TMI Blog2011 (11) TMI 75X X X X Extracts X X X X X X X X Extracts X X X X ..... laim of bad debts by the amount of opening balance in the provision for bad and doubtful debts account as at the beginning of the year instead of the closing balance and then allowing deduction u/s 36(1)(viia). This ground of the Revenue's appeal fails. Foreign exchange loss - both the transactions of sale and purchase of dollars are totally independent of each other - there is no question of estimating any profit or loss on such transaction in the manner in which the assessee has done so, more specifically without divulging the impact of difference in the rate of dollar as at the end of the year vis-a-vis that agreed as per the forward contract. In view of the foregoing reasons we uphold the impugned order by not allowing this ground. - ITA NOS. 3643 & 4032/MUM./2005 - - - Dated:- 23-11-2011 - SHRI R.S. SYAL, AND SHRI N.V. VASUDEVAN, JJ. Represented By:- Revenue by : Shri Jitendra Yadav Assessee by : Shri Vijay Kothari R.S. Syal, These two cross appeals - one by the assessee and the other by the Revenue - arise out of the order passed by the Commissioner of Income-tax (Appeals) on 11.03.2005 in relation to the assessment year 2000-01. 2. First ground of ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... assessee in this year itself. 5. The assessee bank is admittedly following mercantile system of accounting. Under such a method, deduction for expenses is allowed when the liability to pay arises irrespective of the fact whether such an amount has been paid or remained unpaid at the end of the year. In the like manner, income, under such a method of accounting, is recognized on accrual basis. In other words, when the assessee finally acquires the right to receive such income, it is charged to tax. Actual receipt of such amount, whether before or after accrual, is of no consequence. The material thing is the time of its accrual. Once an income has accrued, it is liable to taxed, notwithstanding the fact that it was not received during the year. In the same manner, if some amount has been received, which does not represent the income accrued for the year, it shall not be charged to tax and will assume the character of liability till the time of its accrual. Only when such amount accrues as income, the hitherto liability will get converted into income. Till that time it will continue as liability despite the fact that it was received. Thus what is relevant to magnetize tax under the ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ances money on interest, it receives income and it also pays interest on the monies borrowed by it for the purpose of his business. It is the difference between the interest incurred and interest earned, which constitutes his income. Going with the above example, when the lender, who had borrowed Rs. 100 in his normal course of business on interest at the rate of 8%, advances it on interest at the rate of 10%, he will earn income of the differential interest. His liability to pay interest (expenditure in his hands) shall arise for that part of the year for which he used the borrowed funds or remained deprived of such funds. When he borrowed Rs. 100 on 1.1.2011 and advanced it on the same date, his interest expenditure for the year ending 31.3.2011 shall be to the tune of Rs. 2 (8% interest on Rs. 100 for a period of three months from 1.1.2011 to 31.3.2011). When the interest expenditure for a period of three months is deductible, naturally, going by the matching concept, the interest of only Rs. 3 (10% interest income on Rs.100 for a period of three months from 1.1.2011 to 31.3.2011) can be recognized as income. 8. Normally in a case of advancing loan, interest income becomes due ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... inancer will pay Rs.88 (Rs. 100 - Rs. 12) after retaining discounting charges of Rs.12. In such a situation, the interest which shall accrue at the end of the financial year 31.1.2011 shall be Rs.3 notwithstanding the fact that a sum of Rs.12 became due and was also received on 1.1.2011 itself. In the like manner, if the due date is after say two years, the lender will discount the bill for Rs. 76 (Rs.100 - Rs.24). Here also discounting charges of Rs.3 shall accrue to the financer at the end of the year 31.3.2011 despite the fact that a sum of Rs.24 became due and was received. Thus it is manifest that discounting charges are nothing but the cost of deprivation of funds by the financer. Reverting to the matching concept, the financer shall bear the interest cost on the amount of bill discounted during the year ending 31.3.2011 for a period of three months and resultantly the interest income accruing to him will also match with discounting charges for the similar period. As the interest cost for which the financer remained deprived of his funds for the period beyond 31.3.2011 shall become liable for deduction in the subsequent