M/S Vijaya Bank , Bangalore vs Department Of Income Tax

M/S.Vijaya Bank, Vs. The Addl. Commissioner of No.41/2, M.G.Road, Income Tax, (LTU), Bangalore-5600 085. Bangalore. PAN: AAACV 4791J

APPELLANT RESPONDENT

Revenue by : Shri O.P.Yadav, CIT-III (DR) Assessee by : Shri S.Ananthan and Smt.Lalitha Rameswaran, CAs

Date of hearing : 19.02.2015 Date of Pronouncement : 27.02.2015 ITA Nos. 578 & 653/Bang/2012 Page 2 of 49

ORDER

Per N.V. Vasudevan, Judicial Member

ITA No. 578/Bang/2012 is an appeal by the Revenue, while ITA No.653/Bang/2012 is an appeal by the Assessee. Both these appeals are

directed against the order dated 19.01.2012 of CIT(A), LTU, Bangalore,

relating to AY 08-09.

ITA No.578/Bang/2012 (Appeal by the Revenue)

2. Grounds Nos. 1, 6 and 7 raised by the Revenue in the grounds of

appeal are general in nature and calls for no specific adjudication.

3. Ground No.2 raised by the Revenue projects the grievance of the

Revenue against the order of the CIT(A) whereby the CIT(A) allowed the

claim of the Assessee for deduction u/s.36(1)(viia) of the Act of

Rs.192,57,72,764/- which according to the revenue was in excess of the

provisions made in the accounts by the Assessee. It is the stand of the

revenue that the deduction u/s.36(1)(viia) of the Act ought to be allowed

only to the extent provision is made in the books of accounts for bad and

doubtful debts. The Assessee is a banking company carrying on business

of banking. In its return of income the Assessee claimed deduction of a

sum of Rs.200,03,24,219 on account of Provision for Bad and Doubtful

Debts in respect of rural advances, u/s.36(1)(viia) of the Act. The provisions

of Section 36(1)(viia)(a) of the Act lays down as follows:

ITA Nos. 578 & 653/Bang/2012 Page 3 of 49

"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 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;

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."

4. The AO disallowed claim for deduction of Rs. 192,57,72,764/- out of

the total claim of the Assessee for deduction of RS.200,03,24,219/- on the

ground that the provision for bad and doubtful debts in respect of rural

advances was created by debit to profit and loss account of only a sum of

Rs.7,45,51,455 whereas the claim for deduction actually made

u/s.36(1)(viia) of the Act was a sum of Rs.200,03,24,219/-. The AO was of

the view that as laid down by the Hon'ble Punjab and Haryana High Court

in the case of State Bank of Patiala Vs. CIT 272 ITR 53 (P & H),

claim for deduction u/s.36(1)(viia) of the Act cannot be greater than the

amount debited to the profit and loss account as provision. The AO ITA Nos. 578 & 653/Bang/2012 Page 4 of 49

therefore proposed to disallowed a sum of Rs. 192,57,72,764/- (Difference

between Rs.200,03,24,219 and Rs.7,45,51,455). The CIT(A) deleted the

addition made by the AO by following the decision of the decision of the

ITAT in the case of Syndicate Bank reported in 78 ITD 103 wherein it

was held that irrespective of the debit to the profit and loss account on

account of provision for bad and doubtful debts (PBDD), an Assessee is

entitled to 10% of the AARA as deduction u/s.36(1)(viia) of the Act. The

relevant observations of the Tribunal in the aforesaid decision was as

follows:

"20. The learned CIT has also acted under the misconception that deduction under cl. (viia) is related to the actual amount of provision made by the assessee for bad and doubtful debts. The true meaning of the clause, as indicated earlier, is that once a provision for bad and doubtful debts is made by a scheduled bank having rural branches, the assessee is entitled to a deduction which is quantified not with respect to the amount provided for in the accounts, but with respect to a certain percentage of the total income and also a certain percentage of the aggregate average advances made by the rural branches of the bank. In other words, this is a specific deduction given by the statute irrespective of the quantum provided by the assessee in its accounts towards provision for bad and doubtful debts."

5. The learned DR relied on the decision of the ITAT Bangalore Bench

in the case of Canara Bank in ITA No.58/Bang/2004 dated

9.6.2006. In the aforesaid decision this Bench considered the decision of

the ITAT in the case of Syndicate Bank 78 ITD 103(Bang) and the

decision of the Hon'ble Punjab and Haryana High Court in the case of ITA Nos. 578 & 653/Bang/2012 Page 5 of 49

State Bank of Patiala (supra) and held that the decision rendered by

the Hon'ble High Court has to be followed. The above decision is the

decision brought to our notice on the issue rendered after the decision in

Assessee's own case. Judicial discipline demands that we follow the later

decision which has considered both the decisions on the issue. We

therefore respectfully following the decision of the Tribunal in the case of

Canara Bank (supra), hold that claim for deduction u/s.36(1)(viia) of the

Act cannot be greater than the amount debited to the profit and loss

account as provision.

6. The learned counsel for the Assessee while conceding that the

decision of the Tribunal referred to by the learned DR covers the issue in

favour of the Assessee, submitted that the provision for bad and doubtful

debts made by the Assessee in the books of account was

Rs.100,55,07,213. According to him the AO considered the provision for

bad and doubtful debts created in the books of accounts only with

reference to the rural advances Rs.7,45,51,455. The AO omitted to

consider the Provision for Bad and Doubtful debts(PBDD) of

Rs.100,55,07,213/- which included both PBDD for rural as well as non-rural

advances. According to him for allowing deduction u/s.36(1)(viia) on

account of PBDD what is to be considered is PBDD created in the books of

accounts which need not be confined only to rural advances. He brought

our notice that this Tribunal in the case of ING Vysya Bank in ITA No.53 & ITA Nos. 578 & 653/Bang/2012 Page 6 of 49

54/Bang/2013 order dated 25.10.2013 wherein this Tribunal after

considering the history of the provisions of Sec.36(1)(viia) of the Act held

that there is no requirement in Sec.36(1)(viia) of the Act as it stood for AY

2003-04 and thereafter that the provision should relate to rural advances.

As long as the Bank makes any provision for bad and doubtful debts, it is

eligible to claim deduction u/s.36(1)(viia) of the Act as per the calculation

provided therein.

7. The learned DR however opposed the alternate prayer made by the

learned counsel for the Assessee on the ground that no such submission

was made before the lower authorities and the Assessee cannot in

proceedings before the tribunal raise the issue. The learned counsel for

the Assessee however in rejoinder submitted that the Assessee can raise

legal issues which can be decided on facts which are already on record.

According to him the powers of the Tribunal in dealing with appeals are

expressed in section 254(1) of the Act in the widest possible terms.

"The Appellate Tribunal may, after giving both parties to the appeal an opportunity of being heard, pass such orders thereon as it thinks fit."

It was his submission that the word "thereon", of course, restricts the

jurisdiction of the Tribunal to the subject-matter of the appeal. The words

"pass such orders as the Tribunal thinks fit" include all the powers (except

possibly the power of enhancement) which are conferred upon the

Commissioner of Income Tax (Appeals) by section 251 of the Act. Our ITA Nos. 578 & 653/Bang/2012 Page 7 of 49

attention was drawn to Rule 11 and 27 of the Appellate Tribunal Rules,

1963, which provides as follows :-

Rule-11 provides:

"The appellant shall not, except by leave of the Tribunal, urge or be heard in support of any ground not set forth in the memorandum of appeal; but the Tribunal, in deciding the appeal, shall not be confined to the grounds set for the in the memorandum of appeal or taken by leave of the Tribunal under this rule :

Provided that the Tribunal shall not rest its decision on any other ground unless the party who may be affected thereby has had a sufficient opportunity of being heard on that ground."

Rule 27 provides that:

"The respondent, though he may not have appealed, may support the order appealed against on any of the grounds decided against him."

Reliance was placed by him on the decision of the Hon'ble Gauhati High

Court in the case of Assam Company (India) Ltd. Vs. CIT 256 ITR

423 (Gau), where it was held that it is permissible on the part of the

Tribunal to entertain a ground beyond those incorporated in the

memorandum of appeal though the party urging the said ground had

neither appealed before it nor had filed a cross-objection in the appeal filed

by the other party.

8. We have considered the rival submissions. In the case of Assam

Company (India) Ltd. (supra) the question before the Court was as to

whether the Tribunal ought to have considered the plea of the applicant-

ITA Nos. 578 & 653/Bang/2012 Page 8 of 49

company that it was entitled to the benefit of weighted deduction under

section 35B(1)(b)(iv) of the Act in the absence of any appeal or any cross-

objection filed by it against the order of the Commissioner of Income-tax

(Appeals). The Court after considering several judicial pronouncements on

the subject held as follows:

"We are therefore of the view that it is permissible on the part of the Tribunal to entertain a ground beyond those incorporated in the memorandum of appeal though the party urging the said ground had neither appealed before it nor had filed a cross- objection in the appeal filed by the other party. We must however hasten to add that in order to enable either the assessee or the Department to urge a ground in the appeal filed by the other side, the relevant facts on which such ground is to be founded should be available on record. In the absence of such primary facts, in our opinion, neither the assessee nor the Department can be permitted to urge any ground other than those which are incorporated in the memorandum of appeal filed by the other party. In other words, if the assessee or the Department, without filing any appeal or a cross-objection seeks to urge a ground other than the grounds incorporated in the memorandum of appeal filed by the other side, the evidentiary facts in support of new ground must be available on record."

