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Income Tax Appellate Tribunal, ‘A’ BENCH, CHENNAI
Before: SHRI V. DURGA RAO & SHRI G. MANJUNATHA
This appeal filed by the assessee is directed against order passed by the learned Commissioner of Income Tax (Appeals)-11, Chennai, dated 22.04.2016 and pertains to assessment year 2006-07.
The assessee has raised following grounds of appeal:-
“1. The order of the Commissioner of Income tax (Appeals) is contrary to Law, facts and in the circumstances of the case.
2. The Commissioner of Income tax (Appeals) erred in confirming disallowance of provision for Bad Debt Written off amounting to Rs.10,19,08,345/-
2.1 The Commissioner of Income tax (Appeals) ought to have appreciated that as per 4.2 of part IV of Electricity (supply) Annual Account Rule (ESSAR)1985, based on which electricity company accounts are prepared, a fixed percentage of dues from consumers shall be maintained as a provision from meeting debts which turn bad.
2.2 The Commissioner of Income tax (Appeals) ought to have appreciated that as per the above statutory rule, the provision for bad and doubtful debts shall at the closure of the financial year be at the rate of 2.5% of the sundry debtors on sale of power at the end of the year. Every year, the difference in the provision for Bad and Doubtful debts alone has been charged to profit and Loss and not afresh provision of 2.5%.
2.3 The Commissioner of Income tax (Appeals) ought to have appreciated that the provision for doubtful debts have been netted off against the Debtors in the balance and hence would amount to write off. Hence the provision for Debts doubtful of recovery should be allowed as a deduction.
2.4 The Appellant relies on the decision of the Apex Court in the case of Vijaya Bank Limited Vs CIT - 323 ITR 166 (SC)”
The brief facts of the case are that the assessee is a Public Sector Undertaking of State Government of Tamil Nadu and is engaged in the business of generation, transmission and distribution of electricity in the State of Tamil Nadu. The assessee has filed its return of income for the assessment year 2006-07 on 28.11.2006 declaring loss of Rs.8,71,38,55,895/- and said return has been, subsequently revised on 27.10.2007 declaring loss at Rs.8,96,94,34,534/-.
During the financial year relevant to assessment year 2006-07, the assessee has made a provision for bad and doubtful debts @ 2.5% of sundry debtors on sale of power at Rs.10,19,08,345/- and claimed that such provision is required to be made in terms of Electricity (Supply) Annual Account Rule, 1985. The assessee has made provision @ 2.5% of sundry debtors year on year and same has been reversed in subsequent years and fresh provision is made every year. The assessee claimed that provision is required to be made as per Electricity (Supply) Annual Account Rule, 1985, because dues from customers may become bad and to compensate loss, provision is required to be made in books of account of the assessee.
The Assessing Officer, however was not convinced with the explanation furnished by the assessee and according to him, provision made by the assessee for bad and doubtful debts @ 2.5% on sundry debtors is a mere provision, but not written off of actual bad debts irrecoverable. Therefore, the Assessing Officer opined that provision made by the assessee is not in accordance with provisions of section 36(1)(viia) r.w.s 36(2) of the Income Tax Act, 1961, and thus, rejected arguments of the assessee and disallowed provision made for bad and doubtful debts at Rs.10,19,08,345/- The relevant findings of the Assessing Officer are as under:-
“The assessee claimed a sum of Rs.10,19,08,345/- towards provision for bad and doubtful debts in the profit and loss account under the head other debits account. It was asked to the assessee’ why the provision for bad and doubtful debts cannot be disallowed and added to the total income as it is not an eligible expenditure for deduction?’. The reply submitted by the assessee dated 15.12.2008 stated “As we have explained during the previous occasions as per the Statutory Rule by the Government of India for adoption by State Electricity Boards vide the para 4.2 of part 1V of Electricity (supply) Annual Account rule, 1985, a fixed percentage of dues from consumers shall be maintained as a provision for meeting debts which turn bad. As per the above statutory rule this provision is made at the rate of 2.5% of the sundry debtors on sale of power during the year. This is not accumulated or carried over but reversed and provided afresh every year. It is also submitted that the actual dues from customers which would turn bad will be much more than that of the provision and eventually all these get written off. A copy of the relevant rule prescribed is enclosed for reference. Therefore it is submitted that provision made in the accounts is statutory and in addition whatever the actual bad debts over and above the provision also gets written off “.
