THE issues before the Bench are - Whether the
assessee, a scheduled bank is entitled to deduction under the head provision for
fraud in the regular operations of the bank, irregularities and embezzlements
and Whether deduction u/s 36(1)(vii) is allowed to the assessee on provision for
bad and doubtful debts not exceeding ten per cent of the aggregate average
advances made by the rural branches as well as urban branches. And the verdict
partly goes in favour of the assessee.
A) Assessee, a scheduled bank, claimed as a deduction under the head “Provision for Frauds” in the profit & loss account. Assessee submitted that in the regular operations of the bank, irregularities and embezzlements occur. Such losses have a direct and proximate connection to the carrying on of the business and therefore claim of the assessee for deduction on account of anticipated liability towards irregularities and embezzlement is business expenditure. The bank has a vigilance department. Wherever a fraud or embezzlement occurs, the vigilance department submits a report and also suggests recovery action to the audit committee. Such cases of fraud are reported to RBI as per the RBI directions. The provisions were made only after netting of the recoveries. FIRs were filed in respect of such frauds. The assessee thus submitted that the liability in question has crystallized during the previous year.
AO after going through the vigilance report and the FIR filed accepted the fact that the Assessee has a well-placed mechanism to identify frauds and initiate recovery action. AO however was of the view that the amount which should be considered to have crystallized as liability of the Assessee should only be the amount shown as recoverable in the FIR or Vigilance Report whichever is lower.
Assessee contended that the loss on account of irregularities and embezzlement is considered after the vigilance report and the vigilance department considers the loss as having been crystallized. Since the loss relates to the previous year, the same has to be allowed as deduction for the relevant assessment year.
The CIT (A) allowed the appeal observing that the actual amount involved in the fraud as made out by the vigilance cell should be accepted as crystallized liability of the assessee.
B) Assessee in its books of accounts had created provision for Bad and Doubtful Debts in respect of rural advances. U/s 36(1)(viia) of the Act, a deduction on account of provision for bad and doubtful debts of amount not exceeding ten per cent of the aggregate average advances made by the rural branches of a bank computed in the prescribed manner, will be allowed as a deduction. Assessee also created a PBDD in respect of non-rural advances and claimed the same as deduction u/s 36(1)(vii). In the computation of income, deduction on account of PBDD u/s 36(1)(vii) was claimed by the assessee and deduction on account of bad debts written off was claimed u/s 36(1)(vii).
According to the AO, the deduction is allowed only to the extent PBDD in respect of rural advances is created in the books of accounts. According to him the limits upto to which such deduction is allowed alone is laid down in Rule 6ABA of the Rules. AO disallowed the deduction claimed in respect of on rural advance.
CIT (A) allowed the claim of the assessee for deduction u/s 36(1)(viia)(a) in view of the decision of Apex Court in the case of Catholic Syrian Bankwherein it was held that banks are entitled to full deduction of the write-off of urban advances without reducing any part of the provision made in respect of rural advances. AO was directed to recompute the deduction u/s 36(1)(viia) of the Act in accordance with the decision of the Apex Court cited.
Assessee contended that after amendment of Sec 36(1)(viia) by the IT (Amendment) Act, 1985, the requirement that the PBDD should be in relation to rural advances was not a requirement. What has to be seen is as to whether the bank had made any provision for bad and doubtful debts. There is no need to bifurcate the same into rural and non-rural debts. Once a bank creates provision for bad and doubtful debt, then the deduction is allowed u/s.36(1)(viia) based on the calculation as provided in the section.
After hearing both the parties, the ITAT held that,
A) ++ the bank has a vigilance cell, which does an in-house investigation and reports cases of irregularities and embezzlement to the management. The bank also has a system of reporting such irregularities and frauds to the RBI which is also mandatory as per the relevant law governing the banks. AO accepted the fact that the assessee bank has a well placed mechanism to identify frauds and initiate recovery action. AO has gone by the figures as stated in the FIRs or the Vigilance report, whichever is less. The figures mentioned in the FIR are only a provisional figure which is arrived at for the purpose of filing an FIR immediately on occurrence of the fraud. The vigilance report, on the other hand, is prepared after detailed study. Since the vigilance report is prepared after a deeper study, in our view, that figure should be considered as a loss to the assessee. The loss in question has to be held to have crystallized during the previous year. Thus, the revenues appeal is dismissed;
B) ++ what has to be seen by the AO is as to whether PBDD is created (irrespective of whether it is in respect of rural or non-rural advances) by debiting the Profit & Loss A/C. To the extent PBDD is so created, the Assessee is entitled to deduction subject to the upper limit of deduction laid down in Sec.36(1)(viia) of the Act. To avoid possible claim for double deduction in respect of one and the same debt first as PBDD and thereafter as Bad Debts, the legislature has already provided in Sec.36(2)(v) of the Act that where such debt or part of debt relates to advances made by an assessee to which cl. (viia) of sub-s. (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 provision for bad and doubtful debts account made under that clause. Further the proviso also limits the claim for deduction u/s.36(1)(vii) of the Act to an Assessee to which Sec.36(1)(viia) of the Act applies to the amount by which such debt or part thereof (written off as Bad debts) exceeds the credit balance in the provision for bad and doubtful debts account made under clause(viia) to Sec.36(1) of the Act. It would be just and fair if the order of CIT(A) is set aside and the AO directed to examine the claim of the Assessee in the light of the discussion made above.
