Recovery of Bad Debts Not Taxable Unless Earlier Deduction Claimed: ITAT rules in favour of SBI [Read Order]

The Income Tax Appellate Tribunal (ITAT), ‘G’Bench, Mumbai, has ruled in favour of the State Bank of India (SBI) regarding the taxability of bad debt recoveries. The Tribunal held that the recovery of bad debts written off in earlier years is not taxable as income under Section 41(4) of the Income Tax Act unless a specific deduction was claimed in the past under Section 36(1)(vii) (write-off of bad debts).

The Revenue had taxed the recovery of bad debts amounting to approximately Rs. 931.60 crores, which were written off in earlier years. The Revenue argued that such recoveries are taxable regardless of the nature of the deduction claimed previously. SBI, the appellant argued that for the debts in question, it had claimed deductions under Section 36(1)(viia) (provision for bad and doubtful debts) rather than Section 36(1)(vii) (actual write-off of bad debts). SBI contended that Section 41(4), which taxes recoveries, is contingent upon a prior deduction under Section 36(1)(vii). Since no such deduction was claimed, the recovery should not be taxed.

It was submitted that the recovery pertains to advances written off in earlier years, and such recovery cannot be brought to tax under section 41(4) unless a corresponding deduction was allowed in earlier years. It was submitted that the assessee had not claimed a deduction under section 36(1)(vii) in the earlier year and therefore is not hit by the provisions of Section 41(4) of the Act. On the contrary, the department submitted that the assessee has not placed any material on record to demonstrate that deduction was not allowed earlier and no verification has been carried out and therefore the claim should not be entertained.

Before this Tribunal, the assessee claimed deduction in respect of provision for bad and doubtful debts, including provision for rural advances and standard assets, in accordance with statutory limits prescribed under section 36(1)(viia). It was submitted that the claim is computed as per law and supported by the Notes to computation.

Section 36(1)(viia) provides for a deduction to the Bank in respect of ‘any provision made for Bad and Doubtful debts’ subject to certain ceiling. It does not specify the methodology for calculation of provision for Bad and Doubtful debts. The Banks are required to make provision for Bad and Doubtful debts in accordance with the RBI guidelines.

The Tribunal agreed with SBI’s legal premise. It clarified the distinction between the two sections, Section 36(1)(vii) which allows a deduction for debts actually written off as irrecoverable and Section 36(1)(viia) which allows a deduction for a provision made for bad and doubtful debts (a provisioning entry).

The Tribunal relied on the decisions in State Bank of Mysore and the Supreme Court’s judgment in Nectar Beverages, which established that the different sub-sections of Section 41 operate in distinct spheres. A deduction under Section 36(1)(viia) (a provision) cannot be equated with a loss or expenditure under Section 36(1)(vii) for the purpose of taxation under Section 41(4).

Respectfully following the judicial precedent in the assessee’s own case cited, the two-member bench of Smt. Beena Pillai (Judicial Member) & Shri Jagadish (Accountant Member) upheld the plea of the assessee that provisions of section 41(4) of the Act are applicable only when recovery of bad debts is in relation to debts for which a deduction under section 36(1)(vii) is allowed.

While accepting the legal principle that the recovery is not taxable in this scenario, the Tribunal restored the matter to the file of the Assessing Officer for verification. The Officer is directed to verify whether the specific recovery in question relates to a debt for which a deduction was claimed under Section 36(1)(vii). It was held that if the deduction was claimed under Section 36(1)(viia) (provision), the recovery is not taxable, and if the deduction was claimed under Section 36(1)(vii) (write-off), the recovery remains taxable.

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