Bad Debts Deduction under Income Tax

Bad Debts Meaning

Bad Debts is the amount of debt in a business that becomes irrecoverable due to the inability of a customer to repay the debt. As soon as the debt is bad, the business should be allowed to write it off as an expense in its income tax return.

Income Tax Bill, 2025 also specifies that where a debt has become irrecoverable, the taxpayer shall be allowed a deduction thereof while computing their income under the head “Profits and Gains of Business or Profession”. Let’s try to understand how to claim deduction towards bad debts in a business or profession.

Bad Debts Deduction- Section 31 of Income Tax Bill, 2025

Section 31 of the Income Tax Bill, 2025 states that while computing business or profession income, a deduction shall be allowed towards bad debts in the tax year in which such amount is written off as recoverable. Please note that no deduction shall be allowed towards provision for bad debts (subject to exceptions). Thus, bad debts need to be actually written off in the books for making a legitimate deduction claim in ITR filing.

Deduction towards bad debts shall be allowed subject to the following conditions:

• It must be a debt or part thereof;
• Such debt must be revenue in nature;
• Such debt must have been taken into account in computing the income of the assessee of the tax year in which it is written off or in earlier tax years or it represents money lent in the ordinary course of business of banking or money lending which is carried on by the assessee;
• Such debt must be incidental to the business or profession of the assessee;
• Such debt must have been actually written off as irrecoverable in the accounts of the assessee for the tax year.

Case Study:

X Limited made an advance Rs. 2 Lakhs towards purchase of raw material to Y Limited. Later, Y Limited forfeited the said amount due to breach of contract terms. Will this amount be allowed as bad debts?

Answer:

The important condition to check allowability for bad debts is that such amount should have been considered as a revenue in the same tax year or earlier tax year. But, in this case, the advance so paid by X Limited has never been considered as revenue in any tax year. Therefore, irrecoverable advance in this case shall not be considered as “Bad Debts”. However, it may be claimed as a loss looking into other provisions of the Income Tax.

Clause (b) of Section 31(2) states that if any amount is written off against a debt and there is an ultimate recovery of certain amount against such debt which is less than the difference between the debt and the amount so written off, the deficiency shall be deductible in the tax year in which the ultimate recovery is made.

In other words, if the amount ultimately recovered does not exceed the expected recoverable amount, the remaining amount of debt shall be treated as bad in the year of ultimate recovery.

For example: X Limited sold goods Rs. 2 Lakhs to Y Limited in FY 2020-21. It written off Rs. 50,000 as bad debts in FY 2021-22. In the FY 2023-24, it recovered Rs. 70,000 as final settlement. Thus, it shall write off Rs. 80,000 [150,000 – 70,000] in the FY 2023-24 as bad debts.

Treatment of Bad Debts Recovery

Section 38(1)(d) of the Income Tax Bill 2025 provides that if any amount has been claimed and allowed as bad debts, then if the amount is subsequently recovered, it shall be treated as the income of the tax year in which the amount is so recovered, even though, the business in respect of which the bad debt was allowed may or may not continue in the tax year in which recovery is made.

For example: X Limited sold goods Rs. 2 Lakhs to Y Limited in FY 2021-22. X Limited written off Rs. 2 Lakhs as bad debts in P&L in FY 2022-23 out of which Rs. 90,000 is recovered in the FY 2023-24. In this case, Rs. 90,000 will be treated as income in the FY 2023-24 and credited to P&L A/c.

Suppose, in this example, X Limited written off Rs. 120,000 as bad debts and expected Rs. 80,000 as recoverable amount. However, it recovered Rs. 110,000 in FY 2023-24. Then, Rs. 30,000 will be credited in P&L A/c as income towards bad debts recovery following the section 38(1)(d).

Suppose, in this example, Amount actually recovered is only Rs. 50,000 against the expected recoverable amount of Rs. 80,000, then, deficiency of Rs. 30,000 shall be written off as bad debts in FY 2023-24.

Bad Debts Vis-à-vis ICDS

Application of some ICDS like Revenue Recognition or Provisions, Contingent Liabilities and Contingent Assets may have resulted in accelerated recognition of income for tax purposes though the same may not be recorded in books of accounts as per applicable AS. It is possible that such income may eventually be found to be irrecoverable. While the Income Tax law provides deduction for bad debts only when such amount has already been recorded as revenue, it would be difficult to claim bad debts deduction for income which is irrecoverable but hitherto not recognized in the books.

In tackle this issue, clause (b) of section 31(3) provides that any such income which has already been considered while computing the income of the assessee as per ICDS without recording in the accounts, becomes irrecoverable shall be deemed as if such debt has been written off as irrecoverable in the accounts of the assessee for this purpose.

Important Judicial Decisions

CIT vs. Streyas S. Morakhia (2012) 249 CTR 30(Mum): Non-recovery of amount receivable from the clients against purchase of shares is deductible as bad debts to the assessee who is a share broker.

CIT V. Syed Mohammed Saheb (SM) & Bros (1995) 214 ITR 745 (Ker): Bad debts of the predecessor in business can be written off and claimed by the successor as bad debt if it becomes irrecoverable after the successor has taken over.

Suresh Gaggal V. ITO (2009) 180 Taxmann 90 (HP): Once assessee has written off debt in his books of accounts, it is not requirement of law that he should establish that debt has in fact become bad and it is not open to the Assessing Officer to reject claim of assessee on ground that he has failed to establish that debt has become a bad debt.

Provision for Bad and Doubtful Debts

According to Section 31(1) of the Income Tax Bill, 2025, only the following entities can claim deduction towards “Provision for Bad & Doubtful Debts”:

(a) Bank (Scheduled & Non-Scheduled)

(b) Co-operative Bank

(c) Bank incorporated under any law outside India

(d) Public Financial Institution or a State Financial Institution

(e) State Industrial Investment Corporation

(f) Non-Banking Finance Company

However, there is a limit to deduction allowed to the above entities. Thus, the above-mentioned entities will be allowed a deduction in respect of provision for bad & doubtful debts subject to limits given in the table below:

Conclusion:

Any business or profession can claim deduction towards bad debts which has been irrecoverable and written off in the books of accounts. No deduction will be allowed towards provision for bad & doubtful debts. However, banks and financial institutions shall be allowed to claim deduction towards provision for bad & doubtful debts subject to limits prescribed in the section 31 of the Income tax Bill, 2025.

Disclaimer: The above information is meant for educational purposes only. Readers are requested to act diligently and under consultation with any professional before applying the information contained in this article. For any support mail at: support@taxwink.com