9. It would be useful to refer to the decision of the Hon'ble Supreme

Court in the case of National Thermal Power Corporation 229 ITR

383 (SC). The Hon'ble Supreme Court in the aforesaid decision reframed

question of law for consideration as follows:

"Where on the facts found by the authorities below a question of law arises (though not raised before the authorities) which bears on the tax liability of the assessee, whether the Tribunal has jurisdiction to examine the same ?"

ITA Nos. 578 & 653/Bang/2012 Page 9 of 49

Answering the above question, the Hon'ble Supreme Court held as follows:

"3. Under s. 254 of the IT Act the Tribunal may, after giving both the parties to the appeal an opportunity of being heard, pass such orders thereon as it thinks fit. The power of the Tribunal in dealing with appeals is thus expressed in the widest possible terms. The purpose of the assessment proceedings before the taxing authorities is to assess correctly the tax liability of an assessee in accordance with law. If, for example, as a result of a judicial decision given while the appeal is pending before the Tribunal, it is found that a non-taxable item is taxed or a permissible deduction denied, we do not see any reason why the assessee should be prevented from raising that question before the Tribunal for the first time, so long as the relevant facts are on record in respect of that item. We do not see any reason to restrict the power of the Tribunal under s. 254 only to decide the grounds which arise from the order of the CIT(A). Both the assessee as well as the Department have a right to file an appeal/cross- objections before the Tribunal. We fail to see why the Tribunal should be prevented from considering questions of law arising in assessment proceedings although not raised earlier.

............ Undoubtedly, the Tribunal will have the discretion to allow or not allow a new ground to be raised. But where the Tribunal is only required to consider a question of law arising from the facts which are on record in the assessment proceedings we fail to see why such a question should not be allowed to be raised when it is necessary to consider that question in order to correctly assess the tax liability of an assessee.

6. The reframed question, therefore, is answered in the affirmative, i.e., the Tribunal has jurisdiction to examine a question of law which arises from the facts as found by the authorities below and having a bearing on the tax liability of the assessee."

10. From the aforesaid decision of the Hon'ble Supreme Court, it is clear

that:-

ITA Nos. 578 & 653/Bang/2012 Page 10 of 49

(a) it is the discretion of the Tribunal to admit or not to admit a new

ground to be raised before it;

(b) if the Tribunal is required to only consider a question of law arising

from the facts which are on record in the assessment proceedings

such question should be allowed to be raised; and

(c) that the proceedings before the tax authorities are for correctly

assessing the tax liability of an assessee in accordance with law.

11. In the light of the above legal position on the alternative plea raised

by the learned counsel for the Assessee for the first time before the

Tribunal, is permitted to be raised even though the Assessee has neither

filed a cross-objection nor has raised the issue in the appeal filed by the

Assessee.

12. This Tribunal in the case of ING Vysya Bank (supra) had to

consider the question as to whether there is no requirement in

Sec.36(1)(viia) of the Act as it stood for AY 2003-04 and thereafter that for

claiming deduction under the said provision that the provision for Bad and

Doubtful debts should relate to rural advances or as to whether as long as

the Bank makes any provision for bad and doubtful debts, it is eligible to

claim deduction u/s.36(1)(viia) of the Act as per the calculation provided

therein. The Tribunal analysed the provision of Sec.36(1)(viia) of the Act

as it existed at various point of time and concluded as follows:-

ITA Nos. 578 & 653/Bang/2012 Page 11 of 49

"34. It can be seen from the history of Sec.36(1)(viia) of the Act that at stage-I the deduction was allowed 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. At this stage the PBDD had to be linked to the advances made by Bank's rural branches. At stage-II of Sec.36(1)(viia), the deduction while computing the taxable profits was allowed of an amount not exceeding ten per cent of the total income (computed before making any deduction under the proposed new provision) or two per cent of the aggregate average advances made by rural branches of such banks, whichever is higher. At this stage also the PBDD had to be created and debited to the profit and loss account but it was not required to be done in relation to advances made by Bank's rural branches and can be in relation to any debt. PBDD need not be in relation to rural advances but can be in relation to any advances both rural and non-rural advances. The two percent AAA made by rural branches of such banks had to be computed and the PBDD made in books has to be in relation to rural advances.

The other eligible sum which can be considered for deduction u/s.36(1)(viia) of the Act viz., ten per cent of the total income (computed before making any deduction under the proposed new provision) does not require computation in relation to rural advances. Nevertheless the debit of PBDD to Profit and Loss account is necessary of the higher of the two sums to claim deduction u/s.36(1)(viia) of the Act. If the concerned bank does not have rural branches then they could not claim the deduction. Therefore the deduction was confined only to banks that had rural branches.

35. At Stage-III of the provisions of Sec.36(1)(viia) of the Act, the deduction allowed earlier was enhanced. The enhancement of the deduction was consequent to representation to the Government that the existing ceiling in this regard i.e. 10% of the total income or 2% of the aggregate average advances made by the rural branches of Indian banks, whichever is higher, should be modified. Accordingly, by the Amending Act, the deduction presently available under cl. (viia) of sub-s. (1) of s. 36 of the IT Act has been split into two separate provisions. One of these limits the deduction to an amount not exceeding 2% (as it existed originally, now it is 10% ) of the aggregate average advances made by rural branches of the banks concerned. This will imply that all scheduled or non-scheduled banks having rural branches would be allowed the deduction (a) upto 2% (now 10%) of the aggregate average advances made by such branches and (b) a further deduction upto 5% of their ITA Nos. 578 & 653/Bang/2012 Page 12 of 49

total income in respect of provision for bad and doubtful debts. The further deduction of 5% of total income was available to banks which did not have rural branches.

36. Therefore after 1.4.1987, scheduled or non-scheduled banks having rural branches were allowed deduction., (a) upto 2% (now 10%) of the aggregate average advances made by such branches and (b) Schedule or non-scheduled banks whether it had rural branches or not a deduction upto 5% of their total income in respect of provision for bad and doubtful debts. Even under the new provisions creating a PBDD in the books of accounts is necessary.

37. Though under Stage-II and Stage-III of the provisions of Sec.36(1)(viia) of the Act, PBDD has to be created by debiting the profit and loss account of the sum claimed as deduction, the condition that the provision should be in respect of rural advances is not necessary. At stage-II of the provisions of Sec.36(1)(viia) of the Act, this condition was done away with and it was only necessary to create PBDD in the books of accounts and debit to profit and loss account. The quantification of the maximum deduction permissible u/s.36(1)(viia) of the Act had to be done. Firstly it has to be ascertained as to what is 10% of the aggregate average advances made by rural branches, if the Bank has rural branches, otherwise that part of the deduction u/s.36(1)(viia) of the Act will not be available to the bank. The second part of the deduction u/s.36(1)(viia) has to be ascertained viz., 7.5% seven and one-half per cent of the total income (computed before making any deduction under this clause and Chapter VI-A). The above are the permissible upper limits of deductions u/s.36(1)(viia) of the Act. The actual provision made in the books by the Assessee on account of PBDD (irrespective of whether it is rural or non-rural) has to be seen. To the extent PBDD is so created, then subject to the permissible upper limits referred to above, the deduction has to be allowed to the Assessee. The question of bifurcating the PBDD as one relating to rural advances and other advances (Non-rural advances) does not arise for consideration."

13. The facts with regard to the PBDD created by the Assessee in the

books of accounts are available on record and therefore there should not ITA Nos. 578 & 653/Bang/2012 Page 13 of 49

be any difficulty in deciding the quantum of deduction that the Assessee

should be allowed u/s.36(1)(viia) of the Act.

14. Not content with the above relief, the learned counsel made a further

alternate submission that the Assessee should be allowed deduction on

account of PBDD u/s.36(1)(viia) of the Act for the entire permissible limit

because the provision whatever is the shortfall between the eligible limits

and the PBDD made in the books of accounts by the Assessee viz.,

shortfall of Rs.99,47,57,006 (Rs.200,03,24,219 - Rs.100,55,67,213/-) was

made good by providing excess provision in subsequent years and

therefore the entire Rs.200,03,24,219/- should be allowed as deduction. In

support of the claim that the provision made in subsequent year was much

more than the eligible limits u/s.36(1)(viia) of the Act and such excess will

take care of the shortfall of PBDD in the books of accounts, the learned

counsel for the Assessee filed a chart before us and the same is annexed

as Annexure-1 to this order. The learned counsel for the Assessee in

support of the proposition that if there is shortfall in the PBDD made in the

books of accounts to the eligible limits and if the shortfall is made good by

providing excess provision in subsequent years the upper limit permissible

u/s.36(1)(viia) of the Act should be allowed as deduction, referred to

decision of the Hon'ble Punjab & Haryana High Court in the case of CIT Vs.

