2024 (3) TMI 1371 - AT - Income Tax

Taxing the recovery in respect of bad debts written off by banks - addition u/s 41(4) - assessee argued that since the bad debts written off were adjusted against the provisions created under section 36(1)(viia), and no deduction was claimed u/s 36(1)(vii), the recovery should not be taxed - HELD THAT - Where a deduction has not been allowed in respect of bad debts written off under the 2nd stream, the question of charging the recovery effected out of such bad debts written off to tax will not arise. In the third situation discussed in the chart, when the assessee does not make any provision as per RBI Guidelines, then it cannot claim any deductions under section 36(1)(viia) of the Act and it can only claim deduction u/s 36(1)(vii) of the Act, if there is any recovery, it can be charged to tax u/s 41(4) of the Act. Therefore, the proposed addition of recovery of bad debts by the AO is not proper and observation of CIT (A) is also not correct, the revenue has to appreciate the actual claim of deductions made by the assessee under various provisions exclusively enacted for the purpose of banking companies has to be read along with the tax computation submitted by the assessee and not express their opinion without properly verifying the impact in the tax computation. It may look double deduction while reading the provisions in isolation. Accordingly, the grounds raised by the assessee is allowed.

Summary

Issues Involved:

1. Whether the amounts recovered from bad debts written off by the bank should be taxed under section 41(4) of the Income Tax Act.
2. Compliance with the provisions of sections 36(1)(vii), 36(1)(viia), and 36(2)(v) of the Income Tax Act regarding deductions for bad debts and provisions for bad and doubtful debts.

Issue-wise Detailed Analysis:

1. Taxation of Recovered Bad Debts:

The primary issue was whether the amounts recovered from bad debts written off by the bank should be taxed under section 41(4) of the Income Tax Act. The assessee argued that since the bad debts written off were adjusted against the provisions created under section 36(1)(viia), and no deduction was claimed under section 36(1)(vii), the recovery should not be taxed. The assessee relied on the decision of ITAT in its own case for a prior assessment year and the case of State Bank of Mysore vs. DCIT, arguing that section 41(4) applies only when bad debts are claimed under section 36(1)(vii).

The Ld. CIT(A) rejected this argument, stating that the decision in the State Bank of Mysore case did not consider the effect of section 36(2)(v). The CIT(A) emphasized that for a banking company, the write-off of bad debts is allowed in two situations: when debited to the provision account under section 36(1)(viia) and when the credit in the provision account is exhausted, allowing for a separate write-off under section 36(1)(vii).

The Tribunal, however, found that the issue was covered in favor of the assessee by the Coordinate Bench's decision in the assessee's own case. The Tribunal noted that the deduction under section 36(1)(viia) is allowed based on the provisions made as per RBI guidelines, and any recovery from such bad debts should not be taxed unless a deduction has been allowed under section 36(1)(vii). The Tribunal concluded that the recovery of bad debts should not be taxed as the deduction was not claimed under section 36(1)(vii), aligning with the provisions of section 41(4).

2. Compliance with Sections 36(1)(vii), 36(1)(viia), and 36(2)(v):

The Tribunal examined the compliance with sections 36(1)(vii), 36(1)(viia), and 36(2)(v) regarding deductions for bad debts and provisions for bad and doubtful debts. The assessee argued that it followed the provisions by creating a provision for bad and doubtful debts as per RBI guidelines and claiming deductions under section 36(1)(viia). The assessee contended that the actual bad debts written off were charged to the provision account and reversed in the tax computation, ensuring no double deduction.

The Ld. CIT(A) had argued that the write-off should be taxed as it was adjusted against the provision account created under section 36(1)(viia), which was already allowed as a deduction. However, the Tribunal found that the assessee's claim was consistent with the provisions, as the actual bad debts written off never exceeded the deduction claimed under section 36(1)(viia). The Tribunal clarified that the provisions of section 41(4) apply only when a deduction is allowed under section 36(1)(vii), which was not the case here.

The Tribunal explained that the deduction under section 36(1)(viia) forms a separate stream of deduction, and any recovery from bad debts written off should not be taxed unless allowed under section 36(1)(vii). The Tribunal emphasized that the revenue should appreciate the actual claim of deductions made by the assessee and not express opinions without verifying the tax computation's impact.

In conclusion, the Tribunal allowed the appeal filed by the assessee, holding that the recovery of bad debts should not be taxed under section 41(4), and the deductions claimed were in compliance with the relevant provisions of the Income Tax Act.