2006 (7) TMI 524 - AT - Income Tax

Disallowance of expenditure - earning interest on tax free bonds and dividend income - Expenditure incurred in relation to income not includible in total income - Bad debts - HELD THAT - In the case of the assessee bank, it is an admitted position that the assessee is having the indivisible business and considering the nature of the business of the assessee the investment in the tax free bonds or investment in the shares may be in the nature of stock-in-trade. There is no identity in respect of the funds applied for investment in the tax free bonds or shares and funds which are applied for earning taxable income. The Assessing Officer has adopted the method which is not prescribed as per the provisions of sub-section (2) of section 14A. Moreover, we find that unless the method for working out disallowance of the expenditure in case of an indivisible business is prescribed as provided in sub-section (2) of section 14A, no disallowance is permissible. We are, therefore, of the opinion that in spite of the introduction of section 14A, the principles laid down by the Apex Court in the case of Rajasthan State Warehousing Corpn. 2000 (2) TMI 5 - SUPREME COURT still hold good law and as there is no clear identity in respect of the funds applied by the assessee for making the investment for earning the tax free income as well as taxable income and as assessee s business is indivisible one, the method adopted by the Assessing Officer for making the disallowance is not a permissible method and Assessing Officer was not justified in making the disallowance from the expenditure in respect of the interest attributable to investment on tax free bonds and expenditure incurred for earning the dividend income. We, therefore, set aside the order of the CIT(Appeals) on this issue and direct the Assessing Officer to delete the said addition. Bad debt - It is revealed that the assessee had made certain provision directly to the profit and loss account which as per the assessee, is the special provision made for working out the realizable value. It is not denied on the facts of this case that the provision was in respect of only bad and doubtful debts. As per the Explanation to clause ( vii ) to section 36(1) of the Act, any provision which is in the nature of bad and doubtful debt is not an allowable deduction and cannot be treated as bad debt for the purpose of the said clause. We, therefore, confirm the disallowance made by the Assessing Officer on this issue. In the result, the assessee s appeal is partly allowed whereas revenue s appeal is dismissed.

Issues Involved:
1. Proportionate disallowance of expenditure for earning interest on tax-free bonds and dividend income.
2. Disallowance of deduction under section 35D.
3. Disallowance of bad debt.
4. Expenditure on club membership.
5. Disallowance of broken period interest.
6. Bad debt written off under section 36(1).

Detailed Analysis:

1. Proportionate Disallowance of Expenditure for Earning Interest on Tax-Free Bonds and Dividend Income:
The first issue concerns the proportionate disallowance of expenditure incurred to earn interest on tax-free bonds and dividend income. The Assessing Officer (AO) disallowed Rs. 2,75,77,410 as expenditure attributable to earning interest on tax-free bonds and Rs. 90,60,850 for earning dividend income, citing section 14A of the IT Act. The assessee contended that only direct expenditure should be disallowed and argued that investments were made from interest-free funds. The AO, however, rejected these contentions, noting the absence of documentary evidence. The Tribunal observed that section 14A was introduced to clarify existing principles and that the business was indivisible. It concluded that the AO's method was not permissible and directed the deletion of the disallowance.

2. Disallowance of Deduction Under Section 35D:
The second issue relates to the disallowance of deduction under section 35D for public issue expenses. The assessee claimed Rs. 16,67,332, which was disallowed by the AO. The Tribunal referred to its earlier decision in the assessee's own case, which held that such expenses are capital expenditure and not allowable under section 35D. Consequently, the Tribunal upheld the disallowance.

3. Disallowance of Bad Debt:
The third issue involves the disallowance of a bad debt claim of Rs. 2,96,89,000. The AO disallowed the claim, noting that the provision for bad debt was not allowable as per the Explanation to section 36(1)(vii). The Tribunal upheld the disallowance, stating that the provision for bad and doubtful debts is not an allowable deduction.

4. Expenditure on Club Membership:
The fourth issue concerns the disallowance of Rs. 96,081 for club membership subscriptions. The AO disallowed the expenditure, treating it as non-business-related. The CIT(A) deleted the addition, and the Tribunal upheld this decision, citing the Madras High Court's ruling in CIT v. Sundaram Industries Ltd., which held that such expenses are allowable if incurred to promote business relationships.

5. Disallowance of Broken Period Interest:
The fifth issue pertains to the disallowance of Rs. 29,34,38,339 on account of broken period interest paid at the time of purchasing securities. The AO treated the interest as a capital expenditure but allowed additional depreciation and reduction in profit on the sale of securities, resulting in an addition of Rs. 1,53,88,750. The CIT(A) deleted the addition, and the Tribunal upheld this decision, referencing the Kerala High Court's ruling in CIT v. Nedungadi Bank Ltd., which allowed broken period interest as a deductible expense.

6. Bad Debt Written Off Under Section 36(1):
The final issue involves the disallowance of Rs. 24,34,305 written off as bad debt. The AO disallowed the claim, citing insufficient evidence and non-compliance with section 36(2)(v). The CIT(A) deleted the addition, noting the absence of a clear finding that the bad debt related to rural branches. The Tribunal upheld the CIT(A)'s decision, agreeing that the bad debt written off was not in the nature of a provision for bad and doubtful debts.

Conclusion:
The Tribunal partially allowed the assessee's appeal and dismissed the revenue's appeal. The key takeaways include the Tribunal's emphasis on the indivisibility of business operations, the necessity for clear identification of funds, and adherence to judicial precedents in determining the allowability of various expenditures and deductions.

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