2024 (3) TMI 1445 - HC - Income Tax

Disallowance of bad debts u/s 36(1)(vii) - comparison between the pre amendment and post amendment of Section 36(1)(vii) - ITAT deleted addition - HELD THAT - The amount was never recovered by the assessee. There is nothing to infer that the write off was not genuine. The amount was duly written off and the amount has been treated as income due to the assessee in his books due to the business transactions entered into by the assessee with M/s. Unitech Ltd. There was relationship of debtor and creditor. It is pertinent to note that the income from the sale of the land has been accepted by the revenue in the preceding year as such income from business. The assessee has also shown the income as business income. We find that the claim of the assessee is in consonance with Section 36(1)(vii) and Section 36(2) of the Act. It cannot be said that assessee has not complied with the conditions u/s 36(2) of the said Act. The assessee has taken into account the debt so written off in computing the income of assessee in the previous year in which the amount of such debt is written off. Tribunal has taken into consideration these aspects. It was observed that even if the income has not been taken into account in the earlier previous years it cannot be said that the assessee has not complied with provisions of Section 36(2). It is the case where ultimately no recovery has been made by the assessee from M/s. Unitech Ltd. Once the assessee sold the land to M/s. Unitech Ltd the debtor and creditor relationship has come into existence due to the business transaction between the assessee and M/s. Unitech Ltd. The legislature by amendment has sought to exclude the burden on the assessee to prove that the debt is bad debt. The subsequent circulars reflects the object of amendment. The object of provision is to avoid litigation and to do away with disputes regarding allowing bad debts as deduction in computing income of assessee as observed by this Court in the decision referred above. No reason to interfere in the order of ITAT.

Summary

1. ISSUES PRESENTED and CONSIDERED

The core legal question considered in this appeal is whether the Income Tax Appellate Tribunal (ITAT) was correct in deleting the disallowance of a bad debt claim of Rs. 7,99,37,826/- made by the assessee under Section 36(1)(vii) of the Income Tax Act, 1961. The substantial question of law framed was: "Whether the ITAT was right in deleting disallowance of bad debts under Section 36(1)(vii) claimed by assessee to the tune of Rs. 7,99,37,286/-."

Other relevant issues considered include:

• Whether the debt in question qualifies as a bad debt under the provisions of Section 36(1)(vii) and Section 36(2) of the Income Tax Act.
• Whether the assessee complied with the conditions stipulated under Section 36(2) regarding the timing and manner of writing off the bad debt.
• Whether the debt arose from a bona fide business transaction, establishing a debtor-creditor relationship.
• The applicability and interpretation of the amendment to Section 36(1)(vii) effective from 1.4.1989 and relevant circulars issued by the Central Board of Direct Taxes (CBDT).
• The effect of judicial precedents, including the Supreme Court's decisions on the requirements for claiming deduction on bad debts.
• Whether the assessee's claim was correctly disallowed by the Assessing Officer and upheld by the Commissioner of Income Tax (Appeals), or rightly allowed by the ITAT.

2. ISSUE-WISE DETAILED ANALYSIS

Issue 1: Whether the debt qualifies as a bad debt under Section 36(1)(vii) and Section 36(2)

Relevant legal framework and precedents: 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). Prior to amendment on 1.4.1989, the assessee had to establish that the debt had become bad in the previous year. Post amendment, it suffices if the bad debt is written off as irrecoverable in the books of account based on commercial expediency.

The CBDT Circular No.551 dated 23.01.1990 clarified that the amendment was intended to eliminate disputes about the year in which a bad debt can be allowed and to rationalize provisions, allowing claim in the year the debt is written off.

The Supreme Court in T.R.F. Ltd. vs. Commissioner of Income-tax held that after 1.4.1989, it is not necessary for the assessee to establish that the debt has in fact become irrecoverable; it is enough if the bad debt is written off as irrecoverable in the accounts.

The Bombay High Court in Director of Income Tax (International Taxation) vs. Oman International Bank SAOG held that the burden of proving that the debt had become bad was removed post-amendment, and the decision to write off must be bona fide and based on material.

