Kindly inform me any circulars, case laws etc. regarding allowability under income tax with respect to provision made on standard assets as per prudential norms issued by RBI. The Department has issued an internal circulars to its officers. As per clause (xi) of the said Instruction No. 17/2008 dated 26-11-2008 Asssessment of Banks - Checklist for Deductions - Regarding. The line no. 3 of the said clause is reproduced " However, it has been found that Banks are claimimg provisions on different accounts probably under the RBI guidelines (e.g. provision for wage arrears for which negotiations are yet to be finalised , provision on Standard Assets etc......)."
Based on the above line of the instructions, the AO has added back the income of assessee by disallowing the provision made on statndard assets as per prudential norms as debited to Profit and loss account.
Kindly advise / inform to me the relevant case laws, circulars etc. in this regard.
As I replied over phone to you, the section as quoated by you is related to bad and doubtful debts. Please read the query again. The banks make a provision on standard assets also as per rate prescibed (0.25% or 0.40%)as per prudential norms as issued by RBI from time to time and the said provision alongwith new provision on NPA assets debited in P/L a/c of the concerned banks. The contention of AO is that the provision on standard assets is neither covered under 36(1)(viia)nor under section 37(1). The standard assets are regularly earning interest hence it is not bad or doubtful as the first proviso of section 36(1)(viia) line four and five says. Moreover, it is also clearly given in Departmental Instruction no. 17/2008 dated 26-11-2008 that banks are claiming deduction as provision on standard assets which I have also mentioned in my query. Secondly, the AO again saying that under section 37(1) it can not allow as deduction because it is not a acertained liability hence it is contingent in nature.
Therefore, I made a query at this fourm for expert advice in the form of departmental instructions, circulars, case laws etc.
26 December 2015
Provision u/s 36(1)(viia) is for bad & doubt full debts on the average advances of rural branches. standard assets is internal classification as per RBI and not of Income Tax ACT. Section says only for avg Advances of Rural ( it all Advance inclulding stand, sub stand or other)
20 August 2018
Provision for standard assets is a provision for bad and doubtful debt and is covered u/s 36(1)(viia).
Clause (viia) was firstly inserted in sub section (1) to section 36 by Finance Act, 1979. The clause (viia) as inserted by Finance Act, 1979 was as under: “(viia) in respect of any provision for bad and doubtful debts made by a scheduled bank in relation to advances made by its rural branches, an amount not exceeding one and a half per cent of the aggregate average advances made by such branches, computed in the prescribed manner.”
After introduction of such clause (viia) by the Finance Act, 1979, with effect from April 1, 1980, Circular No. 258, dated June 14, 1979, was issued by the Central Board of Direct Taxes to clarify the application of the new provisions as under: “Deduction in respect of provisions made for bad and doubtful debts relating to rural branches of scheduled commercial banks—Sec. 36(1) (viia). Under section 36(l)(vii) of the Income-tax Act, a taxpayer carrying on business or profession is entitled to a deduction, in the computation of the taxable profits, of the amount of any debt which is established to have become bad during the previous year, subject to certain conditions, However, a mere provision for bad and doubtful debts is not allowed as a deduction in the computation of the taxable profits. In order to promote rural banking and assist the scheduled commercial banks in making adequate provisions from their current profits to provide for risks in relation to their rural advances, the Finance Act has inserted a new clause (viia) in sub-section (1) of section 36(l) of the Income-tax Act to provide for a deduction, in the computation of the taxable profits of all scheduled commercial banks, in respect of provisions made by them for bad and doubtful debts relating to advances made by their rural branches. The deduction will be limited to 1 per cent, of the aggregate average advances made by the rural branches computed in the manner to be prescribed by rules in the Income-tax Rules, 1962. For this purpose, a "rural branch" means a branch of a scheduled bank situated in a place with a population not exceeding 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 expression "scheduled bank" has the same meaning as in the Explanation below section 11(2)(b) of the Income- tax Act but does not include a co-operative bank. The expression " scheduled bank" would, therefore, cover the State Bank of India constituted under the State Bank of India Act, 1955, any subsidiary bank of the State Bank of India as defined in the State Bank of India (Subsidiary Banks) Act, 1959, a nationalised bank as specified in section 3 of the Banking Companies (Acquisition and Transfer of Undertakings) Act, 1970, or any other bank included in the Second Schedule to the Reserve Bank of India Act, 1934, It may be mentioned that all co-operative banks have been excluded from the purview of this provision in view of the position that under section 80P(2)(a)(i) of the Income-tax Act, the profits and gains of a co-operative society engaged in the business of banking or providing credit facilities to its members are completely exempt from income-tax. It may be relevant to mention that the provisions of new clause (viia) of section 36(1) relating to the deduction on account of provisions for bad and doubtful debts is distinct and independent of the provisions of section 36(1)(vii) relating to allowance of the bad debts. In other words, the scheduled commercial banks would continue to get the full benefit of the write-off of the irrecoverable debts under section 36(1)(vii) in addition to the benefit of deduction of the provision for bad and doubtful debts under section 36(l)(viia).
