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LAHORE: No taxpayer can seek a deduction for a debt as bad debt unless it is treated in the books and accounts as bad debt and has been written off in the relevant tax year, said sources in local field formation of the Federal Board of Revenue (FBR).

They said the question of seeking a deduction for such debt as bad debt does not arise when a taxpayer has not written off the debt within its books and accounts for the relevant tax year while declaring it as irrevocable.

However, they added that if a debt deemed irrecoverable is subsequently recovered, the taxpayer has to offer it for taxation purposes.

When inquired about the characteristics attached to a debt as bad debt, they said such amount must be included in the previous income from business chargeable to tax, and it must be written off in the accounts in that tax year.

Also, they added the amount of deduction must not exceed the amount written off, and the taxpayer must have a reasonable basis to believe that the debt is irrecoverable.

They stressed that it is not for the tax department to second guess the taxpayer’s belief so long as such belief has a reasonable basis.

According to sources, taxpayers claiming the deduction for bad debt in a tax year must meet the above conditions. They have further pointed out that under the Income Tax Ordinance of 1979, the debt for deduction had to be determined as irrecoverable by the deputy commissioner, while the same condition would be satisfied if the taxpayer had a reasonable ground for believing at the time of filing tax returns that the debt is irrecoverable in the case of Ordinance 2001.

Leading tax practitioners said this change in law aligns with the idea of self-assessment introduced for the Ordinance of 2001, they added.

However, the entitlement for deduction of bad debt in a tax year is linked with the belief that the debt has become irrecoverable under both statutes. But it is not a matter of discretion for the tax officer to decide what a bad debt is.

Instead, they said, the tax authority would have to establish reasonable grounds showing that having taken the requisite lawful steps to recover the outstanding debts, which are not recoverable in the foreseeable future.

The tax department would determine the facts and circumstances to answer whether there was no ray of hope for recovering a debt.

Copyright Business Recorder, 2023

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