Punjab State Industrial Development Corporation 323 ITR 495 ( Pun.&

Har.) and the Special Bench ITAT Chandigarh Bench in the case of

Punjab State Industrial Development Corporation Ltd. 102 ITD 1 ITA Nos. 578 & 653/Bang/2012 Page 14 of 49

(Chd.)(SB). In the aforesaid decisions the Assessee claimed deduction

u/s.36(1)(viii) of the Act in respect of special reserve created and

maintained by a specified entity, an amount not exceeding twenty per cent

of the profits derived from eligible business computed under the head

"Profits and gains of business or profession" (before making any deduction

under this clause) carried to such reserve account. The Assessee did not

create special reserve to the extent of 20% of the profits derived from

eligible business. It was held that the Assessee should be afforded an

opportunity to assessee to create further reserve. Reference was made to

the decision of ITAT Delhi in the case of Power Finance Corporation Ltd.

2008-TIOL-475-ITAT-Del wherein in the context of deduction u/s.32A of the

Act, the Tribunal held that the reserve created by holding a second Annual

general meeting and where accounts were amended creating reserve

required u/s.32A of the Act, the Assessee should be allowed deduction

u/s.36(1)(viia) of the Act.

15. We have considered the submissions and are of the view that the

same cannot be accepted. The creation of a special reserve u/s.32A or

Sec.36(1)(viii) of the Act cannot be equated with creation of PBDD

u/s.36(1)(viia) of the Act. Creation of provision u/s.36(1)(viia) of the Act is

governed by certain rules like Rule 6ABA of the rules in respect of rural

advances. It cannot be created at the bank's whims and fancy. Moreover

the Assessee is not making a claim for creation of PBDD in the books of

accounts of PY relevant to AY 08-09. The excess reserve created in the ITA Nos. 578 & 653/Bang/2012 Page 15 of 49

subsequent year cannot be equated to the PBDD created in the books for

the present AY. The decisions relied upon by the learned counsel for the

Assessee do not lay down a proposition that excess provision created in

the subsequent year can supplement the inadequate created in an earlier

year. The decisions relied upon by the learned counsel for the Assessee

lay down proposition that the Assessee should be given liberty to create a

reserve in the books of accounts of the relevant AY. For the reasons given

above, we reject the second alternate submission made by the learned

counsel for the Assessee. Thus the Assessee will be entitled to deduction

u/s.36(1)(viia) of the Act of Rs.100,55,67,213/- only. Ground No.2 of the

Revenue is allowed to this extent.

16. Ground No.3 raised by the Revenue is with regard to the deduction

of Rs.108,53,62,763 claimed by the Assessee u/s.36(1)(vii) of the Act on

account of Bad Debts written off in the books of accounts by the Assessee

which was disallowed by the AO on the ground that the credit balance in

the PBDD relating to non-rural branches have to be adjusted against the

debit to the profit and loss account on account of bad debts.

17. The Assessee claimed deduction of a sum of Rs.108,53,62,763/-

u/s.36(1)(vii) of the Act in respect of Bad Debts written off. The Assessee

submitted before the AO that the bad debts written off relating to its rural

branches were adjusted against the provision claimed u/s.36(1)(viia) of the

Act, to ensure that there is no double deduction, once as PBDD for rural ITA Nos. 578 & 653/Bang/2012 Page 16 of 49

debts u/s.36(1)(viia) and again as bad debts u/s.36(1)(vii) of the Act. The

Assessee further brought to the notice of the Bench the decision of Hon'ble

Karnataka High Court dated 19.3.2008 in the case of CIT Vs.

Karnataka Bank, wherein the Hon'ble Karnataka High Court held that

bad debts written off in respect of non-rural branches need not be adjusted

against the PBDD of non-rural branches because such provision is not

allowed as deduction u/s.36(1)(viia) of the Act. The Assessee gave the

break-up of Bad debts written off as under:-

Bad Debts written off Rs.185,53,26,012 LESS: Amount written off in respect of Rural Rs.13,17,13,161

advances for which deduction u/s.36(1)(viia) was claimed in earlier years LESS: Amount written off in respect of Non-

rural branches and for which deduction u/s.36(1)(viia) was claimed in earlier years

a) NPA accounts in respect of which Rs.2,92,45,322 deduction is claimed u/s.36(1)(viia) @ 7.5% of the total income in the A.Y. 2003- 04

b) NPA account in respect of which Rs.15,91,33,959 deduction is claimed u/s.36(1)(viia) @ 10% of the Bad & Doubtful Debts in the AY 2003-04.

c) NPA account in respect of which Rs.22,29,88,026 deduction is claimed u/s.36(1)(viia) @ 7.5% of the total income in the A.Y. 2004- 05

d) NPA account in respect of which Rs.22,68,82,781 deduction is claimed u/s.36(1)(viia) @ 10% of the Bad & Doubtful Debts in the AY 2004-05.

ITA Nos. 578 & 653/Bang/2012 Page 17 of 49

18. The AO was of the view that just as how the Assessee has adjusted

the PBDD in respect of rural advances, it ought to have adjusted PBDD in

respect of non-rural advances and claimed only the remaining sum, if any,

as bad debts u/s.36(1)(vii) of the Act. The AO accordingly tabulated the

figures of PBDD in respect of non- rural branches as under:-

Assessment Optional 7.5% of Optional year deduction 10% total income deduction - of loss and premium on doubtful debts buyback of Govt. Securities 2003-04 50,55,36,813 5,88,05,215 0 2004-05 - 42,86,11,182 70,00,40,702 2005-06 - - - 2006-07 - - - Total 50,55,36,813 48,74,16,397 70,00,40,702

Thereafter the AO tabulated the claim for bad debts u/s.36(1)(vii) of the Act

made by the Assessee in various AYs as under:

Assessment Debts written off Debts written off Debts written off Year against optional against the against provision deduction provision allowed allowed in allowed as 10% as 7.5% of total relation to the of loss and income income from doubtful redemption of securities.

2004-05 3,27,58,000 1,07,94,000 - 2005-06 11,00,95,215 3,69,01,418 15,39,76,237 2006-07 12,52,42,584 6,85,80,516 25,60,40,154 2007-08 6,20,48,994 11,78,17,181 9,87,94,655 Total 33,01,44,793 23,40,93,115 50,88,11,046 ITA Nos. 578 & 653/Bang/2012 Page 18 of 49

19. According to the AO, section 36(1)(vii) of the Income-tax Act, 1961

(the Act) allows deduction in computing the income referred to in Section

28 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 during the previous year. Proviso to Sec.36(1)(vii) provides as

follows:

"Provided 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.--For the purpose 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."

20. According to the AO as per the proviso to Sec.36(1)(vii) of the Act,

the Assessee was required to set off the bad debts written off against the

provision created u/s.36(1)(viia) of the Act. The AO further held that the

credit available in the PBDD of non-rural debts was much more than the

sum of Rs.108,53,62,763 claimed as deduction on account of bad debts

written off by the Assessee hence cannot be allowed.

21. Aggrieved by the aforesaid disallowance, assessee preferred appeal

before the CIT(Appeals). With regard to deduction u/s.36(1)(vii) of the Act,

the Assessee contended that proviso to Sec.36(1)(vii) is applicable only to

bad debts written off of rural debts and not to non-rural debts. Since the ITA Nos. 578 & 653/Bang/2012 Page 19 of 49

claim of deduction of Rs.168,97,00,000 made by the Assessee

u/s.36(1)(vii) of the Act pertained to bad debts of non-rural debts, the credit

balance in the PBDD account should not be looked into at all. It was

contended that bad debts written off under section 36(1)(vii) and provision

for bad and doubtful rural debts under section 36(1)(viia) are two distinct

and separate class of debts. The bad debts referred to in section 36(1)(vii)

are urban debts, whereas the bad debts referred to in section 36(1)(viia)

are rural debts. Proviso to section 36(1) provides that rural debts cannot be

written off in excess of the provision made for such debts and is applicable

only if the write-off and the provision are in respect of the same class of

debts. It was also pointed out that both the allowances envisaged under

section 36(1)(vii) and 36(1)(viia) are admissible deductions in computing

the income of Banks and are independent of each other is confirmed by the

Central Board of Direct Taxes (CBDT) Circular No. 258, dated 14.06.1979,

which is still in force. Provisions made under section 36(1)(viia) are in

respect of aggregate advances made by rural branches, whereas the write-

off under section 36(1)(vii) is in respect of a separate set of urban

branches' debts, i.e., other than the rural debts covered by the provision

made under section 36(1)(viia). The proviso clearly indicates that the debts

for which provision has been made under section 36(1)(viia), if written off

under section 36(1)(vii), would not be allowed to the extent of the provision

made for such debt. The proviso does not apply to debts that are

independent of the provisions under section 36(1)(viia), viz., urban debts.

