DCIT (IT)-2(1)(2), AIR BUILDING, NARIMAN POINT, MUMBAI vs. DBS BANK LIMITED, MUMBAI

Without prejudice to ground nos. (1) to (4) above, the CIT(A) erred in not allowing deduction of Rs.427,46,46,000 under section 28 of the Act.

The CIT(A) erred in upholding the action of AO in not allowing deduction for bad debts written off of Rs.3,28,68,000 on conversion of debt to equity shares of the borrower, under section 36(I)(vii) of the Act. The Appellants submit that the bad debts written off of Rs.3,28,68,000 ought to be allowed as deduction under section 36(1)(vii) of the Act read with section 36(2) of the Act.

Without prejudice to ground no. (5) above, the CIT(A) erred in upholding the action of AO in not allowing deduction for bad debts written off of Rs.3,28,68,000, under section 37(1) of the Act.

Without prejudice to ground nos. (5) and (6) above, the CIT(A) erred in not allowing deduction for Rs.3,28,68,000 under section 28 of the Act. 3

The CIT(A) erred in not deleting the disallowance under section 14A of the Act read with Rule 8D of the Income tax Rules, 1962, for the year under consideration.

The CIT(A) erred in upholding action of the AO in not including the amount taxed as income of the HO while working out adjusted total income for computing the deduction under section 36(1)(viia) and section 44C of the Act.

The Appellant submits that considering the facts and circumstances of its case and the law prevailing on the subject, the impugned order dated 13 February 2018 passed u/s 143(3) r.w.s. 144C(3) of the Income-tax Act, 1961 is ab-initio void being barred by limitation and hence, ought to be struck down. The appellants crave leave to add, to amend, alter, vary, omit or substitute the aforesaid grounds of appeal or add a new ground or grounds of appeal at any time before or at the time of hearing of the appeal as they may be advised." Ground Nos. 1 to 5 relate to the denial of claim of bad debts written off amounting to Rs. 4,27,46,46,000/- being net of sale consideration of the non-performing asset (NPA) u/s 36(1)(vii) of the Act. Representatives of both the sides were heard at length. Case records carefully perused and the relevant documentary evidence brought on record duly considered in the light of Rule 18(6) of the ITAT Rules. Briefly stated the facts of the case are that the assessee is a non- resident banking company operating in India as a branch of DBS Bank Ltd. Singapore. The assessee is engaged in banking activities permitted by the Reserve Bank of India (RBI), which includes corporate and institutional banking, retail banking, trade finance, transactional and treasury solutions. During the year under consideration, the assessee bank was operating from twelve branches in India. The bank was involved in wholesale lending (both loans and trade based) to its corporate customers. It also offered treasury solutions to its clients. The assessee was not involved in credit card services, auto loans, portfolio management and financial planning for clients.

While scrutinising the return of income, the AO noticed that the assessee has claimed a sum of Rs. 8,02,67,53,014/- as bad debt written off excess over opening provisions u/s 36(1)(viia) of the Act. The assessee was requested to explain and justify its claim for bad debts. The assessee furnished the following breakup of bad debts claimed in the computation of income:- Amount in 000 INR SI No 1 2 3 Particulars Write Off of Bad Debts Loss on Sale of NPA Loss on Conversion of Debt 43,66,698 42,74,646 32,868 Less: Adjsuted Opening Balance from of 4 36(1)(viia) Provision 6,47,460 5 Net Bad Debt Claimed 80,26,752

