MADHUSUDAN B.KOCHA vs. THE ASSTT. COMMISSIONER OF INCOME-TAX,CIRCLE-22, MUMBAI.

This Appeal, filed by the Assessee under Section 260A of the Income Tax Act, 1961 (here-in-after referred to as the “ACT of 1961”), is directed against the Judgment and Order dated 1st May, 2003 passed by the learned Income Tax Appellate Tribunal, REKHA PRAKASH PATIL REKHA PRAKASH PATIL Date: 2026.06.16 17:48:29 +0530 CNR No : HCBM020168222003 2026:BHC-OS:13189-DB Mumbai Bench, ‘H’ Mumbai, in connection with Income Tax Appeal No. 308/Bom/1994 pertaining to the Assessment Year 1990-1991, whereby the learned Tribunal has reversed the finding of the Commissioner of Income-Tax (Appeals) [‘CIT(A)’ for short] on the key issue involved in this Appeal.

By the order dated 23rd November, 2004, the Appeal was admitted by framing the following substantial question of law:- “ Whether on the facts and in the circumstances of the case, the Tribunal was justified in law in holding that the bad debt claim of Rs.12,67,121/- made by the Appellant in respect of amount due from Gannon Dunkerly and Co. Limited by writing off the said amount in the Profit and Loss Account and making corresponding entry in the bad debt reserve account was not allowable as deduction?”

The facts and circumstances of the case, giving rise to the filing of the Appeal, in a nutshell, are that the National Thermal Power Corporation (‘NTPC’ for short) was in the process of setting up two Gas based Combined Cycle Power Projects at Auraiya and Kawas. Accordingly, two separate contracts were awarded to M/s Gannon Dunkerly & Co. Limited for setting up the water treatment projects at Auraiya and Kawas. Gannon Dunkerly and Co. Limited entered into a sub-contract with the Appellant for providing chlorination system for both the projects for a consideration of Rs.26 lakhs for each project. However, certain disputes and differences arose by and in between the Appellant and Gannon Dunkerly & Co. Limited pertaining to delay in commissioning the chlorination plant, as a result of which, a sum of Rs.12,67,120.79 payable by Gannon Dunkerly & Co. Limited to the Appellant was withheld. The Appellant had instituted legal proceeding in the High Court of Judicature at Bombay and Delhi for recovery of amount and had also effectively ‘written off’ the amount of Rs.12,67,120.79 in his Profit and Loss Account as “Bad debts Allowance Provision”. The return of the assessee for the Assessment Year 1990-1991 disclosing income of Rs 24,03,990/- was filed on 31-12-1990. The Assessment was completed under Section 143(3) of the Tax Act of 1961 by determining the total income of the assessee as Rs 72,57,595/-. However, by the order dated 31st December, 1992 the Assessing Officer (AO) had disallowed the deduction claimed by the Appellant of an amount of Rs.12,67,120.79, based on the provision made for bad debts by opining that by merely making provision for bad debts of Rs.12,67,121/-, which was not based on ascertained liability, the deduction was not permissible and accordingly, added the said amount to the income of the assessee. The AO had also disallowed certain other allowances claimed by the Assessee with which we are not concerned in the present Appeal and, therefore, the same are not being referred to in this Judgment.

The Appellant had preferred an Appeal before the Commissioner of Income Tax (Appeals) [CIT(A)] against the order of the Assessing Officer dated 31st December, 1992 inter-alia on the ground of dis-allowance of the deduction. The CIT(A), by his Order dated 29th October, 1993, had allowed the appeal by deleting the amount of Rs 12,67,121/- with regard to the provision of bad debt. By observing that the Assessing Officer (AO) has not given cogent reasons for the disallowance, the CIT(A) has also taken the view that the fact that due to the dispute between Gannon Dunkerly and Co. Limited and the Appellant, the said amount was not forthcoming and that there were litigations going on between the parties in the High Court of Judicature at Bombay and Delhi and the Appellant had also posted entries in the Profit and Loss Account and corresponding entries in the bad debts reserve account ought to have been treated as sufficient compliance with the provisions of the statutory requirement for writing off the above amount as irrecoverable debt in the books of the Assessee. As such, it was held that the Assessee/Appellant would be entitled to the deduction in respect of bad debts to the tune of Rs.12,67,121/-.

