2025 (4) TMI 916 - AT - Income Tax

Disallowance on account of the claim of bad debts - HELD THAT - Even though the assessee has not proved to have carried out the business of money lending business/loans and advances on interest but even if it is considered that the expenditure which has been wrongly claimed for the impugned assessment year but then we cannot ignore the fact that the income of Rs. 10.00 lakh has been offered out of the alleged claim of bad debts in the return for A.Y. 2005-06. Therefore to this extent the assessee deserves relief since it has been taxed in A.Y. 2005-06 because the facts are of mixed nature not giving the clear cut picture of the actual nature of business carried out by the assessee as well as the observation of the AO for the one taken for A.Y. 2002-03 and for the one taken for A.Y. 2005-06 accepting the recovery of bad debts. We therefore partly allow the grounds of appeal raised by the assessee and affirm the disallowance of bad debts of Rs. 11.20 lakh and delete the addition of Rs. 10.00 lakh solely on the ground that the same has been offered to tax in A.Y. 2005-06. Effective grounds of appeal raised by the assessee are partly allowed.

Summary

ISSUES PRESENTED and CONSIDERED

The core legal issues considered in this judgment are:

1. Whether the assessee's claim for the deduction of bad debts amounting to Rs. 21,20,000/- is valid under Section 36(1)(vii) of the Income-tax Act, 1961.

2. Whether the activities of the assessee constitute a business of money lending, thereby justifying the claim of bad debts.

3. The treatment of recoveries from bad debts in subsequent assessment years, specifically whether the recovery of Rs. 10,00,000/- should affect the disallowance of the bad debt claim for the assessment year 2002-03.

ISSUE-WISE DETAILED ANALYSIS

1. Deduction of Bad Debts Under Section 36(1)(vii)

Relevant Legal Framework and Precedents: Section 36(1)(vii) of the Income-tax Act allows a deduction for bad debts written off as irrecoverable in the accounts of the assessee, subject to the provisions of Section 36(2). Section 36(2)(i) stipulates that no deduction is allowed unless the debt has been taken into account in computing the income of the assessee for the relevant or previous years, or it represents money lent in the ordinary course of business of banking or money lending.

Court's Interpretation and Reasoning: The Tribunal observed that the assessee did not record the loans and advances in the regular books of account, and there was no evidence of conducting a money lending business in the ordinary course. The Tribunal noted that the claim of bad debts was made only after the search operations revealed undisclosed income, and the loans were not part of the regular business accounts.

Key Evidence and Findings: The search operation unearthed unaccounted business activities, but the assessee failed to provide evidence of maintaining regular accounts for the money lending business. The loans and advances were not recorded in the regular books of account, and the claim of bad debts was not made in the original return of income.

Application of Law to Facts: The Tribunal applied Section 36(1)(vii) and found that the conditions for claiming bad debts were not met, as the loans were not part of the regular business accounts, and there was no evidence of writing off the debts as irrecoverable in the accounts for the previous year.

Treatment of Competing Arguments: The assessee argued that since the income from the money lending business was offered to tax, the bad debts should also be allowed. However, the Tribunal found that the business activities were not part of the regular accounts, and the claim was made only after the search operations.

Conclusions: The Tribunal concluded that the claim for bad debts could not be allowed as the conditions under Section 36(1)(vii) were not satisfied.

2. Business of Money Lending

Relevant Legal Framework and Precedents: For a claim of bad debts to be allowed, the business of money lending must be conducted in the ordinary course, and the debts must be part of the regular business accounts.

Court's Interpretation and Reasoning: The Tribunal found no evidence of the assessee conducting a money lending business in the ordinary course. The loans and advances were not recorded in the regular business accounts, and there was no license or regular income shown from such business.

Key Evidence and Findings: The Tribunal noted that the loans were given for entering into a partnership business, and there was no clear evidence of a money lending business. The agreements with Mr. Mohd Ali Ganji indicated a partnership arrangement rather than a money lending transaction.

Application of Law to Facts: The Tribunal applied the legal framework and found that the activities did not constitute a money lending business in the ordinary course, as required for the claim of bad debts.

Treatment of Competing Arguments: The assessee argued that the business was unearthed during the search, and income was offered to tax. However, the Tribunal found that the activities were not part of the regular business accounts and did not constitute a money lending business.

Conclusions: The Tribunal concluded that the assessee was not conducting a money lending business in the ordinary course, and therefore, the claim for bad debts could not be allowed.

3. Treatment of Recoveries from Bad Debts

Relevant Legal Framework and Precedents: The recovery of bad debts in subsequent assessment years can affect the treatment of bad debt claims, especially if the recovery is taxed as business income.

Court's Interpretation and Reasoning: The Tribunal noted that Rs. 10,00,000/- was recovered and offered as income in the assessment year 2005-06. This recovery was accepted by the Revenue authorities, which created an inconsistency in the treatment of the bad debt claim.

Key Evidence and Findings: The Tribunal found that the recovery of Rs. 10,00,000/- was part of the income for the assessment year 2005-06, and the Revenue authorities accepted this recovery as business income.

Application of Law to Facts: The Tribunal applied the legal framework and found that the recovery of Rs. 10,00,000/- should be considered when assessing the bad debt claim, as it was taxed as business income in a subsequent year.

Treatment of Competing Arguments: The assessee argued that the recovery should affect the disallowance of the bad debt claim. The Tribunal agreed to the extent that the recovery was taxed as business income, creating an inconsistency in the treatment.

Conclusions: The Tribunal allowed the assessee relief for Rs. 10,00,000/- of the bad debt claim, as this amount was recovered and taxed as business income in a subsequent year.

SIGNIFICANT HOLDINGS

The Tribunal held that the claim for bad debts could not be allowed under Section 36(1)(vii) as the conditions were not satisfied. The business activities did not constitute a money lending business in the ordinary course, and the loans were not part of the regular business accounts. However, the Tribunal allowed relief for Rs. 10,00,000/- of the bad debt claim, as this amount was recovered and taxed as business income in a subsequent year. The final determination was to partly allow the appeal, affirming the disallowance of Rs. 11,20,000/- and deleting the addition of Rs. 10,00,000/-.