ORDER
R.V. Easwar, J.M.
1. These appeals, all by the Department, have been placed before the Special Bench in the following circumstances.
2. The assessee is a scheduled bank. In respect of the assessment years under consideration, it claimed deduction in respect of debts written off under the provisions of Section 36(1)(vii) of the Act. The AO found that the assessee had made provision for bad and doubtful debts and that the actual write-off of debts was less than the provision and, therefore, in terms of the proviso to Section 36(1)(vii); the assessee was not entitled to any deduction in respect of the write-off. The assessee contended before the AO that the amount actually written off in the books as bad debts represented non-rural advances, that the proviso to Section 36(1)(vii) would apply only in respect of rural advances written off as bad and, therefore, notwithstanding the fact that the actual amount written off is less than the provision for bad and doubtful debts, the assessee would be entitled to the deduction. This contention was not accepted by the AO who rejected the claim.
3. On appeal, the CIT(A) accepted the assessee’s contention for all the years. His view was that the intention of the legislature in enacting both Clauses (vii) and (viia) of Section 36(1) was that the banks should not get away with a double deduction in respect of the same amount-one, under the head “general provision for bad and doubtful debts” and again as a provision made for bad and doubtful debts in respect of advances made by their rural branches. Since in the present case, the latter (ie., the provision made in respect of rural advances) is not included in the former (i.e., the general provision for bad and doubtful debts), there is no justification for disallowing the claim made by the assessee which is only in respect of non-rural advances, fn this view of the matter, he allowed the claim of the assessee.
4. In respect of the asst. yr. 1992-93, the CIT(A) while allowing the claim, also observed that the bad debts mentioned in the proviso to Section 36(1)(vii) are those in respect of rural advances only and do not include other debts, i.e., non-rural or urban advances.
5. The Department is aggrieved and is in further appeal.
6. In some of the orders passed by the Cochin Bench in the Tribunal, a view had been expressed in favour of the Department. In the case of Dhanalakshmi Bank Ltd. (ITA Nos. 602 of 605/Coch/94 and 190/Coch/95), order dt. 29th May, 2001, it has been held that no distinction has been made in the proviso to Section 36(1)(vii) between rural and non-rural advances and, therefore, its application cannot be limited to rural advances, that under Clause (viia) a bank is entitled to have deduction in respect of a provision made for rural and non-rural advances and, therefore, the assessee’s contention cannot be accepted. In the case of Federal Bank Ltd. there are a series of orders taking the contrary view. In these orders, it has been held that the proviso to Clause (vii) covers only bad debts arising out of rural advances and if the actual write-off is in respect of non-rural or urban advances that cannot be controlled or restricted by the application of the proviso and the same should be allowed without making adjustment with the provision for bad and doubtful debts. These orders are in ITA No. 505, 854/Coch/93, dt. 5th March, 1998, ITA No. 376/Coch/95, dt. 8th Dec., 1998, ITA No. 284/Coch/1995, dt. 6th Oct., 1998. Since contrary views were expressed in these orders, a reference has been made to the Special Bench for resolving the issue and the following question has been referred.
“Whether, on the facts and in the circumstances of the case, the assessee 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 the excess over credit balance made under Clause (viia) of Section 36(1) of the IT Act, 1961 ?”
7. Section 36(1)(vii), as it stands with effect from the asst. yr. 1989-90, allows deduction in respect of 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. This is subject to certain conditions prescribed in Sub-section (2) with which we are not concerned in these appeals. The proviso is as under :
“Provided that in the case of an assessee to which Clause (viia) applies, the amount of 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”.
Clause (viia) insofar as it is relevant for our purpose, is as under :
“in respect of any provision for bad and doubtful debts made by :–
(a) a 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 two per cent of the aggregate average advances made by the rural branches of such bank computed in the prescribed manner.”
8. The question for our consideration is whether on a proper interpretation of the provisions extracted above, it is permissible to hold that the proviso to Section 36(1)(vii) refers only to the rural advances so that only the bad debts arising out of rural advances can be controlled or restricted to the excess of the amount written off over the amount of provision for bad and doubtful debts.
9. Clause (viia) of Sub-section (1) of Section 36 was introduced by the Finance Act, 1979, w.e.f. 1st April, 1980. The Memorandum explaining the provision (Circular No. 258, dt. 14th June, 1979) gives a clue to the object and intention behind the provision. The following is the text of the circular:
“Deduction in respect of provisions made for bad and doubtful debts relating to rural branches of scheduled commercial banks–Section 36(1)(viia).
