Interest on bad & doubtful debts kept in reserve account eligible for deduction u/s. 43D

 IN THE ITAT MUMBAI BENCH ‘L’

American Express Bank Ltd.

versus

Additional Commissioner of Income-tax 

IT APPEAL NO. 5374 (MUM.) OF 2001

INT. T.A. NO. 97 (MUM.) OF 2001

[ASSESSMENT YEAR 1998-99]

AUGUST 10, 2012

ORDER

I.P. Bansal, Judicial Member

Both the aforementioned appeals are filed by the assessee. They are directed against two separate orders of Ld. CIT(A)-VII, Mumbai, both dated 14/6/2001, one in respect of assessment framed under section 143(3) of the Income Tax Act, 1961 (the Act) and other against assessment made under section 8(2) of the Interest Tax Act, 1976. The grounds by the assessee in both these appeals read as under:

Grounds raised in ITA No.5374/Mum/2001:

“Aggrieved by the order passed by the Commissioner of Income-tax (Appeals)-VII, Mumbai [hereinafter referred to as ‘the learned CIT(A)’], under section 250 of the Income tax Act, 1961 (‘Act’), and based on the facts and circumstances of the case, the Appellant respectfully submits that the learned CIT(A) erred in upholding the order of the Additional Commissioner of Income-tax, Special Range 32, Mumbai [hereinafter referred to as the ‘learned Assessing Officer’], on the following grounds:

  1.  In upholding the disallowance of expenses amounting to Rs. 121,802,048 incurred at the head office directly in relation to the Indian branches.

  2.  In upholding the disallowance of expenses amounting to Rs. 54,243,810 incurred for solicitation of deposits from non- resident Indians.

  3.  In upholding the disallowance of Rs. 40,196,300, being an estimate by the learned Assessing Officer of the expenditure incurred by the Appellant for earning interest on tax free bonds.

  4.  In upholding the disallowance of Rs. 5,253,361, being an estimate by the learned Assessing Officer of the expenditure incurred by the Appellant for earning interest on foreign currency loans.

  5.  In upholding the disallowance of Rs. 4,257,712, being an estimate on a notional basis by the learned Assessing Officer dividend income.

  6.  In upholding the disallowance of the exemption claimed in respect of interest income earned on funds placed with foreign branches amounting to Rs. 296,723,640 and the offering to tax of the interest paid to its foreign branches of Rs. 1,909,987.

  7.  In upholding the disallowance of the deduction claimed under section 43D of the Act, in respect of interest on bad or doubtful debts amounting to Rs. 58,713,862.

The Appellant craves leave to add, alter, vary, omit, substitute or amend any or all of the above grounds of appeal, at any time before or at, the time of the appeal, so as to enable the honourable Tribunal to decide this appeal according to law.”

Grounds raised in INT. T.A.No.97/Mum/2001:

“Aggrieved by the order passed by the Commissioner of Income-tax (Appeals)—VII, Mumbai [hereinafter referred to as ‘the learned CIT(A)’], under section 15(4) of the Interest-tax Act, 1974, (‘Act’) and based on the facts and circumstances of the case, the Appellant respectfully submits that the learned CIT(A) erred in upholding the order of the Additional Commissioner of Income-tax, Special Range 32, Mumbai, on the following grounds:

In upholding the disallowance of the deduction claimed under the proviso to section 5 of the Act read with section 43D of the Income-tax Act, 1961, in respect of interest on bad or doubtful debts amounting to Rs. 58,713,862.

In upholding the addition of Rs. 58,713,862 to the chargeable interest of the Appellant though the same had been offered to tax in the revised return of chargeable interest, thereby resulting in double taxation of the said amount.

The Appellant craves leave to add, alter, vary, omit, substitute or amend any or all of the above grounds of appeal, at any time before or at, the time of the appeal, so as to enable the honourable Tribunal to decide this appeal according to law.”

2. These appeals were heard along with cross appeals for A.Y. 1997-98. It was the contention of both the parties that the grounds raised by the assessee in A.Y. 1998-99 are mostly common with the grounds of appeal filed by the assessee and revenue in respect of assessment year 1997-98 and it was contended that Ground No. 1 to 5 of assessee’s appeal are covered by the grounds raised by the assessee as well as revenue in respect of A.Y. 1997-98. We have passed a separate order in respect of assessment year 1997-98. The reference of which is being made in this order for grounds which are covered by the said order.

3. Ground No. 1 to 2 are covered by the following observations of the Tribunal in ITA No. 6022/Mum2000, A.Y. 1997-98.

“2. First ground of the assessee’s appeal is against the confirmation of disallowance of expenses amounting to Rs. 6,39,13,217 incurred for solicitation of deposits from non-resident Indians on the ground that such expenses were covered by the provisions of section 44C of the Income-tax Act, 1961 (hereinafter called the ‘Act’) and should, therefore, be allowed as deduction in the manner and to the extent provided in that section. The second ground is against the confirmation of disallowance of expenses amounting to Rs. 13,50,87,275 incurred at the head office directly in relation to Indian branches on the ground that such expenses were covered by the provisions of section 44C and should, therefore, be allowed as deduction in the manner and to the extent provided in that section.

2.1 Briefly stated the facts of these two grounds are that the assessee, a non-resident banking company, claimed deduction of head office expenses and NRI expenditure amounting to Rs. 13.50 crore and Rs. 6.39 crore respectively in relation to the Indian branch. The assessee was called upon to explain as to why these expenses be not covered u/s 44C and hence disallowed as was held by the Tribunal for assessment year 1987-89. The assessee tendered its reply submitting that the deduction was claimed for head office expenses and NRI marketing expenses from income chargeable to tax which was not subject to the provisions of section 44C. It was stated that such expenses were : ‘direct in nature and incurred exclusively for the branch in India. There is no question of there being allocated/apportioned on a reasonable basis to the Indian branch as required under clause (c) of section 44C of the Act’. It was further explained that these expenses were incurred only in respect of Indian branch and were not expenses which needed to be attributed to it. Relying on the Tribunal order for assessment year 1987-88, the Assessing Officer restricted the deduction to 5% of the gross total income u/s 44C, which led to the denial of separate deduction on account of head office and NRI expenses. The learned CIT(A) sustained these two disallowances, against which the assessee has come up in appeal before us.

