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The Supreme Court has ruled that it is not necessary to square off bad debts by closing borrower’s account individually to claim deduction by the assessee lending institutions under the provision of the Income Tax Act. A bench comprising Justice SH Kapadia and Swatanter Kumar rejected the plea of the income tax department that it is mandatory for financial institutions to square off each individual account.
When a borrower’s account is written off by debiting profit and loss account and by creating loans and advances or debtor’s account on the asset side of the balance sheet, but the borrower repays the loan subsequently, the lending institutions may credit the repaid amount to the loans and advance account and not to the profit and loss account, thus resulting in escapement of income from assessment. On the other hand, if the bad debt is written off by closing borrower’s account individually, the repaid amount in subsequent years will be credited to the profit and loss account, on which the assessees have to pay tax, the department had said.
The court turned down this argument on the following grounds. First, section 41 (4) of the Income Tax Act, 1961, lays down that where a deduction has been allowed in respect of a bad debt or a part thereof under section 36(1) (vii) of the Act, then, if the amount subsequently recovered on any such debt is greater than the difference between the debt and the amount so allowed, the excess shall be deemed to be profits and gains of business and accordingly, chargeable to income tax as the income of the previous year in which it was recovered.
Second, the court zeroed in on the accounting practices under which the accounts of sub-branches and head office has to tally. If the repaid amount in subsequent years is not credited to the profit and loss account, mismatch may crop up between the accounts of branches.
The apex court allowed the appeal of Vijaya Bank against I-T department’s disapproval of Rs 7,10,47,161 which the assessee bank had reduced from bank loans for the assessment year 1994-95.

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