Section 36(1)(vii)

Section 36(1)(vii) — the law in short

What the courts have decided on section 36(1)(vii), in one screen. Read this first; open an entry when you need the facts, the reasoning and the source.

• Catholic Syrian Bank Ltd v CIT Supreme CourtHelps taxpayer
  My bank has a section 36(1)(viia) provision for rural advances. Does that provision cut down my deduction for urban bad debts actually written off under section 36(1)(vii)?
  No. The Supreme Court held that the deduction under section 36(1)(viia) for a provision against rural advances is distinct and independent of the deduction under section 36(1)(vii) for a bad debt actually written off. The proviso to clause (vii), which limits the write-off deduction to the excess over the credit balance in the clause (viia) account, exists only to prevent double deduction, and can operate only where that risk exists - that is, in respect of rural advances. Where the debts written off arise out of urban advances, the allowance is not affected by the proviso at all. The banks' appeals were allowed and the Revenue's dismissed.
• Vijaya Bank v CIT Supreme CourtHelps taxpayer
  I debited the bad debt to the profit and loss account and reduced debtors in the balance sheet, but did not close each debtor's ledger account — is that an actual write-off under section 36(1)(vii)?
  Yes. The Supreme Court held on 15 April 2010 that debiting the profit and loss account and simultaneously reducing loans and advances or debtors on the asset side, so that the year-end figure is shown net of the provision, is an actual write-off. What the Explanation inserted with effect from 1 April 1989 excludes is a debit to the profit and loss account matched by a credit to current liabilities and provisions — that is a provision, not a write-off. There is no further requirement to close the individual account of each debtor. The Assessing Officer can call for those accounts if he has reason to believe the deduction is being claimed twice.
• TRF Ltd v CIT Supreme CourtCuts both ways
  The AO wants proof my debt is actually irrecoverable before allowing the bad debt write-off. Is that right?
  No. For years after 1 April 1989 you do not have to establish that the debt has in fact become irrecoverable — it is enough that it is written off as irrecoverable in your accounts. The officer can still check that the write-off was actually made in the books, which is why the matter was remitted.
• Southern Technologies Ltd v Joint CIT Supreme CourtHelps department
  My NBFC has to debit a provision for non-performing assets to the profit and loss account under the RBI norms. Can the officer add it back when computing my taxable income?
  Yes. The Supreme Court held that a provision for non-performing assets made by a non-banking financial company under the RBI's Prudential Norms Directions 1998 must be added back in computing total income. The Directions are prudential and disclosure norms; they govern income recognition and how the provision is presented in the balance sheet, and have nothing to do with computation of taxable income. The provision is not a write-off, so section 36(1)(vii) is not satisfied, and because the Explanation to section 36(1)(vii) expressly puts a provision for doubtful debt outside that clause, section 37(1) cannot be used instead. The constitutional challenge to sections 36(1)(viia) and 43D also failed.
• Badridas Daga v CIT Supreme CourtHelps taxpayer
  My employee embezzled money from the business bank account. Can I write that off for tax?
  Yes, as a trading loss, provided the loss springs from the way the business is carried on. The Court refused the claim as a bad debt and refused it as expenditure, and then allowed it under the charging provision itself, because profits of a business cannot be computed without taking account of losses incidental to that business. The route matters: this is a deduction in computing profits, not an item of expenditure under s.37(1).
• M/s Ashok Leyland Finance Ltd v DCIT (Madras High Court) — a non-banking financial company cannot claim a deduction for a provision against non-performing assets beyond the amount the statute recognises High CourtHelps departmentNo later treatment found
  My client is an NBFC that has made a provision against non-performing assets in accordance with the Reserve Bank of India's directions. Can it deduct that provision, or claim it as a business loss if it is not a bad debt?
  The Madras High Court held it cannot claim beyond the statutory limit and dismissed the appeal. It reasoned that section 36(1)(viia) provides a special dispensation for named institutions, that a non-banking financial company within the meaning of section 45-I of the Reserve Bank of India Act 1934 is included in that list, and that the provision for bad and doubtful debts made by such a company cannot exceed five per cent of the total income computed before any deduction under section 36 and Chapter VI-A. Its conclusion is stated in one sentence: the appellant cannot claim a deduction beyond the amount that is statutorily recognised. It also answered against the assessee the questions on diminution in the value of investments and on diminution in the value of repossessed stock of vehicles, the latter by reference to a separate order passed the same day in a connected appeal.
• Principal Commissioner of Income Tax-6 v Nalwa Sons Investment Ltd High CourtHelps taxpayerNo later treatment found
  My company deals in shares as part of its business, but its income comes mainly from lending. The Commissioner (Appeals) has treated the share loss as a speculation loss under the Explanation to section 73. Is the company excepted?
