Income Tax - assessee is no more required to prove that debt had become bad before claiming allowance for bad debt; recovery of the principal amount itself being doubtful there cannot be any accrual of interest: ITAT

By TIOL News Service

MUMBAI, JUNE 21, 2009: SEVERAL grounds were agitated and decided in this case.

Bad Debts: Assessee is manufacturer of synthetic fibre yarn and related materials and also did job work. On the bad debt claim, assessee was required by the A.O to explain when it was offered to tax and steps that were taken to recover the debts. Though the assessee did not initially give reply, later on, in response to a show cause notice issued by the A.O, it claimed such bad debts which were written off in its books of accounts to be allowable under Section 36(1)(vii) of the Income Tax Act 1961 (in short the Act). However, the A.O disallowed the claim citing two reasons. First one was that assessee could not prove that the debtors which were written off were on Revenue Account and formed the part of the total income in any of the earlier previous year and the second reason was that assessee could not establish the debts to have become bad.

The CIT(A) confirmed the disallowance since according to him, the Madras High Court in South India Surgical Co. Vs. ACIT (2006-TIOL-163-HC-MAD-IT) had clearly held that an assessee had to establish that debts had become bad, before effecting a write off.

The Tribunal observed that there is no onus cast on an assessee to prove that a debt had indeed become bad, and what is required is that assessee should have made a write off bad debts in its books. Undisputedly, this has been done in the given case. Though the CIT(A) relied on the decision of the Madras High Court in South India Surgical Co. Ltd's case, the Tribunal found that the jurisdictional High Court in the decision of CIT Vs. Star Chemical Pvt. Ltd., has taken the same view as that of the Special Bench of this Tribunal in Oman International Bank Ltd's case and hence assessee's claim that it was not obliged to prove that the debts had indeed become bad is correct. Nevertheless, the ITAT found that, though the assessee now claims that it had furnished the details of bad debts and how it related to the sales for the preceding previous years the A.O., there is a conclusive finding in the assessment order that assessee was unable to establish whether the transactions giving rise to the debtors were offered as revenue income in any of the preceding previous year. Therefore, in the interest of justice, the Tribunal set aside the orders of the CIT(A) and the A.O in this regard remit the matter back to the A.O. for verifying details submitted by the assessee. If it is found that amount of bad debts written off arose out of sales effected in earlier years, no doubt assessee's claim has to be allowed. As already stated, assessee is no more required to prove that debt had become bad before claiming allowance for bad debt.

Modvat Credit and Closing Stock: A.O had made an addition of Rs.58,95,043/-considering the tax audit report filed by the assessee along with the return of income in which such amount was shown as unutilized Modvat credit. Though assessee had explained that it was following exclusive method for accounting Modvat account i.e. by reducing from the purchase cost the modvat credit related to the purchases A.O was not impressed.

The Tribunal found that the issue is squarely covered by the decision of Delhi High Court in the case of CIT Vs. Mahavir Aluminum Ltd. (2007-TIOL-742-HC-DEL-IT). The crux of this decision is that adjustments for excise duty and modvat credit while giving effect to Section 145A, has to be done on every component mentioned in Section 145A i.e. value of purchases, sale of goods and inventory. It was held by their Lordship that if there was a change in valuation of closing stock, there needed to be a corresponding adjustment in the opening stock also. Section 145A uses the term 'inventory' and there is no reason why the application of the said section should be limited to closing inventory and not opening inventory. Therefore, AO is directed to make adjustments in the purchases, sales and inventory of the assessee for the Excise Duty and Modvat and to make the addition limited to the extent of result thereof.

Prior period expenses:  During the assessment proceedings, it was noted by the A.O that assessee had debited a sum of Rs.34,31,609/- as prior period expenses. Assessee was asked to explain why this amount should not be disallowed whereupon it submitted that such prior period expenses comprised of very small amounts, and most of such amounts were determined and quantified during the relevant previous year. Assessee also pleaded for allowance of such expenses in the preceding years if it was not allowed in the relevant previous year. A.O observed from the details filed by the assessee that many of the items of expenditure related to 1993 and were more than 10 years old and assessee could not explain why these were not claimed in the respective previous years. Thus, he disallowed the claim of prior period, of Rs.34,31,609/-.

The Tribunal observed, “The details of the prior period expenses by assessee clearly proves that these were related to telephones traveling, office, guest house, labour training, Hire charges, commission and brokerage, legal and other miscellaneous expenditure. Assessee has not been able to establish that the bills for such related were received by it only during the relevant previous year. Many of the expenditures related to 2002 and none of the expenditure were of such nature as which could not be ascertained or accounted for in the respective previous years. Hence, there is nothing on record which could substantiate assessee's contention that the prior period expenses had crystallized in the relevant previous year. On the other hand, in the tax audit report for the relevant previous year, the auditors had specifically commented such amount to be prior period expenses. Hence, Tribunal found that the prior period disallowance was correctly made by the A.O. and no interference is called for in the order of CIT(A). As for alternative plea of the assessee that a direction has to be given for giving such allowances in the respective previous year, Tribunal found that no such powers are vested in this Tribunal for giving any such directions.

Deemed accrual of interest on loan/advance: During the course of assessment, it was noticed by the A.O. that assessee had in the notes to its accounts mentioned interest of Rs.72 lakhs on loan given to a company as not charged, since the recovery was considered doubtful. The note also mentioned that the accumulated interest to Rs. 360 lakhs. Assessee's explanation was that it had not received any interest on loans and had not provided for the same in its accounts since the Company to which, such loans were given was incurring heavy losses. However, the A.O noting that assessee was obliged to show such interest since it was following mercantile system of accounting made an addition of Rs.72 lakhs.

Tribunal observed, “There is no dispute to the fact that non-charging of interest of Rs.72 lakhs was mentioned only in the notes to the accounts and assessee had never shown such amount as income in its Profit & Loss Account. That there was accrual of interest on loan, can only be considered as a presumption unless and until it is shown that there was an agreement which made the debtor liable to pay such interest. In the given case, Revenue has not been able to bring on record any agreement or understanding between the assessee and M/s. GSL Products Ltd., wherein M/s. GSL had agreed to pay any interest to the assessee. When the financial condition of a debtor is bad, prudence would not allow a business-man to claim interest on the principal. This is because the recovery of the principal amount itself being doubtful there cannot be any accrual of interest. Recognition of the revenue can be done only when there is reasonable certainty of recovery of such income. When, assessee itself is not sure of its recoveries it cannot be fastened with an income which was not real simply for the reason that it was following mercantile system of accounting.

In the result, ITAT had no hesitation to delete the addition of Rs.72 lakhs.

(See 2009-TIOL-385-ITAT-MUM in 'Income Tax')