period, naturally, the discounting charges as relatable ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ear or extend beyond that also. Thus it is evident that the bank, by furnishing guarantee, does not incur any financial obligation of its own. Its funds are not deployed in the transaction of giving guarantee or its invocation. The bank does not incur any expenditure in standing as guarantee. Irrespective of the period of guarantee, the bank charges one time guarantee commission. It, therefore, transpires that the entire guarantee commission accrues at the time of the bank furnishing guarantee, regardless of the period for which such guarantee is given. As there are no matching costs over the period of guarantee, the entire amount of guarantee commission accrues and is chargeable to tax in the year of furnishing guarantee. 12. Having noted the nature of discounting charges and guarantee commission, it becomes crystal clear that the decision given in the context of guarantee commission on the accrual of income cannot de facto or de jure apply to the discounting charges. The period for which guarantee is given is irrelevant in so far as the question of accrual of guarantee commission is concerned. But when it comes to the discounting charges, the period of the bill is relevant as i ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ount, the assessee also claimed separate deduction in respect of provision for bad debt amounting to Rs. 35,02,564 made during the current year. The Assessing Officer observed that section 36(1)(vii) provides that the deduction for bad debt actually written off should be allowed which is in excess of the provision created u/s 36(1)(viia). It was noticed that in the present case the assessee considered only the balance of provision created last year and the provision for the current year was not considered. He held that the bad debts deduction should be allowed only in excess of the balance at the end of the year and not at the beginning of the year. He, therefore, granted deduction of Rs. 1,54,12,252 u/s 36(1)(vii) as well as section 36(1)(viia) thereby making disallowance of Rs. 3,34,665. The learned CIT(A) overturned the assessment order on this aspect and ordered for the deletion of addition. 17. We have heard the rival submissions and perused the relevant material on record. In order to decide this issue, it will be apt to take note of the section 36(1)(vii) and the relevant part of clause (viia), which reads as under :- "36. Other deductions.--(1) The deductions provided f ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... time of creating provision under clause (viia) and then, on actual write off under clause (viia), two safeguards have been enshrined in clause (vii). Firstly the Explanation stipulates that 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 assessee and secondly proviso explicitly mandates that where in the case of a bank 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 in the provision for bad and doubtful debts account made under that clause. 19. It is imperative to note at this stage that the quantum aspect of the provision as not exceeding five percent of the specified income, has not been disputed by the AO. The dispute has arisen only on the question of reducing the opening or the closing provision for bad and doubtful debts. 20. Now coming to the sequence of allowing deduction under clauses (vii) and (viia), deduction is first allowed towards bad debts actually written off under clause (vii) as reduced ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ear, naturally, it is only the opening balance of the provision against that debt, which has now become bad and hence written off, can be allowed as deduction. Moreover, when a debt has become bad and is written off, there can be no question of creating provision on that account. From here it clearly emerges that opening balance of the provision is required to be adjusted against the amount of bad debts written off during the year for computing the amount deductible under clause (vii) and it is only thereafter that the provision is made under clause (viia) in respect of the remaining debts outstanding as at the end of the year. 21. This view is fortified from the practical angle of the position as well. Advances of the banks are broadly classified into performing or non-performing assets. In case an account does not pose any problem as regards the recovery of interest or installments of principal loan, it is categorized as performing. No provision is required to be made in respect of such advances. In case an account is not doing well, it slips into non-performing asset. The non-performing advances are further classified into sub-standard or doubtful depending upon the period for ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... , ordinarily there are two types of deductions, viz., firstly on account of provision made at the end of the