2025 (8) TMI 1192 - HC - Income Tax

Appeal allowed: impugned amounts are actual write-offs, not provisions, and s.41(4) governs tax on recoveries

Sri Jahar Matilal Versus The Commissioner Of Income Tax, Kolkata – Xviii & Anr.

Sri Jahar Matilal Versus The Commissioner Of Income Tax, Kolkata – Xviii & Anr. - TMI ISSUES PRESENTED AND CONSIDERED 1. Whether the sum of Rs. 8,97,676 claimed as bad debt was an actual write-off in the assessee's books of account or merely a provision for bad and doubtful debts, for purposes of deduction under Section 36(1)(vii) of the Income Tax Act. 2. Whether the Assessing Officer could rely on an extra-judicial statement of a third party (proprietor of the debtor) not put to the assessee and not subject to cross-examination to disallow the bad-debt claim. 3. Whether relevant Supreme Court principles (on how to distinguish an actual write-off from a mere provision and on taxability of subsequent recoveries) govern the present factual matrix and compel allowance of the deduction. ISSUE-WISE DETAILED ANALYSIS Issue 1: Characterisation of the amount as actual write-off versus provision (Statutory/Accounting Framework) Legal framework: Section 36(1)(vii) permits deduction of bad debts written off as irrecoverable in the assessee's accounts; the Explanation (post-1989 amendment) excludes mere provisions for bad and doubtful debts from being treated as write-offs. Accounting distinction: (a) actual write-off-debit profit & loss and credit the sundry debtor/loans & advances account (reducing assets); (b) provision-debit profit & loss and credit current liabilities/'reserve for bad debts' (liabilities side). Precedent treatment: The Court relied on binding Supreme Court exposition (including Southern Technologies and subsequent decisions) holding that post-Explanation an actual reduction of debtors/loans and advances on the asset side (so that closing debtors are shown net of the write-off) constitutes a write-off; mere creation of a provision on the liabilities side does not. A High Court/Tribunal decision finding mere provision cannot be treated as write-off was applied where facts showed no reduction of debtors. Interpretation and reasoning: The Court examined the assessee's balance sheet and the Reserve for Bad Debts schedule. The Reserve schedule itself contains a column headed 'Bad Debts written off during the year' showing Rs. 8,97,676 and the balance sheet exhibits sundry debtors net of reserve corresponding to the stated figures, demonstrating that the asset side was shown net of the amount claimed. The party ledger for the specific debtor further recorded reversal of cheques and showed facts consistent with actual irrecoverable loss. On this factual foundation, the Court held the accounting treatment met the Supreme Court's test for an actual write-off (i.e., the amount was effectively removed from loans and advances/debtors in the balance sheet), and therefore the Explanation to Section 36(1)(vii) does not bar the deduction. Ratio vs. obiter: Ratio - where the books show simultaneous debit to profit & loss and corresponding reduction in the asset account (loans & advances/debtors) so that closing debtors are net of the amount, the amount qualifies as an actual write-off under Section 36(1)(vii). Obiter - discussion of practical administrative concerns (e.g., desirability of closing individual debtor accounts for transparency) is explanatory and not decisive of the legal test. Conclusion: The amount of Rs. 8,97,676 is to be treated as a bad debt actually written off (not a mere provision) and is allowable under Section 36(1)(vii) in view of the books and ledger entries showing netting off on the asset side. Issue 2: Admissibility and weight of third-party statement relied upon by the Assessing Officer Legal framework: Principles of natural justice and regularity in assessment proceedings require that statements or material adversely affecting an assessee be put to the assessee and afford opportunity of explanation/cross-examination where appropriate; evidence not so tested cannot be used to conclude facts against the assessee. Precedent treatment: The Tribunal and lower authorities relied on a statement attributed to the proprietor of the debtor (denying outstanding or cheques). The Court treated that reliance as improper because the statement was not put to the assessee and there was no opportunity to cross-examine or rebut same during assessment proceedings. Interpretation and reasoning: The Court found that the Assessing Officer's reliance on the untested statement was unjustified in view of the contemporaneous documentary entries (ledger, cheques reversed, reserve schedule and balance sheet). The procedural omission (failure to furnish the statement to the assessee or allow cross-examination) rendered that material inadmissible for the purpose of disallowing the deduction. Ratio vs. obiter: Ratio - an untested, extra-judicial statement relied upon to displace contemporaneous books and records, when not put to the assessee or subjected to cross-examination, is inadmissible to justify disallowance. Obiter - none material beyond the foregoing principle. Conclusion: The Assessing Officer's reliance on the third-party statement was procedurally improper and could not form a lawful basis to deny the bad-debt deduction. Issue 3: Applicability of Section 41(4) (taxation of subsequent recoveries) to safeguard revenue and its effect on the allowable write-off Legal framework: Section 41(4) deems excess recoveries (when recoveries exceed difference between debt and amount already allowed) to be income of the year of recovery; this mechanism prevents permanent tax escape where an earlier write-off deduction is allowed and later recovered. Precedent treatment: The Court relied on Supreme Court authority explaining that fears of escapement of income do not justify disallowance of a bona fide write-off when statutory safeguards (Section 41(4)) and accounting/head-office practices ensure subsequent recoveries are taxed. Interpretation and reasoning: The Court considered the Department's apprehension that not closing individual accounts could permit double benefit or escapement. It found the apprehension addressed by (i) accounting/head-office reconciliation practices, (ii) absence of any finding of actual double claim, and (iii) Section 41(4) which empowers taxation of subsequent recoveries. Thus revenue protection concerns do not negate an otherwise allowable write-off. Ratio vs. obiter: Ratio - statutory provision (Section 41(4)) and accounting reconciliation suffice to protect tax revenue; such protection does not justify denying deduction where the accounting treatment shows an actual write-off. Obiter - detailed policy discussion on desirability of closing individual accounts is explanatory. Conclusion: Revenue protection considerations do not justify disallowance of the deduction where write-off is established; subsequent recoveries can be taxed under Section 41(4). Overall Conclusion and Disposition The Court held that the authorities below erred in treating the claimed amount as mere provision; on the facts the amount was actually written off in the books (asset side shown net, ledger and cheque entries support write-off), the Assessing Officer's reliance on an untested third-party statement was inadmissible, and established Supreme Court principles and Section 41(4) support allowance of the deduction. The Tribunal's and lower orders were set aside and the bad-debt deduction of Rs. 8,97,676 was allowed.