All About Provision For Bad And Doubtful Debts In Respect Of Rural Advances Of Certain Banks: Section 36(1)(viia)

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All About Provision For Bad And Doubtful Debts In Respect Of Rural Advances Of Certain Banks: Section 36(1)(viia)

One section which is very relevant for the banking industry is section 36(1)(viia). It provides for deduction towards provision for bad and doubtful advances. There are a lot of litigations and disputes. Here is an attempt to simplify it.

 First of all, sections provide for deduction towards provision for bad and doubtful advances u/s 36(1)(viia) @ 7.5% of Gross total income and also further deduction @ 10% of aggregate advances made by rural branches.

 Let us go to the background of the section right from the 1922 Act.

 

 Position under the 1922 Act

There was no provision in the IT Act, 1922 corresponding to this provision.

Position at the time of insertion by the Finance Act, 1979

This clause was inserted by the Finance Act, 1979 w.e.f. 1st April, 1980 and at the time of its insertion, this clause read as under :

“(viia) in respect of any provision for bad and doubtful debts made by a scheduled bank in relation to the 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.

Explanation : For the purposes of this clause,-

(i) “rural branch” means a branch of a 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;

(ii) “scheduled bank” has the same meaning as in the Explanation at the end of cl. (b) of sub-section (2) of section 11, but does not include a co-operative bank.”

This clause, as explained in para 13 of the CBDT Circular No. 258, dt. 14th June, 1979 TC15S.1697 was inserted to promote rural banking and to assist the scheduled commercial banks in making adequate provisions in relation to their rural advances.

(iii) Benefit extended to non-scheduled banks-Amendment by the Finance Act, 1982

By section 10(a) of the Finance Act, 1982 in the opening portion of the word (scheduled bank” was substituted with the words “scheduled bank or a non-scheduled bank.”

Further in the Explanation to this clause, the existing cl. (i) was renumbered as cl. (ia) and the following clause was inserted as cl(i) :

“Non-scheduled bank” means a banking company as defined in cl. (c) of section 5 of the Banking Regulation Act, 1945 (10 of 1949) which is not a scheduled bank”

As explained in para 17 of the CBDT Circular No. 346, dt. 30th June, 1982 TC15S.1706, the object of the amendment was to extend the benefit of the deduction to advances by rural branches of non-scheduled commercial banks as well.

Deduction enhanced-Amendment by the Finance Act, 1985

For the portion beginning with the words “in respect of any provision” and ending with the words “in the prescribed manner”, the following was substituted w.e.f. 1st April, 1985 :

“in respect of any provision for bad and doubtful debts made by a scheduled bank [not being a bank approved by the Central Government for the purposes of cl. (viiia) or a bank incorporated by or under the laws of a country outside India] or a non-scheduled bank, an amount not exceeding ten per cent of the total income (computed before making any deduction under this clause and Chapter VI-A) or an amount not exceeding two per cent of the aggregate average advances made by the rural branches of such banks, computed in the prescribed manner, whichever is higher.”

In cl. (ii) of the Explanation, the words “to cl. (iii) of sub-section (5)” were substituted for “at the end of cl. (b) of sub-section (2).”

As explained in para 17 of the CBDT Circular No. 421, dt. 12th June, 1985 TC15S.1712, the benefit of deduction under this clause was enhanced having regard to the increasing social commitments of banks.

 

Deduction enhanced and scope extended-Amendment by the IT (Amendment) Act, 1986

The IT (Amendment) Act, 1986 substituted the present cl. (viia) for the one as substituted by the Finance Act, 1985.

The object of the substitution, as explained in para 5 of the CBDT Circular No. 464, dt. 18th July, 1986 TC15S.1714, was to give the separate deduction, viz. , one in respect of rural advances and the other for provision for bad and doubtful debts in general and also to extend the benefit of deduction to all banks including foreign banks.

