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Income Tax Appellate Tribunal, BENGALURU A BENCH, BENGALURU
O R D E R Per: B.R. Baskaran, A.M. These cross appeals are directed against the order dated 27-03-2018 passed by Ld CIT(A), Mangaluru and they relate to the assessment year 2014-15.
The assessee is a banking company carrying on banking business. The Karnataka Bank Ltd.
We shall first take up first the appeal filed by the Revenue. Following issues are contested by Revenue. a) Disallowance of depreciation claimed on investments (HTM) b) Disallowance made u/s 14A of the Act c) Disallowance made u/ 36(1)(viia)
The first issue relates to the disallowance of depreciation claimed on Investments held to Maturity. The AO noticed that the assessee has revalued the investments held to maturity as at the yearend and the fall in the value was claimed as depreciation in their value amounting to Rs.436.81 crores as deduction. The AO noticed that the RBI, vide its Master Circular dated 02-09-2003, has classified the investments made by banks into three categories and also provided the methodology for valuing those investments. As per the above said circular, the Investments held to maturity should be valued at cost and no depreciation is to be provided in respect of this category. He also noticed that the Hon’ble Karnataka High Court, in the assessee’s own case for AY 2004-05 and also in the case of ING Vysya Bank Ltd (ITA No.2886/2005), has held that the “investments held under HTM category” should be valued at Cost only. He further noticed that the assessee has valued the said investments “at cost” only in its books of accounts and the assessee has revalued the investments and the fall in the value of investment was claimed as depreciation for income tax purposes alone. In view of the above, the AO took the view that the assessee has followed two different methods of valuing “investments held to maturity”, one for book purposes and another one for income tax purposes. The AO took the view that the above said dual methodology adopted by the assessee is contrary to the CBDT’s Circular No.665 (F No.201/3/92 -ITA-H dated 5.10.1993) read with the guidelines issued by RBI from time to time. Hence the AO disallowed the claim of depreciation of Rs.436.81 crores claimed in respect of “Investments held to maturity”. 4.1 The Ld CIT(A) decided this issue in favour of the assessee by observing as under:- The Karnataka Bank Ltd.
“7.3 The submissions of the appellant were considered. This is a covered issue in favour of the appellant. The Hon’ble ITAT, Banglore B Bench in Corporation Bank’s case in & 1352 (B)/2013 for the asst. year 2011-12 upheld the orders of the CIT(A) by holding that the assessee is entitled to value all the investments at cost price or market price whichever is lower by treating such investments as stock in trade. The Jurisdictional Hon’ble High Court of Karnataka in the case of Vijaya Bank in ITA No.687/2008 dated 11.3.2013 and Karnataka Bank in ITA No.172/2009 dated 11.1.2013 decided the issue in favour of the appellant. Respectfully following the binding decisions of the Hon’ble High Court of Karnataka and Hon’ble ITAT, Bangalore B bench, the appeal on this ground is allowed.” The revenue is aggrieved. 4.2 We heard the parties on this issue and perused the record. We notice that the Ld CIT(A) has followed the subsequent decision rendered by the jurisdictional Hon’ble Karnataka High Court in the assessee’s own case and also the decision rendered by Tribunal in the case of Corporation Bank (supra) in deciding this issue in favour of the assessee. We also notice that the co-ordinate bench of Tribunal has upheld the identical view taken by Ld CIT(A) in assessee’s own case in AY 2012-13 in ITA No.89/PAN/2017 has upheld the identical view taken by Ld CIT(A) in that year with the following observations:- “…..The AO noticed that the assessee has revalued its investment as at the year end and claimed depreciation of investments amounting to Rs.155.06 crore as deduction. The AO disallowed the same by following the decision rendered by Hon’ble High Court of Karnataka in the case of ING Vysya Bank Ltd., (ITA No.2886/2005).
The Ld CIT(A) noticed that an identical issue was decided in favour of the assessee by the Tribunal in the assessee’s own case in ITA No.681/Bang/2012 dated 13.06.2014 relating to AY 2009-10, wherein the decision rendered by Hon'ble jurisdictional Karnataka High Court in the case of Vijaya Bank (ITA No.687/2008 dated 11.3.2013) and in the case of Karnataka Bank (ITA No.172/2009 dated 11.01.2013) was followed. Accordingly, the Ld CIT(A) deleted the addition in both the years.
We heard the parties on this issue and perused the record. We notice that the co-ordinate bench in AY 2009-10 (supra) has followed the decision rendered in the assessee’s own case in ITA No.708/B/2010 dated 19-06-2013 relating to AY 2006-07 on an identical issue. The co-ordinate bench, in AY 2006-07, has noticed that the Hon'ble jurisdictional High Court has rendered its decision The Karnataka Bank Ltd.
in the case of ING Vysya Bank Ltd (supra) without considering the decision rendered by Hon'ble Supreme Court in the case of UCO Bank (240 ITR 355)(SC). It was further noticed that the Hon'ble jurisdictional Karnataka High Court, in two subsequent decisions rendered in the cases of Vijaya Bank (supra) and Karnataka Bank (supra), has held that the 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. Accordingly, the co-ordinate bench followed later decision of the jurisdictional High Court in AY 2006-07 and deleted the disallowance made by the AO. The decision so rendered in AY 2006-07 was followed in AY 2009-10 by another co-ordinate bench.
We notice that the Ld CIT(A) has followed the decision rendered by the co-ordinate bench in the assessee’s own case and also subsequent decisions rendered by Hon'ble jurisdictional High Court in the case of Vijaya Bank (supra) and Karnataka Bank (supra) in deciding this issue in favour of the assessee in both the years. Hence we do not find any reason to interfere with the order passed by Ld CIT(A) in both the years on this issue.”
4.3 As the facts surrounding this issue is identical in nature, we do not find any reason to interfere with the order passed by Ld CIT(A) on this issue. Since the assessee has claimed depreciation only for income tax purposes, both the assessee and the assessing officer shall ensure that the profit/loss arising on sale of these investments should be ascertained by considering the value of investments as per income tax records and not as per books of account.
The next issue contested by the revenue relates to the disallowance made u/s 14A of the Act. The AO noticed that the assessee did not make any disallowance u/s 14A of the Act even though it has earned tax free income during the year under consideration. When questioned, the assessee submitted that it has got cost free funds and they have been used for making investments. It was further submitted that the assessee’s investment portfolio has shown negative incremental investment in the assets generating tax free income. It was also contended that, making investments is part of its banking business and hence no part of expenditure can be related to the dividend income, which is generated incidentally. The AO held that the assessee has not given factual details and it has only furnished a write up on the disallowance to be made u/s The Karnataka Bank Ltd.
