Bad debt is one that cannot be collected and is therefore worthless to the creditor. It is usually the result of a bankruptcy filing by a debtor. Bad debts can also emerge when the expense of collecting exceeds the amount owed. As soon as the loan becomes bad, the company should be able to deduct it as an expense on its tax return.
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If a debt relating to a company or profession has become irrecoverable in the preceding fiscal year, a deduction is allowed. A deduction may be granted if the loans lent by banking or money lending organizations are unable to recover the obligations in full or in part. The deduction is based on the existence of unrecoverable debts that are entirely within the law or through the courts. Before any exemption for bad debts is granted, the conditions outlined in the Income Tax Act of 1961 under section 36(2) must be met. The following are the requirements:
Bad debts from a discontinued business that is already closed before the accounting year begins cannot be deducted from the assessee’s profit from the assessee’s continuing business. If bad debts have previously been written off in the books of accounts, they are not recognized as a deduction by A.O on the grounds that the debt still has a chance of recovery, as per section 36(2)(iii). Any such obligation, or portion of a debt, shall be deducted in the year in which it becomes irrecoverable.
If a debt was written off as bad in a previous year and the relevant deduction was claimed, but the debt was later recovered in full or in part, the amount recovered will be included in the income of the financial year in which the amount was recovered. If the assessee has written off a portion of the debt in a prior year and the Assessing Officer has approved the deduction, and money is collected from the debtors in the future, the amount recovered will be treated as a normal realization of debts. If the amount recovered falls short of expectations, the remaining balance will be classified as bad debts. If the amount received exceeds the amount recoverable, the excess amount will be recognized as income in the financial year in which it was received.
Only banks and financial institutions are authorized to deduct provisions for bad and doubtful debts under section 36(1)(viia) of the Income Tax Act of 1961. No other assessee is permitted to claim the bad debt provision deduction.
Banks and financial institutions are entitled to deduct up to the following amounts:
| Bank type | Allowed deduction | Explanation |
| Indian Bank | 10% of average aggregate advances issued by rural branches + 7.5 percent of adjusted total income | Any bank that is not a foreign bank and is incorporated in India is referred to as an Indian bank. Total Adjusted Income – Gross total income before deduction under section 36(1) (viia).
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| Foreign Bank | 5 percent of total income (adjusted) | Total Adjusted Income – Gross total income before deduction under section 36(1) (viia). |
| State Financial Corporation, Public Financial Institution | 5 percent of total income (adjusted) | Total Adjusted Income – Gross total income before deduction under section 36(1) (viia). |
An assessee must account for provisions that arise in the usual course of business under Accounting Standard 29 “Provisions, Contingent Liabilities, and Assets.” Because the provisions are sometimes prohibited by the Internal Revenue Service, there is a temporal discrepancy between the books of accounts and the books required by the I.T. Act.
As a result, an assessee must also construct Deferred Tax Assets/Liabilities. An assessee must only have a deferred tax asset/liability if the time difference of the transaction is only temporary and can be reversed in the future.
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