ITAT Ruling: Businesses Can Claim Bad Debt Deductions Without Concluding Legal Proceedings

Key Ruling on Bad Debt Deductions

The Ahmedabad Bench of the Income Tax Appellate Tribunal (ITAT) has made a significant ruling, stating that businesses can claim tax deductions for bad debts even while legal actions to recover unpaid amounts are ongoing. This decision, announced on June 30, 2026, favored Hemant Brothers, a commodity trading firm based in Ahmedabad, allowing them to deduct Rs 2.69 crore related to losses from the National Spot Exchange Ltd. (NSEL) payment crisis.

The Tribunal clarified that once a debt is written off in the financial records and the necessary conditions of the Income-tax Act are met, the deduction should not be denied solely because recovery efforts are still in progress. This case pertains to the assessment year 2014-15, during which Hemant Brothers sought a deduction under Section 36(1)(vii) after writing off receivables linked to NSEL trades, reflecting this in their profit and loss statement.

Initially, the firm's assessment was finalized in December 2016, but the case was reopened for revision under Section 263. Following this review, the Assessing Officer (AO) issued a new assessment order in December 2019, denying the deduction. The Commissioner of Income Tax (Appeals) upheld this decision, prompting the company to appeal to the ITAT.

Reasons for Tax Department's Rejection

The tax authorities contended that the deduction claim was premature since the legal proceedings to recover the dues from NSEL were still pending. The AO also raised concerns about the legitimacy of the commodity transactions, arguing that the debt could not be deemed irrecoverable while recovery efforts were active.

However, the Tribunal determined that the taxpayer had provided adequate documentation, including contract notes, broker confirmations, delivery reports, and ledger confirmations, to validate the transactions. The Tribunal noted that the Revenue failed to present any evidence that would undermine these records.

Ultimately, the ITAT ruled that pending recovery actions cannot be the sole reason to deny a bad debt deduction when the statutory requirements have been fulfilled.

Alternative Business Loss Claim Approved

In addition to the relief granted under Section 36(1)(vii), the Tribunal accepted the company's alternative claim that the loss also qualified as a deductible business loss under Section 28 of the Income-tax Act. Reviewing previous Tribunal decisions related to the NSEL crisis, the Bench highlighted that there were no allegations implicating Hemant Brothers in the underlying fraud. Since the loss occurred in the normal course of business, it was deemed eligible for deduction as a business loss.

The Tribunal referenced the Supreme Court's ruling in TRF Ltd. v. CIT and CBDT Circular No. 12/2016, which clarify that post-1989 amendments to the Income-tax Act do not require taxpayers to prove that a debt is permanently irrecoverable. A deduction can be claimed once the debt is written off in the financial records, provided the conditions of Section 36(2) are met.

Implications of the Decision for Businesses

This ruling underscores a crucial principle for businesses facing commercial defaults and extended litigation. Companies are not required to wait for the conclusion of recovery proceedings or court cases to claim a bad debt deduction, as long as the debt is legitimate, written off in the books, and meets the relevant provisions of the Income-tax Act. Furthermore, if any part of a bad debt that has been written off is later recovered, that amount must be reported as taxable income in the year of recovery. This decision is anticipated to offer greater clarity for businesses seeking valid tax relief while actively pursuing the recovery of outstanding debts.