After considering the aforementioned chart, the assessee was asked to explain how the loss on sale of NPA amounting to Rs. 4,27,46,46,000/- is allowable u/s 36(1)(viia) of the Act. The assessee was also asked to explain as to how the loss of conversion of debt amounting to Rs.3,28,68,000/- is an allowable claim u/s 36(1)(viia) of the Act, though, this issue is related to the subsequent grounds of appeal. 7.2. 1. The assessee explained that it assigned outstanding loans due from Tecpro Systems Ltd. to Edelweiss Asset Reconstruction Company Limited, and submitted a copy of the assigning agreement. It was explained that the loan outstanding and amount of provision was Rs.537.47 Crores as on the date of assigning. It was further explained that the consideration for the assignment was Rs.110 Crores and both the sale consideration and the bad debt arising out of the assignment were duly recognized in the financial statement of the bank. It was explained that the amount of balance in the debtors account, net of sale consideration has been written off as bad debts and debited to the profit and loss account for the year under consideration and accordingly, a provision for doubtful debts of Rs.147 Crores has been reversed and credited to the profit and loss account and, therefore, in the computation of income, loss on sale of NPA Rs.427.46 Crores has been claimed as bad debts allowable u/s 36(1)(vii) of the Act. It was brought to the notice of the AO that the reversal of provision for doubtful debts of Rs.147 Crores, has been claimed as not taxable since the said amount was added back and offered to tax in the year when the provision was made.

The claim and the submissions made by the assessee did not find any favour with the AO who was of the opinion that the loss incurred by sale of NPA is not a bad debt to be considered u/s 36(1)(viia) of the Act. The assessee has debited the loss on sale of NPA as bad debt in view of the RBI prudential norms but the deduction u/s 36(1)(vii) of the Act is allowable to any bad debt or part thereof which is written off as irrecoverable in the accounts of the assessee for the previous year. Drawing support from the decision of the Hon'ble Madras High Court in the case of Tower finance infrastructure Development Corporation Limited v. JCIT 280 ITR 491 (Mad), the AO was of the opinion that the RBI guidelines cannot override the statutory provisions of Income-tax. Further heavily relying upon the decision of the Hon'ble Supreme Court in the case of and not allowable u/s 36(1)(vii) of the Act.

The assessee carried the matter before the ld. CIT(A) but without any success.

Before us, the ld. Counsel for the assessee reiterated the claim of write off as bad debt. It is the say of the ld. Counsel for the assessee that both the lower authorities have grossly erred in placing heavy reliance on the decision of the Hon'ble Supreme Court in the case of Southern Technologies Limited (supra), which is totally on different context and, therefore, not applicable on the facts of the case in hand. Per contra, the ld. D/R strongly supported the findings of the ld. CIT(A).

We have given a thoughtful consideration to the orders of the authorities below. The undisputed fact is that Tecpro Systems Ltd. was a customer of the assessee bank since 2009 and started defaulting in servicing of the outstanding loans since 2014 and due to persistent default, Tecpro Systems Ltd., turned into a NPA and as per the regulatory requirements due provisions were made in the books of the assessee. Since there was no recovery forthcoming, the assessee decided to assign the outstanding loans due from Tecpro Systems Ltd. to Edelweiss Asset Reconstruction Company Limited, for a sale consideration of Rs.110 Crores against the outstanding loans of Rs. 537.47 Crores. The sale consideration was duly recognized in the financial statement of the assessee and balance in debtors account was actually written off as bad debts.

At this juncture, it is to be understood that on the date of assignment, the loan outstanding in the account of Tecpro Systems Ltd. was a debt in the books of the assessee as per the provisions of Section 36(2) of the Act, which means that the assessee could have written off the same as bad debt and claimed as such instead, as a prudent business man it sold the debt to Edelweiss Asset Reconstruction Company Limited, for a consideration of Rs.110 Crores. Assuming, yet not accepting, that it is not a bad debt then also the loss is definitely a business loss incurred in the ordinary course of business of money lending.

Coming to the decision of the Hon'ble Supreme Court in the case of Southern Technologies Limited (supra), we must first understand the context in which it was delivered. The Hon'ble Supreme Court was seized with the following question of law:- “2. An interesting question of law which arises for determination in these Civil Appeals filed by Non-Banking Financial Companies ("NBFCs" for short) is : - "Whether the Department is entitled to treat the "Provision for NPA", which in terms of RBI Directions, 1998 is debited to the P&L Account, as "income" under section 2(24) of the Income-tax Act, 1961 ("Income-tax Act" for short), while computing the profits and gains of the business under sections 28 to 43D of the Income-tax Act?" *********************************************

