ITAT Ruling on Deductibility of Loss on Inter-Corporate Deposits

Introduction

In Nayara Energy Ltd. v. Assistant Commissioner of Income Tax, Central Circle – 2 (1)[i], the Income Tax Appellate Tribunal (‘ITAT’) addressed whether the loss arising from the assignment of receivables and payables qualified for deductions under the Income-tax Act, 1961 (‘IT Act’). Nayara Energy Ltd. (‘Appellant’) filed an appeal before the ITAT, claiming that the tax department had incorrectly disallowed a loss of approximately Rs. 250 crore by stating that such loss is covered under s. 36(1)(vii) of the IT Act as bad debt, or under s. 28(i) of the IT Act as business loss.

Facts and Submissions

• The Appellant filed its income tax return for the relevant assessment year (A.Y.), reporting a total loss of Rs. 20.39 crore and book profits reflecting a loss of Rs. 882.22 crore. However, during scrutiny under s. 143(3), the Assessing Officer (‘AO’) recalculated the total income, assessing it as an income amounting to Rs. 1681.78 crore.

• The Appellant had transferred certain receivables, including inter-corporate deposits (‘ICD’) worth Rs. 955.38 crore and related liabilities around Rs. 699.29 crore, to a related entity for a nominal consideration of Rs. 4.8 crore, resulting in a loss of approximately Rs. 250 crore. The Appellant asserted that the loss was in line with its business operations and, therefore, classified the loss as deductible under s. 36(1)(vii) of the IT Act, as bad debt. Alternatively, the Appellant also claimed the loss as a business loss under s. 28(i) of the IT Act.

• The AO and the Commissioner of Income Tax (Appeals) (CIT(A)) flagged such a transaction as a sham as it did not have any business rationale and contended that the transaction was, in fact, an intra-group arrangement designed to minimise taxable income.

• The Appellant claimed that the loss was a proper deduction, citing partial interest income on the ICDs offered to tax in previous years as proof of compliance with s. 36(2) of the IT Act conditions. The Appellant further asserted that the ICDs formed part of the company’s regular business activities; therefore, the loss was incidental to the business.

• The Respondent argued that the transaction did not have a business rationale, was not incidental to the Appellant’s operations, and emphasized that it did not meet the requirements under s. 36(1)(vii) or s. 28(i)of the IT Act. The Respondent further claimed that the Appellant did not prove the recoverability of the ICDs or sufficient documentation for the stated loss.

Held

• The ITAT refused the claim by the Appellant and held that the transaction was not a bad debt under s. 36(1)(vii) of the IT Act, and the assignment of receivables did not amount to an actual write-off of irrecoverable debt.

• The ITAT further held that the transaction was capital in nature and unrelated to the Appellant’s regular business activities. Therefore, it was disqualified from being considered a business loss under s. 28(i) of the IT Act as well.

• The ITAT further considered the genuineness of the transaction and took note of the inconsistency in the valuation and documentation. The fact that critical documents such as signed agreement(s) and prior attempts to recover ICDs were missing further fortified the ITAT’s belief that such transactions were bogus and fabricated.

Conclusion

The ruling emphasizes the importance of substance over form, particularly when evaluating the genuineness and purpose of financial transactions. The decision reiterates that deductibility depends on the transaction being closely tied to core business activities and meeting all statutory requirements. The findings of the decision underscore that the deductions under ss. 36(1)(vii) and 28(i) of the IT Act require strict compliance with statutory conditions and evidentiary proof.

The ITAT concluded that the assignment of receivables did not constitute an ‘actual write-off’ under s. 36(1)(vii) of the IT Act, highlighting that merely reclassifying a debt does not suffice, and the taxpayer must demonstrate that the debt is genuinely irrecoverable and has been formally written off in the books of accounts. This strict interpretation ensures that claims of bad debt are not misused for tax planning purposes without a genuine financial basis.

Further, the rejection of the alternative claim under s. 28(i) of the IT Act, as a business loss was equally significant. The ITAT’s finding that the transaction lacked a business rationale reflects upon its insistence that losses arising from transactions should be incidental to the taxpayer’s regular business activities. The tribunal’s characterization of the loss as capital in nature rather than revenue underscores its scrutiny of the purpose and structure of transactions. This aligns with broader judicial trends to prevent the misuse of business loss provisions to offset taxable income from unrelated transactions.

End Note

[i] 2024 SCC OnLine ITAT 1806 dated 11.09.2024.

Authored by Prashant Singh, Advocate at Metalegal Advocates. The views expressed are personal and do not constitute legal opinions.