Catholic Syrian Bank Ltd. Vs Commissioner of Income Tax, Thrissur

1

REPORTABLE IN THE SUPREME COURT OF INDIA

CIVIL APPELLATE JURISDICTION CIVIL APPEAL NO. 1143 OF 2011

Catholic Syrian Bank Ltd. … Appellant Versus

Commissioner of Income Tax, Thrissur … Respondent

WITH

CIVIL APPEAL NO. 1147 of 2011 CIVL APPEAL NO. 1151 OF 2011 CIVIL APPEAL NO. 1155 OF 2011

CIVIL APPEAL NOS. 1156-1160 OF 2011 CIVIL APPEAL NO. 1170 OF 2011 CIVIL APPEAL NO. 1171 OF 2011 CIVIL APPEAL NO. 1172 OF 2011 CIVIL APPEAL NO. 1173 OF 2011 CIVIL APPEAL NO. 1174 OF 2011 CIVIL APPEAL NO. 1175 OF 2011 CIVIL APPEAL NO. 1176 OF 2011 CIVIL APPEAL NO. 1177 OF 2011 CIVIL APPEAL NO. 1178 OF 2011 CIVIL APPEAL NO. 1179 OF 2011 CIVIL APPEAL NO. 1180 OF 2011 CIVIL APPEAL NO. 1181 OF 2011 CIVIL APPEAL NO. 1182 OF 2011 CIVIL APPEAL NO. 1183 OF 2011 CIVIL APPEAL NO. 1184 OF 2011 CIVIL APPEAL NO. 1185 OF 2011 CIVIL APPEAL NO. 1186 OF 2011 CIVIL APPEAL NO. 1187 OF 2011 CIVIL APPEAL NO. 1188 OF 2011 CIVIL APPEAL NO. 1189 OF 2011

CIVIL APPEAL NOS. 1190-1193 OF 2011 CIVIL APPEAL NO. 1194 OF 2011 CIVIL APPEAL NO. 1396 OF 2011 CIVIL APPEAL NO. 1397 OF 2011

J U D G M E N T

2

Swatanter Kumar, J.

1. The assessee in C.A. No. 1143 of 2011, a Scheduled

Bank, filed its return of income for the assessment year 2002-

2003 on 24th October, 2002, declaring total income of Rs.

61,15,610/-. The return was processed under Section 143(1)

of the Income Tax Act, 1961 (for short ‘the Act’) and eligible

refund was issued in favour of the assessee. However, the

assessing officer issued notice under Section 143(2) of the Act

to the assessee, after which the assessment was completed.

Inter alia, the assessing officer, while dealing, under Section

143(3) of the Act, with the claim of the assessee for bad debts

of Rs. 12,65,95,770/-, noticed that the argument put forward

on behalf of the assessee, that the deduction allowable under

Section 36(1)(vii) of the Act is independent of deduction under

Section 36(1)(viia) of the Act, could not be accepted.

Consequently, he observed that the assessee having a

provision of Rs. 15,01,29,990/- for bad and doubtful debts

under Section 36(1)(viia) of the Act could not claim the amount

of Rs. 12,65,95,770/- as deduction on account of bad debts

because the bad debts did not exceed the credit balance in the

provision for bad and doubtful debts account and also, the

3

requirements of clause (v) of Sub-section (2) of Section 36 of

the Act were not satisfied. Therefore, the assessee’s claim for

deduction of bad debts written off from the account books was

disallowed. This amount was added back to the taxable

income of the assessee, for which a demand notice and challan

was accordingly issued. This order of the assessing officer

dated 24th January, 2005, was challenged in appeal by the

assessee on various grounds.

2. The Commissioner of Income Tax (Appeals) [hereafter

referred to as ‘the CIT(A)’], vide its order dated 7th April, 2006,

partly allowed the appeal, particularly in relation to the claim

of the appellant Bank for bad debts. Relying upon the

judgment of a Division Bench of the Kerala High Court in the

case of South Indian Bank Ltd. v. CIT [(2003) 262 ITR 579], the

CIT(A) held that the claim of the appellant was fully supported

by the said decision and since the entire bad debts written off

by the bank under Section 36(1)(vii) were pertaining to urban

branches only and not to the provision made for rural

branches under Section 36(1)(viia), it was entitled to the

deduction of the full claimed amount of Rs. 12,65,95,770/-.

Consequently, he directed deletion of the said amount.

3. For the years of assessment in question and being

4

aggrieved from the order of the CIT(A), the Revenue as well as

the assessee filed appeals before the Income Tax Appellate

Tribunal, Cochin (for short, the ‘ITAT’). All the appeals were

heard together and vide its order dated 16th April, 2007, while

relying upon the judgment of the jurisdictional High Court in

the case of South Indian Bank Ltd. (supra), the ITAT dismissed

the appeal of the Revenue on this issue and also granted

certain other benefits to the assessee in relation to other

items.

4. We consider it appropriate to notice at this stage the fate

of the orders passed for the previous assessment years in

relation to the appellant and other banks.

