Bad Debts Written Off and Earlier Year Income: Key Takeaways from ITAT Delhi in M. Sons Gems N Jewellery Pvt. Ltd Vs ACIT

1. Background of the Dispute

The appeal in M. Sons Gems N Jewellery Pvt. Ltd Vs ACIT came up before the ITAT Delhi against an order dated 26.03.2019 passed by the CIT(A)-27, New Delhi, arising from an assessment order framed u/s 143(3) of the Income Tax Act 1961 for AY 2015-16.

The assessee, a private limited company, is engaged in the business of trading and export of gems and jewellery. For AY 2015-16, multiple additions were made by the Assessing Officer (AO), several of which were confirmed partly or fully by the CIT(A). The assessee carried the matter to the Tribunal, challenging various additions and legal issues.

At the hearing, the assessee chose not to press certain legal grounds (jurisdiction, procedure, etc.), and the core surviving issues largely related to:

  • Disallowance of bad debts written off u/s 36(1)(vii)
  • Rejection of revised computation of income
  • Disallowance of loss on sale of assets
  • Disallowance u/s 43B
  • Additions relating to expenses payable, advances from customers, and trade payables u/s 68 or as unconfirmed liabilities

The most significant finding of the ITAT relates to the allowability of bad debts u/s 36(1)(vii) where the corresponding income had already been offered to tax in earlier years.

2. Grounds of Appeal and Issues Pressed

2.1 Grounds Not Pressed

The assessee initially raised a large number of grounds (1 to 13). However, at the outset, the assessee’s counsel stated that grounds 1 to 4 would not be pressed. These grounds broadly related to:

  • Alleged lack of jurisdiction
  • Contention that proceedings should have been u/s 153C
  • Absence of recorded reasons for issuing notice u/s 143(2)
  • General challenge to the validity of assessment on multiple procedural and legal counts

The Tribunal, therefore, dismissed grounds 1 to 4 as “not pressed”.

2.2 Substantive Grounds Considered

The Tribunal proceeded to adjudicate upon, inter alia, the following major issues:

  1. Disallowance of bad debts of Rs. 5,75,38,704/- claimed u/s 36(1)(vii) and non-acceptance of revised computation (Grounds 5 & 6).
  2. Disallowance of loss on sale of assets of Rs. 44,15,227/- (Ground 7).
  3. Disallowance u/s 43B aggregating Rs. 11,94,513/- (Ground 8).
  4. Disallowance of expenses payable of Rs. 5,01,332/- (Ground 9).
  5. Addition of Rs. 50,96,137/- on account of advances from customers u/s 68 (Ground 10).
  6. Addition of Rs. 4,25,38,806/- on account of trade payables / unconfirmed liabilities (Ground 11).
  7. A general ground seeking costs for alleged harassment and high-pitched assessment (Ground 12).

3. Core Issue: Bad Debts u/s 36(1)(vii)

3.1 Facts Relating to Bad Debts Claim

  • The assessee claimed a deduction of Rs. 5,75,38,704/- as bad debts written off under Section 36(1)(vii) in AY 2015-16.
  • The bad debts primarily related to export sales made to two foreign entities: M/s MSM Gems LLC and M/s Allure Jewells LLC.
  • The assessee explained that business disputes with these entities had been subject to mediation before the Hon’ble Delhi High Court, and despite such proceedings, recovery was not successful. Hence, the assessee wrote off the outstanding amounts as bad debts in its books.
  • The assessee also submitted that it had, due to a clerical omission, failed to add back Rs. 16,40,175/- in the computation but sought to correct this through a revised computation filed during assessment proceedings.

The AO disallowed the entire claim on the basis that the assessee could not, in his view, substantiate that adequate recovery efforts were made. The CIT(A) endorsed the AO’s approach, also pointing to alleged deficiencies in the mediation settlement documents.

The Tribunal reproduced and examined the statutory text of:

  • Section 36(1)(vii) – which allows deduction of bad debts written off as irrecoverable in the accounts of the assessee for the previous year, subject to Section 36(2).
  • Section 36(2) – which imposes key conditions, particularly that the debt must have been taken into account in computing the income of the assessee in the relevant or an earlier previous year (or must represent money lent in the ordinary course of business of banking or money-lending).

Thus, the two essential tests are:

  1. The debt must have been recognized as income in an earlier year; and
  2. The amount must be written off as irrecoverable in the books of account of the assessee in the year in which deduction is claimed.

3.3 Reliance on Supreme Court in TRF Ltd. 323 ITR 397 (SC)

The assessee placed heavy reliance on the decision of the Hon’ble Supreme Court in:

TRF Ltd. 323 ITR 397 (SC)