A claim for a bad debt deduction requires not only a write-off in the books but also proof that the debt was previously offered to tax.

By | October 9, 2025
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A claim for a bad debt deduction requires not only a write-off in the books but also proof that the debt was previously offered to tax.

Issue

Can a bad debt deduction be allowed by an appellate authority by only considering the condition of the “write-off” under Section 36(1)(vii) of the Income-tax Act, 1961, without also examining the mandatory condition under Section 36(2) that the debt was previously taken into account when computing the taxpayer’s income?

Facts

  • The Assessing Officer (AO) disallowed the assessee’s claim for bad debts due to a lack of supporting evidence.
  • The Commissioner (Appeals) deleted this disallowance. The CIT(A)’s reasoning was based on the well-known legal principle that after the 1989 amendment to the Act, a taxpayer is only required to write off the debt in their books and is not required to prove that the debt has actually become irrecoverable.
  • However, the higher court noted that the CIT(A) had made a significant error of omission. They had completely failed to examine the second, equally important condition for claiming a bad debt, which is laid out in Section 36(2). This condition requires the assessee to prove that the amount of the debt was taken into account when computing their income in a previous year (or that it represents money lent in the ordinary course of a money-lending business).

Decision

The court remanded the matter back to the Assessing Officer for a fresh decision.

  • It held that while the CIT(A) was correct about the “write-off” condition, their order was legally incomplete and flawed because it had completely ignored the mandatory requirement of Section 36(2).
  • A claim for a bad debt deduction can only be allowed if both of these conditions are satisfied. The AO was therefore directed to re-adjudicate the entire issue after examining the assessee’s compliance with both parts of the law.

Key Takeways

  1. There are Two Key Conditions for Claiming Bad Debts: For a bad debt to be deductible, a taxpayer must satisfy two crucial tests: (1) they must have actually written it off in their books of account (as per Section 36(1)(vii)), and (2) the amount must have been previously offered to tax as their income (as per Section 36(2)).
  2. An Incomplete Application of the Law is an Error: An appellate order that is based on an incomplete or partial application of the relevant legal provisions is not sustainable and is liable to be set aside. Both conditions of the law must be examined.
  3. Remand for Proper Verification: When a lower appellate authority has failed to examine a crucial factual or legal aspect of a claim, the standard judicial remedy is to remand the case back to the original authority for a proper and complete examination.

The mere fact that a company’s accounts are audited is not, by itself, sufficient proof to justify an expenditure without any supporting documents.

Issue

Can an addition for an unsubstantiated expenditure be deleted by an appellate authority simply on the ground that the taxpayer’s books of account are subject to a tax audit?

Facts

  • The Assessing Officer (AO) disallowed the “operator expenses” that were claimed by the assessee because the assessee had failed to provide any supporting documents to prove the claim.
  • The Commissioner (Appeals), however, deleted this addition. The sole reason given for the deletion was that the assessee maintained audited accounts.
  • The higher court noted that the AO’s remand report, which was before the CIT(A), clearly stated that the assessee had failed to furnish any details even during the remand proceedings, providing only the basic ledger accounts. The CIT(A) had completely ignored this crucial fact.

Decision

The court remanded the matter back to the Assessing Officer.

  • It held that the reasoning of the Commissioner (Appeals) was legally flawed and insufficient. The mere fact that a company’s accounts are audited does not automatically prove the genuineness or the business purpose of every single expenditure that is claimed.
  • The CIT(A) should have taken into account the assessee’s repeated failure to provide the primary evidence for the expense. The issue was therefore sent back for a proper factual examination by the AO.

Key Takeways

  1. An Audit Report is Not a Blank Cheque: A tax audit report is an expression of the auditor’s opinion. It does not absolve the assessee of their fundamental legal responsibility to prove that an expenditure is genuine and was incurred for the business, using primary evidence like bills and vouchers, when asked to do so by the Assessing Officer.
  2. The Onus is Always on the Taxpayer to Prove an Expense: The burden of proof to establish that an expense was genuinely incurred for the purpose of the business always lies with the taxpayer making the claim.
  3. Appellate Authorities Must Pass Reasoned Orders: The CIT(A)’s order was found to be unreasoned because it deleted a validly made addition without dealing with the core issue, which was the assessee’s complete and continuous failure to provide any supporting evidence for their claim.

