Businesses often find themselves in a peculiar position when a customer default turns into a prolonged dispute. Even where recovery proceedings are actively being pursued, companies may commercially conclude that the amount is doubtful and provide for it in their books. The tax department has traditionally taken a view that unless each debtor account is formally written off, the deduction for bad debts should not be available. The Bombay High Court has held that the allowability of a bad debt claim must turn on the substance of the accounting treatment and not merely on the form of the entries passed.
In the present case, the assessee had debited the amount to its Profit and Loss Account and reflected it as irrecoverable in its books while simultaneously pursuing legal proceedings for recovery. The tax department argued that the amount represented nothing more than a provision for bad debts and that, in the absence of a formal closure of the debtor account, the requirements of the deduction were not satisfied.
The High Court, drawing support from the Supreme Court decisions in Vijaya Bank and Southern Technologies, held that what matters is whether the accounts, viewed as a whole, demonstrate that the debt has effectively been treated as irrecoverable. In the facts of the case, the assessee had already treated the amount as bad for all practical purposes while continuing to pursue recovery proceedings. The Court also recognised the commercial reality that a formal closure of the debtor account could have prejudiced the assessee’s recovery claim in the ongoing litigation. In these circumstances, the absence of a specific ledger write-off was held not to be fatal to the deduction particularly when any future recovery would, in any event, be taxable under the Income Tax Act
This ruling reinforces an important principle that while a mere provision for doubtful debts would continue to remain disallowable, the allowability of a bad debt claim cannot be denied solely because the accounting entries do not follow a rigid form, if the books of account otherwise clearly evidence an effective write-off.
For businesses dealing with disputed receivables and long-drawn recovery proceedings, the decision provides welcome clarity. Nevertheless, taxpayers should ensure that the accounting treatment and supporting documentation consistently reflect the commercial reality that the debt has become irrecoverable, as the distinction between a mere provision and an actual write-off remains central to sustaining the claim.
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