Substitution of cl. (ii) in the Explanation by the Direct Tax Laws (Amendment) Act, 1987

Consequent upon the omission of the Explanation to section 11(5)(iii) to which reference was made in Explanation (ii) of this clause, Explanation (ii) was substituted with the present Explanation (ii) w.e.f. 1st April, 1989.

Benefit extended to public financial institutions, etc.-Amendment by the Finance (No. 2) Act, 1991

Section 14 of the Finance (No. 2) Act. 1991 w.e.f. 1st April, 1992 inserted the present sub-cl. (c) and also cls. (iii),(iv)and (v) in Explanation to the clause. As explained in para 20 of CBDT Circular No. 621 dt. 19th Dec., 1991 TC15S.1719, the object of the amendment is to extend deduction under this clause to public financial institutions, State Financial Corporations and State Industrial Investment Corporation.

Limit for deduction enhanced-Amendment by the Finance Act, 1993

The Finance Act, 1993 substituted the words “two percent” occurring in sub-cl. (a) in cl. (viia) with the words “four percent” 1st April, 1994.

As explained in para 25 of the CBDT Circular No. 657 dt. 30th Aug., 1993 TC15S.1722 the limit for deduction is raised having regard to the needs for stepping up the provisioning for the banks.

Amendments by the Finance Act, 1994

The following amendments have been made by the Finance Act, 1994 w.e.f. 1st April, 1995 :

(i) In sub-cl. (a), the words, brackets, figures and letter ‘‘a bank approved by the Central Government for the purpose of cl. (viiia) or” are omitted.

(ii) For the words ‘‘four percent” in sub-cl. (a) the words ‘‘ten percent” were substituted.

An explained in para 30 of the CBDT Circular No. 684 dt. 10th June, 1994 TC15S.1722, the first amendment is consequent to the omission of cl. (viiia) and the second amendment is made having regard to the stepping up provisioning by the banks mentioned in the clause.

Amendment by the Finance Act, 1999

In clause (viia), in sub-clause (a), the following proviso and the Explanations were inserted w.e.f. 1st April, 2000 :

“Provided that a scheduled bank or a non-scheduled bank referred to in this sub-clause shall, at its option, be allowed in any of the relevant assessment years, deduction in respect of any provision made by it for any assets classified by the Reserve Bank of India as doubtful assets or loss assets in accordance with the guidelines issued by it in this behalf, for an amount not exceeding five per cent. of the amount of such assets shown in the books of account of the bank on the last day of the previous year.

Explanation : For the purposes of this sub-clause, “relevant assessment years” means the five consecutive assessment years commencing on or after the 1st day of April, 2000 and ending before the 1st day of April, 2005.”

Need for approval of Central Government dispensed with-Amendment to cl. (v) of the Expln. to cl. (viia) of sub-s. (1)

In cl. (v) of the Expln. to cl. (viia) of sub-s. (1), the words “approved by the Central Government under cl. (viii) of this sub- section”, were substituted by the words “eligible for deduction under cl. (viii) of this sub-section”.

Limits for allowance modified by the Finance Act, 2002

By the Finance Act, 2002, in section 36 of the Income-tax Act, in sub-section (1), in clause (viia), with effect from the 1st day of April, 2003,-

(i) in sub-clause (a),-

(A) for the words “not exceeding five per cent”, the words “not exceeding seven and one-half per cent.” were substituted;

(B) after the proviso and before the Explanation, the following proviso was inserted, namely:–

‘Provided further that for the relevant assessment years commencing on or after the 1st day of April, 2003 and ending before the 1st day of April, 2005, the provisions of the first proviso shall have effect as if for the words “five per cent.”, the words “ten per cent.” had been substituted.’;

(ii) in sub-clause (c), the following proviso was inserted, namely:–

“Provided that a public financial institution or a State financial corporation or a State industrial investment corporation referred to in this sub-clause shall, at its option, be allowed in any of the two consecutive assessment years commencing on or after the 1st day of April, 2003 and ending before the 1st day of April, 2005, deduction in respect of any provision made by it for any assets classified by the Reserve Bank of India as doubtful assets or loss assets in accordance with the guidelines issued by it in this behalf, of an amount not exceeding ten per cent. of the amount of such assets shown in the books of account of such institution or corporation, as the case may be, on the last day of the previous year.”

