Business expenditure — Banks — The provisions of clause (viia) of section 36(1) relating to the deduction on account of the provision for bad and doubtful debt(s) are distinct and independent of the provisions of section 36(1) (vii) relating to allowance of the bad debts — The scheduled commercial banks would continue to get the full benefit of the writeoff of the irrecoverable debt(s) u/s.36(1)(vii) in addition to the benefit of deduction for the provision made for bad and doubtful debt(s) u/s<

The assessee, a scheduled bank, filed its return of income for the A.Y. 2002-03 on October 24, 2002, declaring total income of Rs.61,15,610. The return was processed u/s.143(1), and eligible refund was issued in favour of the assessee. However, the Assessing Officer issued notice u/s.143(2) to the assessee, after which the assessment was completed. Inter alia, the Assessing Officer, while dealing, u/s.143(3), with the claim of the assessee for bad debts of Rs.12,65,95,770, noticed that the argument put forward on behalf of the assessee, that the deduction allowable u/s.36(1) (vii) is independent of deduction u/s.36(1)(viia), could not be accepted. Consequently, he observed that the assessee having a provision of Rs.15,01,29,990 for bad and doubtful debts u/s.36(1)(viia), could not claim the amount of Rs.12,65,95,770 as deduction on account of bad debts because the bad debts did not exceed the credit balance in the provision for bad and doubtful debts account and also the requirements of clause (v) of s.s (2) of section 36 were not satisfied. Therefore, the assessee’s claim for deduction of bad debts written off from the account books was disallowed. This amount was added back to the taxable income of the assessee, for which a demand notice and challan was accordingly issued. This order of the Assessing Officer dated January 24, 2005, was challenged in appeal by the assessee on various grounds.

The Commissioner of Income-tax (Appeals) vide his order dated April 7, 2006, partly allowed the appeal, particularly in relation to the claim of the appellantbank for bad debts. Relying upon the judgment of a Division Bench of the Kerala High Court in the case of South Indian Bank Ltd. v. CIT, (2003) 262 ITR 579 (Ker.), the Commissioner of Income-tax (Appeals) held that the claim of the appellant was fully supported by the said decision and since the entire bad debts written off by the bank u/s.36(1)(vii) were pertaining to urban branches only and not to the provision made for rural brances u/s.36(1)(viia), it was entitled to the deduction of the full claimed amount of Rs.12,65,95,770. Consequently, he directed deletion of the said amount.

Being aggrieved from the order of the Commissioner of Income-tax (Appeals), the Revenue as well as the assessee filed appeal before the Income Tax Appellate Tribunal, Cochin. Vide its order dated April 16, 2007, while relying upon the judgment of the jurisdictional High Court in the case of South Indian Bank Ltd. (supra), the Income Tax Appellate Tribunal dismissed the appeal of the Revenue on this issue and also granted certain other benefits to the assessee in relation to other items.

However, the Department of Income-tax, being dissatisfied with the order of the Income Tax Appellate Tribunal in the A.Y. 2002-03, filed an appeal before the High Court u/s.260A of the Act.

The Division Bench of the High Court of Kerala at Ernakulam hearing the batch of appeals against the order of the Income Tax Appellate Tribunal expressed the view that the judgment of that Court in the case of South Indian Bank (supra) was not a correct exposition of law. While dissenting therefrom, the Bench directed the matter to be placed before a Full Bench of the High Court.

Vide its judgment dated December 16, 2009, the Full Bench not only answered the question of law but even decided the case on the merits. While setting aside the view taken by the Division Bench in South Indian Bank (supra) and also the concurrent view taken by the Commissioner of Income-tax (Appeals) and the Income Tax Appellate Tribunal, the Full Bench of the High Court held as under (page 181 of 326 ITR):

“What is clear from the above is that provision for bad and doubtful debts normally is not an allowable deduction and what is allowable under the main clause is bad debt actually written off. However, so far as banks to which clause (viia) applies are concerned, they are entitled to claim deduction of provision u/ss.(viia), but at the same time when bad debts written off is also claimed deduction under clause (vii), the same will be allowed as a deduction only to the extent it is in excess of the provision created and allowed as a deduction under clause (viia). It is worthwhile to note that deduction u/s.36(1)(vii) is subject to s.s (2) of section 36 which in clause (v) specifically states that any bad debt written off should be claimed as a deduction only after debiting it to the provision created for bad and doubtful debts. What is clear from the above provisions is that though the respondent-banks are entitled to claim deduction of provision for bad and doubtful debts in terms of clause (viia), such banks are entitled to deduction of bad debt actually written off only to the extent it is in excess of the provision created and allowed as deduction under clause (viia). Further, in order to qualify for deduction of bad debt written off the requirement of section 36(2)(v) is that such amount should be debited to the provision created under clause (viia) of section 36(1). Therefore, we are of the view that the distinction drawn by the Division Bench in the South Indian Bank’s case between the bad debts written off in respect of advances made by rural branches and bad debts pertaining to advances made by other branches does not exist and is not visualised under the proviso to section 36(1)(vii). We, therefore, hold that the said decision of this Court does not lay down the correct interpretation of the provisions of the Act. Admittedly, all the respondent-assessees have claimed and have been allowed deduction of provision in terms of clause (viia) of the Act. Therefore, when they claim deduction of bad debt written off in the previous year by virtue of the proviso to section 36(1)(vii), they are entitled to claim deduction of such bad debt only to the extent it exceeds the provision created and allowed as deduction under clause (viia) of the Act.

