“Assessment of Banks”

Issues and case Laws

&
Issues related to
“Treatment of Bad-debts by Banks”

Online Training organized by NADT, Regional Campus, Ahmedabad

Dated : 22.11.2022

Presented by
Ram Dutt Sharma
ITO (Retd.)
 Indian Banking System – Evolution

 The first banks were The General Bank of India which started in 1786, and the Bank of Hindustan.
 Thereafter,
three presidency banks namely the Bank of Bengal (this bank was originally started in the year 1806 as
Bank of Calcutta and then in the year 1809 became the Bank of Bengal), the Bank of Bombay and the Bank of Madras,
were set up.
 For
many years the Presidency banks acted as quasi-central banks. The three banks merged in 1925 to form the
Imperial Bank of India. Indian merchants in Calcutta established the Union Bank in 1839, but it failed in 1848 as a
consequence of the economic crisis of 1848-49.
 Bank of Upper India was established in 1863 but failed in 1913.
 The Allahabad Bank, established in 1865, is the oldest survived Joint Stock bank in India.
 Oudh Commercial Bank, established in 1881 in Faizabad, failed in 1958.
 The next was the Punjab National Bank, established in Lahore in 1895, which is now one of the largest banks in India.
 The
Swadeshi movement inspired local businessmen and political figures to found banks of and for the Indian
community during 1906 to 1911.
 A numberof banks established then have survived to the present such as Bank of India, Corporation Bank, Indian
Bank, Bank of Baroda, Canara Bank and Central Bank of India. A major landmark in Indian banking history took place
in 1934 when a decision was taken to establish ‘Reserve Bank of India’ which started functioning in 1935.
 Since then, RBI, as a central bank of the country, has been regulating banking system.
 Constituents of the Indian Banking System

 The constituents of the Indian Banking System can be broadly listed as under :

 (a) Commercial Banks:

(i) Public Sector Banks

 The term ‘public sector banks’ by itself connotes a situation where the major/full stake in the
banks are held by the Government. Public Sector Banks (PSBs) are banks where a common
stake (i.e. more than 50%) is held by a government. The shares of these banks are listed on
stock exchanges.

 Nationalization of Banks for implementing Govt. policies

 Indian Banking System witnessed a major revolution in the year 1969 when 14 major
commercial banks in the private sector were nationalized on 19.07.1969. Most of these banks
having deposits of above Rs. 50 crores were promoted in the past by the industrialists. In 1980,
another six more commercial banks with deposits of above ` 200 crores were nationalized :
The purpose of nationalization was:

(a) to increase the presence of banks across the nation.

(b) to provide banking services to different segments of the Society.

(c) to change the concept of class banking into mass banking, and

(d) to support priority sector lending and growth.

Example- State Bank of India, Bank of Baroda, Punjab National Bank, Canara Bank.

(ii) Private Sector Banks

 In 1991, the Narasimham committee recommended that banks should increase operational
efficiency, strengthen the supervisory control over banks and the new players should be allowed to
create a competitive environment. Based on the recommendations, new private banks were
allowed to start functioning.
 The major stakeholders (share capital of the Bank) in the private sector banks are private
individuals and corporate. These Banks are registered as companies with limited liability. 
 Some of the leading banks which were given licenses are: Axis Bank, ICICI Bank, HDFC Bank,

Kotak Mahindra Bank, Yes Bank etc.

(iii) Foreign Banks

The other important segment of the commercial banking is that of foreign banks. Foreign banks have
their registered offices outside India, and through their branches they operate in India. Foreign banks
are allowed on reciprocal basis. They are allowed to operate through branches or wholly owned
subsidiaries. These foreign banks are very active in Treasury (forex) and Trade Finance and Corporate
Banking activities. These banks assist their clients in raising External Commercial Borrowings
through their branches outside India or foreign correspondents. They are active in loan syndication as
well. Foreign banks have to adhere to all local laws as well as guidelines and directives of Indian
Regulators such as Reserve Bank of India, Insurance and Regulatory Development Authority,
Securities Exchange Board of India. The foreign banks have to comply with the requirements of the
Reserve Bank of India in respect to Priority Sector lending, and Capital Adequacy ratio and other
norms.

Some foreign banks operating in our country are Hong Kong and Shanghai Banking Corporation
(HSBC), Citibank, American Express Bank, Standard & Chartered Bank.
(b) Cooperative Banks:

Cooperative banks play an important role in the Indian Financial System, especially at the village level. The
growth of Cooperative Movement commenced with the passing of the Act of 1904. A cooperative bank is a
cooperative society registered or deemed to have been registered under any State or Central Act. If a
cooperative bank is operating in more than one State, the Central Cooperative Societies Act is applicable. In
other cases the State laws are applicable.

Apart from various other laws like the Banking Laws (Application to Co-operative Societies) Act, 1965 and
Banking Regulation (Amendment) and Miscellaneous Provisions Act, 2004, the provisions of the RBI Act,
1934 and the BR Act, 1949 would also be applicable for governing the banking activities.

The Cooperative rural Credit Structure in our country are of following types:

(i) Short term agricultural institutions

The short term credit structure consists of the Primary Agricultural Credit Societies at the base level,
which are affiliated at the district level into the District Central Cooperative bank and further into the
State Cooperative Bank.

(ii) Long term agricultural credit institutions

The long term cooperative credit structure consists of the State Cooperative Agriculture & Rural
Development Banks (SCARDBs) and Primary Cooperative Agriculture & Rural Development Banks
(PCARDBs) which are affiliated to the SCARDBs.

(iii) Non-agricultural credit institutions

(c) Development Banks:
(i) National Bank for Agriculture and Rural Development (NABARD)
National Bank for Agriculture and Rural Development (NABARD) was
established in July 1982 by an Act of Parliament based on the recommendations of
CRAFICARD. It is the apex institution concerned with the policy, planning and
operations in the field of agriculture and other rural economic activities.
NABARD undertakes a number of inter-related activities/services which fall
under three broad categories
(a) Credit Dispensation :
(b) Developmental & Promotional
(c) A Supervisory Activities
(ii) Small Industries Development Bank of India (SIDBI)
Small Industries Development Bank of India (SIDBI) was established in October
1989 and commenced its operation from April 1990 with its Head Office at Lucknow as
a development bank. It is the principal and exclusive financial institution for the
promotion, financing and development of the Micro, Small and Medium Enterprise
(MSME) sector and for co-ordination of the functions of the institutions engaged in
similar activities. It is a central government undertaking. The prime aim of SIDBI is to
support MSMEs by providing them the valuable factor of production finance. Many
institutions and commercial banks supply finance, both long-term and short-term, to
small entrepreneurs. SIDBI coordinates the work of all of them.
(iii) Export Import Bank of India (EXIM Bank)
Export-Import Bank of India was set up in 1982 by an Act of Parliament for the
purpose of financing, facilitating and promoting India’s foreign trade. It is the
principal financial institution in the country for coordinating the working of
institutions engaged in financing exports and imports. Exim Bank is fully owned by
the Government of India
(iv) National Housing Bank
National Housing Bank was set up in July, 1988 as the apex financing institution
for the housing sector with the mandate to promote efficient, viable and sound
Housing Finance Companies (HFCs). Its functions aim at to augment the flow of
institutional credit for the housing sector and regulate HFCs. NHB mobilizes
resources and channelizes them to various schemes of housing infrastructure
development. It provides refinance for direct housing loans given by commercial
banks and non-banking financial institutions.
 Banking Related Laws

(1) Reserve Bank of India Act, 1934

 It was enacted to constitute RBI with objectives to regulate the issue of bank notes, keeping reserves to
ensure stability in the monetary system and operate the nation’s currency and credit system effectively.

 The Act mainly covers the constitution, powers and functions of the RBI. The act does not deal with the
regulation of the banking system except for Section 42 which is related to regulation of cash reserve ratio
and Section 18 which mainly talks about direct discounting of bills of exchange and promissory notes.

 Hence, The RBI Act deals with:

 Incorporation, Capital, Management and Business of the RBI.

 Various functions of the RBI which include: the issue of bank notes, monetary control, banker to the
Central and State Governments and banks, lender of last resort etc.
 Provisions talking about reserve funds, credit funds, audits and accounts.
 Issuing directives and imposing penalties for violation of provisions of the Act.
(2) Banking Regulation Act, 1949
It is deemed to be one of the most important legal framework for banks. It was initially
passed as the Banking Companies Act, 1949 and it was eventually changed to the Banking
Regulation Act, 1949. Along with the RBI Act, The Banking Regulation Act provides a lot
of guidelines to the banks. They cover a wide variety of areas, some of the major provisions
are:
 (3) Prevention of Money Laundering Act, 2002 (“PMLA”)
RBI has been a supervisor of Banking companies in India. It has been playing an important
role in ensuring that the good corporate governance practices are being followed by the
banking companies. RBI’s various guidelines in M&As, pattern of shareholding, restrictions
on various issues can be seen as some of the important steps by RBI to ensure good corporate
governance practices of banks in India.
Laundering means acquiring, owning, possessing or transferring any proceeds of money of
crime or knowingly entering into a transaction which is related to these proceeds.
Involvement in the crime directly, indirectly, concealing or aiding in the concealment of
proceeds or gains of crime within or outside India. It can be described as process for
conversion of money obtained illegally to appear to have originated from legitimate sources.
Role of the Banks
All kinds of banks are covered under the Act. The money launderers can open deposit
accounts with banks in fake names and banks will be required to be vigilant for not becoming
a party to such transactions. It is suggested that banks should do a full-scale customer due
diligence before opening an account. This prevents the banks from being used, by being part
of a criminal conspiracy for money laundering or terror financing.
The banks should also observe the reasonable and logical norms for record keeping, reporting,
account opening and monitoring transactions. The act has several provisions regarding money
laundering transactions which include maintenance of a record of all transactions relating to
money laundering. These records should be saved up for at least 10 years from the date of
cessation of the particular transactions between the client and the banking company.
The government has set up a Financial Intelligence Unit (FIU-IND) to track and curb offences
of money laundering. Banks, financial institutions, stock brokers etc. have to report non-cash
transactions totalling to over 1 crore a month and cash transactions of 10 lakh a month, to
Financial Intelligence Unit. 
(4) Foreign Exchange Management Act, 1999
The Foreign Exchange Management Act, 1999 deals with the regulation and management of
foreign exchange. Its objective is to amend laws related to foreign exchange so that foreign
exchange markets can be developed and foreign trade and payments increase. The Act
extends to the whole of India. It came into effect on 01.06.2000.

(5) Limitation Act, 1963

 Deemed to be one of the most important law in the aspects of Lending. This particular Act
gives the power to the lending bank in taking legal action against the borrower in case he
defaults on his loan payments.

 The Limitation Act, 1963 (“LI Act”) specifies a certain period within a suit or an appeal or
any kind of application can be filed. It basically means that there is a period of limitation
which is accordance with the LI Act. A banker is allowed to take action by the filing of any
particular suit, application or appeal and apply for any kind of recovery ONLY if
documents are within the period of limitation. If the documents are expired or time-barred,
the banker would have no choice to proceed with any kind of legal recourse to recover any
kind of dues.
(6) Recovery of Debts Due to Banks and Financial Institutions Act, 1993 (“DRT Act”)
Important Highlights of the DRT Act are:
(i) The act constitutes a Debt Recovery Tribunal for speedy recovery of loans mainly.
(ii) The act is applicable to any bank, financial institution or a consortium of them for the
recovery of debt which is more than 10 Lakhs.
(iii)Debt is a used in a broad purpose, the following are some of its types:
• Any liability inclusive of interest, it may be secured or unsecured;
• Any liability which is to be paid under a decree, order of any civil court or any
arbitration award or otherwise; and
• Any liability payable under a mortgage and subsisting on and legally recoverable on the
date of application.
(7) SARFAESI Act, 2002

The main objective of the act is to regulate securitization and reconstruction of financial
assets and enforcement of security interest and for the matters connected to it.

