BLOG on Income Tax Management for - AY 2022-23 & 2023-24

Bad debts [Section-36(1)(vii)]

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.

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.

If there is a bad debt on account of sale made, it will be allowed as a deduction because sale has been treated as income. Similarly, in the case of a money lending business if interest is not realisable it will be allowed as a deduction because it has been treated as income either of current year or earlier year. However, there is one exception to this rule, where bad debt will be allowed even if such debt, which has become bad, has not been treated as an income. In the case of money lending business, interest is an income. If that income is not realisable, it can be treated as a bad debt. However, in this case even the money which was lent, if not realised, can be treated as a bad debt as per condition (b) above.

If there is any advance given for purchase of raw material and it is forfeited by the creditor, it will not be treated as a bad debt because it has never been treated as income. It will, however, be allowed as a loss u/s 28.

Thus, the following are the requisite conditions for allowance of a debt as bad debt:

It must be a debt or part thereof;
Such debt must be revenue in nature;
Such debt must have taken into account in computing the income of the assessee or it represents money lent in the ordinary course of business of banking or money lending which is carried on by assessee;
Such debt must be incidential to the business or profession of the assessee;
Such debt must have been written off as irrecoverable in the accounts of the assessee for the previous year.

Bad Debts of a Discontinued Business.

Bad debt of a business which has been discontinued before the commencement of the accounting year, cannot be claimed as deduction from the profit of the continuing business of the assessee.

U/s 36(2)(iii) if bad debt already written off in the books of accounts but actually not allowed as deduction by A.O. on the ground that the debt has still the possibility of recovery, any such debt or part thereof shall be allowed as deduction in the year in which it actually becomes irrecoverable.

U/s 36(2)(iv) where any such debt or part of debts is written off as irrecoverable in the accounts of the previous year and the Assessing Officer is satisfied that such debt or part has become a bad debt in any earlier previous year not falling beyond a period of which previous years immediately preceding the previous year in which such debt or part is written off, the provisions of sub-section (6) of section 155 shall apply. It means that the assessment made for these years shall be re-opened and total income shall be recomputed after allowing the claim for bad debts.

Treatment of subsequent recovery of an amount claimed and allowed as a Bad Debt [Section 41(4)]:

If any amount has been claimed and allowed as a bad debt, then if the amount is subsequently recovered, it shall be treated as the income of the previous year in which it is recovered, even though, the business in respect of which the bad debt was allowed may or may not continue in the previous year in which it is recovered.

For example,

X sold goods of Rs. 80,000 on credit to Y during the previous year 2014-15. Despite all efforts, X could not recover the money and finally the amount of Rs. 80,000 was written off in the accounts of X during the previous year 2015-16. This amount of Rs. 80,000 was allowed as deduction for the assessment year 2016-17. In the previous year 2016-17, X could recover Rs. 25,000 from Y out of the amount written off. This amount of Rs. 25,000 shall be treated as an income in the assessment year 2017-18.

Bad debts Recovered but disallowed earlier.

If in any previous year, the debt written of as bad was disallowed by the Assessing Officer and later on the debt in full or in part is realised, the amount so realised shall not be treated as income in the year of realisation because the amount recovered was taxed when it was disallowed as bad debt by the Assessing Officer.