ITA Nos. 578 & 653/Bang/2012 Page 20 of 49

The restriction laid down by the proviso is to prevent double claims for

deduction under both sections 36(1)(vii) and 36(1)(viia) in respect of rural

debts. It was also brought to the notice of the CIT(A) that the Hon'ble High

Court of Karnataka has held in DCIT (Asst.) Special Range, Bangalore,

Vs. The Karnataka Bank Ltd. [2008 175 Taxman 325, that deduction

under section 36(1)(vii) is allowable independently and irrespective of the

provision for bad and doubtful debts created by the assessee in relation to

the advances of the rural branches, subject to the limitation that an amount

should not be deducted twice under section 36(1) (vii) and 36(1) (via)

simultaneously. The facts in that case were that the appellant bank had, in

the return for assessment year 1993-94 filed on 30-12-1993, claimed a

sum of Rs. 38,28,836 as bad debts actually written off. It had also claimed

provision for bad and doubtful debts under section 36(1)(via) in a sum of

Rs. 1,10,94,360. The assessing officer did not allow the claim for deduction

of debts amounting to Rs. 38,28,836 actually written off. The CIT(A)

rejected the assessee's claim and upheld the order of Assessing Officer

and the ITAT held that deduction under section 36(1)(vii) was allowable

independently and irrespective of the provision for bad and doubtful debts

created by the assessee in relation to advances of rural branches, subject

to the imitation that an amount should not be deducted twice under section

36(1)(vii) and 36(1)(viia) simultaneously. It was pointed out that the

Hon'ble jurisdictional High Court considered the questions of law answered

by two judgments of Kerala and Madras High Courts in South Indian Bank ITA Nos. 578 & 653/Bang/2012 Page 21 of 49

Ltd. Vs. CIT [2003 262 ITR 579], and in CIT Vs. City Union Bank Ltd.

[20071 291 ITR 144]. The ratio of the case of Kerala High Court, after

considering the provisions of section 36(1)(vii) and (viia), was that a

scheduled bank might be having both urban and rural branches and

advances were given from both branches. Having regard to the hazards

involved in realising the advances made by rural branches, particularly to

agriculturists, certainly the assessee-bank would prefer to make provision

for bad debt in respect of advances made in the rural branches. If an

assessee made a provision under clause (viia) in respect of bad debts

relating to rural advances only, to deny such an assessee the benefit

provided under clause (vii) which was available to all other assessees who

were engaged in money lending business would result in discrimination

without reason. The Legislature could not be presumed to have intended

such a result in the case of scheduled banks. The intention of the

Legislature in enacting the proviso to clause (vii) of section 36(1) and

clause (v) to section 36(2) simultaneously was only to see that a double

benefit in respect of the same bad debt is not being given to a scheduled

bank. It was only for the said purpose that the proviso and clause (v) were

introduced simultaneously by the Amendment Act, 1985, with effect from

April 1, 1985. The scope of the proviso to clause (vii) of section 36(1) of the

Act was only to deny the deduction to the extent of bad debt written off in

the books with respect to which provision was made under clause (viia) of

the Act. If the bad debt written off related to debts other than for which the ITA Nos. 578 & 653/Bang/2012 Page 22 of 49

provision was made under clause (viia), such debts would fall squarely

under the main part of clause (vii) which was entitled to deduction, and in

respect of that part of the debt with reference to which a provision was

made under clause (viia), the proviso would operate to limit the deduction

to the extent of the difference between that part of debt written off in the

previous year and the credit balance in the provision for bad and doubtful

debts account made under clause (viia). If the bad debt written off related

to debts other than those for which provision was made under section

36(1)(viia), such debts would fall squarely under the main part of sub-

section (vii) and would be entitled to the deduction. In respect of that part of

debt with reference to which a provision was made under clause (viia), the

Proviso would operate to limit the deduction to the extent of the difference

between that part of the debt written off in the previous year and the credit

balance in the provision for bad and doubtful debts account made under

clause (viia). The Assessee also relied on the decision of the ITAT in its

own case in ITA No.150 & 151/Bang/2001 order dated 9.6.2006 for AY

1999-2000 & 2000-01 wherein on identical issue, the Tribunal allowed

deduction as claimed by the Assessee.

22. The ld. CIT(Appeals) agreed with the contentions put forth by the

Assessee and directed the AO to allow the claim for deduction on account

of bad debts as made by the Assessee.

ITA Nos. 578 & 653/Bang/2012 Page 23 of 49

23. Aggrieved by the order of the CIT(Appeals), the revenue has raised

grounds No. 3 before the Tribunal. The ld. DR relied on the order of the

AO. The ld. counsel for the assessee relied on the decision of Hon'ble

Supreme Court in the case of Catholic Syrian Bank v. CIT, 343 ITR

270 (SC), wherein the Hon'ble Supreme Court has clearly held that

deduction u/s. 36(1)(vii) of the Act is an independent deduction and the

provision for doubtful debts made u/s. 36(1)(viia) of the Act has nothing to

do with the claim for deduction u/s. 36(1)(vii) of the Act.

24. We have considered the rival submissions. Identical issue raised by

the Revenue in ground No.3 had come for consideration before the Hon'ble

Supreme Court in the case of Catholic Syrian Bank (supra). The facts

of the case before the Hon'ble Supreme Court in the case of Catholic

Syrian Bank (supra) was that the Assessee claimed deduction on

account of bad debts written off in respect of non-rural branches

u/s.36(1)(vii) of the Act. The AO noticed that there was already credit

balance in the Provision for Bad and Doubtful Debts Account u/s.36(1)(viia)

(a) of the Act, which was in excess of the claim of the assessee for

deduction on account of bad debts. The AO after making reference to

proviso to Sec.36(1)(vii) of the Act and also Sec.36(2)(v) of the Act was of

the view that the Assessee could not be allowed the deduction claimed

because (i) the amount claimed as deduction on account of bad debts was

not the excess available in the credit of the Provision for Bad and Doubtful ITA Nos. 578 & 653/Bang/2012 Page 24 of 49

Debts Account created u/s.36(1)(viia)(a) of the Act and (ii) that u/s.36(2)(v)

of the Act the amount of bad debts written off should first be debited in the

Provision for Bad and Doubtful Debts Account created u/s.36(1)(viia)(a) of

the Act. The stand of the Assessee was that since the claim of deduction

of Bad debts made by the Assessee was u/s.36(1)(vii) of the Act and

pertained to bad debts of non-rural debts, the credit balance in the PBDD

account should not be looked into at all because it pertains only to Rural

Branches. The Hon'ble Supreme Court held:-

(i) The provisions of Section 36(1)(vii) and 36(1)(viia) are separate items of deduction. These are independent provisions and, therefore, cannot be intermingled or read into each other.

(ii) Clear legislative intent of the relevant provisions and unambiguous language of the circulars with reference to the amendments to s. 36 demonstrate that the deduction on account of provisions for bad and doubtful debts under s. 36(1)(viia) is distinct and independent of the provisions of s. 36(1)(vii) relating to allowance of the bad debts. The legislative intent was to encourage rural advances and the making of provisions for bad debts in relation to such rural branches.

(iii) The language of s. 36(1)(vii) is unambiguous and does not admit of two interpretations. It applies to all banks, commercial or rural, scheduled or unscheduled. It gives a benefit to the assessee to claim a deduction on any bad debt or part thereof, which is written off as irrecoverable in the accounts of the assessee for the previous year. This benefit is subject only to s.

36(2). It is obligatory upon the assessee to prove to the AO that the case satisfies the ingredients of s. 36(1)(vii) on the one hand and that it satisfies the requirements stated in s. 36(2) on the other. The proviso to s. 36(1)(vii) does not, in absolute terms, control the application of this provision as it comes into operation only when the case of the assessee is one which falls squarely under s. 36(1)(viia). The Explanation to s. 36(1)(vii) specifically excluded any provision for bad and doubtful debts made in the ITA Nos. 578 & 653/Bang/2012 Page 25 of 49

account of the assessee from the ambit and scope of 'any bad debt, or part thereof, written off as irrecoverable in the accounts of the assessee'. Thus, the concept of making a provision for bad and doubtful debts will fall outside the scope of s. 36(1)(vii) simpliciter.

(iv) As per the proviso to cl. (vii) of s. 36(1), the deduction on account of the actual write off of bad debts would be limited to excess of the amount written off over the amount of the provision which had already been allowed under cl. (viia). The proviso by and large protects the interests of the Revenue. In case of rural advances which are covered by cl. (viia), there would be no such double deduction. The proviso, in its terms, limits its application to the case of a bank to which cl. (viia) applies. Indisputably, cl. (viia)(a) applies only to rural advances.

