INCOME TAX APPELLATE TRIBUNAL - COCHIN BENCH

ITA NoS. 354 & 380 (Coch.) of 2013
[ASSESSMENT YEAR 2008-09]

N.R.S. GANESAN, JUDICIAL MEMBER
AND B.R. BASKARAN, ACCOUNTANT MEMBER

S. Vijayaprabha for the Appellant.
V. Devarajan for the Respondent.

ORDER

The order of the Bench was delivered by

B.R. Baskaran, Accountant Member—These cross appeals are directed against the order dated 27-03-2013 passed by the Ld. CIT(A), Trivandrum and they relate to the assessment year 2008-09.

2. While completing the assessment, the Assessing Officer made the following additions:

In the appeal filed by the assessee, the Ld. CIT(A) deleted the addition relating to bad debts claim and confirmed the addition of remaining two items. Aggrieved by the order of the Ld. CIT(A) both the parties have filed these appeals before us on the points decided against each of them.

3. The facts relating to the case are stated in brief. The assessee is a Government of Kerala undertaking engaged in providing financial assistance for industrial projects developed in the State of Kerala. The financial assistance is provided by way of giving term loans and/or by making investments in the share capital of the borrower. During the year under consideration, the assessee earned dividend income of Rs. 1.57 crores. However the assessee did not allocate any amount as expenditure incurred in relation to the dividend income. Accordingly it did not disallow any amount as required by the provisions of sec. 14A of the Act. The AO, by placing reliance on the decision of Hon'ble Bombay High Court in the case of Godrej & Boyce Mfg. Co. Ltd. v. Dy. CIT [2010] 328 ITR 81/194 Taxman 203, held that the disallowance is required to be made under Rule 8D. Accordingly, by applying Rule 8D(2)(iii), the Assessing Officer disallowed 0.5% of the average value of investment which worked out to Rs. 24,64,479/-.

3.1 The assessee had claimed deduction for bad debts u/s. 36(1)(vii) of the Act to the tune of Rs. 55,99,112/-. The Assessing Officer noticed that the assessee was also claiming deduction for the provision created for bad and doubtful debts u/s 36(1)(viia) of the Act. Hence, as per the proviso to sec. 36(1)(vii) of the Act, the amount of bad debts or part thereof claimed by the assessee is required to 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 sec. 36(1)(viia) of the Act. The AO noticed that the assessee has created the provision for bad and doubtful debts to the extent of Rs. 57.00 lakhs and has claimed the same u/s 36(1)(viia) of the Act. Since the bad debt claim of Rs. 55,99,112/- was less than the Provision amount of Rs. 57.00 lakhs claimed u/s 36(1)(viia) of the Act, the Assessing Officer held that the bad debts claim does not exceed the credit balance in the provision for bad and doubtful debts account. Accordingly, the AO disallowed the bad debts claim of Rs. 55,99,112/- made by the assessee.

3.2 The Assessing Officer noticed that the assessee was also claiming deduction u/s. 36(1)(viii) of the Act in respect of special reserve created and maintained by it. During the year under consideration, the assessee claimed a deduction of Rs. 2.50 croes. The AO noticed that the assessee has depicted the Special Reserve Account in Schedule -2 of the Balance Sheet as at 31.3.2008 as under:—

The provisions of sec. 36(1)(viii) requires the assessee to maintain the special reserve account. Further as per the provisions of sec. 41(4A) of the Act, any amount withdrawn from the special reserve account created u/s. 36(1)(viii) of the Act, shall be deemed to be profits and gains of the assessee and accordingly, be chargeable to income tax as the income of the previous year in which the amount is withdrawn. Since the assessee has reduced the loans and advances amount from the special reserve account, the Assessing Officer proposed to treat the amount of Rs. 53.96 crores as the income of the assessee u/s 41(4A) of the Act. The assessee submitted that it has reduced the amount of Rs. 53.96 crores both from the Special Reserve account and Loans and Advances account, as a contra item, for the purpose of preparation of financial statements only and not in the books of account. It was further submitted that the assessee is required to create Provision for bad debts as per the guidelines issued by IDBI. As per the said guide lines, the amount available in Special reserve account created u/s 36(1)(viii) of the Act can be treated as part of the Provision for bad debts. The assessee further submitted that the Special Reserve account is maintained intact in the books of account. It was further submitted that the assessee is following the above said method of presentation of accounts for the past several years and the same has been accepted by the department. However, the AO did not agree with the contentions of the assessee and held that the amount of Rs. 53.96 crores is to be treated as utilisation of amount available in the special reserve account. Accordingly, the AO assessed the sum of Rs. 53.96 crores as income of the assessee under section 41(4A) of the Act.

