2025 (8) TMI 1314 - AT - Income Tax

Advances written off to subsidiary held deductible under section 37(1) or as bad debt under section 36(1)(vii)

Adarsh Developers Versus The Deputy Commissioner of Income Tax, Central Circle 2 (1), Bangalore. And (Vice-Versa)

Adarsh Developers Versus The Deputy Commissioner of Income Tax, Central Circle 2 (1), Bangalore. And (Vice-Versa) - TMI ISSUES PRESENTED AND CONSIDERED 1. Whether the write-off of advances to a wholly-owned subsidiary qualifies as a deductible business expenditure under section 37(1) of the Income-tax Act. 2. Whether the write-off is assessable under section 36(1)(vii)/section 36(2)(i) (bad debts/provision rules) instead of section 37, and the relevance of precedents that treat advances to subsidiaries as non-trading/capital in nature. 3. Whether the write-off is capital in nature (hence not deductible) or revenue in nature. 4. Whether the write-off could be disallowed because (a) the subsidiary was making repayments/reducing outstanding balances, (b) there was no evidence that the loss accrued in the relevant year, or (c) the write-off was a colourable device to avoid tax on other receipts. 5. Whether allowing the write-off in the assessee's hands would result in double relief when the subsidiary offered equivalent amounts as income. ISSUE-WISE DETAILED ANALYSIS Issue 1 - Allowability of write-off under section 37(1) Legal framework: Section 37(1) allows deductions for expenditure (not falling under sections 30-36 and not capital or personal) 'wholly and exclusively for the purposes of the business'. Precedent treatment: The Tribunal reviewed multiple authorities permitting write-offs of advances to group/wholly-owned subsidiaries where there was business nexus and commercial expediency (decisions of various High Courts and Tribunals cited by the assessee). It also considered authorities cited by Revenue which deny deduction where advances are capital/investment in an unrelated business. Interpretation and reasoning: The Tribunal analysed facts showing (a) transfer of hospitality business and related assets/licenses to the subsidiary; (b) identity/similarity of business objects between the assessee and the subsidiary; (c) substantial equity infusion and continuing advances from the assessee to the subsidiary; (d) lenders' preference for a corporate SPV and consequent transfer for commercial expediency; and (e) resolution by partners crystallising irrecoverability during the relevant year (triggered by COVID-19 impact). Applying the statutory test, the Tribunal found the advances were made in the ordinary/extended course of the assessee's business and were incidental to carrying on that business; the write-off therefore satisfied the 'wholly and exclusively' requirement and was not capital or personal expenditure. Ratio vs. Obiter: The finding that the write-off met the tests of section 37(1) on the particular factual matrix is ratio for the allowed deduction. Observations about commercial expediency and the irrelevance of the AO 'sitting in the arm-chair of the businessman' follow established ratio and are applied here (ratio). Conclusion: The write-off was allowable as an expenditure under section 37(1) on the facts presented. Issue 2 - Applicability of section 36(1)(vii)/section 36(2)(i) and Southern Technologies line Legal framework: Section 36(1)(vii) permits deduction of bad debts subject to conditions in section 36(2)(i); the explanation excludes provisions for doubtful debts from 'bad debt' treatment. The Supreme Court authority relied on by AO dealt with allowability of provisions (i.e., accounting provisions/NPA provisions) under section 37 when excluded from section 36. Precedent treatment: Revenue relied on a Tribunal decision (VST) and the apex decision concerning provisions; the Tribunal distinguished those precedents on facts and legal scope. Interpretation and reasoning: The Tribunal emphasised that the apex case concerned provisions for doubtful debts (i.e., accounting provisions) and not a crystallised write-off by resolution. The VST decision was factually distinguishable because in VST parent and subsidiary had divergent businesses and the advances were not incidental to the parent's trade. Here, advances arose from identical/related hospitality activities, and some part of the amounts had been reflected as income in the subsidiary's books in earlier years. The Tribunal also noted authorities holding that where part of a debt was earlier taken into account for income computation, the requirements of section 36(2)(i) can be satisfied for that part. Ratio vs. Obiter: Distinguishing VST and Southern Technologies on factual and legal scope is ratio for the conclusion that those precedents do not bar deduction under section 37(1) in the present facts; the general observations about the distinction between provisions and crystallised write-offs are clarificatory but necessary to the ratio. Conclusion: Section 36(2)(i) jurisprudence and the apex ruling on provisions do not preclude a section 37(1) deduction where the write-off is a crystallised business decision