Bad Debts Deduction Under Section 36(1)(vii) Before the September 30, 2026 Tax Audit: The Write-Off Test and the Move to Section 31 of the Income-tax Act 2025

Quick Summary: The Bad Debts Deduction in One Screen

• The governing law for this audit season is the 1961 Act. Your September 30, 2026 tax audit covers financial year 2025-26 (assessment year 2026-27), so bad debts are claimed under Section 36(1)(vii) read with Section 36(2) of the Income-tax Act, 1961.
• Writing it off is enough. After the April 1, 1989 amendment, you do not have to prove a debt actually became irrecoverable. It is sufficient that you write it off as irrecoverable in your books. This is the settled position of the Supreme Court in TRF Ltd v CIT (2010) 323 ITR 397 (SC).
• But the debt must have been in your income. Under Section 36(2), the debt must have been taken into account in computing your income in the year of write-off or an earlier year, or it must be money lent in the ordinary course of banking or money-lending.
• A provision is not a write-off. A mere provision for doubtful debts is not deductible under Section 36(1)(vii). The Supreme Court in Vijaya Bank v CIT (2010) 323 ITR 166 (SC) held you must actually reduce the debtor in your accounts.
• From FY 2026-27, the number changes. Under the Income-tax Act, 2025 (in force April 1, 2026), the bad debts rule moves to Section 31, titled “Deduction for bad debt and provision for bad and doubtful debt.” The substance is carried forward; only the section number changes.

This is instalment #11 of our CBDT FAQ Deep-Dive series on the transition to the Income-tax Act, 2025. Tax audit season is here, and bad debts is one of the most common adjustments a tax auditor examines. The rule looks simple, yet it is one of the most litigated deductions in the Act because businesses routinely confuse a provision with a write-off, or forget that the debt had to have been offered to income in the first place. This post sets out exactly what you can claim under Section 36(1)(vii) before September 30, 2026, and how the same rule reappears as Section 31 in the new Act.

What Section 36(1)(vii) allows

Section 36(1)(vii) of the Income-tax Act, 1961 allows a deduction for the amount of any bad debt, or part of it, that is written off as irrecoverable in the accounts of the assessee for the previous year. Two words carry the entire weight of the provision: written off. The deduction is anchored to the accounting act of writing the debt off in the books, not to a legal finding that the money is gone forever.

The two conditions in Section 36(2) you cannot skip

Section 36(1)(vii) does not stand alone. It is read with Section 36(2), which imposes the real gatekeeping test. A bad debt is deductible only if one of the following is satisfied:

1. The income limb. The debt (or part of it) has been taken into account in computing the income of the assessee in the year of the write-off or in an earlier year. In plain terms, you can only write off as bad something that you first recognised as income. A trade receivable from a sale you booked as revenue qualifies. A loan or advance you never offered to tax generally does not.
2. The money-lending limb. The debt represents money lent in the ordinary course of the business of banking or money-lending carried on by the assessee.

This is where a large number of bad-debt claims fail. A capital advance, a security deposit, or an inter-corporate deposit that was never routed through your profit and loss account as income usually will not clear Section 36(2). If it does not qualify as a bad debt, the fallback is to test it as a business loss under Section 37(1) or as a trading loss, which is a different and harder argument.

The write-off test: do you have to prove the debt is actually bad?

No. This was settled by the Supreme Court. Before the April 1, 1989 amendment, an assessee had to establish that the debt had in fact become bad. After that amendment, the language changed to “written off as irrecoverable in the accounts.”

In TRF Ltd v CIT (2010) 323 ITR 397 (SC), the Supreme Court held that after April 1, 1989 it is not necessary for the assessee to establish that the debt has, in fact, become irrecoverable. It is enough if the bad debt is written off as irrecoverable in the accounts of the assessee. This is the single most important sentence for a tax auditor to remember when a client asks whether a receivable can be written off.

Write-off versus provision: the Vijaya Bank line

If writing off is enough, what counts as writing off? A book entry that merely creates a provision for doubtful debts on the liabilities side, while the debtor still sits at full value on the assets side, is not a write-off. It is a provision, and a provision for bad and doubtful debts is not deductible under Section 36(1)(vii).

In Vijaya Bank v CIT (2010) 323 ITR 166 (SC), the Supreme Court clarified that an actual write-off requires the assessee to debit the profit and loss account and correspondingly reduce the loans and advances or the debtors on the asset side of the balance sheet, so that the aggregate of the debtors is reduced. Where that is done, the requirement of a write-off is met even without squaring off each individual debtor’s account.

The practical takeaway: if you want the deduction this year, make sure your books show a genuine reduction in the debtor balance, not a parked provision.

Bad debts for banks and NBFCs: Section 36(1)(viia)

Banks and certain financial institutions have a parallel, separate deduction under Section 36(1)(viia) for a provision for bad and doubtful debts, within prescribed percentage limits. This is distinct and independent of the Section 36(1)(vii) write-off deduction. The two operate together through the proviso to Section 36(1)(vii) and Section 36(2)(v), which prevent a double deduction: a bank claiming the (viia) provision can claim a (vii) write-off only to the extent the write-off exceeds the credit balance in the (viia) provision account. If you audit a bank, an NBFC or an HFC, read the two clauses together rather than in isolation.