Popularly known as the Securitization Act, The act basically empowers the banks
and financial institutions to recover their dues in Non Performing Assets (NPAs)
without the intervention of the Court. The act empowers the banks and financial
institutions to issue notice for recovery from the borrowers and guarantors calling them to
discharge their respective dues within 60 days.
 Overview of Banking System

 Structure of Banks in India

 Banks can be classified into scheduled and non- scheduled banks based on certain factors(a)
Scheduled Banks:

 (a) Scheduled Banks:

 Scheduled Banks in India are the banks which are listed in the Second Schedule of the Reserve Bank
of India Act1934.
 The scheduled banks enjoy several privileges as compared to non- scheduled banks.
 Scheduled banks are entitled to receive refinance facilities from the Reserve Bank of India.
 They are also entitled for currency chest facilities.
 They are entitled to become members of the Clearing House.
 Besides commercial banks, cooperative banks may also become scheduled banks if they fulfill the
criteria stipulated by RBI.
(b) Non-scheduled banks:
 These are those banks which are not included in the Second Schedule of the Reserve
Bank of India.
 Usually those banks which do not conform to the norms of the Reserve Bank of India
within the meaning of the RBI Act or according to specific functions etc. or according
to the judgement of the Reserve Bank, are not capable of serving and protecting the
interest of depositors are classified as non-scheduled banks.
 Assessment of Banks

 In a recent review of assessment of Banks carried out by C&AG, it has been observed
that while computing the income of banks under the head ‘Profit and Gains of Business
& Profession’, deductions of large amounts under different sections are being allowed
by the Assessing Officers without proper verification, leading to substantial loss of
revenue.
 It is, therefore, necessary that assessments in the cases of banks are completed with due
care and after proper verification.
 In particular, deductions under the provisions referred to below should be allowed only
after a thorough examination of the claim on facts and on law as per the provisions of
the Income Tax Act, 1961.
Basics of Banking : Items of Profit and Loss Account

 [1] Income

 (I). Income:

 The Schedules of Income are :

 (A) Interest Earned :

 It includes

(i) interest/discount on advances/bills,

(ii) income on investments,
(iii) interest on balance with RBI etc..

 it should be noted that according to the new form, bad debts and provision for bad debts and other
provisions are not to be deducted from the interest earned. For greater transparency in accounts, these
items are shown as separate item in the Profit and Loss Account.
Interest income received by bank in advance on discounting of bills against letter of
credit was to be subjected to taxation on accrual basis and not on receipt basis as
assessee-bank was following mercantile system of accounting
Assessee-bank excluded interest income from taxable income claiming that same was
received in advance, on discounting of bills against letter of credit which need not be
assessed in relevant year as it was following mercantile system of accounting. Assessing
Officer accepted that amount represented interest pertaining to a subsequent year but, he
held that as same was received during year under consideration, same should be included
in total income of year under consideration. On facts, income received in advance in
nature of interest income on discounting of bills against letter of credit was to be
subjected to taxation on accrual basis and not on receipt basis. [In favour of assessee]
(Related Assessment year : 2003-04) – [Karur Vysya Bank Ltd. v. Addl. CCIT,
Tiruchirapalli (2021) 276 Taxman 463 : (2020) 120 taxmann.com 331 (Mad.)]
(B) Other Incomes: It include
(i) Commission / Exchange and Brokerage: includes all remuneration on services such as
commission on collection, commission/exchange on remittances and transfers, commission
on letter of credit, letting out of lockers and guarantees, commission on Government
Business, commission on the other permitted agency business including consultancy and
other services, brokerage etc., on securities. It does not include foreign exchange income.
(ii) profit on sale of investments, : Less – loss on sale of investment.
(iii)profit on revaluation of investments, : Less – Loss on revaluation of Investments.
(iv)profit on sale of land, building and other assets, : Less-Loss on sale of land, building
and other assets. Includes profit/loss on the sale of securities, furniture, land and buildings,
motor vehicles, gold, silver etc. only the net position should be shown. If the net position is
a loss, the amount should be shown as deduction. The profit or loss on revaluation may
also be shown.
(v) profit on exchange transactions, : Less- Loss on Exchange Transaction: Includes
profit/loss on dealing in foreign exchange, all income earned by way of foreign exchange,
commission and charges on foreign exchange transactions excluding interest which will be
shown under interest. Only the net position should be shown. If the net position is loss, it is
to be shown as deduction.
 (vii) Income Earned by way of dividends : includes from subsidiaries, companies,
joint ventures abroad-and in India.
(i) Miscellaneous Income: Includes recoveries from constituents for godown rents,
income from bank’s properties, security charges, insurance etc., and any other
miscellaneous income. In case any item under this head exceeds one percentage of the
total income, particulars may be given in the notes.
[2] Expenditure
I. Interest Expenses:
(ii) Interest paid on deposits, includes interest paid on all type of deposits from banks and
other institution.
(iii)interest on RBI Borrowings;
(iv)interest on inter bank borrowings, etc. include discounts/interest on all borrowings and
refinance from Reserve Bank of India and other banks.
(iv) Others: Includes discount/interest on all borrowings/refinance, penal interest paid
etc.
are shown under this item.
II. Operating Expenses:
(i) Salaries and wages of staff,
(ii) rent, rates and taxes;
(iii)printing and stationary;
(iv)advertisements;
(v) depreciation on bank’s property;
(vi)directors’s fees, auditor’s fees;
(vii)law charges;
(viii)postage;
(ix)repairs, insurance etc.
are shown under this item.
Operating Expenses
1. Payment to and provision for employees:
Include staff salaries/wages, allowances, bonus, other staff benefits like provident
fund, pension, gratuity, leave fare concessions, staff welfare, medical allowance to
staff, etc.
2. Rent, taxes and lighting:
Includes rent paid by the banks on buildings and municipal and other taxes paid
excluding income tax and interest tax, electricity and other similar charges and levies.
House rent allowance and other similar payments to staff should appear under the
head “Payments to and Provision to Employees”
3. Printing and Stationary:
Includes books and forms and stationery used by bank and other printing charges which
are not incurred by way of publicity matter.
4. Depreciation on bank’s property:
Includes depreciation on bank’s own property, motor cars and other vehicles, furniture,
electric fittings, vaults, lifts, leasehold properties, non-banking assets, etc.
5. Directors fees, allowances and expenses:
Include sitting fees and all other items of expenditure incurred on behalf of directors. It
includes the daily allowance, hotel charges, conveyance charge, etc. which though in
the nature of reimbursement of expenses in curred may be included under this head.
Similar expenses of local committee members may also be included under this head.
6. Advertising and Publicity:
Includes expenditure incurred by the bank for advertisement and publicity purposes
including printing charges for publicity matter.
7. Auditors Fees and Expenses: (including branch auditor’s fees and expenses)
Includes the fees paid to the statutory auditors and branch auditors for professional
services rendered and all expenses for performing their duties, even though they may
be in the nature of reimbursements. If external auditors have been appointed by the
banks themselves for internal inspections and audit and other services, the expenses
incurred in that context including fees may not be included under this head but shown
under ‘Other Expenditure’.
8. Law Charges:
All legal expenses and reimbursement of expenses incurred in connection with legal
services are to be included here.
9. Postage, telegram, telephones etc.:
Includes all postage charges like stamps, telegrams, teleprinters, communication etc.
 10. Repairs and Maintenance:

Includes repairs to bank’s property, their maintenance charges etc.

11. Insurance:

Include insurance charges on bank’s property and insurance premium paid to DICGC, to the extant it is not
recovered from customers.

12. Other Expenditure:

All expenses other than those not included in any of the other heads like, license fees, donations, subscriptions
to papers, periodicals, entertainment expenses, travel expenses etc., may be included under this head. In case
any particular item under this head exceeds one percent of the total income, particulars may be given in notes.

Third item of this section is provisions and contingencies, provisions for bad debts, provision for taxation and
other provision are shown under this item.

[3] Profit/Loss

In this section, profit/loss for the current year (difference between income and expenditure explained above) and
brought forward profit/loss are shown.

[4] Appropriations

In this section amount transferred to statutory reserve as per section 17 of the Banking Regulation Act; amount
transferred to other reserve; proposed dividend, etc. are shown. The Balance is transferred to the Balance Sheet.
 Mistakes noticed in assessments of banks

[1] Incorrect allowance of bad debts written off

[2] Incorrect allowance of provision for bad and doubtful debts
[3] Non correlation of bad debts figures in income tax returns of banks with returns furnished to
RBI
The operations of the banking sector are regulated by the Reserve Bank of India under the powers given to it under the
RBI Act, 1934.
As per the RBI Circular dated 01.07.2005, banks are required to furnish a report on non performing assets (NPA) as on
31st March each year after the completion of audit.
In this report the banks are required to show all the details about the NPAs including the amount of bad debts written
off.
Verify the correctness of deductions in respect of bad debts written off
Verify the correctness of deductions in respect of bad debts written off
called for the details of bad debts written off from RBI shown by the banks in their NPA returns.
correlated the above figures of bad debts written off in NPA returns with the corresponding figures of bad debts written
off
whether, the figures of bad debts shown in ITR were different from those shown by the banks in their NPA returns
furnished to RBI.
[4] Deduction towards advances given by rural branches of bank
[5] Incorrect allowance of depreciation on valuation of investments made by banks
 As per the RBI guidelines dated 16.10.2000, the entire investment portfolio of the
banks is required to be classified under three categories viz. Held to Maturity (HTM),
Held for Trading (HFT) and Available for Sale (AFS).
 Investments classified under HTM category need not be marked to market and are
carried at acquisition cost unless these are more than the face value, in which case the
premium should be amortised over the period remaining to maturity.
 In the case of Available for Sale (AFS) and Held for Trading (HFT) categories, the
depreciation/appreciation is to be aggregated scrip wise and only net depreciation, if
any, is required to be provided for in the accounts.
Banking companies are eligible to claim depreciation on securities categorised as
‘Held to maturity’ investments
Assessee-bank claimed depreciation on securities which were classified as 'Held to
maturity'. Assessing Officer rejected such claim on grounds that such securities were
notional in nature and against RBI guidelines for valuation of securities. Assessee-bank
was eligible to claim depreciation on securities categorised as ‘Held to maturity’
investments. [In favour of assessee] (Related Assessment year : 2007-08) – [CIT, LTU,
Bangalore v. Vijaya Bank (2021) 429 ITR 407 : 277 Taxman 148 : 123 taxmann.com
214 (Karn.)]
 Compliance issues

