S.36 Income Tax Act | Deduction For Bad Debt Allowed Only If Assessee Lends In Ordinary Course Of Banking/Money Lending Business: Delhi HC

(a) the debt was taken into account for computing the income of the assessee in the previous year in which the amount is written off or prior previous years; or

(b) represents money lent in the ordinary course of business of banking or money lending.

A division bench of Justices Vibhu Bakhru and Swarana Kanta Sharma thus set aside an ITAT order allowing the Respondent-assessee, a financial services company, to claim over ₹27 crore as bad debt of a borrower, which was a group company of the Assessee.

In doing so, the Court found that though the assessee was engaged in financial services, its ordinary business was confined to managing investments, undertaking bill discounting, purchasing, discount, re-discount, bills of exchange, to invest etc.

“There is also no material on record to establish that it was engaged in the business of standing as a surety for consideration,” it observed.

The Court was dealing with Revenue's appeal against the ITAT order, which set aside the addition made by the AO on account of the disallowance of bad debts amounting to ₹27,76,90,000/-.

The assessee claimed that it stood as guarantor for one M/s Carissa Investment Private Limited (CIPL,) which defaulted in repaying its loan to Indiabulls Financial Services and as a result, the assessee had to indemnify Indiabulls.

Significant to note that CIPL had agreed to pay a commission of ₹20 crores, which would accrue after the expiry of three years from the date of guarantee obligations. It was also agreed that in the event the Guarantors were required to repay the loan amount, they would also be entitled to a further sum of ₹20 crores as damages.

However, since CIPL failed to fulfill the promise, the assessee wrote off the balance amount in the Financial Year 2014-15.

The AO disallowed the deduction on account of bad debts, primarily on the ground that giving a guarantee was not one of the main objects of the assessee and that the assessee had not initiated any legal proceedings for recovery of the amounts due despite the fact that accounts of CIPL reflected that it had given a donation of ₹10 crores during the FY 2014- 15 and therefore, had the resources to repay the amounts.

The High Court at the outset referred to Section 36(2)(i) of the Act to state that no deduction on account of bad is allowed if the same was not accounted for in computing the income of the previous year or prior years, or represents money lent in the ordinary course of the business of banking or money lending.

“It is apparent from the main objects that carrying on the business of standing as a surety, is not one of the main objects of the Assessee company. Although the main object is couched in wide terms, it does not include standing as a guarantor to secure the lenders against defaults in repayment obligation by borrowers, for consideration/ commission. Furnishing of guarantees is a part of the objects, which are incidental or ancillary to the main objects and therefore, it is difficult to accept that the Assessee had furnished guarantees as a part of its ordinary course of business,” it said.

The Court also found that the assessee had not entered into any similar transaction whereby it had stood as a surety/guarantor for any other entity for a consideration.

“It is apparent that the Assessee had furnished a guarantee for the loan availed by the Borrowers (its group companies) as an isolated transaction. Plainly, the same was not a transaction that was entered into in its ordinary course of business.”

Court also agreed with the AO that the assessee had written off a large amount due from CIPL as unrecoverable without taking any steps for recovering the said amount.

“The issue flagged by the AO and learned CIT(A) was that the Assessee had deliberately refrained from taking any steps for recovering the dues from CIPL as it was a group company. Further, the facts indicated that CIPL had the wherewithal to pay at least part of the funds. This was established by the fact that it had made a donation of ₹10 crores during the said financial year. The AO and the learned CIT(A) had found that the Assessee had arranged the affairs in a manner whereby it had reflected a loss on account of bad debts, which could be set off against its income. On the other hand, CIPL, which had suffered losses, would in any event not be liable to pay tax on account of writing off its liability. Thus, the arrangement in effect transfers the loss within the same group from a loss-making entity to a profit making entity and conversely profits resulting from remission of liability to a loss making entity,” Court held and allowed the Revenue's appeal.

Appearance: For the Appellant :Mr. Puneet Rai, Mr. Ashvini Kumar & Mr. Rishabh Nangia, Advs. For the Respondent : Ms. Shreya Jain and Mr. Gaurav Tanwar, Advocates

Case title: Principal Commissioner Of Income Tax-7 v. WGF Financial Services Pvt. Ltd.

Citation: 2025 LiveLaw (Del) 304

Case no.: ITA 184/2022

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