2025 (2) TMI 530 - AT - Income Tax

Deduction claimed u/s 36(1)(viia) - Disallowance of claim as this provision was made by the assessee for NPA as per RBI guidelines which cannot be equated with provision for bad and doubtful debts as required to be made as per the provisions of section 36(1)(viia) - CIT(A) concluded that NPAs qualify as bad debts because such assets do not generate income and their categorization as provision for non-performing assets is essentially equivalent to a provision for bad and doubtful debts - HELD THAT - The Act permits such deductions considering that unrealized debts should be allowed based on the provision made in the books of account. The nomenclature of the provision though referred to as NPAs in essence and substance constitutes a provision for bad and doubtful debts as recognized in Davangere District Central Co-operative Housing Society Ltd. 2020 (11) TMI 654 - KARNATAKA HIGH COURT Decided in favour of assessee. Disallowance u/s 14A - assessee had not allocated expenses related to the earning of exempt income as required under Section 14A r.w. Rule 8D - HELD THAT - Section 14A of the Act read with Rule 8D of the Rules is applicable where the assessee is unable to determine or allocate the correct expenses incurred to earn exempt income. In the present case CIT(A) relied solely on the judicial precedents and allowed the issue in favor of the assessee without duly considering the relevant facts. As per the ratio laid down in various case laws the disallowance u/s 14A is required to be made when the assessee has earned any exempt income. In the instant case it is submitted that the interest free funds available with the assessee is more than the value of investments. In that case no disallowance out of interest expenses is called for. However disallowance may be called for from out of administrative expenses in terms of sec.14A - assessee may be provided with an opportunity to present the relevant facts before the AO. Accordingly we set aside the order passed by Ld CIT(A) and restore this issue to his file for examining this issue afresh. After providing adequate opportunity of being heard to the assessee the AO may take appropriate decision. Ground of revenue s appeal is allowed for statistical purposes. Deduction u/s 36(1)(vii) - CIT(A) decided issue in favor of the assessee and held that the proviso to Section 36(1)(vii) pertains only to actual debts and therefore only actual (realized) debts need to be adjusted against the provisions of Section 36(1)(viia) - HELD THAT - We find that the Ld. CIT(A) has correctly examined and adjudicated the issue. The matter is squarely covered by the decision of the co-ordinate bench of the ITAT Bengaluru in the assessee s own case 2022 (3) TMI 1131 - ITAT BANGALORE . We see no infirmity in the order passed by the Ld. CIT(A). Penalty paid to RBI disallowed u/s 37 - HELD THAT - CIT(A) considered the submission of the assessee and found that penalty is not sustainable as it is not against the infraction of law and same issue has already been taken care in the appeal order for A.Y. 2017-18 where the Ld.CIT(A) allowed the claim of the assessee. The Ld. CIT(A) followed the precedence in the earlier year and doctrine of consistency was followed. As decided in M/s Stock Bond Trading Co. 2011 (10) TMI 172 - BOMBAY HIGH COURT payments made by the Assessee to the Stock Exchange for violation of their regulation are not an account of an offence or which is prohibited by law. Hence the invocation of explanation to section 37 of the Income Tax Act 1961 is not justified. Interest on Perpetual Bond - AO held that the said interest is not admissible for deduction under section 36(1)(iii) for the reason that the bonds are (a) perpetual nature; (b) high loss absorption capacity provision for write down of principal; or conversion of equity on tracker and (c) discretionary pay out with existence of full coupon discretion - HELD THAT - Innovative Perpetual Debt Instruments (IPDI) are hybrid instruments that exhibit characteristics of both debt and equity. These bonds are typically issued by banks to meet capital adequacy requirements under Basel norms. Although perpetual in nature and subordinated to other debt the interest on IPDI is payable periodically unless deferred by the issuer under specific circumstances (e.g. insufficient profits). Section 36(1)(iii) of the Act allows for a deduction of interest on borrowings if such borrowings are utilized for business purposes. The interest paid on IPDI despite the instrument s hybrid nature has been held to be deductible as it represents a cost of funds incurred in the ordinary course of banking business. As in case of State Bank of India 2022 (9) TMI 1640 - ITAT MUMBAI held that the interest on IPDI is an allowable deduction under Section 36(1)(iii) as the borrowings are directly linked to the business activities of the bank. In the present case the Ld. CIT(A) upheld this view and rightly concluded that the addition of interest on IPDI under Section 36(1)(iii) is not warranted. Decided in favour of assessee.

