The Hindu Business Line : Honest opinion necessary for write-off

The judgment of the assessee in regarding a debt as a bad debt must be an honest judgment and not a convenient one. The question is really one of fact depending upon diverse circumstances bearing on the debtor's pecuniary position, his commitments and obligations.

There are a few provisions in the Income tax Act, 1961 that permit a taxpayer to claim a deduction based on his judgment as to the true nature and character of a transaction. In case of every item of expense, the taxpayer has to take a call and decide whether such expense is revenue or capital in nature and if it is on revenue account, whether it is incurred for the purpose of his business.

Another important issue on which a taxpayer is required to decide at the time of claiming deduction pertains to the write-off of an amount which he considers irrecoverable. The Courts have emphasised that so long as the decision of the taxpayer is an honest one, the tax department is bound by it and Courts will stand by such opinion of a taxpayer who alone can take a view having regard to the credit worthiness of the debtor and the nature of the transaction.

Some Cases in point

In Devi Films Ltd v. C.I.T. (49 I.T.R. 874), it was held that what is required is an honest judgment on the part of the assessee at the time when he makes the write-off in the light of events up to that stage and the Department cannot insist on demonstrative proof, which is infallible.

The Division Bench concluded that there is no acid test to ascertain whether a debt has become bad and doubtful. The question is really one of fact depending upon congeries of facts and diverse circumstances bearing on the debtor's pecuniary position, his commitments and obligations, and the natural apprehensions that would be caused in the minds of the creditors regarding recovery of their dues.

The Court further held that it cannot be laid down as an inflexible rule of law that a waiver by a creditor of a position of his debt would amount to proof of the debt, or any portion thereof, having become bad and doubtful. The onus of establishing that the write-off of the alleged bad debt is proper and permissible in the circumstances of the case is upon the assessee.

In Sarangpur Cotton Mfg Co Ltd v. C.I.T. (143 I.T.R. 166) rendered by the Gujarat High Court, it was held once the assessee has posted entries in the profit and loss account, that would be sufficient compliance with the provisions of statutory requirement for writing-off as irrecoverable the concerned debt. When a businessman writes-off an amount, there is prima facie evidence that the amount is irrecoverable.

In A.W. Figgis and Co P Ltd v. C.I.T. (254 I.T.R. 63), it was held by the Calcutta High Court that if the assessee knows that filing of a suit would not in any way help the assessee to recover the amount, but rather burden the assessee with additional financial expenses, the filing of the suit is not necessary to write-off the debt as a bad debt.

The decision of Jhunjhunwala Co v. Asst C.I.T. (259 I.T.R. 178), rendered by the Bombay High Court is a case where the management of the two debtor textile mills was taken over by the Union Government which categorically informed the assessee that it was not possible for the Government to make payment to the suppliers of raw material to the two mills during the pre-takeover period.

Further, in view of Section 8(1)(c) of the Textile Undertakings (Taking Over of Management) Ordinance, 1983, no proceedings for winding up or for the appointment of a liquidator or for the appointment of a receiver could lie except with the consent of the Union Government. It categorically rejected the representation made by the assessee. On that fact, the Court came to the conclusion that there was no material available which would show the possibility of recovery.

In the case of South India Surgical Co Ltd v. C.I.T. (287 I.T.R. 62), the facts were that the assessee carried on the business of manufacturing and marketing surgical instruments.

It supplied goods to reputed hospitals and most of them were Government hospitals. While still maintaining the business transactions and making supplies to these hospitals from which amounts were due, the amounts due from them were written-off by the assessee as bad debts. The Assessing Officer disallowed the claim of bad debts in a sum of Rs 65.2 lakh under Section 36(1)(vii) of the Income tax Act, 1961, for the assessment year 1996-97 which was confirmed by the appellate authorities.

Madras High Court judgement

The Madras High Court held that it was clear from the order of the Commissioner (Appeals) that on a perusal of the correspondence produced by the assessee, the hospitals concerned had acknowledged that they were due to pay these amounts to the assessee. It was only paucity of allocated budget to the hospitals that resulted in non-payment.

It would be preposterous to consider that the Government was not in a position to discharge its acknowledged debt. It might be due to certain fund flow problems and priority between different needs that there was postponement in discharging liability by the Government. There was no negation of the claim nor had any Government hospital written that they would not pay any of these amounts.

The other parties to whom huge amounts running into lakhs were due were public and private hospitals with whom the assessee was continuing its business transactions. Except the unilateral act of the assessee to write-off the debts as bad debts in the books of account for the previous year relevant to the assessment year in question, the assessee had not made out any case to regard the debts in question as irrecoverable.

The judgment of the assessee in regarding the debts as bad was not an honest judgment having regard to the financial position of the hospitals. Therefore, the Tribunal was right in law in holding that the debts claimed by the assessee as bad had not become bad and thus were not allowable as deduction under Section 36(1)(vii).

Honest, but not convenient

In conclusion, the Court laid down the proposition that it is not sufficient for the assessee to say that he became pessimistic about the prospect of recovery of the debt in question.

He must feel honestly convinced that the financial position of the debtor was so precarious and shaky and that it would be impossible to collect any money from him. The question is really one of fact depending upon diverse circumstances bearing on the debtor's pecuniary position, his commitments and obligations.

The judgment of the assessee in regarding a debt as a bad debt must be an honest judgment and not a convenient judgment. The judgment of the assessee must be established to have been taken on relevant facts and circumstances which should show that the debt is not realisable for some fault on the part of the debtor or some supervening impossibility on the part of the debtor to pay, but not possible difficulties or hurdles the assessee may have to incur to compel the recalcitrant debtor to pay.

The Court further held that the assessee for his convenience may decide that the debt is too small and it is not worthwhile to pursue the debtor but that judgment would not be an honest one which would establish that the debt has become a bad debt. A time-barred debt can be assumed to be bad, but is not necessarily bad because of expiry of limitation for recovery of the same.

(The author, a Mumbai-based advocate specialising in tax laws, can be contacted at ranina@bom2.vsnl.net.in)