An appellate authority cannot delete an ad hoc disallowance made by an AO without first considering the taxpayer’s own failure to provide any supporting details for the expenditure.

Issue

Can an appellate authority delete an ad hoc disallowance made by an Assessing Officer for the personal use of assets, without taking into account the fact that the taxpayer had completely failed to provide any details to prove that the expenditure was fully for business purposes?

Facts

  • The Assessing Officer (AO) disallowed 10% of the motor car and telephone expenses on an estimated basis. This disallowance was made to account for the element of personal use. The reason the AO resorted to an estimate was that the assessee had failed to provide any details to support their claim that the entire expense was for business.
  • The Commissioner (Appeals) deleted this disallowance. The reasons given were that the disallowance was “ad hoc” in nature and that the assessee’s books of account were audited.
  • However, the higher court noted that the assessee had failed to furnish any details not only during the original assessment but also during the subsequent remand proceedings before the AO. The CIT(A) had completely overlooked this continuous failure on the part of the assessee to substantiate their claim.

Decision

The court remanded the matter back to the Assessing Officer.

  • It held that the Commissioner (Appeals) was not correct in simply deleting the addition by labeling it “ad hoc.” The CIT(A) should have first examined the reason why the AO had to make an ad hoc disallowance in the first place—which was the assessee’s own failure to provide any evidence to prove their claim.
  • The issue was sent back for a proper factual examination.