13.1 Under Section 36(1)(vii) of the IT Act, a taxpayer carrying on business or profession is entitled to a deduction, in the computation of the taxable profits, of the amount of any debt which is established to have become bad during the previous year, subject to certain conditions. However, a mere provision for bad and doubtful debts is not allowed as a deduction in the computation of the taxable profits.
13.2 In order to promote rural banking and 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, 1979, has inserted a new Clause (viia) in Sub-section (1) of Section 36 of the IT Act to provide for a deduction, in the computation of the taxable profits of all scheduled commercial banks, in respect of provisions made by them for bad and doubtful debts relating to advances made by their rural branches. The deduction will be limited to 1-1/2 per cent of the aggregate average advances made by the rural branches computed in the manner to be prescribed by rules in the IT Rules, 1962. For this purpose, a ‘rural branch’ means 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 before the first day of the previous year. The expression ‘scheduled bank’ has the same meaning as in the Explanation below Section 11(2)(b) of the IT Act but does not include a co-operative bank. The expression ‘scheduled bank’ would, therefore, cover the State Bank of India constituted under the State Bank of India Act, 1955, any subsidiary bank of the State Bank of India as defined in the State Bank of India (Subsidiary Bank) Act, 1959, a nationalized bank as specified in Section 3 of the Banking Companies (Acquisition and Transfer of Undertakings) Act, 1970, or any other bank included in the Second Schedule to the Reserve Bank of India Act, 1934. It may be mentioned that all co-operative banks have been excluded from the purview of this provision in view of the position that under Section 80P(2)(a)(i) of the IT Act, the profits and gains of a co-operative society engaged in the business of banking or providing credit facilities to its members are completely exempt from income-tax.
13.3 It may be 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 36(1)(vii) relating to allowance of bad debts. In other words, the scheduled commercial banks would continue to get the full 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).
13.4 This provision will take effect from 1st April, 1980, and will accordingly apply in relation to the asst. yr. 1980-81 and subsequent years.”
It may be noted from the circular that the object of Clause (viia) is to allow a deduction in respect of provision made for bad and doubtful debts in respect of advances made by the rural branches of the bank. This is further clarified by the following Circular (No. 464, dt. 18th July, 1986) explaining certain amendments made to the clause by the IT (Amendment) Act, 1986 :
“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 IT Act inserted by the Finance Act, 1979, provision for bad and doubtful debts made by a scheduled or a non-scheduled Indian bank is allowed as deduction within the prescribed limits. The limit prescribed is 10 per cent of the total income or 2 per cent 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 which 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 per cent of the total income or 2 per cent of the aggregate average advances made by the rural branches of Indian banks, whichever is higher, should be modified. Accordingly, by the Amending Act, the deduction presently available under Clause (viia) of Sub-section (1) of Section 36 of the IT Act has been split into two separate provisions. One of these limits the deduction to an amount not exceeding 2 per cent of the aggregate average advances made by the rural branches of banks concerned. It may be clarified that the foreign banks do not have rural branches and hence this amendment will not be relevant in the case of the foreign banks. The other proviso secures 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 per cent 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 per cent of the aggregate advances made by such branches and a further deduction up to 5 per cent of their total income in respect of provision for bad and doubtful debts”.
10. We may also note one more Circular issued by the Board (No. 421 dt. 12th June, 1985) explaining the amendments made to Clause (vii) of Sub-section (1) of Section 36 and Sub-section (2) of the section and clarifying the position vis-a-vis the provisions of Clause (viia) of Section 36(1). The circular is reproduced below :
“Deduction in respect of provisions made by banking companies for bad and doubtful debts.
17.1 Section 36(1)(vii) of the IT Act, provides for a deduction in the computation of 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 IT 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 1-1/2 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)(viia) of 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 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)(viii) 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 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 debts account made under Clause (viia) of Section 36(1).”
11. A reading of the above circulars shows that the intention behind the relevant provisions, in the case of banks, is like this. Normally a deduction for bad debts can be allowed only if the debt is written off in the books as debt. No deduction is to be allowed in respect of a mere provision for bad and doubtful debts. 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. This, however, may result in double allowance in the sense in respect of the same rural advance the bank may get an allowance of the provision on the basis of Clause (viia) and also on the basis of the 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 provision account created under Clause (viia).