and advances are incidental to the business; the AO's reliance on those authorities was misplaced on the facts. Issue 3 - Revenue v. capital character of the write-off Legal framework: Deduction requires the expenditure not be capital in nature; investments/advances that create enduring benefits are typically capital. Precedent treatment: The Tribunal applied precedent treating investments in a 100% subsidiary made for business purposes (and treated as stock-in-trade or business assets) as revenue in nature when the investment/advance was in furtherance of the assessee's business and not for creating an independent enduring capital asset. Interpretation and reasoning: The Tribunal found facts that the assessee transferred the business to the subsidiary for funding/operational reasons, retained control, infused equity and loans, and routinely treated divestment proceeds as business income in prior years. Those facts showed the advances were part of ordinary business operations (revenue), not an investment resulting in a separate enduring capital asset. The Tribunal rejected AO's characterization of the advances as capital on these facts. Ratio vs. Obiter: The factual determination that advances were revenue in nature is ratio for allowance; the legal proposition that nature depends on the factual business nexus is established law applied here (ratio). Conclusion: On the factual matrix, the advances/write-off were revenue in nature and not capital, supporting allowance under section 37(1) (and alternatively under section 36 where applicable). Issue 4 - Timing, repayments, and alleged colourable device to avoid tax Legal framework: Deduction must generally correspond to expenditure/loss 'incurred' in the relevant year; repayments or subsequent receipts are relevant facts but do not automatically preclude write-off if irrecoverability crystallised. Precedent treatment: Authorities cited demonstrate that book write-off by a bona fide business decision, supported by resolutions and facts (including triggering events), suffices; courts have cautioned against the revenue substituting commercial judgment for taxpayer's business decisions. Interpretation and reasoning: Revenue pointed to ledger patterns showing repayments/reductions and to a large receipt in the relevant AY as indicative of a tax-avoidance motive. Tribunal examined the ledger history (showing back-and-forth flows and substantial cumulative advances), the partner resolution of 16.3.2020, the pandemic as a heightened triggering event, and documentary support (approvals, funding history, loan schedules). It held that partial repayments and running account movements do not negate bona fide crystallisation; the AO cannot substitute his business judgment for appellant's commercial call. The Tribunal also found that proceeds yielding income had been offered in earlier years and that corresponding amounts were shown in subsidiary's books, so disallowing the write-off would entail double addition. Ratio vs. Obiter: The conclusion that repayments and account fluctuations do not preclude a bona fide write-off when supported by resolution and circumstances is ratio on facts; remarks on the limits of AO's role are reiterations of established law (ratio/applicable guidance). Conclusion: The write-off occurred in the relevant year as a bona fide commercial decision triggered by objective circumstances (pandemic and negative net worth); ledger movements and repayments did not justify disallowance nor establish a colourable device to avoid tax. Issue 5 - Double addition concern where subsidiary offered equivalent amount as income Legal framework and precedent: The Tribunal noted that where corresponding income is offered in the books of the subsidiary, disallowing deduction in the parent would create double taxation; earlier decisions recognise relevance of reciprocal tax positions in group write-off contexts. Interpretation and reasoning: The Tribunal found that equivalent amounts were offered/treated in the subsidiary's accounts in relevant years, and this fact supports the assessee's position that the write-off is revenue-neutral for the consolidated group and that denying the deduction in the parent would result in double addition. Ratio vs. Obiter: The finding is fact-specific but forms part of the operative ratio justifying allowance to avoid double counting of income/loss within related entities. Conclusion: The existence of corresponding entries in the subsidiary's hands reinforced allowability and weighed against the AO's disallowance (avoiding double addition). OVERALL CONCLUSION The Tribunal upheld the appellate authority's conclusion: the write-off of advances to the wholly-owned subsidiary qualified as a deductible business expenditure under section 37(1) (and alternatively met conditions for bad debt treatment where relevant) on the facts-business nexus, commercial expediency, crystallisation during the year (triggered by COVID-19 impact and partner resolution), revenue (not capital) character, and corresponding income recognition in the subsidiary. The revenue's appeal was dismissed.