Recently in a decision, the Income Tax Appellate Tribunal ( ITAT ) of Bangalore upheld a bank’s claim for the write-off of non-rural bad debts, overturning the Assessing Officer’s ( AO ) disallowance under Section 36 of the Income Tax Act 1961 ( ITA ). The case, which concerned the 2015-16 assessment year, revolved around whether the assessee/appellant bank, Karnataka Bank Ltd, could claim deductions for bad debts written off from non-rural branches without adjusting them against provisions made under Section 36(1)(viia) of ITA, which is primarily meant for rural branches.
The dispute began when the assessee-bank claimed a deduction of Rs. 218.09 crore for bad debts, primarily from non-rural branches. Of this, Rs. 145.16 crore was disallowed by the AO, who argued that these amounts were merely prudential write-offs, not actual bad debts eligible for deduction under Section 36(1)(vii) of the tax statute. The AO further claimed that the bank had already claimed deductions for these bad debts under Section 36(1)(viia) of ITA, which allows banks to make provisions for bad and doubtful debts, and that allowing a deduction under both provisions would result in a double benefit to the bank.
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The assessee-bank, however, maintained that Section 36(1)(vii) of ITA, which deals with actual bad debts, and Section 36(1)(viia) of ITA, which pertains to provisions for rural bad debts, are independent of each other. The assessee argued that the proviso to Section 36(1)(vii), which limits deductions in cases where provisions have already been made under Section 36(1)(viia), only applies to rural debts. Therefore, bad debts from non-rural branches should be allowed as a deduction without needing to be adjusted against the provisions for rural branches.
Citing the Supreme Court’s ruling in Catholic Syrian Bank Ltd. vs. CIT, the bank stressed that the two sections were distinct and should not be conflated. The Supreme Court had previously held that Section 36(1)(vii) of ITA applies separately to non-rural debts, while Section 36(1)(viia) of the tax statute only applies to rural debts, making it clear that banks are entitled to claim both deductions, provided they pertain to different types of advances.
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The bench of Mr Laxmi Prasad Sahu and Mr Keshav Dubey agreed with the assessee-bank’s arguments and found that the AO had misinterpreted the provisions of Section 36 of the tax legislature. The Tribunal observed that the proviso to Section 36(1)(vii) of ITA was wrongly applied to non-rural debts by the AO. It reaffirmed that only rural advances are subject to the proviso under Section 36(1)(viia) of tax statute, and non-rural bad debts can be claimed as a deduction without being adjusted against provisions for bad and doubtful debts.
In its judgment, the ITAT observed that the legislative intent of Section 36(1)(viia) of ITA was to support rural banking, and the two sections were meant to operate independently. By disallowing the deduction for non-rural bad debts, the AO had incorrectly applied the law, which the Tribunal corrected by allowing the full deduction for the bank’s non-rural bad debts.
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