In a recent and landmark judgment, honorable Supreme court has decided the following issue:

Whether AO was justified in adding back the provision for doubtful debts of Rs.92,15,187/- to the net profit under clause (c) of the Explanation to Section 115JA of the Income-tax Act, 1961?

In this case honorable Supreme Court observed that:

Explanation to section to 115JA has provided six items, i.e., Item Nos.(a) to (f) which if debited to the profit and loss account can be added back to the net profit for computing the book profit. In this case, we are concerned with Item No. (c) which refers to the provision for bad and doubtful debt. The provision for bad and doubtful debt can be added back to the net profit only if Item (c) stands attracted. Item (c) deals with amount(s) set aside as provision made for meeting liabilities, other than ascertained liabilities. The assessee's case would, therefore, fall within the ambit of Item (c) only if the amount is set aside as provision; the provision is made for meeting a liability; and the provision should be for other than ascertained liability, i.e., it should be for an unascertained liability. In other words, all the ingredients should be satisfied to attract Item (c) of the Explanation to Section 115JA. In our view, Item (c) is not attracted. There are two types of "debt". A debt payable by the assessee is different from a debt receivable by the assessee. A debt is payable by the assessee where the assessee has to pay the amount to others whereas the debt receivable by the assessee is an amount which the assessee has to receive from others. In the present case "debt" under consideration is "debt receivable" by the assessee. The provision for bad and doubtful debt, therefore, is made to cover up the probable diminution in the value of asset, i.e., debt which is an amount receivable by the assessee. Therefore, such a provision cannot be said to be a provision for liability, because even if a debt is not recoverable no liability could be fastened upon the assessee. In the present case, the debt is the amount receivable by the assessee and not any liability payable by the assessee and, therefore, any provision made towards irrecoverability of the debt cannot be said to be a provision for liability. Therefore, in our view Item (c) of the Explanation is not attracted to the facts of the present case. In the circumstances, the AO was not justified in adding back the provision for doubtful debts of Rs.92,15,187/- under clause (c) of the Explanation to Section 115JA of the 1961 Act.

(For full text of judgment - visit 2008 -TMI - 30808 - SUPREME COURT)

 

(Please note that Explanation1 to section 115JB contains item no. (a) to (j) as against items no. (a) to (f) of Explanation to section 115JA, but the item no. (c) is same on which honorable Supreme Court has delivered this landmark judgment.)

Provision for doubtful debts: not an add back to book profit when it reflects diminution in receivables rather than a liability. A provision for doubtful debts that reflects probable diminution in the value of receivable assets is not a provision made to meet a liability and therefore does not fall within the Explanation's item permitting add back to book profit; the item requires (1) an amount set aside as a provision, (2) that the provision is for meeting a liability, and (3) that the liability is other than ascertained, so all three ingredients must be satisfied before an add back can be made.