2022 (8) TMI 1141 - SC - Income Tax

Deduction of bad and doubtful debt u/s 36(1)(vii) or u/s 37 - Advance against the purchase of property - It was contended that the project did not appear to make any progress and consequently the assessee sought return of the amounts from the builder. However the latter did not respond. As a result the assessee s Board of Directors resolved to write off the amount as a bad debt - HELD THAT - As noted by the CIT(A) there was no material to substantiate this submission in respect of payment of the amount the time by which the constructed unit was to be given to it the area agreed to be purchased etc. Equally in support of its other argument that the amount was given as a loan the assessee nowhere established the duration of the advance the terms and conditions applicable to it interest payable etc. The assessee conceded that it had received interest income for the relevant assessment year. However it could not establish that any interest was paid (or shown to be payable in its accounts) for the sum of Rs. 10 crores. Furthermore there is nothing on record to suggest that the requirement of the law that the bad debt was written-off as irrecoverable in the assessee s accounts for the previous year had been satisfied. Another reason why the amount could not have been written-off is that the assessee s claim was that it was given to M/s Bhansali Developers Pvt. Ltd. for acquiring immovable property it therefore was in the nature of a capital expenditure. It could not have been treated as a business expenditure. In view of the above discussion it is held that the assessee s claim for deduction as a bad and doubtful debt could not have been allowed. The findings of the ITAT and the High Court to the contrary are therefore insubstantial and have to be set aside. Admissibility of an expenditure as a deduction which does not fall within the provisions of Sections 28 to 43 and is not capital in nature but is laid out or spent exclusively for the purpose of business under Section 37 - This court was satisfied that the disallowance of the amount on account of bad and doubtful debt did not preclude a claim for deduction on the ground that the expenditure was exclusively laid out for the purpose of business. The court applied the test of whether the expense was incurred for business or whether it fell into the capital stream. In the facts of the case the tests were satisfied the expenditure was for the purpose of business and did not fall in the capital stream. This court is of the opinion that as a proposition of law that enunciation is unexceptional since the heads of expenditure that can be claimed as deduction are not exhaustive which is the precise reason for the existence of Section 37. Therefore in a given case if the expenditure relates to business and the claim for its treatment under other provisions are unsuccessful application of Section 37 is per se not excluded. This court is of the opinion however that in the facts of this case the judgment in Southern Technologies 2010 (1) TMI 5 - SUPREME COURT on this issue (where the claim of bad and doubtful debt was disallowed) is appropriate and applicable. Thus the Revenue s appeal has to succeed. The impugned judgment of the High Court and the order of ITAT are hereby set aside.

Summary

The core legal questions considered in this judgment are:

(i) Whether the assessee was entitled to claim a deduction of Rs. 10 crores as a bad debt under Section 36(1)(vii) read with Section 36(2) of the Income Tax Act, 1961, given the facts relating to the advance made to a developer and its subsequent write-off;

(ii) Whether the amount advanced, purportedly for acquisition of commercial premises, could be treated as a business debt or loan in the ordinary course of business, thereby qualifying for deduction as a bad debt;

(iii) Whether the assessee complied with the statutory conditions, including the requirement that the bad debt be written off as irrecoverable in the accounts of the previous year, as mandated by the provisions of Section 36;

(iv) Whether the claim for deduction under Section 37 of the Act, relating to expenditure laid out exclusively for business purposes but not falling under Sections 30 to 36, was admissible in the facts of this case;

(v) The scope of judicial scrutiny and the evidentiary burden on the assessee to establish the conditions for claiming deductions under Sections 36 and 37;

(vi) The interplay between provisions relating to bad debts and provisions for doubtful debts, especially post the 1989 amendment to Section 36(1)(vii).

Issue-wise Detailed Analysis:

1. Claim of Deduction as Bad Debt under Section 36(1)(vii) and Section 36(2):

The legal framework under Section 36(1)(vii) allows deduction of any bad debt or part thereof written off as irrecoverable in the accounts of the assessee for the previous year, subject to conditions in Section 36(2). Section 36(2) stipulates that no deduction shall be allowed unless the debt has been taken into account in computing the income of the assessee in the previous or an earlier year or represents money lent in the ordinary course of banking or money-lending business.

Precedents such as Catholic Syrian Bank Ltd. v. Commissioner of Income Tax and Southern Technologies Ltd. v. Joint Commissioner of Income Tax emphasize that the deduction is conditional upon the debt being written off as irrecoverable in the accounts and not merely being a provision for bad and doubtful debts. The 1989 amendment clarified that provisions for bad debts do not qualify as write-offs under Section 36(1)(vii).

The Court noted that the assessee failed to demonstrate that the Rs. 10 crores advance was written off as irrecoverable in its accounts for the relevant previous year. The AO and CIT(A) found no material evidence such as payment records, terms of the advance, or accounting entries evidencing the write-off. The assessee's contention that the amount was given as a loan lacked substantiation regarding terms, interest, or repayment conditions. Further, the advance was made for acquiring commercial premises, which prima facie suggested capital expenditure rather than a business debt.