14A of the Act. Accordingly, the AO held that the explanation furnished by the assessee is not satisfactory. Further, the AO, relying upon the decision rendered by Hon’ble Bombay High Court in the case of Godrej & Boyce vs. DCIT (328 ITR 81) and certain other decisions, held that the disallowance u/s 14A read with Rule 8D should be computed in the hands of the assessee. Accordingly, the AO disallowed a sum of Rs.51.44 crores u/s 14A r.w.r 8D, which consisted of interest disallowance of Rs.42.17 crores u/r 8D(2)(ii) and expenditure disallowance of Rs.2.98 crores u/r 8D(2)(iii). 5.1 The Ld CIT(A) took the view that the AO has not recorded dissatisfaction over the claim of the assessee with regard to the disallowance to be made u/s 14A of the Act. Accordingly, he directed the AO to delete the disallowance. The revenue is aggrieved. 5.2 We heard the parties on this issue and perused the record. We notice that an identical issue was restored to the file of AO in the assessee’s own case in AY 2012-13 (supra) with the following observations:- “8. We have heard the parties on this issue and perused the record. We have noticed that the assessee has not disallowed any expenditure u/s 14A of the Act, even though it has earned exempt income. From the asst. order we noticed that the AO has made following observations with regard to the claim of the assessee. “It is a known fact that there are certain expenses for earning these exempted income. The actual income which qualifies for exemption can be ascertained only after considering the expenses related to it and such expenses are disallowable under the provisions of Sec.14A of the Income Tax Act. Without utilising the resources and the existing establishment of the assessee Bank, it would not have been possible to earn this income. Any income earned should have related expenditures attributed to it. The words "in relation to" in section 14A encompass not only the direct expenses but also the indirect expenses which has any relation to the exempt income. The banks contention that being a banking Company it does not incur any expenditure on earning exempt income is not acceptable as the investments made on shares/bonds/mutual fund etc. for earning exempt income will always have a notional interest The Karnataka Bank Ltd. cost attached to it. So, the explanation given by the assessee bank is not acceptable. The investments (generating tax free income) are made by the assessee bank from the common pool of funds. As per the provisions of section 14A, no deduction shall be allowed in respect of the expenditure incurred by the assessee against the income claimed as exempt from the tax. Apportionment of the expenditure is inherent part of section 14A. In the absence of direct nexus between the assesee's own funds and investment, the investment will be treated from common pool of account having both borrowed as well as own funds of the assessee.”
Thus we noticed that the AO has recorded his dissatisfaction over the claim made by the assessee that it did not incur any expenditure to earn exempt income. There is no particular method/manner to record satisfaction or dissatisfaction. The satisfaction or dissatisfaction has to be inferred from the discussions made by the assessing officer. It is so held by Hon’ble Supreme Court in the case of MAK Data (P) Ltd vs. CIT (2013)(358 ITR 593)(SC). Hence, whether the AO has recorded his satisfaction/ dissatisfaction has to be found out from the discussions made by him in the assessment order. The discussions made by the AO in the assessment order, which are extracted above, in our view, show that the AO was not satisfied with the contentions of the assessee and hence the same satisfies the requirement of recording of dissatisfaction by the assessing officer. We notice that the co- ordinate benches in the earlier year in the assessee’s own case as well as in the case of Canara Bank had upheld the deletion of disallowance made u/s 14A of the Act only on the reasoning that the AO has not recorded dissatisfaction. However, in the instant year, we are of the view that the assessing officer has recorded dissatisfaction. Accordingly, the decision rendered by the co-ordinate bench for asst. year 2008-09 is distinguishable.
The Hon’ble Supreme Court has settled the issue relating to disallowance to be made u/s 14A of the Act in the case of Maxopp Investments Ltd., Vs. CIT (Civil Appeal No.104-109 of 2015 dated 12/2/2018). The following observations made by the Hon’ble Supreme Court in para 39 of the order are relevant here. “39) In those cases, where shares are held as stock-in-trade, the main purpose is to trade in those shares and earn profits there from. However, we are not concerned with those profits which would naturally be treated as ‘income’ under the head ‘profits and gains from business and profession’. What happens is that, in the process, when the shares are held as ‘stock-in-trade’, certain dividend is also earned, though incidentally, which is also an income. However, by virtue The Karnataka Bank Ltd.
of Section 10 (34) of the Act, this dividend income is not to be included in the total income and is exempt from tax.This triggers the applicability of Section 14A of the Act which is based on the theory of apportionment of expenditure between taxable and non-taxable income as held in Walfort Share and Stock Brokers P Ltd. case. Therefore, to that extent, depending upon the facts of each case, the expenditure incurred in acquiring those shares will have to be apportioned. 40) We note from the facts in the State Bank of Patiala cases that the AO, while passing the assessment order, had already restricted the disallowance to the amount which was claimed as exempt income by applying the formula contained in Rule 8D of the Rules and holding that section 14A of the Act would be applicable. In spite of this exercise of apportionment of expenditure carried out by the AO, CIT(A) disallowed the entire deduction of expenditure. That view of the CIT(A) was clearly untenable and rightly set aside by the ITAT. Therefore, on facts, the Punjab and Haryana High Court has arrived at a correct conclusion affirming the view of the ITAT, though we are not subscribing to the theory of dominant intention applied by the High Court. (bold portions highlighted by us)
The observations made by the Hon’ble Supreme Court in the above said case, which have been highlighted by us, would clearly show that the Hon’ble Supreme Court, in clear terms, has clarified that (a) the provisions of sec.14A would be triggered when exempt income is earned while carrying on the activity of trading in shares. (b) the theory of “dominant intention” is not applicable to the provisions of sec.14A of the Act. Hence, the claim that shares are held as stock in trade (which is dominant intention), would not absolve the liability of the assessee to make disallowance u/s 14A of the Act, when exemption is claimed in respect of any part of its income.
In the instant case the assessee has claimed that the investments are held as stock in trade and hence earning of dividend income is incidental to its business activity. However as noticed earlier, the said theory of dominant intention should not be applied as perthe decision rendered by the Hon’ble Supreme Court in the case of Maxopp Investments (supra) and hence disallowance u/s 14A is called for even in respect of investments held as stock in trade, when the exempt income is earned by the assessee.
The Karnataka Bank Ltd.