The tax audit angle: what to check before September 30, 2026

For a business or profession whose accounts are subject to audit under Section 44AB, the tax audit report for financial year 2025-26 is due by September 30, 2026, ahead of the October 31, 2026 return due date. Bad debts are a recurring item of examination. Use this checklist before you sign:

1. Trace the debt back to income. Confirm the amount was offered to tax in this year or an earlier year (the Section 36(2) income limb), or that it is money lent in the ordinary course of banking or money-lending.
2. Confirm a real write-off. Verify the debtor balance is actually reduced in the books, not merely provided for. Apply the Vijaya Bank test.
3. Separate provisions from write-offs. A general provision for doubtful debts is disallowed under Section 36(1)(vii) and, for most non-bank assessees, has to be added back.
4. Do not demand proof of irrecoverability. Per TRF Ltd, the write-off itself is sufficient. Do not create a documentation burden the statute does not require.
5. Watch for recovery of a written-off debt. If a bad debt written off earlier is later recovered, the recovery is taxable in the year of receipt under Section 41(4).
6. Test failed claims under Section 37(1). Where a write-off does not qualify as a bad debt (for example, an advance never offered to income), consider whether it is an allowable business loss under Section 37(1), and disclose accordingly.

How bad debts move to the Income-tax Act, 2025

The Income-tax Act, 2025 came into force on April 1, 2026 and first applies to financial year 2026-27 (assessment year 2027-28). The bad debts rule survives the rewrite intact; only its address changes. In the new Act, the cluster of business deductions that sat in old Section 36 has been reorganised, and bad debts have been carved out into their own provision, Section 31, titled “Deduction for bad debt and provision for bad and doubtful debt.”

Rule	Income-tax Act, 1961 (FY 2025-26, the current audit)	Income-tax Act, 2025 (FY 2026-27 onward)
Deduction for bad debt written off	Section 36(1)(vii)	Section 31
Conditions (debt offered to income / money lent in banking or money-lending)	Section 36(2)	Section 31(2)(a)
Provision for bad and doubtful debts (banks and specified institutions)	Section 36(1)(viia)	Within Section 31
Recovery of a written-off debt taxed later	Section 41(4)	Successor provision in the Act 2025 (confirm the section before citing)

Section 31 of the Act 2025 keeps the write-off test and the two-limb condition. It requires the amount to have been taken into account in computing income in the year of write-off or an earlier year, or to represent money lent in the ordinary course of banking or money-lending, and it allows the deduction in the tax year in which the amount is written off as irrecoverable in the accounts. It also keeps the distinction between an actual write-off and a provision for bad and doubtful debts. So the TRF Ltd and Vijaya Bank principles you apply this audit season carry over in substance to next year’s numbers.

Frequently asked questions

Do I have to prove a debt is irrecoverable to claim a bad debt deduction?

No. After the April 1, 1989 amendment, and as confirmed by the Supreme Court in TRF Ltd v CIT (2010) 323 ITR 397, it is sufficient that the debt is written off as irrecoverable in the accounts. You do not have to establish that it actually became bad.

Is a provision for doubtful debts deductible?

For most non-bank businesses, no. A mere provision is not a write-off under Section 36(1)(vii). You must actually reduce the debtor balance in the books, as explained in Vijaya Bank v CIT (2010) 323 ITR 166. Banks and specified financial institutions have a separate provision-based deduction under Section 36(1)(viia).

Can I write off an advance or a loan that I never offered to tax?

Usually not as a bad debt. Section 36(2) requires the debt to have been taken into account in computing income, unless it is money lent in the ordinary course of banking or money-lending. A pure advance or deposit that never passed through your income may instead have to be tested as a business loss under Section 37(1).

What happens if I recover a debt I had written off?

A subsequent recovery of a bad debt that was allowed as a deduction is taxable in the year of recovery under Section 41(4) of the Income-tax Act, 1961.

Which section governs bad debts from FY 2026-27?

Section 31 of the Income-tax Act, 2025, titled “Deduction for bad debt and provision for bad and doubtful debt.” For the September 30, 2026 tax audit, which covers FY 2025-26, you still apply Section 36(1)(vii) of the 1961 Act.

Related reading on TaxUpdate.in

• CBDT FAQ Deep-Dive #7: Section 43B actual-payment deductions and the move to Section 37
• CBDT FAQ Deep-Dive #9: Inter-corporate dividends under Section 148 (successor to Section 80M)
• CBDT FAQ Deep-Dive #10: ICDS and method of accounting under Sections 276 and 277

Source and verification

Section 36(1)(vii), Section 36(2), Section 36(1)(viia) and Section 41(4) are provisions of the Income-tax Act, 1961, the governing law for FY 2025-26 (AY 2026-27). Judicial position: TRF Ltd v CIT (2010) 323 ITR 397 (SC) and Vijaya Bank v CIT (2010) 323 ITR 166 (SC), settled law on the write-off test. Transition mapping: old Section 36(1)(vii)/(2)/(viia) maps to Section 31 of the Income-tax Act, 2025 (“Deduction for bad debt and provision for bad and doubtful debt”), verified against the enacted-Act text via eztax.in/income-tax-act-2025/section-31, retrieved September 8, 2026, corroborated by taxheal.com. The exact successor to Section 41(4) in the Act 2025 has not been pinned to primary source in this article and is left concept-level. Period-aware citation: apply the 1961 Act for the current audit; apply the Act 2025 for FY 2026-27 onward.

Get expert guidance

Bad debts, provisions and Section 37 business losses are among the most contested items in a tax audit. If you want a second set of eyes on your FY 2025-26 write-offs before the September 30 deadline, or help mapping your business deductions to the Income-tax Act, 2025, Tax Update India can help. Schedule a strategy session to review your position. Our advisory work is reviewed by experienced tax professionals.

Disclaimer

This article is for general information and does not constitute tax or legal advice. It reflects the law and reported judicial position as of the date of publication. Section numbers under the Income-tax Act, 2025 are stated as verified at the date of writing; confirm the current text against primary source before relying on it. Seek professional advice for your specific facts.