Applying the law to facts, the Court held that the assessee did not satisfy the conditions under Section 36(1)(vii) and Section 36(2). The advance did not constitute a bad debt in the statutory sense, and the absence of proper accounting treatment of write-off was fatal to the claim. The Court also relied on the principle that a debt must be a genuine trading debt related to business profits to qualify as a bad debt, as explained in A.V. Thomas and Co. Ltd. v. Commissioner of Income Tax.

Competing arguments by the assessee, including reliance on the T.R.F. Limited case, were distinguished on the basis that the latter did not address the accounting write-off requirement or the conditions in Section 36(2). The Court accorded primacy to the binding precedents of Southern Technologies and Catholic Syrian Bank, which clarified the mandatory nature of these conditions.

Conclusion: The assessee's claim for deduction of Rs. 10 crores as a bad debt under Section 36(1)(vii) and Section 36(2) was rejected due to non-compliance with statutory conditions and lack of evidentiary support.

2. Claim for Deduction under Section 37 of the Income Tax Act:

Section 37 allows deduction of any expenditure (not covered under Sections 30 to 36, not capital or personal in nature) laid out exclusively for business purposes. The Court examined whether the assessee could claim the amount under this residual provision after disallowance under Section 36.

The Court referred to the Mysore Sugar Co. Ltd. case, which held that while certain expenditures may not fit within specific deduction heads, they may still qualify under Section 37 if they are revenue in nature and exclusively for business. The test involves determining whether the expenditure is capital or revenue and whether it was laid out wholly for business purposes.

However, the Court also relied on the Southern Technologies judgment, which clarified that if an item falls within Sections 30 to 36 but is excluded by an Explanation (such as provisions for doubtful debts excluded from Section 36(1)(vii)), Section 37 cannot be invoked to claim deduction for that item. The Court found that the expenditure in question was either capital in nature or fell within the ambit of Sections 30 to 36 but was excluded under the Explanation, thus precluding reliance on Section 37.

Moreover, the assessee's claim under Section 37 was raised belatedly and lacked substantiation. The Court emphasized that Section 37 is not a catch-all provision to circumvent the specific conditions of other sections.

Conclusion: The claim for deduction under Section 37 was not allowable in the facts of this case.

3. Evidentiary and Procedural Aspects:

The Court underscored the obligation on the assessee to prove to the AO that the conditions for claiming deductions under Sections 36(1)(vii) and 36(2) are met. The absence of documentary evidence such as accounting entries, loan agreements, or proof of write-off weighed heavily against the assessee. The Court rejected the contention that the AO's scrutiny was unduly harsh, highlighting the statutory mandate for evidentiary proof.

The Court also noted that the High Court erred in declining to entertain the Revenue's appeal on the ground that no substantial question of law arose, given the factual and legal errors in the ITAT's decision.

4. Interpretation of 'Bad Debt' and 'Write-Off':

The Court reiterated the distinction between a 'provision' for bad debts and an actual 'write-off'. Post-1989 amendment, only the latter qualifies for deduction. A write-off involves debiting the bad debt account and crediting the debtor's account, effectively removing the debt from the books. Mere provisions credited to a provision account do not suffice.

This interpretation aligns with the principle that tax is on 'real income', requiring adjustments to reflect actual losses rather than notional provisions.

5. Capital vs. Revenue Expenditure:

The Court applied the test from Mysore Sugar Co. Ltd. to determine the nature of the expenditure. Since the advance was for acquisition of commercial premises, it was capital in nature and not deductible as a business loss or bad debt.

Significant Holdings:

"The amount of any bad debt or part thereof has to be written-off as irrecoverable in the accounts of the assessee for the previous year."

"Such bad debt or part of it written-off as irrecoverable in the accounts of the assessee cannot include any provision for bad and doubtful debts made in the accounts of the assessee."

"No deduction is allowable unless the debt or part of it has been taken into account in computing the income of the assessee of the previous year in which the amount of such debt or part thereof is written off or of an earlier previous year, or represents money lent in the ordinary course of the business of banking or money-lending carried on by the assessee."

"The assessee is obliged to prove to the AO that the case satisfies the ingredients of Section 36(1)(vii) as well as Section 36(2) of the Act."

"If an item falls under Sections 30 to 36 but is excluded by an Explanation to Section 36(1)(vii), then Section 37 cannot come in."

"A debt in such cases is an outstanding which if recovered would have swelled the profits. It is not money handed over to someone for purchasing a thing which that person has failed to return even though no purchase was made."

"The test to determine whether expenditure is capital or revenue is whether the money was laid out to acquire an asset of an enduring nature for the benefit of the business (capital) or was an outgoing in the doing of the business (revenue)."

The final determination was that the assessee's claim for deduction of Rs. 10 crores as a bad debt under Section 36(1)(vii) and Section 36(2) was not sustainable due to failure to comply with statutory conditions and lack of evidentiary support. The alternative claim under Section 37 was also disallowed. The orders of the ITAT and the High Court were set aside, and the Revenue's appeal was allowed.