4. In the appellate proceedings, the Ld. CIT(A) noticed that the Assessing Officer omitted to make disallowance of proportionate interest expenditure relatable to the exempted dividend income u/s. 14A of the Act. The Ld. CIT(A), by placing reliance on the decision of the Hon'ble Jurisdictional High Court in the case of CIT v. Catholic Syrian Bank [2012] 207 Taxman 2/[2011] 9 taxmann.com 148 (Ker.) held that interest expenditure is required to be disallowed in terms of Rule 8D(2)(iii) of the Income Tax Rules. Accordingly, the Ld. CIT(A) issued notice for enhancement for making disallowance of proportional interest relatable to the investments. After hearing the assessee, he determined the proportional interest at Rs.11,69,196/- and directed the AO to add the same to the total income of the assessee. With regard to the expenditure relatable to the dividend income, the Ld. CIT(A) upheld the disallowance of Rs. 24,64,479/- made by the Assessing Officer.

4.1 With regard to the disallowance of bad debts claim of Rs.55,99,112/-, the assessee submitted before Ld. CIT(A) that the "provision for bad and doubtful debts" referred to under the proviso to sec. 36(1)(vii) is the "opening balance of provisions" available as on the first day of financial year and not the closing balance of the provision account. The Ld. CIT(A) accepted the said contentions of the assessee by placing reliance on the decision rendered by the Hon'ble Gujarat High Court in the case of CIT v. UTI Bank Ltd. [2013] 212 Taxman 296/29 taxmann.com 79 Before the Ld. CIT(A), the assessee also placed reliance on the decision of the Delhi Bench of the Tribunal in the case of Tourism Finance Corpn. of India Ltd. v. Jt. CIT [2010] 2 ITR (Trib.) 1 (Delhi.) wherein similar view was found expressed. Accordingly, the Ld. CIT(A) deleted the disallowance of Rs. 55,99,112.

4.2 With regard to the assessment made u/s. 41(4A) of the Act, the assessee submitted before the Ld. CIT(A) that it did not withdraw any amount from the special reserve account. It was further submitted that the assessee has made an adjustment by reducing amount from both the Loans and advances account and also from the Special Reserve account only in the balance sheet for presenting the same to the shareholders and also to comply with the directions issued by the IDBI. The assessee has also submitted account copies of special reserve account as available in its journal ledger to substantiate its claim that it did not withdraw any amount from the special reserve account. However, the Ld. CIT(A) did not agree with the said contentions of the assessee and held that the method adopted by the assessee for presenting the account would amount to utilisation of amount available in Special reserve account for making provisions as per the directions issued by IDBI. Accordingly, he confirmed the assessment made u/s. 41(4A) of the Act.

5. The first issue relates to the disallowance made u/s 14A of the Act. The contention of the assessee is that it did not incur any expenditure in earning the dividend income. It was also submitted that the assessee has invested into the share capital of many companies in the regular course of business of providing financial assistance. He further submitted that the assessee has used its own funds for making investments in shares. He also submitted that the AO was not right in taking average value of all the investments for the purpose of calculating the disallowance of expenses, instead of the average value of dividend yielding investments.

5.1 However, the Ld D.R submitted that the Ld CIT(A) has followed the decision rendered by the Hon'ble jurisdictional Kerala High Court in disallowing a part of interest expenditure. The Ld D.R further submitted that the claim of the assessee that it did not incur any expenditure in realising the dividend income is not admissible in view of the specific provision contained in sub. sec. 3 of sec. 14A, wherein it is clearly stated that the provisions of sec. 14A(2) shall apply in relation to a case where an assessee claims that no expenditure has been incurred.

