bad debts

The assessee, a Non-Banking Financial Company (NBFC), made provision for bad and doubtful debts following the RBI guidelines and claimed deduction of the same under section 36(1)(vii). In original assessment proceedings, the Assessing Officer allowed the assessee’s claim for deduction of amount of provision for bad and doubtful debts. Subsequently, the Assessing Officer issued on the assessee a notice under section 154 seeking to disallow the amount of provision for bad and doubtful debts. During the course of rectification proceedings, the assessee submitted before the Assessing Officer that it being a non-banking financial company was bound by NBFC Prudential Norms (Reserve Bank) Directions, 1998 issued by the RBI vide notification dated 31-1-1998 and, accordingly, made provision on account of bad and doubtful debts following these guidelines. The Assessing Officer held that the provision for bad and doubtful debts was in nature of diminishing in the value of assets and, therefore, could not be said to be a provision to meet a liability He, therefore, disallowed the assessee’s claim for deduction of amount of provision for bad and doubtful debts.

On appeal, the Commissioner (Appeals) accepting the contention of the assessee that the provisions of section 45Q of the RBI Act contained non obstante clause and had overriding effect on the provisions of the Income-tax Act and further placing reliance on the decisions of the Tribunal in the cases of Overseas Sanmar Financial Ltd. v. Jt. CIT [2003] 86 ITD 602 (Mad.) and TEDCO Investment & Financial Services Ltd. v. Dy. CIT [2003] 87 ITD 298 (Delhi), wherein on identical facts the Tribunal allowed the claim of provision for bad and doubtful debts made by NBFC in accordance with prudential norms issued by the RBI, upheld the assessee’s claim for deduction of amount of provision for bad and doubtful debts.

On revenue’s appeal :

The Finance Act, 2001 inserted an Explanation in section 36(1)(vii) with retrospective effect from 1-4-1989. The insertion of the Explanation to section 36(1)(vii) clarifies two issues, i.e., firstly the mandatory nature of the provisions as is seen from words ‘shall not include’ and secondly, the application of the Explanation with retrospective effect from 1-4-1989. It is well-settled that the purpose of insertion of the Explanation is to explain the statutory provisions. A plain reading of the Explanation to section 36(1)(vii) shows that the legislative intention is to allow deduction in respect of bad debts actually written off in the books of account and deny the benefit of section 36(1)(vii) in respect of provision made for ‘bad and doubtful debts’. It makes the position of law clear beyond controversy or doubt. Thus, the provision for bad and doubtful debts made in the account books of the assessee could not be allowed as deduction under section 36(1)(vii). It was not the case of assessee that the assessee had squared up the accounts of various parties by crediting their account by the amounts written off. Unless the amount was written off in the accounts of various parties, the provision made in the books of account could not be allowed as deduction under section 36(1)(vii), which is clear from the language of  Explanation to section 36(1)(vii). Therefore, there was no debate about the allowability of provision for bad and doubtful debts. Hence, the Assessing Officer was justified in disallowing the claim under section 154. [Paras 8, 9 and 10]

The contention of the assessee that the decision of the Special Bench of the Delhi Tribunal in the case of New India Industries Ltd. v. Asstt. CIT [2007] 18 SOT 51 did not settle the debate and did not create a binding precedent, did not hold water. The Madras High Court in the case of  TN Power Finance & Infrastructure Corpn. Ltd. v. Dy. CIT [2006] 280 ITR 491 has held that the RBI Guidelines cannot override the statutory provisions of Income-tax Act. As on the date, no contrary decision of any other High Court was cited by the assessee; therefore, no controversy existed when the Assessing Officer sought to rectify the order under section 154. Another contention of the assessee that the RBI Guidelines made inroads into the provisions of section 145 was also devoid of any merits. If the contention of the assessee was accepted, it would amount to allowing the assessee to follow hybrid system of accounting, which is not permissible in view of provisions of section 145 with effect from 1-4-1997. From this date, the assessee could either follow mercantile system of accounting or cash system. Hybrid system of accounting was not permitted. [Para 11]

The Commissioner (Appeals) had allowed the claim of the assessee without considering the Explanation inserted in section 36(1)(vii) by the Finance Act, 2001 with retrospective effect from 1-4-1989. Therefore, the Commissioner (Appeals) was not justified in allowing the claim of the assessee by creating a debate that the RBI Guidelines would override the provisions of the Income-tax Act. The issue involved in the instant case was about allowability of provision for ‘bad and doubtful debts’. The legal position is clear that if the amount of bad debt has been written off in the accounts of various persons, the same would be allowable as deduction. In case where the amount has been claimed as provision for bad and doubtful debts and is not written off in the accounts of various persons, the same would not be allowable as deduction in view of the  Explanation to section 36(1)(vii) of the Act. Therefore, the impugned order passed by the Commissioner (Appeals) was set aside and that of the Assessing Officer was restored. [Para 13]

Overseas Sanmar Financial Ltd. v. Jt. CIT [2003] 86 ITD 602 (Chennai) (para 3), TEDCO Investment & Financial Services (P.) Ltd. v. Dy. CIT [2003] 87 ITD 298 (Delhi) (para 3), Hotz Hotels (P.) Ltd. v. CIT [2001] 248 ITR 647/118 Taxman 94 (Delhi) (para 5), CIT v. MMTC Ltd. [2000] 246 ITR 725/112 Taxman 647 (Delhi) (para 5), CIT v. Honda Seil Power Product Ltd. [2007] 158 Taxman 56 (Delhi) (para 5), New India Industries Ltd. v. Asstt. CIT [2007] 18 SOT 51 (Delhi) (SB) (para 6), CIT v. India Equipment Leasing Ltd. [2007] 293 ITR 350 (Mad.) (para 6), CAIT v. Plantation Corpn. of Kerala Ltd. [2001] 247 ITR 155 (SC) (para 9), CIT v. Orissa Cement Ltd. [2002] 254 ITR 24/122 Taxman 353 (Delhi) (para 9), CIT v. Kerala Electric Lamp Works Ltd. [2003] 261 ITR 721/129 Taxman 549 (Ker.) (para 9) and TN Power Finance & Infrastructure Development Corpn. Ltd. v. Jt. CIT [2006] 280 ITR 491 (Mad.) (para 11).