income referred to in Section 28'. For the purposes of computing income chargeable to tax, therefore, besides specific deductions, 'other deductions' enumerated in different clauses of Section 36 can be allowed by the AO. Each of the deductions must relate to the business carried out by the assessee. If the assessee carries on a business and writes off a debt relating to the business as irrecoverable, it would without doubt be entitled to a corresponding deduction under clause (vii) of sub-section (1) of Section 36 subject to the fulfilment of the conditions set forth in sub-section (2) of Section 36 of the IT Act.

2. Scheme of deduction under section 36(1)(vii)

Clause (vii) of section 36(1) provides for deduction of 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, subject to the provisions of sub-section (2).

In order to claim deduction for bad debt, the following conditions must be satisfied-

(i) The debt must be written off as irrecoverable in the accounts.

(ii) The conditions laid down in section 36(2) must be duly met.

The Explanation to section 36(1)(vii) provides that any bad debt or part thereof written off as irrecoverable in the accounts of the assessee shall not include any provision for bad and doubtful debts made in the accounts of the assessee.

3. Conditions for bad debts--Pre and Post 1989

Before the amendment in 1989, the law was that even in cases where the assessee had made only a provision in its accounts for bad debts and interest thereon, without the amount actually being debited from the assessee's Profit and Loss account, the assessee could still claim deduction under Section 36(1)(vii) of the Act.

With effect from 1 April 1989, with the insertion of the new Explanation under Section 36(1)(vii), any bad debt written-off as irrecoverable in the account of the assessee would not include any 'provision' for bad and doubtful debt made in the accounts of the assessee. In other words, before this date, even a provision could be treated as a write off. However, after this date, the Explanation to Section 36(1)(vii) brought about a change. As a result, a mere provision for bad debt per se was not entitled to deduction under Section 36(1)(vii).

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