Can a business claim a bad debt deduction even when efforts to recover the money are still going on?
The Ahmedabad bench of the Income Tax Appellate Tribunal (ITAT) has answered this question in favour of a taxpayer. In a recent ruling, the Tribunal allowed a commodity trading firm to claim a Rs 2.69 crore deduction even though recovery proceedings relating to the National Spot Exchange Ltd. (NSEL) crisis were still pending.
The Tribunal held that once a debt has been written off in the books of account and the conditions prescribed under the Income Tax Act are fulfilled, the deduction cannot be denied merely because recovery efforts have not yet concluded.
How the dispute began
The case relates to Hemant Brothers, an Ahmedabad-based partnership firm engaged in commodity trading.
For the assessment year (AY) 2014-15, the firm claimed a deduction of Rs 2.69 crore as bad debt under Section 36(1)(vii) of the Income Tax Act. The amount represented dues that became unrecoverable after the NSEL payment crisis.
The transactions had been carried out through Chimanlal Popatlal Commodities Brokers Pvt. Ltd., and the firm wrote off the amount in its books by debiting it to the Profit and Loss account.
A dispute that lasted nearly a decade
The firm’s original assessment for AY 2014-15 was completed on December 5, 2016.
Nearly three years later, on March 1, 2019, the Principal Commissioner of Income Tax revised the assessment under Section 263 of the Income Tax Act and directed the Assessing Officer (AO) to complete a fresh assessment.
Following this, the AO passed a fresh assessment order on December 26, 2019, but disallowed the entire deduction of Rs 2.69 crore.
Hemant Brothers challenged the order before the Commissioner of Income Tax (Appeals). However, on July 18, 2024, the first appellate authority also dismissed the appeal.
The dispute finally reached the Ahmedabad ITAT, which pronounced its decision on June 30, 2026, giving relief to the taxpayer.
Why was the deduction rejected?
The Assessing Officer raised two objections.
First, the officer questioned whether the commodity transactions involved actual delivery.
Second, the AO held that the bad debt claim was premature because recovery proceedings relating to the NSEL default were still pending. According to the department, until those proceedings concluded, the debt could not be treated as irrecoverable.
The Commissioner (Appeals) agreed with this reasoning and upheld the disallowance.
ITAT disagrees
The Tribunal, however, found that the assessee had placed sufficient material on record, including contract notes, broker confirmations, delivery reports and ledger accounts. It also observed that the Revenue had not produced any evidence to show that these documents were unreliable.
The ITAT further noted that Hemant Brothers was engaged in commodity trading in the ordinary course of business and that the disputed transactions were part of its regular business activity.
More importantly, the Tribunal rejected the department’s view that a taxpayer must wait for recovery proceedings to conclude before claiming a deduction.
Relying on the Supreme Court’s judgment in TRF Ltd. and CBDT Circular No. 12/2016, it held that once a debt is written off in the books and the statutory conditions are met, the deduction cannot be denied simply because recovery efforts are continuing.
Why the ruling matters
According to Ashish Mehta, Partner at Khaitan & Co, the ruling does not create a new legal principle but reinforces one that has already been settled by the Supreme Court.
“The ruling reinforces the settled legal position laid down by the Supreme Court in TRF Ltd. Once a debt is written off as irrecoverable in the books of account, the taxpayer is not required to independently establish that the debt has in fact become irrecoverable,” Mehta said.
He added that the mere pendency of recovery proceedings does not postpone or prevent a taxpayer from claiming the deduction, provided the conditions under Sections 36(1)(vii) and 36(2) are satisfied.
Proper records remain important
While the ruling makes it clear that taxpayers are not required to prove actual irrecoverability, documentation still plays an important role.
Mehta said businesses should maintain contract notes, invoices, trade confirmations and bank records to establish that the underlying transactions were genuine. They should also preserve broker statements, ledger accounts and reconciliations showing the outstanding amount.
Equally important, taxpayers should retain accounting records showing that the debt was written off by debiting the profit and loss account and removing the receivable from the balance sheet. Where applicable, they should also maintain financial statements and earlier tax records demonstrating compliance with Section 36(2), which requires that the amount should have been taken into account while computing taxable income.
ITAT also accepted an alternative claim
The Tribunal did not stop at allowing the bad debt deduction.
It also accepted the firm’s alternative argument that the amount was allowable as a business loss under Section 28 of the Income Tax Act. The Bench relied on earlier Tribunal decisions involving similar losses arising from the NSEL crisis and noted that there was no allegation that Hemant Brothers itself had any involvement in the scam. It therefore deleted the addition of Rs 2.69 crore.
Explaining the distinction, Mehta said a bad debt deduction under Section 36(1)(vii) is available only where the amount qualifies as a debt and has already been considered while computing taxable income, as required under Section 36(2).
A business loss under Section 28, however, operates differently.
“It does not require prior recognition of the amount as taxable income. The key requirement is that the loss should have arisen in the ordinary course of carrying on the business,” he explained.
According to Mehta, unpaid sale proceeds generally fall within the scope of bad debts, whereas losses arising from trade advances, broker defaults, exchange failures or business transactions that ultimately fail are often claimed as business losses. In tax litigation, taxpayers frequently raise a Section 28 claim as an alternative where the facts support it.
What if the money is recovered later?
The Tribunal also referred to earlier decisions pointing out that if money written off as a bad debt is recovered later, the Revenue is free to tax the amount in the year of recovery.
Mehta said this position is specifically recognised under Section 41 of the Income-tax Act.
“If a deduction has been allowed in respect of a bad debt or business loss, any subsequent recovery—whether in cash or in any other form—is deemed to be business income in the year of recovery,” he said.
This means taxpayers who recover part or all of the amount in future must offer that amount to tax under the head “Profits and gains of business or profession” in the relevant financial year.
Could the ruling help other NSEL-affected taxpayers?
According to Mehta, although every case depends on its own facts, the ruling could have wider relevance for taxpayers affected by the NSEL crisis or similar broker and exchange defaults.
He said the Tribunal has reaffirmed two important legal principles—that pending recovery proceedings do not automatically make a write-off premature, and that taxpayers are not required to prove actual irrecoverability once the statutory conditions are fulfilled.
“These principles are capable of wider application in comparable factual situations involving genuine business losses or bad debts,” he said.
Disclaimer: This article is based on an Income Tax Appellate Tribunal (ITAT) order. The ruling applies to the specific facts of this case and should not be treated as legal or tax advice. Taxpayers should consult a qualified tax professional before taking any decision based on this judgment.
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