Journal adjustment entry passed accepted in it act

Hi Kollipara! Regarding your question on writing off outstanding balances between two different parties (creditor and debtor) through journal adjustment entries and its acceptance under the Income Tax Act:

Scenario recap:

• Cash loan from creditor (Mr. A) = ₹3,00,000 (Credit balance)

• Cash loan to debtor (Mr. B) = ₹2,00,000 (Debit balance)

• Adjustment journal passed to set off ₹2,00,000, leaving ₹1,00,000 balance with creditor

Key issues:

1. Is such adjustment entry allowed as per Income Tax Act?

2. Is the write-off of the difference (₹1,00,000) allowed as expense or disallowed?

1. Adjustment of balances between two different parties

• Under normal accounting and commercial practice, you cannot simply set off balances of two different partiesunless there is an explicit consent/agreement from both parties.

• For tax purposes, the Income Tax Department usually requires proper documentation to support such adjustments.

• The department may disallow the adjustment if it appears to be a device to write off bad debts without following proper steps.

2. Write-off of remaining balance (₹1,00,000) in books

• If the remaining balance (₹1,00,000) is written off as bad debt, it can be claimed as a business expense only if:

  • It is a genuine loss.

  • Proper efforts have been made to recover it.

  • The amount has actually become irrecoverable.

  • It relates to a trading transaction.

• Section 37(1) of the Income Tax Act allows deduction of any revenue expenditure incurred wholly and exclusively for business, including bad debts.

• However, the onus is on the taxpayer to prove the genuineness of bad debt write-off.

• Mere adjustment entries without proper evidence of debt recovery efforts may lead to disallowance.

3. Important points to note:

• If cash loan creditor and debtor are different persons, you cannot offset their balances directly unless they consent or there is a clear legal basis.

• If such an entry is passed just to avoid showing the loan in books or to claim expenses, the Income Tax department may disallow the claim.

• You should maintain documents like written consent from parties, communication about adjustment, and proof of bad debts.

• If the amount is written off, keep supporting evidence that recovery is impossible.

Summary:

Suggestion:
For tax compliance, do not pass adjustment entries merely to write off loans between different parties. Instead:

• Collect consents or legal documents to support the adjustment.

• If writing off bad debt, maintain evidence to justify the claim.