The AO preferred an Appeal against the order dated 29th October, 1993 on as many as four grounds where-in, the third ground was pertaining to the reversal of finding by the CIT(A) on the point of dis-allowance of the deduction of Rs 12,67,121/-. By the impugned judgement and order dated 1st May,2003, the learned Income Tax Appellate Tribunal (‘ITAT’ for short) had affirmed the order of the CIT(A) as regards the first, second and fourth grounds but reversed the findings of the CIT(A) with regard to the third ground pertaining to the deduction claimed by the Appellant. The findings and observations of the learned Tribunal pertaining to the question of deduction based on provision of bad debt of Rs.12,67,121/- are as follows :- “8. The third ground relates to addition on account of provision for bad debts of Rs.12,67,121. Te AO disallowed the claim of the assessee on the ground that the assessee did not pass proper accounting entry in the books of account. A provision has been created and respective party has not been credited. The CIT(A) deleted the said addition after relying upon the judgment of Hon’ble Gujarat High Court in the case of Sarangpur Cotton CIT(A) and restore that of the AO.”

From the facts and circumstances of the case narrated above, it would be apparent that the core issue involved in this Appeal is pertaining to question as to whether, the assessee had written off the bad debts as per requirement of the statute so as to maintain the claim of deduction under Section 36(1)(vii) of the Act of 1961. 7. It would be pertinent to note herein that as per the pre- amended provision of Section 36(1)(vii), subject to provisions of sub-section (2) of Section 36, the amount of any bad debt or part thereof, which is written off as irrecoverable in the accounts of Assessee for the previous year, would qualify for deduction. By interpreting the said provision, the Gujarat High Court, by relying upon the decision in Jwala Pradad’s case [1953] 24 ITR 537 (Bom), has held in Vitthaldas H. Dhanjibhai Bardanwala vs. Commissioner of Income-Tax, Gujarat-V1 that “writing off” is a technical term used by the financiers and auditors. It was, therefore, observed that once the assessee, by following a particular simple system of account, has posted the relevant debit entries in his Profit and Loss Account and corresponding credit entries are made in the bad debt reserve account thereby, clearly expressing his intention to treat the concerned debt as irrecoverable bad debt, he is said to have done what is required by him by the aforesaid statutory provision and as such, no further duty can be foisted upon him requiring the assessee to also close the existing ledger account of the concerned party in his books of account.

However, by the amendment of the Finance Act of 2001 Explanation-1 has been inserted in Section 36 (1)(vii) of the Act of 1961 with effect from 01-04-1989 which provides that any bad debt or part thereof written off as irrecoverable in the accounts of the assessee shall not include any provision for bad and doubtful debts made in the accounts of the assessee.

Resisting the above arguments, Mr. Suresh Kumar, learned Counsel appearing for the Respondent-Revenue, has argued that the decision in the case of Vithaldas H. Dhanjibhai Bardanwala (Supra) was rendered prior to April 1, 1989, i.e., before the Explanation was inserted to Section 36(1)(vii) and, therefore, the (2010) 323 ITR 166 (SC) said decision of the Gujarat High Court would not have any bearing in the facts of the present Appeal. According to Mr. Suresh Kumar, having regard to the plain language of the “Explanation”, post April 1, 1989, no deduction could be claimed unless the bad debt or any part thereof was written off as irrecoverable in the accounts of the Assessee. He submits that the Assessee cannot claim deduction merely by making provision for bad debt and doubtful debt in the accounts of Profit and Loss Account.

In his attempt to distinguish the decision of the Supreme Court in the case of Vijaya Bank (Supra), Mr. Suresh Kumar has further argued that the aforesaid decision was rendered in the facts of that case, by taking note of the law laid down in the case of Vithaldas H. Dhanjibhai Bardanwala (Supra), which was applicable to the transaction prior to 1st April, 1989 only and not thereafter. Therefore, the Appeal be dismissed.

