Bad debts

On the basis of the standard accounting principles, a debt becomes irrecoverable when it is written off and so the entitlement regarding deduction for bad debts is, to the extent of irrecoverable loans, determined as such under the regulatory framework governing financial institutions

Thus, it would be a matter to be determined on a case to case basis whether the deduction for bad debts was allowable to a particular taxpayer/financial institution or not

Such issue is required to be determined under the (repealed) Income Tax Ordinance, 1979, by the concerned Deputy Commissioner being the competent Officer

Deputy Commissioner is to determine whether deduction for bad debts is to be allowed to a particular taxpayer individually on the basis of the treatment that has been given by the taxpayer/financial institution in its books of account

High Court , therefore, remitted the present case for the necessary determination regarding irrecoverability of a loan to the concerned Deputy Commissioner

Appeal was disposed of accordingly.

Argument of the Department was that depreciation must be calculated after reducing the income from lease rentals by deducting other allowances

Validity

In Cl. V of S. 23(1) of Income Tax Ordinance, 1979, the word "income" is not to be to read as "net income" as this would be adding words to a provision which is not permissible as there is no intendment in taxation laws

In fact, the expression "income from lease rentals only" has to be taken in its ordinary connotation and it signifies simply that depreciation on assets given on lease shall be allowed against any income from lease rentals

Term "income" in this clause has not been used in the isolated sense that it has been defined in the Income Tax Ordinance, 1979

Thus, argument of the Department was misconceived

Question of law to said extent was decided in favour of the appellant and against the respondents / Department

High Court set-aside impugned order passed by Appellate Tribunal

Appeal filed by financial institution was allowed.

Simply on the basis of mere provision an expenditure cannot be allowed and for allowing the claim of the assessee the Assessing Officer is duty bound to call the record, necessary explanations/clarifications from the assessee and thereafter allow or disallow any claim.

While claiming any income from any business and profession, under S. 22 of the Income Tax Ordinance, 1979, certain expenditures under S. 23 are allowable

Section 23(1)(x) deals with the claim made in respect of the bad debts claimed by an assessee

Bad debts are generally those accounts/amounts which due to any reason have become irrecoverable and all possible efforts with regard to their recovery including the hope of recovery has vanished which amounts are claimed as bad debts by an assessee

However, legislature has put a bar upon an assessee that only such amounts would be allowed as bad debts which are determined by the Deputy Commissioner to be irrecoverable

It is not a matter of discretion of an assessee to decide what is a bad debt, rather the assessee has to establish with cogent material and on reasonable grounds that such and such accounts/amounts since have become irrecoverable, therefore, the same are declared as bad debts

However the discretion to allow or not to allow the same has not been given to the assessee rather the said power is given to the concerned Deputy Commissioner Inland Revenue to determine the amounts which actually have become irrecoverable as bad debts and the onus in this regard for claiming any accounts/amounts as irrecoverable as bad debts lies squarely on an assessee.

Assessee is required to give the names of the account holders and amounts considered as bad debt in each case, as may be indicated in a certificate issued by the State Bank of Pakistan

Assessing Officer has the authority under the law to enquire into genuineness of the claim and the assessee has no arbitrary or irrational authority to write off any amount as bad debt until and unless the parameters, as provided under the law, have been fulfilled or met out, as simply making a provision for doubtful debt is not sufficient to claim deduction under S. 23(1)(x) of the Income Tax Ordinance, 1979.

For purposes of any tax year in relation to which either Income Tax Ordinance, 1979 or Income Tax Ordinance, 2001 is applicable, a necessary precondition for any debt to qualify as bad debt is for the taxpayers to have written off such debt in its books and accounts for such tax year as bad debt

Such written off amount in lieu of bad debts then determines ceiling of bad debt in lieu of which adjustment can be sought in relation to a particular tax year

Treatment in the books and accounts of debt in relation to which taxpayer seeks a deduction on account of it being bad debt as having been written off in relevant tax year is a necessary precondition

Once such condition is met, the second condition to be satisfied is reasonability of belief that such written off debt is irrecoverable

Where a taxpayer has not written off debt within its own books and accounts for relevant tax year for having become irrecoverable, question of seeking deduction for such debt as bad debt does not arise.

