Deduction of Bad Debts u/s 36 Income Tax Act only if Lends in Ordinary Course of Banking/ Money Lending Business: Delhi HC [Read Order]

The Delhi High Court has made it clear that allowance in respect of bad debts as an expense under Section 36 of the Income Tax Act, 1961, is permissible only if the assesseee represents money lent in the ordinary course of business of banking or money lending.

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Respondent assessee WGF Financial Services Pvt. Ltd. provided financial services; its regular operations were limited to investment management, bill discounting, purchase, discounting, re-discounting, bills of exchange, and investing, among other activities. As a guarantor for one M/s Carissa Investment Private Limited (CIPL), the assessee said that it was required to compensate Indiabulls Financial Services for its failure to repay the loan.

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In the Financial Year 2014-15, the assessee wrote off the remaining amount because CIPL had failed to fulfill its commitment to pay a commission of ₹20 crores, which would be paid after three years from the date of guarantee obligations. It was also agreed that the Guarantors would be entitled to an additional ₹20 crores in damages if they were forced to repay the loan amount.

In spite of the fact that CIPL's accounts showed that it had donated ₹10 crores in FY 2014–15 and thus had the resources to repay the amounts, the AO rejected the deduction for bad debts, mainly on the grounds that providing a guarantee was not one of the assessee's primary goals and that the assessee had not started any legal action to recover the amounts owed.

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The bench cited Section 36(2)(i) of the Act to declare that no deduction for bad debt is permitted if it was not taken into consideration when calculating income in the previous year or years, or if it reflects funds lent in the regular course of banking or money lending operations.

The Court also concluded that the assessee had not entered into any such transaction whereby it had stood as a surety/guarantor for any other corporation for a price. The assessee had written off a sizable sum owed from CIPL as unrecoverable without taking any action to recover the money, the court also concurred with the AO.

A division bench of Justices Vibhu Bakhru and Swarana Kanta Sharma observed that the Assessee had purposefully avoided taking any action to collect the debt from CIPL because it was a group company, which was the problem that the AO and CIT(A) pointed out. The facts also showed that CIPL had the resources to cover at least a portion of the costs. Its ₹10 crore donation during the aforementioned fiscal year served as evidence of this. 

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As a result, the arrangement effectively transfers the loss within the same group from a loss-making entity to a profit-making entity, and vice versa. The AO and the CIT(A) had determined that the Assessee had set up the affairs in such a way that it had reflected a loss on account of bad debts, which could be set off against its income, while CIPL, which had suffered losses, would in any event not be liable to pay tax on account of writing off its liability.

The court struck aside an ITAT ruling permitting the Respondent-assessee, a financial services business, to claim over ₹27 crore as bad debt of a borrower, which was a group company of the Assessee.

To Read the full text of the Order CLICK HERE

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