Sucheta Dalal :Supreme Court allows deductibility of bad loans
Sucheta Dalal

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Supreme Court allows deductibility of bad loans   

March 4, 2010

The Supreme Court has ruled that it is not obligatory on the taxpayer to prove whether a loan has become a bad loan, once such loan has been written off in the books of accounts.


The apex court in a ruling in the case of TRF Ltd versus Commissioner of Income-Tax held that the position in the law is well-settled and after 1 April 1989, it is not necessary for the assessee to establish that the loan, in fact, has become irrecoverable.


This is an important decision rendered by the Supreme Court on the issue of allowability of bad loan as a deduction from business income and this sets at rest the doubts and the widespread litigation that was prevalent in the matter, said Ameet Patel, partner, Sudit K Parekh & Co.


In a tax-alert note, the chartered accountancy firm said that the Income-Tax Act, 1961 has a special section that allows deduction from business or professional income in respect of bad loans. The relevant section is 36(1) (vii).


Earlier, the section was worded in a manner which was interpreted to mean that the taxpayer needed to establish conclusively to the satisfaction of the assessing officer that the amount written off had actually become bad. This led to a situation where most of the times, the taxpayer had to put in extra efforts to show that the loan had actually become bad, the steps taken for recovery of the same and whether any legal action had been taken against the loaner.


Practically, in many cases, bad loans were not allowed as a deduction because the taxpayer was not able to conclusively establish that the loan had become bad.


However, with effect from assessment year 1989-90, there was an amendment in the said section whereby the necessity for establishing the fact that the loan has actually become bad has been done away with. After the said amendment, the only conditions to be fulfilled by a
taxpayer for successfully claiming a deduction in respect of bad loans are as under:


1. The amount which is claimed as a deduction should have been taken into account in computing the income of the assessee for the year in which the amount is written off or any earlier year and

2. The amount should be written off as irrecoverable in the books of accounts of the assessee for the accounting year in which the claim for deduction is made.


The wordings of the Section 36(1)(vii) read with circular 551 dated 23 January 1990 issued by the Central Board Of Direct Taxes (CBDT) leave no scope for debate that any amount incidental to the business or profession of the assessee, which is taken into account in computing the assessable income would be allowed for deduction as a bad loan, if it is written off in the books of the assessee in the previous year.


Despite the above clear provisions of the law, many tax officers continued to disallow the claim for bad loans on the ground that the taxpayer had not conclusively established that the loan had actually become bad. In most cases, the matter had been taken up for litigation. Many Tribunal Benches have held against the Income-tax Department and in favour of the taxpayer that after the amendment to Section 36(1) (vii), the taxpayer does not have to prove the fact that the loan has actually become bad. 


Indian courts have time and again reaffirmed the above view and accordingly allowed the claim of bad loans deductibility.


In a judgment in the case of the Commissioner of Income-Tax versus Star Chemicals (Bombay) Pvt Ltd, the Bombay High Court has reiterated the view that the fact that the loan has been written off as irrecoverable in the accounts of the assessee will suffice for claiming it as a deductible bad loan. It is for the assessee to decide whether the loan has become bad or not and the assessing officer can never insist on production of demonstrative and infallible proof that the loan has become bad. — Moneylife Digital Team


-- Sucheta Dalal