DCIT vs. Shreyas S. Morakhia (ITAT Mumbai Special Bench)

If brokerage offered to tax, the principal debt qualifies as a “bad debt” u/s 36(1)(vii) r.w.s. 36(2)

The assessee, a broker, claimed deduction for bad debts in respect of shares purchased by him for his clients. The AO rejected the claim though the CIT (A) upheld it. On appeal by the Revenue, the matter was referred to the Special Bench. Before the Special Bench, the department argued that u/s 36(2), no deduction on account of bad debt can be allowed unless “such debt or part thereof has been taken into account in computing the income of the assessee”. It was argued that as the assessee had offered only the brokerage income to tax but not the value of shares purchased on behalf of clients, the latter could not be allowed as a bad debt u/s 36(1)(vii). HELD rejecting the claim of the department:

(i) In Veerabhadra Rao 155 ITR 152 the Supreme Court held in the context of a loan that if the interest is offered to tax, the loan has been “taken into account in computing the income of the assessee” and qualifies for deduction u/s 36(1)(vii). The effect of the judgement is that in order to satisfy the condition stipulated in s. 36(2)(i), it is not necessary that the entire amount of debt has to be taken into account in computing the income of the assessee and it will be sufficient even if part of such debt is taken into account in computing the income of the assessee. This principle applies to a share broker. The amount receivable on account of brokerage is a part of debt receivable by the share broker from his client against purchase of shares and once such brokerage is credited to the P&L account and taken into account in computing his income, the condition stipulated in s. 36(2)(i) gets satisfied. Whether the gross amount is reflected in the credit side of the P&L A/c or only the net amount is finally reflected as profit after deducting the corresponding expenses or only the net amount of brokerage received by the share broker is reflected in the credit side of the P&L account makes no difference because the ultimate effect is the same;

(ii) The argument that the loss was suffered owing to breach of SEBI Guidelines framed to safeguard the interest of brokers in respect of amount receivable from the clients against purchase of shares is irrelevant. If the broker chooses not to follow the guidelines, it is a decision taken by him as a businessman having regard to his business relations with the client. The loss cannot be equated to expenditure incurred by the assessee for any purpose which is an offence or which is prohibited by law. (CIT vs. Pranlal Kesurdas 49 ITR 931 (Bom) followed where bad debts on account of forbidden vayada transactions were held allowable);

(iii) The contention of the Revenue that the sale value of the shares remaining with the assessee should be adjusted against the amount receivable from the client so as to arrive at the actual amount of bad debt should be raised, if permissible, before the Division Bench.