Facts of the Case

The assessee, All Grow Finance and Investment Pvt. Ltd., was a Non-Banking Financial Company engaged in the business of money lending and earning interest income.

The assessee had advanced Rs. 60 lakhs to M/s Bhav Portfolio. After adjustment of the opening credit balance, a sum of Rs. 56.90 lakhs remained recoverable. Despite repeated requests, reminders and legal notices, the amount could not be recovered. Consequently, 50% of the amount due, i.e., Rs. 28.45 lakhs, was written off during Assessment Year 2000-01. The remaining amount was written off in Assessment Year 2004-05.

Similarly, Rs. 6.50 lakhs relating to another borrower, M/s Gallery, was also written off during the relevant assessment year.

The assessee claimed deduction of the aggregate amount of Rs. 34,95,000 as bad debts.

The Assessing Officer disallowed the claim on the ground that the debt had not been taken into account as income in earlier years as allegedly required under Section 36(2) of the Act. The disallowance was upheld by the Commissioner of Income Tax (Appeals) and subsequently by the Income Tax Appellate Tribunal.

Aggrieved by the Tribunal's order, the assessee filed an appeal before the Delhi High Court.

Issues Involved

1.      Whether the Tribunal was justified in holding that bad debts amounting to Rs. 34,95,000 were not allowable under Section 36(1)(vii) read with Section 36(2) of the Income-tax Act, 1961.

2.      Whether the Tribunal erred in holding that the conditions of Section 36(2) were not fulfilled merely because the advance/debt itself had not been shown as income in the profit and loss account.

Petitioner’s Arguments (Assessee)

• The assessee contended that once a debt had been written off as irrecoverable in its books, deduction was allowable under Section 36(1)(vii).

• It was argued that Section 36(2) creates a separate category for money lent in the ordinary course of banking or money-lending business.

• The assessee submitted that for a money-lending concern, it is not necessary that the principal amount of loan should have been reflected as income in earlier years.

• The only relevant requirement is that the money should have been lent in the ordinary course of the money-lending business with the expectation of earning interest.

• Since the assessee was an NBFC carrying on money-lending activities and the loans were advanced during the course of such business, the deduction could not be denied.

Respondent’s Arguments (Revenue)

• The Revenue contended that deduction under Section 36(2) is available only when the debt or a part thereof has been taken into account while computing income in the relevant or earlier previous years.

• Since the principal amount advanced by the assessee was never reflected as income, the statutory conditions prescribed under Section 36(2) were not fulfilled.

• Accordingly, the Revenue argued that the amount written off could not qualify as a bad debt deduction.

Court Findings

The Delhi High Court examined Section 36(1)(vii) and Section 36(2)(i) of the Income-tax Act and analyzed the distinction between the two limbs contained in Section 36(2)(i).

The Court observed that the first limb applies generally to business debts and requires that such debt should have been taken into account in computing income.

The second limb separately covers money lent in the ordinary course of banking or money-lending business carried on by the assessee.

The Court held that these two limbs operate independently and are separated by the expression “or”, indicating a legislative distinction.

Relying upon the decision of the Madras High Court in P.C. Dharmalinga Mudaliar v. Commissioner of Income Tax (1985) 152 ITR 454 (Mad), the Court observed that in the case of money-lending businesses, money advanced constitutes stock-in-trade and is inherently on revenue account.

Therefore, it is not necessary for such money lent to be separately shown as income before deduction can be claimed as a bad debt.

The Court further held that for money-lending concerns, the essential requirement is that the loan must have been advanced in the ordinary course of the money-lending business.

Once this condition is satisfied and the amount is written off as irrecoverable, no additional requirement from the first limb of Section 36(2)(i) can be imported into the second limb.

Important Clarification

The Delhi High Court clarified that in the case of banking and money-lending businesses, the requirement that a debt must have been taken into account while computing income is not applicable in the same manner as it is for ordinary business debts.

For money-lending entities, the decisive test is whether the amount was advanced in the ordinary course of the money-lending business.

If that condition is fulfilled and the debt is written off as irrecoverable, deduction under Section 36(1)(vii) read with Section 36(2) cannot be denied merely because the principal amount of the loan was not reflected as income.

Court Order

The Delhi High Court allowed the appeal filed by the assessee.

The Court answered the questions of law in favour of the assessee and against the Revenue.

It held that the authorities below were not justified in disallowing the deduction of Rs. 34,95,000 claimed as bad debt under Section 36(1)(vii) read with Section 36(2) of the Income-tax Act, 1961.

Since the claim was allowed as bad debt, the alternative plea for deduction as business loss under Section 37 did not require adjudication.

 

Sections Involved

• Section 36(1)(vii) of the Income-tax Act, 1961
• Section 36(2) of the Income-tax Act, 1961
• Section 37 of the Income-tax Act, 1961 (alternative plea)
• Section 143(1) of the Income-tax Act, 1961

Link to download the order -

https://delhihighcourt.nic.in/app/case_number_pdf/2011:DHC:3183-DB/MLM03062011ITA6822011.pdf

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