Bad debts are such debts which are not recoverable. Doubtful debts are such debts which are suspected to be recovered.
As per judgment of TRF Limited vs. CIT (Supreme Court). Bad debts need not be proven to be irrecoverable u/s 36(1)(vii). It is sufficient if they are written off.
As per judgment of VIJAYA BANK vs. COMMISSIONER OF INCOME TAX & ANR. (SUPREME COURT OF INDIA), Every account need not to be closed as loan accounts are kept in the branch and provision is made at head office level. Also it is not recommendable in case of suit filed loan accounts. So, it is sufficient to deduct the provision made for bad debts from gross loan amount and only net amount is to be shown at assets side of balance sheet. In any event, s. 41(4) of 1961 Act, inter alia, lays down that, where a deduction has been allowed in respect of a bad debt or a part thereof under s. 36(1)(vii) of 1961 Act, then, if the amount subsequently recovered on any such debt is greater than the difference between the debt and the amount so allowed, the excess shall be deemed to be profits and gains of business and, accordingly, chargeable to income-tax as the income of the previous year in which it is recovered.
As per judgment of Catholic Syrian Bank Ltd. v. CIT (SC) (Civil Appeal No. 1143 of 2011) order dated 17 February 2012, THE SUPREME COURT OF INDIA,CIVIL APPELLATE JURISDICTION CIVIL APPEAL NO. 1143 OF 2011, Catholic Syrian Bank Ltd. … Appellant Versus Commissioner of Income Tax, Thrissur -- held that
“It is useful to notice that in the proviso to Section 36(1)(vii), the explanation to that Section, Section 36(1)(viia) and 36(2)(v), the words used are ‘provision for bad and doubtful debts’ while in the main part of Section 36(1)(vii), the Legislature has intentionally not used such language. The proviso to Section 36(1)(vii) and Sections 36(1)(viia) and 36(2)(v) have to be read and construed together. They form a complete scheme for deductions and prescribe the extent to which such deductions are available to a scheduled bank in relation to rural loans etc., whereas Section 36(1)(vii) deals with general deductions available to a bank and even nonbanking businesses upon their showing that an account had become bad and written off as irrecoverable in the accounts of the assessee for the previous year, satisfying the requirements contemplated in that behalf under Section 36(2). The provisions of Section 36(1)(vii) operate in their own field and are not restricted by the limitations of Section 36(1)(viia) of the Act. In addition to the reasons afore-stated, we also approve the view taken by the Special Bench of ITAT and the Division Bench of the Kerala High Court in the case of South Indian Bank (supra). To conclude, we hold that the provisions of Sections 36(1)(vii) and 36(1)(viia) of the Act are distinct and independent items of deduction and operate in their respective fields. The bad debts written off in debts, other than those for which the provision is made under clause (viia), will be covered under the main part of Section 36(1)(vii), while the proviso will operate in cases under clause (viia) to limit deduction to the extent of difference between the debt or part thereof written off in the previous year and credit balance in the provision for bad and doubtful debts account made under clause (viia). The proviso to Section 36(1)(vii) will relate to cases covered under Section 36(1)(viia) and has to be read with Section 36(2)(v) of the Act. Thus, the proviso would not permit benefit of double deduction, operating with reference to rural loans while under Section 36(1)(vii), the assessee would be entitled to general deduction upon an account having become bad debt and being written off as irrecoverable in the accounts of the assessee for the previous year. This, obviously, would be subject to satisfaction of the requirements contemplated under Section 36(2).
Now, we should check the history of sections 36(1)(vii) and 36(1)(viia) to avoid the confusions regarding their applications.
HISTORY OF INCOME TAX SECTIONS RELATING TO BAD DEBTS PROVISION
[1] FOR THE FIRST TIME IN 1979 THE FINANCE MINISTRY INTRODUCED THE NEW CLAUSE 36(1)(VIIA) TO PROMOTE RURAL ADVANCES BY BENEFITING THE BANKS TO MAKE PROVISIONS ON THEIR AVERAGE RURAL ADVANCES:
SPEECH OF SHRI CHARAN SINGH DEPUTY PRIME MINISTER AND MINISTER OF FINANCE INTRODUCING THE BUDGET FOR THE YEAR 1979-80
(RELEVANT PARA)
88. In recent years, commercial banks, particularly public sector banks, have been asked to reach out into the rural areas and to expand rural credit. in order to promote rural banking and to assist the scheduled commercial banks in making adequate provisions from their current income to provide for risks in rural advances, I propose to amend the income-tax Act to grant a deduction in respect of provisions made for bad and doubtful debts by scheduled commercial banks relating to advances made by their rural branches. Such a deduction will, however” be limited to 1.5 per cent of the aggregate average advances made by the rural branches. This measure will result in a revenue loss of Rs.12 crores during 1979-80 but it will be in a good cause.
CBDT CIRCULAR NO 258 DATED 14-06-1979
(RELEVANT PARA)
Amendments to income-tax Act, Finance Act, 1979
13.2 In order to promote rural banking and 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, 1979 has inserted a new clause (viia) in sub-section (1) of section 36 to provide for a deduction, in the computation of the taxable profits of all scheduled commercial banks, in respect of provisions made by them for bad and doubtful debts relating to advances made by their rural branches. The deduction will be limited to 1½ per cent of the aggregate average advances made by the rural branches computed in the manner to be prescribed by rules in the Income-tax Rules, 1962. For this purpose, a "rural branch" means a branch of a scheduled bank situated in a place with a population not exceeding 10,000 according to the last preceding census of which the relevant figures have been published before the first day of the previous year. The expression "scheduled bank" has the same meaning as in the Explanation below section 11(2)(b) but does not include a co-operative bank. The expression "scheduled bank" would therefore, cover the State Bank of India constituted under the State Bank of India Act, 1955, any subsidiary bank of the State Bank of India as defined in the State Bank of India (Subsidiary Banks) Act, 1959, a nationalised bank as specified in section 3 of the Banking Companies (Acquisition and Transfer of Undertakings) Act, 1970 or any other bank included in the Second Schedule to the Reserve Bank of India Act, 1934. It may be mentioned that all co-operative banks have been excluded from the purview of this provision in view of the position that under section 80P(2)(a)( i), the profits and gains of a co-operative society engaged in the business of banking or providing credit facilities to its members are completely exempt from income-tax.