25. The Hon'ble Chief Justice, His Lordship, Mr. S.H. Kapadia, in his

concurring judgment had summed up the position in the following words:

"The provisions of cl. (viia) of s. 36(1) relating to the deduction on account of the provision for bad and doubtful debt(s) is distinct and independent of the provisions of s. 36(1)(vii) relating to allowance of the bad debt(s). In other words, the scheduled commercial banks would continue to get the full benefit of the write off of the irrecoverable debt(s) under s. 36(1)(vii) in addition to the benefit of deduction for the provision made for bad and doubtful debt(s) under s. 36(1)(viia). A reading of the circulars issued by CBDT indicates that normally a deduction for bad debt(s) can be allowed only if the debt is written off in the books as bad debt(s). No deduction is allowable in respect of a mere provision for bad and doubtful debt(s). But in the case of rural advances, a deduction would be allowed even in respect of a mere provision without insisting on an actual write off. However, this may result in double allowance in the sense that in respect of same rural advance the bank may get allowance on the basis of cl. (viia) and also on the basis of actual write off under cl. (vii). This situation is taken care of by the proviso to cl. (vii) which limits the allowance on the basis of the actual write off to the excess, if any, of the write off over the amount standing to the credit of the ITA Nos. 578 & 653/Bang/2012 Page 26 of 49

account created under cl. (viia). CBDT itself has recognized the position that a bank would be entitled to both the deductions, one under cl. (vii) of s. 36(1) on the basis of actual write off and another, on the basis of cl. (viia) in respect of a mere provision.

Further, to prevent double deduction, the proviso to cl. (vii) was inserted which says that in respect of bad debt(s) arising out of rural advances, the deduction on account of actual write off would be limited to the excess of the amount written off over the amount of the provision allowed under cl. (viia). Thus, the proviso to cl. (vii) stood introduced in order to protect the Revenue. It would be meaningless to invoke the said proviso where there is no threat of double deduction. In case of rural advances, which are covered by the provisions of cl. (viia), there would be no such double deduction. The proviso limits its application to the case of a bank to which cl. (viia) applies. Clause (viia) applies only to rural advances. This has been explained by the circulars issued by CBDT. Thus, the proviso indicates that it is limited in its application to bad debt(s) arising out of rural advances of a bank. It follows that if the amount of bad debt(s) actually written off in the accounts of the bank represents only debt(s) arising out of urban advances, the allowance thereof in the assessment is not affected, controlled or limited in any way by the proviso to cl. (vii)."

26. The ratio laid down by the Hon'ble Supreme Court can be summed

up as follows:-

(1) Deduction under Section 36(1)(vii) of the Act is available for deduction on account of Bad debts written off pertaining to non-rural debts. This deduction is allowed only when the amount of bad debt is actually written off in the books and debited to Profit & Loss account. Deduction cannot be claimed for creating Provision for Bad and Doubtful Debts of Non-rural branches. It is like any other bad debt written off which is allowed as deduction in the case of Assessees who are not in banking business.

ITA Nos. 578 & 653/Bang/2012 Page 27 of 49

(2) Deduction u/s.36(1)(viia)(a) is allowed when a Provision for bad and doubtful debts relating to rural advances is made in the books of account subject to the limit laid down therein.

(3) When a deduction is allowed u/s.36(1)(viia)(a) of the Act by way of provision, there will be no deduction under clause

(vii) for actual write off of bad debts relating to rural advances, until or unless there is a balance lying in the provision account made under clause (viia). This so because of the Proviso to Section 36(1)(vii) of the Act which provides 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. Thus the proviso ensures that there is no double deduction, i.e., firstly getting a deduction when a provision is created and secondly getting a deduction when bad debts are written off.

27. In view of the aforesaid decision of the Hon'ble Supreme Court in

the case of Catholic Syrian Bank (supra), we are of the view that the

CIT(A) was right in directing the AO to allow the claim for deduction made

u/s.36(1)(vii) of the Act. We therefore dismiss Gr.No.3 raised by the

Revenue.

28. Ground No.4 raised by the Revenue is with regard to the action of

the CIT(A) in directing the AO to allow the claim for deduction made by the

Assessee on account of depreciation in the value of investments held by

the Assessee in the category of HTM (Held to Maturity) holding that even

such investments are stock-in-trade of business of banking and therefore

they have to be valued at cost or market price whichever is lower and

consequent deduction allowed.

ITA Nos. 578 & 653/Bang/2012 Page 28 of 49

29. The assessee claimed deduction of a sum of Rs.171,29,30,664 in

respect of Diminution in the value of Investments held by the Assessee in

the "Held to Maturity" (HTM) category of Investments. According to the

Assessing Officer, as per the RBI's Master Circular - Prudential norms for

classification, valuation and operation of Investment Portfolio by banks -

RBI/2010-11/50 revised as on 1.7.2010, investment portfolio of banks

cannot be treated as stock in trade where the investments are held on the

basis of "Held to Maturity" category or "Available for Sale" category. The

Assessing Officer was also of the view that for IT purposes the Assessee

had chosen to treat all investments as stock in trade and claimed

diminution in value of stock in trade (closing stock) as loss. According to

Assessing Officer, such a course of action cannot be permitted. The AO

also referred to CBDT Circular No.665 dated 5/10/93 wherein the CBDT

had clarified that whether a particular investment constitutes Investment or

stock-in-trade is a question of fact and the AO's should be guided by RBI

Circulars issued from time to time in this regard. The Assessing Officer

accordingly held that Master Circular issued by the RBI had to be followed.

Accordingly, the loss on diminution value of investments was disallowed by

the AO.

30. On appeal by the assessee; the CIT (A), following the decision of

the Hon'ble Supreme Court in the case of UCO Bank 240 ITR 355(SC)

and decision of ITAT in Assessee's own case in AY 03-04 in ITA ITA Nos. 578 & 653/Bang/2012 Page 29 of 49

No.253/Bang/2007 dated 24.1.2008, deleted the disallowance made

by the Assessing Officer. Aggrieved by the order of the CIT (A), Revenue

has preferred the present appeal before the Tribunal.

31. The learned DR relied on the order of the Assessing Officer.

32. The learned counsel for the assessee brought to our notice the

decision of the Hon'ble ITAT, Bangalore Bench on similar issue in the case

of Syndicate Bank v. DCIT (2013) 38 taxmann.com 25

(Bangalore - Trib.) and the decision of the Hon'ble Karnataka High

Court in the case of Karnataka Bank Ltd., v. ACIT (356 ITR 549).

33. We have considered the rival submissions. Similar issue as to

whether depreciation on investments held under the category "Held to

Maturity" or "Available for Sale" can be allowed as deduction came up for

consideration in Assessee's own case in AY 10-11 in ITA

No.1310/Bang/2012 and this Tribunal upheld similar order of CIT(A). The

following were the relevant observations of the Tribunal:-

"21. We have considered the rival submissions. Similar issue as to whether depreciation on investments held under the category "Held to Maturity" can be allowed as deduction came up for consideration in the case of Syndicate Bank (supra) before the ITAT Bangalore Bench. The Tribunal on the issue held as follows:

"58. We have heard the submissions of the ld. DR and the ld. counsel for the assessee. The ld. DR relied on the ITA Nos. 578 & 653/Bang/2012 Page 30 of 49

decision of the Hon'ble High Court of Karnataka in the case of CIT v. ING Vysya Bank Ltd. in ITA No.2886/2005 dated 06.06.2012. In the aforesaid decision, the Hon'ble High Court of Karnataka took a view that the guidelines issued by the RBI will not be relevant while computing income under the Income-tax Act. The Hon'ble Court further took the view that every investment held by a bank cannot be considered as stock- in-trade. The Hon'ble High Court finally concluded that 30% of the investments can be clothed to the character of stock-in-trade and that the remaining amounts will be investments and therefore diminution in their value cannot be allowed as a deduction.

59. The ld. counsel for the assessee, however, submitted that in the assessee's own case for the A.Y. 2005-06, this Tribunal has confirmed the order of the CIT(A), deleting identical addition made by the AO. Our attention was also drawn to the order of the Tribunal in assessee's own case in ITA No.492/Bang/2009 for the A.Y. 2005-06, order dated 13.01.2012, wherein the Tribunal had to deal with identical issue as to whether the CIT(A) was correct in deleting the addition made by the AO on account of profit on sale of investments of Rs.200,77,13,662/- and deleting the action of the AO in disallowing loss claimed on treating investments as stock-in-trade by drawing the investment trading account of Rs.775,96,55,047. The Tribunal held

"16. We have heard both sides and find that the Supreme Court in the case of UCO Bank in 240 ITR 355 has held as under :

"In our view, as stated above, consistently for 30 years, the assessee was valuing the stock-in-trade at cost for the purpose of statutory balance-sheet, and for the income-tax return, valuation was at cost or market value, whichever was lower. That practice was accepted by the Department ITA Nos. 578 & 653/Bang/2012 Page 31 of 49

and there was no justifiable reason for not accepting the same. Preparation of the balance-sheet in accordance with the statutory provision would not disentitle the assessee in submitting the Income-tax return on the real taxable income in accordance with the method of accounting adopted by the assessee consistently and regularly. That cannot be discarded by the departmental authorities on the ground that the assessee was maintaining the balance- sheet in the statutory form on the basis of the cost of the investments. In such cases, there is no question of following two different methods for valuing its stock-in- trade (investments) because the bank was required to prepare the balance-sheet in the prescribed form and it had no option to change it. For the purpose of income tax as stated earlier, what is to be taxed is the real income which is to be deduced on the basis of the accounting system regularly maintained by the assessee and that was done by the assessee in the present case."