5.3 We have heard the rival contentions on this issue. Though the assessee has contended that it did not utilise borrowed funds for making investments in purchase of shares, yet no material was furnished by it to substantiate the said claim. The assessee has also not shown as to how the decision rendered by the Hon'ble jurisdictional High Court in the case of Catholic Syrian Bank (Supra) is not applicable to the facts of the instant case. We notice that the Ld CIT(A) has duly addressed the contention of the assessee with regard to the manner of computation of average value of investments in paragraph 11.2 of his order, i.e., the Ld CIT(A) has expressed the view that, as per Rule 8D(2)(iii), the average value of investment, income from which does not or shall not form part of the total income is required to be considered, meaning thereby the entire value of investments made in shares is required to be considered. We agree with the said view expressed by Ld CIT(A). Further, as per sec. 14A(3) of the Act, the disallowance as per sec. 14A(2) is required to be made, even if the assessee claims that it did not incur any expenditure in earning the dividend income. Under these circumstances, we do not find any reason to interfere with the decision rendered by Ld CIT(A) on this issue.

6. The next issue relates to the disallowance of claim of bad debts. Before AO, the assessee submitted a copy of "Provision for Bad and Doubtful account, which is extracted by the AO as under:—

Provision for Bad and Doubtful Debts Accounts

Before Ld CIT(A), the assessee placed reliance on the following case law to contend that the "provision for bad and doubtful debts" referred to in the proviso to sec. 36(1)(vii) of the Act is the Opening balance of the provision as on 1.4.2007 for the year under consideration.

Tourism Finance Corpn. of India Ltd. (supra), UTI Bank Ltd.
The Ld CIT(A) accepted the contentions of the assessee and accordingly decided this issue in favour of the assessee. The relevant observations made by Ld CIT(A) are extracted below:—

"11.3 The third ground of appeal is regarding denial of deduction of bad debts written off amounting to Rs. 55,99,112 over and above the provision created u/s. 36(1)(viia). In the assessment order, the Assessing Officer has observed that the assessee has not set off the said amount of bad debts written off during the year against the provisions made during the year of Rs. 57,00,000 and claimed deduction for both the amounts. He has further stated that the proviso to sec. 36(1)(vii) restricts the write off relating to such debts by putting a restriction that the write off shall be limited to the amount by which such debt exceeds the credit balance in the provisions for bad and doubtful debts made under clause 36(1)(viia). During the course of appellate proceedings, the appellant submitted that as decided by Hon'ble ITAT Delhi Bench in the case of Tourism Finance Corpn. of India Ltd. (supra) and Hon'ble Gujarat High Court in the case of UTI Bank Ltd. (supra), the amount of opening balance in the provision for bad and doubtful debt account created u/s. 36(1)(viia) is to be considered and not the closing balance (as done by Assessing Officer) for the purpose of restriction. In the aforesaid case, the Hon'ble Gujarat High Court has held as under:

"Held: From the statutory provisions, it can be seen that in addition to the deduction available to an assessee under sec. 36(1)(vii) for bad debts, in case of special class of banks mentioned in cl. (viia), deductions subject to fulfilment of certain conditions is available in respect of any provision for bad and doubtful debts. One of the restrictions is of limiting such deduction to a maximum of a specified percentage of total income of the assessee computed before making any deduction under this clause and not exceeding prescribed percentage of aggregate average advance made by the rural branches of such bank. In the present case, the question of method of operation of proviso to sec. 36(1)(vii) arises. Such proviso as noted, provides that in case of an assessee to which cl.(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. In this respect, the provision is silent. However, the issue has been made sufficiently clear by the CBDT Circular No. 17 of 2008 dt. 26th Nov. 2008, which says that "while considering the claim for bad debts u/s. 36(1)(vii), the Assessing Officer should allow only such amount of bad debts written off as exceeds the credit balance available in the provision for bad and doubtful debt account created u/s. 36(1)(viia). The credit balance for this purpose will be the opening credit balance i.e. the balance brought forward as on 1st April of the relevant accounting year. When such circular issued u/s. 119(2) clarifies the position beyond any doubt, there is no reason to entertain the Revenue's appeals. To work out the proviso to sec. 36(1)(vii), the amount of deduction claimed by the assessee in respect of bad debts was not required to be reduced by the closing balance for the doubtful debts account but by the opening balance thereof - Catholic Syrian Bank Ltd. v. CIT [2012] 248 CTR (SC) 1: [2012] 68 DTR (SC) 1: [2012] 343 ITR 270 (SC) and UCO Bank v. CIT [1999] 237 ITR 889 (SC) applied."