  Yes, if its total income mainly consists of income derived from the granting of loans and advances. The Delhi High Court held that the Tribunal was textually right to find the company within the exception carved out in the parenthesis of the Explanation to s.73, so the Commissioner (Appeals) fell into error in treating the reported loss as pertaining to a speculative transaction, and no question of law arose.
• CIT v Vodafone Essar Gujarat Ltd (Full Bench) — clause (i) catches a provision for doubtful debts but not an actual write-off High CourtCuts both ways
  The Assessing Officer has added our provision for bad and doubtful debts to book profit under clause (i) of Explanation 1, relying on the retrospective 2009 amendment. We reduced the provision from sundry debtors on the asset side. Does that make a difference?
  It does. After the retrospective insertion of clause (i) by the Finance (No.2) Act 2009 from 1 April 2001, a provision for diminution in the value of any asset — which is what a provision for doubtful debts is — must be added back, and the earlier line based on HCL Comnet under clause (c) no longer helps. But if the assessee simultaneously obliterates the provision by reducing the corresponding amount from loans and advances or debtors on the asset side, so that the balance sheet shows those figures net of the provision, that is an actual write-off and clause (i) is not attracted.
• CIT v Shreyas S. Morakhia High CourtHelps taxpayer
  I am a share broker. I bought shares for a client, he never paid, and I have written the whole amount off. The assessing officer allows me only the brokerage and says the value of the shares was never my income, so it was never my debt. Is that right?
  No. The Bombay High Court held that a share broker is entitled to deduction of the whole of the irrecoverable amount, not merely the brokerage. The debt owed by the client is a single debt arising out of a single transaction, and it comprises the value of the shares purchased on the client's behalf as well as the brokerage charged on the purchase. Section 36(2)(i) requires that the debt, or part of it, has been taken into account in computing the income of the assessee. The brokerage is credited to the profit and loss account and is assessed as business income, so part of the debt has been taken into account, and the section is satisfied for the whole of the debt. The Court pointed to the bill itself, which shows the rate, the quantity and the total value of the shares as well as the brokerage, and held that once the brokerage has been taxed as business income it is evident that within the meaning of section 36(2)(i) the debt or part thereof has been taken into account in computing the income of the assessee. The appeal was disposed of by answering the question of law in the affirmative and in favour of the assessee, with no order as to costs. One thing was left over: the value of any shares still in the broker's hands has to be adjusted against what is receivable from the client.
• Haryana State Industrial Development Corporation v CIT (Punjab and Haryana High Court) — the provision made in the current year itself sits in the credit balance and reduces the bad-debt write-off High CourtHelps departmentNo later treatment found
  The Assessing Officer has reduced my client's bad-debt claim by the s.36(1)(viia) provision created in the SAME year, not just by the opening balance. Is the current year's provision part of the credit balance for the purposes of the proviso to s.36(1)(vii)?
  On this authority, yes. The Punjab and Haryana High Court dismissed a State industrial development corporation's appeal and upheld the Tribunal's finding that the provision for bad and doubtful debts created during the year under section 36(1)(viia), of Rs.19,77,535, had to be reduced from the actual bad debts claimed under section 36(1)(vii) by reason of the proviso. The Court's own statement of the law is that to the extent to which the provision for bad and doubtful debts has been allowed under section 36(1)(viia), there can be no deduction under section 36(1)(vii), in view of section 36(2)(v). It held the Tribunal's finding to be in conformity with the proviso to section 36(1)(vii) and with section 36(2)(v) and not shown to be perverse or illegal, and dismissed the appeal.
• DCIT, Central Circle 8(3), Mumbai v Sanjana Cryogenic Storages Ltd ITATHelps taxpayerNo later treatment found
  The Approving Panel held that my client's arrangement is NOT an impermissible avoidance arrangement, but the Assessing Officer has taxed the same transaction under another section anyway. Can he do that?
  The Mumbai Tribunal did not decide the wide question, but it held that the Assessing Officer could not, while giving effect to the statutory process under section 144BA, proceed on a factual premise diametrically opposed to the findings returned by the Approving Panel on the very arrangement referred to it. It then dismissed the Revenue's appeal on the narrower ground that a company buying back its own shares, which must then be extinguished, does not 'receive' property within section 56(2)(x) at all.
• The Karnataka Bank Ltd v DCIT (ITAT Bangalore) — Explanation 2 to s.36(1)(vii) brings in the clause (b) to (d) assessees; it does not make a clause (a) bank set its non-rural write-off against the rural provision ITATHelps taxpayer
  For assessment year 2014-15 onwards the Assessing Officer says Explanation 2 to s.36(1)(vii) requires my client bank to set its NON-RURAL bad debts against the s.36(1)(viia) provision account before claiming anything. Is that right?