Key Takeways

  1. An Ad hoc Disallowance is a Consequence of Non-cooperation: While ad hoc disallowances are generally disfavored by the courts, they are often made by Assessing Officers as a last resort when the assessee fails to provide the necessary details to properly segregate the personal and business use of an asset.
  2. The Onus to Rebut the Disallowance is on the Assessee: When an AO makes such a disallowance, the onus is on the assessee to produce evidence (like log books, call records, or a reasonable basis for allocation) to prove that the AO’s estimate of personal use is incorrect or excessive.
  3. An Appellate Authority Cannot Ignore the Assessee’s Failure: The Commissioner (Appeals) cannot simply delete an ad hoc disallowance without considering the underlying reason for it. If the reason was the taxpayer’s own failure to provide the required information, then deleting the addition without any basis is itself an unreasoned decision.
IN THE ITAT MUMBAI BENCH ‘SMC’
Deputy Commissioner of Income-tax
v.
Ispat Infrastructure India Ltd.
SANDEEP SINGH KARHAIL, Judicial Member
and Narendra Kumar Billaiya, Accountant Member
IT Appeal No.1502 (Mum) of 2025
[Assessment year 2015-16]
SEPTEMBER  26, 2025
A.M.K. Mahadevan, Sr. DR for the Appellant. Hemant Vora for the Respondent.
ORDER
Sandeep Singh Karhail, Judicial Member.- The Revenue has filed the present appeal against the impugned order dated 27.12.2024, passed under section 250 of the Income-tax Act, 1961 (“the Act”) by the learned Commissioner of Income Tax (Appeals)- National Faceless Appeal Centre, Delhi [“learned CIT(A)”], for the assessment year 2015-16.
2. In this appeal, the Revenue has raised the following grounds: –
“1. Whether the CIT(A) erred in deleting the disallowance of bad debts claimed under Section 36(1)(vii) without requiring the assessee to prove the actual irrecoverability of the debt, despite the settled position that mere book entry is not sufficient to justify such a claim?”
“2. Whether the CIT(A) was justified in deleting the addition on account of labour expenses despite the assessee’s failure to furnish documentary evidence proving the authenticity of such expenses?”
“3. Whether the CIT(A) was justified in deleting the disallowance of operator expenses merely based on ledger accounts without any documentary proof, such as invoices or contracts, supporting the actual incurrence of expenses?”
“4. Whether the CIT(A) was correct in deleting the disallowance of 10% of motor car and telephone expenses without considering the possibility of personal use, which is a standard practice in income tax assessments?”
3. The issue arising in Ground No.1, raised in Revenue’s appeal, pertains to the disallowance of bad debts claimed under section 36(1)(vii) of the Act.
4. The brief facts of the case pertaining to this issue are that: The assessee is engaged in the business of reselling construction equipment. For the year under consideration, the assessee filed its return of income on 31.10.2015, declaring a loss of Rs.2,18,93,166/-. The return filed by the assessee was selected for complete scrutiny, and statutory notices under section 143(2) and section 142(1) were issued and served on the assessee. During the assessment proceedings, it was observed that the assessee had claimed bad debts amounting to Rs. 2,23,73,875/-. However, no supporting evidence for the same was provided by the assessee, and the assessee did not respond to the show cause notice issued during the assessment proceedings. Accordingly, the Assessing Officer (“AO”), vide order dated 29.12.2017 passed under section 143(3) of the Act, disallowed the bad debts claimed by the assessee.
5. During the appellate proceedings before the learned CIT(A), the assessee filed the ledger of bad debts claimed for Rs.2,23,73,875/- and also the ledger of all accounts receivable from parties which were treated as bad debts. The learned CIT(A), in compliance with Rule 46A of the Income Tax Rules, 1962, forwarded the evidence received from the assessee to the AO and sought the remand report. After consideration of the remand report received from the AO and submissions filed by the assessee, the learned CIT(A) vide impugned order, deleted the disallowance made on account of bad debts on the basis that after 01.04.1989 there is no requirement for the assessee to establish that the debts, in fact, have become irrecoverable. Being aggrieved, the Revenue is in appeal before us.
6. During the hearing, the learned Departmental Representative (“learned DR”) submitted that the learned CIT(A) has not examined whether the assessee has complied with the conditions of section 36(2) of the Act and how the income was offered in the earlier year.
7. On the other hand, the learned Authorised Representative (“learned AR”) submitted that all the details were filed before the AO on 29.12.2017 in response to the show cause notice issued during the assessment proceedings. However, the AO passed the assessment order on the very same date without considering the assessee’s response.
8. We have considered the submission of both sides and perused the material available on record. From the perusal of the impugned order, we find that the AO furnished the following response in its remand report before the learned CIT(A) on this issue:
“2.2 The AO observed that the assessee has claimed Bad Debts of Rs. 2,23.73,875/-. However, as the assessee has not furnished details thereof, thence, he AO disallowed the same. During the course of remand proceedings, the assessee has furnished only the names and ledger accounts of said parties.
Mere furnishing the names and addresses and figures does not establish the debts becoming bad and doubtful. The assessee also has not furnished the details of purchases, items purchased, details of sales of those items, proceeds and repaid to the purchaser, details of entire transactions and correspondences with said parties. The assessee also has not furnished details as to how the debts became bad and doubtful. The assessee also has not furnished any other supporting evidences to establish its claim. Hence, the AO has correctly disallowed the claim of the assessee. Accordingly, the issue may be decided on merits.”