I have considered the arguments of the assessee. But the contention of the assessee cannot be accepted. After careful reading of the above said rules referred by the assessee, it is clear that there is a clause for making provision for the bad and doubtful debts at the prescribed percentage. But at the same time there is no material to show, that it can be claimed as a revenue expenditure in the profit and loss account. Further, since it is only a provision it cannot be claimed as an expenditure. Moreover according to the provisions of the Income Tax Act, any provision made by assessee cannot be claimed as an eligible expenditure for deduction unless it is specifically allowed u/s 36(1)(viia). Considering the facts of the case, as the expenditure is not a statutory liability to be charged against the revenue and actually there was no payment in this regard the claim of the assessee is hereby is not accepted and a sum of Rs. 10,19,08,345/- is added to the total income.”
Being aggrieved by the assessment order, the assessee preferred an appeal before the learned CIT(A). Before the learned CIT(A), the assessee has filed detailed written submissions on the issue which has been reproduced at para 5.2 on page 3 to 7 of the learned CIT(A) order. The assessee had also taken support from certain judicial precedents. The sum and substance of arguments of the assessee before the learned CIT(A) are that provision for bad and doubtful debts @ 2.5% of sundry debtors is a bad debt, which has been reduced from debtors account in the balance sheet and therefore, even if it was shown as liability in the books of account of the assessee, but, because same was deducted from asset side in the balance sheet, it amounts to actual write off of bad debt.
Therefore, argued that it had satisfied conditions prescribed u/s.36(1)(vii) r.w.s 36(2) of the Act, and thus, the assessee is entitled for deduction towards provisions for bad and doubtful debts.
6, The learned CIT(A), after considering relevant facts and also taken note of various case laws held by the assessee held that even though the assessee is bound by rule of Regulatory Authority and is required to create provision for bad debts on certain percentage, but the assessee is entitled for deduction under section 36(10(vii) rws 36(2) of the Income tax Act, 1961 if such deductions are permissible. Since, provision made by the assessee for bad and doubtful debts is not bad debt which is irrecoverable and which does not satisfies conditions prescribed u/s.36(1)(vii) r.w.s 36(2) of the Act, the assessee is not entitled for deduction towards provision for bad and doubtful debts and therefore, rejected arguments of the assessee and sustained additions made by the Assessing Officer . The relevant findings of the learned CIT(A) are as under:-
“5.3.2 I have considered both the points of view. In this connection, 1 have also perused the revision order u/s.263 dt.3 1/3/2015 in the appellant’s case for the assessment year 2010- 11 on the aforesaid issue. The Pr.CIT-III, Chennai has made the following observation while setting aside the AO’s order directing it as erroneous and prejudicial to the interest of revenue and the relevant portion of the same is reproduced below:
“It is understood that the assessee is bound by the rule for its regulatory authority and is required to create provision for bad debts @ 2.5% of the sundry debtors. However, the issue at hand is whether such provision is allowable as deduction in computing the total income under the Income tax Act.
Provision for bad debts is allowable only in the case of banking companies under Sec.36(1)(viia) of the Act, subject to the specified conditions. The assessee is not a banking company. The issue is now clarified and settled by the decision of Hon’ble Supreme Court in the case of Southern Technologies Ltd. v. JCJT (2010) 320 ITR 577. The Hon’ble Apex Court while dealing with allowability of such provision for bad debts in the case of Non-banking Finance Companies (NBFCs), held that the directions of RBI to NBFCs to create provision for bad and doubtful debts constitute a code by themselves.
However, these directions and the Income-tax Act operate in different areas. These directions cannot overrule the ‘permissible deductions’ or ‘their exclusion’ under the Income- tax Act. The inconsistency between these directions and the Companies Act is only in the matter of income recognition and presentation of financial statements. The accounting policies adopted by an NBFC cannot determine the taxable income.
