THE COMMR.OF INCOME TAX vs. THE DHANALAKSHMI BANK LTD.
What did the High Court hold?
The High Court held that for substantial question no.1 (depreciation on government securities) and substantial question no.3 (loss on redemption of securities), the Tribunal was correct in its findings. The Court relied on its previous decisions in Commissioner of Income Tax v. Nedungadi Bank Ltd and Commissioner of Income Tax v. Lord Krishna Bank Ltd, which established that securities held by banks constitute their stock-in-trade or investment, and losses arising from their valuation are allowable deductions. For substantial question no.2 (bad debts under Section 36(1)(viia)), the Court, following its decision in Commissioner of Income Tax v. Lord Krishna Bank Ltd, held that the definition of a 'rural branch' should be based on the revenue village as the unit, with a population of less than 10,000, rather than wards of local authorities. Consequently, the matter was remitted to the Assessing Officer for re-determination of the claim in accordance with this principle. The appeal was allowed-in-part.
What were the facts?
The Commissioner of Income Tax (Revenue) appealed against an order of the Income Tax Appellate Tribunal (Tribunal) concerning the assessment year 1998-99 for Dhanalakshmi Bank Ltd (Assessee). The Assessing Officer had disallowed certain claims and made additions to the assessee's income. The assessee's appeal to the CIT(Appeals) was partly allowed. The Revenue then appealed to the Tribunal, which also partly allowed the appeal, ruling in favour of the assessee on three specific aspects: claim of depreciation on government securities, deduction under Section 36(1)(viia) for bad debts from rural branches, and loss on redemption of securities. The present appeal by the Revenue challenges the Tribunal's order on these three points.
What were the issues?
The Tribunal had to decide three substantial questions of law: 1. Whether the Tribunal was correct in allowing depreciation claimed by the assessee on current securities? 2. Whether the Tribunal was correct in allowing an excess claim of bad debts under Section 36(1)(viia) of Rs. 1,89,03,372/-? 3. Whether the Tribunal was correct in deleting the addition made in respect of the loss on redemption of securities? The Revenue argued that the Tribunal erred in its findings on these issues. The Assessee contended that its claims were valid. The judgment relies on previous High Court decisions in Commissioner of Income Tax v. Nedungadi Bank Ltd and Commissioner of Income Tax v. Lord Krishna Bank Ltd for all three questions.
Which sections of the Income-tax Act were involved?
AI-generated summary — verify with the full judgment below
Cause title — parties, addresses and appearances
J U D G M E N T S.V. Bhatti, J. Heard learned Standing Counsel Mr.Jose Joseph and learned Advocate Mr.Mohan Pulikkal for the parties.
The Commissioner of Income Tax, Trichur (for short 'Revenue') is the appellant. Dhanalakshmi Bank Ltd, Trichur (for short 'Assessee') is the respondent. The present Tax Appeal is directed against the order of Income Tax Appellate Tribunal, Cochin Bench, in I T A No.1261/Coch/2004 dated 20.02.2007. The subject appeal deals with a few issues arising from the tax returns filed by the assessee for the Assessment Year 1998-99. 3. The assessee is a scheduled bank, engaged in the business of banking. The Assessment Officer finalized the return of the assessee for the Assessment Year 1998-99 under Section 143(3) of the Income Tax Act (for short 'the Act'). The -3- Assessing Officer disallowed a few claims made by the assessee, added a few heads of income to the income of assessee, and assessed to tax. In the present appeal, we are not adverting to all the dis-allowances made by the Assessing Officer, and, likewise, the additions made to the income of the assessee. For, the subject appeal deals with or confined to three aspects; namely, claim of depreciation on government securities; deduction under Section 36(1)(viia) as bad debts from the rural branches of the assessee, and loss on redemption of securities. The assessee, aggrieved by the order in Annexure-A, filed appeal before CIT (Appeals) in ITA No.15/RI/JC/TCR/CIT- V/2000-01. The appeal filed by the assessee was allowed in part and the heads of addition/dis-allowance, referred to above, have been held in favour of the assessee. The Revenue filed ITA No.1261/Coch/2004 before the Appellate Tribunal, Cochin Bench. Through the order assailed in the instant appeal, the -4- Tribunal allowed the appeal in part. The claim of assessee, under the heads referred to above, has been answered in favour of assessee and against the Revenue. Hence, the appeal at the instance of Revenue.
The Revenue raises the following substantial questions of law in the instant appeal. “1. whether, on the facts and in the circumstances of the case the Tribunal is right in law in interfering with the disallowance of depreciation claimed by the assessee on current securities?
Whether, on the facts and circumstances of the case, the Tribunal is right in law in allowing excess claim of bad debts u/s.36(1)(viia) of Rs.1,89,03,372/-?
Whether, on the facts and in the circumstances of the case, the Tribunal is right in law and in fact in deleting the addition made in respect of the loss on redemption of securities.”
The three questions of law referred to above are no more res integra. Question no.1 deals with claim of depreciation -5- on government securities. The question is considered by this Court in Commissioner of Income Tax v. Nedungadi Bank Ltd1 and Commissioner of Income Tax v. Lord Krishna Bank Ltd2, and this Court had answered in favour of the assessee. The questions considered by this Court in Nedungadi Bank Ltd (supra) are excerpted hereunder:
“1. Whether the investments made by the assessee in the form of Government securities acquired for the purpose of complying with the requirements of the provisions of the Banking Regulation Act, ie., to maintain the SLR, can be treated as the trading asset/stock-in- trade
of the business
of the assessee?
