Write-off of debts, IMF, and domestic debt restructuring

A State bank confessed before COPE that they have written off Rs. 57.4 billion as bad debts. Good. But this can be utilised to solve all our debt problems, and we do not have to plead and bow to the IMF or battle for domestic debt restructuring.

As per generally accepted accounting principles, a write-off of a bad debt is an income in the hands of the respective debtor, who now has no need to pay the corresponding debt. Assume that these debtors have a tax file (which they should have, given the volume of their debts and business transactions), these figures will be treated as income and added to their taxable income and taxes levied.

In a worst-case scenario, even those entities that have reported losses for tax purposes according to their tax returns, these debts written off will nullify the impact and make them liable for taxes. Even if we generously consider that only half of this amount (Rs. 57.4 billion), is taxed at the lowest rate of 14% (remember this is the lowest rate for companies and the other rates range from 28% to 40% and the rate for individuals increased from 18% to now 36%), the tax collection would be ½ of 57.4 x 14% = Rs. 4.018 billion. If we consider the bad debts written off by the other State bank and any other commercial banks, if any, the tax collection would be a sizeable amount. 

Section 24 of the Inland Revenue Act No. 24 of 2017 (as amended) provides ample teeth for the Commissioner General of Inland Revenue to collect this amount.

It is interesting to find out whether these loans written off were allowed as a deduction for income tax purposes by the Department of Inland Revenue for the bank in arriving at its adjusted profits for tax purposes because such allowance normally should go through very stringent rules and regulations.The following two decided cases also vouch for such strict conditions: 

In Dinshaw v L T Commissioners (50 TLR 527 PC), it was held whether a debt is bad or good, is considered at the end of the accounting period, the fact that a debtor is still trading is not a ground to treat a debt as not bad.

Further in Odhams Press Ltd. v Cook (23 TC 233), it was upheld that loans advanced outside the scope of trade, business, or profession and sums irrecoverable on account of such loans is loss of capital and cannot be deducted as bad debt.

The dictum of CIT v R M A A R A M (1 CTC 41), contemplates that a money lender may be assessed to income tax in respect of unpaid interest on recoverable loans which fell due during the period for which profits are ascertained. 

Hence either way, the collection of revenue is mandatorily feasible either from the default debtors or the loan provider, the banks. 

Veerappan Sivagurunathan

Attorney-at-Law