Bad Debt is a debt which is not collectible and is worthless to the Creditor. It is usually a product of the debtor which has gone for bankruptcy. Bad Debts can also occur when the collection cost is more than the amount of the debt. As soon as the debt is bad, the business should be allowed to write off as an expense in its income tax return.
A Deduction is allowed in for the debt related to business and profession if the same has become irrecoverable in the previous financial year. If the Loans lent by banking or money lending concerns are not able to recover the debts in full or part thereof, a deduction may be allowed. The eligibility of the deduction is on the existence of debts which is irrecoverable is totally under the law or through courts. The conditions laid down in Income Tax Act, 1961 u/s 36(2) should be fulfilled before any allowance for bad debts is allowed. The conditions are:
Bad Debts of a discontinued business which is already discontinued before the accounting year starts, cannot be claimed as a deduction from the profit of the continued business of the assessee. As per section 36(2)(iii) if bad debts have already been written off in the books of accounts but they are not allowed as a deduction by A.O on the ground that the debt is still having a possibility of recovery. Any such debt or part of debt should be allowed as a deduction in the year in which is becoming irrecoverable.
If in any previous year, the debt has been written off as bad and the relevant deduction has also been claimed but later on the same debt is recovered in full or part, then the amount so recovered will be included as income of the financial year in which such amount has recovered. If in any previous year, the assessee has written off a part of the debt and the said deduction was also allowed by the Assessing Officer and in future, some money is received from the debtors, then the amount so recovered will be treated as a normal realization of debts. If the amount recovered doesn’t exceed the expected, then the remaining amount will be treated as bad debts. If the amount received exceeds the recoverable amount, then the excess amount received will be treated as the income in the financial year of the receipt.
As per section 36(1)(viia) of the Income Tax Act, 1961 only banks and financial institutions are allowed deduction in respect of the provisions made for bad and doubtful debts. No other assessee is allowed to claim the deduction on the provision of bad debts.
The limits on which the deduction is allowed to the banks and financial institutions are:
|Bank Type||Deduction Allowed||Explanation|
|Indian Banks||7.5% of adjusted total income + 10% of average aggregate advances made by rural branches||Indian Bank means any bank which is not a foreign bank and is a banking company incorporated in India. |
Adjusted Total Income – Gross total income before deduction under section 36(1)(viia).
Average aggregate advances*
|Foreign Banks||5% of adjusted total income||Adjusted Total Income – Gross total income before deduction under section 36(1)(viia).|
|Public Financial Institution, State Financial Corporation||5% of adjusted total income||Adjusted Total Income – Gross total income before deduction under section 36(1)(viia).|
Note: Average aggregate advances can be computed in the following steps:
As per Accounting Standard 29 “Provisions, Contingent Liabilities and Assets” an assessee must account for the provisions that occur in the ordinary course of business. Since the provisions are disallowed sometimes by the Income Tax Department, it creates a timing difference between the books of accounts and books as per the I.T Act.
Thus, an assessee will also need to create Deferred Tax Assets/Liability accordingly. An assessee must only a deferred tax asset/liability only the timing difference of the transaction is temporary in nature and have the possibility of getting reversed in the future.
Know more about Deferred Tax Asset and Deferred Tax Liability