Appellant made "Provision for NPA" amounting to Rs. 81,68,516 for the financial year ending 31-3-1998. This was calculated as per Para 8 of the Prudential Norms, 1998. Accordingly, the P & L Account was debited and corresponding amount was shown in the Balance Sheet. The Department sought to add back Rs. 81,68,516 to the taxable income on the ground that the provision for bad and doubtful debt was not allowable under section 36(1)(vii) of the Income-tax Act. The appellant claimed that the "Provision for NPA", however, represented "loss" in the value of assets and was, therefore, allowable under section 37(1) of the Income-tax Act. This claim of the appellant was dismissed on the ground that the provisions of section 36(1)(vii) of the Income-tax Act could not be by-passed. ****************************************************************************

Prior to 1-4-1989, the law, as it then stood, took the view that even in cases in which the assessee(s) makes only a provision in its accounts for bad debts and interest thereon and even though the amount is not actually written off by debiting the P&L Account of the assessee and crediting the amount to the account of the debtor, assessee was still entitled to deduction under section 36(1)(vii). See CIT v. Jwala Prasad Tewari [1953] 24 ITR 537 (Bom.) and Vithaldas H. Dhanjibhai Bardanwala's case (supra ). Such state of law prevailed up to and including assessment year 1988-89. However, by insertion (with effect from 1-4-1989) of a new Explanation in section 36(1)(vii), it has been clarified that any bad debt written off as irrecoverable in the account of the assessee will not include any provision for bad and doubtful debt made in the accounts of the assessee. The said amendment indicates that before 1-4-1989, even a provision could be treated as a write off. However, after 1-4-1989, a distinct dichotomy is brought in by way of the said Explanation to section 36(1)(vii). Consequently, after 1-4-1989, a mere provision for bad debt would not be entitled to deduction under section 36(1)(viii). To understand the above dichotomy, one must understand "how to write off". If an assessee debits an amount of doubtful debt to the P&L Account and credits the asset account like sundry debtor's Account, it would constitute a write off of an actual debt. However, if an assessee debits "provision for doubtful debt" to the P&L Account and makes a corresponding credit to the "current liabilities and provisions" on the Liabilities side of the balance sheet, then it would constitute a provision for doubtful debt. In the latter case, assessee would not be entitled to deduction after 1-4-1989. 26. We have examined the P&L Account of First Leasing Company of India Limited for the year ending 31-3-2003. On examination of Schedule J to the P&L Account which refers to operating expenses, we find two distinct heads of expenditure, namely, "Provision for Non-performing Assets" and "Bad Debts/Advances Written Off". It is for the appellant(s) to explain the difference between the two to the Assessing Officer. Which of the two items will constitute expenditure under the Income-tax Act has to be decided according to the Income-tax Act. In the present case, we are not concerned with taxability under the Income-tax Act or the accounting treatment. We are essentially concerned with presentation of financial statements by NBFCs under the 1998 Directions. The point to be noted is that even according to the assessee "Bad debts/Advances Written Off" is a distinct head of expenditure vis-a-vis "Provision for Bad Debt". One more aspect needs to be highlighted. It is true that under Part I of Schedule VI to the Companies Act, 1956 an amount could be first included in the list of sundry debtors/loans and then deducted from the list as "provision for doubtful debts". However, these are matters of Presentation of Provisions for doubtful debts even under the Companies Act and have nothing to do with taxability under the Income-tax Act. One more aspect needs to be mentioned. Section 36(1)(vii) is subject to sub-section (2) of section 36. The condition incorporated in section 36 of the Income-tax Act, which was not there in section 10(2)(xi) of the 1922 Act, is that the amount of debt should have been taken into account in computing the income of the assessee in the previous year. Under the Income-tax Act, the emphasis is not on the assessee being the creditor but taking into account of the debt in computing the business income. [See section 36(2)]. In CIT v. T. Veerabhadra Rao, K. Koteswara Rao & Co. [1985] 155 ITR 152 at 157 (SC), it was found that the debt was taken into account in the income of the assessee for the assessment year 1963-64 when the interest accruing thereon was taxed in the hands of the assessee. The said interest was taxed as income as it represented accretion accruing during the earlier year on the moneys owed to the assessee by the debtor. It was held that transaction constituted the debt which was taken into account in computing the income of the assessee of the previous years. **************************************************