2.2 We have heard the rival submissions and perused the relevant material on record. There is no dispute about the fact that the Tribunal decided similar issue against the assessee for assessment year 1987-88 which has been followed by the authorities below for the instant year. However, it is relevant to note that the assessee assailed the said tribunal order before the Hon’ble Bombay High Court, which, vide its judgment dated 17th July, 2003, a copy available on record, decided the issue in assessee’s favour by relying on the judgment of the Hon’ble jurisdictional High Court in the case of CIT v. Emirates Commercial Bank Limited [2003] 262 ITR 55 (Bom.). Eventually, the Hon’ble High Court held that the Tribunal was not right in holding that the allowability of direct expenses incurred at the head office on behalf of the Indian branch of the assessee was covered within section 44C and not section 37(1). It is further observed that the Tribunal, subsequently, in assessee’s own case for assessment years 1993-94 to 1996-97, has decided similar issue in assessee’s favour. A copy of the said Tribunal order for such later years dated 23rd July, 2010 in ITA No. 1187/Mum/2001 etc. is placed on record.

2.3 The ld. DR contended that the ratio decidendi in the case of Emirates Commercial Bank Ltd. (supra) cannot be applied to the facts and circumstances of the present case because here the expenditure is allocated and not exclusive. In principle, we are in full agreement with this contention that the judgment in the case of Emirates Commercial Bank Ltd. (supra) can operate for allowing deduction in full u/s 37(1) where the expenditure is exclusive. In a case of allocated expenses, the amount can be considered only u/s 44C. The Mumbai bench of the tribunal in the case of ADIT (I.T.) v. Bank of Bahrain & Kuwait [2011] 44 SOT 693 (Mum.) has canvassed similar view by holding that the exclusive expenses incurred by the head office for Indian branch are outside the purview of sec. 44C and only common head office expenses are governed by this section. There can be no quarrel over this proposition of law. But the fact of the matter is that the expenses which are subject matter of ground nos. 1 and 2 are exclusive and not common. It is amply borne out from the assessment order, where the AO has reproduced the reply filed by the assessee stating that these expenses were exclusive. Relevant part of such contention advanced on behalf of the assessee has been extracted verbatim in para 2.1 of this order. The AO has no where controverted this submission. Thus, it follows that the assessee’s contention of these amounts representing exclusive head office expenses was accepted by the AO. Once the amount is found to be exclusive expenditure incurred by the head office towards the Indian branch, the same is required to be allowed in terms of section 37(1), without clubbing it with shared head office expenses as per sec. 44C. This submission of the Revenue is jettisoned as shorn of merits. Accordingly, we hold that no adverse inference can be drawn against the assessee on this issue and such exclusive expenses incurred by the assessee are required to be allowed as deduction u/s 37(1) without any reference to section 44C. These two grounds are, therefore, allowed.”

Accordingly these grounds are allowed.

4. So far as it relates to Ground No. 3, which is in respect of disallowance on account of expenditure incurred for earning tax free bonds, the issue is covered by the following observations of the Tribunal in ITA No. 5904/Mum2000, A.Y. 1997-98.

“4.1. Ground no. 1 of the Revenue’s appeal reads as under :-

‘On the facts and circumstances of the case and in law, the ld. CIT(A) has erred in deleting the disallowance of estimated expenses claimed of Rs. 7,25,40,737 on earning the tax free interest (of Rs. 9,91,97,534) on bonds’.

4.2 Briefly stated the facts of the ground are that the assessee earned interest on tax free bonds to the tune of Rs. 9.91 crore. This interest was claimed as exempt u/s 10(15)(iv). The Assessing Officer observed that the assessee claimed exemption on gross amount without reducing any expenditure incurred for earning interest on tax free bonds. It was opined that only the net income would be eligible for exemption. On being called upon to explain as to why the expenditure for earning the exempt income be not deducted, the assessee submitted that it was dealing in securities as part of its business operations and no direct specific expenses were incurred for earning such interest on tax free bonds. The Assessing Officer did not accept the assessee’s contention and came to hold that the gross interest from bank cannot be allowed as exemption. Considering the language of section 10, he held that the exemption is available only in respect of ‘income’ and not the ‘gross receipts’. He, therefore, went on to compute the ‘Proportionate expenditure for earning Tax free income’ which amount was determined by a mathematical exercise at Rs. 7.25 crore. After reducing the so calculated proportionate expenditure of Rs. 7.25 crore from the gross tax free interest, the exempt income u/s 10(15)(iv) was determined at Rs. 2.66 crore. The learned CIT(A) observed that there was no indivisible business carried on by the assessee in respect of such bonds from which tax free income was earned. Relying on the judgment of the Hon’ble Supreme Court in the case of Rajasthan State Warehousing Corporation v. CIT [(2000) 242 ITR 450 (SC)], the learned CIT(A) held that there was no justification for making the disallowance of Rs. 7.25 crore. The Revenue is aggrieved against this finding of the learned CIT(A).

4.3 We have heard the rival submissions and perused the relevant material on record. Insofar as the question of exemption u/s 10(15)(iv) is concerned, we find that the relevant provision clearly refers to the exemption in respect of ‘interest payable by any public sector company in respect of such bonds or debentures and subject to such condition………’. The crucial words used in this provision are ‘interest payable’ in respect of the bonds or debentures etc. as notified by the Central Government in the Official Gazette. There is no reference to allowing exemption in respect of any income arising out of interest payable to the assessee. When the legislature has exempted the amount of ‘interest payable’ in respect of specified bonds, there can be no logic in curtailing the exemption by reducing the expenditure from such interest income. The learned Departmental Representative was fair enough to concede and rightly so that the Revenue was not aggrieved against the allowing exemption u/s 10(15) on gross interest. He submitted that the ground raised by the Revenue restricts itself to the granting of deduction of expenses incurred for earning such exempt income against the taxable income. It was submitted that section 14A inserted by the Finance Act, 2001 with retrospective effect from 01.04.1962, governs the non-deductibility of such expenses incurred on earning exempt income against the taxable income. He relied on the order passed by the Mumbai Bench of the Tribunal in the case of Dresdner Bank AG v. Addl. CIT [(2007) 108 ITD 375 (Mum.)] in which it has been held that exemption u/s 10(15)(iv) is allowable in respect of gross interest but any expenditure incurred in relation to earning of such exempt income is to be disallowed u/s 14A. He submitted that the Tribunal in that case was pleased to remit the matter back to the A.O. for quantifying the expenditure incurred, if any, for earning exempt income. The learned Departmental Representative further submitted that the assessment year in that case was 1998-99, much prior to the insertion of section 14A, as is the case under consideration and hence the decision in that case be applied here also for sustaining the disallowance u/s 14A which was made by the AO on the general principles of law, which subsequently came to be statutorily recognized by way of insertion of section 14A with retrospective effect covering the relevant assessment year under consideration.