9. There is no dispute regarding the fact that after 01.04.1989, it is not necessary for the assessee to establish that the debt, in fact, has become irrecoverable, and it is enough if the bad debt is written off as irrecoverable in the accounts of the assessee. This position is settled by the Hon’ble Supreme Court in TRF Ltd. v. CIT 391/323 ITR 397 (SC). However, at the same time, it is necessary that the assessee satisfies the conditions of the provisions of section 36(2) of the Act. However, in the present case, we do not find that the same has been examined by the learned CIT(A). Furthermore, the AO, in its remand report, as noted above, also identified various infirmities in the submission filed by the assessee.
10. Therefore, in view of the facts and circumstances as noted above, we deem it appropriate to restore this issue to the file of the Jurisdictional AO for de novo adjudication, granting one more opportunity to the assessee in the interest of justice and fair play to submit all the details/documents in support of the claim of allowance of bad debts under section 36(1)(vi) of the Act. Needless to mention, no order shall be passed without affording the assessee a due opportunity to be heard. Accordingly, the impugned order on this issue is set aside, and Ground No.1 raised in Revenue’s Appeal is allowed for statistical purposes.
11. The issue arising in Ground No.2, raised in Revenue’s Appeal, pertains to the deletion of the addition on account of labour expenses.
12. During the hearing, the learned AR, at the outset, in all fairness, submitted that the addition on this issue was upheld by the learned CIT(A), and this ground has been inadvertently raised in the present appeal. Accordingly, without expressing any opinion on the findings of the learned CIT(A) on this issue, as the assessee is not in appeal before us against the same, this ground is left open.
13. The issue arising in Ground No.3, raised in Revenue’s Appeal, pertains to the deletion of operator expenses.
14. We have considered the submission of both sides and perused the material available on record. During the year under consideration, the assessee claimed operator expenses of Rs.10,12,000/-. In the absence of any documents in support of its claim, the AO, vide order passed under section 143(3) of the Act, disallowed the operator expenses amounting to Rs. 10,12,000 claimed by the assessee and added the same to the total income of the assessee. The learned CIT(A), vide impugned order, allowed the ground raised by the assessee on this issue by observing as follows: –
“6.13 The appellant maintains accounts which are subject to audit. By AO’s own admission the ledger account was produced. Therefore disallowance of this claim of expenditure is not in order. This addition is deleted. Ground 3 is allowed.”
15. During the hearing, the learned DR submitted that the assessee neither in the assessment proceedings nor before the remand proceedings furnished any documentary evidence in support of operator expenses and thus could not satisfy the conditions that said expenditure was incurred wholly and exclusively for the purpose of the business. The learned AR, reiterating the submissions made in respect of the afore-noted issue, submitted that all the details were furnished before the AO; however, on the very same date, the AO passed the assessment order.
16. From the response of the AO in its remand report before the learned CIT(A), we find that the assessee did not furnish any details during the remand proceedings and only furnished the ledger accounts. From the perusal of the impugned order, we find that the learned CIT(A), without examining this aspect of the matter, simply deleted the addition on the basis that the assessee has maintained the accounts which are subject to audit. Therefore, we are of the considered view that this aspect requires fresh consideration. Consequently, we restore this issue to the file of the Jurisdictional AO for de novo adjudication, granting the assessee one more opportunity to furnish details/submissions in respect of its claim. Accordingly, the impugned order on this issue is set aside, and Ground no.3 in Revenue’s appeal is allowed for statistical purposes.
17. The issue arising in Ground No.4, raised in Revenue’s Appeal, pertains to the deletion of the disallowance of motor car and telephone expenses.
18. We have considered the submission of both sides and perused the material available on record. As the assessee failed to respond to the show cause notice issued during the assessment proceedings, the AO vide order passed under section 143(3) of the Act disallowed 10% of the motor car and telephone expenses claimed by the assessee and made an addition of Rs.2,84,600/- to the total income of the assessee. The learned CIT(A) vide the impugned order deleted the said addition, mainly on the basis that it was ad hoc and the assessee’s books of account were duly maintained and accounted for.
19. From the perusal of the record, it is evident that neither in the assessment proceedings nor in the remand proceedings before the AO did the assessee furnish details regarding the motor car and telephone expenses amounting to Rs. 2,84,600/- claimed by the assessee. We find that without considering this aspect and examining the fulfilment of section 37 of the Act, the learned CIT(A) deleted the addition on this count. Therefore, we are of the considered view that this aspect of the matter requires fresh consideration, and therefore, we restore this issue to the file of the Jurisdictional AO for de novo adjudication, granting one more opportunity to the assessee to furnish all the details/submissions in respect of its claim of motor car and telephone expenses. With the above directions, the impugned order on this issue is set aside, and Ground No.4 raised in Revenue’s Appeal is allowed for statistical purposes.
20. In the result, the appeal by the Revenue is allowed for statistical purposes.