Section 36(1)(vii ) provides for a deduction in the computation of taxable profits for the debt established to be a bad debt. 9

1 Section 36(1)(viia ) provides for a deduction in respect of any provision for bad and doubtful debt made by a Scheduled Bank or Non-Scheduled Bank in relation to advances made by its rural branches, of a sum not exceeding a specified percentage of the aggregate average advances by such branches. Having regard to the increasing social commitment, section 36(1)(viia) has been amended to provide that in respect of provision for bad and doubtful debt made by a scheduled bank or a non-scheduled bank, an amount not exceeding a specified per cent of the total income or a specified per cent of the aggregate average advances made by rural branches, whichever is higher, shall be allowed as deduction in computing the taxable profits.

2 Even section 36(1)(vii ) has been amended to provide that in the case of a bank to which section 36(1)(viia) applies, the amount of bad and doubtful debt shall be debited to the provision for bad and doubtful debt account and that the deduction shall be limited to the amount by which such debt exceeds the credit balance in the provision for bad and doubtful debt account.

The point to be highlighted is that in case of banks, by way of incentive, a provision for bad and doubtful debt is given the benefit of deduction, however, subject to the ceiling prescribed as stated above. Lastly, the provision for NPA created by a scheduled bank is added back and only thereafter deduction is made permissible under section 36(1)(viia) as claimed.

A perusal of the above extracts from the judgment of the Hon'ble Supreme Court show that it was delivered totally on different facts and on a different context. Therefore, in our considered opinion, the same is not applicable to the facts of the case in hand. As mentioned elsewhere, the claim of the assessee as a bad debt is as per the provisions of the Act and also allowable as a business loss. Therefore, we do not find any merit in the impugned addition. The AO is directed to delete the addition of Rs.4,27,46,46,000/-. Ground Nos. 1 to 5, are accordingly allowed.

Before parting, the AO has also relied upon the decision of the Hon'ble Madras High Court in the case of Tower finance infrastructure Development Corporation Limited v. JCIT (supra). Again, this decision is on a different context in respect of the provision for bad and doubtful debts whereas the claim of the assessee is actually write off of bad debts and not provision and as mentioned elsewhere the provisions of bad and doubtful debts have been written back in the financial statement of the assessee. The relevant findings of the Hon'ble Madras High Court read as under:- “4. Even though the assessee has raised a ground to the effect that the debts have been incurred in the course of business and the purpose for which the finance was used by the other party is not relevant for allowing the deduction of debts written off and hence, section 36(1)(vii) would apply, learned counsel appearing for the assessee has fairly submitted that the assessee is not entitled to deduction, in view of the Explanation to section 36(1)(vii) which says that the provision for bad and doubtful debts made in the accounts of the assessee is not an allowable deduction.

Further, the Commissioner (Appeals), on the facts of the case, found that merely because the Reserve Bank of India has directed the assessee to provide for non- performing assets, that direction cannot override the mandatory provisions of the Income-tax Act contained in section 36(1)(viia) which stipulate for deduction not exceeding 5 per cent of the total income only in respect of the provision for bad and doubtful debts which are predominately revenue in nature or trade related and not for provision for non-performing assets which are of predominately capital nature, and held that the Assessing Officer was right in disallowing the provision of Rs. 30 lakhs debited in the profit and loss account of the assessee towards non-performing assets.

In this view of the matter, we are of the view that the Appellate Tribunal was right in upholding the order of the Commissioner of Income-tax (Appeals) in disallowing provision for non-performing assets which was debited to the profit and loss account. Accordingly, the question of law is answered in the affirmative, against the assessee and in favour of the revenue. The appeals are dismissed. No costs."

Ground Nos. 6 to 8 relates to the denial of deduction for bad debts written off Rs.3,28,68,000/- u/s 36(1)(vii) r.w.s. 36(2) of the Act and also u/s 37(1) of the Act.

The underlying facts in the issue show that the assessee had Rs.

