Bad debts are debts which are not recoverable. In this write up, the treatment of bad debt as per Income Tax Act, 1961 has been explained and focus has been laid on some interesting issues related to it. This article is basically on intersting issues regarding bad debts and its taxation implications.Â TRF Limited vs. CIT (Supreme Court) Held in the case of TRF Ltd, it is not at all necessary for assessee to establish that debt, which has become irrecoverable i.e. debt had become bad in previous year but it is enough if bad debt is written off as irrecoverable in accounts of assessee. However, transaction of bad debt entered in the books of assessee should not be fake entry. Under Scheme of Act, Assessing Officer, before allowing deduction of bad debt is fully empowered to make an enquiry as to whether entry of writing off bad debt or part thereof is genuine entry or not. Allowability of Bad debt As per Section 36(1) (vii), Bad debt is allowed as deduction on fulfillment of the following conditions:
- Debt must be proper debt or a part thereof and it must be of a revenue nature.
- It has been written off as irrecoverable in the accounts of the assessee for the previous year.
- An assessee can claim deduction of bad debt of business, which is carried on by him for at least some time during the previous year. It is not necessary that the business is to be carried on throughout the previous year.
- Further as per section 36(2), the bad debt can be written off in the same previous year or earlier year, if the same has been offered for taxation or, it represents money lent in the ordinary course of business of banking or money lending which is carried on by the assessee.
- Any 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.
Taxability of Bad debt
- If the amount of debt ultimately recovered is less than the difference between the debt and the amount of bad debt deducted, the deficiency shall be deductible in the previous year in which the ultimate recovery is made.
Â Illustration: Total debt is Rs. 15000 and only Rs. 10000 was allowed as deduction in AY 2011-12. Subsequently, the amount of Rs. 2500 was recovered in AY 2012-13. The debt ultimately recovered i.e. Rs. 2500 is less than the difference between debt and amount of bad debt deducted: Rs. 15000 â€“ 10000 = Rs. 5000.The deficiency of Rs. 2500 which was claimed less will be allowed as deduction in AY 2012-13 2.Â Â Â Â Â As per Section 41(4), if the amount of debt ultimately recovered is more than the difference between the debt and the amount of bad debt allowed as deduction, then the excess amount shall be deemed to be the business income and is chargeable to income tax as the income of the previous year in which the ultimate recovery was made. Illustration: Total debt is Rs. 15000 and only Rs. 10000 was allowed as deduction in AY 2011-12. Subsequently, the amount of Rs. 6000 was recovered in AY 2012-13. Difference between debt and amount of bad debt deducted: Rs. 15000 â€“ 10000 = Rs. 5000, which is less than the debt ultimately recovered i.e. Rs. 6000. The excess amount of Rs. 1000 which was claimed more will become taxable in AY 2012-13 as and will be treated as income.
- As per Sec 41(5), where the business or profession is no longer in existence and there is income chargeable to tax u/s 41(4), any loss other than speculation loss, which arose in the business and could not be set off against any other income, can be set off against the income chargeable to tax u/s 41(4) to the extent possible.
Interesting Issues related to bad debt a)Â Â Â Â Â Mr A gave an advance of Rs. 10 lacs for purchase of raw material. Neither raw material supplied nor advance returned. It cannot be claimed as bad debt since earlier was not offered for taxation i.e. since the transaction of raw material was not made, hence the net effect on the profit of the company due to purchase is nil resulting into no effect on taxation. Moreover, it should be claimed as a trading loss incurred in the ordinary course of business u/s 28. b)Â Â Â Â Â ICICI gave an advance of Rs. 10 lacs to Mr. A, so as to enable him to purchase raw material. As a supplier cheated Mr. A, A defaulted in payment to the bank. Since, the nature relates to the lending in the course of banking business, so it can be claimed as bad debt. c)Â Â Â Â Â Mr. A gave an advance to purchase a capital asset and a failure occurred in supplying the asset and returning the advance. Since, the nature of transaction is of capital nature so there is no bad debt. Moreover, it is a capital loss. d)Â Â Â Â Â Mr. A is an agent of Nonresident and has paid tax on behalf of its principal. The tax remained unrecoverable. Held in the case of Abdul bhai abdul kadar, that the payment of tax be the agent of nonresident is not the business of the agent and hence cannot be claimed as bad debt. Also, there is no trading loss. e)Â Â Â Â Â Mr. A an employee of XYZ Co has stolen the cash of the business and ran away. Held in the case of Badridas Naga and also Nainital Bank Ltd, the loss arising due to embezzlement of cash by employee would be a trading loss incurred in course of day to day business and therefore shall be allowed as deductible expense u/s 28. The expense shall be allowed as deduction in the year in which it is identified and not in the year in which it is incurred. Thanks for reading for this article. Please feel free to write to us,Â We want to hear it all!Suggestions? Complaints? Feedback? Requests?Â at [email@example.com] or call us at +91 88208208 11. We would be more than happy to assist you.