Court's interpretation and reasoning: The Court noted that the assessee had entered into agreements for purchase and sale of land with M/s. Unitech Ltd., establishing a debtor-creditor relationship. The assessee earned business income from these transactions, which was accepted by the revenue. The debt of Rs. 7,99,37,826/- was written off in the books in the financial year 2008-09 after passing a board resolution, reflecting commercial expediency.

The Court emphasized that the amended Section 36(1)(vii) excludes the burden on the assessee to prove the debt has become bad, provided it is written off as irrecoverable in accounts. The Assessing Officer's and CIT(A)'s contrary findings were set aside by the ITAT, which the Court upheld.

Key evidence and findings: The assessee produced the board resolution dated 25.06.2009 authorizing the write-off, ledger accounts showing the debt, profit and loss account schedules, and correspondence evidencing attempts to recover the debt. The debt arose from bona fide business transactions involving land sales, accepted as business income by the revenue.

Application of law to facts: The Court applied the amended Section 36(1)(vii) and related circulars, holding that the write-off in accounts was sufficient to claim deduction. The relationship between the parties was commercial and bona fide, satisfying the requirement of a debt. The debt was written off in the year it became irrecoverable, complying with Section 36(2).

Treatment of competing arguments: The appellant argued that the debt was not bad because the debtor existed, no legal action was taken, and no credit entry was made in the debtor's books. The appellant relied heavily on the recent Supreme Court decision in Pr. Commissioner of Income Tax vs. Khyati Realtors Ltd., which held that mere write-off without appropriate accounting treatment and compliance with Section 36 conditions does not entitle deduction.

The Court distinguished the facts from Khyati Realtors Ltd., noting that in the present case the debt arose from business transactions, was accepted as business income, and was written off bona fide in the books with supporting evidence. The appellant's arguments regarding absence of credit entry in debtor's books and lack of legal action were not determinative given the legislative intent and the assessee's compliance with the statutory conditions.

Conclusions: The Court concluded that the debt qualified as a bad debt under Section 36(1)(vii) and Section 36(2), and the ITAT was justified in deleting the disallowance.

Issue 2: Whether the assessee complied with the conditions under Section 36(2) regarding timing and manner of write-off

Relevant legal framework and precedents: Section 36(2) provides that deduction for bad debt shall not be allowed unless the debt has been taken into account in computing income of the previous year when it is written off or an earlier year, or represents money lent in ordinary course of business of banking or money lending. The debt must be written off as irrecoverable in the accounts. The CBDT Circular No.12/2016 reiterated that after amendment, the claim is admissible if the debt is written off in books and conditions of Section 36(2) are fulfilled.

Court's interpretation and reasoning: The Court found that the assessee had taken the debt into account in computing income in the relevant previous year. The write-off was done by passing a board resolution and making entries in the books of account in the financial year 2008-09. The Court held that the assessee complied with the conditions of Section 36(2).

Key evidence and findings: The board resolution dated 25.06.2009, the ledger accounts, and profit and loss schedules showed the debt was written off in the relevant year. The assessee had declared income from the sale of land to the debtor, thereby taking the debt into account.

Application of law to facts: The Court applied the statutory provision and circulars to hold that the assessee's write-off was timely and bona fide, satisfying the statutory conditions.

Treatment of competing arguments: The appellant contended that the write-off was not bonafide and that the debt was not established as bad in the relevant year. The Court rejected these contentions based on the evidence and the legislative intent to avoid litigation on such issues.

Conclusions: The Court concluded that the assessee complied with Section 36(2) and was entitled to the deduction.

Issue 3: Whether the debt arose from a bona fide business transaction establishing debtor-creditor relationship

Relevant legal framework and precedents: Deduction under Section 36(1)(vii) presupposes existence of a debt and debtor-creditor relationship arising from business transactions. The Supreme Court and High Courts have held that mere loss or non-recovery of money does not qualify unless there is a bona fide business relationship.