75 Crores worth of loan outstanding from its customer PSL Limited which signed a Master Restructuring Agreement dated 19/11/2013 with the monitoring bank and various banks and financial institutions as CDR lenders. Pursuant to a scheme of Corporate Debt Restructuring (CDR), of the company, a part of loan amounting to Rs.7.83 Crores was converted into 30,15,380 equity shares of PSL Limited. These shares were allotted by the company on 30/12/2014 and were credited into the assessee's D-Mat account on 06/02/20215. These shares were issued to assessee on preferential basis @ Rs.26/- per share fully converting the loan of Rs.7.83 Crores into equity shares of Rs.10/- each. However, when the shares were credited into the D-Mat account, the market value was Rs.15.1/- per share, thereby giving a loss of Rs.3.29 Crores which was claimed as loss on account of bad debt.

Referring to the analysis given for the denial of bad debt write off of NPA of Rs.427.46 Crores considered vide Ground No. 1 to 5 above, the AO also denied the claim of this loss on conversion of debt.

When the matter was agitated before the ld. CIT(A), the assessee could not get any success.

Before us, the ld. Counsel for the assessee reiterated its claim of loss on conversion of debt to equity share u/s 36(1)(vii) of the Act and in alternative claimed it as a loss incurred in the ordinary course of business u/s 37(1)/ u/s 28 of the Act. Per contra the ld. D/R strongly supported the findings of the ld. CIT(A) and read the operative part.

We have given a thoughtful consideration to the orders of the authorities below. The claim of loss can be understood from the following chart:- A Loan Outstanding

84 B No. of Shares Issued on 30 December 2014 30,15,380 C Value of Shares at the Preferential Issue Price @ INR 7.84 26 each D Date of Receipt of Shares by Bank in Demat Account 06th Feb, 2015 E Closing Price of Shares on 06th Feb 2015 on NSE 4.55 INR 15.1 each (Refer Annexure to this Note) F Loss on Conversion of Loan ('C)-(E) 3.29

On perusal of the aforementioned chart in a very simple analysis, the assessee had assets of Rs.7.84 Crores (being loan outstanding). The assessee was assigned assets, market value of which was Rs.4.55 Crores (being price of shares on NSE on the date of credit in the D-Mat account). Thus, the assets of Rs.7.84 Crores was exchanged for another asset for Rs.4.55 Crores and hence the loss of Rs.3.29 Crores, which is nothing but a business loss and deserves to be allowed.

The reasons for denial of the claim have been considered while deciding Ground Nos. 1 to 5 (supra) and for our detailed reasoning therein, this claim of loss is also allowed. Ground Nos. 6 to 8 are accordingly allowed.

Ground No. 9 relates to the disallowance u/s 14A r.w.r. 8D.

The underlying facts show that the assessee claimed exempt income of Rs. 3,25,11,604/- on which suo moto disallowance u/s 14 of the Act was computed at Rs.4,72,34,861/- by applying Rule 8D. The said disallowance was made out of abundant precaution, though, no disallowance was warranted as the shares held by the assessee were held as stock-in-trade. Since the disallowance was made by the assessee itself, the same was not disturbed by the ld. First Appellate Authority.

Before us, the ld. Counsel for the assessee drew our attention to the decision of the Hon'ble Supreme Court in the case of Maxopp Investment Ltd. v. CIT (2018) 402 ITR 640 (SC) and pointed out that when the shares are held as stock-in-trade and not as investments, no disallowance is to be made u/s 14A r.w.r. 8D and further drew our attention to the decision of the Hon'ble Madras High Court in the case of Marg Ltd. Vs. CIT reported in 120 taxmann.com 84 (Madras) and pointed out that even if suo moto disallowance is made, the same has to be ignored. Per contra, the ld. D/R strongly supported the findings of the lower authorities.