5. M/s. Dhanalakshmi Bank Ltd., one of the appellants

before us, had also raised the same issue before the ITAT in

Income Tax Appeal Nos.602-605 (Coch.) of 1994 and 190

(Coch.) of 1995, in relation to earlier assessment years. A view

had been expressed that there was no distinction made by the

Legislature in the proviso to Section 36(1)(vii) between rural

and non-rural advances and, therefore, its application cannot

be limited to rural advances. Under clause (viia) also, a bank

was held to be entitled to deduction in respect of the

provisions made for rural and non-rural advances, subject to

5

limitations contained therein. Thus, the contention of the

assessee in that case, for deduction of bad debts from urban

branches under Section 36(1)(vii), was rejected. The earlier

view taken by the Tribunal in the case of Federal Bank in ITA

Nos. 505, 854(Coch.) of 1993, 376(Coch.) of 1995 and

284(Coch.) of 1995 held that the proviso to clause (vii) only

bars the deduction of bad debts arising out of rural advances,

the actual right to set off bad debts in respect of non-rural and

urban advances cannot be controlled or restricted by

application of the proviso and the same would be allowed

without making adjustment vis-a-vis the provision for bad and

doubtful debts. This view was obviously favourable to the

assessee. Noticing these contrary views in the cases of

Dhanalakshmi Bank and Federal Bank, the matter in the case

of the appellant-Bank, for assessment years 1991-92 to 1993-

1994 was referred to a Special Bench of the ITAT for resolving

the issue. The Special Bench, vide its judgment dated 9th

August, 2002, had answered the question of law in the

affirmative, holding that debts actually written off, which do

not arise out of the rural advances, are not affected by the

proviso to clause (vii) and that only those bad debts which

arise out of rural advances are to be deducted under Section

6

36(1)(viia) in accordance with the proviso to clause (vii).

Finally, the matter, in respect of the appellant-Bank, was

ordered to be placed before the assessing officer and with

respect to other banks, before the concerned benches of the

ITAT. The order of the Special Bench of the ITAT was

implemented by the Department and was never called in

question. It may be noticed here that in relation to earlier

assessments, i.e. right from 1985-1986 to 1987-1988 in a

similar case, different banks came up for hearing in appeal

before a Division Bench of the Kerala High Court in the case of

South Indian Bank Ltd. (supra) wherein, as mentioned above,

while discussing the scope of Section 36(1)(viia) and 36(2)(v) of

the Act, the High Court set aside the order of the Tribunal in

that case and held that the assessee was entitled to the

deduction under clause (vii) irrespective of the difference

between the credit balance in the provision account made

under clause (viia) and the bad debts written off in the books

of accounts in respect of bad debts relating to urban or non-

rural advances. It accepted the contention of the assessee and

referred the matter to the assessing officer. This judgment of

the High Court is subject matter of Civil Appeal Nos. 1190-

1193 of 2011 before us.

7

6. However, the Department of Income Tax, being

dissatisfied with the order of the ITAT in assessment year

2002-2003, filed an appeal before the High Court under

Section 260A of the Act.

7. The Division Bench of the High Court of Kerala at

Ernakulam hearing the bunch of appeals against the order of

the ITAT, expressed the view that the judgment of that Court

in the case of South Indian Bank (supra) was not a correct

exposition of law. While dissenting therefrom, the Bench

directed the matter to be placed before a Full Bench of the

High Court.

8. That is how the matter came up for hearing before a Full

Bench of the High Court of Kerala at Ernakulam and vide its

judgment dated 16th December, 2009, the Full Bench not only

answered the question of law but even decided the case on

merits. While setting aside the view taken by the Division

Bench in South Indian Bank (supra) and also the concurrent

view taken by the CIT(A) and the ITAT, the Full Bench of the

High Court held as under:-

“5...What is clear from the above is that provision for bad and doubtful debts normally is not an allowable deduction and what is allowable under main clause is bad debt actually written off.

8

However, so far as Banks to which clause (viia) applies are concerned, they are entitled to claim deduction of provision under sub-clause (viia), but at the same time when bad debt written is also claimed deduction under clause (vii), the same will be allowed as a deduction only to the extent it is in excess of the provision created and allowed as a deduction under clause (viia). It is worthwhile to note that deduction under Section 36 (1)(vii) is subject to sub-section (2) of Section 36 which in clause (v) specifically states that any bad debt written off should be claimed as a deduction only after debiting it to the provision created for bad and doubtful debts. Further, in order to qualify for deduction of the bad debt written off, the requirement of section 36 (2) (v) is that such amount should be debited to the provision created under clause (viia) of claim deduction of provision under sub-clause (viia), but at the same time when bad debt is written off is also claimed deduction under clause (vii), the same will be allowed as a deduction only to the extent it is in excess of the provision created and allowed as a deduction under clause (viia). It is worthwhile to note that deduction under section 36(1) (vii) is subject to sub section (2) of section 36 which in clause (v) specifically states that any bad debt written off should be claimed as a deduction only after debiting it to the provision created for bad and doubtful debts. What is clear from the above provisions is that though Respondent-Banks are entitled to claim deduction of provision for bad and doubtful debts in terms of clause (viia), such Banks are entitled to deduction of bad debt actually written off only to the extent it is in excess of the provision created and allowed as deduction under clause (viia). Further, in order to qualify for deduction of bad debt written off, the requirement of section 36 (2) (v) is that such amount should be debited to the provision created under clause (viia) of Section 36(1). Therefore, we are of the view that the distinction drawn by the Division Bench in SOUTH INDIAN BANK’S case

9

between the bad debts written off in respect of advances made by Rural Branches and bad debts pertaining to advances made by other Branches does not exist and is not visualized under proviso to Section 36(1)(vii). We, therefore, hold that the said decision of this Court does not lay down the correct interpretation of the provisions of the Act. Admittedly all the Respondent-assesses have claimed and have been allowed deduction of provision in terms of clause (viia) of the Act. Therefore, when they claim deduction of bad debt written off in the previous year by virtue of the proviso to section 36(1)(vii), they are entitled to claim deduction of such bad debt only to the extent it exceeds the provision created and allowed as deduction under clause (viia) of the Act.