Amendment effected by the Finance Act, 2003

 

Amendment by the Finance Act, 2007

By the Finance Act, 2007, in clause (viia),-

(a) in sub-clause (a), after the words “or a non-scheduled bank”, the words “or a co-operative bank other than a primary agricultural credit society or a primary co-operative agricultural and rural development bank” were inserted;

(b) in the Explanation,-

(i) in clause (ii) at the end, the words “but does not include a co-operative bank” were omitted;

(ii) after clause (v), the following clause was inserted, namely:-

‘(vi) “co-operative bank”, “primary agricultural credit society” and “primary co-operative agricultural and rural development bank” shall have the meanings respectively assigned to them in the Explanation to sub-section (4) of section 80P;

About the section:

Initially this clause was introduced with a view to promoting rural banking and assisting the scheduled commercial banks in making adequate provisions from their current profits to provide for risks in relation to their rural advances and subsequently w.e.f. 1st April, 1983 non-scheduled banks were included within the purview of the section. The amendment made by the Finance Act, 2007 w.e.f. 1st April, 2007, seeks to extend the deductions in question which are available to a scheduled bank and non-scheduled bank to a co-operative bank not being a primary agricultural credit society or a primary co-operative agricultural and rural development bank.

Effective from the asst. yr. 1987-88, this clause provides for deduction in respect of not only rural advances but also any advances in general and the concession under this clause was extended to banks incorporated outside India, with the result that the deduction is now available to all banks in respect of all their branches.

From the asst. yr. 1992-93 onwards, the benefit of deduction under this clause is extended to public financial corporation, State Financial Corporation and State Industrial Investment Corporation.

Where any scheduled of bank is approved for the purpose of grant of deduction under cl. (viiia) of section 36(1), deduction under cl. (viia) was not available to such bank. It may be noted that the quantum of deduction under cl. (viii) is higher of 40% of the total income. However, the Finance Act, 1994 has omitted cl. (viiia) w.e.f. 1995-96.

The Finance Act, 1999 inserted a proviso in sub-cl. (a) of cl. (viia) of sub-s. (1). This proviso gives an option to a scheduled bank (not being a bank incorporated by or under the laws of a country outside India) or a non-scheduled bank to claim a deduction in respect of any provision for assets classified by the Reserve Bank of India as doubtful assets or loss assets in accordance with the guidelines issued by it. The amount of deduction shall not exceed five per cent of the amount of doubtful assets or the loss assets shown in the book of account of such bank at the end of the previous year.

From the definition of scheduled bank in cl. (ii) of Explanation, words “but does not include co-operative bank” have been omitted w.e.f. 1st April, 2007. Besides cl. (vi) has been inserted in Explanation to provide that “co-operative bank”, “primary agricultural credit society” and “primary co-operative agricultural and rural and development bank” shall have the meanings respectively assigned to them in the Explanation to sub-s. (4) of s. 80P.

In CIT vs. Micromax Systems (P) Ltd. (2005) 277 ITR 409 (Mad) it was pointed out that since assessee in that case was a company other than a banking company or public financial institution, provisions of s. 36(1)(viia) were not applicable.

In State Bank of Patiala vs. CIT & Anr. (2005) 272 ITR 54 (P&H) it was held that disallowance of enhanced claim was justified as provision was made in subsequent year.

In CIT vs. State Bank of Indore (2005) 196 CTR (MP) 153 it was held that question whether and in what manner deduction can be claimed under s. 36(1)(vii) as well as under s. 36(1)(viia) has to be decided on the basis of recognized methods, principles of accountancy and requirement of said sections. Since Tribunal had decided the issue without application of any judicial precedent, recognized method of accounting, matter was liable to be remanded to the Tribunal for deciding the appeal afresh.

