The amount of any bad debt or part thereof, which has been written off as irrecoverable in the accounts of the assessee for the previous year, shall be allowed as a deduction subject to the provisions of section 36(2) which are as under:—
- Such debt or part thereof must have been taken into account in computing the income of the assessee of the previous year or of an earlier previous year, or
- It represents money lent in the ordinary course of the business of banking or money-lending which is carried on by the assessee.
In order to claim deduction under section 36(1)(vii), one must keep in view the following points:
1. There must be a Debt -
Before claiming an amount as a debt, it must be shown that it is a proper debt. In other words, a bad debt presupposes the existence of a debt and relationship of a debtor and creditor. Unless, therefore, there is an admitted debt it cannot be allowed as bad debt when it becomes irrecoverable.
2. Debt must be Incidental to the Business or Profession of the Assesee -
The debt which is claimed as bad debt under section 36(1)(vii) must be incidental to the business or profession carried on by the assessee. In other words, debts not connected with business or profession carried on by the assessee or not arising out of the operation of business or profession carried on by the assessee, are not admissible as bad debts even if other conditions are satisfied.
3. Debt must have been taken into Account in computing Assessable Income -
No deduction on account of bad debt is admissible unless the amount of debt is taken into account in computing the total income of the assessee of that previous year or of an earlier year. This condition is however, not relevant, if bad debt represents money lent in the ordinary course of money-lending or banking business.
4. Debt must have been Written Off in the Books of Account of the Assessee -
No deduction in respect of bad debt is allowable under section 36(1)(vii) unless it is written off as irrecoverable in the books of the assessee in the previous year in which claim for deduction is made††. It is not necessary to establish that debt has become bad during the relevant previous year. For this purpose, transfer to “provision for bad and doubtful debts account” shall not be taken as bad debts written off.
5. Deduction in the case of an Assessee who is also eligible for Deduction under Section 36(1)(viia) -
Deduction relating to a bad debt (or part thereof) in the case of an assessee to which section 36(1)(viia) applies is limited to the amount by which such debt exceeds the credit balance in the provision for bad and doubtful debts account made under that section.
6. Adjustment at the time of Recovery -
A deduction on account of bad debt is based upon a mere estimate and it is allowed as deduction on the basis of amount written off in the books of account of the taxpayer. Therefore, in a case where debt ultimately recovered is less (or more) than the amount of debt left after writing off bad debt, some adjustment is required.
7. Debts of a Discontinued Business Not Deductible -
No allowance can be claimed in respect of bad debts of a business which has been discontinued before the commencement of the previous year. Such bad debt cannot be deducted even from profits of a separate existing business.
8. Allowable in the hands of Successor -
In some cases (e.g., one of the partners taking over business of the firm with all assets and liabilities or conversion of firm into company by taking over all assets and liabilities), the successor can claim the benefit of deduction of bad debt if the successor carries on the business of the predecessor and bad debt is written off in the books of account of the successor.