Summary

Issues Presented and Considered

The core legal issues considered in this judgment include:

(i) Whether the deduction claimed under Section 36(1)(viia) for provisions made for Non-Performing Assets (NPAs) is valid.

(ii) Whether the disallowance under Section 14A related to expenses incurred to earn exempt income was correctly applied.

(iii) Whether the deduction for bad debts under Section 36(1)(vii) was justified, particularly concerning non-rural branches.

(iv) Whether the penalty paid to the Reserve Bank of India (RBI) is deductible under Section 37.

(v) Whether the interest on Innovative Perpetual Debt Instruments (IPDI) Bonds qualifies for deduction under Section 36(1)(iii).

(vi) Whether the provisions of Section 115JB and related adjustments are applicable.

(vii) Whether the education cess is deductible.

Issue-Wise Detailed Analysis

Deduction under Section 36(1)(viia)

The relevant legal framework involves Section 36(1)(viia) of the Income-tax Act, which allows deductions for provisions for bad and doubtful debts. The Court considered precedents from the Karnataka High Court, which recognized NPAs as equivalent to bad debts. The Court agreed with the CIT(A)'s interpretation that NPAs, though categorized differently, essentially qualify as bad debts. The revenue's arguments were dismissed, aligning with judicial precedents that permit such deductions.

Disallowance under Section 14A

The legal framework involves Section 14A and Rule 8D, which address the allocation of expenses related to exempt income. The CIT(A) relied on precedents from the Supreme Court and other High Courts, emphasizing that if investments are made from own funds, disallowance is not warranted. The Court found that the CIT(A) did not adequately consider the facts, and thus, the issue was remanded for fresh examination.

Deduction under Section 36(1)(vii)

The legal framework includes Section 36(1)(vii) and the proviso concerning bad debts. The Court referenced the Supreme Court's decision in Catholic Syrian Bank Ltd, which clarified the conditions for such deductions. The CIT(A) correctly applied this precedent, and the revenue's grounds were dismissed as the deductions were deemed justified.

Penalty Paid to RBI

The legal question involved Section 37, which disallows deductions for penalties related to infractions of law. The CIT(A) found that the penalty was not for legal infractions but for procedural non-compliance, thus allowing the deduction. The Court upheld this view, referencing previous judicial decisions that supported this interpretation.

Interest on IPDI Bonds

The issue involved Section 36(1)(iii), which allows interest deductions on borrowings used for business purposes. The CIT(A) and the Court relied on consistent judicial precedents that recognized IPDI interest as a business expense. The revenue's arguments were dismissed, and the deduction was upheld.

Applicability of Section 115JB and Education Cess

The issues related to Section 115JB and education cess were deemed consequential and did not require separate adjudication, as they were dependent on the outcomes of the primary issues discussed.

Significant Holdings

The Court upheld several key principles:

- NPAs can be treated as bad debts for deduction purposes under Section 36(1)(viia).

- Disallowance under Section 14A requires careful factual examination, especially concerning the source of funds.

- Penalties not related to legal infractions are deductible under Section 37.

- Interest on IPDI Bonds is deductible under Section 36(1)(iii) as a legitimate business expense.

- The Court emphasized the importance of consistency in applying judicial precedents, especially in the assessee's own cases from previous years.

The appeals were partly allowed, with specific issues remanded for further consideration, while others were conclusively decided based on established legal principles and precedents.