In T.N. Power Finance & Infrastructure Development Corporation Ltd. vs. Jt. CIT (2006) 280 ITR 491 (Mad) assessee engaged in the business of long-term finance for infrastructure development, had made provision for non-performing assets as per directives of Reserve Bank of India and had debited the said provision to profit and loss account and had claimed deduction as bad debt. It was held the mere provision was not deductible under section 36(1)(vii) and as far as section 36(1)(viia) was concerned, it stipulated a deduction not exceeding five per cent of the total income only in respect of provision for bad and doubtful debts which are predominantly revenue in nature or trade related and not for provision for non-performing assets which are predominantly capital in nature.

In Rural Electrification Corporation Ltd., In re (2009) 223 CTR (AAR) 105 : (2009) 312 ITR 122 (AAR), that reserve for bad and doubtful debts created by the applicant by debiting the P&L appropriation account is in fact a ‘provision’ as envisaged under cl. (viia)(c) of s. 36(1) though named as ‘reserve’ and, therefore, applicant is entitled to claim deduction under s. 36(1)(viia)(c); debit in P&L appropriation account cannot by itself disentitle the applicant from claiming the deduction.

Deduction to Rural Branch of banking Industry:

In CIT vs. The Lord Krishna Bank Ltd. (2011) 339 ITR 606 (Ker), it was held that definition clause does not exclude the literal meaning of rural branch which necessarily excludes urban areas. If the assessee’s case accepted by the Tribunal that population in a ward has to be reckoned for deciding as to whether the location of a Panchayat is in a rural area or not is accepted, then probably even in municipal areas there may be wards with less than 10,000 population thereby answering the branch located in such municipal area also as a rural branch. Going by the ordinary meaning of rural branch, only branches of the bank located in rural areas are covered. When the legislature adopts population as the basis for classification of rural branches, that too, with reference to the last census report, the basic unit as available for identification of rural area in the census report can be legitimately adopted. So much so, the meaning of rural area contained in the census report wherein revenue village is treated as a unit of rural area, can be rightly adopted. So much so, “place” referred to in the definition clause for the purpose of identifying the branch of a bank as a rural branch with reference to its location is the revenue village. Therefore, in the finding of the Tribunal that “place” referred to in the definition is the ward of a local authority like Panchayat or municipality is incorrect and a rural branch has to be always in rural areas and the place referred can easily be taken as a village. Several wards may come within a village, whether it be in corporation, municipality or Panchayats. There can be no village in a municipal or corporation area where the population is less than 10,000. So much so, rural branches are such of the branches located in a village where the population in the village as a unit is less than 10,000

The deduction is granted with reference to the provision for bad and doubtful debts subject the limits mentioned below.

(i) For the asst. yrs. 1980-81 to 1984-85 (both inclusive) the ceiling was 1-1/2% of the aggregate average advances made by rural branches of scheduled banks.

(ii) For the asst. yrs. 1985-86 and 1986-87, the limit was 10% of the total income (computed before making any deduction under this clause and Chapter VIA) or 2% of the aggregate average advances made by the rural branches, whichever is higher.

(iii) Effective from the asst. yr. 1987-88, the quantum of deduction available is as under-

(a) in the case of banks incorporated in India 5% of the total income (computed before making any deduction under this clause and under chapter (VI-A) plus an amount of 10% of the average aggregate advances made by the rural branches.

(b) in the case of banks incorporated outside India, the quantum of deduction available is 5% of the total income (computed before making deduction under this clause and chapter VIA).

With effect from the asst. yr. 1994-95 the limit in respect of rural advances is enhanced to four per cent by the Finance Act. 1993. With effect from the asst. yr. 1995-96 the said limit stands increased to 10%.