[1] Incorrect allowance of expense towards exempt income 10

 Further, section 10(23G) of the Act provides that any income by way of dividend or interest from
investments made by way of shares or long-term finance advanced to any enterprise or undertaking wholly
engaged in the infrastructure business shall not be included in taxable income.
 Section 14A of the Act provides that for the purpose of computing total income under the Act, no deduction
shall be allowed in respect of expenditure incurred by the assessee in relation to income, which does not
form part of the total income.
 Section 10(15) and 10(33) of the Act provides that income by way of interest, premium on redemption or
other payment on such securities issued by Central Government or any income arising from transfer of
capital assets being a unit of the Units Scheme 1964 shall not be included in the total income.
 Section 80M of the Act provides that where the gross total income of a domestic company in any previous
year includes any income by way of dividend from another domestic company, there shall be allowed in
computing the total income of such domestic company, a deduction of an amount of dividend from another
domestic company.
NOTE
 Ascertain : Proportionate expenditure on income earned on long term finance made to infrastructure
enterprises for making disallowance
[2] Incorrect allowance of deductions
 Section 43B(b) of the Act envisages that deduction towards contribution to any
provident fund or superannuation fund or gratuity fund or any other fund for the
welfare of employees is allowable in computing total income of the assessee only on
actual payment basis.
 Section 35DDA of the Act provides that where an assessee incurs any expenditure by
way of payment of any sum to an employee at the time of his retirement in accordance
with any scheme of voluntary retirement, one fifth of the amount so paid shall be
deducted in computing the profit and gains of the business and the balance shall be
deducted in equal instalments for each of the four immediately succeeding years.
Section 35DDA : Amortisation of expenditure incurred under voluntary
retirement scheme.
Tax Audit Checklist for Section 35DDA - Amortisation of expenditure
incurred under VRS
 Deduction to assessee (employer) is admissible under section35DDA even if
VRS is not framed as per guidelines prescribed under section 10(10C).
 Verify the amounts paid under VRS with reference to documentary
evidences available. One fifth of the amount paid is admissible in the year of
payment and balance in 4 equal instalments. Admissible amounts should be
computed accordingly and reported against clause 19 (in the third column of
the tabular format).
 Verify that there is no violation of section 40A(3) while making payment.
 Verify the documentary evidence supporting payments under VRS,
Approval of competent authority (e.g. Board minutes), vouchers evidencing
receipt by employees.
CBDT Circular No. 14/2001, Dated 09.11.2001 (Finance Act, 2001) -
Subject : New provisions for amortization of expenditure incurred under Voluntary
Retirement Scheme
33.1 The Act has introduced a new section 35DDA in the Income-tax Act regarding
amortization of expenditure incurred under Voluntary Retirement Scheme. The section
provides that the expenditure incurred by way of payment of any sum to an employee at
the time of his voluntary retirement, in accordance with any scheme of voluntary
retirement, would be allowable as deduction over a period of five years.
33.2 The payments made in accordance with any scheme or schemes of voluntary
retirement are only covered within the purview of the said section. Such payments are
normally in the nature of ex-gratia payments and are made over and above the regular
terminal benefits like pension, gratuity, leave encashment, etc., in respect of which normal
provisions of the Act will apply.
33.3 The amendment will take effect from 1st April, 2002, and will, accordingly, apply in
relation to the assessment year 2002-2003 and subsequent years.
Compliance of rule 2BA of the Income-tax Rules for voluntary retirement scheme is not mandatory for
deduction in hands of employer under section 35DDA

Assessee-bank claimed deduction under section 35DDA in respect of expenditure incurred to meet
employee's claim, who had taken voluntarily retirement and had retired prematurely. The claim was
disallowed on the ground that voluntary retirement scheme was not in consonance with rule 2BA of the
Income-tax Rules. On appeal, the Tribunal held that the scheme was covered under section 35DDA and the
condition imposed in rule 2BA with reference to the recipient of the amount under voluntary retirement
scheme for the purpose of section 10(10C) is not attracted to the provisions of section 35DDA. As under the
provisions of section 35DDA entire amount cannot be allowed as deduction, but it can be spread over for a
period of five assessment years, the Tribunal allowed 1/5th of the amount by way of deduction for the
relevant assessment year. The revenue filed appeal before the High Court contending that even for the
deduction of the amount under section 35DDA, there should be compliance with rule 2BA.

The provisions of section 35DDA, section 10(10C) and rule 2BA reveal that no mention is made of any rule
in the body of section 35DDA. On the other hand, in rule 2BA, which is substantially relied upon by the
revenue, specific reference to section 10(10C) is made and it is captioned as 'Guidelines for purposes of
section 10(10C)'. Moreover, rule 2BA makes it clear that the amount received is by the employee and for the
purpose of claiming benefit under section 10(10C); this has nothing to do with employer's claim which is
under a different claim under section 35 DDA. Rule 2BA is attracted and applicable only to a circumstance,
where benefit of section 10(10C) is sought for and not in a situation where provision of section 35DDA is
called in aid. Accordingly, the appeal is dismissed. - [CIT, LTU v. State Bank of Mysore (2013) 356 ITR 468 :
263 CTR 666 : 217 Taxman 357 : 36 taxmann.com 552 (Karn.)]
[3] Income not offered to tax
 Section 41(1) of the Act provides that where an allowance or deduction has
been made in the assessment for any year in respect of loss/expenditure or
trading liability incurred by the assessee and subsequently during any
previous year, the amount was obtained by way of remission or cessation of
liabilities thereof (in cash or any other manner), then the income realised
should be treated as profits chargeable to tax.

 Section 41(4) of the Act provides that where a deduction has been allowed
under section 36(1)(vii) and if the amount subsequently recovered on any
such debt or part thereof is greater than the difference between the debt or
part of debt and the amount so allowed, the excess shall be deemed to be the
profits and gains of business or profession and accordingly, chargeable to
income tax as income of the previous year in which it is recovered.
 
[4] Incorrect allowance of depreciation and set off of losses
 Section 32 of the Act provides that deduction on account of depreciation on
block of ‘plant and machinery’ and other assets is admissible at the
prescribed rates while computing the business income of the assessee, if
these are owned by the assessee and used for the purpose of business during
the relevant previous year.
 Section 72 of the Act provides that where the net result of the computation
under the head ‘Profits and gains of the business or profession’ is a loss to
the assessee and such loss including depreciation cannot be wholly set off
against income under any other head of the relevant year, so much of the loss
as has not been set off shall be carried forward to the following assessment
year/years to be set off against the ‘Profits and gains of business or
profession’.
In case of assessee-bank, loss incurred on shifting securities from ‘Available
for sale’ (AFS) category to ‘Held to Maturity’ (HTM) category is not
allowable as business loss
The assessee-bank filed its return claiming loss on shifting of securities from
‘Available for sale’ (AFS) category to ‘Held to Maturity’ (HTM) category as
business loss. The revenue authorities noted that assessee had been debiting
profit and loss Account with amounts towards provisions for ‘investment
depreciation’ and ‘Investment fluctuations’ which had been allowed as
deductions. They thus opined that assessee’s claim for business loss was patently
erroneous and a duplicate claim which was liable to be rejected. On second
appeal:
In case of assessee-bank, loss incurred on shifting securities from ‘Available for
sale’ (AFS) category to ‘Held to Maturity’ (HTM) category was not allowable as
business loss. [In favour of revenue] (Related Assessment year : 2009-10) –
[Hindustan Co-operative Bank Ltd. v. JCIT, Mumbai (2017) 162 ITD 434 :
(2016) 76 taxmann.com 276 (ITAT Mumbai)]
[5] Incorrect allowance of provisions, capital expenditure & liabilities
 Section 37 of the Act envisages that a provision made in the accounts for an accrued or
ascertained liability is an admissible deduction, while other provisions do not qualify for
deduction.
Liability claimed by assessee as a liability on account of excise duty was merely a contingent liability and
would not constitute expenditure for purposes of income-tax

High Court held that there was no actual liability in praesenti, no demand was raised against the assessee. What
was served by the Collector on the assessee was merely a show-cause notice. The assessee did not admit any
liability and showed cause refuting the allegations made in the show-cause notices. In fact, in the instant case, the
cause shown by the assessee was accepted by the excise authorities and proceedings initiated by the show-cause
notices were dropped. It was, thus, clear that the liability claimed by the assessee as a liability on account of
excise duty was merely a contingent liability which could not constitute expenditure for the purposes of income-
tax. Hence, the Tribunal was not justified in allowing the claim of the assessee. On appeal to the Supreme Court :

Held that a contingent liability could not constitute expenditure for the purposes of income tax. It has been held
that expenditure which is allowable for income tax purposes, is one which is towards a liability actually existing at
that point of time but putting aside of money which may become expenditure on the happening of an event is not
an expenditure. The view taken by the High Court, on the facts and in the circumstances of the case, was correct
and no interference was called for. [In favour of revenue] (Related Assessment year : 1980-81) – [Indian Smelting
and Refining Company Ltd. v. CIT (2001) 248 ITR 4 : 166 CTR 510 : 116 Taxman 606 (SC)]
[6] Incorrect deduction of income from securities
 Under the third proviso of section 36(1)(viia) of the Act, a scheduled bank or
non-scheduled bank shall, at its option, be allowed a further deduction in
excess of the limits specified in the preceding two provisos for an amount not
exceeding the income derived from redemption of securities in accordance
with a scheme framed by the Central Government. It is further provided that
no deduction shall be allowed under the third proviso, unless such income
has been disclosed in the return of income under the head "Profits and gains
of business or profession".
 Under section 145 of the Act, income under the heads ‘profits and gains of
business or profession’ or ‘income from other sources’ shall be computed in
accordance with either cash or mercantile system of accounting, regularly
employed by the assessee. Under the RBI guidelines and the Indian
Companies Act, 1956, banks follow the mercantile system of accounting and
prepare accounts on accrual basis.
Loss incurred on account of transfer of securities held under category ‘Available for Sale’
to ‘Held to Maturity’ was to be allowed as business loss
Assessment in case of assessee was completed under section 143(3). Subsequently, the
Commissioner noticed that assessee had debited to the profit and loss account loss on account
of transfer of securities from the category ‘Available for Sale’ to ‘Held to Maturity’ and the
same had been allowed by the Assessing Officer. According to the Commissioner, since the
allowance of such a notional loss was erroneous and prejudicial to the interest of the Revenue,
he invoked his powers under section 263 of the Act and passed an order directing the Assessing
Officer to modify his assessment order and disallow the deduction of loss. The Tribunal set
aside revisional order holding that the claim of the assessee for the loss on the transfer of
securities from the category 'Available for Sale' to ‘Held to Maturity’ was an allowable
deduction. On revenues’ appeal :
It was noted that the issue in the instant case squarely covered by the orders passed in the case
of CIT v. Bank of Baroda (2003) 262 ITR 334 : 129 Taxman 716 (Bom.) and Karnataka Bank
Ltd. v. ACIT (2013) 356 ITR 549 : 216 Taxman 192 : 34 taxmann.com 150 (Karn.). Following
the orders passed in the aforesaid cases, it was to be held that impugned order passed by the
Tribunal did not require any interference. [In favour of assessee] – [CIT, Mumbai v. HDFC
Bank Ltd. (2014) 368 ITR 377 : 52 taxmann.com 333 : (2015) 228 Taxman 350 (Bom.)]
[7] Incorrect allowance of deduction towards head office expenses/ interest relating to
foreign banks
 The object of enacting section 44C was to restrict the inflated claims on account of head
office expense.
 That object was required to be kept in mind in order to interpret section 44C. Section 44C
of the Act provides that in the case of an assessee being a non resident, no allowance shall
be made in computing the income chargeable under the head “Profits and gains of business
or profession”, in respect of so much of the expenditure in the nature of head office
expenditure as is in excess of the amount computed as under namely:
(a) an amount equal to 5 percent of adjusted total income1 ; or
(b) the amount of so much of the expenditure in the nature of head office expenditure
incurred by the assessee, as is attributable to the business or profession of the assessee in India,
whichever is the least,
provided that in a case where the adjusted total income of the assessee is a loss, the amount
under clause (a) shall be computed at the rate of 5 percent of the average adjusted total
income1 of the assessee.

 
 Board vide its circular no. 740 dated 17.07.1996 clarified that a branch of a foreign
company /concern in India is a separate entity for the purpose of taxation. Interest
paid/ payable by such branch to its head office or any branch located abroad would be
liable to tax in India and would be governed by the provisions of section 115A of the
Act.