We noticed that the AO has disallowed interest expenditure also under Rule 8D(2)(ii). It is the submission of the assessee that the interest free funds available with it is more than the value of investments. Hence, as per the decision rendered by Hon’ble jurisdictional high court in the case of Micro Labs Ltd. (Supra), interest disallowance is not called for. However, this contention of the assessee requires verification at the end of the AO. Since the assessee has earned dividend income, the disallowance u/s 14A is, in any way, called for. In view of the foregoing discussions, we are of the view that this issue requires fresh examination at the end of AO. Accordingly, we set aside the order passed by ld CIT(A) on this issue and restore the same to the file of AO for examining it afresh.” 5.3 In the current year also, we notice that the assessing officer has expressed his dissatisfaction at paragraphs 4.2 and 4.4 of his order. In this year also, the AO has disallowed interest expenditure without considering interest free funds available with the assessee. Hence this issue requires to be set aside to the file of AO for examining it afresh. 5.4 Before us, the Ld A.R also placed his reliance on the latest decision rendered by Hon’ble Supreme Court in the case of South Indian Bank Ltd (2021)(438 ITR 1)(SC), wherein the Hon’ble Supreme Court has expressed following view:- “24. Another important judgment dealing with Section 14A disallowance which merits consideration is Godrej and Boyce Manufacturing Company Ltd. V. DCIT [(2017) 7 SCC 421. Here the assessee had access to adequate interest free funds to make investments and the issue pertained to disallowance of expenditure incurred to earn dividend income, which was not forming part of total income of the Assessee. Justice Ranjan Gogoi writing the opinion on behalf of the Division Bench observed that for disallowance of expenditure incurred in earning an income, it is a condition precedent that such income should not be includible in total income of assessee. This Court accordingly concluded that for attracting provisions of Section 14A, the proof of fact regarding such expenditure being incurred for earning exempt income is necessary. The relevant portion of Justice Gogoi’s judgment reads as follow: “36. ……… what cannot be denied is that the requirement for attracting the provisions of Section 14-A (1) of the Act is proof of the fact that the expenditure sought to be disallowed/deducted The Karnataka Bank Ltd. had actually been incurred in earning the dividend income………….” 25. Proceeding now to another aspect, it is seen that the Central Board of Direct Taxes (CBDT) had issued the Circular no. 18 of 2015 dated 02.11.2015, which had analyzed and then explained that all shares and securities held by a bank which are not bought to maintain Statutory Liquidity Ratio (SLR) are its stock-in-trade and not investments and income arising out of those is attributable, to business of banking. This Circular came to be issued in the aftermath of Page 18 of 22 CIT Vs. Nawanshahar Central Cooperative Bank Ltd.12 wherein this Court had held that investments made by a banking concern is part of their banking business. Hence the income earned through such investments would fall under the head Profits & Gains of business. The Punjab and Haryana High Court, in the case of Pr. CIT, vs. State Bank of Patiala13 while adverting to the CBDT Circular, concluded correctly that shares and securities held by a bank are stock in trade, and all income received on such shares and securities must be considered to be business income. That is why Section 14A would not be attracted to such income.” The Ld A.R submitted that the above said decision rendered by Hon’ble Supreme Court has expressed the view that the provisions of sec.14A would not be attracted when the income received on shares and securities held as stock in trade is assessed as business income. 5.5 As held in AY 2012-13, we set aside the order passed by Ld CIT(A) on this issue and restore the same to the file of AO for examining this issue afresh. In the set aside proceedings, the AO should also consider the effect of the decision rendered by Hon’ble Supreme Court in the case of South Indian Bank (referred supra). The assessee is free to make all contentions on this issue before the AO. 6. The next issue urged by the revenue relates to the relief granted by Ld CIT(A) in respect of disallowance made u/s 36(1)(viia) of the Act. During the year under consideration, the assessee had claimed deduction towards Provision for bad and doubtful debts (PBDD) u/s 36(1)(viia) of the Act as detailed below:- The Karnataka Bank Ltd.
(i) 7.5% of the total income - 10.18 crores (ii) 10% of aggregate average advances of rural branches - 102.00 crores ---------- 112.18 crores ---------- -- The aggregate average advances of rural branches had been computed by the assessee at Rs.1020.08 crores. The assessee had aggregated month end balances of rural advances and divided the sum so arrived at by 12 in order to arrive at aggregate average advances of rural branches. The AO, however, took the view that the above said methodology results in enhanced deduction, since the assessee would have created provision @ 10% on the opening balances of advances in the preceding year. Accordingly, the AO took the view that the assessee should be eligible for deduction only on “incremental advances” given during the year @ 10%. Accordingly, the AO computed the incremental advances as under:- Aggregate Average Advances as on 31.3.2013 - Rs. 88.15 crores Aggregate Average Advances as on 31.3.2014 - Rs.102.01 crores Incremental advance - Rs. 13.86 crores Accordingly, the AO computed 10% of AAA rural advances at Rs.1.39 crores. After adding amount of 7.5% of the total income, the AO allowed deduction u/s 36(1)(viia) at Rs.24.04 crores. The Ld CIT(A), however, accepted the workings given by the assessee, since the same is supported by the decision rendered by the Tribunal in the case of Canara Bank vs. JCIT (60 ITR (Trib.) 1)(ITAT Bang) and also some other cases. The Revenue is aggrieved. 6.1 We heard the parties on this issue and perused the record. We notice that an identical issue has been decided by the co-ordinate bench in the case of Canara Bank vs. Addl CIT (ITA No.1900/Bang/2017 dated 28- 09-2018) as under: - 7.1 In this ground (supra), the assessee assails the methodology of computation of deduction u/s.36(1)(viia) of the Act. As per the details on record, it is seen that the assessee bank had created a provision for bad and doubtful debts amounting to Rs.667,00,00,000 in the books of ITA No. 230/Pan/2018 The Karnataka Bank Ltd. account and claimed deduction of Rs.667,00,00,000 u/s.36(1)(viia) of the Act based on the Aggregate Rural Advances (AAA) computed as per Rule 6ABA of the Income Tax Rules, 1962 ('the Rules'). The Assessing Officer, however, was of the view that it is only the incremental advances that has to be considered for computing the 'AAA' and consequently allowed the deduction to the extent of Rs.251,73,53,415 and thereby disallowed Rs.415,26,46,585. On appeal, the assessee submitted that the provisions of Rule 6ABA are very clear and do not mandate that only incremental advance is to be considered, but rather the advances outstanding at the end of each month is to be considered. The learned CIT (Appeals) disregarded, both the contentions of the assessee and the judicial pronouncements cited and upheld the Assessing Officer's view that it is only the incremental advances that has to be considered for the purpose of computing AAA. 7.2 Before us, the learned Authorised Representative for the assessee reiterated the submission that the language of Rule 6ABA is very clear and does not mandate that only incremental advances has to be considered and nothing can be read into it as has been done by the authorities below. It was submitted that this issue has been considered and decided in favour of the assessee by the co-ordinate bench of this Tribunal in the case of Canara Bank Vs. JCIT (2017) 60 ITR (Trib) 1 [ITAT (Bang)]. 7.3 Per contra, the learned Departmental Representative for revenue placed reliance on the orders of the authorities below. 7.4.1 We have heard the rival contentions, perused and carefully considered the material on record; including the judicial pronouncements cited. We find that the issue before us; i.e. in respect of the computation of deduction under Section 36(1)(viia) of the Act; has been considered and decided by a co-ordinate bench of this Tribunal in the assessee's own case (supra). Further, we find that the aforesaid decision was followed by another co-ordinate bench in the case of Vijaya Bank in & 845/Bang/2017 and others dt.5.1.2018, wherein at para 7.4.1 and 7.4.2 thereof it has been held as under :- " 7.4.1 We have heard the rival contentions, perused and carefully considered the material on record; including the judicial pronouncement cited. We find that the issue before us; in respect of computation of the deduction under Section 36(1)(viia) of the Act; has been considered and decided by a co-ordinate bench of this Tribunal in the case of Canara Bank (supra); wherein at paras 18.2 and 18.3 thereof, it has been held as under :-
The Karnataka Bank Ltd.