The above principle laid down by the Hon’ble Supreme Court equally applies to the present case. The directions issued under Electricity (Supply) Annual Account Rule 1985 cannot overrule the ‘permissible deductions’ or ‘their exclusion’ under the income tax Act. Accordingly, the provision for bad debts claimed by the assessee company, which is a non-banking company, is required to be disallowed.”
5.3.3 After considering all the submissions of the appellant, the Pr.CIT-III, Chennai has decided that the aforesaid provision is not an eligible deduction. In spite of specific opportunity given, the appellant could not substantiate its 1aim for the provision @ 2.5%. The working of the provision @ 2.5% is not based on empirical data. As such it is a contingent and unascertained liability. In the following case laws, the Courts have held that a provision which is an unascertained liability is not allowable as revenue deduction:
(a) Seagram Distilleries Pvt. Ltd. (Now Pernod Ricard India Pvt. Ltd.) Vs. CIT (Delhi High Court), Income Tax (Appeal) No.898- 901 of 2009 and 237 of 2015, Date of Judgement: 06.10.2015. In this case, the Hon’ble Delhi High Court has held that there is no reasonable scientific method adopted by the assessee to estimate the transit breakage to justify such provision. The provision would, in the circumstances be a provision for a contingent liability and, therefore, interms of the AS-29 ought not be recognised. The actual transit breakages as and when they occur are allowable as revenue expenditure in the accounting year in which such breakages occur.
(b) Renowned Auto Products Mfrs. Ltd. Vs. ITO: (2013) (354 ITR 127) : High Court of Madras. In this case, it was held that where provision for warranty cost was not created on a scientific basis, same was not allowable.
(c) CIT Vs. Shri Goverdhan Ltd. : (1968) (69 ITR 675)(SC) - In this case, the Hon’ble Supreme Court has observed that “the legal position is that a liability depending upon a contingency is not a debt in presenti or in futuro till the contingency happens. But, if it is a debt; the fact that the amount has to be ascertained does not make it any the less a debt if the liability is certain and what remains is only a quantification of the amount.
5.3.4 I have perused the decisions relied on by the appellant as mentioned above under para 5.2. The decision in the case of CIT v. Ahmedabad Electricity Co. Ltd. cited supra is not on the provision for bad and doubtful debts. The same is the position with respect to other case laws relied on by the appellant. The issue involved in the appellant’s case is provision for bad and doubtful debts, and not write off of bad debts per se. Therefore, the case laws relied on by the appellant did not support the appellant’s point of view.
5.3.5 In view of the above remarks, the AO’s disallowance of provision for bad and doubtful debts in the assessment year 2005-06 and 2006-07 is upheld and the appellant’s ground on this issue is dismissed.”
The learned A.R for the assessee submitted that the learned CIT(A) has erred in confirming disallowance of provision for bad and doubtful debts written off amounting to Rs.10,19,08,345/- without appreciating fact that as per Part IV of Electricity (Supply) Annual Account Rule, 1985, the assessee is required to make provision for bad and doubtful debts at a fixed percentage of dues from consumers to meet possible bad debts and thus, the assessee is entitled for deduction for the same, when the same has been reduced from sundry debtors account in the asset side of the balance sheet. The learned AR further referring to decision of the Hon'ble Supreme Court in the case of Vijaya Bank Vs CIT & Anr., (2010) 323 ITR 0166, submitted that the case of the assessee is covered by the Hon'ble Supreme Court decision in the above said case, where it was clearly held that when a bad debt is written off and reduced from asset in the books of account of the assessee and also in balance sheet, then it amounts to actual write off of bad debts and thus, the assessee satisfies conditions of section 36(1)(vii) r.w.s 36(2) of the Act and further, is entitled for deduction towards provision for bad and doubtful debts. The learned CIT(A) without appreciating these facts has simply confirmed additions made by the Assessing Officer and his order should be reversed.