 It has also been judicially held that the interest payment made by a permanent
establishment in India to its own branch outside India is not an allowable expenditure
as the payment is made to self. The tribunal held that the deductibility has to be in
accordance with the provisions of local law and subject to the limitations provided
therein, as provided in section 44C, etc.
In view of provisions of articles 7(3) and 25(1) of DTAA between India and UAE laws in force in India should
continue to govern taxation of income of permanent establishment situated in India - Where assessee-
commercial bank incorporated in UAE had incurred certain expenses in respect of its head office/permanent
establishment in India, said head office expenses would be allowed as per Indian taxation laws, i.e., subject to
restriction contained in section 44C

The assessee-commercial bank incorporated in the UAE had incurred certain expenses in respect of its head
office/permanent establishment in India. The Assessing Officer as well as the Commissioner (Appeals) allowed said
claim as per provisions of section 44C. On further appeal, the Tribunal confirmed the said order. The assessee filed
the instant miscellaneous application and sought for rectification of order of the Tribunal. It was the contention of
the assessee that in view of article 7(3) of the DTAA between India and the UAE the Indian Taxation law would not
be applicable for computation of profits of the permanent establishment and, therefore, head office expenses were to
be allowed without subjecting the same to the restriction contained in section 44C.

Article 7(3) does not contain an express provision to lay down that the Indian taxation law would not be applicable
for computation of profits of the permanent establishment; hence, the provision of article 25(1) relating to
elimination of double taxation would prevail and the laws in force in India should continue to govern the taxation of
income of the permanent establishment situated in India. Thus, the combined reading of provisions of articles 7(3)
and 25(1) of the DTAA between India and the UAE, shows that the profits of the India branch or permanent
establishment of the assessee-bank would have to be determined in accordance with the domestic laws of India and
all restrictions on allowance of various business expenses as contained in the Income-tax Act would be applicable
on the profits of the permanent establishment. Thus, the head office expenses, in the instant case, had to be allowed
as per provisions of section 44C and the contention of the assessee, that it was to be allowed without subjecting the
same to the restriction contained in section 44C, could not be accepted. Assessment years 1995-96 to 1997-98 –
[Abu-Dhabi Commercial Bank Ltd. v. JCIT, Special Range (2007) 18 SOT 169 (ITAT Mumbai)]
 Special provision in case of income of public financial
institutions, etc
[Section 43D]

Interest accrued on bad and doubtful debts under section 43D

In
 the case of a scheduled bank, income by way of interest on such categories of bad
and doubtful debts as may be prescribed (Rule 6EA of Income Tax Rules) having regard
to the guidelines issued by the Reserve Bank of India in relation to such debts, shall be
chargeable to tax in the previous year in which it is credited to the profit and loss
account by the said institution for that year or in the previous year in which it is actually
received by them, whichever is earlier.
Taxability under section 43D
Section 43D of the Act, provides relief to certain assessees, such as public financial
institutions, scheduled banks, certain co-operative banks, housing finance companies, by
specifically providing for taxability of interest on non-performing assets on receipt basis;
this relaxation is, however, not extended to other NBFCs.
A reading of rule 6EA of the Rules explicitly makes it clear that Rule also applies to
income by way of interest only. While prescribing those bad and doubtful debts, the
rule making authority has taken into consideration the guidelines issued by the
Reserve Bank of India in relation to such debts. Therefore, what follows is section 43-
D is not applicable to all bad and doubtful debts. It applies only to such bad and
doubtful debts as prescribed under rule 6EA of the Rules. The said rules are framed
by the rule making authority on the basis of the guidelines issued by the Reserve
Bank of India in relation to such debts. Therefore, we have to look into the guidelines
issued by the Reserve Bank of India only to find out in respect of which bad and
doubtful debts, the benefit of section 43D is attracted.
CBDT Circular No. 2/2018, Dated 15.02.2018 - Finance Act, 2017 -

21. Extension of scope of section 43D to Co-operative Banks.

21.1 Section 43D of the Income-tax Act specifies inter alia that interest income received by certain institutions or
banks or corporations or companies in relation to certain categories of bad or doubtful debts shall be chargeable to
tax in the previous year in which it is credited to its profit and loss account for that year or actually received,
whichever is earlier. This provision is an exception to the accrual system of accounting which is regularly followed
by such assessees for computation of total income.

21.2 The benefit of this provision, before amendment by the Act, was available to scheduled banks, public financial
institutions, state financial corporations, state industrial investment corporations and certain public companies like
housing finance companies. With a view to provide a level playing field to co-operative banks vis-à-vis scheduled
banks and to rationalise the scope of the section 43D, the said section has been amended so as to include co-
operative banks other than a primary agricultural credit society or a primary co-operative agricultural and rural
development bank/within its scope.

21.3 Consequentially, as per matching principle in taxation, if the interest income on bad or doubtful debts is
chargeable to tax on receipt basis, the interest payable on such bad or doubtful debts need to be allowed on actual
payment. In view of this, section 43B of the Income-tax Act has also been amended to provide that any sum
payable by the assessee as interest on any loan or advances from a co-operative bank other than a primary
agricultural credit society or a primary co-operative agricultural and rural development bank shall be allowed as
deduction if it is actually paid on or before the due date of furnishing the return of income of the relevant previous
year.

21.4 Applicability: This amendment takes effect from 1st April, 2018 and will, accordingly, apply from assessment
year 2018-19 and subsequent assessment years.
CBDT Circular No. 779, Dated 14.09.1999 - Finance Act, 1999 -

Extension of provisions of section 43D to Housing Finance Companies

25.1 Under the existing provisions of section 43D of the Income-tax Act, in the case of a public financial
institution or a scheduled bank or a State Financial Corporation or a state industrial investment corporation,
income by way of interest in relation to such categories of bad or doubtful debts, as may be prescribed
having regard to the guidelines issued by the Reserve Bank of India, is chargeable to tax in the previous
year in which it is credited to the profit and loss account or, as the case may be, in which it is actually
received, whichever is earlier.

25.2 With a view to improve the viability of the Housing Finance Companies and to provide a boost to the
housing sector, the Act amends section43D so as to extend its provisions to a public company whose main
object is carrying on the business of providing long-term finance for construction or purchase of houses in
India for residential purposes and which is registered in accordance with the Housing Finance Companies
(NHB) Directions, 1989 given under section 30 and section 31 of the National Housing Bank Act, 1987.
The Act provides that in the case of such a company, the income by way of interest in relation to such
categories of bad or doubtful debts, as may be prescribed having regard to the guidelines issued by the
National Housing Bank in relation to such debts, shall be chargeable to tax in the previous year in which it
is credited by the company to its profit and loss account or, as the case may be, in which it is actually
received by that company, whichever is earlier.

25.3 This amendment will take effect from 1st April, 2000 and will, accordingly, apply in relation to the
assessment year 2000-2001 and subsequent years.
Unrealised lease rent on non-performing assets was not covered in rule 6EA and, therefore, deduction on
same was not allowable under section 43D

Section 43D applies only to such bad and doubtful debts as prescribed under rule 6EA; since unrealised lease rent
on non-performing assets was not covered in said rule, deduction was not allowable.

The assessee-bank claimed deduction for unrealised lease rentals on the non-performing assets. The Assessing
Officer held that section 43D deals with the taxability of bad debts recovered and not with the allowability of the
claims and therefore he disallowed the claim with respect to unrealized lease rentals and added back the said
amount to the total income of the assessee. On appeal, the Commissioner (Appeals) allowed the claim of the
assessee. On revenue’s appeal, the Tribunal upheld the order of the Commissioner (Appeals). On appeal:

Held : When the Legislature has expressly used the words “income by way of interest” in section 43D, if one had to
include in that section the unrealized rentals from equipment leasing activity, it would amount to the Court rewriting
the section, which is impermissible in law. In fact, the authorities have not carefully read the aforesaid statutory
provision. It is a case of misreading the provision. A liability under the Income-tax Act cannot be foisted on the
basis of analogy. Unless the Statute provides, no tax to be levied. Similarly, when the Statute expressly provides
how the income received is to be taxed and in which year, strictly in accordance with the statutory provision, the tax
has to be levied. The language employed in the aforesaid section is simple. There is no ambiguity. One has to follow
the words used in that section. There is no scope for interpretation at all. Hence, the impugned order passed by the
Appellate Authorities cannot be sustained. Accordingly, the fifth substantial question of law is answered in favour
of the revenue and against the assessee. To that extent, the appeals succeed and the impugned order on that aspect
only is hereby set aside. [In favour of revenue] (Related Assessment years : 1998-99 to 2003-04) – [CIT, Mangalore
v. Karnataka Bank Ltd. (2015) 232 Taxman 578 : 59 taxmann.com 93 (Karn.)]
Interest on bad debts - Interest on bad and doubtful debts kept in reserve account would be
eligible for deduction under section 43D

Arguments of department : Department contended that section 43D is applicable to the scheduled
banks and assessee had not established that it was a scheduled bank and moreover, it had credited the
interest in its books of account and, therefore, the Assessing Officer as the well as Commissioner
(Appeals), both were correct in rejecting the claim of the assessee.

Arguments of assessee : The interest was never credited by it to profit and loss account and whatever
was actually received by the assessee had been shown as income.

Issues for consideration : Whether interest on bad or doubtful debts could be claimed as deduction
under section 43D?

Held : Mere crediting of interest to a reserve cannot be said to be an incidence by which said interest
could be charged to tax. Where interest on loans granted by assessee-bank remained unpaid which
were classified as non-accrual loans and were reversed to an account called Reserve for Doubtful
Interest account, assessee would be entitled to claim deduction under section 43D in respect of said
interest and simply on ground that interest had been credited on such type of debts in reserve account,
deduction could not be taken away. [In favour of assessee] (Related Assessment year : 1998-99) –
[American Express Bank Ltd. v. Addl. CIT Spl. Range Mumbai (2013) 55 SOT 136 : (2012) 25
taxmann.com 572 (ITAT Mumbai)]
Sections 36(1)(vii) and 43D are not violative of articles 14 and 19 of Constitution

As regards challenge to the validity of sections 43D and 36(1)(viia ) as violative of article 19, it was
found that the RBI Directions govern the business of NBFCs. To protect the investors, the RBI has
prescribed norms for provisioning and disclosure. These norms have nothing to do with computation
of taxable income under the Income-tax Act. These directions do not apply to banks. Ultimately, the
challenge is to the validity of a taxing enactment. In such cases, one must give some latitude to the
lawmakers in enacting laws which impose reasonable restrictions under article 19(6). This is so for
two reasons. Firstly, the impugned allowance under section 36(1)(viia) cannot be extended to NBFCs
which are vulnerable to economic and financial uncertainties. Secondly, the RBI Directions are only
disclosure norms. They require NBFCs to make a provision for possible loss to be made and disclosed
to the public. Such debits are only notional for purposes of disclosure and, hence, they cannot be
made an excuse for claiming deduction under the Income-tax Act and, hence, ‘add back’. Since the
RBI Directions are not applicable to banks, there is no question of extending the benefit of deduction
to the NBFCs under section 36(1)(viia ) or under section 43D. Keeping in mind an important role
assigned to the banks in our market economy, the restriction, if any, placed on the NBFC by not
giving them the benefit of deduction, satisfies the principle of ‘reasonable justification’. - [Southern
Technologies Ltd. v. JCIT, Coimbatore (2010) 320 ITR 577 : 228 CTR 440 : 187 Taxman 346 (SC)]
 Special reference to the admissibility of deductions and
exemptions relating to banking companies

[1] Deduction towards bad debts under section 36(1)(vii)

Bad debts which have been written off as irrecoverable [Section 36(1)(vii)]
Deduction relating to any bad debt or part thereof written off shall be limited to the amount by which such debt or
part thereof exceeds the credit balance in the provision for bad and doubtful debts account made under that clause.