[2] IN 1985 THE FINANCE MINISTRY INTRODUCED ANOTHER CONCEPT FOR INCREASE IN SOCIAL COMMITMENTS OF BANKS REGARDING PROVISION MADE OUT OF INCOME FOR BAD AND DOUBTFUL DEBTS.
i.e. 10% OF TOTAL INCOME OR 2 % OF RURAL ADVANCE WHICHEVER IS HIGHER. (THERE IS NO MENTION THAT INCOME SHOUD BE OF RURAL ADVANCE BUT WE HAVE TO COUNT TAXABLE INCOME BEFORE THIS CLAUSE)
CBDT CIRCULAR NO 421 DATED 12-06-1985
(RELEVANT PARA)
Finance Act, 1985
17.2 Section 36(1)(viia) of the Income-tax Act provides for a deduction in respect of any provision for bad and doubtful debts made by a scheduled bank or a non-scheduled bank in relation to advances made by its rural branches, of any amount not exceeding 1½ per cent of the aggregate average advances made by such branches.
Finance Act, 1985
17.3 Having regard to the increasing social commitments of banks, section 36(1)(viia) has been amended to provide that in respect of any provision, for bad and doubtful debts made by a scheduled bank [not being a bank approved by the Central Government for the purposes of section 36(1)(viiia) or a bank incorporated by or under the laws of a country outside India] or a non-scheduled bank, an amount not exceeding ten per cent of the total income (computed before making any deduction under the proposed new provision) or two per cent of the aggregate average advances made by rural branches of such banks, whichever is higher, shall be allowed as a deduction in computing the taxable profits.
[3] THEN IN 1986 THE FINANCE MINISTRY SEPERATED THIS CLAUSE IN TO PARTSà ONE OF 2 % OF RURAL ADVANCES AND THE SECOND OF 10 % OF TOTAL TAXABLE INCOME BEFORE THIS CLAUSE.
Circular No.464 Explanatory Notes on the provisions of the Income-tax (Amendment) Act, 1986
Explanatory Notes on the provisions of the Income-tax (Amendment) Act, 1986Circular No.464 Dated 18/7/1986
(RELEVANT PARA)
Modification in respect of deduction on provisions for bad and doubtful debts made by the banks5.1 Under the existing provisions of clause (viia) of sub-section (1) of section 36 of the Income-tax Act inserted by the Finance Act, 1979, provision for bad and doubtful debts made by a scheduled or a non-scheduled Indian bank is allowed as deduction within the prescribed limits. The limit prescribed is 10% of the total income or 2% of the aggregate average advances made by the rural branches of such banks, whichever is higher. It had been represented to the Government that the foreign banks were not entitled to any deduction under this provision and to that extent, they were being discriminated against. Further, it was felt that the existing ceiling in this regard, i.e., 10% of the total income or 2% of the aggregate average advances made by the rural branches of Indian banks, whichever is higher, should be modified. Accordingly, by the Amending Act, the deduction presently available under clause (viia) of sub-section (1) of section 36 of the Income-tax Act has been split into two separate provisions. One of these limits the deduction to an amount not exceeding 2% of the aggregate average advances made by the rural branches of the banks concerned. It may be clarified that foreign banks do not have rural branches and hence this amendment will not be relevant in the case of the foreign banks. The other provisions secures that a further deduction shall be allowed in respect of the provision for bad and doubtful debts made by all banks, not just the banks incorporated in India, limited to 5% of the total income (computed before making any deduction under this clause and Chapter VI-A). This will imply that all scheduled or non-scheduled banks having rural branches would be allowed the deduction upto 2% of the aggregate average advances made by such branches and a further deduction up to 5% of their total income in respect of provision for bad and doubtful debts.
[4] IN 2002 THIS 5% LIMIT WAS INCREASED TO 7.5% WHICH IS STILL CONTINUED.
Budget 2002-2003
Speech of Shri Yashwant Sinha
Minister of Finance
28th February, 2002
PART A
(RELEVANT PARA)
1 6 7. Presently, banks are allowed to deduct upto 5% of their total income against provisions made by them for bad and doubtful debts. In order to strengthen the financial position of banks I propose to increase this allowance to 7.5% of the total income. Further, in my budget for the year 1999-2000, I had granted an option to banks to deduct upto 5% of their NPAs falling in the category of loss or doubtful assets as on the last day of the accounting year. I propose to enhance this optional deduction to 10%, and also allow a similar option of deduction upto 10% of loss or doubtful assets to public financial institutions.
Note: The additional 5% or 10% deduction of npa is not available at present as that was allowed only up to 2005.
Conclusion
The provisions of sections 36(1)(vii) and 36(1)(viia) of the Act are distinct and independent items of deduction and operate in their respective fields.
Bad debt written off relating to non-rural advances are allowable in full and not restricted to the credit balance of provision for doubtful debts allowed as per section 36(1)(viia)(a) of the Act.
Bad debts written off relating to rural advances allowable only in excess of the credit balance in the provision for doubtful debts as per section 36(1)(viia) of the Act.
By: Dipesh shah
CAclubindia