The Bangalore Bench of ITAT in Corporation Bank (supra) has also followed the above decision of the Hon'ble Supreme Court as also the ITAT, Mumbai and ITAT, Chennai.

Following the above decisions, we are deciding this issue in favour of the assessee. This ground of appeal by the Revenue is dismissed.

60. Apart from the above, the ld. counsel for the assessee also submitted that the decision rendered by the Hon'ble High Court of Karnataka in the case of ING Vysya Bank (supra) is per incuriam the decision of the Hon'ble Supreme Court in the case of UCO Bank v. CIT, 240 ITR 355 (SC). He brought to our notice that the Hon'ble Supreme Court approved the practice of ITA Nos. 578 & 653/Bang/2012 Page 32 of 49

nationalized bank governed by Banking Regulation Act, following mercantile system of accounting both for book keeping as well for income-tax purposes. The Hon'ble Apex Court upheld the method adopted by the banks valuing stock-in-trade (investments) at cost in balance sheet in accordance with the Banking Regulation Act and valuing the same at cost or market value, whichever was lower for income-tax purposes. The Hon'ble Court took the view that all investments held by a bank are to be regarded as stock-in-trade.

61. The ld. counsel for the assessee further drew our attention to a very recent decision of the Hon'ble High Court of Karnataka rendered on 11.03.2013 in the case of CIT v. Vijaya Bank, ITA No.687/2008. The Hon'ble High Court of Karnataka in the aforesaid case followed its own decision rendered in the case of Karnataka Bank Ltd. v. CIT in ITA No.172/2009 rendered on 11.01.2013, wherein the Court took the view that depreciation claimed on investments 'held on maturity' by a bank has to be treated as stock-in-trade in accordance with RBI guidelines and CBDT Circular. It was his submission that the later decision of the Hon'ble Karnataka High Court has to be followed.

62. We have given a careful consideration to the rival submissions and are of the view that the contentions put forth on behalf of the assessee deserve to be accepted. The Tribunal in assessee's own case on an identical issue for the A.Y. 2005-06 has upheld the claim of the assessee. The later decision of the Hon'ble High Court of Karnataka is also in favour of the assessee. In such circumstances, we are of the view that the issue raised by the revenue in its appeal is without merit. Consequently, the same is dismissed."

22. The above decision squarely covers the issue in favour of the Assessee. Respectfully following the same, we uphold the order of the CIT(A) and dismiss the relevant grounds of appeal of the Revenue."

ITA Nos. 578 & 653/Bang/2012 Page 33 of 49

34. The above decision squarely covers the issue in favour of the

Assessee. Respectfully following the same, we uphold the order of the

CIT(A) and dismiss the relevant ground of appeal No.4 of the Revenue.

35. Ground No.5 raised by the revenue is with regard to the action of

the CIT(A) in deleting the disallowance of penalty paid by the Assessee of

Rs.90,94,829. The AO disallowed the claim of the Assessee for deduction

of the aforesaid sum as they were in the nature penalty for infraction of law

and could be allowed as deduction in view of explanation to Sec.37(1) of

the Act. The CIT(A) deleted the addition on the reasoning that the sums in

question were not in the nature of penalty for infraction of law.

36. It is not in dispute before us that the nature of the penalty in the

present case is identical to the penalty that was disallowed on similar

grounds in the case of CIT Vs. Syndicate Bank 261 ITR 528 (Kar).

The Hon'ble Karnataka High Court held that the penalty was not to be

allowed as deduction. The question before the Hon'ble Court was as to

whether penal interest to RBI for non-compliance with provisions of s. 24 of

Banking Regulation Act, 1949, is in the nature of penalty for infraction of

law and hence to be disallowed under explanation to sec.37(1) of the Act.

The Hon'ble Court observed that if a payment is a penalty for infraction of

law it does not qualify for deduction. The Hon'ble Court thereafter found

that the Assessee-bank paid 'penalty' though termed as "penal interest"

ITA Nos. 578 & 653/Bang/2012 Page 34 of 49

under s. 24(4)(a) and 24(4)(b) of the 1949 Act for non-compliance with the

requirement stipulated under s. 24(2A). The Hon'ble Court found that Sub-

s. (6) of s. 24 clearly indicates that the penal interest payable under sub-ss.

(4) and (5) is a "penalty" and if the penalty amount is not paid it can be

enforced as a decree made by a Civil Court. Further, an opportunity is also

provided to the defaulting banking company to satisfactorily explain the

non-compliance and to avoid the penalty. According to the Hon'ble Court

that shows that the amount in question is not compensatory in nature but

definitely penal and that the said amount paid by way of penalty though

called penal interest cannot be treated as legitimate item of expenditure.

The Hon'ble Court held that permitting penalty paid for the nature of such

violations as an item of deductible expenditure under s. 37 of the IT Act will

only amount to placing a premium on the commission of infraction of the

assessee. Therefore, penalty payable under s. 24(4)(a) and 24(4)(b) could

not be allowed as deductible expenditure.

37. Respectfully following the aforesaid decision of the Hon'ble

Karnataka High Court, we hold that the sum in question is not allowable as

a deduction. The order of the CIT(A) on this issue is accordingly reversed

and the order of the AO restored. Ground No.5 raised by the revenue is

allowed.

38. The Revenue has filed the following additional grounds of appeal

and seek admission of the same on the ground that the issues raised ITA Nos. 578 & 653/Bang/2012 Page 35 of 49

therein are legal issues relating to allowance of deduction of PBDD

u/s.36(1)(viia) & 36(1)(vii) of the Act. The additional grounds sought to be

raised in this regard read thus:

"(1) Assessee's claim of deduction u/s. 36(1)(vii) of Rs.108.53 Cr is not in accordance with the provisions under the Act where bad debts written off was not debited into the profit & loss account.

(2) The provision of NPA for both rural and non rural branches debited into the profit and loss account was only Rs.100.56 Cr, whereas the bad debt written off of Rs.108.53 Cr was claimed as a deduction in computation of income u/s.

36(1)(vii) of the IT Act over and above the provisions for band and doubtful debts of Rs.200.03 Cr claimed u/s. 36(1)(vii) of the IT Act ought to be disallowed.

(3) The bad debt write off claimed in computation of income was prudential write off and it is a balance sheet adjustment and not profit and loss adjustment that has lead to double deduction."

39. As far as additional ground No.1 is concerned, the same was not the

case made out by the AO. In the order of assessment, the AO never

disputed the fact that the sum of Rs.108.53 crores claimed as deduction

u/s.36(1)(vii) of the Act was not actually written off in the books of accounts

of the Assessee. As far as ground No.2 is concerned, it proceeds under a

misconception that deduction u/s.36(1)(vii) of the Act is linked with the

PBDD for non-rural debts. This is absolutely incorrect as has been brought

out while deciding ground No.3 raised by the Revenue. Ground No.3 is

again a claim which was never the case made out by the AO. We are of ITA Nos. 578 & 653/Bang/2012 Page 36 of 49

the view that the additional grounds sought to be raised by the revenue is

devoid of any merit. They are therefore dismissed as without merit, not

arising out of the order of the AO and not based on the facts as borne out

by the records. The additional grounds are thus dismissed.

35. In the result, the appeal by the revenue is partly allowed.

ITA NO. 653/Bang/2012 (Assessee's Appeal)

40. Ground No.1 raised by the Assessee is general in nature and calls

for no specific adjudication. Ground No.2 & 3 raised by the Assessee is

with regard to the action of the CIT(A) in confirming the order of the AO

rejecting the claim of the Assessee for deduction u/s.36(1)(viii) of the Act of

Rs.25,00,00,000/-. The provisions of Sec.36(1)(viii) of the Act reads as

follows:

"Section 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--

(i) to (vii)......

(viii) in respect of any special reserve created and maintained by a specified entity, an amount not exceeding twenty per cent. of the profits derived from eligible business computed under the head "Profits and gains of business or profession" (before making any deduction under this clause) carried to such reserve account:

Provided that where the aggregate of the amounts carried to such reserve account from time to time exceeds twice the amount of the paid up share capital and of the general reserves of the specified entity, no allowance under this clause shall be made in respect of such excess.