The learned DR, on the other hand, supporting order of the learned CIT(A) submitted that the assessee has made a mere provision on ad-hoc basis without identifying each individual consumer accounts as bad and doubtful debts which is irrecoverable. Therefore, the learned CIT(A) has very clearly held that provision made by the assessee is not a bad debt, which is irrecoverable which can be allowed as deduction u/s.36(1)(vii) r.w.s 36(2) of the Act. The learned DR further submitted that decision of the Hon'ble Supreme Court in the case of Vijaya Bank vs. CIT (supra) is distinguishable on facts, because in the said case before the Hon'ble Supreme Court, the appellant has identified bad debts, made provisions and also bad debt has been written off as irrecoverable in books, but individual entries was not passed in the books of account, because the bank was fighting legal battle against borrowers for recovery of dues. Therefore, under those facts, the Hon'ble Supreme Court came to the conclusion that when debt became bad which is irrecoverable and also same is written off as irrecoverable, which satisfies conditions prescribed u/s.36(1)(vii) r.w.s 36(2) of the Act, and thus, the assessee is entitled for deduction. In this case, the assessee has made mere provision on ad-hoc basis as
per certain regulatory rules without identifying bad debts. Therefore, the Assessing Officer as well as learned CIT(A) has very rightly held that provision made by the assessee for bad and doubtful debts is only a provision, but not actual written off of bad debts and thus, the assessee is not entitled for deduction.
Therefore, there is no merit in the arguments of the assessee in light of decision of the Hon'ble Supreme Court in the case of Vijaya Bank Vs. CIT (supra) and hence, order of the learned CIT(A) should be upheld.
We have heard both the parties, perused material available on record and gone through orders of the authorities below. The solitary issue that came up for our consideration from the given facts and circumstances of the case is whether the assessee is entitled for deduction towards provision for bad and doubtful debts, even though same was not written off in the books of account of the assessee, but reduced from the sundry debtors account in asset side of balance sheet at the end of the relevant financial year.
The provisions of section 36(1)(vii) deals with deduction for bad debts and as per which subject to provisions of sub-section (2) of section 36 of the Act, amount of any bad debt or part thereof which is written off as irrecoverable in the accounts of the assessee for the previous year shall be allowed as deduction. Sub-section (2) of Section 36 of the Act, makes it clear that to get benefit of section 36(1)(vii) of the Act, the assessee should write off debt in its books of account as irrevocable. This legal position has been very well explained by the courts, including the Hon'ble Supreme Court in the case of M/s. Southern Technologies Ltd. Vs. JCIT, (2010) 320 ITR 577(SC), where it was clearly held that prior to 01.04.1999, the law as it then stood took view that even if in cases in which assessee makes only a provision in its accounts for bad debts and their interest thereon and even though amount is not actually written off by debiting profit & loss account of the assessee and crediting amount to the account of debtor, the assessee is still entitled for deduction u/s. 36(1)(vii) of the Act. It was further held that such state of law prevailed up to and including assessment year 1988-89. However, by insertion of new Explanation to section 36(1)(vii) w.e.f.
01.04.1999, it has been clarified that any bad debt written off as irrecoverable in the accounts of the assessee will not include any provision for bad and doubtful debts made in the books of account of the assessee. The said amendment indicates that before 01.04.1999 even provision would be treated as write off, however, after 01.04.1999, distinct dichotomy has brought in by way of Explanation to said section 36(1)(vii) of the Act. Consequently, after 01.04.1999, a mere provision for bad debt would not be entitled to deduction u/s.36(1)(vii) of the Act.