From a careful scrutiny of the material on record , we find that there were court proceedings pending for recovery of the disputed amount of Rs 12,67,121/- and therefore, the Appellant had written off the amount for all practical purposes by making entry in the P & L Account as bad debt allowance provision against the entry of “sundry debtors”. Corresponding entry was also made in the Ledger account of Gannon Dunkerly & Co. Ltd on the liability side for the period from 1-4-1989 to 31-3-1990 indicating that the same was irrecoverable debt. There is no dispute about the facts that legal proceeding was instituted by the Appellant for recovery of the said amount. However, the amount was not expressly written off by the Appelant by closing the Ledger account. It was on such count the AO had disallowed the deduction by holding that dis-allowance cannot be granted on mere provision.

It is no doubt correct that the decision in the case of Vitthaldas H. Dhanjibhai Bardanwala (Supra), was rendered prior to the amendment of the Finance Act of 2001 inserting the Explanation to Section 36(1)(vii) and to that extent, the ratio laid down in the said decision may not have any relevant bearing in a post 01-04-1989 transaction like the one in hand. However, a question as to whether, the Department was entitled to treat the provision for NPA, which in terms of the RBI Directions, is debited to the P & L Account as ‘income’ under Section 2(24) of the Income Tax Act, while computing the profits and gains of the business under Sections 28 to 43-D of the IT Act came up for consideration Commissioner of Income-Tax, Coimbatore3. While answering the said question, the Hon’ble Supreme Court has made certain observations on the scope of the Finance Act (No.2) of 2001 which came into effect from 1st April, 1989. The observations made in paragraph Nos. 36 and 37 are relevant for this case and therefore, are being reproduced here-in-below :- “36. Prior to 1.4.1989, the law, as it then stood, took the view that even in cases in which the assessee (s) makes only a provision in its accounts for bad debts and interest thereon and even though the amount is not actually written off by debiting the P&L Account of the assessee and crediting the amount to the account of the debtor, the assessee was still entitled to deduction under Section 36(1)(vii). [See CIT v. Jwala Prasad Tiwari (1953) 24 ITR 537 and Vithaldas H. Dhanjibhai Bardanwala (1981) 130 ITR 95 (Guj). Such state of law prevailed upto and including assessment year 1988-89. However, by insertion (w.e.f. 1.4.1989) of a new Explanation to Section 36(1)(vii), it has been clarified that any bad debt written off as irrecoverable in the account of the assessee will not include any provision for bad and doubtful debt made in the accounts of the assessee. The said amendment indicates that before 1.4.1989, even a provision could be treated as a write-off. However, after 1.4.1989, a distinct dichotomy is brought in by way of the said Explanation to Section 36(1) (vii). Consequently, after 1.4.1989, a mere provision for bad debt would not be entitled to deduction under Section 36(1) (vii).

From the above decision, it is clear that after the amendment of the Finance Act 2001 with effect from 1st April, 1989 inserting Explanation to Section 36(1)(vii), a mere provision for bad debt would not be entitled to deduction under Section 36(1)(vii), unless the same is “written off’ by the assessee as irrecoverable debt. However, if the assessee debits the amount of the doubtful debt in the P & L Account and credits the account as “sundry debtors ” account on the liability side, in view of the observations made in paragraph 37 of Southern Technologies Limited (Supra),in our considered opinion, the same would effectively constitute a valid write-off even without an express entry to that effect in the P & L Account and the Ledger, especially in view of the litigation instituted by the Appellant before the competent court of law for recovery of the same amount.

