By TIOL News Service

HYDERABAD, DEC 09, 2013: THE issues before the Bench are - Whether investment made by the bank to comply with the SLR requirement would constitute their stock in trade and depreciation in value of the same is an allowable deduction; Whether the broken period interest included in the purchase price of Government securities held by the banking company to comply with SLR requirement is entitled to deduction; Whether no disallowance can be made u/s 14A applying rule 8D prior to AY 2008-09; Whether provision made in the accounts of the assessee bank and debited to the provision for bad and doubtful debts account made under that clause 36(1)(viia) is only allowable as expenditure & Whether in view of the specific provisions of sub-clause (f) to Section 43B the claim of the assessee for deduction towards provisions for leave encashment cannot be allowed. And the verdict partly favours the assessee.

Facts of the case

A) AO disallowed depreciation on HTM investment on the ground that the claim was not routed through P&L account but a claim was made through a note and therefore was not allowable. CIT (A) set aside the issue with the direction to ascertain the facts and allow depreciation. Assessee contended that issue was decided in its favour by the Division Bench in assessee’s own case.

B) AO observed that assessee had been paying broken period interest on purchase of securities and claimed the same as a deduction from the interest income earned. AO disallowed the broken period interest, on the ground that HTM category of securities are capital assets. CIT (A) directed AO to delete the disallowance.

C) AO observed that assessee claimed Rs. 18.84 crores as exempt income and assessee considered only Rs. 28.19 lacs for disallowance u/s 14A. AO noted that assessee considered only two months salary of the assessee-bank’s investment department for disallowance even though there was expenditure incurred in relation to income not includible in total income as interest expenses which was indirectly attributable to earning of such income. Thus, applying Rule 8D disallowance was made of Rs. 24.82 crores.

CIT (A) directed the AO recalculate the disallowance u/s 14A by observing that in the AYs 2000-01 to 2005-06, the AO made the disallowance using the formula tax free income/gross income X interest paid on loans, which had been confirmed by the predecessor. Further Rule 8D was held as not applicable as it is applicable w.e.f. AY 2008-09.

D) AO noted that assessee made a provision for bad and doubtful debts and also made a provision towards standard assets. AO observed that assessee claimed revised higher deduction u/s 36(1)(viia) which was the maximum deduction allowable under the head provision for doubtful debts. Even though assessee claimed a higher deduction u/s 36(1)(viia) in the computation sheet, its reflection was not seen in the total income in the revised return. Thus, the computation with revised return was ignored on technical ground. On merits also AO held that the claim of maximum permissible deduction as per formula in section 36(1)(viia) is related to the provision made in the books of account, since without making any provision in the books of account, the assessee cannot claim the maximum permissible deduction.

Before CIT (A) assessee contended that AO ought to have seen deduction u/s 36(1)(viia) allowable on account of bad and doubtful debts to the extent of seven & one half percent of the total income and an amount not exceeding 10% of the aggregate average advances made by rural branches of a bank in computing its total income, irrespective of the provision made in its books of account. CIT (A) confirmed the disallowance following the decision of P & H High Court in the case of State Bank of Patiala Vs. CIT.

E) AO observed that assessee deducted interest that was not realized on advances identified as NPAs in the current year and credited only net interest to the profit and loss account. AO disallowed the claim stating that there was no provision under the Act to deduct, from out of current year’s income of a claim which was not at all relevant to the current year. CIT (A) confirmed the order of AO.

F) AO noted that assessee made a provision towards leave encashment and debited to P & L Account. As per the provisions of section 43B, the same had to be added back in computation of income, but, the assessee had not added the said amount to the income in the computation of statement stating in view of the decision of Exide Industries that leave encashment is neither a statutory liability nor a contingent liability and it is a provision to be made for the benefit of the employees in each financial year and is thus ascertained liability. AO disallowed the claim observing the decision of Apex Court in the said case that where it was directed to pay taxes as if Clause of section 43B exists on the statute book. CIT (A) confirmed the order of AO.

After hearing both the parties, the ITAT held that,

A) ++ issue is decided in favour of assessee by the Division Bench in assessee’s own case observing that the government securities held for the purpose of comply with the SLR has been held to be stock in trade and therefore value of the same as on 31st March has to be made and there is any depreciation the same should be allowed as a revenue deduction. However, the RBI has issued Circular wherein they have classified the investment made to comply with SLR requirement as 'Held to maturity’ (HTM), 'Available for sale’ (AFS) and 'Held for Trade’ (HFT). Based on the RBI Circular lower authorities came to the conclusion that investment in Government Securities which are classified under the head HTM cannot be considered as stock in trade and therefore depreciation in value of such securities cannot be allowed as a deduction. The Apex Court in the case of UCO Bank Ltd held that value of the securities at cost or market value whichever is less should be accepted for income tax even if the banks in their books do not value on that basis. Therefore, investment made by the bank to comply with the SLR requirement would constitute their stock in trade and depreciation in value of the same is an allowable deduction. Since there is no change in facts, assessee’s appeal allowed;

B) ++ issues is covered in favour of assessee by the Division Bench in which case it was held that the entire such investment in order to comply with SLR would constitute stock in trade and classification of these assets by the RBI is not binding on the Income tax authorities. Such classification would not alter the characteristic of the investments to comply with SLR requirement as stock in trade. Thus, the broken period interest included in the purchase price of Government securities held by the banking company to comply with SLR requirement is entitled to deduction;

C) ++ the issue is covered in assessee’s own case, in which it was observed that when the Assessee has sufficient interest free funds, the investments should be considered to have been made out of those funds and not interest bearing borrowals. It is only with the introduction of Rule 8D, interest expenditure was apportioned on the basis of investment, even though there was no direct nexus between the borrowals and the investments. Rule 8D is not applicable to the AY under appeal. As regards disallowance of administrative, no expenses were incurred cannot be accepted. The expenditure to be disallowed is to be necessarily to be made on an estimate basis and reduce the disallowance to 2% expenditure as relating to earning of the exempted income u/s 14A;

D) ++ there is no infirmity in the order of CIT (A) in which it was held that any provision in the section refers to any provision made in the accounts of the assessee bank and debited the amount of such debt or part of the debt in that previous year to the provision for bad and doubtful debts account made under that clause and therefore disallowance for provision for bad and doubtful debt is confirmed;

E) ++ issue is decided in favour of assessee following the decision of coordinate bench in the case of assessee in which it was observed that AO is to allow unrealized interest offered for tax in the earlier year now reversed by the assessee;

F) ++ issue is covered against the assessee, in its own case in which it was held that ITAT which is creature of the Income tax Act is bound by the provisions of the Act and therefore in view of the specific provisions of sub-clause (f) to Section 43B the claim of the assessee for deduction towards provisions for leave encashment cannot be allowed.

(See 2013-TIOL-1051-ITAT-HYD)