Therefore, it is seen that the Hon'ble Gujarat High Court relying upon the various judgments of Hon'ble Supreme Court and also CBDT Circular No. 17 of 2008 held that for the purposes of proviso to sec. 36(1)(vii), the amount of deduction claimed by the assessee in respect of bad debts was required to be reduced by the opening balance of provision for bad and doubtful debts created and not the closing balance. As given in the assessment order, the opening balance of provision for bad and doubtful debts is nil and therefore, the entire amount of bad debt of Rs. 55,99,112/- is allowable as deduction. The addition made by the Assessing Officer is therefore, deleted.'

We notice that the Ld CIT(A) has followed the decision rendered by the Hon'ble Gujarat High Court, wherein the Hon'ble High Court has placed reliance on the circular No.17 of 2008 dated 26th Nov. 2008 issued by the CBDT in deciding this issue. Hence, we do not find any infirmity in the decision of Ld CIT(A) on this issue.

7. The next issue relates to the assessment of Rs.53.96 crores relating to the Special reserve created u/s 36(1)(viii) of the Act. According to the assessee, it has reduced the above said amount from the Special Reserve Account while preparing the Balance sheet for presenting the same to the shareholders by making corresponding reduction from the Loans and Advances account. According to the assessee, it has maintained the Special Reserve Account intact in its books of account and such a reduction was not made in the books of account, but only in the Balance Sheet. However, the said explanation was not accepted by the AO. Hence, the AO treated the above said amount of Rs. 53.96 crores as utilisation of special reserve account and accordingly brought the same to tax as per section 41(4A) of the Act.

7.1 The submissions made by the assessee before Ld CIT(A) has been explained by the first appellate authority as under in paragraph 11.4 of his order:—

'During the course of appellate proceedings, the appellant has pointed out that no amount has been withdrawn from the Reserve created u/s 36(1)(vii) and only for the purpose of presentation in the balance sheet, total amount of loans and advances has been deducted from it. It has been submitted that the same has done for meeting the IDBI guidelines. The appellant has also filed General Ledger of 'Special Reserves' from 1.4.2007 to 24.3.2012 to show that no amount has been deducted in the Special Reserve. As per this ledger, the opening balance as on 1.4.2007 was Rs.53,96,19,451/-. Separate figures for Special Reserve created for F.Yrs. 2007-08, 2008-09, 2009-10 and 2010-11 have been given in this General Ledger A/c and the closing balance as on 31.3.2011 has been shown at Rs. 62,20,71,451/-. There is no debit in this account. Further, the appellant has filed balance sheet relevant to F.Y 2011-12 showing figures of Special Reserve u/s 36(1)(vii) of the I T Act as on 31.3.2011 and 31.3.2012. The amount as on 31.3.2011 is same as shown in the ledger i.e Rs. 62,20,71,451/-. For working out the said Reserve as on 31.3.2012, the aforesaid amount has been taken as opening balance and after making the addition made during the year 2011-012 at Rs. 327 lakhs, closing balance has been shown at Rs. 6547.71 lakhs. Further, the appellant has given a copy of Schedule 8 of Balance sheet as at 31.3.2008 loans and advances which is reproduced as under:

It can be seen from the above that Special Reserve amount has been deducted from Assets in the forms of secured loan, unsecured loan and soft loan as given in IDBI guidelines discussed below.

The appellant has also contended that as per sec. 41(4A), any amount subsequently withdrawn from Special Reserve only is deemed to be income chargeable to tax, therefore, the section comes into play only when any amount is withdrawn from the account. It has been contended that the appellant has not withdrawn any amount from the said amount and only for the purpose of presentation in the balance sheet in schedule 2; amount of loan and advances has been shown as contra and reduced from special reserves.