4.4 In the opposition, the ld. AR stated that the securities on which exempt income was earned were stock-in-trade of the assessee bank. Relying on the judgment of the Hon’ble Supreme Court in the case of CIT v. Indian Bank Limited [(1965) 56 ITR 77 (SC)], the learned AR argued that the interest paid by bank in that case on deposits received in the course of its business and utilized for buying such tax free securities was held to be deductible in arriving at the taxable profit of the business notwithstanding that the interest earned by the bank on tax free securities could not be taxed. It was stated that the facts of the instant case are similar to those considered and decided by the Hon’ble Supreme Court. The learned AR submitted that no specific ground has been taken by the Revenue for sustaining any disallowance u/s 14A and as such it was too late in the day for the Revenue to request for sustaining disallowance under this section. Without prejudice to such submissions and taking his argument to next level, it was submitted that where exempt income is earned from securities held as stock-in-trade, no disallowance can be made u/s 14A as the income from such securities is only incidental to the holding of shares. For this proposition he relied on the judgment dated 14.06.2010 of the Hon’ble Kerala High Court in the case of CIT v. Smt. Leena Ramachandran [(2011) 339 ITR 296 (Ker.)]. When the attention of the ld. was drawn towards the judgment of the Hon’ble Bombay High Court in the case of Godrej & Boyce Mfg. Co. Ltd. v. DCIT (supra) and the special bench order in the case of ITO v. Daga Capital Management (P.) Ltd. [(2009) 117 ITD 169 (Mum.) (SB)], it was submitted that the ratio in the case of Godrej & Boyce (supra) is not applicable where the disallowance u/s 14A is in respect of exempt income from securities held as stock-in-trade. As regards the special bench decision in Daga Capital (supra), it was stated that albeit it has been laid down in this case that section 14A applies whether or not the shares are held as stock in trade, but the judgment in the case of Smt. Leena Ramachandran (supra) will prevail over the special bench order.

4.5 It has been noticed above that the Revenue is not aggrieved, and rightly so, on the question of availability of exemption on interest u/s 10(15)(iv)(h) on gross basis. The only view point canvassed before us by the learned Departmental Representative is to sustain disallowance us/ 14A of the Act. It is patent that the learned CIT(A) passed order on 26.09.2000 and at that time section 14A was not on statute. This provision came to be introduced by the Finance Act, 2001 with retrospective effect from 01.04.1962. From the assessment order it is manifest that the Assessing Officer computed a sum of Rs. 7.25 crore as ‘proportionate expenditure for earning tax free income’. Even though there is no direct reference to the provisions of section 14A, which naturally could not have been because of this insertion coming on the statute at a later point of time but with retrospective effect, but the essence of the action of the A.O. was not to allow any expenditure incurred for earning tax free income against the taxable income. The view of the AO came to be statutorily recognized by way of insertion of section 14A. Now the Revenue is aggrieved against the ‘disallowance of estimated expenses …on earning the tax free interest’. The Mumbai Bench of the Tribunal in the case of Dresdner Bank AG (supra) dealt with assessment year 1998-99 and the question therein was also about the exemption u/s 10(15)(iv) on gross or net interest basis. The bench, inter alia, held that section 14A is applicable and for computing the disallowance the matter was sent back to the AO. The extant position prevailing before us herein is more or less identical. Here also when the order was passed by the learned CIT(A), section 14A was not there and naturally the recourse to such action could not have been taken. Since the disallowance was made by the Assessing Officer on the ground that the proportionate expenditure for earning tax free income cannot be allowed as deduction, in a way he applied the same spirit as is there in section 14A. Even though there is no reference to section 14A in the ground taken by the Revenue, which naturally could not have been possible because of this provision being inserted later on, but challenging the deletion of proportionate expenditure in relation to exempt income in a wider sense amounts to requesting for the sustenance of disallowance u/s 14A itself. No material has been placed on record to indicate that the view taken by the co-ordinate bench in the case of Dresdner Bank AG (supra) has been modified or reversed by the Hon’ble jurisdictional High Court. Respectfully following the precedent, we hold that recourse to the provisions of section 14A for making disallowance of proportionate expenditure incurred for earning exempt income, has been validly taken on behalf of the Revenue.

4.6 We now proceed to deal with the arguments put forth by the learned AR on the non-applicability of section 14A. First part of his submissions was devoted to relying on the judgment of the Hon’ble Supreme Court in the case of Indian Bank Ltd. (supra) for bringing home the point that the interest paid by the bank on deposits utilized for purchasing tax free securities has to be allowed as deduction in entirety against the taxable profit of the business. It is observed that almost similar view was taken by the Hon’ble Supreme Court in CIT v. Maharashtra Sugar Mills Ltd. [(1971) 82 ITR 452 (SC)] which was reiterated by the Hon’ble Apex Court in the case of Rajasthan State Warehousing Corporation (supra). In this latter case, the Hon’ble Summit Court held that in computing the profits and gains of business or profession when an assessee is carrying on business in various ventures and some among them yield taxable income and the others do not, the question of allowability of expenditure u/s 37 will depend on – (i) fulfillment of requirements of that provision, and (ii) on the fact whether all the ventures carried on by him constitute one indivisible business. It was held that if all the ventures constitute one indivisible business then the entire expenditure, including that which was incurred for earning the tax free income, would be a permissible deduction against the taxable income.

