2022 (7) TMI 963 - HC - Income Tax

Deduction of bad debt written off u/s. 36(i) (vii) - outstanding debtors against lease rental - AO held that as per the mercantile system of accounting followed by the assessee, the accrued lease incomes were taxable in the respective years and writing off was not allowed observing that in view of the pendency of the dispute of the assessee before the High Court, assessee had not foregone its right to claim the lease rentals and that the write off was premature - whether the Tribunal was right in rejecting the claim of the assessee for deduction of bad debt written off under Section 36 (1)(vii)? - HELD THAT - The assessee following the mercantile system of accounting offered these incomes as set out earlier in the Assessment Years 1987-88, 1988-89 and 1989-90. However, in view of the dispute with the lessee, the assessee filed a winding up petition against the lessee in the Bombay High Court. It is not in dispute that the assessee had entered into a bona fide lease agreement with the lessee or that it had paid amounts to the suppliers of the equipment on behalf of the lessee. The first installment of the lease amount was received by the assessee. Further installments due were also accounted for in view of the mercantile system of accounting followed by the assessee. The depreciation was also claimed by the assessee on the equipment which was not disallowed by the AO. The legal dispute between the assessee and the lessee was pending in the Bombay High Court. It is recorded in the order of the Commissioner of Appeals that the lessee company had become a sick company. Obviously, the prospects of recovery of lease rentals were quite bleak and the assessee considering that the same could not be recovered in the foreseeable future decided to write off a debt as bad debt during the previous year relevant to the Assessment Year 1991-92. It is nobody s case that the assessee had not complied with the provisions of Section 36(2) - The assessee took a business decision to write off the debt as a bad debt. Wise businessman would not want to spend good money in litigating for a bad bargain especially in the light of the facts noted above. Having taken the commercial decision to write off the debt as a bad debt based on the material, cannot lead to a conclusion that the decision was not bona fide. The lease rentals offered as income by the Appellant on mercantile basis had become bad and the Appellant decided to write it off and did write off the same in its books of accounts in the previous year in relation to A.Y. 1991-92 in terms of the amended Section 36(1) (vii). In our view, no fault can be found with the same. Reversal of lease rentals - As in our view is not a requirement of Section 36(1)(vii) of the Income Tax Act for allowing a debt as a bad debt. In fact, what emerges from Note-5 of making a special mention is that a prudent practice has been adopted by a limited company of informing its shareholders about the remote possibility of recovery of the said amounts and the decision to reverse and that the same would be accounted for as and when received. The reliance by the Tribunal on the decision of Commissioner of Income - Tax V/s. Coates of India Ltd. 1998 (2) TMI 102 - CALCUTTA HIGH COURT in our view is also misplaced. We observe that the said decision was rendered with respect to the facts of a case relating to the pre-amended Section 36(1)(vii) and not to the post amended situation and is therefore distinguishable. Moreover, in view of what we have already observed with respect to the bona fide nature of the decision by the assessee to write off the debt as irrecoverable, the said decision would not further the case of the Revenue. In our view, the finding of the Tribunal that the claim of the assessee in respect of bad debt cannot be considered, is without any basis. Once, a business decision has been taken to write off a debt as a bad debt in its books which decision as discussed above, is bona fide, that in our view, should be sufficient to allow the claim of the assessee. The method of accounting has no relevance to the issue. Tribunal has misdirected itself in proceeding to give precedence to accounting principles over clear statutory provisions. Evidently, the written off lease rental amount has not been reversed from the income entry in Schedule-16. This is a clear case of writing off a bad debt in accordance with the provision of Section 36(1)(vii) - The Tribunal has erred in rejecting the claim of the assessee for deduction of bad debt written off under Section 36(1)(vii) - The substantial question of law framed in this Appeal is accordingly answered in favour of the Appellant Assessee

Issues Involved:
1. Rejection of the claim for deduction of bad debt written off under Section 36(1)(vii) of the Income Tax Act, 1961.
2. Compliance with the mercantile system of accounting.
3. Bona fide nature of the decision to write off the debt.

Detailed Analysis:

1. Rejection of the Claim for Deduction of Bad Debt Written Off:
The primary issue in this case is whether the Tribunal was right in rejecting the appellant's claim for deduction of bad debt written off under Section 36(1)(vii) of the Income Tax Act, 1961. The appellant, a Non-Banking Finance Company, had written off an amount of Rs. 20,69,805.30 as bad debt for the assessment year 1991-92 due to defaults in lease payments by M/s. Orson Electronics Ltd. The Tribunal had rejected the claim, stating that the write-off was against the established principle of accountancy and violated the mercantile system of accounting. However, the High Court noted that post the amendment of Section 36(1)(vii) effective from 1st April 1989, it is not necessary for the assessee to establish that the debt has become irrecoverable; it is sufficient if the bad debt is written off as irrecoverable in the accounts of the assessee.

2. Compliance with the Mercantile System of Accounting:
The Tribunal had held that the reversal of the entry to claim bad debt was a violation of the mercantile system of accounting. However, the High Court observed that the requirement under Section 36(1)(vii) does not necessitate adherence to the mercantile system for the purpose of writing off bad debts. The High Court emphasized that the statutory provision takes precedence over accounting principles. The appellant had offered the lease incomes for assessment in the respective years and had written off the amount as irrecoverable in its books of accounts, which aligns with the requirements of the amended Section 36(1)(vii).

3. Bona Fide Nature of the Decision to Write Off the Debt:
The High Court examined whether the decision to write off the debt was bona fide. It was noted that the appellant had entered into a bona fide lease agreement and had made payments to the suppliers on behalf of the lessee. The lessee defaulted on further payments, and the appellant had initiated legal proceedings for winding up the lessee company, which had become a sick company. The High Court concluded that the appellant's decision to write off the debt was based on a commercial assessment of the bleak prospects of recovery and was therefore bona fide. The Court referred to the Supreme Court's decision in T.R.F. Ltd. v. Commissioner of Income-tax, which clarified that post the amendment, it is enough if the bad debt is written off as irrecoverable in the accounts of the assessee.

Conclusion:
The High Court found that the Tribunal had erred in rejecting the claim for deduction of bad debt written off under Section 36(1)(vii) of the Act. The substantial question of law was answered in favor of the appellant. The Tribunal's order was set aside, and the Assessing Officer was directed to allow the claim of bad debt of Rs. 20,69,805/- and pass an appropriate assessment order in accordance with this decision. The appeal was allowed with no costs.

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