  The Bangalore Tribunal held it is not right for a bank claiming under sub-clause (a) of s.36(1)(viia). It construed Explanation 2, inserted by the Finance Act 2013 with effect from 1 April 2014, as operating in respect of sub-clause (a) only in relation to rural advances, and in respect of sub-clauses (b) to (d) — a foreign-incorporated bank, a public financial institution or State financial corporation or State industrial investment corporation, and a non-banking financial company — for advances given by both rural and non-rural branches. Its reason was that the Supreme Court in Catholic Syrian Bank had held sub-clause (viia)(a) to apply to rural advances only, that Parliament did not amend sub-clause (a), and that an Explanation inserted in clause (vii) does not override that construction. It therefore directed the Assessing Officer to allow the bad debts relating to non-rural branches under s.36(1)(vii) without adjusting them against the provision account.
• DCIT v National Insurance Co. Ltd (ITAT Kolkata) — under s.44 and Rule 5 an amortised premium and an investment written off are neither expenditure nor allowance nor provision, and the unexpired-risk reserve stays out of book profit ITATHelps taxpayerNo later treatment found
  The Assessing Officer has disallowed my general insurance client's amortisation of premium on investments and its investments written off, and has added the reserve for unexpired risks to book profit under s.115JB. What is the limit on his power?
  The Kolkata Tribunal dismissed all three of the Revenue's appeals. It upheld the Commissioner (Appeals) in deleting the disallowance of amortisation of premium paid on purchase of investments and of investments written off, on the footing that under section 44 read with Rule 5 of the First Schedule the Assessing Officer may add back only an expenditure, an allowance or a listed provision that is inadmissible under sections 30 to 43B, and an amount amortised or written off is none of those. It also upheld the Commissioner (Appeals) in holding that the reserve created for unexpired risk need not be added back in computing book profit under section 115JB, that reserve having been created not by a debit to the profit and loss account but out of the premium received, as the Insurance Act 1938 requires and as Rule 5(c) of the First Schedule and Rule 6E of the Income-tax Rules recognise.
• Statutory position — s.43D: interest on a bad or doubtful debt of a bank, financial institution or NBFC is taxed on credit or receipt, not on accrual, and what Rules 6EA and 6EB prescribe CBDT Circulars & InstructionsCuts both ways
  My client is a bank and has stopped accruing interest on non-performing accounts under RBI norms, but the Assessing Officer has added the interest on the mercantile basis. Is there a provision that displaces accrual?
  Yes. Section 43D opens "Notwithstanding anything to the contrary contained in any other provision of this Act" and provides that, for the institutions it names, income by way of interest in relation to such categories of bad or doubtful debts as may be PRESCRIBED — having regard to the guidelines issued by the Reserve Bank of India — is chargeable to tax in the previous year in which it is credited to the profit and loss account, or in which it is actually received, whichever is earlier. It therefore displaces the accrual basis for that interest and nothing else. The institutions named on the current departmental edition are a public financial institution, a scheduled bank, a co-operative bank other than a primary agricultural credit society or a primary co-operative agricultural and rural development bank, a State financial corporation, a State industrial investment corporation, and "such class of non-banking financial companies as may be notified by the Central Government in the Official Gazette in this behalf". The prescribed categories are in Rule 6EA of the Income-tax Rules, 1962.
• Statutory position — the proviso to s.36(1)(vii), s.36(2)(v) and Explanation 2: how a bank's bad-debt write-off is set against the s.36(1)(viia) provision account CBDT Circulars & InstructionsCuts both ways
  My client bank has claimed under s.36(1)(viia) and has also written off bad debts. The Assessing Officer says the write-off must first be set against the provision account and only the excess is deductible. Where does that come from, and does it reach non-rural debts?
  It comes from three places that must be read together. The proviso to s.36(1)(vii) says that where clause (viia) applies to the assessee, the deduction for a bad debt written off is limited to the amount by which the debt exceeds the credit balance in the provision for bad and doubtful debts account made under clause (viia). Section 36(2)(v) adds a condition precedent: where the debt relates to advances made by an assessee to whom clause (viia) applies, no deduction is allowed at all unless the assessee has debited that debt, in that previous year, to the clause (viia) provision account. Explanation 2 to clause (vii), inserted by section 7 of the Finance Act, 2013 with effect from 1 April 2014, then declares that for the purposes of that proviso and of s.36(2)(v) the account referred to is "only one account" and that it "shall relate to all types of advances, including advances made by rural branches". Whether Explanation 2 displaces the Supreme Court's construction in Catholic Syrian Bank for a sub-clause (a) bank is contested and is dealt with separately in this library.

Listed strongest first: Supreme Court, then High Court, then Tribunal, then CBDT. Nothing here has yet been read in full by a chartered accountant — open an entry to see where it came from.