4.7 It is noticed that after the advent of the judgment in the case of Rajasthan State Warehousing Corporation (supra), the legislature inserted section 14A with retrospective from 1st April, 1962 with the intention, as emanating from the Memorandum explaining the provisions of the Finance Bill that : ‘Certain incomes are not includible while computing the total income as these are exempt under various provisions of the Act. There have been cases where deductions have been claimed in respect of such exempt income. This in effect means that the tax incentive given by way of exemption to certain categories of income is being used to reduce also the tax payable on the non-exempt income by debiting the expenses incurred to earn the exempt income against the taxable income. This is against the basic principles of taxation whereby only the net income, i.e., gross income minus the expenditure, is taxed. On the same analogy, the exemption is also in respect of the net income. Expenses incurred can be allowed only to the extent they are relatable to the earning of exempt income’. The Special Bench of the Tribunal in the case of ITO v. Daga Capital Management Pvt. Ltd. (supra) considered the provisions of section 14A in the light of the above referred three Supreme Court judgments granting deduction of interest u/s 36(1)(iii) incurred in respect of borrowings utilized for making investments resulting into exempt income, against the taxable income on the theory of composite basis. In this case, the Special Bench has held that these judgments were rendered at time when the provisions of section 14A were not there and as such the insertion of section 14A has diluted their mandate. The special bench has also held that this section applies to all the heads of income and aims at disallowing expenditure incurred in relation to income which does not form part of the total income even though such expenditure may be allowable under any other provisions such as section 36(1)(iii). It has further been held in this case that provisions of section 14A are applicable with respect to the dividend income earned by the assessee engaged in the business of dealing in shares and securities, on the shares held as stock-in-trade. Insofar as the computation of disallowance u/s 14A is concerned, the Special Bench sent the matter back to the file of A.O. for computing the disallowance as per rule 8D. The said Special Bench order was followed by the co-ordinate bench of the tribunal in the case of Godrej & Boyce Mfg. Co. Ltd. This later case came up before the Hon’ble jurisdictional High Court in Godrej & Boyce Mfg. Co. Ltd. v. DCIT (supra). In this case it has been held that the dividend income and income from mutual funds falling within the ambit of section 10(33) is not includible in computing the total income of the assessee and consequently no deduction can be allowed in respect of expenditure incurred by the assessee in relation to such income by virtue of the provisions of section 14A(1). It has also been held in this case that the provisions of Rule 8D providing for computation of disallowance u/s 14A are not ultra vires but apply only from assessment year 2008-2009. Since the assessment year involved was 2002-2003, the Hon’ble jurisdictional High Court held that the disallowance be computed u/s 14A on some ‘reasonable basis’ and not as per Rule 8D. From the above judgment it emerges beyond any shadow of doubt that the special bench decision in Daga Capital (supra) laying down the making of disallowance of expenditure incurred in earning exempt income has been upheld, except the manner of computation of such disallowance as per rule 8D for the years anterior to A.Y. 2008-09. In the light of the above discussion it is manifest that the reliance by the ld. AR on the judgment in the case of Indian Bank Limited (supra), is no more relevant insofar as the question of disallowance of expenditure u/s 14A in relation to exempt income is concerned.

4.8 The next contention of the ld. AR was that the provisions of section 14A are not applicable where the shares are held as stock in trade. For this proposition he relied on the case of Smt. Leena Ramachandran (supra). It was argued that since the shares were held as the assessee bank as its stock in trade, no disallowance was called for even u/s 14A. Let us examine the facts and ratio of Smt. Leena Ramachandran (supra). The assessee therein was running a business of trading of goods. During the year she paid an interest of Rs. 17,44,310 on funds borrowed for purchase of shares in a company called M/s Homefit Leasing Ltd. The assessee’s claim was that the acquisition of shares with the borrowed funds was for the purpose of controlling the company which was engaged in leasing business. Since the borrowed funds were utilised for acquisition of shares of the company under the control of the assessee, she contended that the utilisation of the borrowed funds was for the business purpose entitling her to deduction of interest under section 36(1)(iii). The Assessing Officer disallowed the claim of interest. First appeal was dismissed confirming the assessment. The Tribunal relying, inter alia, on decision of the Supreme Court in S.A. Builders Ltd. v. CIT (Appeals) [2007] 288 ITR 1 (SC) substantially allowed the claim, but made a disallowance of Rs. 2 lakhs, being the interest stated to be attributable to the dividend income of Rs. 3 lakhs. Against this order, the Revenue preferred an appeal before the Hon’ble High Court. Reversing the order of the Tribunal and restoring the disallowance made by the AO, the Hon’ble High Court observed that any expenditure incurred for earning any income which is not taxable under the Act, is not an allowable expenditure. From the facts of the this case, it is evident that the assessee therein borrowed funds for acquiring shares of the company under its control claiming it as a business purpose. The said ‘business purpose’ was not denied either by the Hon’ble High Court or the authorities under the Act. Obviously, the dividend income from such investment in shares was incidental to the holding of shares of company under its control for the purpose of its business. When the disallowance has been held to be sustainable in that case despite the dividend being incidental income, we are unable to find any logic in not applying the command of the said judgment to the facts of the case under consideration. Here also the assessee has tried to make out a case that the main purpose of the holding of shares was to earn income from sale and the dividend income was just incidental to such holding. Section 14A talks of making disallowance of expenses incurred in relation to an income not chargeable to tax. No exception, such as the dividend being main or incidental income, has been carved out in the provision. The relation of expenses for disallowance is with the exempt income irrespective of the source or nature of the exempt income. When the legislature in its wisdom has not spelt out any exception coming in the way of applicability of section 14A, it is wholly impermissible to artificially find any such exception contrary to the language of the provision and the intention of the legislature. The relevant criterion for making disallowance of expenditure is the exempt income and not whether such exempt income arises intentionally or just incidentally.

4.9 In support of his case, the ld. AR accentuated on the following sentences from the above judgment : ‘In fact, in our view, the assessee would be entitled to deduction of interest under section 36(1)(iii) of the Act on the borrowed funds utilised for the acquisition of shares only if shares are held as stock in trade which arises only if the assessee is engaged in trading in shares. So far as acquisition of shares is in the form of investment and the only benefit the assessee derived is dividend income which is not assessable under the Act, the disallowance under section 14A is squarely attracted and the Assessing Officer, in our view, rightly disallowed the claim.’ It was emphasized that from the above sentences it was clear that the mandate of section 14A has been held to be not applicable in case of the holding of shares as stock in trade. We are unable to find any sanction given by the Hon’ble High Court for not making disallowance u/s 14A when the shares are held as stock in trade. What is provided in the first sentence is that the assessee would be entitled to deduction of interest under section 36(1)(iii) of the Act on the borrowed funds utilised for the acquisition of shares only if shares are held as stock in trade, which arises only if the assessee is engaged in trading of shares. It is obvious that these observations are in the context of allowing deduction u/s 36(1)(iii) and not for making disallowance u/s 14A. The provisions of section 14A come into play only when there is some exempt income. In these observations it has been nowhere said that the disallowance u/s 14A will not be made in respect of exempt dividend income arising from the shares held as stock-in-trade. It is the second sentence, which refers to the receipt of exempt dividend and mandates the making of disallowance under section 14A.

4.10 Be that as it may and without prejudice to above finding, it is seen that the Hon’ble High Court in this case was confronted with a question of disallowance in a situation in which dividend was earned from the shares held for business purpose, which has been decided against the assessee. So the ratio decidendi of the judgment is this disallowance of interest u/s 14A and the other observations are simply obiter dicta, which have been made without there being any question before it. It is a trite law that it is the ratio of a decision which is binding and not its obiter dicta.