12. But the Revenue disputes the position that the proviso to Clause (vii) refers only to rural advances and says that there are no words therein which would lead to such an interpretation, viz., that it applies only to rural advances. We are unable to uphold the objection firstly because the Board itself has recognized the position that a bank would be entitled to both the deductions–one, under Clause (vii) on the basis of the actual write-off and another, on the basis of Clause (viia) in respect of a mere provision. This may lead, as noted earlier, to the result that in respect of the same advance the assessee may get a double deduction, one on the basis of the write-off and again on the basis of the provision. It was to prevent this that the proviso to Clause (vii) was inserted which says that in respect of the bad debt arising out of rural advances the deduction on account of the actual write-off would be limited to the excess of the amount written, off over the amount of the provision which has already been allowed under Clause (viia). The proviso has been introduced to protect the Revenue but it would be meaningless to invoke the same where there would be no threat of double-deduction. In the case of rural advances, which are covered by the provisions of Clause (viia), there would be no such double-deduction. The proviso in terms limits its application to the case of a bank “to which Clause (viia) applies”. Now undisputedly Clause (viia) applies only to rural advances. That has been made clear by the circular of the Board (supra) explaining the provisions of the said clause while introducing the same by the. Finance Act, 1979. It has further been clarified by the circular of the Board (supra) while explaining the position with reference to the foreign banks in the context of the amendments made by the IT (Amendment) Act, 1986. In particular, it has been explained that the foreign banks do not have rural branches in India and, therefore, they are not eligible for the deduction under the said clause. The proviso further refers to the excess of the amount written off over the credit balance in the provision for bad and doubtful debts account “made under that clause” which can only refer to Clause (viia). Thus, there is inherent evidence in the proviso itself to indicate that it is limited in its application to bad debts arising out of rural advances. The Board circulars referred to above also unmistakably show that, Clause (viia) is intended to apply only to rural advances of a bank. The circulars which throw light on the intention and object behind the provisions cannot be ignored.
13. Our attention was drawn in the course of the arguments to the judgment of
the Rajasthan High Court in CIT v. Bank of Rajasthan Ltd. (2002) 255 ITR 599 (Raj). In fairness to both the sides, it must be stated that.
they agreed that the judgment is not directly relevant to the controversy arising
in the present case. On a careful reading of the judgment we agree with them. It
at all, there is some support to be derived by the assesgee-bank from the
judgment as pointed out before us by Mr. Sarangan, the learned senior counsel
for the assessee-bank, inasmuch as the judgment recognizes the position that
the deductions allowable under Clause (vii) and (viia) are distinct and Independent;
a position which hag also been recognized by the Board in one of its circulars
extracted supra.
14. In the light of the aforesaid discussion, it follows that if the amount of bad
debts actually written off in the accounts of the bank represents only debts
arising out of non-rural (urban) advances, the allowance thereof in the
assessment is not affected, Controlled or limited in any way by the proviso to
Clause (vii). We hold accordingly.
15. In our opinion, the view taken in the orders passed by the Cochin Bench of the Tribunal in the case of Federal Bank Ltd. (supra) and the recent order of the Madras Bench of the Tribunal in the case of Kami Vysya Bank Ltd. (ITA No. 1410/Mds/93, dt. 21st March, 2002), (copy filed), appear to reflect the correct legal position. The contrary view expressed by the Cochin Bench in the case of Dhanalakshmi Bank Ltd. (supra) does not, in our opinion, reflect the correct view.
16. We, therefore, answer the question referred to the Special Bench in the affirmative and hold that the debts actually written off which do not arise out of 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 limited in accordance with the proviso.
17. As regards the actual application of the provisions of both Clause (vii) and (viia) to the case, we find that the CIT(A) has found that the assessee-bank is maintaining two separate accounts, one for bad and doubtful debts other than the provision for bad debts in rural branches for which separate accounts’ are maintained and that this is evidenced by the entries in the printed P&L a/c, balance sheet and break-up details. That this is the factual position was also confirmed before us by the learned senior counsel for the assessee. In fact, he also stated that debtwise position can also be ascertained from the records maintained by the bank. Under the circumstances, the matter has to be restored to the AO to enable him to examine the factual position and decide the same as per our directions.
18. The appeals will now be placed before the Division Bench, which will give effect to our order in respect of this issue and also dispose of the other grounds, after giving both the sides an opportunity of being heard.