While dealing with a similar question in the case of Vijaya Bank (Supra), the Hon’ble Supreme Court has made the following observations in paragraph No. 8, which are reproduced herein- below for ready reference:- “8. Coming to the second question, we may reiterate that it is not in dispute that Section 36(1)(vii) of 1961 Act applies both to banking and non-banking businesses. The manner in which the write off is to be carried out has been explained hereinabove. It is important to note that the assessee-Bank has not only been debiting the profit and loss account to the extent of the impugned bad debt, it is simultaneously reducing the amount of loans and advances or the debtors at the year-end, as stated hereinabove. In other words, the amount of loans and advances or the debtors at the year-end in the balance-sheet is shown as net of the provisions for the impugned debt. However, what is being insisted upon by the Assessing Officer is that mere reduction of the amount of loans and advances or the debtors at the year-end would not suffice and, in the interest of transparency, it would be desirable for the assessee-bank to close each and every individual account of loans and advances or debtors as a pre-condition for claiming deduction under Section 36(1)(vii) of the 1961 Act. This view has been taken by the Assessing Officer because the Assessing Officer apprehended that the assessee-bank might be taking the benefit of deduction under Section 36(1)(vii) of the 1961 Act, twice over. (See Order of the Commissioner of Income-tax (Appeals) at Pages 66, 67 and 72 of the paper book, which refers to the apprehensions of the Assessing Officer). In this context, it may be noted that there is no finding of the Assessing Officer that the assessee had unauthorisedly claimed the benefit of deduction under Section 36(1)(vii), twice over. The Order of the Assessing Officer is based on an apprehension that, if the assessee fails to close each and every individual account of its debtor, it may result in assessee claiming deduction twice over. In this case, we are concerned with the interpretation of Section 36(1)(vii) of the 1961 Act. We cannot decide the matter on the basis of apprehensions/desirability. It is always open to the Assessing Officer to call for details of individual debtor's account if the Assessing Officer has reasonable grounds to believe that assessee has claimed deduction, twice over. In fact, that exercise has been undertaken in subsequent years. There is also a flip- side to the argument of the Department. The assessee has instituted recovery suits in Courts against it's debtors. If individual accounts are to be closed, then the debtor/defendant in each of those suits would rely upon the bank statement and contend that no amount is due and payable in which event the suit would be dismissed. Before concluding, we may refer to an argument advanced on behalf of the Department. According to the Department, it is necessary to square off each individual account failing which there is likelihood of escapement of income from assessment. According to the Department, in cases where a borrower's account is written off by debiting profit and loss account and by crediting loans and advances or debtors accounts on the assets side of the Balance Sheet, then, as and when in the subsequent years if the borrower repays the loan, the assessee will credit the repaid amount to the loans and advances account and not to the profit and loss account which would result in escapement of income from assessment. On the other hand, if bad debt is written off by closing the borrower's account individually, then the repaid amount in subsequent years will be credited to the profit and loss account on which the assessee-bank has to pay tax. Although, prima facie, this argument of the Department appears to be valid, on a deeper consideration, it is not so for three reasons. Firstly, the Head Office accounts clearly indicate, in the present case, that, on repayment in subsequent years, the amounts are duly offered for tax. Secondly, one has to keep in mind that, under the Accounting practice, the Accounts of the Rural Branches have to tally with the Accounts of the Head Office. If the repaid amount in subsequent years is not credited to the Profit and Loss Account of the Head Office, which is ultimately what matters, then, there would be a mis-match between the Rural Branch Accounts and the Head Office Accounts. Lastly, in any event, Section 41(4) of the 1961 Act, inter alia, lays down that, where a deduction has been allowed in respect of a bad debt or a part thereof under Section 36(1) (vii) of the 1961 Act, then, if the amount subsequently recovered on any such debt is greater than the difference between the debt and the amount so allowed, the excess shall be deemed to be profits and gains of business and, accordingly, chargeable to income tax as the income of the previous year in which it is recovered. In the circumstances, we are of the view that the Assessing Officer is sufficiently empowered to tax such subsequent repayments under Section 41(4) of the 1961 Act and, consequently, there is no merit in the contention that, if the assessee succeeds, then it would result in escapement of income from assessment.”