4.11 At this juncture it will be relevant to note the facts of Godrej & Boyce (supra), which case also deals with the question of disallowance u/s 14A and, being that of the Hon’ble jurisdictional High Court, has a binding force on us. In that case the assessee claimed a dividend of Rs. 34.34 crores as exempt from the total taxable income under section 10(33). On being called upon to show as to why the net dividend income from tax free securities should not be exempted instead of the gross dividend receipts as claimed in the return, the assessee stated that a major portion of its dividend amounting to Rs. 19.86 crores was received from group companies and the shares of Godrej Soaps Limited were acquired several years earlier as a promoter of that company. The AO made disallowance u/s 14A. The tribunal following the special bench order in Daga Capital (supra) restored the matter to the AO for computing disallowance. On appeal by the assessee, the Hon’ble High Court, has accepted in principle that the disallowance of interest is called for.

4.12 It can be seen from the facts of Godrej & Boyce (supra) that the earning of the dividend income in that case was also incidental to the holding of shares. As the shares were of group concerns and held by that assessee as promoter, naturally there could have been no intention of the assessee to reap the benefit of increase in the price of such shares in the market by parting with them. The assessee was supposed to hold the shares irrespective of any dividend income. The amount of dividend income can, by no stretch of imagination, be characterized as main income and not incidental to the holding of shares. Without going deep into the determination of the character of such shares and drawing a parity from the case of Smt. Leena Ramachandran (supra), which has been relied on by the ld. AR in his support, it can be seen that in both these cases the shares were held in group concerns or for controlling interest. Since in both the cases it has been held that the disallowance u/s 14A is warranted, we see no reason to hold that where the dividend income is only incidental to the shares held as stock in trade, the operation of section 14A shall cease.

4.13 Further, the ld. AR failed to point out, after thoroughly going through the judgment in Godrej & Boyce Mfg. Co. Ltd. (supra), that reference in this case has been made to compute disallowance u/s 14A only in respect of shares held as investment and not as stock in trade. In that view of the matter, the obvious conclusion which follows is that the decision of the Special Bench in the case of Daga Capital Management Pvt. Ltd. (supra), which has been referred to at several places in this judgment, about the applicability of the provisions of section 14A with respect to dividend income earned by the assessee from the shares held as stock-in-trade also, has not been disturbed.

4.14 We, therefore, hold that the contention raised by the learned AR for not applying the provisions of section 14A in respect of dividend income from shares held as stock-in-trade cannot be accepted. As the Assessing Officer computed proportionate expenditure for earning tax free income by certain mathematical exercise, which has also been challenged by the assessee before us, we are of the considered opinion that the ends of justice will meet adequately if the Assessing Officer is directed to compute the disallowance u/s 14A on some ‘reasonable basis’ as per the mandate of the Hon’ble jurisdictional High Court in the case of Godrej & Boyce Mfg. Co. Ltd. (supra). ………………………….”

4.1 It may be mentioned here that for assessment year 1997-98 the CIT(A) had deleted the addition and the revenue was in appeal and the matter is restored back to the file of AO with the aforementioned directions. The aforementioned arguments as well as decision will be equally applicable to the present case. Accordingly, for this year also the matter is restored back to the file of AO with similar directions and this ground of the assessee is considered to be allowed for statistical purposes.

5. Ground No.4 & 5 are covered by the following observation of the Tribunal in ITA No. 5904/Mum/2000, A.Y.1997-98.

5.1 Second ground of the Revenue’s appeal is as under:-

“On the facts and circumstances of the case and in law, the ld. CIT(A) has erred in holding (indirectly) that the expenses attributable to earning the interest income and dividend income of Rs. 43,47,247 and Rs. 40,51,189 are allowable against the income other than interest income and dividend income.”

5.2 The factual matrix apropos this ground is that the assessee earned gross dividend income of Rs. 43,39,411 and also gross interest on foreign currency deposits given to Indian enterprises amounting to Rs. 46,61,509, both eligible for tax at lower rate u/s 115A(1). This amount was offered for taxation on gross basis for the purposes of applying the special rate of tax. The Assessing Officer computed proportionate expenditure incurred for earning these items of income liable to tax u/s 115A at Rs. 40,51,189 and Rs. 43,47,247 respectively in the body of the order and also expressed opinion there itself that such proportionate expenditure at Rs. 83.90 lakh could not be allowed as deduction against the regular income, but shall slice away the amount chargeable to tax at lower rate. That is how, he applied lower rate of tax on the net income amounting to Rs. 6.12 lacs. However, while computing total income of the assessee at the end of the assessment order, he started with the gross total income as per the return of income. Then, he made certain disallowances, but omitted to disallow the proportionate expenditure of Rs. 83.90 lacs against the income chargeable to tax at the normal rate. Thereafter, he computed income chargeable to tax at lower rate u/s 115A on net basis at Rs. 6.12 lac. In this way he committed an error by allowing deduction of Rs. 83.90 lacs twice, firstly, by not adding it to the total income and then by specifically computing income u/s 115A on net basis. Unaware of the overall effect of the AO’s action, the assessee challenged the computation u/s 115A made by the AO on net basis, before the ld. CIT(A). The ld. first appellate authority decided this issue in assessee’s favour by holding that the provisions of section 115A apply on gross income. The Revenue has accepted the finding of the ld. CIT(A) on the question of taxability of the gross amount for the purposes of applying lower rate of taxation. It is evident from the language of the ground reproduced above and also the arguments put forth by the ld. DR that the Revenue now wants that the expenses of Rs. 83.90 lacs should not be allowed as deduction against the income chargeable to tax at the normal rate. In view of the above discussion it is discernible that the issue of not allowing deduction of such expenses against the income chargeable to tax at the normal rate does not emanate from the order of the authorities below. The AO, though discussed the issue in the body of the order and also computed the amount disallowable at Rs. 83.90 lac but committed a mistake by not disallowing such amount in the final computation of total income chargeable to tax at the normal rate. Then, the ld. CIT(A) also never held that such expenses are deductible against the other income. He was called upon to decide the question of gross or net amount eligible for taxation at special rate, which he decided in assessee’s favour, which finding has been accepted by the Revenue.

5.3 It is therefore, palpable that the grouse of the Department through this ground in requiring us to hold that such expenses should not be allowed as deduction against the other income chargeable to tax at normal rate, does not emanate from the impugned or the assessment order. It is axiomatic that the tribunal is not a forum for rectifying such mistakes committed by the AO. For that purpose, there are other provisions, such as, revision u/s 263 and rectification u/s 154. On this very short point, this ground is liable to be dismissed.

5.4 We find that it is recurring issue in other years as well. Further, the ld. AR has not argued on this line of reasoning. Rather both the sides have made submissions on merits, for or against the deductibility of such expenses against the income chargeable to tax at normal rate. As such, we are proceeding to dispose of this issue on merits by considering the arguments put forth by the rival parties.