 Under section 36(1)(vii) of the Act, deduction on account of bad debts which are written off as irrecoverable in the accounts
of the assessee is admissible. However, this should be allowed only of the assessee had debited the amount of such debts to
the provision for bad and doubtful debt account under section 36(1)(viia) of the Act, as required by section 36(2)(v) of the
Act.

 While considering the claim for bad debts under section 36(1)(vii), the assessing officer should allow only such amount of
bad debts written off as exceeds the credit balance available in the provision for bad & doubtful debt account created under
section 36(2)(viia) of the Act, The credit balance for this purpose will be the opening credit balance i.e., the balance brought
forward as on 1st April of the relevant accounting year.

Quantum of Deduction
 Actual bad debts which have been written off from books of accounts
Deduction of Bad Debts
Bad debts as well as the year in which the deduction was to be allowed. The dispute
regarding the year in which the debt has to be allowed as deduction was held to be resolved
by the clear statement of the amended law that the deduction was allowable in the year in
which the debt has been written off as irrecoverable.
Once a debt is written off as a bad debt, the same has to be allowed as deduction under
section 36(1)(vii) of the Income Tax Act, 1961, unless the write off is not genuine and is
proved by the Assessing Officer that the same is not genuine.
Conditions
(i) Debt must be incidental to the business or profession of the assessee
There must be a close nexus between the debt and the business of the assessee.
Example: Bad debt arising out of advances made by a lawyer to his client to assist him in
purchasing properties is not admissible as bad debt.
As it is not the business of lawyer to provide loans. Such loss is not allowed in any
provision of the Act.
(ii) The debt has been considered as income of the assessee of that previous year or of earlier previous
years
Example : Advance given to supplier for purchase of raw-material later forfeited, is not allowed as
deduction under this section, this is because the same has never been a part of income. However, deduction
can be claimed under section 37(1).
EXCEPTION:
Bad debt arising due to insolvency of borrower is allowed as deduction provided money has been lent in
ordinary course of money lending business (even though such money lent had never been a part of income).
(iii) It must have been written off in the accounts of the assessee
Provision for bad debt is not allowed as deduction.
EXCEPTION
Where the amount of such debt has been taken into account in computing the income of the assessee of the
previous year in which the amount of such debt becomes irrecoverable or of an earlier previous year on the
basis of notified Income Computation and Disclosure Standards (ICDS) without recording the same in the
accounts, then, such debt shall be allowed in the previous year in which such debt becomes irrecoverable
and it shall be deemed that such debt has been written off as irrecoverable in the accounts.
(iv) Business must be carried on during the previous year or any part of the previous
year
Bad debt of a discontinued business is not allowed as deduction even though the assessee has
any other business continued.
(v) It must be of a revenue nature
(a) Bad debt arising due to insolvency of a debtor for sale of an asset (not goods) is not
allowed as deduction.
(b) Bad debt is not allowed as deduction to the assessee who maintains accounts on cash basis.
(c) Bad debts are also allowed in the hands of successor of the business.
Recovery of bad debts written off taxable under section 41(4)
Section 41(4) of the Act provides that where a deduction has been allowed under section 36(1)
(vii) and if the amount subsequently recovered on any such debt or part thereof is greater than
the difference between the debt or part of the debt and the amount so allowed, the excess shall
be deemed to be the profits and gains of business or profession and is accordingly chargeable
to income tax as income of the previous year in which it is recovered.
NBFC’s claim for bad debts written off cannot be rejected on the grounds of change of method of accounting
from mercantile to cash
• Where assessee-NBFC had offered lease rentals to tax on accrual basis and subsequently the same turned
irrecoverable and had to be written off as bad debt, the claim of assessee-NBFC for deduction of bad debts written off
under section 36(1)(vii) cannot be disallowed on the grounds of change in the method of accounting from mercantile
to cash even if such change is a violation of accounting principles.

• A change of the method of accounting by the assessee from mercantile to cash may even be a breach of the
accounting principles. However, that in our view is not a requirement of Section 36(1)(vii) of the Income Tax Act for
allowing a debt as a bad debt. In fact, what emerges from Note-5 of making a special mention is that a prudent
practice has been adopted by a limited company of informing its shareholders about the remote possibility of recovery
of the said amounts and the decision to reverse and that the same would be accounted for as and when received.

• In our view, the finding of the Tribunal that the claim of the assessee in respect of bad debt cannot be considered, is
without any basis. Once, a business decision has been taken to write off a debt as a bad debt in its books which
decision as discussed above, is bona fide, that in our view, should be sufficient to allow the claim of the assessee. The
method of accounting has no relevance to the issue. In our view, the Tribunal has misdirected itself in proceeding to
give precedence to accounting principles over clear statutory provisions. Evidently, the written off lease rental amount
has not been reversed from the income entry in Schedule-16.This is a clear case of writing off a bad debt in
accordance with the provision of Section 36(1)(vii) of the Income Tax Act. The Tribunal has erred in rejecting the
claim of the assessee for deduction of bad debt written off under Section 36(1)(vii) of the Act. The substantial
question of law framed in this Appeal is accordingly answered in favour of the Appellant Assessee and against the
Revenue. – [L.K.P. Merchant Financing Ltd. v. DCIT (2022) 140 taxmann.com 548 (Bom.)]
Where in case of scheduled bank, deduction under section 36(1)(vii) is allowable
independently and irrespective of provision for bad and doubtful debts created by it in
relation to advances made by its rural branches, subject to limitation that an amount
should not be deducted twice under section 36(1)(vii) and 36(1)(viia) simultaneously – [In
favour of Assessee] - [DCIT v. Karnataka Bank Ltd. (2012) 25 taxmann.com 235 (SC)]

The position in law is well-settled. After 01.04.1989, it is not necessary for the assessee to
establish that the debt, in fact, has become irrecoverable. It is enough if the bad debt is
written off as irrecoverable in the accounts of the assessee. When a bad debt occurs, the
bad debt account is debited and the customer's account is credited, thus, closing the
account of the customer. In the case of companies, the provision is deducted from Sundry
Debtors. - [In favour of Assessee] - [T.R.F. Limited v. CIT (Civil Appeal No. 5293 of 2003)
(SC)]
[2] Deductions for provision for bad and doubtful debts created by certain banks, Financial
Institutions and Non-Banking Financial Company
[Section 36(1)(viia)]

 As per section 36(1)(viia) of the Income Tax Act, 1961 only banks and financial institutions
are allowed deduction in respect of the provisions made for bad and doubtful debts. No
other assessee is allowed to claim the deduction on the provision of bad debts.
 Note: Deduction in respect of bad debts actually written off under section 36(1)(vii) shall
be limited to that amount of bad debts which exceed the provision for bad and doubtful
debts created under section 36(1)(viia).
 In respect of any provisions for bad and doubtful debts made by a bank, an amount not
exceeding 5 percent up to 31 March 2003 and thereafter 8.5 percent of the total income
(computed before making any deduction under this clause and Chapter VIA of the Act) and
an amount not exceeding 10 percent of the aggregate average advances made by rural
branches of such banks computed in the manner prescribed under the Income Tax Rules,
1962, shall be allowed as deduction, while computing the business income of the assessee.
Deduction towards advances given by rural branches of bank
 Section 36(1)(viia)(a) of the Act provides that deduction in respect of provision for
bad and doubtful debts not exceeding ten percent of the aggregate average advances
made by the rural branches of such bank computed in the prescribed manner shall be
allowed.
 Rural branches have been defined as the branch of the bank situated in a place which
has a population of not more than 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 method for computing aggregate average advances is prescribed under Rule
6ABA of the Income Tax Rules, 1962 according to which the amounts of advances
made by each rural branch as outstanding at the end of the last day of each month in
the previous year shall be aggregated separately and the sum so arrived at in the case
of each such branch shall be divided by the number of months.
 The aggregate of the sums so arrived at in respect of each of the rural branches shall
be the aggregate average advances made.
NOTE
Deductions towards advances given by rural branches of the following banks were
allowed without correlating with the population figures, aggregate average advances and
monthly outstanding advances
 To see the correctness of the deductions claimed, obtain details regarding population
of places where rural branches are located, aggregate average advances and monthly
outstanding advances
 Such deductions are allowed only after suitable verification by the assessing officer
so as to safeguard the interests of revenue.

Eligible assessee
Banks, Public Financial Institutions, Non-banking financial company, State Financial
Corporation, State Industrial Investment Corporations.
Conditions
The conditions laid down in Income Tax Act, 1961 under section 36(2) should be fulfilled before any
allowance for bad debts is allowed. The conditions are:—
(i) The debt or loan should be for the business or profession of the assessee and the said debt or loan
should be for the relevant accounting year. Any debt which does not relate to the assessee’s business or
profession, the deduction is not allowed in case of such debt.
(ii) In the case of Girdhari Lal Gian Chand v. CIT (1971) 79 ITR 561 (All), it is settled that if a debt
due from retired partners is irrecoverable then the assessee cannot write off and claim the same as a
deduction since it is a capital loss.
(iii) An assessee can take the deduction in respect of those debts only which have been included in the
computation of the Income Tax Return in the current period or any previous financial year. In case of
the money lending business, the money lent in the ordinary course of business should be considered.
(iv) The deduction claimed as the bad debts against any debt or loan or any part of it thereof should
have actually been bad in the accounting year.
(v) An assessee will only be eligible to take the deduction in respect of those debts only which they
have written off from the books of accounts in the previous financial year in which the deduction is
also claimed.
Quantum of Deduction
Deductions for provision for bad and doubtful debts shall be limited to following:—
(a) In case of scheduled and non-scheduled banks : Sum not exceeding aggregate of
8.5% of total income (before any deductions under this provision and Chapter VI-A) and
10% of aggregate average advances made by rural branches of such bank;
(b) In case of Financial Institutions : Up to 5% of total income before any deductions
under this provision and Chapter VI-A;
(c) In case of foreign banks : Up to 5% of total income before any deductions under this
provision and Chapter VI-A; and
(d) In case of non-banking financial company : Up to 5% of total income before any
deduction under this provision and Chapter VI-A.
Text of Rule 6ABA
Computation of aggregate average advances for the purposes of clause (viia) of sub-
section (1) of section 36.
6ABA. For the purposes of clause (viia) of sub-section (1) of section 36, the aggregate
average advances made by the rural branches of a scheduled bank shall be computed in
the following manner, namely :—
(a)the amounts of advances made by each rural branch as outstanding at the end of the
last day of each month comprised in the previous year shall be aggregated separately ;
(b)the sum so arrived at in the case of each such branch shall be divided by the number of
months for which the outstanding advances have been taken into account for the
purposes of clause (a) ;
(c)the aggregate of the sums so arrived at in respect of each of the rural branches shall be
the aggregate average advances made by the rural branches of the scheduled bank.
Explanation : In this rule, “rural branch” and “scheduled bank” shall have the meanings
assigned to them in the Explanation to clause (viia) of sub-section (1) of section 36.]
The limits on which the deduction is allowed to the banks and financial institutions are:—
Bank Type Deduction Allowed Explanation
Indian Banks 8.5% of adjusted total income Indian Bank means any bank which is not a
foreign bank and is a banking company
+
incorporated in India.
10% of average aggregate advances
Adjusted Total Income – Gross total income
made by rural branches
before deduction under the section 36(1)(viia).
Average aggregate advances (Note below)

Foreign Banks 5% of adjusted total income Adjusted Total Income – Gross total income
before deduction under the section 36(1)(viia).

