Bad Debts Deduction: When a Business Can Actually Write Off Unpaid Dues

A customer owes your business ₹4 lakh for goods delivered eight months ago. The emails stopped getting replies a while back, the calls don't connect anymore, and it's increasingly obvious the money isn't coming. The instinct is to write it off and claim the deduction, and for a genuine trade debt, that instinct is usually right. But the bad debts deduction under income tax law is narrower than most business owners assume, and it trips people up in both directions: some claim a deduction they were never entitled to because the amount was never actually income in the first place, and others sit on a perfectly valid write-off while over-preparing a legal case for irrecoverability that the law doesn't actually ask for. Here's what genuinely qualifies for FY 2026-27, what doesn't, and what happens if the money shows up after all.

What Actually Counts as a Bad Debt You Can Deduct

The bad debts deduction comes from Section 36(1)(vii) read with Section 36(2) of the Income-tax Act, 1961. The Income-tax Act, 2025, which governs FY 2026-27 onward, carries the same substantive rule forward as part of the broader renumbering the new Act carried out across the statute. This piece cites the older, still widely used section numbers rather than guess at a specific new one that hasn't been reliably confirmed yet, so confirm the current citation with your tax software or CA if you need it for a formal filing. The rule itself is straightforward once you internalise it: a debt is deductible only if it was already taken into account in computing your business income, either in the year you're writing it off or in an earlier year, or if it represents money actually lent in the ordinary course of a money-lending business you carry on. Miss both conditions, and there's no deduction available, regardless of how genuinely uncollectible the amount is.

In practice, this covers the debt almost every business owner actually deals with: a trade receivable. You raised an invoice, recognised that amount as revenue, and paid tax on the resulting profit for that year, and the customer never paid. Because the amount was already offered to tax as income once, the law lets you reverse that position when the money turns out never to have actually arrived. Taxed once as income, deducted once when it fails: that symmetry is the entire logic behind the provision, and it applies the same way to a professional's unpaid fees as it does to a trader's unpaid invoice.

What this rules out is anything that was never routed through your income computation to begin with. A personal loan to a friend or relative, paid from your own funds and never connected to your business's income, doesn't qualify: you never paid tax on that amount as income, so there's nothing to reverse when it isn't repaid. The same logic knocks out a capital advance, a security deposit, or an advance paid to a supplier or landlord, that sat on your balance sheet rather than passing through your profit and loss account. If it was never income, it can't become a bad debt later, whatever your books happen to call it. The one specific carve-out is for businesses that actually lend money as their business: banks, NBFCs, and registered money-lenders. For them, a loan gone bad qualifies even though the loan amount itself was never 'income,' because lending is the business itself, not something incidental to it. An ordinary trading or services business that occasionally advances money to a supplier or contractor doesn't get this carve-out just by calling the advance a loan.

You Don't Have to Prove the Debt Is Dead, Only Write It Off

Here's the part that usually comes as a pleasant surprise. Once the threshold condition above is met, you do not need to prove, through a recovery suit, an insolvency filing, or any other litigation, that the debt has actually become irrecoverable. It is enough that you have written the debt off as bad in your own books of account for that year. This is settled, stable law, and it's genuinely taxpayer-favourable: an assessing officer generally cannot insist that you first exhaust legal remedies or otherwise prove beyond doubt that the money will never come in, once a genuine write-off has actually been made in the books.

This wasn't always the rule. Before a 1989 amendment, a taxpayer did have to establish that a debt had genuinely become irrecoverable, a higher, fact-heavy standard that made bad debt claims a frequent source of litigation. That requirement was specifically removed so taxpayers wouldn't have to fight this battle in every assessment, and the current position, that a genuine write-off in the books is enough, has since been upheld by the Supreme Court and can be relied on with confidence.

That doesn't mean a bare assertion is enough. The write-off has to be an actual, contemporaneous accounting entry made in the books for the year you're claiming the deduction, debited to the profit and loss account and credited against that specific debtor's account, not a note added later, after a query or an assessment has already put the deduction under scrutiny. An entry that's genuinely dated and reflected in that year's books carries real weight. One that looks like it was inserted retrospectively to support a claim already being challenged does not. Keep the distinction straight: whether you actually wrote the debt off when you say you did is fair game for scrutiny. Whether the debt was truly, provably unrecoverable is not.