Whether the assessee is entitled to revalue the securities held by the banks at the close of the year based on the market value of the securities prevailing then and to claim depreciation on the basis of such notional loss in computing the profits and gains of the business of the assessee ? In other words, the question is as to whether the assessee is entitled to claim depreciation on the basis of the notional loss suffered on account of the revaluation of the securities held by it at the close of the assessment year ?”
(emphasis supplied) 1 (2003) 264 ITR 545 (Ker.) 2 (2011) 339 ITR 606 (Ker)
-6- Held: “ Nedungadi Bank Ltd (supra) For all these reasons, we are of the view that the Income-tax Appellate Tribunal has rightly held that the securities held by the assessee-bank in all these cases are the stock-in-trade of the business of the assessee-banks and the notional loss suffered on account of the revaluation of the said securities at the close of the year is an allowable deduction in the computation of the profits of the appellant. This disposes of the first two questions mentioned in para. 10 above” Lord Krishna Bank Ltd (supra) “The first question raised pertains to valuation of unquoted Government securities. Since securities involved are not quoted in the market, market price is not known. The assessee treats the unquoted Government securities as current assets and, therefore, it has to work out the profit or loss in the end of the year for the purpose of payment of tax. The assessee adopted the RBI guidelines for valuation of unquoted Government securities and based on the same it claimed a substantial loss. The Assessing Officer, however, rejected the claim because according to him when shares are not quoted, the cost price has to be adopted and going by the cost price the assessee has not suffered the loss as claimed. It is a settled position through various decisions including that of this CIT v. Nedungadi Bank Ltd. reported in [2003] 264 ITR 545 (Ker) that for -7- purpose of assessment cost price or market value, whichever is lower, should be adopted. Admittedly, market value is not known and so much so, some method has be adopted to fix the market value and thereafter only the lower of the cost price or the market value has to be taken for the purpose of computation of profit or loss in respect of the unsecured securities. Senior counsel appearing for the assessee produced the RB guidelines before us wherein the RBI has suggested banks to value unquoted Central Government securities on the basis of the prices/YTM rates put out by the PDAI/FIMMDA at periodical intervals. YTM is the yield to maturity method adopted for valuation of securities. It is seen that the Tribunal accepted the assessee's valuation which is based on the RBl guidelines. RBI being the apex body issuing guidelines to the banks for valuation of unquoted Government securities, we feel it is the rational basis which the assessee was bound to adopt. The Assessing Officer also has not come out with any formula for computation of market value of unquoted securities and he has no case that the RBI guidelines for valuation is irrational. So much so, we feel the Tribunal rightly upheld the assessee's claim for valuation of unquoted Government securities based on the RBI guidelines. We, therefore, dismiss the Revenue's appeal on this issue.” It is now settled by a series of decisions of this Court and Supreme Court that the securities held by the Banks constitute their stock-in-trade or investment and consequently the loss -8- claimed by the Banks on the valuation of their securities should be allowed as a deduction in computing the taxable income of the assessee. Substantial question no.1 is answered in favour of assessee and against the Revenue.
Substantial question no.2 deals with bad debts provision, covered under Section 36(1)(viia). The claim for bad debts provision is made by treating most of the assessee's branches as rural branches. The categorization of a branch as rural or urban has fallen for decision in Commissioner of Income Tax v. Lord Krishna Bank Ltd3 and it has been held that: “In our view, the 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 10000 population thereby answering the branch located in such municipal area also as a rural branch. Going by the ordinary meaning of rural branch, we feel only branches of the bank located in rural areas are covered. 3 (2011) 339 ITR 606 (Ker)
-9- When the Legislature adopts population as the basis for classification of rural branches, that too, with reference to the last Census Report, we feel the basic unit as available for identification of rural area in the Census Report can be legitimately adopted. So much so, we feel the above 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 above 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 our view, 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, in our view, 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 10000. 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 10000. We, therefore, allow the appeal on this issue by reversing the order of the Tribunal and by restoring the assessment. ” The substantial question is answered in favour of Revenue, against the assessee, and matter is remitted to Assessing Officer for disposal in accordance with the principle laid down in the -10- decision referred to above.
Question no.3 deals with notional loss on revaluation. The question is considered by this Court in Commissioner of Income Tax v. Nedungadi Bank Ltd4, and this Court had answered in favour of the assessee. The operative portion of the reported judgments is excerpted hereunder: “Nedungadi Bank Ltd (supra) For all these reasons, we are of the view that the Income-tax Appellate Tribunal has rightly held that the securities held by the assessee-bank in all these cases are the stock-in-trade of the business of the assessee-banks and the notional loss suffered on account of the revaluation of the said securities at the close of the year is an allowable deduction in the computation of the profits of the appellant. This disposes of the first two questions mentioned in para. 10 (page 552) above” In conclusion, it is reiterated that substantial question nos.1 and 3 are answered in favour of the assessee and against 4 (2003) 264 ITR 545 (Ker.)
-11- the Revenue; substantial question no.2 is answered in favour of the Revenue and against the assessee. The appeal allowed-in- part as indicated above.. The matter is remitted to Assessing Officer for determination of the claim of assessee under Section 36(1)(viia), in accordance with the principle laid down in Lord Krishna Bank Ltd. (supra). S.V.BHATTI JUDGE BECHU KURIAN THOMAS JUDGE jjj -12-
Appendix — schedule of exhibits
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