6. In the normal course we should answer the question referred to us by the Division Bench and send back the appeals for the Division Bench to decide the appeals consistent with the Full Bench decision. However, since this is the only issue that arises in the appeals, we feel it would be only an empty formality to send back the matter to the Division Bench for disposal of appeals consistent with our judgment. In order to Avoid unnecessary posting of appeals before the Division Bench, we allow the appeals by setting aside the orders of the Tribunal and by restoring the assessments confirmed in first Appeals.”

9. Dissatisfied from the judgment of the Full Bench of the

Kerala High Court, the assessee has filed the present appeal

purely on question of law.

10. The basic question of some significance, that arises for

consideration in the present appeals, is regarding the scope

and ambit of the proviso to clause (vii) of sub-section (1) of

10

Section 36 of the Act. According to the contention raised on

behalf of the assessee, the view taken by the Full Bench of the

Kerala High Court cannot be sustained in law as there are

distinct and different items of account that are maintained by

the bank in the normal course of its business and it is not

permissible to interchange these items in accordance with the

settled standards of accountancy or even in law. As such, the

claim of doubtful and bad debts could not have been added

back to taxable income as it was an additional liability of the

bank being shown as an independent item.

11. To put it more precisely, the contentious questions of law

that have been raised in the present appeals are as follows:-

“(j) Whether the Full Bench of the High Court has grossly erred in reversing the finding of the earlier Division Bench that on a correct interpretation of the Proviso to clause (vii) of Section 36(1) and clause (v) to Section 36(2) is only to deny the deduction to the extent of bad debts written off in the books with respect to which provision was made under clause (viia) of the Income Tax Act?

(k) Whether the Full Bench was correct in reversing the findings of the earlier Division Bench that if the bad debt written off relate to debt other than for which the provision is made under clause (viia), such debts will fall squarely within the main part of clause (vii) which is entitled to be deduction and in respect of that part of the debt with reference to which a provision is made under clause (viia), the proviso will operate to limit the deduction to the extent of the difference between that part of debt written off in the previous year and the

11

credit balance in the provision for bad and doubtful debts account made under clause (viia)?”

12. The appellant has contended that as the similar claims

had been decided in favour of the banks for the assessment

years 1991-1992 to 1993-1994, by Special Bench of the ITAT,

which had not been challenged by the Department. As such,

the issue had attained finality and could not be disturbed in

the subsequent years.

13. The above contention of the appellant banks does not

impress us at all. Merely because the orders of the Special

Bench of the ITAT were not assailed in appeal by the

Department itself, this would not take away the right of the

Revenue to question the correctness of the orders of

assessment, particularly when a question of law is involved.

There is no doubt that the earlier order of the CIT(A) had

merged into the judgment of the Special Bench of the ITAT and

attained finality for that relevant year. Equally, it is true that

though the Full Bench of the Kerala High Court specifically

overruled the Division Bench judgment of that very Court in

the case of South Indian Bank (supra), it did not notice any of

the contentions before and principles stated by the Special

Bench of the ITAT in its impugned judgment. As already

12

noticed, the question raised in the present appeal go to the

very root of the matter and are questions of law in relation to

interpretation of Sections 36(1)(vii) and 36(1)(viia) read with

Section 36(2) of the Act. Thus, without any hesitation, we

reject the contention of the appellant banks that the findings

recorded in the earlier assessment years 1991-1992 to 1993-

1994 would be binding on the Department for subsequent

years as well.

14. Now, we would proceed to examine the provisions of

Sections 36(1)(vii), 36(1)(viia) and 36(2) of the Act and their

scope. It would be appropriate for this Court to notice the

relevant provisions of the Sections at this stage itself.

“Section 36 (1) The deductions provided for in the following clauses shall be allowed in respect of the matters dealt with therein, in computing the income referred to in section 28 – (i) to (vi)….. (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 made under that clause;

Explanation – For the purposes of this clause, any

13

bad debt or part thereof written off as irrecoverable in the accounts of the assess shall not include any provision for bad and doubtful debts made in the accounts of the assessee. (viia) In respect of any provision for bad and doubtful debts made by - (a) A scheduled bank not being a bank incorporated by or under the laws of a country outside India or a non-scheduled bank, an amount not exceeding five per cent of the total income (computed before making any deduction under this clause and Chapter VI-A) and an amount not exceeding ten per cent of the aggregate average advances made by the rural branches of such bank computed in the prescribed manner; Provided that a scheduled bank or a non- scheduled bank referred to in this sub-clause shall, at its option, be allowed in any of the relevant assessment years, deduction in respect of any provision made by it for any assets classified by the Reserve Bank of India as doubtful assets or loss assets in accordance with the guidelines issued by it in this behalf, for an amount not exceeding five per cent. of the amount of such assets shown in the books of account of the bank on the last day of the previous year.