current year by limiting it to the adjusted total income for the year; and secondly the amount of bad debts actually written off, net of the provision allowed as deduction in the earlier year. However in no case, the amount of cumulative deduction under both the clauses, that is under clause (viia) in the preceding year and under clause (vii) in the current year, can exceed the amount of any bad debt written off as irrecoverable in the accounts of the current year. In our considered opinion the ld. CIT(A) was justified in directing the AO to restrict the claim of bad debts by the amount of opening balance in the provision for bad and doubtful debts account as at the beginning of the year instead of the closing balance and then allowing deduction u/s 36(1)(viia). This ground of the Revenue's appeal fails. 23. The assessee is aggrieved against the confirmation of disallowance of loss on revaluation of foreign exchange contracts amounting to Rs. 26,86,979. The learned Counsel for the assessee drew our attention towards the orders passed by the Tribunal in assessee's own case ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... g the working of Rs. 85,302. It was explained that the assessee received FCNR deposit of $2,50,000 on 14th January, 2000. This deposit was converted into Indian rupees by selling the same in the open market at the rate of Rs. 43.565 per dollar. It was stated that on the same day, the assessee entered into a forward contract with another to buy equal number of dollars at the rate of Rs. 45.165 on 29.12.2000. The difference between the rates of Rs.43.565 and Rs. 45.165 when multiplied with $2,50,000 was stated to be resulting loss of Rs. 4,00,000 covering the period 14.01.2000 to 29.12.2000. It was explained that out of total loss of Rs. 4 lakh arising out of this transaction covering the above referred period, loss on pro-rata basis from January 14 to March 31,2000 amounting to Rs. 85,302 was considered as SWAP cost in this year. In support of its claim for deduction, the ld. AR relied on the Special Bench order of the Tribunal in the case of DCIT (International Taxation) v. Bank of Bahrain Kuwait (2010) 132 TTJ (Mum.) (SB) 505. 27. At this stage it will be relevant to note that page 4 of the assessee's paper book is a copy of the letter dated 13.03.2011 issued by the RBI to all ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... contract is equal to the rate earlier contracted, there shall not be any profit or loss. Neither the buyer will be interested in buying nor the seller will be interested in selling the dollars at the rate contracted because this transaction will be profit neutral in view of the availability of dollar at the same rate in the open market. But if the prevailing market rate of dollar as on the date of execution of contract is more or less than the rate earlier contracted, there shall arise the question of profit or loss due to forward contract. To illustrate, if a forward contract is made, say on 1st January for purchase of dollar as on 31st January at the rate of Rs. 45, the profit or loss from such contract will arise by considering the rate of dollar prevailing as on 31st January. The rate of dollar as on the date of entering into forward contract cannot cause profit or loss. It is only if the rate of dollar on such date is say Rs. 46, the assessee will be benefitted with Re.1 per dollar on 31st January. Had he not entered into forward contract, he would have to spend Rs. 46 for purchasing dollar on 31st January to discharge his business obligations. Now by virtue of the earlier fo ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... he same currency and in order to repay in dollars, the assessee needed dollars at the maturity date of deposit, being 29.12.2000. In order to repay in dollars on such date, the assessee had the option of either purchasing the dollars from market on the said date or to enter into a forward contract. On 29.12.2000 being the date of repayment of FCNR deposit in the next year, the rate of dollar may have been higher or lower than the rate at which the assessee get converted $2,50,000 at the rate of Rs. 43.565 during the current year. Whether such rate would be higher or lower at the time of maturity in the succeeding year is not capable of ascertainment as at the close of the year on 31.3.2000. The decision of the Special Bench in the case of Bank of Bahrain Kuwait (supra) applies to a forward transactions and permits deduction towards loss on the rate at which the contract was entered vis- -vis the rate prevailing as at the close of the year. Suppose the assessee in the instant case having entered into forward contract for buying dollars on 29.12.2000 at Rs.45.165 had found that as at the end of the year i.e. 31st March, 2000 the rate of dollar was higher or lower than the rate at w ..... X X X X Extracts X X X X X X X X Extracts X X X X
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