Circumstances when debts claimed by an assessee may reasonably be believed as irrecoverable and therefore be classified as bad debts

Reasonableness test

Scope

Held, that it was not a matter of discretion for the assessee to decide what a bad debt was; rather the assessee had to establish reasonable grounds showing that having taken the requisite lawful steps for recovery of the outstanding debts, the same were not recoverable in the foreseeable future

Classification of a bad debt was not left to the discretion of the taxpayer; it must be demonstrated by the securities and the bona fide measures taken by the taxpayer to secure repayment of the outstanding debt

If in a subsequent tax year recovery of a bad debt was effected then the same was taxable as income.

Circumstances when debts claimed by an assessee may reasonably be believed as irrecoverable and therefore be classified as bad debts

Reasonableness test

Scope

Held, that it was not a matter of discretion for the assessee to decide what a bad debt was; rather the assessee had to establish reasonable grounds showing that having taken the requisite lawful steps for recovery of the outstanding debts, the same were not recoverable in the foreseeable future

Classification of a bad debt was not left to the discretion of the taxpayer; it must be demonstrated by the securities and the bona fide measures taken by the taxpayer to secure repayment of the outstanding debt

If in a subsequent tax year recovery of a bad debt was effected then the same was taxable as income.

Taxpayer had claimed bad debts amounting to Rs. 13,306,000 and Rs. 48,867,000 for the tax years 2005 and 2006 respectively which were disallowed by Additional Commissioner Inland Revenue due to the sole reason that taxpayer had not fulfilled legal formalities and no evidence was provided to support that it had made adequate recovery arrangements

Appeal filed by taxpayer was allowed by Commissioner (Appeals)

Validity

Bad debts were written off in the accounts after duly considering the feasibility of recovery as the companies from whom amounts were due had been liquidated and no recovery was possible to be made under any stretch of imagination

Appeal was dismissed.

Appellate Tribunal held that First Appellate Authority was not justified in deleting the same as no legal efforts had been made by the assessee to recover the amount so that bad debts could not be held to be "bad" and irrecoverable; and in absence of proper efforts to recover the same the disallowance made by the Taxation Officer was restored and order of First Appellate Authority was vacated

Rectification of such order

Validity

Omission to decide the issue on the part of the earlier Benches of Appellate Tribunal was not correct and proper as per facts and in law, while in the order of the first appeal before the First Appellate Authority it was found that litigation was not considered to be proper and germane in view of the high cost of litigation and non-cooperation of the debtors and for other objections which had not been repelled

Order of Appellate Tribunal was recalled and rectified and that of First Appellate Authority was approved and restored

Addition of bad debts stood corrected, revised and allowed by the Appellate Tribunal.

Additional Commissioner made addition as admissibility of those written off was not proved in terms of S.29 of Income Tax Ordinance, 2001

Commissioner (Appeals) deleted that addition on the ground that said written off were only for disclosure purpose

Since no amount was claimed as 'written off', Commissioner (Appeals), deleted that addition

Expense could only be allowed, if deduction of the same was claimed in the return

Issue was decided in favour of taxpayer and against the department by the Tribunal.

Question "whether receivable amount could be written off by debiting it in the Profit and Loss account as expenditure with the nomenclature "provision for bad debts' or not" was answered in favour of bank by a Larger Bench after examin-ing various judgments

All the departmental appeals failed and that of taxpayer were succeeded in circumstances.

Claim of bad debts was disallowed by observing that the claim was premature and once the taxpayer had transferred the rights of its recovery to the successor company in which the taxpayer with all of its assets and liabilities had been merged, the claim of bad-debts on provisional basis was legally valid

First Appellate Authority upheld the disallowance of the claim of bad-debts by holding the action of the Taxation Officer to be valid in law

Validity

Action of Taxation Officer in disallowing bad debts which was confirmed by the First Appellate Authority was upheld by the Appellate Tribunal for the reason that after merger/amalgamation the right to recover the bad-debts rested with the new company formed as a result of the merger

Appeal of the taxpayer was dismissed by the Appellate Tribunal.