Supreme Court rules write off of debt is sufficient for claiming bad debts

 

Mar 7, 2010

In a recent ruling Supreme Court in the case of TRF Ltd. 

on the issue of whether a taxpayer, while claiming deduction

of bad debts in its return of income, is required to establish 

that the debts have, in fact, become irrecoverable. 

The SC held that post the amendment to 

Section 36(1)(vii) (Section) of the Indian Tax Law (ITL), f

or claiming deduction of bad debts, it is sufficient that 

the debt is written off in the books of account as bad debt.

It is not necessary for the taxpayer to establish that the debt

has become irrecoverable.

Under the ITL, deduction is allowed for bad debts 

subject to certain conditions. Prior to the amendment from

1 April 1989 to the Section, for claiming the deduction, 

the taxpayer was required to establish that the debt had, 

n fact, become irrecoverable. The factual aspect of establishing 

the irrecoverability of the debt had been prone to litigation. 

To relieve the taxpayers from the burden of proving the bad debts,

the Section was amended to the effect that for claiming deduction 

on account of bad debts, it is sufficient that the debt is

written off as bad debt in the books of account.

However, the Tax Authority, despite the amendment, 

used to take the position that what is contemplated 

by the statute is the write off of ‘bad debts’ as 

distinguished from the write off of ‘debt’. 

Therefore, the taxpayer was required to prove

that the debt has, in fact, become irrecoverable.

 The SC held that the position in law is well-settled. 

After the amendment from 1 April 1989, it is not 

necessary for the taxpayers to establish that the debt,

in fact, has become irrecoverable. It is enough that the

debt is written off as irrecoverable in the books of account

of the taxpayer.

In the present case, the SC observed that since

the Tax Authority has not examined whether the

debt has been written off in the books of account, 

the matter be remitted for fresh consideration by the 

Tax Authority on the limited aspect of write off of the 

debt in the books.

This ruling would settle the controversy surrounding 

the claim for deduction of bad debts post the amendment 

of the Section and relieve the taxpayers from the burden

of establishing the factum of the irrecoverability of the

debt which is written off in the books of account.

Taxpayer is not required to demonstrate that the debt has become bad debt once it is written off in the books of account

Supreme Court Ruling: After 1 April 1989 the Taxpayer 

is not required to demonstrate that the debt has become 

bad debt once it is written off in the books of account 

[TRF Ltd. v. CIT (2010-TIOL-15-SC-IT)]

Supreme Court Ruling:

In order to claim a bad debt as a deduction under

section 36(1)(vii) of the Income tax Act (Act) it 

has been a long drawn controversy between the 

Taxpayer and the Revenue whether in addition to

write-off the debt in the books of account, it is obligatory on the

Taxpayer to establish that such debt has become a bad debt,
especially after the amendment brought in by the
Direct Tax Laws (Amendment) Act, 1987 w.e.f. 1 April 1989.

This controversy has now been put to rest by the Supreme 

Court in the case of TRF Ltd. v. CIT wherein it has been 

held that after 1 April 1989 it is not necessary for the 

Taxpayer to establish that the debt, in fact, has become

irrecoverable. It is enough if the bad debt is written off

 irrecoverable in the accounts of the Taxpayer.

 

Our View:

The Direct Tax Laws (Amendment) Act, 1987 substituted the 

words “any bad debt or part thereof” in place of “any debt, 

or part thereof, which is established to have become a bad 

debt in the previous year” in section 36(1)(vii) of the Act 

w.e.f. 1 April 1989. Subsequent to the above amendment the 

Central Board of Direct Taxes (CBDT) has issued 

Circular 551 dated 23 January 1990. 

The issue pertaining to bad debt is set out in para. 6.6. and

the relevant portion reads as under :-

“In order to eliminate the disputes in the matter of determining 

the year in which a bad debt can be allowed and also to rationalise 

the provisions, the Amending Act, 1987 has amended clause (vii) 

of sub-section (1) and clause (i) of sub-section (2) of the section to 

provide that the claim for bad debt will be allowed in the year 

in which such a bad debt has been written off as irrecoverable

in the accounts of the assessee.”

The Circular of the CBDT clearly spells 

out that the amendment is to eliminate the disputes

in the matter of determining the year in which the 

bad debt is written off as irrecoverable. 

If we apply the Rule of interpretation as spelt 

out in Hyden’s case, it would lead to an irresistible 

conclusion, that the Legislature by the amendment

has sought to exclude the burden on the 

Taxpayer to prove that the debt is bad debt and 

leaves it to the commercial wisdom of the Taxpayer

to treat the debt as bad, once it is written off as 

irrecoverable in the accounts of the Taxpayer.

Inspite of this clear provision the Taxpayer was 

again called upon to establish that the debt has

become bad debt.

The Supreme Court has now given a ruling 

in favour of the Taxpayer that it is not obligatory 

on the Taxpayer to prove whether the debt has 

become bad debt once such debt has been written 

off in the books of account. 

This is a welcome decision and would give a 

substantial relief to the Taxpayer. 

It seems that the judgement of the Rajasthan High Court 

in the case of Kashmir Trading Co. v. DCIT (291 ITR 228)

is overruled, while judgements of High Courts in the 

case of DIT v. Oman International Bank (313 ITR 128)(Bom)

and CIT v. Global Capital Ltd. (306 ITR 332) (Del) are approved.

 

Although the aforesaid judgement of the Supreme Court 

does not clearly spell out, we believe that after the 

amendment, though it is neither obligatory nor is there

burden on the Taxpayer to prove that the debt written 

off by him is indeed a bad debt; the write-off needs to

be bona fide and should be based on commercial wisdom or expediency.