In the case of Vijaya Bank (Supra), the Assessing Officer had disallowed a sum of Rs.7,10,47,161/- claimed as deduction by the Assessee-Bank, which was reduced from loans and advances or debtors but the Bank had not “written off” the amount in a manner as required under the accounting principles. According to the Assessing Officer, the bad debt supposedly written off by the Assessee-Bank was nothing but a mere provision and the same could not be equated with the actual “write off” of the bad debt, as per the requirement of Section 36(1)(vii) of the IT Act with the Explanation thereto, which was inserted by the Finance Act 2001 with effect from 1st April, 1989. Being aggrieved by the same, the Assessee-Bank had preferred an Appeal before the Commissioner of Income Tax (Appeals), who had held that it was not necessary for the purpose of “writing off” bad debts to pass corresponding entries in the individual account of each and every debtor and it would be sufficient if the debit entries are made in the Profit and Loss Account and corresponding credit is made in the “bad debt reserve account”. The revenue had challenged the decision of the CIT(A) before the Income Tax Appellate Tribunal. However, the Tribunal upheld the contention of the Assessee on three grounds. Firstly, the Assessee had rightly made a provision for bad debt and doubtful debt by debiting the amount of bad debt to the Profit and Loss Account so as to reduce the profits of the year. Secondly, the provision account so created was debited and simultaneously the amount of loans and advances or debtors stood reduced and, consequently, the provision account stood obliterated. Lastly, loans and advances or the sundry debtors of the assessee at the end of the year lying in the Balance Sheet was shown as net of "provisions for doubtful debt" created by way of debit to the Profit and Loss Account of the year and, therefore, the Tribunal was of the view that the deduction under Section 36 (1)(vii) of the Income Tax Act was allowable. The above view of the ITAT was, however, not accepted by the High Court which came to the conclusion that in view of the Explanation vide the Finance Act, 2001 with effect from April 1, 1989, the decision of the Gujarat High Court in the case of Vithaldas H. Dhanjibhai Bardanwala (Supra), no more held the field and hence, mere creation of a provision did not amount to actual “write off’ of the bad debt. However, as would be evident from the foregoing paragraphs, the above view of the High Court was not accepted by the Supreme Court in a case of Vijaya Bank (Supra) for the reasons recorded therein.

That was also a case, where a litigation was pending before the Court for recovery of the amount and, therefore, the assessee- Bank had taken a plea that if the amounts are shown to have been written off then the defendant would take advantage of the same before the Court. In such fact situation, it was held in the case of Vijaya Bank(Supra) that the assessee will be entitled to claim deduction even without specifically writing off the bad debt in the Profit and Loss Account. The above decision also takes note of the law laid down in the case of Southern Technologies Limited (Supra) regarding the manner in which a bad debt is required to be written off.

From a conjoint reading of the observations made by the Supreme Court in the case of Southern Technologies Limited (Supra) and Vijaya Bank (Supra), we are of the considered opinion that the ratio laid down in the two aforesaid decisions would be squarely applicable to the facts of this case. Having made provision for bad debt for the amount of Rs 12,67,121/- in the P&L account and corresponding entry in the Ledger of Gannon Dunkerly & Co.Limited on the liability side, the Appellant had virtually written off the debt as irrecoverable although the said amount may not have been written off strictly as per the Accounting Principles. The amount could not have been expressly reflected as “written off” in the P&L account and the Ledger as the same would have given undue advantage to Gannon Dunkerly & Co Ltd in the litigation. There can be no manner of doubt that unless the Appellant succeeds in obtaining an order or decree from the competent court there is no possibility of recovery of the said amount. The mere fact that the Appellant had instituted legal proceedings for recovery of the amount bears ample testimony of the fact that the amount in question was irrecoverable. Therefore, the present is not a case where the Appellant has claimed deduction of the sum of Rs 12,67,121/- by merely making provision for bad debts in the P&L Account. If the Appellant succeeds in recovering the amount on the strength of a decree or order of the Court any time in future than in that event, the amount would automatically be liable to be taxed for the relevant assessment year. As such, the question of escapement of tax due to the procedure adopted by the Appellant, in our view, also cannot arise in the eyes of law.

For the reasons stated above, the substantial question of law formulated in the Appeal is answered in favour of the Assessee/Appellant and against the Revenue.

In the result, this Income Come Tax Appeal stands allowed to the extent indicated above.

Consequently, the Judgment and Order dated 1st May,2003 passed by the learned ITAT relating to the third ground pertaining to dis-allowance of the deduction, is hereby set aside. The appellate order dated 29th October,1993 of the CIT(A) stands restored to the above extent.

Parties to bear their own cost. (FIRDOSH P. POONIWALLA, J.) (SUMAN SHYAM, J.) { Powered by TCPDF (www.tcpdf.org)