This provision will take effect from 1st April, 1980, and will accordingly apply in relation to the assessment year 1980-81 and subsequent years.
Clause (viia) amended subsequently and provision as stand for the year under consideration reads as under: “(viia) in respect of any provision for bad and doubtful debts made by- (a) a scheduled bank not being a bank incorporated by or under the laws of a country outside India] or a non-scheduled bank or a co-operative bank other than a primary agricultural credit society or a primary co-operative agricultural and rural development bank, an amount not exceeding seven and one-half per cent of the total income (computed before making any deduction under this clause and Chapter VI-A) and 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….”
Proviso to sub clause (vii) inserted by Finance Act, 1985, w.e.f. 01.04.1985 reads as under: “Provided further that in 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 in the provision for bad and doubtful debts account made under that clause.”
Explanation 1 & 2 to clause (vii) inserted by finance act 2001 w.r.e.f. 1-4-1989 and by finance act, 2013 w.e.f. 1-4-2014 respectively reads as under: “Explanation — 1. 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 assessee; Explanation — 2. For the removal of doubts, it is hereby clarified that for the purposes of the proviso to clause (vii) of this sub-section and clause (v) of sub-section (2), the account referred to therein shall be only one account in respect of provision for bad and doubtful debts under clause (viia) and such account shall relate to all types of advances, including advances made by rural branches.”
From the perusal of the legislative intent as explained in the circular issued by the CBDT the provision is allowable irrespective of the fact that the debt for which provision has been made by the assessee is ‘GOOD’ or ‘BAD’. The legislative intent was to promote the banking sector to create provision well before a ‘DEBT’ became ‘BAD’. The limit of the allowability under the section is with reference to total income and not with reference to the quality of the advance [Standard, NPA, Bad Debt etc.]. Further where the quantum of provision linked with advances made by bank [By rural branches] the amount of all advances of the rural branches should be taken into consideration and not the advances which became bad. Considering these points the provisions of clause (viia) of sub section (1) of section 36 cannot be interpreted that the provision which is allowable is required to be made for bad debts and provision made with respect to debt which are not bad debt as on date of creation of provision is not allowable. Such interpretation is contrary to the legislative intent and cannot be upheld on judicial scrutiny. It may be pertinent to mention here that under the provisions of income tax there is no classification of advances as ‘performing’ and ‘non performing’ and therefore reach to a conclusion that provision under 36(1)(viia) will be allowable only if same was made with respect to debts which are ‘non performing’ on the date when provision was made is grossly erroneous and untenable in eye of law.
Further to this first proviso to sub-clause (a) to clause (viia) of sub section (1) of section 36 clearly demonstrate that for allowability of provision made for bad or doubtful debts under the main provisions of clause (a) is not linked to the nature or classification of debt as ‘GOOD’ or ‘BAD’ and provision made shall be allowed up to certain percentage of total income. By first proviso an option is provided to scheduled bank to claim the provision made by it for any assets classified by the Reserve bank of India as doubtful assets or loss assets for an amount not exceeding 5% of such assets shown in the books of account on the last day of the previous year. If provision made for the assets classified as NPA by RBI only allowable under the main clause than why there is any need for the first proviso.
Provision for Standard Assets is provision for bad and doubtful debt and is allowable debt u/s 36(1)(viia). The provision for Standard Assets will be used to write off any debt which became bad and recovery of which not probable. One must understand as to why the provision is made for bad and doubtful debt is made for. Provision for the bad and doubtful debt is made to write off any debt which in turn became bad. It is not necessary that creation of Provision for the bad and doubtful debt means that the debts of the bank became bad and recovery of which is not possible on the date on which provision for bad and doubtful debt made in the books of account. The Provision for bad and doubtful debt is made over the years so that any debt if considered bad and non recoverable and therefore required to be write-off, same can be write off from such provision. Following this methodology there will be no extraordinary impact on the financial statement of bank in the year in which the decision of written off taken.
One must understand that the standard assets in banking nomenclature describe an advance from which recovery of principal and interest is regular and on the date of classification there is no doubt about the recovery of loan advanced by the bank. In such situation what is the purpose behind creation of provision for standard asset. There is requirement for creation of provision for standard asset because the asset (advance) which is standard on the balance sheet date may became sub standard [NPA] in future. To meet out such situation provision for standard asset made.
Provision is made not only for the losses or liability incurred till the balance sheet date but also for the probable losses or liability that may arise in future. Under income tax generally provision made for any loss or liability is allowable only if loss or liability is related to the year in which the same is made. If any provision made for loss or liability which is not related to the year in which the provision made, same is not allowable. Contrary to the this general principal, section 36(1)(viia) provided that for in the case of assessee engaged in the business of banking, provision made up to a specified limit will be allowed in the year of provision made. The claim deduction u/s 36(1)(viia) merely making a provision is enough and there is no condition that in the year in which provision made the debt should became bad or doubtful. The provision so made will be used as and when the debt became bad. Therefore the provision made for the standard asset is a provision for bad and doubtful debt and is allowable u/s 36(1)(viia).
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