Income Tax Act | Provision for Doubtful Debts Is Not a Reserve – Cannot Be Added to Book Profits Under Section 115JA – Bombay High Court Rules in Favour of Assessee

“Legislature Introduced Clause (g) for Diminution in Value of Assets Only from 01.04.1998 – Its Absence in A.Y. 1997–98 Confirms It Was Never Covered Under Clauses (b) or (c)”, In a pivotal ruling Division Bench of the Bombay High Court comprising Chief Justice Alok Aradhe and Justice Sandeep V. Marne held that a provision for doubtful debts cannot be added to the book profits under clause (b) or (c) of the Explanation to Section 115JA of the Income Tax Act, 1961. The Court allowed the appeal filed by M.J. Exports Pvt. Ltd., setting aside concurrent findings of the Assessing Officer, Commissioner of Income Tax (Appeals), and the Income Tax Appellate Tribunal (ITAT), which had erroneously treated such a provision as a "reserve".

The decision in M.J. Exports Pvt. Ltd. v. JCIT & CIT clarifies the scope of permissible adjustments to book profits under Minimum Alternate Tax (MAT) provisions for the assessment year 1997–1998, and affirms that provisions for diminution in asset value could not be added back unless specifically provided for under clause (g), which was inserted only from April 1, 1998.

M.J. Exports Pvt. Ltd., a recognized export house, had exported goods worth over ₹3.8 crores to a U.S.-based company, Regal International Inc., between November 1995 and May 1996. Due to alleged quality issues raised by Russian authorities, Regal International withheld payments and ultimately defaulted on approximately ₹2.35 crores. In light of this, the company made a provision of ₹2.49 crores in its 1996–97 Profit and Loss Account as “provision for doubtful debts/advances”, anticipating diminished recoverability.

The Assessee’s accounts were duly audited and filed with the Registrar of Companies. However, the Assessing Officer (AO) added back the provision to book profits under clause (c) of Explanation to Section 115JA, treating it as provision for unascertained liability. The CIT(A) upheld the addition, but under clause (b), calling it a "reserve". The ITAT affirmed the CIT(A)’s view, triggering this appeal under Section 260A of the Income Tax Act.

The central legal question framed and answered by the High Court was:

“Whether the Tribunal was justified in holding that the provision for doubtful debts of ₹2,49,73,218 was a 'reserve' and therefore, liable to be added to book profit under clause (b) of Explanation to Section 115JA?”

The Court ruled against the Revenue and provided detailed reasoning for each of the incorrect approaches taken by the lower authorities.

Provision for Doubtful Debts Is a Diminution in Asset Value, Not Liability

Rejecting the AO’s classification under clause (c), the Court cited the landmark decision in CIT v. HCL Comnet Systems & Services Ltd. [(2008) 305 ITR 409 (SC)], stating:

“A provision for doubtful debt is made to cover up the probable diminution in the value of an asset — a debt receivable — and not for meeting any liability.”

The Court observed: “A debt payable is a liability; a debt receivable is an asset. The Assessing Officer grossly erred in treating a provision for doubtful recovery from debtors as a provision for liability.”

Clause (b) Cannot Be Invoked to Treat Provision as Reserve

The ITAT and CIT(A) had justified the addition under clause (b) by referring to Clause 7(2) of Part III of Schedule VI of the Companies Act, 1956, interpreting excess provisions as reserves. The Court rejected this reasoning, noting:

“Clause (g) dealing with diminution in value of assets was inserted in Section 115JA only with effect from April 1, 1998. Its prior absence demonstrates that such provisions were never intended to be added back under clause (b).”

Emphasizing legislative intent, the Court held: “If such provision was already covered under clause (b), there was no need for the Legislature to later insert clause (g).”

Provisions Certified Under the Companies Act Cannot Be Arbitrarily Recharacterized

Relying on the authoritative ruling in Apollo Tyres Ltd. v. CIT [(2002) 9 SCC 1], the Court reiterated the limited power of the tax authorities under MAT:

“The Assessing Officer has only the power of increasing or reducing net profits to the extent specified in the Explanation. He cannot alter the nature of provisions properly certified and disclosed in accordance with the Companies Act.”

The Court emphasized: “The Assessee's accounts were prepared under statutory requirements, certified by auditors, and filed with the Registrar of Companies. No objection was raised by any statutory authority regarding the classification of the provision.”

The Provision Was Specific and Reflected a Reasonable Business Decision

The Court noted that the provision was based on specific outstanding amounts from foreign buyers, including Regal International, and reflected a bona fide judgment of doubtful recovery. It recorded:

“The Assessee ultimately recovered only about 50% of the outstanding dues in subsequent years, affirming the commercial prudence behind the provision.”

The Bombay High Court decisively set aside the orders of the AO, CIT(A), and ITAT, answering the substantial question of law in favour of the Assessee. The Court held:

“The said amount was not a ‘Reserve’ and therefore, the book profit could not be increased by the said amount under clause (b) of the Explanation to Section 115JA of the Act.”

“The orders passed by the ITAT, CIT(A) and AO to the extent of adding back the amount of ₹2,49,73,218 to the book profit of the Assessee for A.Y. 1997–1998 are set aside.”

This judgment reinforces the principle that Minimum Alternate Tax adjustments must strictly adhere to statutory clauses, and provisions made in good faith for doubtful recoveries cannot be mechanically equated to reserves or liabilities.

Date of Decision: July 9, 2025