Provided further that for the relevant assessment years commencing on or after the 1st day of April, 2003 and ending before the 1st day of April, 2005, the provisions of the first proviso shall have effect as if for the words “five per cent”, the words “ten per cent” had been substituted :

Provided also that a scheduled bank or a non- scheduled bank referred to in this sub-clause shall, at its option, be allowed a further deduction in excess of the limits specified in the foregoing provisions, for an amount not exceeding the income derived from redemption of securities in accordance with a scheme framed by the Central Government.

14

Explanation. - For the purposes of this sub-clause, "relevant assessment years" means the five consecutive assessment years commencing on or after the 1st day of April, 2000 and ending before the 1st day of April, 2005.

Section 36 (2) In making any deduction for a bad debt or part thereof, the following provisions shall apply –

(i) No such deduction shall be allowed unless such debt or part thereof has been taken into account in computing the income of the assessee of the previous year in which the amount of such debt or part thereof is written off or of an earlier previous year, or represents money lent in the ordinary course of the business of banking or money- lending which is carried on by the assessee; (ii) If the amount ultimately recovered on any such debt or part of debt is less than the difference between the debt or part and the amount so deducted, the deficiency shall be deductible in the previous year in which the ultimate recovery is made; (iii) Any such debt or part of debt may be deducted if it has already been written off as irrecoverable in the accounts of an earlier previous year (being a previous year relevant to the assessment year commencing on the 1st day of April, 1988, or any earlier assessment year), but the Assessing Officer had not allowed it to be deducted on the ground that it had not been established to have become a bad debt in that year; (iv) Where any such debt or part of debt is written off as irrecoverable in the accounts of the previous year (being a previous year relevant to the assessment year commencing on the 1st day of April, 1988, or any earlier assessment year) and the Assessing Officer is satisfied that such debt or

15

part became a bad debt in any earlier previous year not falling beyond a period of four previous years immediately preceding the previous year in which such debt or part is written off, provisions of sub-section (6) of section 155 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 provision for bad and doubtful debts account made under that clause.”

15. The income of an assessee carrying on a business or

profession has to be assessed in accordance with the scheme

contained in Part ‘D’ of Chapter IV dealing with heads of

income. Section 28 of the Act deals with the chargeability of

income to tax under the head ‘profits and gains of business or

profession’. All ‘other deductions’ available to an assessee

under this head of income are dealt with under Section 36 of

the Act which opens with the words ‘the deduction provided for

in the following clauses shall be allowed in respect of matters

dealt with therein, in computing the income referred to in

Section 28’. In other words for the purposes of computing the

income chargeable to tax, beside specific deductions, ‘other

deductions’ postulated in different clauses of Section 36 are to

be allowed by the assessing officer, in accordance with law.

16. Sections 36(1)(vii) and 36(1)(viia) provide for such

16

deductions, which are to be permitted, in accordance with the

language of these provisions. A bare reading of these

provisions show that Sections 36(1)(vii) and 36(1)(viia) are

separate items of deduction. These are independent

provisions and, therefore, cannot be intermingled or read into

each other. It is a settled canon of interpretation of fiscal

statutes that they need to be construed strictly and on their

plain reading.

17. The provisions of Section 36(1)(vii) would come into play

in the grant of deductions, subject to the limitation contained

in Section 36(2) of the Act. Any bad debt or part thereof,

which is written off as irrecoverable in the accounts of the

assessee for the previous year is the deduction which the

assessee would be entitled to get, provided he satisfies the

requirements of Section 36(2) of the Act. Allowing of

deduction of bad debts is controlled by the provisions of

Section 36(2). The argument advanced on behalf of the

Revenue is that it would amount to allowing a double

deduction if the provisions of Sections 36(1)(vii) and 36(1)(viia)

are permitted to operate independently. There is no doubt

that a statute is normally not construed to provide for a double

17

benefit unless it is specifically so stipulated or is clear from the

scheme of the Act. As far as the question of double benefit is

concerned, the Legislature in its wisdom introduced Section

36(2)(v) by the Finance Act, 1985 with effect from 01.04.1985.

Section 36(2)(v) concerns itself as a check for claim of any

double deduction and has to be read in conjunction with

Section 36(1)(viia) of the Act. It requires the assessee to debit

the amount of such debt or part thereof in the previous year to

the provision made for that purpose.

Effect of Circulars

18. Now, we shall proceed to examine the effect of the

circulars which are in force and are issued by the Central

Board of Direct Taxes (for short, ‘the Board’) in exercise of the

power vested in it under Section 119 of the Act. Circulars can

be issued by the Board to explain or tone down the rigours of

law and to ensure fair enforcement of its provisions. These

circulars have the force of law and are binding on the income

tax authorities, though they cannot be enforced adversely

against the assessee. Normally, these circulars cannot be

ignored. A circular may not override or detract from the

provisions of the Act but it can seek to mitigate the rigour of a

particular provision for the benefit of the assessee in certain

18

specified circumstances. So long as the circular is in force, it

aids the uniform and proper administration and application of

the provisions of the Act. {Refer to UCO Bank, Calcutta v.

Commissioner of Income Tax, W.B. (1999) 4 SCC 599]}.

