ITAT Mumbai Ruling on Bad Debts, Prior Period Allegations and 143(1) Adjustments for Co-operative Banks

Background of the Dispute

The Mumbai Bench of the Income Tax Appellate Tribunal in TJSB Sahakari Bank Ltd. Vs DCIT decided a batch of three connected appeals for AYs 2017-18, 2018-19 and 2020-21. The assessee, a co-operative bank, was aggrieved by:

  • Disallowance of bad debts written off claimed under Section 36(1)(vii) on the ground that they were “prior period expenses”
  • Addition of exempt interest on tax-free bonds
  • Adjustments made under Section 143(1) relating to
    • delayed deposit of employees’ provident fund contribution under Section 36(1)(va)
    • addition under Section 41 for recovery of loans earlier written off
  • The interplay between intimation under Section 143(1) and a subsequent scrutiny assessment under Section 143(3)

The Tribunal passed a consolidated order, allowing the appeals for AYs 2017-18 and 2018-19, and partly allowing the appeal for AY 2020-21 for statistical purposes.

AY 2017-18 – Bad Debts Written Off and “Prior Period” Objection

Core Issue

For AY 2017-18, the only effective controversy was the disallowance of a claim of bad debts written off under Section 36(1)(vii) amounting to Rs. 91,71,179/-.

  • The assessee, a co-operative bank, had certain loan accounts that had been treated as non-performing assets (NPAs) and classified as “loss assets” prior to 01.04.2006.
  • These loans were finally written off in the books in FY 2016-17 (relevant to AY 2017-18), and deduction was claimed under Section 36(1)(vii).
  • The Assessing Officer held that since the assets had already become loss assets before 01.04.2006, the write-off in AY 2017-18 represented a prior period item, and the deduction was not allowable in this year.

Assessee’s Stand

The assessee argued, in substance, as follows:

  1. No Section 36(1)(viia) benefit before AY 2007-08

    • Up to AY 2006-07, co-operative banks were not eligible for deduction under Section 36(1)(viia) in respect of provision for bad and doubtful debts.
    • Hence, any provision made in the books in earlier years was not claimed as deduction in computing taxable income and was in fact added back.
    • Consequently, there was no balance in a provision for bad and doubtful debts account, in terms of Section 36(1)(viia), for these old NPAs.

  2. Year of deduction is the year of actual write-off

    • Under Section 36(1)(vii), deduction is allowed in the year in which the amount is actually written off as irrecoverable in the books, not necessarily the year in which the debt became bad.

  3. Commercial decision of timing the write-off

    • The decision to write off a loan is driven by the bank’s internal policies and practical recovery experience.
    • Factors include period for which the asset remains NPA, success or failure of legal and recovery measures (including actions under SARFAESI Act, Debt Recovery Tribunal proceedings etc.).
    • The Assessing Officer cannot substitute his judgment on when the loan “should have” been written off.

Revenue’s Position

The Assessing Officer:

  • Relied on an RBI Master Circular for commercial banks (DBOD No. BP.BC/20/21.04.048/2001-2002 dated 30.08.2001) to say that loss assets are to be written off or fully provided for when so classified.
  • Treated the write-off in AY 2017-18 as a belated claim and therefore a prior period expense.
  • The CIT(A) endorsed this approach, additionally stating that:
    • The assessee retained these loan assets on its books for an unduly long time;
    • The write-off was an afterthought;
    • Documentary proof that similar provisions were not allowed as deduction in earlier years had not been produced to the satisfaction of the Department.

Tribunal’s Analysis

The Tribunal first noted that there was no dispute about actual write-off of the relevant loans in the books during AY 2017-18.

1. Scope of Section 36(1)(vii) after TRF Ltd.

The Tribunal relied on the Supreme Court decision in TRF Ltd. 323 ITR 397 (SC), which held:

Once a bad debt is actually written off in the books of account of the assessee, it is not necessary to establish that the debt has become irrecoverable in that year, or to prove the precise point of time when it became bad.

Accordingly, the test is actual write-off in the books. The question of whether the loan should have been written off in an earlier year is not relevant for disallowing the claim in the year of write-off, so long as other legal conditions are fulfilled.

2. Incorrect reliance on RBI circular for commercial banks