Public Financial 5% of adjusted total income Adjusted Total Income – Gross total income
Institution, State before deduction under the section 36(1)
Financial (viia).
Corporation
 Average aggregate advances can be computed in following steps:
 Calculate separately all the advances made by every rural branch
 Calculate average advances made by branch i.e advances made divided by no. of
months outstanding
 Total of all the average advances by every branch
Treatment as per Accounting Standard
As per Accounting Standard 29 “Provisions, Contingent Liabilities and Assets” an assessee
must account for the provisions that occur in the ordinary course of business. Since the
provisions are disallowed sometimes by the Income Tax Department, it creates a timing
difference between the books of accounts and books as per Income Tax Act. Thus, an
assessee will also need to create Deferred Tax Assets/Liability accordingly.
An assessee must only a deferred tax asset/liability only the timing difference of the
transaction is temporary in nature and have the possibility of getting reversed in the future.
Bad Debts of Discontinued Business
Bad Debts of a discontinued business which is already discontinued before the accounting
year starts, cannot be claimed as a deduction from the profit of the continued business of
the assessee. As per section 36(2)(iii) if bad debts have already been written off in the
books of accounts but they are not allowed as a deduction by Assessing Officer on the
ground that the debt is still having a possibility of recovery. Any such debt or part of debt
should be allowed as a deduction in the year in which is becoming irrecoverable.
Bad Debts Recovered
If in any previous year, the debt has been written off as bad and the relevant deduction has
also been claimed but later on the same debt is recovered in full or part, then the amount so
recovered will be included as income of the financial year in which such amount has
recovered.
CBDT Instruction No. 10/2008, Dated 31.07.2008

Subject : Section 36(1)(viia) of the Income-tax Act, 1961 - Bad Debts - Assessment of banks - Allowance of deduction
to Rural Branches

2. While computing the income under the head 'Profit and Gains of Business & Profession' a scheduled bank (not being a
bank incorporated by or under the laws of a foreign country) or a non-scheduled bank or a cooperate bank other than a
primary agricultural credit society or a primary co-operative agricultural and rural bank is entitled to claim deduction of
provision for bad debt of an amount not exceeding ten per cent of the aggregate average advances made by the rural
branches of such bank computed in the prescribed manner. The term 'rural branch' has been defined in Explanation (ia) to
section36(1)(viia) to be a branch of a scheduled or a non-scheduled bank situated in a place which has a population of not
more than ten thousand according to the last preceding census of which the relevant figures have been published before the
first day of the previous year.

3. It has, however, come to the notice of the Board through the report of the C&AG's office that, in many instances, claims
made by banks for deduction under section36(1)(viia) of the Income-tax Act, 1961 are being allowed without verification
as to whether the concerned branches come with the definition of 'rural branch'. In several cases, this has resulted in large
under assessment of income.

4. The Assessing Officers should, therefore, ensure that the claims of deduction towards advances given by rural branches
of banks are allowed only after verifying (at least by way of test check) as to whether such branches are eligible to be
treated as a ‘rural branch’ according to the definition given in Explanation (ia) to section 36(1)(viia) of the Income-tax Act,
1961.

5. A review of completed assessments may also be carried out and appropriate remedial action may be taken as may be
necessary.
Deduction under section 36(1)(vii)(a) is not allowable in absence of a provision for bad and
doubtful debt in accounts of assessee-bank
Assessee is a Public Limited Company engaged in banking business. A conjoint reading of provision
contained in section 36(1)(viia) and explanatory note dated 30.06.1982 it is evident that deduction
provided in section 36(1)(viia) shall be allowed in respect of the matters dealt therein in computing the
income. The condition precedent for claiming deduction under section 36(1)(viia) of the Act is that a
provision for bad and doubtful debt should be made in the accounts of the assessee. The aforesaid
section mentions the maximum amount for which such a provision should be made. If a provision is
made in excess of the limits prescribed under the section , the assessee would not be entitled to
deduction of the excess amount. Once a provision is made and the amount of deduction is within the
limit prescribed under the Act, the assessee would be entitled to deduction of the amount for which
provision is made in the books of accounts.
Language employed in section 36(1)(viia) is clear and unambiguous, therefore, question of going into
intention or object behind provision viz., section 36(1)(viia) does not arise. Condition precedent for
claiming deduction under section 36(1)(viia) is that a provision for bad and doubtful debt should be
made in accounts of assessee. Thus, in absence of any provision, assessee-bank is not entitled to
deduction under section 36(1)(viia). [In favour of revenue] (Related Assessment years : 2003-04 and
2004-05) – [CIT, Bangalore v. Syndicate Bank (2020) 422 ITR 460 : 274 Taxman 522 : 120
taxmann.com 258 (Karn.)]
Provisions of section 115JA does not apply to Banking Companies - [In favour of
assessee] (Related Assessment years : 2003-04 and 2004-05) – [CIT, Bangalore v.
Syndicate Bank (2020) 422 ITR 460 : 274 Taxman 522 : 120 taxmann.com 258 (Karn.)]

Value of standard assets in case of Banks could not be included in provision of bad
and doubtful debts
Standard assets are always considered recoverable and any provision made on such assets
cannot be considered as a provision for bad and doubtful debts. Assessee, a public sector
bank, filed its return and claimed deduction under section 36(1)(viia). Assessing Officer
allowed same. However, Commissioner revised said order on ground that provision for
standard assets was also included in provision for bad and doubtful debts and, thus, a
higher claim was allowed. He set aside order passed by Assessing Officer. It was found
that except allowance of deduction under section 36(1)(viia), there was no discussion as to
how section 36(1)(viia) was applied and whether limits were correctly worked out or not.
Since there was no application of mind by Assessing Officer, original order was erroneous
and prejudicial to revenue. [In favour of revenue] (Related Assessment year : 2007-08) –
[Bharat Overseas Bank Ltd. v. CIT (2013) 152 TTJ 546 : (2012) 139 ITD 154 : 26
taxmann.com 330 (ITAT Chennai)]
Assessee, a rural bank, claimed deduction on account of provision for bad and doubtful debts under
section 36(1)(viia) which was rejected on ground that assessee did not debit its profit and loss account
any sum towards ‘provision for bad and doubtful debts’, impugned order passed by Assessing Officer
did not require any interference
Assessee was a rural regional bank engaged in business of banking. Assessee claimed deduction on account
of provision for bad and doubtful debts under section 36(1)(viia). Assessing Officer rejected assessee’s
claim on ground that assessee did not debit its profit and loss account any sum towards ‘provision for bad
and doubtful debts’. At the time of hearing it was agreed by the parties that similar issue had come up for
consideration before the ITAT in assessee’s own case for Assessment year 2009-10 & 2010-11 in JCIT v.
Karnataka Vikas Grameena Bank (2018) 93 taxmann.com 256 (ITAT Bangalore) and this Tribunal reversed
the order of the CIT(A) and held that the deduction under section 36(1)(viia) of the Act cannot be allowed
unless the provision is created by debited to provision for bad and doubtful debts account.
In absence of any change in circumstances, Respectfully following the decision of the Tribunal in assessee’s
own case we hold that the Assessing Officer was justified in disallowing the claim for deduction on account
of provisions for bad and doubtful debts under section 36(1)(viia) of the Act as admittedly the assessee did
not debit its profit and loss account any sum towards provision for bad and doubtful debts. We therefore
restore the order of the Assessing Officer and allow ground raised by the revenue. [In favour of revenue]
(Related Assessment years : 2012-13 and 2013-14) – [JCIT v. Karnataka Vikas Grameena Bank (2020) 181
ITD 672 : 113 taxmann.com 530 : 79 ITR(T) 207 (ITAT Bangalore)]
SLP dismissed against High Court ruling that where revenue had not established that
excess provision for bad and doubtful debts allowable under section 36(1)(viia)
written back in profit and loss account was allowed as deduction in previous years,
no addition could be made holding that excess provision written back amounted to
income within meaning of section 41(1)
Assessee as per RBI guidelines made provision of bad and doubtful debts, in terms of
section 36(1)(viia). Same being excess, was written back in books of account. Assessing
Authority made certain additions relating to excess provision of bad and doubtful debts
viewing that excess provision written back amounted to income within meaning of section
41(1). High Court by impugned order held that since revenue had not established that
excess provision for bad and doubtful debts allowable under section 36(1)(viia) written
back in profit and loss account was allowed as deduction in previous years, no addition
could be made holding that excess provision written back amounted to income within
meaning of section 41(1). Special Leave Petition filed against impugned order was to be
dismissed. [In favour of assessee] (Related Assessment year : 2008-09) – [CIT v. Pragathi
Gramina Bank (2018) 259 Taxman 219 : 99 taxmann.com 153 (SC)]
SLP dismissed against High Court’s ruling that in order to determine status of a bank as
a ‘rural branch’ for allowing claim of deduction under section 36(1)(viia) even
provisional figures of census data available on first day of relevant financial year can be
taken into consideration and if figure shown in provisional population total exceeds
10,000, then bank would not be entitled to benefit granted for rural branch
The assessee was a scheduled bank of the Government of India. It, relying upon census of
1991, declared it as a ‘rural bank’ and claimed deduction under section 36(1)(viia). The
revenue authorities, relying upon provisional data of census of 2001, concluded that the
assessee was not a rural branch. Accordingly, the assessee’s claim for deduction under section
36(1)(viia) was disallowed. The Tribunal confirmed order passed by authorities below. On
appeal, the assessee contended that since census data of 2001 was finally published after first
day of previous year, it could not be taken into consideration while disposing of aforesaid
claim. High Court held that in order to determine status of a bank as a ‘rural branch’ for
allowing benefit of deduction under section 36(1)(viia) even provisional figures of census data
available on first day of relevant financial year can be taken into consideration and if figure
shown in provisional population total in a village exceeds 10,000, then bank would not satisfy
requirement of rural branch and, consequently, would not be entitled to benefit granted to rural
branch. Special Leave Petition filed against impugned order was to be dismissed. [In favour of
revenue] (Related Assessment years : 2003-04 and 2004-05) – [State Bank of Mysore v. ACIT,
Bangalore (2017) 246 Taxman 58 : 79 taxmann.com 65 (SC)]
Special reserve created and maintained by financial corporation
(Transfer to Special Reserve)
[Section 36(1)(viii)]