19. In the present case, after introduction of Section

36(1)(viia) by the Finance Act, 1979, [(1981) 131 ITR (St.) 88],

with effect from 1st April, 1980, Circular No. 258 dated 14th

June, 1979 was issued by the Board to clarify the application

of the new provisions. The provisions were introduced in order

to promote rural banking and assist the scheduled commercial

banks in making adequate provision from their current profits

to provide for risks in relation to their rural advances. The

deductions were to be limited as specified in the Section. A

‘rural branch’ for the purpose of the Act had meant a branch

of a scheduled bank, situated in a place with a population not

exceeding 10,000, according to the last preceding census of

which the relevant figures have been published. Under clause

13.3, the Circular found it relevant to mention that the

provisions of new clause (viia) of Section 36(1), relating to the

deduction on account of provisions for bad and doubtful debts,

is distinct and independent of the provisions of Section

19

36(1)(vii) relating to allowance of deduction of the bad debts.

In other words, the scheduled commercial banks would

continue to get the benefit of the write-off of the irrecoverable

debts under Section 36(1)(vii) in addition to the benefit of

deduction of the provision for bad and doubtful debts under

Section 36(1)(viia).

20. The Finance Act, 1985, which was given effect from 1st

April, 1985, added the proviso to Section 36(1)(vii), amended

Section 36(1)(viia) and also introduced clause (v) to Section

36(2) of the Act. To complete the history of amendments to

these clauses, we may also notice that proviso to Section

36(1)(viia)(a) was introduced by Finance Act, 1999 with effect

from 1st April, 2000 and explanation to Section 36(1)(vii) was

introduced by Finance Act, 2001 with effect from 1st April,

2001.

21. A Circular No.421 dated 12th June, 1985 [(1985) 156 ITR

(St.) 130] attempted to explain the amendments made to

Section 36 and also explained the provisions of clause (viia) of

Section 36(1). It reads as under :

“Deduction in respect of provisions made by banking companies for bad and doubtful debts.

17.1 Section 36(1)(vii) of the Income-tax Act provides for a deduction in the computation of

20

taxable profits of the amount of any debt or part thereof which is established to have become a bad debt in the previous year. This allowance is subject to the fulfilment of the conditions specified in sub-section (2) of section 36.

17.2 Section 36(1)(viia) of the Income-tax Act provides for a deduction in respect of any provision for bad and doubtful debts made by a scheduled bank or a non-scheduled bank in relation to advances made by its rural branches, of any amount not exceeding 1½ per cent of the aggregate average advances made by such branches.

17.3 Having regard to the increasing social commitments of banks, section 36(1)(viia) has been amended to provide that in respect of any provision for bad and doubtful debts made by a scheduled bank [not being a bank approved by the Central Government for the purposes of section 36(1)(viiia) or a bank incorporated by or under the laws of a country outside India] or a non- scheduled bank, an amount not exceeding ten per cent of the total income (computed before making any deduction under the proposed new provision) or two per cent of the aggregate average advances made by rural branches of such banks, whichever is higher, shall be allowed as a deduction in computing the taxable profits.

17.4 Section 36(1)(vii) of the Act has also been amended to provide that in the case of a bank to which section 36(1)(viia) applies, the amount of bad and doubtful debts shall be debited to the provision for bad and doubtful debts account and that the deduction admissible under section 36(1)(vii) 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.

17.5 Section 36(2) has been amended by insertion of a new clause (v) to provide that where a debt or

21

a part of a debt considered bad or doubtful relates to advances made by a bank to which section 36(1)(viia) applies, no such deduction shall be allowed unless the bank has debited the amount of such debt or part of debt in that previous year to the provision for bad and doubtful debt account made under clause (viia) of section 36(1).”

22. Still another circular being Circular No.464, dated 18th

July, 1986 [(1986) 161 ITR(St.) 66] was issued with the

intention to explain the amendments made by the Income Tax

(Amendment) Act, 1986. Clause 5 of the Circular dealt with

the modifications introduced in respect of the deductions on

provisions for bad and doubtful debts made by the banks and

it stated as follows :

“5. Modification in respect of deduction on provisions for bad and doubtful debts made by the banks

5.1 Under the existing provisions of clause (viia) of sub-section (1) of section 36 of the Income-tax Act inserted by the Finance Act, 1979, provision for bad and doubtful debts made by scheduled or a non-scheduled Indian bank is allowed as deduction within the prescribed limits. The limit prescribed is 10% of the total income or 2% of the aggregate average advances made by the rural branches of such banks, whichever is higher. It had been represented to the Government that the foreign banks were not entitled to any deduction under this provision and to that extent, they were being discriminated against. Further, it was felt that the existing ceiling in this regard, i.e., 10% of the total income or 2% of the aggregate average advances made by the rural branches of Indian banks, whichever is higher, should be modified.

22

Accordingly, by the Amending Act, the deduction presently available under clause (viia) of sub- section (1) of section 36 of the Income-tax Act has been split into two separate provisions. One of these limits the deduction to an amount not exceeding 2% of the aggregate average advances made by the rural branches of the banks concerned. It may be clarified that foreign banks do not have rural branches and hence this amendment will not be relevant in the case of the foreign banks. The other provisions secure that a further deduction shall be allowed in respect of the provision for bad and doubtful debts made by all banks, not just the banks incorporated in India, limited to 5% of the total income (computed before making any deduction under this clause and Chapter VI-A). This will imply that all scheduled or non-scheduled banks having rural branches would be allowed the deduction up to 2% of the aggregate average advances made by such branches and a further deduction up to 5% of their total income in respect of provision for bad and doubtful debts.”