5.5 The learned Departmental Representative vehemently contended that the proportionate expenditure incurred for earning dividend and interest income liable for tax at special rate u/s 115A, could not have been allowed as deduction against the other incomes chargeable to tax at the normal rate. It was submitted that if a lower rate of tax is applied to a particular income and the expenditure incurred on earning such income is allowed to be set off against other incomes, it amounts to undue benefit to the assessee, contrary to the intent of the statute. He submitted that the action of the ld. CIT(A) has unduly favoured the assessee, firstly, by the application of the reduced rate of taxation u/s 115A on such income and secondly, by allowing the deduction of expenditure incurred for earning income liable to tax at lower rate, against the income liable for tax at regular rates.

5.6 We are not convinced with the submissions made on behalf of the Revenue. It is undisputed that the Revenue is aggrieved against the allowability of expenditure incurred in respect of earning dividend and interest income liable to tax at special rate u/s 115A, against the income chargeable to tax at normal rate. It is not a case and cannot be that such dividend and interest income are not at all chargeable to tax. The contention which has been made is that the expenses incurred by the assessee in respect of income liable to tax at special rate u/s 115A should not be allowed as deduction against the income chargeable to tax at normal rate. This contention, in our considered opinion, is devoid of merits. The judgment of the Hon’ble Supreme Court in Rajasthan State Warehousing Corporation (supra) is authority for the proposition that if an assessee is carrying an indivisible business then the entire expenditure including that which was incurred for earning the tax free income would be a permissible deduction. The legislature introduced section 14A with an intention to set at naught the ratio of this and such other judgments by providing that expenditure incurred in relation to ‘income which does not form part of total income under this Act’ shall not be allowed as deduction. In other words, the deductibility of expenses incurred for earning exempt income has been inhibited. But for that, the ratio of these judgments is intact. To put it simply, the decision of allowing entire expenditure incurred by the assessee in an indivisible business against the taxable income has been statutorily altered by forbidding the allowability of expenses incurred in relation to exempt income.

If the income is not exempt but chargeable to tax at a lower rate, then two consequences follow. Firstly, the provisions of section 14A shall cease to apply and secondly, the position will stand covered by the judgment in the case of Rajasthan State Warehousing Corporation (supra) for allowing the expenses in full without any apportionment. Section 14A does not provide that if income is liable to tax at a lower rate then also the proportionate expenditure should not be allowed as deduction against the other business income. As the assessee in the instant case is carrying on one composite business earning incomes, which are either not at all chargeable to tax, or chargeable tax at the lower rate or chargeable to tax at regular rate, what has been inhibited by section 14A is the deduction of expenses incurred by the assessee in relation to income not at all chargeable to tax and not the income chargeable to tax at lower rate of tax. We, therefore, do not find any force in this submission advanced by the ld. DR. Ex consequenti, it is held that the assessee is entitled to deduction of Rs. 83.90 lac against the income chargeable to tax at the regular rate of tax, which has, in fact, been inadvertently allowed by the AO. This ground is dismissed on merits as per law and on facts as having become academic.

Accordingly these grounds of the assessee are allowed.

6. Apropos Ground No.6, this issue has been discussed by the AO at page 21 of the assessment order under the head “(V) Interest received from and paid to overseas branches.” The AO noted that during the financial year ended as on 31/3/1998, the assessee had received interest amounting to Rs. 29,67,23,640/- on funds placed with its overseas branches and paid interest amount to Rs.19,09,987/- on funds placed with it by its overseas branches. The AO required the assessee to explain as to why the interest received from the funds placed by the assessee with its overseas branches should not be assessed as income and not being satisfied with the submissions of the assessee, the AO held that assessee is covered by section 9(1)(v)(c) of the Act as the interest is paid by the head office for carrying out the smooth business operations in India, therefore, interest income earned by the assessee from its head office is taxable in India and in this manner a sum of Rs. 29,48,13,653/- was added to the income of the assessee. Ld. CIT(A) has confirmed the disallowance and the assessee has raised the aforementioned ground.

7. It was submitted that this issue is covered in favour of the assessee by the decision of ITAT in assessee’s own case for A.Y. 1991-92. To support such contention a copy of the decision dated 28/02/2007 in ITA No. 2770/Mum/1996 & 2439/Mum/1996 was filed, wherein the issue has dealt by the Bench from para 28 to 35. The ground raised by the revenue on this issue and the facts narrated in the said order are as under:-

“28. Ground No. 13 raised by the Revenue, reads as under:

“On the facts and in the circumstances of the case and in law, the learned CIT(A) has eared in holding that interest received by the assessee from their non-resident branches cannot be taxed, relying upon the decision in the case of Citibank v. IAC (Bombay Tribunal) without appreciating the fact that said decision has not been accepted by the Department.”

Briefly stated the facts are, that the assessee had shown gross interest received from non resident branches at Rs. 1,84,70,485/- and interest paid at Rs. 32,16,015/-. Accordingly, the sum of Rs. 1,52,54,470/- was shown as net interest received from non resident branches. This net amount was claimed as deduction from the income shown in the P&L Account on the ground that no one can earn from oneself. Reliance was placed on the decision of the Tribunal in the case of Citibank N.A. v. IAC the Assessing Officer observed that the Department had filed appeal against the order of the Tribunal before High Court and, therefore, he refused to allow any deduction on this account. However, on appeal, the Learned CIT (Appeals) allowed the claim of the assessee following the decision of the Hon’ble Calcutta High Court in the case reported as 116 ITR 455. Aggrieved by the same, the Revenue is in appeal before the Tribunal.”

The Tribunal after hearing both the parties has decided the issue as under:

“31. Rival submissions of the parties have been carefully considered. We are faced with a dilemma since, on one hand, there is decision of Special Bench in the case of ABN Amro Bank (supra) as well as four decisions of Division Benches (Bombay Benches) in favour of assessee wherein it has been held that despite entries in books of accounts, no income by way of interest accrues or arises between the branches and Head Office or vice-versa on the theory that there cannot be any income/expenditure from self to self, while on the other hand, there is decision of Division Bench of the Tribunal in the case of Dresdner Bank (supra), wherein it has been held that it is the income of PE/Indian Branches which accrues or arises in India that is taxable under the Act and, therefore, interest received by or interest paid by Indian branches of non-resident has to be taken into consideration while computing the income of such Indian branches/PE.

32. In the case of ABN Amro Bank (supra), the question before the Special Bench was as under:

“Whether the provision of interest by a permanent establishment of a foreign enterprise payable to head office and/or other branches outside India is allowable deduction and if so, whether the provision of Section 40(a)(i) is attracted in respect of such payment/provision?”

