Section 36(1)(vii)
Bad Debts, Provisions and NBFCs
Deduction of Bad Debts
under income tax Act is a very simple issue yet it gets complex for various
entities. Mostly complexity arises when it is confused with the term
“Provision”.
Section 36(1)(vii):-
Subject to sub-section (2)
The amount of
ANY BAD DEBT or
Part Thereof
Which is written off as irrecoverable
In the Accounts of the assessee
FOR the Previous year.
Explanation:-
Any bad debt or part thereof written off
SHALL
NOT include
Any PROVISION for bad & doubtful debts.
The section itself specifically excludes the amount
of Provision to be allowed as deduction.
However section 36(1)(viia) allows the deduction
for any provision for bad & doubtful debt for a specified amount but only
for:
·
Schedule Banks (not being incorporated outside
India), Non-schedule Bank(under banking regulation Act, 1949), Co-operative
Bank other than primary agricultural society or a primary co-operative
agricultural & rural development bank.
·
Bank incorporated outside India
·
Public Financial Institution, State Financial
corporation, State industrial investment corporation.
Here conflict arises for NBFC’s. Since section
36(1)(viia) does not include NBFCs and Explanation to section 36(1)(vii)
squarely applies hence NBFCs are not entitled to deduction of any provision
created for bad and doubtful debts, no matter such provision is created based
on the guidelines issued by the RBI.
The issue whether NBFCs are allowed deduction for
provision of bad debts has been debated for long. But there are various
judgments clarifying the issue.
In the case of Art
Leasing Ltd. v. Commissioner of Income-tax*, Kottayam [2010] 187 Taxman 29
(KER)/[2010] 229 CTR 272 (KER) the same issue was discussed in detail and
held as below:
“Section 36(1)(vii) of the Income-tax Act, 1961 -
Bad debts - Assessment years 1997-98 to 2000-01 – Whether Parliament is well aware
of risk undertaken by banks in making advance to rural sector in terms of
guidelines issued by Government and RBI and only such cases are treated as
exceptions to general provision contained in Explanation to section 36(1)(vii),
which prohibit granting of deduction of any provision for bad and doubtful debts
- Held, yes –
Whether NBFCs are not covered by section 36(1)(viia)
and, therefore, they are not entitled to deduction of any provision created for
bad and doubtful debts, no matter such provision is created based on guidelines
issued by RBI - Held, yes
Section 45Q of the Reserve Bank of India Act, 1934 -
Chapter III-B to override other laws - Whether ‘any other law’ referred to in
section 45Q does not cover Income-tax Act which applies to all assessees in
computation of taxable income - Held, yes
…. ….. ….. ……
“…..In fact, section 36(1)(viia) is a complete
answer to this query raised by the appellant wherein special provisions are
made in the Income-tax Act for allowing provision for bad and doubtful debts of
scheduled banks, non scheduled banks, co-operative banks, etc., to the extent
permissible there under. In fact, under section 36(1)(viia), the eligible Banks
are authorised to create provision subject to certain limits in respect of
rural advances and other loans referred to therein and claim deduction of the
same. This provision clearly indicates that Parliament is well aware of the
risk undertaken by the Banks in making advance to the rural sector in terms of
the guidelines issued by the Government and the RBI and only such cases are
treated as exception to the general provision contained in Explanation to
section 36(1)(vii), which prohibits granting of deduction of any provision for
bad and doubtful debts. Unfortunately, for the appellant NBFCs are not covered
by section 36(1)(viia) of the Income-tax Act and so much so, Explanation to
section 36(1)(vii) squarely applies or in other words, the appellant NBFCs are not
entitled to deduction of any provision created for bad and doubtful debts, no
matter such provision is created based on the guidelines issued by the RBI..”
Further in the leading decision of the case of Southern Technologies Ltd. v.Joint
Commissioner of Income-tax* , Coimbatore [2010] 187 TAXMAN 346 (SC) the
issues related to provision for doubtful debts were discussed in depth and held
as under concluding that provision of bad debts is not allowable deduction for
NBFCs.
“Section 36(1)(vii) of the Income-tax Act, 1961,
read with the NBFCs Prudential Norms (Reserve Bank) Directions, 1998 - Bad
debts - Whether 1998 Directions deal only with presentation of NPA provisions
in balance sheet of a NBFC and they have nothing to do with computation or
taxability of provisions for NPAs under Income-tax Act - Held, yes –
Whether provision for NPAs in terms of 1998
Directions constitutes expense on basis of which deduction can be claimed by
NBFCs under section 36(1)(vii) - Held, no –
Whether even applying theory of real income, a
debit, which is expressly disallowed by Explanation to section 36(1)(vii), if
claimed, has got to be added back to total income of assessee, because Act
seeks to tax ‘real income’ which is income computed according to ordinary
commercial principles but subject to provisions of Act - Held, yes
Section 36(1)(vii), read with section 43D, of the
Income-tax Act, 1961 - Bad debts - Whether sections 36(1)(vii) and 43D are
violative of articles 14 and 19 of Constitution - Held, no
Section 37(1) of
the Income-tax Act, 1961 - Business expenditure - Allowable as - Whether
section 37 applies only to items which do not fall in sections 30 to 36; if a
provision for doubtful debt is expressly excluded from section 36(1)(vii), then
such a provision cannot be claimed as a deduction under section 37 even on basis
of ‘real income theory’ - Held, yes”
After going through the above cases, situation gets clear
that provision for bad debts is not allowable deduction.
Now for the clarity of accounting treatment differentiating
between provision & bad debts write off, some more judgements have been
reproduced below:
The writing off of the bad debts, without charging the same
in the profit & loss account is not writeoff at all- CIT V. Hotel Ambassador 2002 121 taxmann 437 (Ker.)
Where the amount has been claimed as provision for bad and
doubtful debt and is not written off in the accounts of various persons, the
same would not be allowable as deduction. Even RBI Guidelines would not
override this provision of income tax Act- ITO
v. Maruti Countrywide Auto financial services P Ltd. 2008, 20 SOT 237 (Delhi)
It is not obligatory for assessee to place demonstrative
proof for establishing a debt as bad- Ajitkumar
C. Kamdar v. CIT 2005, 1 SOT 183 (MUM)
Hence with the above detailed discussion following checks
can be concluded for bad debts:
·
There must be a debt i.e.
existence of relationship of debtor & creditor.
·
Debt must be
incidental to the business or profession of the assessee
· Debt must have been
taken into account in computing assessable income [This condition is not relevant
if bad debts represent money lent in the ordinary course of money-lending or
banking business sec 36(2)(i)].
·
Entire debt need not
to be considered.
·
Debt must have been
actually written off in the books of accounts of the assessee.
·
No allowance for Bad debt
of a business which has been discontinued before the commencement of the previous
year.
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