" 18.2 We heard rival submissions and perused the material on record. The Finance Act, 1979 inserted a new clause (viia) in sub- section (1) of section 36 to provide for deduction in computation of taxable profits of schedule bank in respect of provision made for bad and doubtful debts relating to advances made by the rural branches computed in the manner prescribed under IT Rules,1962. For this purpose, 'rural branches' has been defined to mean 'branch of schedule bank situated at place with population not exceeding 10,000 according to last census'. Rule 6BA of the Income- tax Rules provides the procedure for computing AAA for the purpose of provisions of section 36(1)(viia) which reads as under: "6ABA. Computation of aggregate average advances for the purposes of clause (viia) of sub-section (1) of section 36 - For the purposes of clause (viia) of sub-section (1) of section 36, the aggregate average advances made by the rural branches of a scheduled bank shall be computed in the following manner, namely : (a) the amounts of advances made by each rural branch as outstanding at the end of the last day of each month comprised in the previous year shall be aggregated separately ; (b) the sum so arrived at in the case of each such branch shall be divided by the number of months for which the outstanding advances have been taken into account for the purposes of clause (a) ; (c) the aggregate of the sums so arrived at in respect of each of the rural branches shall be the aggregate average advances made by the rural branches of the scheduled bank. Explanation: In this rule, rural branch and scheduled bank shall have the meanings assigned to them in the Explanation to clause (viia) of sub-section (1) of section 36." From a bare reading of the above rule it is crystal clear that the said rules prescribe three steps for computing AAA in the following manner: Step One - In respect of each rural branch, note down the amounts of advances outstanding at the end of the last day of each month comprised in the previous year and aggregate the amounts so noted.
The Karnataka Bank Ltd.
Step Two- Divide the aggregate amount arrived at in Step One by the number of months for which the outstanding amounts have been taken into account for the purpose of Step One. Step Three- Aggregate the amounts arrived at under Step Two in respect of all the rural branches. Thus, it is clear that the said Rules do not provide for only fresh advances made by each rural branch during each month alone is to be considered. It only prescribes that the amount of advances made by rural branch and is outstanding at the end of the last day of each month shall be aggregated. Having regard to the plain provisions of the IT Rules, it cannot be construed that only fresh loans made by rural branches outstanding at the end of each month should be considered for the purpose of calculating AAA. It is trite law that the condition not imposed by the statute cannot be imported while construing a particular provision of Rules or statutes. Thus, the reasoning adopted by the AO as well as the CIT(A) does not stand the test of law. Furthermore, co-ordinate bench of Hyderabad Tribunal in the case of Nizamabad District Cooperative Central Bank Ltd. (supra) held as follows: "8. We have considered the submissions of the parties and perused the orders of revenue authorities as well as other materials on record. Before going into the issue, it is necessary to look into the relevant statutory provisions. Section 36(1)(vii) provides for deduction on account of bad debts actually written off in the books of account. However, proviso to 36(1)(vii) makes an exception by providing that in case of an assessee to which clause (viia) applies the claim of bad debt shall be limited to the amount by which such debt exceeds the credit balance in the provision for bad and doubtful debts made under clause (viia). Clause (viia) permits a cooperative bank to claim deduction of provision made for bad and doubtful debts as per the prescribed conditions. As has been correctly observed by ld. CIT(A), the only dispute between assessee and department is in respect of working out 10% of aggregate average rural advances. While assessee has made such working by considering the entire outstanding advances at the end of each month, AO has worked out by considering the aggregate average rural advances of each month and not on the entire outstanding advances. However, a perusal of the provision contained u/s 36(1)(viia) and rule 6ABA, would make it clear that the 10% of aggregate average advances has to be worked out on the entire outstanding advances and not the advances of that month alone. That being the case, we agree with the view held by ld. CIT(A).” …………… 18.3 In the light of the above, we hold that the methodology adopted by the AO for the purpose of computing AAA is against The Karnataka Bank Ltd. the plain provisions of rules and also against the ratio of the decision of the coordinate bench in the cases cited supra. However, remit this issue back to the file of the AO to identify rural branches less than 10,000 population as per last census and the AAA of such rural branches alone should be considered for the purpose of this deduction. Thus, these grounds of appeal are allowed for statistical purposes." 7.4.2 We find that the issue is settled in favour of the assessee by the aforesaid decision of the co-ordinate bench of this Tribunal in the case of Canara Bank (supra) and in view thereof we hold that the computation of the AAA made by the Assessing Officer is incorrect. " 7.4.2 We find that this issue is covered in favour of the assessee by the aforesaid decisions of the co-ordinate benches of this Tribunal in the assessee's own case (supra) and that of Vijaya Bank (supra), and respectfully following the same, we hold that the computation of the AAA made by the Assessing Officer while working out the deduction under Section 36(1)(viia) of the Act is incorrect and therefore delete the disallowance made there under. Consequently, ground NO.3 of the assessee's appeal is allowed. 6.2 We notice that the co-ordinate bench has rejected the view taken by the AO that the 10% of aggregate average advances of rural branches shall be available only on incremental advances. The co-ordinate bench has held that the workings given by the assessee are in accordance with Rule 6ABA and hence the 10% of aggregate average advances of rural advances has to be worked out on entire outstanding advances. We notice that the Ld CIT(A) has followed the decision rendered in the case of Canara Bank (2017)(60 ITR (Trib) 1)(Bang.) and accordingly approved the workings given by the assessee. Since the Ld CIT(A) has followed the decision rendered by the Tribunal, in which the Tribunal has held that the workings given by the assessee is in accordance with Rule 6ABA, we do not find any reason to interfere the decision rendered by Ld CIT(A) on this issue.
6.3 The revenue has also raised a ground relating to the correctness of classification of branches as “rural branches”. However, we notice that the AO, after discussing about the correctness or otherwise of the classification of certain branches as “Rural branches” and also after The Karnataka Bank Ltd. discussing the decision rendered by Hon’ble Kerala High Court in the case of CIT vs. Lord Krishna Bank, has not disallowed any portion of the claim applying this principle. Hence there was no occasion for Ld CIT(A) to address on this issue. Hence we are of the view that the observation made by the AO on this point shall become infructuous, since no disallowance was made on this principle.
We shall now take up the appeal filed by the assessee. The first issue urged by the assessee relates to the disallowance of bad debts claimed u/s 36(1)(vii) of the Act applying the proviso to sec. 36(1)(vii) of the Act to non- rural/urban advances also, while the contention of the assessee is that the proviso to sec.36(1)(vii) shall apply to rural advances only for categories of bank like that of the assessee, who has claimed deduction under clause (a) of sec. 36(1)(viia) of the Act.