23. Reference usefully can also be made to the Statement of

Objects and Reasons for the Finance Act, 1986, wherein, inter

alia, it was stated that the amendments were intended to

provide a deduction on the provisions for bad debts made by

all banks upto 5 per cent of their total income and an

additional 2 per cent of the aggregate average advances made

by the rural branches of the banks. These percentages stood

altered by subsequent amendments in 1993 and 2001.

24. Clear legislative intent of the relevant provisions and

unambiguous language of the circulars with reference to the

23

amendments to Section 36 of the Act demonstrate that the

deduction on account of provisions for bad and doubtful debts

under Section 36(1)(viia) is distinct and independent of the

provisions of Section 36(1)(vii) relating to allowance of the bad

debts. The legislative intent was to encourage rural advances

and the making of provisions for bad debts in relation to such

rural branches. Another material aspect of the functioning of

such banks is that their rural branches were practically

treated as a distinct business, though ultimately these

advances would form part of the books of accounts of the

principal or head office branch. Thus, this Court would be

more inclined to give an interpretation to these provisions

which would serve the legislative object and intent, rather

than to subvert the same. The Circulars in question show a

trend of encouraging rural business and for providing greater

deductions. The purpose of granting such deductions would

stand frustrated if these deductions are implicitly neutralized

against other independent deductions specifically provided

under the provisions of the Act. To put it simply, the

deductions permissible under Section 36(1)(vii) should not be

negated by reading into this provision, limitations of Section

36(1)(viia) on the reasoning that it will form a check against

24

double deduction. To our mind, such approach would be

erroneous and not applicable on the facts of the case in hand.

Interpretation and Construction of Relevant Sections

25. The language of Section 36(1)(vii) of the Act is

unambiguous and does not admit of two interpretations. It

applies to all banks, commercial or rural, scheduled or

unscheduled. It gives a benefit to the assessee to claim a

deduction on any bad debt or part thereof, which is written off

as irrecoverable in the accounts of the assessee for the

previous year. This benefit is subject only to Section 36(2) of

the Act. It is obligatory upon the assessee to prove to the

assessing officer that the case satisfies the ingredients of

Section 36(1)(vii) on the one hand and that it satisfies the

requirements stated in Section 36(2) of the Act on the other.

The proviso to Section 36(1)(vii) does not, in absolute terms,

control the application of this provision as it comes into

operation only when the case of the assessee is one which falls

squarely under Section 36(1)(viia) of the Act. We may also

notice that the explanation to Section 36(1)(vii), introduced by

the Finance Act, 2001, has to be examined in conjunction with

the principal section. The explanation specifically excluded

any provision for bad and doubtful debts made in the account

25

of the assessee from the ambit and scope of ‘any bad debt, or

part thereof, written off as irrecoverable in the accounts of the

assessee’. Thus, the concept of making a provision for bad

and doubtful debts will fall outside the scope of Section

36(1)(vii) simplicitor. The proviso, as already noticed, will

have to be read with the provisions of Section 36(1)(viia) of the

Act. Once the bad debt is actually written off as irrecoverable

and the requirements of Section 36(2) satisfied, then, it will

not be permissible to deny such deduction on the

apprehension of double deduction under the provisions of

Section 36(1)(viia) and proviso to Section 36(1)(vii). This does

not appear to be the intention of the framers of law. The

scheduled and non-scheduled commercial banks would

continue to get the full benefit of write off of the irrecoverable

debts under Section 36(1)(vii) in addition to the benefit of

deduction of bad and doubtful debts under Section 36(1)(viia).

Mere provision for bad and doubtful debts may not be

allowable, but in the case of a rural advance, the same, in

terms of Section 36(1)(viia)(a), may be allowable without

insisting on an actual write off.

26. The Special Bench of the ITAT had rejected the

contention of the Revenue that proviso to Section 36(1)(vii)

26

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 clause (vii) of Section 36(1) of the Act

on the basis of actual write off and the other on the basis of

clause (viia) of Section 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 Section

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 ITAT 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.

27. As per this proviso to clause (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 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

27

terms, limits its application to the case of a bank to which

clause (viia) applies. Indisputably, clause (viia)(a) applies only

to rural advances.

28. As far as foreign banks are concerned, under Section

36(1)(viia)(b) and as far as public financial institutions or State

financial corporations or State industrial investment

corporations are concerned, under Section 36(1)(viia)(c), they

do not have rural branches. Thus, it can safely be inferred

that the proviso is self indicative that its application is to bad

debts arising out of rural advances.

29. In a recent judgment of this Court, in Southern

Technologies Ltd. v. Joint Commissioner of Income Tax,

Coimbatore [(2010) 2 SCC 548] (authored by one of us,

Kapadia, J., as he then was), both Sections 36(1)(vii) and

36(1)(viia) were discussed. Then, this Court went on to state

how these provisions operate in the case of a Non Banking

Financial Corporations (NBFC) vis-à-vis bank covered under

Section 36(1)(viia). The Court held as under:

“37. 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

28

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, the assessee would not be entitled to deduction after 1-4-1989.

