Deduction of Bad Debts: Supreme Court's Ruling on Section 36 Compliance and alternative claim u/s 37

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Deciphering Legal Judgments: A Comprehensive Analysis of Case Law

Reported as:

2022 (8) TMI 1141 - Supreme Court

Introduction

In a landmark judgment, the Supreme Court addressed the complexities surrounding the deduction of bad debts under the Income Tax Act, 1961 ("IT Act"). The case involved the Revenue's appeal against the Bombay High Court's decision, which had affirmed the Income Tax Appellate Tribunal's (ITAT) ruling in favor of the assessee, a real estate developer and financier. The central issue was whether the assessee's claim of ₹10 crores as a bad debt, written off due to non-repayment by a developer, was justified under Section 36(1)(vii) read with Section 36(2) of the IT Act. The ₹10 crores was initially advanced as a deposit towards acquiring commercial premises in an upcoming project by the developer. When the project failed to progress, the assessee sought the return of the funds, which were not repaid, leading to the write-off. Additionally, the court examined the alternative claim under Section 37 of the IT Act, addressing whether the amount could be considered a business expenditure.

Arguments Presented

Revenue's Contentions

Inadequate Substantiation: The Revenue argued that the assessee failed to provide adequate material or documentation to substantiate the claim that ₹10 crores were advanced to M/s C. Bhansali Developers Pvt. Ltd. for a commercial project.
Contradictory Claims: The Revenue highlighted the inconsistency in the assessee's claims, noting that while the amount was initially presented as an advance for property acquisition, it was later described as a loan, without clear terms or conditions.
Section 36 Compliance: It was contended that the AO must be satisfied that the write-off meets the criteria under both Section 36(1)(vii) and Section 36(2) of the IT Act. The Revenue relied on precedents like Catholic Syrian Bank Ltd. v. Commissioner of Income Tax to emphasize the assessee's obligation to prove the validity of the claim.
Belated Claims: The Revenue also argued that the alternative claim under Section 37, for business expenditure, was raised belatedly, after the CIT(A) order.

Assessee's Defense

Ordinary Course of Business: The assessee contended that the advance was made in the ordinary course of business, aligning with its business objectives of real estate development and financing.
Board Resolution: The decision to write off the amount as a bad debt was made by the Board of Directors due to the builder's failure to return the funds.
Post-1989 Legal Position: The assessee relied on the judgment in T.R.F. Limited v. Commissioner of Income Tax to argue that post-1989, the AO should not scrutinize the write-off in detail if it is recorded as irrecoverable in the accounts.
Alternative Claim: The assessee argued that even if the claim under Section 36(1)(vii) was unsuccessful, the expenditure could be considered under Section 37 as it was laid out for business purposes.

Court's Analysis

Section 36 of the IT Act

The court examined the provisions of Section 36, noting that deductions for bad debts under Section 36(1)(vii) are subject to the conditions in Section 36(2). The court referenced key judgments, including Southern Technologies Ltd. v. Joint Commissioner of Income Tax and Catholic Syrian Bank Ltd., to outline the prerequisites for claiming such deductions. The court emphasized that mere write-off without appropriate accounting treatment and compliance with statutory requirements does not entitle an assessee to claim deductions.

Inconsistent and Unsubstantiated Claims

The court observed that the assessee failed to substantiate the claim that the ₹10 crores were advanced in the ordinary course of business. The documentation was inadequate, and there was no clear evidence of the terms and conditions of the alleged loan or the property acquisition agreement. Additionally, the court noted the inconsistency in the assessee's claims, which further weakened their case.

Capital Expenditure

The court also addressed the nature of the expenditure, determining that the amount given for acquiring immovable property constituted capital expenditure. As such, it could not be treated as a business expenditure eligible for deduction under Section 36 or Section 37.

Section 37 of the IT Act

The court cited Southern Technologies Ltd., reiterating that 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. Section 37 applies only to items which do not fall in Section 30 to 36. If a provision for doubtful debt is expressly excluded from Section 36 (1) (vii) then such a provision cannot claim deduction under Section 37 of the IT Act.

Conclusion

The Supreme Court set aside the judgments of the ITAT and the Bombay High Court, concluding that the assessee's claim for the deduction of ₹10 crores as a bad debt did not meet the statutory requirements. The appeal by the Revenue was allowed, reinforcing the need for clear substantiation and compliance with the IT Act provisions for claiming such deductions.

Comprehensive Summary

The Supreme Court, in this judgment, clarified the conditions under which bad debts can be written off for tax purposes. The court emphasized the importance of substantiating claims with adequate documentation and highlighted the statutory requirements under Sections 36(1)(vii) and 36(2) of the IT Act. The court found that the assessee failed to provide sufficient evidence to support their claim and noted inconsistencies in their arguments. Furthermore, the court ruled that the expenditure in question was capital in nature and could not be claimed as a business expense under Section 37. Consequently, the court set aside the decisions of the ITAT and the Bombay High Court, allowing the Revenue's appeal.

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2022 (8) TMI 1141 - Supreme Court