The Hindu Business Line : Treatment of claims for bad debts

If investors do not pay up and settle transactions, brokers eventually have to write off the dues as bad debt.
How does the income-tax law deal with these bad debts incurred by a stock broker?

V.K. Subramani

Volatile movement of the stock market this year has left many investors high and dry due to huge capital losses. The share broking community, too, is faced with twin dilemmas. One, a shrinkage in daily transaction volume and resultant commission income and, two, erosion of capital due to non-payment of settlement dues by customers.

When the capital market was booming, share brokers acted as wise counsel to the investors, who had surplus funds and were looking for investment avenues to make quick profits. Without looking into the strength or weakness of the financial statements of entities, based on mere movement of shares and its trends using the statistical techniques, huge amounts were deployed in share markets, which eventually caved in, putting the investors in jeopardy.

With markets falling every other day, share brokers now advise potential buyers to opt for blue-chip scrips to their portfolio to make profits when the market recovers. But, after the completion of transaction, if investors do not make payment for settlement of the transaction, the brokers eventually have to write off the dues as bad debt.

How does the income-tax law deal with these bad debts incurred by a stock broker?

In Ashokkumar & Lalithkumar’s case (53 ITD 326) (Ahd.) it was held that for claiming bad debt the condition to be satisfied by the taxpayer is mere write-off in the book of accounts. The change of law, effective . April 1, 1989, was recognised by the tribunal in this decision. However, other parameters for bad debt claim remain as before, that is, it must be a debt in the course of business and is reckoned for computing the income of the taxpayer.

India Infoline

Taxpayer India Infoline Securities (25 SOT 123) resorted to purchase and sale of shares on behalf of customers. When the purchase order was placed, it had 20 per cent as margin money for executing the transaction on behalf of its client. Ultimately, when the settlement was made, the profit or loss from the transaction was booked in the account of the customer resulting in amounts due from the client or a payout.

However, the broking firm could not recover money from the customers and claimed bad debt of Rs 50.26 lakh for assessment year 2003-04. The bad debt claim of the taxpayer was not accepted by the assessing officer, who held that the claim does not satisfy the conditions prescribed by law. The Commissioner (Appeals) technically found the reasoning of AO as valid and confirmed the disallowance.

The tribunal held that two conditions are to be satisfied for allowance as bad debt: (i) the debt is taken into account for computing the income of the taxpayer and (ii) it represents money lent in the ordinary course of business carried on by the taxpayer.

The alternative plea for allowance as “business loss” was impliedly admitted by the tribunal in principle. The matter was remanded to AO to consider the allowance as business loss.

Kotak Securities

In the Kotak Securities case (25 SOT 440), the taxpayer similarly claimed bad debts write-off, which was not accepted by the tax officer. However, the taxpayer explained that the amounts written off as bad debt were taken into account in computing the income in that year or in the earlier year.

Factually, it was found that the amount written off as bad debt was disclosed as income previously and, hence, the tribunal directed the AO to allow bad debts claim.

Onus of proof

What should the stock broker do to prove that the amount written off was taken into account in computing his taxable income? The brokerage income from the defaulting customer must have been accounted for as income first and thereafter it could be written off as bad debt. Such write offs may be in the same year or in the subsequent year.

(The author is an Erode-based chartered accountant.)

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