Deduction for provision for bad and doubtful debts

Introduction

The provision for bad and doubtful debts is allowed only to eligible assessee, being a bank, NBFC or financial institutions. The deduction to be allowed under this provision shall be lower of provision made or the amount computed as percentage of total income of eligible assessee.

1. About

Entities create the provision for bad-debts that may arise in future. This provision is created on estimation basis on the amount of bad debt that may arise from accounts receivable that have been issued but not yet collected.

The provision for bad-debts are allowed as deduction only to the specified entities. While as the actual bad-debts are allowed as deduction to every assessee in accordance with the provision of Section 31(2).

1.1. Who can claim this deduction?

Scheduled bank, non-scheduled bank, co-op. bank other than a primary agriculture credit society or a primary co-operative agricultural and rural development bank, foreign bank, financial institutions and NBFC can claim deduction in respect of provision made for bad and doubtful debts. Any other assessee shall not be allowed to claim deduction for any provision made for bad-debts.

1.2. How much deduction is allowed?

The deduction to be allowed under this provision shall be lower of provision made for bad and doubtful debts or the amount calculated on basis of following.

1.2-1. Additional deductions

A scheduled bank (other than a foreign bank) or a non-scheduled bank shall, at its option, be allowed further deductions for an amount not exceeding the income derived from redemption of securities in accordance with a scheme framed by the Central Government. However, this deduction shall be allowed only if the said income has been disclosed under the head ‘Profit and Gains from business and profession ’in the return of Income.

1.3. Meaning of certain terms

The meaning of various terms used in the foregoing discussions shall be as under.

‘Total Income’ shall be computed before making any deduction under this provision and deductions as referred to in Chapter VIII.

‘Rural branch’ means a branch of a scheduled or non-scheduled bank which is situated in a place which has a population of not exceeding 10,000 as per last preceding census, which has been published before the first day of the tax year.

‘Average advance’ made by the rural branch of a schedule bank, which is considered for calculation of deduction under this provision, will be computed in the following steps:

Step 1: The amount of advances made by each rural branch, as outstanding at the end of the last day of each month comprised in the tax year, is to be aggregated separately.

Step 2: The sum so arrived is to be divided by the number of months for which the outstanding advances have been considered.

Step 3: The aggregate of the sum so arrived at in respect of each of the branches is the aggregate average advances made by the rural branches of the scheduled banks.

1.4. How to claim deduction for bad-debts?

In the case of an assessee to which this provision applies, the amount of deduction relating to any bad debt or part thereof shall be limited to the amount by which such bad-debt exceeds the credit balance in the provision for bad and doubtful debts account made under this provision.

In other words, no deduction shall be allowed for the actual bad-debts unless it is debited to the provision for bad and doubtful debts account. The deduction admissible under Section 36(1)(vii) shall be limited to the amount by which such debt or part thereof exceeds the credit balance in the provision for bad and doubtful debts account.

1.5. How to tax bad-debts recovered?

Any amount recovered towards a debt, against which deduction has been allowed under this provision, shall be charged to tax under Section 38(1)(a)/(b) in the tax year in which amount is recovered.

1.6. Urban and rural advances treated as a single account

Earlier assessees were maintaining separate accounts in respect of provision for bad and doubtful debts for urban and rural advances. Consequently they were claiming deduction for bad debts separately in respect of both the accounts. To overcome such situation it was clarified that these accounts, in respect of urban and rural advances, shall be treated as a single account in respect of all type of advances, including advances made by rural branches.

(Also see Taxation of banks or financial institution in respect of interest on bad or doubtful debts)

This article is general information and not tax advice. Provisions change. Confirm your position with a qualified professional before acting.