7.1 The assessee claimed a sum of Rs.146.28 crores bad debts, which consisted of bad debts relating to rural branches Rs.1.12 crores and the non-rural branches Rs.145.16 crores. The AO noticed that the bad debts written off was not debited to Profit and Loss account. The AO also noticed that the new provision created during the year was Rs.210.54 crores, out of which the assessee had claimed a sum of Rs.112.19 crores as deduction u/s 36(1)(viia) of the Act. Accordingly, the AO took the view that the assessee is claiming deduction both u/s 36(1)(vii) and 36(1)(viia) of the Act. The assessee submitted that the bad debts claimed by it included prudential write off of Rs.134.86 crores. The AO expressed the view that the Prudential write off is not eligible for deduction u/s 36(1)(vii) of the Act, since it is not actual write off. He then relied upon the decision rendered by Hon’ble Supreme Court in the case of Southern Technologies vs. ACIT (352 ITR 577)(SC), wherein it was held that the mere making of provision for NPA cannot be considered as write off u/s 36(1)(vii) of the Act. He also relied upon the decision rendered by Hon’ble Kerala High Court in the case of CIT vs. Hotel Ambassador (2002)(253 ITR 430)(Ker), wherein it was held that the deduction u/s 36(1)(vii) of the Act only if the assessee debits the same into the accounts as irrecoverable. Accordingly, the AO took the view The Karnataka Bank Ltd. that the amount of bad debts claimed by the assessee was mere provision and not actual write off. Before the AO, the assessee had placed reliance on the decision rendered by Hon’ble Supreme Court in the case of Vijaya Bank vs. CIT (2010)(320 ITR 166 (SC)) to reiterate that it is entitled for deduction u/s 36(1)(vii) of the Act. The AO expressed the view that the issue considered by Hon’ble Supreme Court in the case of Vijaya Bank (supra) related to category of “Loss Assets”, which is required to be provided @ 100% of the outstanding amount. He further expressed the view that the Hon’ble Supreme Court did not consider the question viz., Whether the provision for non-performing assets created by the assessee bank by debiting P & L a/c and crediting the provision account would comply with the requirement of actual write off of ‘bad debts” as mentioned in sec. 36(1)(vii) of the Income tax Act? Accordingly, the AO held that the assessee cannot place reliance on the decision rendered by Hon’ble Supreme Court in the case of Vijaya Bank (supra). Accordingly the AO held that the amount of Rs.145.16 crores was mere prudential write off and hence not allowable as deduction. He also held that it is a clear case of double deduction, i.e., once u/s 36(1)(viia) and again u/s 36(1)(vii) of the Act. Accordingly he disallowed the claim of bad debts of Rs.145.16 crores relating to non-rural advances. 7.2 The Ld CIT(A) did not agree with the view expressed by AO. He followed his decision rendered in the earlier year in the assessee’s own case and held that the assessee’s case is covered by the decision rendered by Hon’ble Supreme Court in the case of Vijaya Bank 323 ITR 166. It is pertinent to note that in AY 2013-14, the Ld CIT(A) had held as under:- “6.5 Conclusion:- a) It seen that the write off at the branch (Rs.101.72 cr.) & HO level (Rs.90.65 cr) together amounting to Rs.192.37 crores was debited to Provision account (which is part of the accounts of the assessee) which has the effect of reducing the advances in the balance sheet. b) It is clear from the working of net advances and submissions that the assessee bank has not only debited provision a/c to the extent of bad debts, it simultaneously reduced the amount of loans and advances at the year end. In other words, the The Karnataka Bank Ltd. amount of loans and advances at the year end in the Balance sheet is shown as net of bad debts written off. We also notice that the revenue has not filed appeal challenging the above said decision of Ld CIT(A) and hence this view of Ld CIT(A) on this issue has attained finality. 7.3 The Ld CIT(A), however, proceeded to examine this aspect from another angle, i.e., he took the view that the AO has not examined the claim of write off ‘non-rural bad debts” of Rs.145.16 crores in terms of the proviso to sec. 36(1)(vii) read with 36(1)(viia) of the Act. Before Ld CIT(A), the assessee submitted that the “provision for bad and doubtful debts” (PBDD) allowed u/s 36(1)(viia) of the Act is related to rural debts only and hence, in terms of the proviso to sec. 36(1)(vii), only rural debts written off as bad should be adjusted against the PBDD allowed u/s 36(1)(viia) of the Act. However, the Ld CIT(A) expressed the view that the PBDD allowed u/s 36(1)(viia) of Act is applicable to both Rural and non-Rural debts. Accordingly, he held that the entire amount of bad debts written off (both rural and non-rural) should be first adjusted against the PBDD a/c allowed u/s 36(1)(viia) of the Act and only the excess should be allowed as deduction. He expressed the view that the decision rendered by Hon’ble Supreme Court in the case of Catholic Syrian Bank (2012)(343 ITR 270)(SC) was rendered under the assumption that the banks would maintain separate PBDD a/c in respect of rural branches and non-rural branches and therefore it is possible to distinguish PBDD as one in respect of rural branches and non-rural branches. The Ld CIT(A) expressed the view that the claim of the bank that the provisions of sec. 36(1)(viia) are distinct and independent of sec. 36(1)(vii) is based on the old circular no. 258 dated 14.6.1979 issued in connection with old law. Accordingly the Ld CIT(A) held that the PBDD allowed u/s 36(1)(viia) of the Act is for single account since its introduction in 1985 and it is for all types of advances including rural advances. He also observed that the above said view has been clarified by Finance Act, 2013 by inserting Explanation 2 to sec 36(1)(vii) of the Act. Accordingly, the Ld CIT(A) held that the bad debts pertaining to non-rural advances should also be first adjusted against The Karnataka Bank Ltd.
PBDD created u/s 36(1)(viia) of the Act. Accordingly, the Ld CIT(A) directed the assessee to furnish workings of PBDD a/c. As per the working so furnished, the opening credit balance as on 1.4.2013 in the PBDD account was shown at Rs.562.17 crores. Since it is more than the bad debts pertaining to non-rural branches of Rs.145.16 crores, the Ld CIT(A) held that the bad debts claim of non-rural branches is not allowable as deduction u/s 36(1)(vii) of the Act, as it does not exceed the Opening balance shown in PBDD a/c. 7.4 In AY 2013-14 also, the Ld CIT(A) had disallowed the claim made u/s 36(1)(vii) on identical reasons. However, the Tribunal has reversed the decision rendered by Ld CIT(A) by following the decision rendered by Hyderabad bench of Tribunal in the case of State Bank of Hyderabad vs. DCIT (ITA No.450/Hyd/2015, and 499/Hyd/2015 dated August 14, 2015). The relevant observations made by the Tribunal are extracted below:- “19. We have considered the rival submissions and perused the materials on record as well as the orders of revenue authorities. As could be seen from the finding of AO as well as ld. CIT(A), only reason for which claim of deduction for Rs. 209,07,50,831 representing actual write off of bad debts relating to non-rural advances u/s 36(1)(vii) was denied is, assessee having already availed deduction u/s 36(1)(viia), it is not eligible to claim deduction u/s 36(1)(vii) as it will amount to double deduction. In our view, both AO as well as ld. CIT(A) have committed fundamental error by mixing up provisions of sections 36(1)(vii) and 36(1)(viia). While 36(1)(vii) speaks of actual write off of bad debts in the books of account, section 36(1)(viia) even allows provision made towards bad and doubtful debts in respect of rural advances to the extent of provision made in the books of account subject to the ceiling fixed under clause (viia) of section 36(1). Proviso to section 36(1)(vii) operates only in a case where deduction is also claimed under section 36(1)(viia). In other words, proviso to section 36(1)(vii) applies to write off of bad debts relating to rural advances to the extent it exceeds the provision made u/s 36(1)(viia). If we examine the facts of the present case in the context of aforesaid statutory provision, it will be evident that assessee, though, has written off in the books of account an amount of Rs. 210.74 crore, but, in the computation of total income, the actual deduction claimed u/s 36(1)(vii) is Rs. 209.08 crore representing bad debts written off relating to non-rural/urban advances. The balance amount of bad debts relating to rural advances was not claimed as deduction by assessee in terms with the proviso to section 36(1)(vii) as it has not exceeded the provision for bad and doubtful debts relating to rural advances created u/s 36(1)(viia). Both AO and ld. CIT(A) have misconstrued the statutory provisions while observing that proviso to section 36(1)(vii) would also apply in case of bad debts relating to non-rural advances. The Hon'ble Supreme Court in case of Catholic Syrian Bank Vs. CIT (supra) while analyzing provisions The Karnataka Bank Ltd. of section 36(1)(vii) and 36(1)(viia) have observed that section 36(1)(viia) applies only to rural advances. The observations made by Hon'ble Apex Court in this regard in paras 26 & 27 of the judgment is extracted hereunder for convenience. "26. The Special Bench of the Tribunal had rejected the contention of the Revenue that proviso to s. 36(1)(vii) applies to all banks and with reference to the circulars issued by the Board, held that a bank would be entitled to both deductions, one under cl. (vii) of s. 36(1) of the Act on the basis of actual write off and the other on the basis of cl. (viia) of s. 36(1) of the Act on the mere making of provision for bad debts. This, according to the Revenue, would lead to double deduction and the proviso to s. 36(1)(vii) was introduced with the intention to prevent this mischief. The contention of the Revenue, in our opinion, was rightly rejected by the Special Bench of the Tribunal and it correctly held that the Board itself had recognized the position that a bank would be entitled to both the deductions. Further, it concluded that the proviso had been introduced to protect the Revenue, but it would be meaningless to invoke the same where there was no threat of double deduction.