XXX XXX XXX

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

59. Having regard to the increasing social commitment, Section 36(1)(vii-a) 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. Even Section 36(1)(vii) has been amended to provide that in the case of a bank to which Section 36(1)(vii-a) 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.

60. 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)(vii-a) as claimed.”

29

30. The scope of the proviso to clause (vii) of Section 36(1)

has to be ascertained from a cumulative reading of the

provisions of clauses (vii), (viia) of Section 36(1) and clause (v)

of Section 36(2) and only shows that a double benefit in

respect of the same debt is not given to a scheduled bank. A

scheduled bank may have both urban and rural branches. It

may give advances from both branches with separate provision

accounts for each.

31. It was neither in dispute earlier, nor dispute before us,

that the assessee bank is maintaining two separate accounts,

one being a provision for bad and doubtful debts other than

provisions for bad debts in rural branches and another

provision account for bad debts in rural branches for which

separate accounts are maintained. This fact is evinced by the

entries in the profit and loss account, balance sheet and break

up details. We need not deliberate this aspect with reference

to records at any greater length as this is not a matter in issue

before us. It was contended on behalf of the Revenue that the

Revenue is only concerned with the assessee as a single unit

and not with how many separate accounts are being

maintained by the assessee and under what items. The

30

Department, therefore, would assess an assessee with

reference to a single account maintained in the head office of

the concerned bank. This, according to the learned counsel

appearing for the Department, would further substantiate the

argument of the Department that the interpretation given by

the Full Bench of the High Court is the correct interpretation

of Section 36(1)(vii). This argument has to be rejected, being

without merit.

32. In the normal course of its business, an assessee bank is

to maintain different accounts for the rural debts for non-

rural/urban debts. It is obvious that the branches in the rural

areas would primarily be dealing with rural debts while the

urban branches would deal with commercial debts.

Maintenance of such separate accounts would not only be a

matter of mere convenience but would be the requirement of

accounting standards.

33. It is contended, and rightly so, on behalf of the assessee

bank that under law, it is obliged to maintain accounts which

would correctly depict its statement of affairs. This obligation

arises implicitly from the requirements of the Act and certainly

under the mandate of accounting standards.

34. Inter alia, following are the reasons that would fully

31

support the view that a bank should maintain the accounts

with separate items for actual bad and irrecoverable debts as

well as provision for such debts. It could, for valid reasons,

have rural accounts more distinct from the urban, commercial

accounts.

(a) It is obligatory upon each bank to ensure that the

accounts represent the correct statement of affairs of

the bank.

(b) Maintaining the common account may result in over

stating the profits or the profits will shoot up which

would result in accruing of liabilities not due.

(c) Accounting Standard (AS) 29, issued in 2003, which

concerns treatment of ‘provisions, contingent liabilities

and contingent assets’. Under the head ‘Use of

Provisions’, clauses 53 and 54 state as under:-

“53. A provision should be used only for expenditures for which the provision was originally recognised.

54. Only expenditures that relate to the original provision are adjusted against it. Adjusting expenditures against a provision that was originally recognised for another purpose would conceal the impact of two different events.”

35. The above clauses justify maintenance of distinct and

32

different accounts.

36. Merely because the Department has some apprehension

of the possibility of double benefit to the assessee, this would

not by itself be a sufficient ground for accepting its

interpretation. Furthermore, the provisions of a section have

to be interpreted on their plain language and could not be

interpreted on the basis of apprehension of the Department.

This Court, in the case of Vijaya Bank v. Commissioner of

Income Tax & Anr. [(2010) 5 SCC 416], held that under the

accounting practice, the accounts of the rural branches have

to tally with the accounts of the head office. If the repaid

amount in subsequent years is not credited to the profit and

loss account of the head office, which is what ultimately

matters, then there would be a mismatch between the rural

branch accounts and the head office accounts. Therefore, in

order to prevent such mismatch and to be in conformity with

the accounting practice, the banks should maintain separate

accounts. Of course, all accounts would ultimately get merged

into the account of the head office, which will ultimately reflect

one account (balance sheet), though containing different items.

37. Another example that would support this view is that, a

bank can write off a loan against the account of ‘A’ alone where

33

it has advanced the loan to party ‘A’. It cannot write off such

loan against the account of ‘B’. Similarly, a loan advanced

under the rural schemes cannot be written off against an

urban or a commercial loan by the bank in the normal course

of its business.

38. The Full Bench of the Kerala High Court expressed the

view that the Legislature did not make any distinction between

provisions created in respect of advances by rural branches

and advances by other branches of the bank. It also returned

a finding while placing emphasis on the proviso to Section

36(1)(vii), read with clause (v) of Section 36(2) of the Act that

the interpretation given by a Division Bench of that Courts in

the case of South Indian Bank (supra) was not a correct

enunciation of law, inasmuch as the same would lead to

double deduction. It took the view that in a claim of

deduction of bad debts written off in non-rural/urban

branches in the previous year, by virtue of proviso to Section

36(1)(vii), the banks are entitled to claim deduction of such

bad debts only to the extent it exceeds the provision created

for bad or doubtful rural advances under clause (viia) of

Section 36(1) of the Act. We are unable to persuade ourselves

to contribute to this reasoning and statement of law.