Facts of the
case
A) Assessee, a scheduled bank, claimed as a deduction under the head “Provision for Frauds” in the profit & loss account. Assessee submitted that in the regular operations of the bank, irregularities and embezzlements occur. Such losses have a direct and proximate connection to the carrying on of the business and therefore claim of the assessee for deduction on account of anticipated liability towards irregularities and embezzlement is business expenditure. The bank has a vigilance department. Wherever a fraud or embezzlement occurs, the vigilance department submits a report and also suggests recovery action to the audit committee. Such cases of fraud are reported to RBI as per the RBI directions. The provisions were made only after netting of the recoveries. FIRs were filed in respect of such frauds. The assessee thus submitted that the liability in question has crystallized during the previous year.
AO after going through the vigilance report and the FIR filed accepted the fact that the Assessee has a well-placed mechanism to identify frauds and initiate recovery action. AO however was of the view that the amount which should be considered to have crystallized as liability of the Assessee should only be the amount shown as recoverable in the FIR or Vigilance Report whichever is lower.
Assessee contended that the loss on account of irregularities and embezzlement is considered after the vigilance report and the vigilance department considers the loss as having been crystallized. Since the loss relates to the previous year, the same has to be allowed as deduction for the relevant assessment year.
The CIT (A) allowed the appeal observing that the actual amount involved in the fraud as made out by the vigilance cell should be accepted as crystallized liability of the assessee.
B) Assessee in its books of accounts had created provision for Bad and Doubtful Debts in respect of rural advances. U/s 36(1)(viia) of the Act, a deduction on account of provision for bad and doubtful debts of amount not exceeding ten per cent of the aggregate average advances made by the rural branches of a bank computed in the prescribed manner, will be allowed as a deduction. Assessee also created a PBDD in respect of non-rural advances and claimed the same as deduction u/s 36(1)(vii). In the computation of income, deduction on account of PBDD u/s 36(1)(vii) was claimed by the assessee and deduction on account of bad debts written off was claimed u/s 36(1)(vii).
According to the AO, the deduction is allowed only to the extent PBDD in respect of rural advances is created in the books of accounts. According to him the limits upto to which such deduction is allowed alone is laid down in Rule 6ABA of the Rules. AO disallowed the deduction claimed in respect of on rural advance.
CIT (A) allowed the claim of the assessee for deduction u/s 36(1)(viia)(a) in view of the decision of Apex Court in the case of Catholic Syrian Bankwherein it was held that banks are entitled to full deduction of the write-off of urban advances without reducing any part of the provision made in respect of rural advances. AO was directed to recompute the deduction u/s 36(1)(viia) of the Act in accordance with the decision of the Apex Court cited.
Assessee contended that after amendment of Sec 36(1)(viia) by the IT (Amendment) Act, 1985, the requirement that the PBDD should be in relation to rural advances was not a requirement. What has to be seen is as to whether the bank had made any provision for bad and doubtful debts. There is no need to bifurcate the same into rural and non-rural debts. Once a bank creates provision for bad and doubtful debt, then the deduction is allowed u/s.36(1)(viia) based on the calculation as provided in the section.
After hearing both the parties, the ITAT held that,
A) ++ the bank has a vigilance cell, which does an in-house investigation and reports cases of irregularities and embezzlement to the management. The bank also has a system of reporting such irregularities and frauds to the RBI which is also mandatory as per the relevant law governing the banks. AO accepted the fact that the assessee bank has a well placed mechanism to identify frauds and initiate recovery action. AO has gone by the figures as stated in the FIRs or the Vigilance report, whichever is less. The figures mentioned in the FIR are only a provisional figure which is arrived at for the purpose of filing an FIR immediately on occurrence of the fraud. The vigilance report, on the other hand, is prepared after detailed study. Since the vigilance report is prepared after a deeper study, in our view, that figure should be considered as a loss to the assessee. The loss in question has to be held to have crystallized during the previous year. Thus, the revenues appeal is dismissed;
B) ++ what has to be seen by the AO is as to whether PBDD is created (irrespective of whether it is in respect of rural or non-rural advances) by debiting the Profit & Loss A/C. To the extent PBDD is so created, the Assessee is entitled to deduction subject to the upper limit of deduction laid down in Sec.36(1)(viia) of the Act. To avoid possible claim for double deduction in respect of one and the same debt first as PBDD and thereafter as Bad Debts, the legislature has already provided in Sec.36(2)(v) of the Act that where such debt or part of debt relates to advances made by an assessee to which cl. (viia) of sub-s. (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 provision for bad and doubtful debts account made under that clause. Further the proviso also limits the claim for deduction u/s.36(1)(vii) of the Act to an Assessee to which Sec.36(1)(viia) of the Act applies to the amount by which such debt or part thereof (written off as Bad debts) exceeds the credit balance in the provision for bad and doubtful debts account made under clause(viia) to Sec.36(1) of the Act. It would be just and fair if the order of CIT(A) is set aside and the AO directed to examine the claim of the Assessee in the light of the discussion made above.
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