As per this proviso to cl. (vii), 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." Concurring with the aforesaid majority view, Hon'ble CJI, S.H. Kapadia, as the then he was, held as under: "2. Under Section 36(1)(vii) of the ITA 1961, the tax payer carrying on business is entitled to a deduction, in the computation or taxable profits, of the amount of any debt which is established to have become a bad debt during the previous year, subject to certain conditions. However, a mere provision for bad and doubtful debt(s) is not allowed as a deduction in the computation of taxable profits. In order to promote rural banking and in order to assist the scheduled commercial banks in making adequate provisions from their current profits to provide for risks in relation to their rural advances, the Finance Act, inserted clause (viia) in subsection (1) of Section 36 to provide for a deduction, in the computation of taxable profits of all scheduled commercial banks, in respect of provisions made by them for bad and doubtful debts relating to advances made by their rural branches. The deduction is limited to a specified percentage of the aggregate average advances made by the rural branches computed in the manner prescribed by the IT Rules, 1962. Thus, the provisions of clause (viia) of Section 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 Section 36(11(vii) relating to allowance of the bad debt(s). In other words, the scheduled commercial banks continue to get the full benefit of the write off of the irrecoverable debt(s) under Section 36(1)(vii) in addition to The Karnataka Bank Ltd.
the benefit of deduction for the provision made for bad and doubtful debt(s) under section 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 clause (viia) and also on the basis of actual write off under clause (vii). This situation is taken care of by the proviso to clause (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 account created under clause (viia). However, the Revenue disputes the position that the proviso to clause (vii) refers only to rural advances. It says that there are no such words in the proviso which indicates that the proviso apply only to rural advances. We find no merit in the objection raised by the Revenue. Firstly, CBDT itself has recognized the position that a bank would be entitled to both the deduction, one under clause (vii) on the basis of actual write off and another, on the basis of clause (viia) in respect of a mere provision. Further, to prevent double deduction, the proviso to clause (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 clause (viia). Thus, the proviso to clause (vii) stood introduced in order to protect the Revenue. It would be meaningless to invoke the said 1 proviso where there is no threat of double deduction. In case of rural advances, which are covered by the provisions of clause (viia), there would be no such double deduction. The proviso limits its application to the case of a bank to which clause (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 clause (vii)." Thus, considered in light of principle laid down as referred to above, when the proviso to section 36(1)(vii) applies to bad debts written off relating to rural advances, the same cannot be applied for disallowing deduction claimed on account of write off of bad and doubtful debts relating to non-rural/urban advances. As far as application of explanation to section 36(1)(vii) is concerned, we agree with the ld. AR that its operation will be prospective and will not apply to the impugned AY. For this proposition, we rely upon the decision of the ITAT Mumbai in case of Bank of India Vs. Addl. CIT (supra). Even otherwise also, careful reading of explanation to section 36(1)(vii) would indicate that nowhere it suggests that the proviso to section 36(1)(vii) would apply in respect of bad debt written off relating to non- rural advances. In the aforesaid view of the matter, we hold that assessee would be eligible to avail deduction of an amount of Rs. 209.94 crore representing actual write off in the books of account of bad debts relating to non-rural/urban advances The Karnataka Bank Ltd. in terms with section 36(1)(vii), as proviso to the said section would not apply to non-rural advances. Accordingly, we delete the addition made by AO and confirmed by ld. CIT(A).” 5.4 Following the above said decision, we hold that the view expressed by Ld CIT(A) is not legally correct. Accordingly, we set aside the order passed by Ld CIT(A) with regard to his alternative decision, i.e., the view that the proviso to sec. 36(1)(vii) which requires adjustment of bad debts against provision allowed u/s 36(1)(viia) would apply to non-rural advances also. Accordingly, we direct the AO to delete the disallowance of Rs.192.02 crores.”
7.5 The Ld A.R submitted that the Ld CIT(A) has rendered his decision by following his decision rendered in AY 2013-14 and earlier years. He submitted that Finance Act, 2013 has inserted “Explanation 2” in sec. 36(1)(vii) of the Act and the same reads as under:-
“Explanation 2 – For the removal of doubts, it is hereby clarified that for the purposes of the proviso to clause (vii) of this sub-section and clause (v) of sub section (2), the account referred to therein shall be only one account in respect of provision for bad and doubtful debts under clause (via) and such account shall relate to all types of advances, including advances made by rural branches;” The Ld A.R submitted that the Ld CIT(A) has referred to the above said Explanation -2 in 6.13.2(viii) -Page 38 of his order and observed that the view taken by him in earlier years has been clarified in Explanation-2. Thus, according to Ld CIT(A) as well as by the revenue that the decision rendered by Hon’ble Supreme Court in the case of Catholic Syrian Bank (2012)( 343 ITR 270) has been undone by the Parliament by inserting Explanation-2 in sec. 36(a)(vii) of the Act by Finance Act 2013.
7.6 The Ld A.R, however, contended that Explanation-2 has not changed the legal position for claiming deduction of bad debts written off u/s 36(1)(vii) and also claiming PBBD u/s 36(1)(viia) for banks having rural branches. According to Ld A.R, the assessee has claimed deduction towards PBDD under clause (a) of sec. 36(1)(viia) and it relates to the rural advances only. Hence the proviso to sec. 36(1)(vii) shall have bearing only The Karnataka Bank Ltd. on PBDD relating to rural advances only. Thus, according to Ld A.R, the bad debts written off relating to non-rural advances should be allowed independently u/s 36(1)(vii) of the Act without first adjusting the same against PBDD allowed under clause (a) of sec. 36(1)(viia) of the Act.
7.7 We heard the Ld D.R and perused the record. Now the core question that arises is whether the bad debts relating to non-rural branches are also required to be first debited to PBDD a/c and then the excess amount over and above the balance available in PBDD alone could be allowed as bad debts u/s 36(1)(vii) of the Act.
7.8 The provisions of sec. 36(1)(vii) allows deduction as under:-
36(1)(vii) 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 for the previous year. 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 under that clause. ……….. Explanation 2 – For the removal of doubts, it is hereby clarified that for the purposes of the proviso to clause (vii) of this sub-section and clause (v) of sub section (2), the account referred to therein shall be only one account in respect of provision for bad and doubtful debts under clause (via) and such account shall relate to all types of advances, including advances made by rural branches; The provisions of sec.36(2)(v) are relevant here and it reads as under:-
“(2) In making any deduction for a bad debt or part thereof, the following provisions shall apply---- …….