34

39. Firstly, the Full Bench ignored the significant expression

appearing in both the proviso to Section 36(1)(vii) and clause

(v) of Section 36(2), i.e., ‘assessee to which clause (viia) of sub-

section (1) applies’. In other words, if the case of the assessee

does not fall under Section 36(1)(viia), the proviso/limitation

would not come into play.

40. It is useful to notice that in the proviso to Section

36(1)(vii), the explanation to that Section, Section 36(1)(viia)

and 36(2)(v), the words used are ‘provision for bad and

doubtful debts’ while in the main part of Section 36(1)(vii), the

Legislature has intentionally not used such language. The

proviso to Section 36(1)(vii) and Sections 36(1)(viia) and

36(2)(v) have to be read and construed together. They form a

complete scheme for deductions and prescribe the extent to

which such deductions are available to a scheduled bank in

relation to rural loans etc., whereas Section 36(1)(vii) deals

with general deductions available to a bank and even non-

banking businesses upon their showing that an account had

become bad and written off as irrecoverable in the accounts of

the assessee for the previous year, satisfying the requirements

contemplated in that behalf under Section 36(2). The

provisions of Section 36(1)(vii) operate in their own field and

35

are not restricted by the limitations of Section 36(1)(viia) of the

Act. In addition to the reasons afore-stated, we also approve

the view taken by the Special Bench of ITAT and the Division

Bench of the Kerala High Court in the case of South Indian

Bank (supra).

41. To conclude, we hold that the provisions of Sections

36(1)(vii) and 36(1)(viia) of the Act are distinct and independent

items of deduction and operate in their respective fields. The

bad debts written off in debts, other than those for which the

provision is made under clause (viia), will be covered under the

main part of Section 36(1)(vii), while the proviso will operate in

cases under clause (viia) to limit deduction to the extent of

difference between the debt or part thereof written off in the

previous year and credit balance in the provision for bad and

doubtful debts account made under clause (viia). The proviso

to Section 36(1)(vii) will relate to cases covered under Section

36(1)(viia) and has to be read with Section 36(2)(v) of the Act.

Thus, the proviso would not permit benefit of double

deduction, operating with reference to rural loans while under

Section 36(1)(vii), the assessee would be entitled to general

deduction upon an account having become bad debt and being

written off as irrecoverable in the accounts of the assessee for

36

the previous year. This, obviously, would be subject to

satisfaction of the requirements contemplated under Section

36(2).

42. Consequently, while answering the question in favour of

the assessee, we allow the appeals of the assessees and

dismiss the appeals preferred by the Revenue. Further, we

direct that all matters be remanded to the assessing officer for

computation in accordance with law, in light of the law

enunciated in this judgment.

…….…………................J. (A.K. Patnaik)

...….…………................J. (Swatanter Kumar) New Delhi; February 17, 2012

37

IN THE SUPREME COURT OF INDIA

CIVIL APPELLATE JURISDICTION

CIVIL APPEAL NO. 1143 OF 2011

Catholic Syrian Bank Ltd. …Appellant(s)

Versus

Commissioner of Income Tax, Thrissur …Respondent(s)

with

Civil Appeal Nos. 1147/11, 1151/11, 1155/11, 1156- 1160/11, 1170/11, 1171/11, 1172/11, 1173/11, 1174/11, 1175/11, 1176/11, 1177/11, 1178/11, 1179/11, 1180/11, 1181/11, 1182/11, 1183/11, 1184/11, 1185/11, 1186/11, 1187/11, 1188/11, 1189/11, 1190-1193/11, 1194/11, 1396/11, and 1397/11.

J U D G M E N T

S. H. KAPADIA, CJI

1. I have gone through the judgment of my esteemed

brother Swatanter Kumar, J. and I agree with the conclusions

contained therein. However, I would like to give my own

reasons.

The question for our consideration is - whether on the

facts and circumstances of the case, the assessee(s) is

eligible for deduction of the bad and doubtful debts

actually written off in view of Section 36(1)(vii) which

limits the deduction allowable under the proviso to

38

the excess over the credit balance made under clause

(viia) of Section 36(1) of Income Tax Act, 1961 (“ITA”

for short)?

2. Under Section 36(1)(vii) of the ITA 1961, the tax payer

carrying on business is entitled to a deduction, in the

computation of 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 sub-

section (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 debt(s) 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

39

the deduction on account of the provision for bad and doubtful

debt(s) is distinct and independent of the provisions of Section

36(1)(vii) relating to allowance of the bad debt(s). In other

words, the scheduled commercial banks would continue to get

the full benefit of the write off of the irrecoverable debt(s)

under Section 36(1)(vii) in addition to 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

40

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 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

41

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).

3. Accordingly, the above question is answered in the

affirmative, i.e., in favour of the assessee(s). For the above

reasons, I agree that the appeals filed by the assessees stand

allowed and the appeals filed by the Revenue stand dismissed

with no order as to costs.

……………………..C.J.I. (S.H. Kapadia)

New Delhi; February 17, 2012

CATHOLIC SYRIAN BANK LTD. Vs COMMISSIONER OF INCOME TAX, THRISSUR

CATHOLIC SYRIAN BANK LTD. Vs COMMISSIONER OF INCOME TAX, THRISSUR