In nutshell the appellant has claimed that the special Reserve created u/s 36(1)(vii) has not been utilized whereas the case of AO is that assessee has made utilization out of the said Reserve. The question to be answered is whether the action of appellant in making provision for bad debts as per IDBI guidelines amounts to withdrawal out of said reserve or not. In this regard note (3) of circular no. F1.1/94-95 dt. 26.4.94 of IDBI issued to all State Industrial Development Corporation (SIDCS) is reproduced as under:

"SIDCs have been permitted to create a special reserve to avail of the benefit as permissible in terms of section 36(1)(viii) of the Income Tax Act, 1961. The cumulative balance of provisions available/made under this section is admissible for provision purposes. The reserve can, therefore, be utilized to create specific provisions for assets classified as doubtful or loss. The assets and liabilities should be reduced to the extent of provision utilized from the cumulative balance of reserves u/s 36(1)(vii), i.e to say, assets are to be shown as net of provisions."'

7.2 We notice that the issue boils down to the question, as rightly posed by Ld CIT(A), whether the action of the assessee in considering the amount available in "Special Reserve Account" for the purpose of determining the "Provision for bad and doubtful debts" as per the guidelines issued by IDBI would amount to utilisation of the said Special Reserve or not. The Ld CIT(A) has taken the view as under:—

"If the appellant claims that guidelines of IDBI have been followed, which is the case here, it is deemed to be taken that there was transfer of funds from special reserve account to Bad & Doubtful debt provision account. By not debiting the amount utilised from the Special Reserve ledger Account and showing the reduction in Special Reserve in Balance Sheet only, the appellant has made an unsuccessful attempt to give an impression that there was no withdrawal from the Special Reserve. No amount of dressing given to the balance sheet can prevent applicability of section 41(4A) in its case. The appellant stopped making provision of bad debts as per the said IDBI guidelines (which in my opinion could be used only till said amendment of Act i.e, till AU 1997-98) from financial 2010-11 onwards and that is why no such deduction was made from the Special Reserve account in the Balance Sheet from said financial year."

7.3 Before us, the Ld Counsel for the assessee submitted that the assessee has made a contra adjustment in the Balance Sheet in order to comply with the directions issued by IDBI, but in the books of account it has maintained the Special Reserve account intact, i.e., it has not used the special reserve as presumed by Ld CIT(A). He further submitted that the assessee is required to compute provision for bad and doubtful debts as per the norms prescribed by IDBI. While determining the amount of provision required to be made, the assessee is permitted to take into account the amount available in Special Reserve Account. According to the said guidelines, the Assets and Liabilities should be reduced to the extent of Provision utilised from the cumulative balance of reserves created u/s 36(1)(viii), i.e., the assets are to be shown as net of provisions. Hence, in the Balance Sheet, the assessee has reduced Special reserve account and Loans and Advances account with the amount of provision. On the contrary, the Ld D.R submitted that the assessee has adopted colourable device to circumvent the provisions of Income tax Act, which was strongly refuted by Ld A.R.

7.4 There should not be any dispute that the books of original entry and evidences supporting the transactions recorded in the books assume primary significance. It is also a well settled proposition that the entries recorded in the books alone are not determinative factors for the purpose of computing true income of the assessee. Hence, the tax authorities are required to determine the correct income of the assessee by considering the books of accounts, evidences, method of accounting, other surrounding factors etc.

7.5 In the instant case, there is no dispute that the assessee has maintained the Special Reserve Account intact, which is evidenced by the fact that the Ld CIT(A) himself has narrated about, which is extracted above, the transactions available in the Special Reserve Account since 1.4.2007. The Balance in the Special Reserve Account as on 1.4.2007 was Rs. 53.96 crores. After adding the amount appropriated to this account every year, the balance available in this account as on 31.3.2011 was Rs. 62.20 crores, which was taken as opening balance of the succeeding financial year. The Ld CIT(A) has given a categorical finding that there is no debit in this account, meaning thereby, the books of account of the assessee do not show any utilisation of "Special Reserve Account".