In the normal course we should answer the question referred to us by the Division Bench and send back the appeals to the Division Bench to decide the appeals consistent with the Full Bench Decision. However, since this is the only issue that arises in the appeals, we feel it would be only an empty formality to send back the matter to the Division Bench for disposal of appeals consistent with our judgment. In order to avoid unnecessary posting of appeals before the Division Bench, we allow the appeals by setting aside the orders of the Tribunal and by restoring the assessments confirmed in first appeals.”

Dissatisfied from the judgment of the Full Bench of the Kerala High Court, the assessee filed the appeals before the Supreme Court purely on question of law.

The Supreme Court held that the income of an assessee carrying on a business or profession has to be assessed in accordance with the scheme contained in Part D of Chapter IV dealing with heads of income. Section 28 of the Act deals with the chargeability of income to tax under the head ‘Profits and gains of business or profession’. All ‘other deductions’ available to an assessee under this head of income are dealt with u/s.36 of the Act which opens with the words ‘the deduction provided for in the following clauses shall be allowed in respect of matters dealt with therein, in computing the income referred to in section 28’. In other words, for the purposes of computing the income chargeable to tax, beside specific deductions, ‘other deductions’ postulated in different clauses of section 36 are to be allowed by the Assessing Officer, in accordance with law.

The provision of section 36(1)(vii) would come into play in the grant of deductions, subject to the limitation contained in section 36(2) of the Act. Any bad debt or part thereof, which is written off as irrecoverable in the accounts of the assessee for the previous year is the deduction which the assessee would be entitled to get, provided he satisfies the requirements of section 36(2) of the Act. Allowing of deduction of bad debts is controlled by the provisions of section 36(2). The argument advanced on behalf of the Revenue is that it would amount to allowing a double deduction if the provisions of section 36(1)(vii) and 36(1)(viia) are permitted to operate independently. There is no doubt that a statute is normally not construed to provide for a double benefit unless it is specifically so stipulated or is clear from the scheme of the Act. As far as the question of double benefit is concerned, the Legislature in its wisdom introduced section 36(2)(v) by the Finance Act, 1985, with effect from April 1, 1985. Section 36(2)(v) concerns itself as a check for claim of any double deduction and has to be read in conjunction with section 36(1)(viia) of the Act. It requires the assessee to debit the amount of such debt or part thereof in the previous year to the provision made for that purpose.

The Supreme Court, referring to the Circular Nos. 258, dated 14-6-1979, 421, dated 12-6-1988, 464, dated 18-7-1986 and the objects and reasons for the Finance Act, 1986, held that clear legislative intent of the relevant provisions and unambiguous language of the Circulars with reference to the amendments to section 36 of the Act demonstrate that the deduction on account of provision for bad and doubtful debts u/s.36(1)(viia) is distinct and independent of the provisions of section 36(1)(vii) relating to allowance of the bad debts. The legislative intent was to encourage rural advances and the making of provisions for bad debts in relation to such rural branches. Another material aspect of the functioning of such banks is that their rural branches were practically treated as a distinct business, though ultimately these advances would form part of the books of accounts of the principal or head office branch. According to the Supreme Court the Circulars in question show a trend of encouraging rural business and for providing greater deductions. The purpose of granting such deductions would stand frustrated if these deductions are implicitly neutralised against other independent deductions specifically provided under the provisions of the Act.

The Supreme Court further held that the language of section 36(1)(vii) of the Act is unambiguous and does not admit of two interpretations. It applies to all banks, commercial or rural, scheduled or unscheduled. It gives a benefit to the assessee to claim a deduction on any bad debt or part thereof, which is written off as irrecoverable in the amounts of the assessee for the previous year. This benefit is subject only to section 36(2) of the Act. It is obligatory upon the assessee to prove to the Assessing Officer that the case satisfies the ingredients of section 36(1)(vii) on the one hand and that it satisfies the requirements stated in section 36(2) of the Act on the other. The proviso to section 36(1)(vii) does not, in absolute terms, control the application of this provision as it comes into operation only when the case of the assessee is one which falls squarely u/s.36(1)(viia) of the Act. The Supreme Court noticed that the Explanation to section 36(1)(vii), introduced by the Finance Act, 2001, had to be examined in conjunction with the principal section. The Explanation specifically excluded any provision for bad and doubtful debts made in the account of the assessee from the ambit and scope of ‘any bad debt, or part thereof, written off as irrecoverable in the accounts of the assessee’. Thus, the concept of making a provision for bad and doubtful debts would fall outside the scope of section 36(1)(vii) simpliciter. The proviso, would have to be read with the provisions of section 36(1)(viia) of the Act. Once the bad debt is actually written off as irrecoverable and the requirements of section 36(2) satisfied, then, it would not be permissible to deny such deduction on the apprehension of double deduction under the provisions of section 36(1)(viia) and the proviso to section 36(1)(vii). According to the Supreme Court this did not appear to be the intention of the framers of law. The scheduled and non-scheduled commercial banks would continue to get the full benefit of write-off of the irrecoverable debts u/s.36(1)(vii) in addition to the benefit of deduction of bad and doubtful debts u/s.36(1)(viia). Mere provision for bad and doubtful debts may not be allowable, but in the case of a rural advance, the same, in terms of section 36(1)(viia)(a), may be allowable without insisting on an actual write-off.