(v) where such debt or part of debt relates to advances made by an assessee to which clause (viia) of sub-section (1) applies, no such deduction shall be allowed unless the assessee has debited the amount of such debt or part of debt in that previous year to the The Karnataka Bank Ltd.
‘provision for bad and doubtful debts’ account made under that clause.” A combined reading of provisions of clause (vii) of sec.36(1), the proviso thereunder and clause (v) of sec.36(2) would show that (a) the bank should debit the actual bad debts written off by it to “PBDD a/c” (sec. 36(2)(v))
(b) the deduction u/s 36(2)(vii) shall be limited to the amount by which such debt or part thereof exceeds the credit balance in the PBDD made under clause (viia) of sec.36(1).
7.9 The contention of the revenue is that the Explanation 2 has expanded the scope of the proviso to sec. 36(1)(vii) and hence the bad debts relating to non-rural branches are also required to be first debited to PBDD a/c and the excess amount alone can be allowed as deduction u/s 36(1)(vii) of the Act. According to revenue, the decision rendered by Hon’ble Supreme Court in the case of Catholic Syrian Bank (2012)( 343 ITR 270). In the above said case, the Hon’ble Supreme Court has expressed the view that the provisions of sec. 36(1)(vii) and 36(1)(viia) allow separate deduction and they are independent provisions. The Supreme Court further held that the clause (viia)(a) applies only to rural advances. So the bad debts relating to non-rural advances need not be deducted against the PBDD allowed under clause (a) of sec.36(1)(viia) of the Act. The Hon’ble Supreme Court, inter alia, also observed as under:-
31 It was neither in dispute earlier nor is it disputed before us, that the assessee-bank is maintaining two separate accounts, one being a provision for bad and doubtful debts other than provision for bad debts in rural branches and another provision account for bad debts in rural branches for which separate accounts are maintained….
Referring to the above said observations, the revenue has taken the view that the Hon’ble Supreme Court has rendered its decision on the assumption that the banks would be maintaining two separate PBDD a/c, viz., one for rural branches and another one for non-rural branches. The Karnataka Bank Ltd.
7.10 It is possible that all banks may not be maintaining two separate accounts, as observed by the Hon’ble Supreme Court. Hence there was an apprehension in the minds of revenue with regard to the effect of the decision rendered by Hon’ble Supreme Court. For instance, if a particular bank is maintaining only a single PBDD a/c for the provision created u/s 36(1)(viia) of the Act and even if that bank is not having any rural branches, then it may try to avail the benefit of decision rendered by Hon’ble Supreme Court and may possibly contend that (i) the provision allowed u/s 36(1)(viia) shall apply only to rural branches.
(ii) since it does not maintain two separate PBDD a/c for rural and non-rural advances, the bad debts relating non-rural branches need not be reduced from the PBDD a/c allowed u/s 36(1)(viia) in terms of sec. 36(2)(v) and the proviso to sec. 36(1)(vii) of the Act.
However, the Ld A.R submitted before us that the Explanation 2 has been inserted in sec. 36(1)(vii) by Finance Act, 2013 (after the decision of Catholic Syrian Bank) to debar certain assessees to avail the interpretation given by Hon’ble Supreme Court in the case of Catholic Syrian Bank (supra).
7.11 We have considered the arguments advanced by Ld A.R on this point. According to Ld A.R, if we closely analyse the provisions of sec. 36(1)(viia) of the Act, the intention of the Parliament in inserting Explanation -2 shall become clear. Accordingly, we analysed the provisions of sec.36(1)(viia) and notice that the said section allows deduction of PBDD to various types of assessees, viz., (i) Clause (a) of sec. 36(1)(viia) shall be applicable to a Scheduled bank (not being a bank incorporated by or under the laws of a country outside India) or non-scheduled bank or a co-operative bank other than a primary agricultural credit society or a primary co- operative agricultural and rural development bank. The quantum of The Karnataka Bank Ltd. deduction is 7.50% of Total income (computed before making any deduction under this clause and Chapter VIA) and an amount not exceeding 10% of aggregate average advances made by the rural branches of such bank.
(ii) Clause (b) of sec. 36(1)(viia) shall be applicable to a bank incorporated by or under the laws of a country outside India. The quantum of deduction is 5% of the total income (computed before making any deduction under this clause and Chapter VIA).
(iii) Clause (c) is applicable to a public financial institution or a State financial corporation or a State industrial investment corporation. The quantum of deduction is 5% of total income (computed before making any deduction under this clause and Chapter VIA).
(iv) Clause (d) is applicable to Non-banking financial company from AY 2017-18.
The Hon’ble Supreme Court in the case of Catholic Syrian Bank (supra) has held that the PBDD allowed under clause (a) of Sec. 36(1)(viia) refers to ‘rural advances’ only. In fact the expression “rural branches” finds place in clause (a) only. It can be noticed that the reference to “rural branches” is not there in clause (b) to (d). Generally, the foreign banks may not have rural branches. However, such kind of banks, financial institutions, NBFC etc. are also eligible to claim deduction towards PBDD u/s 36(1)(viia) of the Act under clauses (b) to (d). In view of the decision rendered in the case of Catholic Syrian bank, it is possible that the assessees covered by clause (b) to (d) may contend that the bad debts written off by them need not be adjusted against PBDD allowed u/s 36(1)(viia) of the Act, since the bad debts relate to “non-rural debts”. Accordingly, we are of the view that the Explanation 2 has been inserted in order to bring the assesses covered by clauses (b) to (d) within the ambit of the proviso to sec. 36(1)(vii) and sec. 36(2)(v) of the Act. Hence, in our The Karnataka Bank Ltd. view, advances given by rural and non-rural branches mentioned in Explanation 2 shall apply to the assesses covered by clause (b) to (d) of sec. 36(1)(viia) of the Act.
7.12 At this juncture, we may gainfully refer to the “MEMORANDUM EXPLAINING FINANCE BILL 2013”, which brings out the intention of the Parliament in inserting Explanation-2 in sec. 36(1)(vii) of the Act. It is extracted below:-
“Clarification for amount to be eligible for deduction as bad debts in case of banks:-
Under the existing provisions of section 36(1)(viia) of the Income-tax Act, in computing the business income of certain banks and financial institutions, deduction is allowable in respect of any provision for bad and doubtful debts made by such entities subject to certain limits specified therein. The limit specified under section 36(1)(viia)(a) of the Act restrict the claim of deduction for provision for bad and doubtful debts for certain banks (not incorporated outside India) and certain cooperative banks to 7.5% of gross total income (before deduction under this clause) of such banks and 10% of the aggregate average advance made by the rural branches of such banks. This limit is 5% of gross total income (before deduction under this clause) under sections 36(1)(viia)(b) and 36(1)(viia)(c) for a bank incorporated outside India and certain financial institutions.