 Deduction under section 36(1)(viii) is allowed to following entities in respect of

amount transferred to special reserve account:—
 (a) Financial Corporation which is engaged in providing long-term finance for
industrial or agricultural development or development of infrastructure facility in India;
or
 (b) Public company registered in India with the main object of carrying on the business
of providing long-term finance for construction or purchase of residential houses in
India.
 Eligible assessee
 Specified financial corporations or public company.
Quantum of Deduction
The amount of deduction under section 36(1)(viii) is as follows:—
(a) the amount transferred during the previous year to the special reserve account created for the
purpose of section 36(1)(viii); or
(b) 20% of the profits derived from the business activities which is computed under section 28 but
before claiming deduction under section 36(1)(viii); or
(c) 200% of (paid-up share capital and general reserve as on the last day of the previous year) minus
the balance of the Special Reserve Account on the first day of the previous year.
 Whichever is Lower.
Amount withdrawn from Reserve Account: [Section 41(4A)]
Where a deduction has been allowed in respect of any special reserve created and maintained under
section 36(1)(viii), any amount subsequently withdrawn from such special reserve shall be deemed to
be the profits and gains of business or profession and accordingly be chargeable to income-tax as the
income of the previous year in which such amount is withdrawn.
Further, where any amount is withdrawn from the special reserve in a previous year in which the
business is no longer in existence, the provisions of this sub-section shall apply as if the business is in
existence in that previous year.
(a) “specified entity” means, -
(i) a financial corporation specified in section 4A of the Companies Act, 1956 (1 of 1956);
(ii) a financial corporation which is a public sector company;
(iii) a banking company;
(iv) a co-operative bank other than a primary agricultural credit society or a primary co-operative
agricultural and rural development bank;
(v) a housing finance company; and
(vi) any other financial corporation including a public company;
(b) “eligible business” means,—
(i) in respect of the specified entity referred to in sub-clause (i) or subclause
(ii) or sub-clause (iii) or sub-clause (iv) of clause (a), the business of providing long-term finance for—
(A) industrial or agricultural development;
(B) development of infrastructure facility in India; or
(C) development of housing in India;
Where 51 per cent shares of assessee bank was held by Government, it was a ‘financial
corporation’ entitled to benefit of deduction under section 36(1)(viii)
Where admittedly, assessee-bank was not a private company and it fulfilled requirement of
section 3 of Companies Act, 1956, it would be a public company. Further, where 51 per
cent of shares of assessee-bank was held by Government of India, same was a Government
company within meaning of section 617 of Companies Act, 1956. Since assessee was
squarely covered within meaning of expression ‘financial corporation’, it would be entitled
to benefit of deduction under section 36(1)(viii). [In favour of assessee] (Related Assessment
year : 2007-08) – [CIT, LTU, Bangalore v. Vijaya Bank (2021) 429 ITR 407 : 277 Taxman
148 : 123 taxmann.com 214 (Karn.)]
Artificial increase of profit by assessee by adding back amortization and depreciation in SLR investment so as
to arrive higher amount of profit for claiming deduction under section 36(1)(viii) was unjustified

The net profit from banking business declared by the assessee, transferred to General Reserve, the assessee before
claiming 20 per cent deduction of the profits, added back the amount of amortization and depreciation in SLR
investments, to arrive at a higher figure of profit for claiming the aforesaid 20 per cent deduction under section 36(1)
(viii). Lower authorities reduced the deduction, ignoring said adding back of amortization and depreciation in SLR
investments. On appeal to High Court:

The profits and gains of business or profession for the purpose of claiming deduction of 20 per cent thereof under
section 36(1)(viii) does not envisage any such artificial raising of the 'profits' by adding back the amortization and
depreciation in the SLR investments, as has been done by the assessee bank in the present case. The profits and gains
of business, as simply computed as per the accounting practices followed by the assessee in normal course of business
under section 28 has to be the basis for computing 20 per cent deduction. The artificial increase of the profits by
adding back amortization and depreciation in SLR investments by the assessee as done by it before the Assessing
Authority was not justified and therefore, the Authorities below appear to be justified in reducing the said deduction,
ignoring the said adding back of the amortization and depreciation in SLR investments. The said deduction has to be
restricted to 20 per cent of profits of banking business as computed by the Assessing Authority. Therefore, the
contention raised by the assessee in this regard in the present appeals is not sustainable. The said contention, therefore,
is liable to be rejected. The same is accordingly rejected. [In favour of revenue] (Related Assessment year : 2012-13) -
[Pragathi Krishna Gramin Bank v. JCIT (2018) 256 Taxman 349 : 95 taxmann.com 41 (Karn.)]
Deduction under section 36(1)(viii) is to be allowed to Government Banks
The Assessing Officer granted deduction to the assessee-bank under section 36(1)(viii).
The Commissioner exercised its power of the revision under section 263 on the question
of deduction claimed under section 36(1)(viii) and held that assessee bank was ineligible
for deduction. On appeal:
In the facts of the present case, there is no occasion for the Commissioner to exercise his
powers under section 263 as the view taken by the Assessing Officer granting deduction
under section 36(1)(viii) to the assessee was a possible view. This possible view is further
fortified by the decision of the Tribunal in Union Bank of India v. ACIT (2012) 49 SOT
32 : (2011) 16 taxmann.com 304 (ITAT Mumbai) which has also been accepted by the
revenue. Besides, even Explanation to section 36(1)(viii) as existing at the relevant time, a
Financial Corporation has been defined to include a Public Company and the Government
Company. Assessee would be covered by definition of 'Financial Corporation' as stated in
the Explanation to section36(1)(viii). In view of the above, there is no reason to entertain
the present appeal. – [CIT v. State Bank of India (2015) 375 ITR 20 : 59 taxmann.com 86 :
(2016) 237 Taxman 252 (Bom.)]
Business deduction under section 36(1)(viii) - Special Reserve Created by Financial
Corporation - Computation of total income on which deduction allowable - In
computing the total income for the purpose of Income Tax Act, 1961, the total income
for calculating deduction has to be computed in accordance with the provisions of
sections 30 to 40A except section 36(1)(viii) before making any deduction under
Chapter VI-A
Against the judgment and order of the Patna High Court (1983) 142 ITR 518 (Pat) holding
that the statutory deduction under section 36(1)(viii) of the Income Tax Act, 1961,
available to a financial corporation providing long-term finance for industrial or
agricultural development should be calculated on the total income before deduction of the
amount allowable under section 36(1)(viii), the department appealed to the Supreme Court.
The department also filed a special leave petition against the judgment of the Andhra
Pradesh High Court to the same effect. The Supreme Court dismissed the appeal as well as
the special leave petition. The appeal against the judgment and decision in CIT v. Bihar
State Financial Corporation (1983) 142 ITR 518 (Pat) was dismissed by the Supreme
Court [See (1998) 233 ITR (SC) 195] thereby affirming the view of the Patna High Court. -
[CIT v. Andhra Pradesh State Financial Corporation (1998) 233 ITR 195 : TaxPub(DT) 33
(SC)]
 Marked to market loss or other expected loss as computed in accordance with the ICDS
notified under section 145(2)
[Section 36(1)(xviii)]
 

 The Finance Act, 2018 has inserted section 36(1)(xviii) w.r.e.f. 01.04.2017 says that any marked to market loss or
other expected loss as computed in accordance with the income computation and disclosure standards notified under
section 145(2) shall be allowed. This is retrospectively applicable from the Assessment Year 2017-18 onwards.
Finance Bill, 2018
 Marked to market losses - ICDS – I provides for not allowing marked to market loss or expected loss while
computing income under the head "profits and gains of business or profession", unless such loss is recognized in
accordance with the provisions of any other ICDSs.
Text of Section 36(1)(xviii)
 (xviii) marked to market loss or other expected loss as computed in accordance with the income computation and
disclosure standards notified under sub-section (2) of section 145.
 Section 40A(13) which specifies that no deduction or allowance shall be allowed in respect of any marked to market
loss or other expected loss, except as allowable under Section 36(1)(xviii).
 NOTE
 Mark-to-market losses are losses generated through an accounting entry rather than the actual sale of a security.
Mark-to-market losses can occur when financial instruments held are valued at the current market value.
It may be seen that prior to amendment, MTM loss was allowed as deduction whereas
MTM gain was ignored on account of prudence. But after amendment not only MTM loss
is allowable as deduction like before but MTM gain has also to be offered for taxation.
Nature of Expenditure
Marked to Market Loss or other Unexpected Loss as Computed in Accordance with
Notified of Income Computation and Disclosure Standards (ICDS).
Section 145(2)
Section 145 (2) of the Act empowers the Central Government to notify from time to time
ICDS to be followed by any class of taxpayers or in respect of any class of income.
Compliance with the said section is mandatory.
It was held that an assessee is obliged to follow the prescribed accounting standards to
determine the taxable income under the head 'business or profession'. Interestingly, the
Central Government has delegated to CBDT, the computation part under Section 145(2)
with retrospective effect from the assessment year 2017-18 onwards. – [CIT v. Woodward
Governor India (P) Ltd. (2009) 312 ITR 254 : 179 Taxman 326 (SC)]
Eligible
All assessees.
Inventory Valuation
ICDS II deals with valuation of inventory and ICDS VIII deals with securities held as
inventory. In line with ICDS II and ICDS VIII, amendment has been made to existing
provisions of section 145A to provide for following:
(i) Valuation of inventory shall be made at lower of actual cost or net realizable value ('NRV')
computed in accordance with notified ICDS.
(ii) Valuation of purchase and sale of goods or services and of inventory shall include the
amount of any tax, duty, cess or fee actually paid or incurred by the taxpayer to bring the goods
or services to the place of its location and condition as on the date of valuation.
(iii) Inventory, being unlisted securities, or listed but not quoted regularly on a recognised stock
exchange, shall be valued at actual cost initially recognised as provided in the ICDS •
Inventory, being listed securities (other than referred above), shall be valued at lower of actual
cost or NRV in the manner provided in ICDS and for this purpose the comparison of actual cost
and NRV shall be done category wise.
CBDT Circular No. 8, Dated 26.12.2018 (Finance Act, 2018)
Amendments in relation to notified Income Computation and Disclosure Standards
39.1 Section 145 of the Income-tax Act empowers the Central government to notify
Income Computation and Disclosure Standards (ICDS). In pursuance to the above, the
Central Government has notified ten such Standards effective from 1st April, 2017 relating
to Assessment Year 2017-18. These are applicable to all assesses (other than an individual
or a Hindu undivided family who are not subject to tax audit under section 44AB of the
Income-tax Act) for the purposes of computation of income chargeable to income-tax
under the head "Profits and gains of business or profession" or "Income from other
sources".
39.2 In order to bring certainty in the wake of recent judicial pronouncements on the issue
of applicability of ICDS -
(i) Section 36 of the Income-tax Act has been amended to provide that marked-to-market
loss or other expected loss, as computed in the manner provided in the ICDS notified
under sub-section (2) of section 145, shall be allowed deduction.
(ii) Section 40A of the Income-tax Act has been amended to provide that no deduction or
allowance in respect of marked-to-market loss or other expected loss shall be allowed
except as allowable under newly inserted clause (xviii) of sub-section (1) of section36.
(iii) A new section 43AA has been inserted in the Income-tax Act to provide that, subject
to the provisions of section 43A, any gain or loss arising on account of effects of changes
in foreign exchange rates in respect of specified foreign currency transactions shall be
treated as income or loss, which shall be computed in the manner provided in ICDS as
notified under sub-section (2] of section 145 of the Income-tax Act.
(iv) A new section 43CB has been inserted in the Income-tax Act to provide that profits
arising from a construction contract or a contract for providing services shall be
determined on the basis of percentage of completion method except for certain service
contracts, and that the contract revenue shall include retention money, and contract cost
shall not be reduced by incidental interest, dividend and capital gains,
(v) Section 145A of the Income-tax Act has been amended to provide that, for the
purpose of determining the income chargeable under the head "Profits and gains of
business or profession",—
(a) the valuation of inventory shall be made at lower of actual cost or net realizable value
computed in the manner provided in the ICDS notified under Sub-Section (2) of section
145;
(b) the valuation of purchase and sale of goods or services and of inventory shall be
adjusted to include the amount of any tax, duty, cess or fee actually paid or incurred by the
assessee to bring the goods or services to the place of its location and condition as on the
date of valuation;
(c) inventory, being securities not listed, or listed but not quoted, on a recognised stock
exchange, shall be valued at actual cost initially recognised in the manner provided in the
ICDS notified under (2) of section 145;
(d) inventory, being listed securities, shall be valued at lower of actual cost or net
realisable value in the manner provided in the ICDS notified under (2) of section 145 and
for this purpose the comparison of actual cost and net realisable value shall be done
category-wise;
(e) inventory, being securities, held by a scheduled bank or public financial institution
shall be valued in accordance with the ICDS notified under sub-section (2) of section 145
after taking into account the extant guidelines of the Reserve Bank of India.
(vi) A new section 145B has been inserted in the Income-tax Act to provide that—
(a) interest received by an assessee on compensation or on enhanced compensation,
shall be deemed to be the income of the year in which it is received;
(b) the claim for escalation of price in a contract or export incentives shall be deemed to
be the income of the previous year in which reasonable certainty of its realisation is
achieved;
(c) income referred to in sub-clause (xviii) of clause (24) of section 2 shall be deemed to
be the income of the previous year in which it is received, if not charged to income tax
for any earlier previous year;
39.3 Applicability: Recent judicial pronouncements have raised doubts on the
legitimacy of the notified ICDS. However, a large number of taxpayers have already
complied with the provisions of ICDS for computing income for assessment year 2017-
18. In order to regularise the compliance with the notified ICDS by a large number
taxpayers so as to prevent any further inconvenience to them, these amendments take
effect retrospectively with effect from 1st April, 2017, i.e., the date on which the ICDS
was made effective and will, accordingly, apply in relation to assessment year 2017-18
and subsequent assessment years.
CBDT Circular No. 665, dated 05.10.1993.