(iv) with effect from the asst. yr. 1992-93 onwards, deduction is available under this clause to public financial institutions, State Financial Corporations or a State Industrial Investment Corporation also to extent of 5% of the total income (computed before making any deduction under clause or under Chapter VIA)

From 1st April, 2003 deduction available is as under :

In case of domestic scheduled or non-scheduled bank an amount not exceeding seven and half per cent of total income (before making any deduction under this section and chapter V1A) and an amount not exceeding ten per cent of the aggregate average advances made by the rural branches of such bank; in case of a foreign bank, an amount not exceeding five percent of total income (before making deduction under this section and Chapter V1A); in case of public financial institution, a, state financial corporation or a state industrial investment corporation, an amount not exceeding five percent of its total income (before making deduction under this chapter and Chapter VIA); in case of a domestic scheduled bank or non scheduled bank, at its option, five percent of the amount of the assets classified as doubtful assets or loss assets in accordance with guidelines of Reserve Bank of India.

Mode of computation of aggregate average advances made by the rural branches

Rule 6ABA provides for the manner of computing the aggregate average advances made by the rural branches and the steps prescribed therein are briefly as under :

Advances made by each rural branch as at the end of each month comprised in the relevant year are aggregated. The sum so aggregated is divided by number of months comprised in the relevant year. The aggregate of the average advances of all rural branches as computed above would constitute the aggregate average advances made by the rural branches.

In CIT vs City Union Bank Ltd. (2007) 291 ITR 144 (Mad) which pertained to asst. yrs. 1991-92 to 1993-94, it was found that assessee bank had not claimed any debts written off in respect of rural branches in the earlier year. It was held that claim of bad debts in relation to non-rural branches of assessee bank was allowable. The Court relied on decision of Kerala High Court in South Indian Bank Ltd. vs. CIT (2003) 183 CTR (Ker) 21 : (2003) 262 ITR 579 (Ker).

Tribunal was justified in deleting the disallowance of deduction claimed in respect of provision for bad and doubtful debts at an amount not exceeding ten per cent of the aggregate average advances made by the rural branches of the bank since its view is consistent with the provisions of s. 36(1)(viia). CIT vs. Bank of Rajasthan Ltd. (2010) 233 CTR (Bom) 530 : (2010) 326 ITR 526 (Bom).

Overruling the decision in South Indian Bank Ltd. vs. CIT (2003) 183 CTR (Ker) 21 : (2003) 262 ITR 579 (Ker) dissented from. and dissenting from Dy. CIT vs. Karnataka Bank Ltd. (2008) 218 CTR (Kar) 273 : (2008) 11 DTR (Kar) 25 : (2009) 316 ITR 345 (Kar), the Full Bench of Kerala High Court in CIT vs. South Indian Bank Ltd. (2010) 233 CTR (Ker)(FB) 214 : (2010) 326 ITR 174 (Ker)(FB) held that banks which are entitled to claim deduction of provision for bad debts in terms of cl. (viia) of s. 36(1) are covered by the proviso to cl. (vii) irrespective of the nature of advances with respect to which the bad debt written off is claimed as deduction; in view of proviso to cl. (vii) when bad debts written off are also claimed as deduction under cl. (vii), the same is allowable only to the extent it is in excess of the provision created and allowed as deduction under cl. (viia).

Now, Approval Of Central Government Not Required W.E.F. 1st April, 2000:

As per the provisions (as they stood upto to 31st March 2000) enshrined in cl. (v) of the Explanation to cl. (viia) of sub-s. (1), approval of the Central Government was required by a Government company referred to in the said clause for the purposes of s. 36(1)(viii). The Finance Act, 2000 dispensed with the need of approval by Central Government w.e.f. 1st April, 2000. This triggered a spate of consequential amendments too, like in sub-cl. (i) of the Expln. to sub-s. (3) of s. 35D, cls. (viii) and (ix) of sub-s. (5) of s. 11, cl. (c) of Expln. 4 to s. 43B, etc.

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