To understand above dichotomy, one must understand what is writing off and how to write off. If an assessee debits an amount of doubtful debts to the profit & loss account and credits asset account like sundry debtors account, it would constitutes a write off of actual debt. However, if the assessee debits provision for bad and doubtful debts to profit & loss account and makes corresponding credit to current liability and provision on the liability side of the balance sheet, then it would constitute a provision for doubtful debts. In the later case, the assessee would not be entitled to deduction after 01.04.1999 u/s.36(1)(vii) of the Act. The very same question has been considered by the Hon'ble Supreme Court in the case of Vijaya Bank Vs. CIT (2010) 323 ITR 166, where the Hon'ble Supreme Court after considering its earlier judgement in the case of M/s.Southern Technologies (supra), very categorically held that there is no dispute with regard to legal position that deduction is not available for provision for bad and doubtful debts u/s.36(1)(vii) of the Act. In fact, the Hon'ble Supreme Court has very categorically and candidly approved its earlier judgement in the case of M/s. Southern Technologies Ltd.(supra). However, considering peculiar facts of the case in Vijaya Bank Vs CIT (supra), the Hon’ble Apex Court went on to explain meaning of actual write off of debt in the context of banking company. The Hon’ble Apex Court had also further explained manner in which write off is to be carried out. Therefore, before applying ratio of Vijaya Bank Vs. JCIT (supra) to any other assessee, it is relevant to understand facts of the case before the Hon'ble Supreme Court in the case of Vijaya Bank Vs. JCIT (supra) and also context in which such observation was made by the Hon'ble Supreme Court.
It is an admitted legal position that ratio decided by the Hon'ble Supreme Court, including observation is binding on all courts and the Tribunal in the country.
There is no dispute on this legal position. But, nowhere the courts held that ratio decided in any case can be applied universally without understanding facts of the present case. Therefore, in order to apply ratio of any judgement, facts of the present case should be analyzed in light of relevant provisions of the Act. In this case, the issue before us is deduction towards bad and doubtful debts u/s.36(1)(vii) of the Act. As we have noted in our earlier part of this judgement, provisions of section 36(1)(vii) of the Act, entitles the assessee for deduction for any bad debt or part of bad debt written off in its books of account as irrecoverable. Therefore, in order to get benefit of deduction, the assessee must prove before the Assessing Officer that particular debt is a bad debt and further it has been written off in its books of account as irrecoverable. Therefore, in the context of 36(1)(vii), if you examine case of the Vijaya Bank Vs. JCIT (supra), one has to understand difference between an assessee who is governed by the Banking Regulations Act, 1949, and other assessee’s.
The Banking Companies are governed by the Banking Regulations Act, 1949, and guidelines issued by Reserve Bank of India from time to time for asset classification and provisions. As per guidelines issued by the RBI under prudential norms, the banks shall classify their accounts in three categories for the purpose of making provision for bad and doubtful debts. Accordingly, the banks would classify their accounts into standard assets, sub-standard assets, doubtful assets and loss assets. Further, when it comes to provision for bad & doubtful debts, even for standard assets, the banks shall make provision as per requirement of the Banking Regulations Act, 1949, and guidelines of the RBI issued from time to time.
However, deduction towards provision for bad & doubtful debts should be governed by the provisions of Section 36(1)(vii)/36(1)(viia) r.w.s 36(2) of the Income Tax Act, 1961. The provisions of Section 36(1)(vii) deals with bad debts written off in cases of assessee’s in general, whereas the provisions of Section 36(1)(viia) deals with specifically for banking companies. Therefore, it is necessary to analyze judgement of the Hon'ble Supreme Court in the context of Section 36(1)(vii) of the Income Tax Act, 1961.
It is an admitted fact that provision for bad & doubtful debts in case of banking companies is different from provisions for bad & doubtful debts in case of other companies. As we have stated in earlier part of this order, the banks are governed by prudential norms for asset classification and provisions. In the case of Vijaya Bank Vs. JCIT (supra), the Hon'ble Supreme Court has considered facts in light of various arguments brought out by the assessee that it has written of bad debts in books of account for all practical purposes as irrecoverable after considering necessary guidelines issued by the RBI. But, individual entries were not passed in the books of account of the assessee to square up debtors account only for simple reason that bank was continuing legal battle against borrowers for recovery of dues. Therefore, to keep a track on identity of debtors, the bank was following practice of not writing off individual loan accounts, however, there was no dispute with regard to fact that the assessee has made 100% provision for bad debts after considering available security and also possibility of recovery of debts. Further, bank had also written off bad debts by crediting to sundry debtors account in the books of account of the assessee and also same has been carried on to balance sheet net of provision for bad & doubtful debts. In the Vijaya Bank case, the Assessing Officer has never disputed fact that deduction claimed by the assessee towards bad & doubtful debts is not bad debt at all. In fact, the Assessing Officer has accepted claim of the assessee for deduction claimed towards provision for bad & doubtful debts and also said debt is in fact, written off in the books of account as irrecoverable.