We have given a thoughtful consideration to the orders of the authorities below. There is no dispute that shares were held as stock-in- trade. Whether disallowance u/s 14A of the Act can be made in the case of shares held as stock-in-trade was considered by the Hon'ble Supreme Court in the case of Maxopp Investment Ltd. vs. CIT [2018] 402 ITR 640 (SC). The relevant findings read as under:- “36) There is yet another aspect which still needs to be looked into. What happens when the shares are held as ‘stock-in-trade' and not as ‘investment', particularly, by the banks? On this specific aspect, CBDT has issued circular No. 18/2015 dated November 02, 2015. 37) This Circular has already been reproduced in Para 19 above. This Circular takes note of the judgment of this Court in Nawanshahar case wherein it is held that investments made by a banking concern are part of the business or banking. Therefore, the income arises from such investments is attributable to business of banking falling under the head ‘profits and gains of business and profession'. On that basis, the Circular contains the decision of the Board that no appeal would be filed on this ground by the officers of the Department and if the appeals are already filed, they should be withdrawn. A reading of this circular would make it clear that the issue was as to whether income by way of interest on securities shall be chargeable to income tax under the head ‘income from other sources' or it is to fall under the head 'profits and gains of business and profession'. The Board, going by the decision of this Court in Nawanshahar case, clarified that it has to be treated as income falling under the head ‘profits and gains of business and profession'. The Board also went to the extent of saying that this would not be limited only to co-operative societies/Banks claiming deduction under Section 80P(2)(a)(i) of the Act but would also be applicable to all banks/commercial banks, to which Banking Regulation Act, 1949 applies. 38) From this, Punjab and Haryana High Court pointed out that this circular carves out a distinction between ‘stock-in-trade' and ‘investment' and provides that if the motive behind purchase and sale of shares is to earn profit, then the same would be treated as trading profit and if the object is to derive income by way of dividend then the profit would be said to have accrued from investment. To this extent, the High Court may be correct. At the same time, we do not agree with the test of dominant intention applied by the Punjab and Haryana High Court, which we have already discarded. In that event, the question is as to on what basis those cases are to be decided where the shares of other companies are purchased by the assessees as ‘stock- in-trade' and not as ‘investment'. We proceed to discuss this aspect hereinafter. 39) In those cases, where shares are held as stock-in-trade, the main purpose is to trade in those shares and earn profits therefrom. 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 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 by affirming the view of the ITAT, though we are not subscribing to the theory of dominant intention applied by the High Court. It is to be kept in mind that in those cases where shares are held as ‘stock-in-trade', it becomes a business activity of the assessee to deal in those shares as a business proposition. Whether dividend is earned or not becomes immaterial. In fact, it would be a quirk of fate that when the investee company declared dividend, those shares are held by the assessee, though the assessee has to ultimately trade those shares by selling them to earn profits. The situation here is, therefore, different from the case like Maxopp Investment Ltd. where the assessee would continue to hold those shares as it wants to retain control over the investee company. In that case, whenever dividend is declared by the investee company that would necessarily be earned by the assessee and the assessee alone. Therefore, even at the time of investing into those shares, the assessee knows that it may generate dividend income as well and as and when such dividend income is generated that would be earned by the assessee. In contrast, where the shares are held as stock-in-trade, this may not be necessarily a situation. The main purpose is to liquidate those shares whenever the share price goes up in order to earn profits. In the result, the appeals filed by the Revenue challenging the judgment of the Punjab and Haryana High Court in State Bank of Patiala also fail, though law in this respect has been clarified hereinabove." 22 The same view was followed by the Hon'ble Supreme Court in the case of South Indian Bank Ltd. vs. CIT [2021] 438 ITR 1 (SC). The relevant findings read as follows:- “23. It would now be appropriate to advert in some detail to Maxopp Investment Ltd. v. CIT10. This case interestingly is relied by both sides' counsel. Writing for the Bench, Justice Dr. A.K. Sikri noted the objective for incorporation of Section 14A in the Act in the following words: - "3.... The purpose behind Section 14-A of the Act, by not permitting deduction of the expenditure incurred in relation to income, which does not form part of total income, is to ensure that the assessee does not get double benefit. Once a particular income itself is not to be included in the total income and is exempted from tax, there is no reasonable basis for giving benefit of deduction of the expenditure incurred in earning such an income........" The following was written explaining the scope of Section 14-A(1):