Subject : Clarification regarding treatment of securities as stock-in-trade or investment

1. By Circular No. 599, dated 24.04.1991 (see clarification 2), it was clarified that securities held by banks must be regarded as their
stock-in-trade and the claim of loss, if debited in the books of account, should be given the same treatment as is normally given to the
stock-in-trade. It was also clarified that the interest paid for broken period on the purchase of securities must be regarded as revenue
payment and allowed accordingly.

2. Consequent upon the judgment of the Supreme Court in the case of Vijaya Bank Ltd v. CIT  (1991) 187 ITR 541, the above circular
was withdrawn by the issue of Circular No. 610, dated 31.07.1991 [See Clarification 1].  There have been representations from the Indian
Banks’ Association to the effect that the Supreme Court in the case of Vijaya Bank Ltd. was concerned only with the claim for broken
period interest and did not decide the issue whether the securities constituted stock-in-trade or investment.  It has therefore been
represented that the withdrawal of Circular No. 599, dated 24.04.1991 in toto was not called for.

3. The Board has reconsidered the treatment to be accorded to securities held by banks.  In the case of Vijaya Bank Ltd. (supra), the
Supreme Court considered the issue whether, in a case where the assessee purchases securities at a price determined with reference to
their actual value as well as the interest accrued thereon till the date of purchase, the entire price paid for them would be in the nature of
capital outlay or whether the interest portion could be claimed as a revenue expenditure.  It was in this context that the Supreme Court
held that whatever was the consideration which prompted the assessee to purchase the securities, the price paid for them was in the nature
of capital outlay and no part of it could be set off as expenditure against income accruing on those securities.  The Court was not directly
concerned with the issue whether the securities form part of stock-in-trade or capital assets.

4. The question whether a particular item of investment in securities constitutes stock-in-trade or a capital asset is a question of fact.  In
fact, the banks are generally governed by the instructions of the Reserve Bank of India from time to time with regard to the classification
of assets and also the accounting standards for investments.  The Board has, therefore, decided that the Assessing Officers should
determine on the facts and circumstances of each case as to whether any particular security constitutes stock-in-trade or investment taking
into account the guidelines issued by the Reserve Bank of India in this regard from time to time.
 General Deductions
[Section 37]

 Section 37 of the Act envisages that an amount debited in the P&L account in respect of an
accrued or ascertained liability only is an admissible deduction, while any provision in
respect of any unascertained liability or a liability which has not accrued, do not qualify for
deduction.
 However, it has been found that Banks are claiming provisions on different accounts,
probably under the RBI guidelines [e.g. Provision for wage arrears for which negotiations
are yet to be finalized, provision for standard asset etc…].
 A contingent liability cannot constitute deductible expenditure for the purposes of Income
Tax Act.
 Thus, putting aside of money which may become expenditure on the happening of an event
would normally not constitute an allowable expenditure under the Income Tax Act.
 The Assessing Officers should verify such claims as to whether these are admissible as per
the Income Tax Act.
Payment of broken period interest on acquisition of securities by assessee-
bank was allowable as revenue expenditure
Assessee-bank filed its return of income claiming broken period interest paid on
acquisition of securities as revenue expenditure. Assessing Officer allowed same.
After four years, Assessing Officer issued a reopening notice on ground that said
broken period interest paid by assessee was to be treated as capital expenditure,
thus, same was to be disallowed. It was noted that reasons for reopening did not
disclose any non-disclosure of facts on part of assessee during original
assessment. Further, in view of decision in case of American Express
International Banking Corpn. v. CIT (2002) 258 ITR 601 :125 Taxman 488/
(Bom.), payment of broken period interest was to be allowed as revenue
expenditure. On facts, impugned reopening of assessment after expiry of four
years was not justified and same was to be set aside. [In favour of assessee]
(Related Assessment year : 2008-09) – [Dena Bank v. ACIT (2022) 287 Taxman
300 : 139 taxmann.com 46 (Bom.)]
 Non-Performing Assets (NPA)

 NPA - an Overview
 In simple words NPA stands for Non Performing Assets. If we do not gain anything from the assets,
it will be called non performing. If we do not receive interest and/or installments in a loan for a
specific period, it will turn into NPA.
 An asset becomes non-performing when it ceases to generate income for the bank. A non
performing asset was defined as credit in respect of which interest and / or installment of principal
has remained ‘past due’ for a specific period of time.
 The lending institutions can take the benefit of the section 36(1)(vii) and 36(1)(viia) of Income tax
Act, 1961.
 History of NPA
 The concept of NPA is introduced by RBI to reflect a bank’s actual financial health in its balance
sheet and as per the recommendations made by the Committee on Financial System (Chairman Shri
M. Narasimham). The Narasimham committee studied the prevailing financial system, identified its
shortcomings and weaknesses and made with ranging suggestions and recommendations in line
with internationally accepted norms. The committee report was first tabled in Parliament on
December 17, 1991. Based on the recommendations of the Committee on "Financial System
Reforms", the RBI evolved prudential norms on Income recognition ,Asset classification and
Provisioning and issued revised instructions to banks in April 1992. The provisioning should be
made on the basis of the classification of assets into different categories. The above instructions of
RBI have since been implemented by banks from the financial year ended March 1998.
Regulatory framework
The Reserve Bank of India (RBI) broadly governs the functioning of banks and Non-
banking Finance Companies (NBFC) in India. As per RBI, NBFCs are only required to
recognize income from non-performing assets, once the income is actually received by such
NBFCs. Further, when an asset is classified as a non-performing asset, the interest recorded
thereon is required to be reversed.
RBI guidelines would not override the provisions of the Income-tax Act, 1961 (the
Act), as both the laws operate in different fields
It was held that RBI guidelines would not override the provisions of the Income-tax Act,
1961, as both the laws operate in different fields. Accordingly, one could contend that RBI
only deals with the recognition of income on NPA in the books of account of an NBFC,
whereas the taxability ought not to be governed by the same; it is only the provisions of the
Act which should be relevant qua determining the taxability of such income de-hors the
regulations of the RBI. – [Southern Technologies Ltd. v. JCIT (2010) 187 Taxman 346 : 320
ITR 577 (SC)]
Provisions for non-performing assets (NPA) made by Co-operative Bank in terms of RBI
guidelines allowable as deduction
This court in Canfin Homes Ltd. after taking note of section 145 of the Act has held that once a
particular asset is shown as non performing asset then the assumption that it is not yielding any
revenue. When an asset is not yielding any revenue, the question of showing that revenue and
paying tax would not arise. The contentions, which are sought to be raised by learned counsel for
the revenue do not arise for consideration in the context of substantial question of law, which has
been framed by this court. The concurrent findings have been recorded by the Commissioner of
Income-tax (Appeals) as well as tribunal in this regard, which cannot be termed as perverse.
Provision for non-performing assets made by assessee-bank in terms of RBI guidelines was
allowable as deduction. Accordingly, the appeal is dismissed. [In favour of assessee] (Related
Assessment year : 2007-08) – [PCIT v. Davangere District Central Co-op. Bank Ltd. (2021) 129
taxmann.com 113 (Karn.)]

Interest on Inter-Corporate Deposits (ICDs) which had become Non-Performing Asset

(NPA) in terms of Prudential Norms issued by RBI, having not accrued, would not be
taxable in hands of a non-banking financial company
Assessee, a non-banking financial company, advanced certain Inter-Corporate Deposits (ICDs) to
a company ‘S’. As no interest could be received on such deposits for more than six months,
assessee, in terms of directions given by RBI, treated said ICDs as NPA and did not show interest
income thereon which, according to it, was not realizable. Assessing Officer, however, added
interest as income of assessee holding that it had accrued to assessee as it was following
mercantile system of accounting - High Court by impugned order held that since as per Prudential
Norms issued by RBI, said ICDs had become NPA on which no interest was received and
possibility of recovery was almost nil, it could not be treated to have been accrued in favour of
assessee and was therefore not exigible to tax. Appeal against said impugned order was to be
dismissed. [In favour of assessee] - [CIT v. Vasisth Chay Vyapar Ltd. (2019) 410 ITR 244 : (2018)
301 CTR 263 : 253 Taxman 401 : 90 taxmann.com 365 (SC)]
Income on NPA was actually not credited but was shown as receivable in balance
sheet of assessee-co-operative bank, interest on NPA would be taxable in year when
it would be actually received by assessee bank
Assessee, a co-operative bank, gave explanation that as per RBI guidelines, income on
non-performing assets (NPA) was not to be credited to profit and loss account but instead
to be shown as receivable in balance sheet and it was to be taken as income in profit and
loss account only when interest would actually be received. Further, as per RBI norms
interest not received within 180 days was to be taken to Overdue Interest Reserve (OIR)
account. However, Assessing Officer discarded said explanation and made addition on
basis of accrual of interest income. Taxing interest on NPA was not justified and was to
be taxable in year when it was actually received by assessee bank. [In favour of assessee]
(Related Assessment year : 2009-10) – [PCIT, Pune v. Solapur District Central Co-op.
Bank Ltd. (2019) 261 Taxman 476 : 102 taxmann.com 440 (Bom.)]
Income from NPA should be assessed on cash basis and not on mercantile basis,
despite assessee following mercantile system of accounting
Indisputably, there is no decision to the contrary by the Hon’ble Supreme Court on this
question. Therefore, the decision aforesaid in CIT v. Canfin Homes Ltd. (2012) 347 ITR
382 : (2011) 201 Taxman 273 : 13 taxmann.com 43 (Karn.) stands concluded on the
views of this Court that when a particular asset is shown to be NPA, the assumption is
that it is not yielding any revenue; and there is no reason that the assessee be subjected to
tax on the alleged notional income, even if it has adopted hybrid system of accounting.
When the said decision in Canfin Homes Ltd.'s case (supra) directly applies to the present
case, the Tribunal cannot be said to have committed any error in approving the decision
of the CIT (A), who had deleted the addition in respect of interest on NPAs.
Income from NPA should be assessed on cash basis and not on mercantile basis, despite
assessee following mercantile system of accounting. In view of aforesaid legal position,
Assessing Officer was not justified in bringing to tax interest on non-performing assets on
accrual basis just because assessee followed hybrid system of accounting. [In favour of
assessee] (Related Assessment year 2010-11) – [PCIT v. Davangere Urban Co-operative
Bank Ltd. (2018) 93 taxmann.com 221 (Karn.)]
 Thanks
Ram Dutt Sharma
ITO (Retd.)

Mob. No. 09910055143

Blog : ramduttsharma.blogspot.com