The Assessing Officer has rejected arguments of the assessee only on the apprehension that in case, if the assessee is not square up individual debtors account in the books of account, then there is every possibility of making a double claim towards bad debts in subsequent financial year. Therefore, under those facts, the Hon'ble Supreme Court came to the conclusion that when the Assessing Officer has not disputed fact that what was claimed by the assessee is write off of bad debts and further, when the assessee has written off bad debts in the books of account by debiting into profit & loss account, and correspondingly crediting into sundry debtors account in the books of account, the Assessing Officer cannot reject claim of the assessee only on the apprehension that the assessee may make double claim in subsequent year without bringing on any example of such double claim by the assessee.
From the facts of Vijaya Bank vs. CIT(Supra), what is clear is that it has rendered judgement considering peculiar facts of Banking Companies, but did not reverse its earlier findings in the case of M/s.Southern Technologies Ltd.(supra). In our considered view, the Hon’ble Apex Court, very candidly approved its earlier ratio and held that to claim deduction u/s.36(1)(vii) of the Act, bad debt should be written off in books of account of the assessee as irrecoverable. Therefore, the argument of the assessee that even if, provision for bad and doubtful debts made in books of account is entitled for deduction u/s.36(1)(vii) of the Act, if such provision is reduced from debtors account in the asset side of balance sheet is incorrect, because presentation of balance sheet is only for understanding of the readers of such balance sheet, but it cannot override provisions of the law. Therefore, on the basis of presentation of account for readers benefit, it cannot be inferred that the assessee has written off bad debt as irrecoverable in the books of account of the assessee to allow benefit of deduction u/s.36(1)(vii) of the Income Tax Act, 1961. Therefore, in our considered view, judgement of the Hon'ble Supreme Court in the case of Vijaya Bank vs. JCIT (supra) has very well explained legal position of provisions of section 36(1)(vii) r.w.s 36(2) of the Act, and very categorically held that in order to claim benefit of deduction u/s.36(1)(vii) of the Act, bad debts should be written off as irrecoverable in the books of account of the assessee. Therefore, in our considered view Vijaya Bank vs. JCIT (supra) case cannot be universally applied to all assessee’s, unless facts brought out by the Hon'ble Supreme Court in the said case are identical to the facts of other cases.
Coming back to facts of the present case on hand.
In the present case, the assessee is into business of generation, transmission and distribution of electricity to consumers in the State of Tamil Nadu. As claimed by the assessee, it has made ad-hoc provision @ 2.5% on total sundry debtors at the end of financial year as provision for bad and doubtful debts for possible bad debts arise in the future course of business in terms of Part IV of Electricity (Supply) Annual Account Rule, 1985. As claimed by the assessee, the assessee has not examined individual consumer account and identified possible bad debt accounts to make provision. The assessee has made provision on ad-hoc basis on total sundry debtors without identifying individual bad debt accounts as irrecoverable. Therefore, in the given facts and circumstances of this case, what we understand is that provision made by the assessee at fixed percentage on sundry debtors is only a mere provision for bad & doubtful debts, but not written off of actual bad debts which is irrecoverable. Therefore, from the facts of present case, it is very clear that the assessee has made ad-hoc provision for bad and doubtful debts on fixed percentage in terms of certain regulatory requirements without identifying individual consumers accounts as bad debts which is irrecoverable.
Therefore, in our considered view, provision made by the assessee for bad and doubtful debts is only a provision, but not actual written off of bad debts which is irrecoverable. Hence, we are of the considered view that the assessee is not entitled for deduction towards provision made for bad and doubtful debts u/s 36(1)(vii) of the Income Tax Act, 1961. The learned CIT(A), after considering relevant facts has rightly upheld additions made by the Assessing Officer towards disallowance of provision for bad and doubtful debts.
Hence, we are inclined to uphold the findings of learned CIT(A) and reject grounds taken by the assessee.