The Supreme Court observed that as per the proviso to clause (vii), the deduction on account of the actual write-off of bad debts would be limited to the excess of the amount written off over the amount of the provision which had already been allowed under clause (viia). According to the Supreme Court the proviso by and large protects the interests of the Revenue. In case of rural advances which are covered by clause (viia), there would be no double deduction. The proviso, in its terms, limits its application to the case of a bank to which clause (viia)applies. Indisputably, clause (viia)(a) applies only to rural advances.

The Supreme Court further observed that as far as foreign banks are concerned, u/s.36(1)(viia)(b) and as far as public finance institutions or State financial corporations or State industrial investment corporations are concerned, u/s.36(1)(viia)(c), they do not have rural branches. The Supreme Court therefore inferred that the proviso is self-indicative that its application is to bad debts arising out of rural advances.

In a concurring judgment, the Chief Justice held that u/s.36(1)(vii) of the Income-tax Act, 1961, the taxpayer carrying on business is entitled to a deduction, in the computation of taxable profits, of the amount of any debt which is established to have become a bad debt during the previous year, subject to certain conditions. However, a mere provision for bad and doubtful debt(s) is not allowed as a deduction in the computation of taxable profits. In order to promote rural banking and in order to assist the scheduled commercial banks in making adequate provisions from their current profits to provide for risks in relation to their rural advances, the Finance Act inserted clause (viia) in relation to their rural advances, the Finance Act inserted clause (viia) in s.s (1) of section 36 to provide for a deduction, in the computation of taxable profits of all scheduled commercial banks, in respect of provisions made by them for bad and doubtful debt(s) relating to advances made by their rural branches. The deduction is limited to a specified percentage of the aggregate average advances made by the rural branches computed in the manner prescribed by the Income-tax Rules, 1962. Thus, the provisions of clause (viia) of section 36(1) relating to the deduction on account of the provision for bad and doubtful debt(s) is distinct and independent of the provisions of section 36(1)(vii) relating to allowance of the bad debts. In other wards, the scheduled commercial banks would continue to get the full benefit of the write-off of the irrecoverable debt(s) u/s.36(1)(vii) in addition to the benefit of deduction for the provision made for bad and doubtful debt(s) u/s.36(1)(viia). A reading of the Circulars issued by Central Board of Direct Taxes indicates that normally a deduction for bad debt(s) can be allowed only if the debt is written off in the books as bad debt(s). No deduction is allowable in respect of a mere provision for bad and doubtful debt(s). But in the case of rural advances, a deduction would be allowed even in respect of a mere provision without insisting on an actual write-off. However, this may result in double allowance in the sense that in respect of the same rural advance the bank may get allowance on the basis of clause (viia) and also on the basis of accrual write-off under clause (vii). This situation is taken care of by the proviso to clause (vii) which limits the allowance on the basis of the actual write-off to the excess, if any, of the write-off over the amount standing to the credit of the account created under clause (viia).

Note: The Court incidentally considered whether, when findings recorded in the other assessment year are accepted by the Revenue, it should be permitted to question the correctness of the same in the subsequent years. The relevant portion of the judgment is extracted below:

The applicant has contended that as the similar claims had been decided in favour of the banks for the A.Ys. 1991-92 to 1993-94 by the Special Bench of the Income Tax Appellate Tribunal, which had not been challenged by the Department, as such, the issue had attained finality and could not be disturbed in the subsequent years.

The above contention of the appellant-banks does not impress us at all. Merely because the orders of the Special Bench of the Income Tax Appellate Tribunal were not assailed in appeal by the Department itself, this would not take away the right of the Revenue to question the correctness of the orders of assessment, particularly when a question of law is involved. There is no doubt that the earlier orders of the Commissioner of Income-tax (Appeals) had merged into the judgment of the Special Bench of the Income Tax Appellate Tribunal and attained finality for that relevant year. Equally, it is true that though the Full Bench judgment of that very Court in the case of South Indian Bank (supra), it did not notice any of the contentions before and principles stated by the Special Bench of the Income Tax Appellate Tribunal in its impugned judgment. As already noticed, the questions raised in the present appeal go to the very root of the matter and are questions of law in relation to interpretation of sections 36(1)(vii) and 36(1)(viia) read with section 36(2) of the Act. Thus, without any hesitation, we reject the contention of the appellant-banks that the findings recorded in the earlier A.Ys. 1991-92 to 1993-94 would be binding on the Department for subsequent years as well.