Bad Debt – Prior to 1-4-1989 – Allowable as deduction even in cases in which the assessee(s) made 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 profit and loss account of the assessee and crediting the amount to the account of the debtor.

The assessee, the Kerala State Industrial Development Corporation Ltd., a limited company wholly owned by the Government of Kerala, had advanced large amounts to Vanchinad Leather Ltd., a joint sector company promoted by the assessee in the year 1974 for processing hides and skins. The company started commercial production in 1977. However, it was closed down in 1980. Later it was reopened in September, 1982 and again closed down in January, 1983.

During the assessment year 1988-89, the assessee claimed deduction of Rs.55,70,949 as a provision for bad debts as in February, 1988 a declaration was made by BIFR that Vanchinad Leather Ltd. had become a sick company. The claim was disallowed on the ground that no reasonable steps had been taken for recovery of the debts and further, no part of the outstanding amount had been assessed as the income of earlier years. Also, the amount was not written off in the assessee’s accounts in claiming bad debts. The Commissioner of Income Tax (Appeals) confirmed the disallowance. The Tribunal dismissed the appeal, taking the view that the assessee could not prove that the debt had become irrevocable during the previous year and that the condition for claiming deduction u/s. 36(2)(i)(b) were not satisfied.

The following question of law was referred to the High Court u/s. 256(1) of the Act:
“Whether, on the facts and in the circumstances of the case, the Tribunal is justified in holding that the claim of bad debts in respect of Vanchinad Leather Ltd. was not legally sustainable and allowable?”

The High Court answered the question in favour of the revenue and against the assessee, holding that in the profit and loss account the assessee had made only a provision for bad and doubtful debt and the debt had not been written off as bad debts.

On an appeal to the Supreme Court by the assessee, the Supreme Court noted that till the end, the company could not be revived and it had been wound up. In the circumstances, applying the commercial test and business exigency test, the Supreme Court held that both the conditions u/s. 36(1)(vii) read with section 36(2)(i)(b) of the Act were satisfied observing that in Southern Technologies Ltd. v. CIT (320 ITR 577) it had held that prior to 1-4-1989 even in cases in which the assessee(s) made 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 profit and loss account of the assessee and crediting the amount to the account of the debtor, the assessee was still entitled to deduction u/s. 36(1) (vii). According to the Supreme Court, there was no reason to deny to the assessee the claim for deduction of bad debt.