Provisions of clause (vii) of section 36(1) of the Act provides for deduction for bad debt actually written off as irrecoverable in the books of account of the assessee. The proviso to this clause provides that for an assessee, to which section 36(1)(viia) of the Act applies, deduction under said clause (vii) shall be limited to the amount by which the bad The Karnataka Bank Ltd. debt written off exceeds the credit balance in the provision for bad and doubtful debts account made under section 36(1) (viia) of the Act. The provisions of section 36(1)(vii) of the Act are subject to the provisions of section 36(2) of the Act. The clause (v) of section 36(2) of the Act provides that the assessee, to which section 36(1)(viia) of the Act applies, should debit the amount of bad debt written off to the provision for bad and doubtful debts account made under section 36(1) (viia) of the Act. Therefore, the banks or financial institutions are entitled to claim deduction for bad debt actually written off under section 36(1)(vii) of the Act only to the extent it is in excess of the credit balance in the provision for bad and doubtful debts account made under section 36(1)(viia) of the Act.
However, certain judicial pronouncements have created doubts about the scope and applicability of proviso to section 36(1)(vii) and held that the proviso to section 36(1)(vii) applies only to provision made for bad and doubtful debts relating to rural advances. Section 36(1)(viia) of the Act contains three sub-clauses, i.e. sub-clause (a), sub-clause (b) and sub-clause (c) and only one of the sub-clauses i.e. sub-clause (a) refers to rural advances whereas other sub-clauses do not refer to the rural advances. In fact, foreign banks generally do not have rural branches. Therefore, the provision for bad and doubtful debts account made under clause (viia) of section 36(1) and referred to in proviso to clause (vii) of section 36(1) and section 36(2)(v) applies to all types of advances, whether rural or other advances. It has also been interpreted that there are separate accounts in respect of provision for bad and doubtful debt under clause (viia) for rural advances and urban advances and if the actual write off of debt relates to urban advances, then, it should not be set off against provision for bad and doubtful The Karnataka Bank Ltd. debts made for rural advances. There is no such distinction made in clause (viia) of section 36(1). In order to clarify the scope and applicability of provision of clause (vii), (viia) of sub-section (1) and sub-section (2), it is proposed to insert an Explanation in clause (vii) of section 36(1) stating that for the purposes of the proviso to section 36(1)(vii) and section 36(2)(v), only one account as referred to therein is made in respect of provision for bad and doubtful debts under section 36(1)(viia) and such account relates to all types of advances, including advances made by rural branches. Therefore, for an assessee to which clause (viia) of section 36(1) applies, the amount of deduction in respect of the bad debts actually written off under section 36(1)(vii) shall be limited to the amount by which such bad debts exceeds the credit balance in the provision for bad and doubtful debts account made under section 36(1)(viia) without any distinction between rural advances and other advances. This amendment will take effect from 1st April, 2014 and will, accordingly, apply in relation to the assessment year 2014-15 and subsequent assessment years.
The CBDT has issued an Explanatory note to the Provisions of Finance Act, 2013 on 24.01.2014 in F No.142/24/2013 – TPC, wherein also the very same explanations have been given for introducing Explanation – 2 in Sec. 36(1)(vii) of the Act. The above said Memorandum and the Explanatory Note issued by the Government/CBDT supports our view.
7.13 Our view is further fortified by certain observations made by Hon’ble Supreme Court in the case of Catholic Syrian Bank (supra). We may refer to paragraph 27 of the decision now:-
“27. As per this proviso to clause (vii), the deduction on account of the actual write off of bad debts would be limited to the excess of the The Karnataka Bank Ltd. amount written off over the amount of the provision which had already been allowed under clause (viia). The proviso by and large protects the interests of the Revenue. In case of rural advances which are covered by clause (viia), there would be no such double deduction. The proviso, in its terms, limits its application to the case of a bank to which clause (viia) applies. Indisputably, clause (viia)(a) applies only to rural advances.”
It is pertinent to note that the Hon’ble Supreme Court has categorically held that clause (a) of sec. 36(1)(viia) applies to rural advances only. If the Parliament wanted to undo the above said interpretation given by the Hon’ble Supreme Court, it should have brought amendment in clause (a) to sec. 36(1)(viia) to make its intention clear that the clause (a) shall apply to both rural and non-rural advances. Since there is no such amendment, the interpretation given by Hon’ble Supreme Court that “clause (viia)(a) applies to rural advances only” shall remain intact. Explanation 2 inserted in sec. 36(1)(vii), in our view, does not override the above said interpretation given by Hon’ble Supreme Court.
7.14 In the Memorandum explaining the purpose of introducing Explanation -2 in Sec. 36(1)(vii), it has been acknowledged that only the clause (a) refers to “rural branches”. It has also been stated that the foreign banks do not have rural branches. The assesses covered by clause (b) to (d) may not be having rural branches. Hence, the memorandum explains as under with regard to the decision rendered by Hon’ble Supreme Court in the case of Catholic Syrian Bank (supra):-
However, certain judicial pronouncements have created doubts about the scope and applicability of proviso to section 36(1)(vii) and held that the proviso to section 36(1)(vii) applies only to provision made for bad and doubtful debts relating to rural advances.
Because of the interpretation so given by Hon’ble Supreme Court, as discussed earlier, there arose a necessity for the Parliament to clarify that the PBDD allowed u/s 36(1)(viia) shall apply to all types of advances The Karnataka Bank Ltd. including advances made by rural branches. However, as stated earlier, the clause (a) to sec.36(1)(viia) has been held to be applicable to rural advances only and this interpretation has not been overridden by any amendment.
7.15 As noticed earlier, the assessees covered by clauses (b) to (d) may not be having rural branches, but they would be getting the benefit of deduction of PBDD u/s 36(1)(viia) of the Act. Hence, in order to bring those assessees within the ambit of the proviso to sec. 36(1)(vii) and sec. 36(2)(v), it was imperative for the Parliament to clarify the legal position and accordingly Explanation-2 has been inserted in sec. 36(1)(vii) of the Act. Accordingly, on the analysis of the provisions discussed above, we are of the view that the above said Explanation-2 shall operate (a) in respect of clause (a) of sec. 36(1)(viia) of the Act only to rural advances and (b) in respect of clauses (b) to (d), for advances given by both rural and non-rural branches. 7.16 In the instant case, the assessee has claimed deduction towards PBDD under clause (a) to sec. 36(1)(viia) of the Act, meaning thereby, the clause (a) is applicable to rural advances only as per the decision given by Hon’ble Supreme Court in the case of Catholic Syrian Bank. Hence the bad debts relating to non-rural branches are not required to be adjusted against PBDD allowed under clause (a) of sec. 36(1)(viia) of the Act in terms of the proviso to sec. 36(1)(vii) and sec. 36(2)(v) of the Act. 7.17 In view of the foregoing discussions, we are unable to agree with the view expressed by Ld CIT(A) on this issue. Accordingly, we set aside the order passed by Ld CIT(A) on this issue and direct the AO to allow the bad debts relating to non-rural branches u/s 36(1)(vii) of the Act without adjusting the same against the PBDD a/c, since the said PBDD a/c relates to rural advances only.
The second issue urged by the assessee by way of additional ground relates to the claim for deduction of Education cess paid by the assessee during the year under consideration. In view of the amendment brought in The Karnataka Bank Ltd.
by the Finance Act, 2022 stating that the education cess is not allowable as deduction, this ground of the assessee is dismissed. 9. In the result, the appeal filed by the Revenue is dismissed and the appeal of the assessee is partly allowed. Order pronounced in the open Court on 26th May, 2022.