2021 (7) TMI 332 - HC - Income Tax

Claim of deduction u/s 36(1)(viia) - Whether Tribunal was right in holding that the amount deductible u/s 36(1)(viia) would have to be limited to the amount actually provided for in the books? - Tribunal not adjudicating on the Appellant s alternate contention that the shortfall in the present years between the upper limit allowable under Section 36(1)(viia) and the actual amount created as a provision in its books in the present years ought to nevertheless be allowed as a deduction in the present years on account of the provision created in the subsequent years that was in excess of such alleged shortfall and as such deemed to have been made good HELD THAT - 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. The assessee is therefore entitled to deduction subject to the limit mentioned in Section 36(1)(viia) of the Act. The substantial Questions of law Nos.1 and 3 framed by this Court are substantially answered by this Court in I.T.A. 2020 (2) TMI 1020 - KARNATAKA HIGH COURT and therefore the said questions are answered in favour of the revenue and against the assessee. The Tribunal was right in holding that the deduction computed at the rate of 7.5% of the total income ought to be computed after setting off of brought forwards losses. Decided in favour of the revenue Deduction computed at the rate of 7.5% of the total income ought to be computed after setting off of brought forwards losses - a plain reading of section 36(1)(viia) of the Act it is clear that the amount of deduction at the rate of 7.5% is to be calculated with reference to total income computed under the head profits and gains of business or profession . The provisions governing the brought forward and set of business loss are not part of the provisions governing the computation of profits under the heads profits and gains of business under Section 28. Hence we hold that the deduction at the rate of 7.5% of the total income should be computed before setting off the loss brought forward. Hence the reasoning adopted in this regard by the assessing officer and the Commissioner of Income Tax (Appeals) is not in accordance with the provisions of the Act - Decided against the revenue and in favour of the assessee.

The core legal questions considered by the Court in this appeal under Section 260A of the Income Tax Act, 1961, pertain to the interpretation and application of Section 36(1)(viia) of the Act concerning deductions claimed by the assessee for provisions made towards bad and doubtful debts by scheduled banks, specifically in relation to rural advances. The issues can be delineated as follows:

i) Whether the deduction allowable under Section 36(1)(viia) of the Act is to be limited strictly to the amount of provision actually made and reflected in the books of accounts for the relevant assessment year.

ii) Whether the deduction computed as a percentage (7.5%) of the total income should be calculated before or after setting off brought forward losses.

iii) Whether provisions made in subsequent years, which compensate for any shortfall in provisions made in the relevant assessment year (within the limits prescribed under Section 36(1)(viia)), can be considered for allowing deduction in the relevant assessment year.

iv) Ancillary issues raised but not adjudicated upon by the Tribunal, including the adjustment of brought forward losses in computing total income for deduction purposes and the treatment of certain additions while computing book profits.

Issue-wise Detailed Analysis

1. Limitation of Deduction to Provision Made in Books of Accounts

Relevant Legal Framework and Precedents: Section 36(1)(viia) of the Income Tax Act allows a deduction in respect of provisions for bad and doubtful debts made by scheduled banks, subject to prescribed limits. The provision explicitly states that the deduction shall not exceed specified percentages of total income and aggregate average advances made by rural branches. The provisos further regulate the conditions and limits for such deductions. Explanatory notes issued by the CBDT (Circular No.346 dated 30.01.1982) clarify that the deduction is intended to promote rural banking by allowing provisions for bad debts to be deducted from income.

Court's Interpretation and Reasoning: The Court emphasized that the condition precedent for claiming deduction under Section 36(1)(viia) is the actual making of a provision for bad and doubtful debts in the books of accounts. The section prescribes maximum limits for such provisions, and any excess provision beyond these limits is not deductible. Therefore, the deduction is necessarily linked to the amount of provision actually created and recorded in the books.

Key Evidence and Findings: The Assessing Officer and the Tribunal restricted the deduction to the amount of provision reflected in the books, disallowing the excess claimed by the assessee. The Tribunal relied on its earlier decisions for prior assessment years, which were upheld by this Court.

Application of Law to Facts: Since the assessee claimed deductions exceeding the provision made in the books, the Court held that such claims could not be allowed. The deduction must be confined to the amount of provision actually made within the statutory limits.

Treatment of Competing Arguments: The assessee argued that limiting deduction to the provision made in books would render the provision otiose and frustrate the legislative intent to promote rural banking. However, the Court found that the legislative framework clearly conditions the deduction on the actual provision made, thereby negating the assessee's contention.

