NBFCs -provisions for bad and doubtful debts not allowable- Kerala High Court- an analysis and suggestions.

[C.A. DEV KUMAR KOTHARI]

Relevant provisions:

Section 45Q of the Reserve Bank Of India Act - will not affect provision of I.T.Act.

S. 36(1) (vii) of the I.T.Act.

Art Leasing Ltd Vs CIT.

Non Banking Finance Companies (NBFC)

Non banking finance companies are of different types depending on their nature and composition of business as well as resources mobilized. They may do some sort of banking business activities yet they are not bank. 

Bad debts are allowed:

Bad debts written off are allowed u/s 36 (1) (vii) in any business. However, provision for bad debts are not allowed due to specific exception provided. Some provisions are also allowed u/s 36(1) (viia) governed by separate provisions but those provisions are not applicable to NBFC. Therefore, NBFC can make a claim u/s 36(1) (vii) and not under clause (viia).

Case of Art leasing Ltd:

Art leasing Ltd is a NBFC and not a bank. This NBFC made provision for bad and doubtful debts in accordance with RBI guidelines. NBFC claimed that as per S. 45Q of the RBI Act, the provisions of RBI Act shall prevail over the provisions of I.T.Act. Therefore the provision for bad and doubtful debt should be allowed.

The court considered the claim in light of following:

Provision of RBI Act: The court considered S. 45Q of RBI Act vis a vis S. 36(1) (vii) of I.T Act. The court held that the provisions of S. 45Q of RBI Act will not have overriding effect on specific provisions of the Income-tax Act in relation to provision for bad and doubtful debts.

The provisions as considered by the court are reproduced with High Lights:

Section 45Q of the RB.I. Act  reads as follows:-

"45Q Chapter IIIB to override other laws -

The provisions of this Chapter shall have effect notwithstanding anything inconsistent therewith contained in any other law for the time being in force or any instrument having effect by virtue of any such law".

Section 36(1)(vii) of the I. T. Act reads as follows:-

"36. Other deductions

(1) The deductions provided for in the following clauses shall be allowed in respect of the matters dealt with therein, in computing the income referred to in section 28-

(vii) subject to the provisions of sub section (2), the amount of any bad debt or part thereof which is written off as irrecoverable in the accounts of the assessee for the previous year:

Provided that » the case of an assessee to which clause (viia) applies, the amount of the deduction relating to any such debt or part thereof shall be limited to the amount by which such debt or part thereof exceeds the credit balance h the provision for bad and doubtful debts account made under that clause.

Explanation- for the purposes of this clause, any bad debt or part thereof written off as irrecoverable in the accounts of the assessee shall not include any provision for bad and doubtful debts made in the accounts of the assesses,"

The courts reasoning and decision:

Any other law referred to in Section 45Q does not cover Income Tax Act which applies to all assessees in the computation of taxable income.

Provisions of Chapter IIIB of the R. B.I. Act may have an overriding effect over the provisions of the Money Lenders Acts or similar Acts made by various states, which may otherwise apply to NBFCs.

The accounting standards prescribed by the R.B.I., so long as they are consistent with the Income Tax Act, are certainty applicable to the Income Tax Authorities in the computation of taxable income. {As a consequence any inconsistent of RBI Act in this regard  shall not apply - added by author)

The Court considered that the basic question is whether an express provision contained in the explanation to Section 36(l)(vii) of the Income Tax Act which prohibits granting deduction of any provision for bad and doubtful debts can be got over by the assessee by relying on Section 45Q of the RB.I Act.

As per Court,  Section 36(1) (viia) is a complete answer to this query raised by the appellant wherein special provisions are made in the Income Tax Act for allowing provision for bad and doubtful debts of scheduled banks, non-scheduled banks, co-operative banks etc to the extent permissible thereunder.

Under Section 36(l)(viia), the eligible Banks are authorised to create provision subject to certain limits in respect of rural advances and other loans referred to therein and claim deduction of the same. This provision clearly indicates that Parliament is well aware of the risk undertaken by the Banks in making advance to the rural sector in terms of the guidelines issued by the Government and the R.B.I. and only such cases are treated as exception to the general provision contained in Explanation to Section 36(1)(viia), which prohibits granting of deduction of any provision for bad and doubtful debts.

Unfortunately, for the appellant NBFCs. are not covered by Section 36(l)(viia) of the I.T Act and so much so, explanation to section 36(l)(vii) squarely applies.

The appellant-N.B.F.Cs. are not entitled to deduction of any Provision created for bad and doubtful debts, no matter such provision is created based on the guidelines issued by the R. B. I.

In view of the above the Court upheld the order of the Tribunal and dismissed the Income-tax Appeals.

Authors views:

When a special enactment deals with any particular business and that enactment require specific provisioning, then that special provision should prevail over general provision of the I.T. Act. This is because general provision of I.T. Act considers all businesses in general way, whereas the specific enactment, considers the specific circumstances of the business. When the specific enactments say that any provision shall apply notwithstanding any other law, then that should be applied. Furthermore when two vies are possible, then view in favor of assessee should have been adopted. Therefore, the author, with due respect submit that the court should have considered provisions of RBI Act, the   provision for bad and doubtful debts should have been allowed in case of NBFC, if such provisions were made under the RBI Act and relevant Rules or guidelines. As per conservative method of accounting, matching principle of accounting, and preparation of profit and also account on reasonable estimate basis also it is required to make a deduction of provisions for bad debts.   

Provision- when can amount to actually written off:

Sundry debtors or receivable are a part of current assets of any business. The accounting theories suggests that just like stock in trade other current assets should also be valued based on cost or market value whichever is less. In case of bank, money lender or NMFC want to sell the business then the receivables have to be valued. Accordingly on the balance sheet date sundry debtors or other receivables like loans granted, advances made etc. also need to be valued at cost or realizable value whichever is less.

Making provision for bad and doubtful debts is nothing but stating realizable value of debts as on balance sheet date and to account for difference being loss due to such valuation. The loss may be presented in any manner like by way of writ off as bad debt or by making provision for bad and doubtful debt or by reducing value of current assets in some other manner. Whatever, method be used, the effect is that the valuation of debts is reduced and thereby profits available are also reduced.

The expression provision is used to keep a track of items covered by provisions.  This is required because many times we notice that there can be a turnaround in business or other affairs of the borrowers. Once an amount is debited in the profit and loss account as bad debts or as provision for bad-debt, that amount is charged on profits and profits are reduced to that extent. The owners of business whether be a proprietor, firm or a company cannot distribute profit to that extent because profits available for appropriation is reduced. Therefore, there is reduction of profits available. When a provision is made, profits available are reduced. Similarly when an items is recovered or becomes recoverable, then the amount is credited tin the profit and loss account and profits available are increased. In case of bad debt allowed, if subsequently any sum is recovered against such allowed portion, the same is specifically taxable u/s 41 (4). Even in absence of such specific provision such recovered amount will be taxable. Similarly, the provisions for bad and doubtful debts are made to prepare accounts on conservative basis and on reasonable estimated basis, as recognized in accounting standards. Therefore, provisions for bad and doubtful debts should be allowed as per accounts and any sum credited against such provision should be included in income as per account.

Bad debts, temporary bad debts, bad debts turning to be good debts are now-a-days common features in any business due to fast changes in circumstances. Therefore, in this regard the accounts of the assessee should be followed instead of making artificial disallowances. Therefore, it is high time that provisions like allowability of or non allowability of any such provision should be deleted from the income-tax Act or the Tax Code.   

NBFCs are not entitled to deduction of any provision created for bad and doubtful debts, no matter such provision is created on RBI guidelines