Court's interpretation and reasoning: The Court found that the assessee had undertaken the business of land acquisition and sale. Agreements and MOUs with Dantras Estate Pvt. Ltd. and M/s. Unitech Ltd. were produced. The sale of land and profit earned were accepted as business income. The debt arose from the balance amount receivable from M/s. Unitech Ltd. for land sold. Thus, the debtor-creditor relationship was clearly established.

Key evidence and findings: Agreements dated 10.07.2005, 26.06.2006, and 13.09.2006, MOUs, sale deeds, ledger accounts, and profit and loss statements were on record. The income from these transactions was accepted by the revenue as business income.

Application of law to facts: The Court applied the legal principle that a bona fide business transaction giving rise to a debt is a precondition for claiming bad debt deduction. The facts satisfied this condition.

Treatment of competing arguments: The appellant argued there was no business or debtor-creditor relationship, no credit entries in debtor's books, and isolated transactions cannot be treated as business. The Court rejected these arguments, emphasizing the nature of the transaction, acceptance of income as business income, and the commercial reality of the dealings.

Conclusions: The Court held that the debt arose from bona fide business transactions, establishing debtor-creditor relationship.

Issue 4: Interpretation and applicability of recent Supreme Court decision in Pr. Commissioner of Income Tax vs. Khyati Realtors Ltd.

Relevant legal framework and precedents: The Supreme Court in Khyati Realtors Ltd. held that mere write-off without appropriate accounting treatment and compliance with Section 36(1)(vii), Section 36(2), and Explanation does not entitle deduction. The assessee must prove that the debt was written off as irrecoverable and complied with statutory conditions.

Court's interpretation and reasoning: The Court distinguished the facts of the present case from Khyati Realtors Ltd. The present case involved bona fide business transactions, proper accounting treatment, and compliance with statutory provisions. The assessee had shown income from business, written off the debt by board resolution, and maintained proper accounts. Hence, the Khyati Realtors Ltd. decision did not apply adversely.

Key evidence and findings: The Court noted the presence of agreements, MOUs, board resolution, ledger entries, and acceptance of business income by revenue, which were absent or insufficient in Khyati Realtors Ltd.

Application of law to facts: The Court applied the principles laid down in Khyati Realtors Ltd. but found the present case factually distinguishable and compliant with the conditions necessary for claiming deduction.

Treatment of competing arguments: The appellant relied heavily on Khyati Realtors Ltd. to argue disallowance was justified. The Court rejected this reliance on facts and evidence.

Conclusions: The Court held that the Khyati Realtors Ltd. decision did not apply to disallow the bad debt claim in the present case.

3. SIGNIFICANT HOLDINGS

"After 1.4.1989, for allowing deduction for the amount of any bad debt or part thereof under section 36(1)(vii) of the Act, it is not necessary for assessee to establish that the debt, in fact has become irrecoverable; it is enough if bad debt is written off as irrecoverable in the books of accounts of assessee."

"The Legislature by amendment has sought to exclude the burden on the assessee to prove that the debt is bad debt and leaves it to the commercial wisdom of the assessee to treat the debt as bad, once it is written off as irrecoverable in the accounts of the assessee."

"The decision to write off a debt as bad must be bona fide and based on material that the debt is not recoverable; the Assessing Officer can interfere only if the decision is not bona fide."

"The assessee's claim of bad debt is in consonance with Section 36(1)(vii) and Section 36(2) of the Act where the debt arises from bona fide business transactions, is written off in the books of account in the relevant previous year, and the income from the transaction has been taken into account."

"Merely stating a bad and doubtful debt as an irrecoverable write off without appropriate treatment in the accounts and non-compliance with the conditions in Section 36(1)(vii), 36(2) and Explanation to Section 36(1)(vii) would not entitle the assessee to claim a deduction. However, in the present case, such compliance is established."

"The relationship of debtor and creditor arises from the business transaction entered into between the assessee and the debtor, and the income from such transaction must be accepted as business income for claiming deduction on bad debts."

"The Income Tax Appellate Tribunal was justified in deleting the disallowance of bad debts and the concurrent orders of the Assessing Officer and Commissioner of Income Tax (Appeals) were rightly set aside."