At the outset, it is pointed out that in the case before the Special Bench, there existed treaty between India and Netherlands. However, for the reasons given by the Special Bench in Para-25, it was held that provisions of treaty did not apply to the dis-allowability of interest paid to Head Office while computing the income of the PE/Indian branches of the bank and, therefore, the question whether such interest is to be disallowed or not has to be considered with reference to local law. Considering the legal position under the local law in Paras-18 to 24 of its judgment i.e. the decision of the apex court in the case of Sir Kikabhai Premchand 24 ITR 506, the decision of Calcutta High Court in the case of Betts Hartley Huett and Co. Ltd. 116 ITR 425, the decision of Allahabad High Court in the case of Ramlal Bechai Ram 14 ITR 1 and various decisions of the tribunal, it was held in para 25 as under:

“Looked at from that point of view we are of the opinion that law and even as per the ld. Counsel of the assessee the local law does not allow any deduction of the payment of expenditure to self. Nor it assumes the interest receipt from self through a branch or PE as its income and charges it to tax.” (Emphasis supplied)

The above legal finding makes it clear that neither the interest paid by Indian Branches to Head Office is deductible as an expense nor interest received from Head Office is to be treated as income under the Income Tax Act, 1961.

This issue was also examined from another angle. In Para-26, it was observed as under:

“We can look at the issue from a different angle and on the assumption that the contention of the parties that PE is a different entity than its head office and the interest payment by the PE to head office is an allowable deduction, on the parity of reasoning, the receipt by the head office of the interest paid by the PE would be chargeable to tax in India u/s 5(2) of the Act read with Article 11 of the DTAA. As there is only one assessment in the case of the assessee Bank both for the profit earned by the PE as well the income earned by the head office in India. The result would be that on one hand, an expenditure by way of payment of interest by PE to head office would be allowable as a deduction and on the other, the receipt by the head office from PE would have to be charged to tax because the interest has been earned by and arisen and accrued to the head office in India. Result would be same in both cases i.e., the income or expense is nil in the first case because no profit is earned from self and, therefore, nothing accrued and in the second case again Nil by allowing deduction of payment of interest by PE to head office and assessing the receipt of interest in the head office being receipt of income by head office from PE.”

The above observations also make it clear that interest received by non-resident from its Branches in India would not be chargeable to tax in India even assuming that both are separate entities.

33. With reference to the second part of the question referred, the Special Bench considered the provisions of Section 40(a)(i) as well as Section 195 of the Act and then observed in Para-30 as under:

“The assessee in this case is the corporate body and its branches are paying interest to its Head office and other offshore Branches i.e., the payment is by one wing of the assessee to its other wing or so to say by one hand to another. The tax is to be deductible under Chapter XVII-B of the Act and in case of a payment to non-resident it is section 195 of the IT Act. This section provide that “Any person responsible for paying to a non-resident not being a company, or to a foreign company, any interest or any other sum chargeable under the provisions of this Act (not being income chargeable under the head ‘Salaries’ shall at the time of credit of such income to the account of the payee or at the time of payment thereof in cash or by the issue of a cheque or draft or by any other mode whichever is earlier deduct income tax thereon at the rates in force. The Branch/PE of the assessee in India is not a person in legal terminology. The person is the Corporate Body ABN Amro Bank NV and not its Branches or the PE. This is also evident from the fact that assessment in this case is made on the Corporate Body ABN Amro Bank NV and not on its Branch or PE. We, therefore, find force in the assessee’s contention that the provisions dealing with deduction of tax at source u/s 195 presupposes the existence of two distinct and separate entities which is absent in the present case. On both the grounds, therefore, section 40(a)(i) does not come into play. Disallowance of interest on this by invoking the provisions of this section would not be justified.” (Emphasis supplied)

Again in Para-33, it was observed as under:

“We also find force in the submission of the assessee that the interest paid being not the income of the assessee on the ground that no income does arise from self and consequently interest paid by PE to head office is not chargeable under the provisions of this Act which is a condition precedent for invoking the provisions of sec. 195 and also on the ground that payment by PE is cancelled by the receipt by the Head Office of the assessee enterprise, in case if the PE is considered as a separate entity than the Head Office of the assessee enterprise.” (Emphasis supplied)

The above observations also make it clear that as per the decision of the Special Bench, the interest received by Head Office of non-resident Bank cannot be said to be income chargeable to tax in India and, therefore, the provisions of Section 195 are not attracted. It is also held in clear terms that it is the body corporate which is assessable and not the branch/PE in respect of the income which accrues or arises in India or the income which is deemed to accrue or arise in India as per section 5(2) r/w section 9 of the Act.

The above reading of the Special Bench clearly reveals as under:

 (i)  That the treaty between the two countries was not applicable regarding disallowability of interest paid by Indian branch to head office and therefore, Local Law would be applicable in deciding such issue;

(ii)  That as per Income Tax Act, 1961, the person assessable in India is non-resident body corporate and not its Branch or PE;

(iii)  That payment of interest form Indian Branches to its head office of non-resident corporate body is the payment from self to self and, therefore, the same neither constitute income nor expenditure in the hands of Indian Branch;

(iv)  That even assuming that both are separate entity, the interest received by Head Office would not be taxable as interest accrued by Head Office would be cancelled by the expenditure allowed in the hands of Branch in India.

34. On the other hand, the Division Bench, in the case of Dresdner Bank (supra), took a different view even after considering the Special Bench Division. It is surprisingly to note that in Para-22, it agreed to the legal position that in case of foreign company, taxable unit under the Income Tax Act, 1961, is the foreign company and not its Branch or PE in India as apparent from the following observations:

“This elementary analysis makes it clear that under the Income Tax Act, so far as foreign companies are concerned, taxable unit is a foreign company and not its branch or permanent establishment in India, even though the taxability of such foreign companies is confined to (i) an income which accrues or arises in India or is deemed to accrue or arise in India and (ii) an income which is received or is deemed to be received by or on behalf of such foreign company.”

But in Para-24, it took contrary stand by observing as under:

“The only way, in our humble understanding, it can be so done is by treating the India PE as a fictionally separate profit center vis-à-vis the German GE. The very concept of computation of PE profits is created as a fiction of tax law in order to demarcate tax jurisdiction over the operations of a company in a country of which it is not a tax resident. Unless the PE is treated as a separate profit center, it is not possible to ascertain the profits of the permanent establishment which, in turn, constitute profits accruing or arising to the foreign GE in India.”