Explanation: In this clause,--

(a) "specified entity" means,--

ITA Nos. 578 & 653/Bang/2012 Page 37 of 49

(i) a financial corporation specified in section 4A of the Companies Act, 1956 (1 of 1956);

(ii) a financial corporation which is a public sector company;

(iii) a banking company;

(iv) a co-operative bank other than a primary agricultural credit society or a primary co-operative agricultural and rural development bank;

(v) a housing finance company; and

(vi) any other financial corporation including a public company;

(b) "eligible business" means,--

(i) in respect of the specified entity referred to in sub-clause (i) or sub-clause (ii) or sub-clause (iii) or sub-clause (iv) of clause

(a), the business of providing long-term finance for-

(A) industrial or agricultural development;

(B) development of infrastructure facility in India; or

(C) development of housing in India;]

(ii) in respect of the specified entity referred to in sub-clause (v) of clause (a), the business of providing long-term finance for the construction or purchase of houses in India for residential purposes; and

(iii) in respect of the specified entity referred to in sub-clause (vi) of clause (a), the business of providing long-term finance for development of infrastructure facility in India;

(c) "banking company" means a company to which the Banking Regulation Act, 1949 (10 of 1949) applies and includes any bank or banking institution referred to in section 51 of that Act;

(d) "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;

(e) "housing finance company" means a public company formed or registered in India with the main object of carrying on the business of providing long-term finance for construction or purchase of houses in India for residential purposes;

ITA Nos. 578 & 653/Bang/2012 Page 38 of 49

(f) "public company" shall have the meaning assigned to it in section 3 of the Companies Act, 1956 (1 of 1956);

(g) "infrastructure facility" means--

(i) an infrastructure facility as defined in the Explanation to clause (i) of sub-section (4) of section 80-IA, or any other public facility of a similar nature as may be notified by the Board in this behalf in the Official Gazette and which fulfils the conditions as may be prescribed;

(ii) an undertaking referred to in clause (ii) or clause (iii) or clause (iv) or clause (vi) of sub-section (4) of section 80-IA; and

(iii) an undertaking referred to in sub-section (10) of section 80- IB;

(h) "long-term finance" means any loan or advance where the terms under which moneys are loaned or advanced provide for repayment along with interest thereof during a period of not less than five years;"

41. The computation of deduction u/s.36(1)(viii) of the Act as made by

the Assessee was as follows:

S.No. & Particulars Amount in Rs. 1. Interest earned from advances made to industrial, 815,24,34,678 agricultural and infrastructure activities 2. Total Income for the year ended 31.3.08 4420,56,84,509 3. % of Interest earned from advances made to 18.44%

industrial, agricultural and infrastructure activities to total interest income (Sl.No.1/Sl.No.2)

4. Operating Profit for the year ended 31.3.2008 660,87,65,493

5. Profits from activities specified u/s.36(1)(viii) 121,87,91,872 (Sl.No.4 x Sl.No.3 x 100)

6. 20% of the profits derived from activities specified 24,37,58,374 u/s.36(1)(viii)

7. Amount transferred to special reserve 25,00,00,000

8. Amount eligible for deduction u/s.36(1)(viii) (lower 24,37,58,374 of amount under Sl.No.6 or Sl.No.7) ITA Nos. 578 & 653/Bang/2012 Page 39 of 49

42. The AO held that the Assessee is not an entity eligible for deduction

u/s.36(1)(viii) of the Act. Without prejudice to the above stand of the AO,

he also found fault with the method of computation of deduction

u/s.36(1)(viii) of the Act done by the Assessee. The loss under the head

"Income from Business or profession" declared by the Assessee in the

return of income was Rs.118,71,25,119. After reducing the deduction of

Rs.25,00,00,000/- claimed u/s.36(1)(viii) of the Act, the loss as per the

return of income under the head "Income from Business or Profession" was

a sum of Rs.93,71,25,119. According to the Assessee since the income

earned from the activities mentioned in Sec.36(1)(viii) of the Act was

18.44% of the total income as per Table given above, the profit from such

activities under the head "Profits and gains of Business or Profession" was

18.44% of 93,71,25,119 viz., Rs.17,28,05,872. 20% of the above

according to the AO was -3,45,61,174/-. Since the Assessee declared a

loss and not profits, the AO held that the Assessee was not entitled to claim

deduction u/s.36(1)(viii) of the Act.

43. On appeal by the Assessee, the CIT(A) accepted the contention of

the Assessee that it was an entity eligible for deduction u/s.36(1)(viii) of the

Act. That finding is not in challenge by the revenue before the Tribunal in

the appeal filed by it against the order of CIT(A) and has now become final.

Therefore the discussion of the CIT(A) in this regard is not discussed.

ITA Nos. 578 & 653/Bang/2012 Page 40 of 49

44. As far as the methodology adopted by the AO for rejecting the claim

of deduction u/s.36(1)(viii) of the Act is concerned, the CIT(A) concurred

with the view of the AO. Aggrieved by the order of the CIT(A), the

Assessee has raised ground No.2 & 3 before the Tribunal.

45. We have heard the submission of the learned counsel for the

Assessee. The learned counsel for the Assessee submitted that the AO

and CIT(A) erred in considering the loss declared by the Assessee under

the head "Income from Business or Profession" as the basis on deduction

u/s.36(1)(viii) of the Act has to be computed. He pointed out that the

provisions of sec.36(1)(viii) of the Act provide that a special reserve has to

be created and maintained by a specified entity. Then an amount not

exceeding twenty per cent of the profits derived from eligible business

computed under the head "Profits and gains of business or

profession" (before making any deduction under this clause) carried to

such reserve account will be allowed as deduction. According to him it is

the profits derived from eligible business computed under the head "profits

and gains of business or profession" that has been seen and not that of the

entity as a whole, as has been done by the AO and CIT(A). The learned

DR relied on the order of the CIT(A).

46. We have considered the rival submissions. A plain reading of the

provisions of Sec.36(1)(viii) of the Act clearly shows that what is relevant is

profits derived from eligible business computed under the head "Profits and ITA Nos. 578 & 653/Bang/2012 Page 41 of 49

gains of business or profession" and not the profits derived by the entity as

a whole as has been done by the AO and CIT(A). We therefore hold that

the method of computation of deduction as done by the AO and CIT(A) is

incorrect. The profits derived from eligible business computed under the

head "Profits and gains of business or profession" as done by the

Assessee has been accepted by the AO and CIT(A). There should be no

difficulty in accepting the claim made by the Assessee for deduction

u/s.36(1)(viii) of the Act. The Assessee has also filed before us an

alternate method of computation of deduction u/s.36(1)(viii) of the Act to

demonstrate that such alternate method will result in claim for deduction

being made at Rs.37,14,84,183/-. The said computation is given as

Annexure-2 to this order. We deem it appropriate to direct the AO to

examine the computation given as annexure-2 to satisfy himself that the

claim as made originally was correct. The AO is thereafter directed to

consider the claim of the Assessee for the correct amount of eligible

deduction u/s.36(1)(viii) of the Act. The relevant grounds are thus treated

as allowed.

47. Ground No.4 & 5 raised by the Assessee is with regard to the

computation of disallowance u/s.14A of the Act. The Assessee earned

interest and dividend income of Rs.2,14,32,814 and Rs.13,83,53,278

respectively which was exempt u/s.10(15) and 10(34) of the Act and does

not form part of the total income under the Act. In view of the provisions of

Sec.14A of the Act which provides that no deduction shall be allowed in ITA Nos. 578 & 653/Bang/2012 Page 42 of 49

respect of expenditure incurred by the Assessee in relation to income,

which does not form part of the total income. The Assessee claimed that it

had not incurred any direct expenditure in the form of interest expenditure

or other expenditure in making the investments which yielded tax-free

income. The AO also does not dispute the claim of the Assessee. The AO

disputed only general and administration expenses (other expenses)

incurred by the Assessee which had to been apportioned as attributable to

earning of the exempt tax free income. The claim of the Assessee in this

regard was that tax free income for the bank is mainly from investments

held by the bank. The investment activities of the bank are carried out by

the Treasury Department at Head Office. Even without earning any free

income, these expenditure would have been incurred by the bank since the

bank has to hold SLR securities to carry on the business and the

expenditure is of fixed in nature. Therefore, there is no expenditure

incurred directly by the bank for earning any tax free income. Since the

expenditure would have been incurred by the bank even without the

earning of tax free income, no part of the expenditure can be related to

earning the tax free income. Therefore no disallowance u/s.14A of the Act

is warranted.

48. The AO did not agree with the above contention. According to him

expenditure relatable to exempt income has to be determined and in the

absence of any other acceptable basis on which the same is determined,

Rule 8D of the Income Tax Rules, 1962 (Rules) have to be applied.

ITA Nos. 578 & 653/Bang/2012 Page 43 of 49

Thereafter the AO invoked Rule 8D(iii) of the Rules and determined a sum

of Rs.2.14 crores as expenditure incurred in relation to income which does

not form part of the total income under the Act.