A Provision for Doubtful Debts Is Not a Write-Off

Businesses that follow accounting standards often carry a general provision, sometimes labelled a reserve, for doubtful debts: an estimate of how much of the total receivables balance is unlikely to be collected, based on ageing or past experience, without identifying which specific customer accounts make up that estimate. This is a legitimate, often necessary accounting practice for financial reporting. It is not, on its own, a tax deduction. The write-off requirement under Section 36(1)(vii) means an actual reduction against a specific debtor's account, not a lump-sum reserve sitting against the total receivables figure. Booking a provision, however carefully calculated, doesn't satisfy the deduction test by itself.

This is one of the more common sources of a book-versus-tax mismatch. A business's financial statements might show, say, ₹8 lakh charged to the profit and loss account this year as a provision for doubtful debts, following its accounting policy. If none of that ₹8 lakh was actually written off against identified debtor accounts, the full amount generally needs to be added back in the tax computation, since accounting profit and taxable profit aren't computed on the same basis here. The deduction becomes available only in the year an amount is actually written off against a specific debtor, which might be the same year as the provision, or, just as often, a later one. If your books and your tax computation are handled by different people or processes, this is exactly the kind of adjustment that gets missed.

Banks and specified financial institutions follow a separate, specific rule for provisions for bad and doubtful debts under Section 36(1)(viia), with its own conditions. What's described above is the general rule for an ordinary trading, manufacturing, or services business, which is what most readers of this piece are actually dealing with.

If the Customer Pays You After All

Claim the deduction, get it allowed, and then have the customer unexpectedly pay up two years later. That recovered amount doesn't stay outside the tax net. Under Section 41(4), an amount you recover against a debt you'd earlier written off and claimed as a deduction becomes taxable as business income in the year you actually receive it, whether or not you're still running the same business at that point. This is really just the mirror image of the deduction you already claimed: the law let you reduce your income when the debt looked dead, so it taxes you back when the money turns out not to be. If only part of the earlier debt was allowed as a deduction, the recovery is taxable to the extent it exceeds what was never allowed in the first place, so it's worth working out the actual arithmetic rather than assuming the whole receipt is automatically taxable, or automatically exempt.

Track this at the level of the specific debtor and the specific year the deduction was claimed. It's exactly the kind of detail that's easy to lose if the person filing the return two or three years later isn't the one who made the original write-off entry, especially once the write-off itself feels like old, settled business.

Documenting the Write-Off So It Holds Up

Since the deduction turns entirely on the write-off itself, being able to show exactly what you wrote off, when, and for which debtor is the difference between a claim that survives scrutiny and one that doesn't. A single lump-sum journal entry at year-end that reduces receivables by some round figure, without naming the debtors it relates to, is a weak position even when the underlying decision was completely genuine. It reads more like an estimate than a write-off of specific, identified debts, and can invite exactly the scrutiny a provision would. Build the habit of writing off each bad debt as its own dated, specific entry, tied to the invoice or account it relates to, as and when you actually decide it's not coming in, rather than batching everything into one adjustment when the books are closed for the year.

A short file for each write-off, built at the time you make the entry rather than reconstructed later if it's ever questioned, should typically include:

• The specific invoice or transaction the debt relates to, with dates and amounts
• The ledger entry writing the amount off against that debtor's account, dated within the year you're claiming the deduction
• Evidence the amount was originally recognised as income, such as the sales invoice or ledger extract (or, for a lender, proof the amount was actually lent in the ordinary course of business)
• A record of the recovery efforts actually made and abandoned: reminder emails, demand notices, calls, or correspondence showing the customer stopped responding, even though you don't need to prove the debt is legally irrecoverable
• Internal approval for the write-off where your business's own policy requires sign-off, particularly for larger amounts
• A short note on the debtor's situation at the time: closure of business, a disputed delivery, insolvency, or simply going unreachable, since it explains why the decision was made when it was

None of this requires a formal legal opinion for every bad debt on your books. Most write-offs are small, routine, and never questioned by anyone. But for anything material enough to move your tax liability, the discipline pays for itself: a specific, dated, well-documented write-off is a deduction you can defend in two lines, while a vague provision or an undocumented claim is one you end up arguing for after the fact. On a large or contested write-off, get your CA to look at the specific facts before you file. A genuinely bad debt is worth claiming correctly the first time, rather than defending it later in assessment.