2022 (7) TMI 963 - HC - Income Tax

Court allows NBFC's bad debt deduction under Income Tax Act, emphasizing commercial assessment validity.

M/s. L.K.P. Merchant Financing Ltd. Versus The Dy. Commissioner of Income Tax, Special Range – 34, Mumbai

M/s. L.K.P. Merchant Financing Ltd. Versus The Dy. Commissioner of Income Tax, Special Range – 34, Mumbai - [2022] 447 ITR 507 (Bom) 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.