49. On appeal by the Assessee, the CIT(A) confirmed the action of the

AO. The CIT(A) however proceeded on the basis that the Assessee had

incurred direct expenditure also in the form of interest expenses in earning

the tax free income. We have already seen that the AO did not raise such

issue in the order of assessment. The disallowance by the AO was only

with reference to other expenses under Rule 8D(iii) of the Rules. Therefore

the observations of the CIT(A) in his order on applicability of Sec.14A of the

Act to both direct and indirect expenses, are without any basis.

50. Before the Tribunal, the learned counsel for the Assessee placed

reliance on the decision of the Hon'ble Karnataka High Court in the case of

CCI Ltd. Vs. JCIT (2012) 20 Taxmann.com 196 (Kar.)/(2012)

250 CTR (Kar) 291. The substantial question of law for consideration

before the Hon'ble Karnataka High Court in the aforesaid case was as to

whether the provisions of Section 14A of the Act are applicable to the

expenses incurred by the assessee in the course of its business merely

because the assessee is also having dividend income when there was no

material brought to show that the assessee had incurred expenditure for

earning dividend income which is exempted from taxation?. The Hon'ble

Court held that when the assessee has not retained shares with the ITA Nos. 578 & 653/Bang/2012 Page 44 of 49

intention of earning dividend income and the dividend income is incidental

to his business of sale of shares, which remained unsold by the assessee,

it cannot be said that the expenditure incurred in acquiring the shares has

to be apportioned to the extent of dividend income and that should be

disallowed from deductions. The learned DR relied on the order of the

CIT(A).

51. We have given a very careful consideration to the rival submissions.

In the present case, the claim of the Assessee before the AO that tax free

income for the bank is mainly from investments held by the bank. The

investment activities of the bank are carried out by the Treasury

Department at Head Office. Even without earning any free income, these

expenditure would have been incurred by the bank since the bank has to

hold SLR securities to carry on the business and the expenditure is of fixed

in nature. Therefore, there is no expenditure incurred directly by the bank

for earning any tax free income. Since the expenditure would have been

incurred by the bank even without the earning of tax free income, no part of

the expenditure can be related to earning the tax free income. In the light

of the above undisputed fact and in view of the decision of the Hon'ble

Karnataka High Court in the case of CCI Ltd. (supra), we are of the view

that no disallowance can be made u/s.14A of the Act. The addition made

in this regard is directed to be deleted. The relevant grounds of appeal of

the Assessee are allowed.

ITA Nos. 578 & 653/Bang/2012 Page 45 of 49

52. In ground No.6 & 7 the Assessee has challenged the action of the

CIT(A) in confirming the action of the AO in rejecting the claim of the

Assessee that provisions of Sec.115JB of the Act are not applicable to

banking companies and in further rejecting the claim of the Assessee to

ascertain book profits as per recasted profit and loss account prepared by

the bank as per the provisions of Companies Act, 1956.

53. We have heard the parties on the above issues. The provisions of

Sec.115JB of the Act are not applicable to banking companies as held by

this Tribunal in the case of Syndicate Bank ITA No.668 & 669/Bang/2010

order dated 19.6.2013. The relevant observations of the Tribunal in this

regard are as follows:

"95. At the time of hearing, it was submitted by the ld. DR that the issue can be remanded for fresh consideration as was done by the Tribunal in A.Y. 2005-06 in ITA No.504/Bang/2009, order dated 13.01.2012. The ld. counsel for the assessee, however, submitted that the Tribunal in its earlier order though noted direct judgments on the point viz.,

(1) Order dated 30.09.2010 in ITA No.3390/2009 passed by ITAT 'G' Bench, Mumbai in the case of Krung Thai Bank;

(2) Order dated 30.06.2011 in ITA Nos.4702 to 4706/2010 passed by the ITAT, Mumbai 'F' Bench in the case of Union Bank of India; and (3) Order dated 03.08.2011 in ITA No.469/2010 passed by the ITAT 'C' Bench, Chennai in the case of Indian Bank,

did not adjudicate on the applicability of section 115JB, but following an earlier order in the assessee's own case for earlier years (at which point of time the above Tribunal's decisions were not available), restored the matter to the Assessing Officer to compute book profits based on recast P & L account prepared in accordance with the Schedule-VI of the Companies Act.

ITA Nos. 578 & 653/Bang/2012 Page 46 of 49

96. The learned counsel for the Assessee also submitted that the provisions of Sec.115JB of the Act were amended with effect from 01.04.2013 making it obligatory, inter alia, for banks to prepare P & L account in accordance with the Banking Regulation Act is clearly indicative of legislative understanding that upto and including A.Y. 2012-13, section 115JB had no application to banks and insurance companies. It was so held by ITAT, Hyderabad in the case of State Bank of Hyderabad dated 07.09.2013 in ITA No. 578/Hyd/2010 and ITAT Mumbai in the case of ICICI Lombard General Insurance Co. Ltd. dated 10.10.2012 in ITA No.2398/Mum/2009.

97. The learned DR relied on the order of the CIT(A).

98. We have considered the rival submissions of the ld. counsel for the assessee. We find that this issue was considered by the Mumbai Bench of the Tribunal in the case of Krung Thai Bank (supra) and on the above issue held as follows:-

"5. Learned counsel for the assessee, however, contends that the provisions of MAT do not apply to the assessee, and , for this reason, very foundation of impugned reassessment proceedings is devoid of legally sustainable merits. His line of reasoning is this. The provisions of MAT can come into play only when the assessee prepares its profit and loss account in accordance with Schedule VI to the Companies Act .It is pointed out that , in terms of the provisions of Section 115JB(2),every assessee is required to prepare its profit and loss account in terms of the provisions of Part II and II I of Schedule VI to the Companies Act . Unless the profit and loss is so prepared, the provisions of Section 115 JB cannot come into play at al l. However, the assessee is a banking company and under proviso to Section 211 (2) of the Act , the assessee is exempted from preparing its books of accounts in terms of requirements of Schedule VI to the Companies Act , and the assessee is to prepare its books of accounts in terms of the provisions of Banking Regulation Act . It is thus contended that the provisions of Section 115 JB do not apply in the case of banking companies which are not required to prepare the profit and loss account as per the requirements of Part II and III of Schedule VI to the Companies Act . Since the provisions of Section 115 JB ITA Nos. 578 & 653/Bang/2012 Page 47 of 49

do not apply to the assessee company, the reasons recorded for reopening the assessment are clearly wrong and insufficient . We are urged to quash the reassessment proceedings on this short ground.

6. Learned Departmental Representative, on the other hand, vehemently relies upon the orders of the authorities below and submits that there is no specific exclusion clause for the banking companies, and in the absence of such a clause, it is not open to us to infer the same. The submissions of the learned counsel, according to the departmental representative, are clearly contrary to the legislative intent and plain wordings of the statute.

7. The plea of the assessee is indeed well taken, and it meets our approval. The provisions of Section 115 JB can only come into play when the assessee is required to prepare its profit and loss account in accordance with the provisions of Part II and I II of Schedule VI to the Companies Act . The starting point of computation of minimum alternate tax under section 115 JB is the result shown by such a profit and loss account. In the case of banking companies, however, the provisions of Schedule VI are not applicable in view of exemption set out under proviso to Section 211 (2) of the Companies Act . The final accounts of the banking companies are required to be prepared in accordance with the provisions of the Banking Regulation Act . The provisions of Section 115 JB cannot thus be applied to the case of a banking company."

99. We are of the view that in the light of the decision of the Mumbai Bench of the Tribunal, we have to necessarily hold that provisions of section 115JB of the Act are not applicable to the assessee which is a banking company. The decisions relied upon by the ld. counsel for the assessee, clearly support the plea of the assessee in this regard. Consequently, ground No.3 raised by the assessee is also allowed."

ITA Nos. 578 & 653/Bang/2012 Page 48 of 49

54. Since the provisions of sec.115JB of the Act are not applicable to

banking companies as held by the Tribunal, we are of the view that the

computation of books profits made by the AO cannot be sustained.

Consequently ground No.6 raised by the Assessee is allowed. Ground

No.7 does not require adjudication in view of the conclusion on ground

No.6 that provisions of Sec.115JB of the Act do not apply to banking

companies.

55. In the result the appeal by the Assessee is allowed.

56. In the result appeal by the revenue is partly allowed, while the

appeal by the Assessee is allowed.

Pronounced in the open court on this 27th day of February, 2015.

Sd/- Sd/-

( JASON P. BOAZ ) ( N.V. VASUDEVAN ) Accountant Member Judicial Member

Bangalore, Dated, the 27th February, 2015.

Encl: Annexures I & II

D S/ ITA Nos. 578 & 653/Bang/2012 Page 49 of 49

Copy to:

1. Appellant 2. Respondent 3. CIT 4. CIT(A) 5. DR, ITAT, Bangalore. 6. Guard file

By order

Assistant Registrar / Senior Private Secretary ITAT, Bangalore.