7.6 However, in the Balance sheet, the assessee has reduced the Special Reserve Account with certain amount. According to the assessee, it is a contra adjustment only and it has made corresponding reduction from "Loans and Advances account" also. According to the assessee, it was required to do so as per the directions issued by IDBI, which the assessee is required to comply with. According to the said guidelines, the Assets and Liabilities should be reduced to the extent of Provision utilised from the cumulative balance of reserves created u/s 36(1)(viii), i.e., the assets are to be shown as net of provisions. Whether the adjustments made in the Balance sheet only for the purpose of presenting the same to the shareholders/ regulator, without actually disturbing the books of account, would amount to utilisation of special reserve is the moot question here. The Ld CIT(A) has taken the view that the same amounts to utilisation of special reserve, which would attract the provisions of sec. 41(4A) of the Act.

7.7 However, we are unable to agree with the view expressed by Ld CIT(A). The financial statements are prepared on the basis of books of account for various purposes. The method of presentation of the financial statements would vary according to the needs of the user of the same. So long as they tally with the books of account, generally no fault is found with regard to the method of presentation.

7.8 The assessee has furnished a copy of guidelines issued by IDBI. As per the said guidelines, the assessee is required to classify its assets, mainly loans and advances, into four categories, viz., Standard assets, Sub-standard assets, Doubtful assets and Loss assets. The purpose of classification of the assets in the above categories appears to be to ascertain about the intrinsic strength of those assets. We notice that the IDBI has also specified the criteria or basis for classifying the assets in the four categories stated above. According to the said guidelines, the assessee is also required to make provisions against the assets classified as Sub-standard, Doubtful and loss category, possibly these categories bear risk of recovery. According to the said guidelines, the SIDCs are required to determine the amount of provision for bad and doubtful debts. According to the guidelines issued by IDBI, the amount available in the Special Reserve Account u/s 36(1)(viii) of the Act is admissible for provision purposes. The meaning of this guideline, in our view, is that the SIDCs can take into account the amount available in the Special Reserve Account while determining the amount of provision. Let us explain this by a small example. Let us assume that one SIDC has determined the amount of "Provision for bad and doubtful debts" as per the guidelines issued by IDBI at Rs.10 crores. Normally, the said SIDC is required to make provision for Rs.10.00 crores in its books of account. Let us assume that the amount available in Special Reserve Account of that SIDC is Rs.4.00 crores. Since the guidelines issued by IDBI permits utilisation of the amount available in Special Reserve Account for making provisions, it will be sufficient compliance of the guidelines, if the SIDC makes provision for Rs.6.00 crores only, instead of Rs.10.00 crores, i.e. (10.00 (-) 4). The provision for bad and doubtful debts is created only to safeguard the financial institution against bad debts, i.e., the possible bad debts risk is evened out to a number of years. Hence, in our view, the permission given by IDBI for utilising the amount available in Special Reserve Account for making provision does not mean that the SIDC has actually utilised the Special Reserve Account. The said relaxation only allows the SIDC to determine the amount of "Provision for bad and doubtful debts" that is required to be made as per the guidelines issued by IDBI, i.e., in terms of IDBI guidelines, the provision for bad and doubtful amount shall be computed by aggregating the amount available in Special Reserve account with the amount available in Provision for bad and doubtful account.

7.9 Accordingly, in our view, the provisions of sec. 41(4A) would not apply so long as the SIDC maintains the Special Reserve Account intact in its books of account. The method of presentation of the same in the Balance Sheet also, in our view, does not matter for the purposes of sec. 36(1)(viii) r.w.s. sec. 41(4A) of the Act. In the instant case, the Ld CIT(A) has given a finding that there is no debit in the "Special Reserve Account", meaning thereby the assessee did not make use of any amount from the said account. Hence, the assessee has not utilised any amount available in Special Reserve account, as presumed by the tax authorities. Hence, in our view, there is no reason to invoke the provisions of sec. 41(4A) of the Act, on the basis of Balance sheet, wherein certain adjustments have been made by the assessee for the purpose of presenting it to the shareholders and the regulator. Accordingly, we set aside the order of Ld CIT(A) on this issue and direct the AO to delete the impugned addition of Rs.53.96 crores.

The order pronounced in the open court on November 6, 2013.