Conclusion: The Court upheld the Tribunal's view that the deduction under Section 36(1)(viia) must be limited to the provision made in the books of accounts for the relevant assessment year.

2. Computation of Deduction as a Percentage of Total Income: Before or After Setting Off Brought Forward Losses

Relevant Legal Framework and Precedents: Section 36(1)(viia) allows a deduction calculated as a percentage of the total income. The term "total income" is to be understood in the context of the Income Tax Act's provisions governing computation of income under the head "Profits and Gains of Business or Profession" (Section 28). The provisions relating to set-off of brought forward losses do not govern the computation of profits under Section 28 but are separate provisions.

Court's Interpretation and Reasoning: The Court held that the deduction at the rate of 7.5% must be computed with reference to the total income before setting off brought forward losses. This interpretation aligns with the plain language of the statute and the scheme of the Act, which distinguishes between computation of income and set-off of losses.

Key Evidence and Findings: The Assessing Officer and the Commissioner of Income Tax (Appeals) had computed the deduction after setting off brought forward losses, which the Court found to be contrary to the statutory provisions.

Application of Law to Facts: The Court directed that the deduction at 7.5% be calculated on the total income before adjustment of brought forward losses, thereby increasing the quantum of deduction allowable to the assessee.

Treatment of Competing Arguments: The revenue defended the approach of computing the deduction after setting off losses. The Court rejected this, holding that such reasoning is inconsistent with the provisions of the Act.

Conclusion: The Court answered the substantial question of law in favor of the assessee on this issue, holding that the 7.5% deduction must be computed before setting off brought forward losses.

3. Consideration of Provisions Made in Subsequent Years for Deduction in the Relevant Assessment Year

Relevant Legal Framework and Precedents: Section 36(1)(viia) and its provisos govern deduction for provisions made in the relevant assessment year. There is no express provision permitting the carry-back or adjustment of provisions made in subsequent years for the purpose of deductions in earlier years.

Court's Interpretation and Reasoning: The Court noted that the Tribunal did not adjudicate the assessee's alternate contention that shortfalls in provision in the relevant year could be made good by provisions in subsequent years. However, the Court relied on its earlier decisions which have held that deduction is allowable only in respect of provisions made in the relevant year and not in subsequent years.

Key Evidence and Findings: The assessee sought to claim deduction in the relevant year by considering provisions made in later years to make up for any shortfall. The Tribunal rejected this approach, consistent with prior rulings.

Application of Law to Facts: The Court affirmed that the deduction cannot be allowed on the basis of provisions created in subsequent years to compensate for shortfalls in the relevant year.

Treatment of Competing Arguments: The assessee's argument was that such an approach would defeat the purpose of the provision and that the provision made in subsequent years should be allowed to be set off against shortfalls in earlier years. The Court found no basis in the statutory language or legislative intent to support this.

Conclusion: The Court answered this question in favor of the revenue and against the assessee, confirming that deductions are limited to provisions made in the relevant assessment year.

4. Ancillary Issues Regarding Adjustment of Brought Forward Losses and Additions to Book Profit

The assessee had raised grounds regarding the adjustment of brought forward losses before computing deduction and the treatment of various additions made while computing book profits under Section 115JB(2). The Tribunal did not adjudicate these grounds. The Court did not delve into these issues in detail but confined its analysis to the substantial questions framed.

Significant Holdings

"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... 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."

"The deduction at the rate of 7.5% of the total income should be computed before setting off the loss brought forward."

"The deduction computed at the rate of 7.5% of the total income ought to be computed before setting off of brought forward losses... The reasoning adopted in this regard by the assessing officer and the Commissioner of Income Tax (Appeals) is not in accordance with the provisions of the Act."

"The Tribunal was right in holding that the amount deductible under Section 36(1)(viia) of the Act would have to be limited to the amount actually provided for in the books."

"The Tribunal was right in not allowing the deduction in the relevant year on the basis of provisions created in subsequent years."

The Court's final determinations on the substantial questions of law were:

(i) The deduction under Section 36(1)(viia) is limited to the amount of provision actually made and reflected in the books of accounts for the relevant assessment year - answered in favor of the revenue and against the assessee.

(ii) The deduction computed at 7.5% of total income must be calculated before setting off brought forward losses - answered in favor of the assessee and against the revenue.

(iii) Provisions made in subsequent years cannot be considered for deduction in the relevant assessment year - answered in favor of the revenue and against the assessee.

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