In view of the above observations in para 24, the bench did not accept the contention of the assessee that intra organization transactions are to be ignored for computing the profits of the organization as a whole (see paras 27 – 30). Vide paras 40-42, the bench, for the reasons given therein, distinguished the decision of Hon’ble Calcutta High Court in the case of Betts Hartley Huett & Co. (116 ITR 425) on which reliance was placed by the Special Bench. In para 46, the bench distinguished the other decisions of coordinate bench by observing that there was no discussion in these cases of any kind whether profits to be taxed in India are of the entire business or only the India branch. On the other hand, the bench followed the decision of another coordinate bench in the case of Banque Indosuez, wherein it has been held that decision of Hon’ble Calcutta High Court in the case of Betts Hartley Huett & Co. cannot be applied where profits of a PE as a separate unit is to be considered.

In view of the above discussion, it is clear that the division bench in the case of Desdner Bank held as under:

 (i)  It is the profit or PE or Indian branch of a non-resident bank which is assessable under the provisions of the Income Tax Act, 1961 and not the income of General Enterprise i.e. non-resident as one unit.

(ii)  If PE/Indian branch is to be assessed as an independent unit then intra organization transaction cannot be ignored. Hence interest received by PE in India is taxable u/s. 5(2) r.w.s. 9(1) of the Act.

35. The comparative study of both the judgments shows that there is conflict between the ratio laid down by the decisions of Special Bench in the case of ABN Amro Bank (supra) and the decision of Division Bench in the case of Desdner Bank (supra). It is not in our domain to make any comment on the decision of the Division Bench. However, there is no dispute to the legal position that in case of conflict between the decisions of Special Bench and Division Bench, it is the decision of Special Bench which would prevail. In the present case, admittedly, there is no treaty between India and USA in the year under consideration. Accordingly, in view of the Special Bench, it is the local law i.e. the provisions of Income Tax Act, 1961 which would be applicable. Therefore, following the decisions of Special bench, it is held that income received/receivable by the Indian branch from head office is not chargeable to tax. The order of learned CIT(A) is therefore, upheld on this issue.”

8. The Id. AR stated not to have any objection if the PE and the GE are treated as one, meaning thereby, that neither any deduction is allowed for the interest paid to HO or foreign branches nor income is recognized in respect of the interest earned in transactions between the HO and PE. It was submitted that the tribunal, in an earlier year, in its own case has held so following the special bench order in the case of ABN Amro Bank NV v. Asstt. DIT [2005] 97 ITD 89 (Kol.)(SB). The Id. DR did not raise any objection to it. In view of the above rival but common submissions, we hold that no deduction be allowed for interest paid to HO at Rs. 19,09,987 and at the same time no income can be taxed on account of interest earned from HO amounting to Rs. 29,67,23,640. This ground is, therefore, partly allowed.

9. Ground No.7. This issue has been discussed by the AO at page 30 of the assessment order. Vide letter dated 14/2/2001, filed during the course of assessment proceedings the assessee claimed an amount of Rs. 5,87,13,861/- under the provision of section 43D. It was submitted that as per accounting policy followed by the assessee, when the interest on loans remains unpaid for more than 90 days or the principle remain unpaid for more than 90 days, the loans are classified as non-accrual loans. Once a loan is classified as non-accrual loan, the unpaid interest in respect of such loan is reversed to an account called Reserve for Doubtful Interest (RFDI ) Account. All subsequent interest accruals of such loans are directly credited to the RFDI Account and not to the P&L Account of the assessee; recoveries of such interest are however, reversed from RFDI Account to interest income. It was further submitted that for the purpose of computing income chargeable to Tax the assessee adds to the net profits as per P&L Account, the net amount credited to RFDI account for that year i.e. the interest accruals in RFDI Account net of recoveries. It was submitted that such tax treatment results in offering the interest on non-accrual loans to tax on the accrual basis, notwithstanding that such interest has not been credited to the P&L Account of the assessee.

10. Considering aforementioned submissions the AO observed that the assessee should have claimed such amount in either original return or in revised return. As the assessee did not claim any such amount even in the revised return, the claim of the assessee cannot be entertained at the stage of assessment. Alternatively, the AO has held that the claim of the assessee is not tenable because the assessee has credited such amount in the RFDI Account. Section 43D of the Act envisages that the assessee had not accounted at all the interest in its account. If the interest is credited in any of the accounts, it will automatically be treated as credited in the P&L Account because P&L Account is ultimately prepared from the accounts of the assessee. It is in this manner AO did not allow the claim of the assessee.

11. Ld. CIT(A) has dealt with this issue in para 31 to 34 of the impugned order and Ld. CIT(A) has rejected the claim of the assessee by upholding the observations of AO made in the assessment order.

12. After narrating the facts, Ld. A.R referred to the provisions of Section 43D of the Act, which is applicable in the case of income of Public Financial Institutions, Public Companies etc. and it will be relevant to reproduce the relevant part of the said section.

“43D. Notwithstanding anything to the contrary contained in any other provision of this Act,—

 (a)  in the case of a public financial institution or a scheduled bank or a State financial corporation or a State industrial investment corporation, the income by way of interest in relation to such categories of bad or doubtful debts as may be prescribed²³ having regard to the guidelines issued by the Reserve Bank of India in relation to such debts;

 (b)  ………………………………………………………………shall be chargeable to tax in the previous year in which it is credited by the public financial institution or the scheduled bank or the State financial corporation or the State industrial investment corporation or the public company to its profit and loss account for that year or, as the case may be, in which it is actually received by that institution or bank or corporation or company, whichever is earlier.”

Referring to the aforementioned provision it was submitted by Ld. A.R that assessee is a Scheduled Bank, the income by way of interest in relation to such categories of bad or doubtful debts as may be prescribed having regard to the guidelines issued by RBI in relation to such debts shall be chargeable to tax in the previous year in which it is credited by the assessee to its P&L Account for that year or, as the case may be, or the year in which it is actually received by the assessee, whichever is earlier. It was submitted that interest was never credited by the assessee bank to P&L Account and whatever was actually received by the assessee has been shown as income and reference was made to the following chart:

“American Express Bank Ltd.

Details of interest on ‘non-accrual loans”

Thus it was pleaded by Ld. A.R that claim of the assessee has wrongly been rejected and it should be allowed as per section 43D of the Act.

13. Ld. DR submitted that firstly Section 43D of the Act is applicable to the Scheduled Banks and assessee has not established that it is a Scheduled Bank. In response Ld. A.R submitted a copy of Explanatory Note dated 1/09/2010 obtained from the website of Reserve Bank of India in which at Point No. 14 it is mentioned that American Express Bank Ltd. is in existence/operation as on 31/3/2005 as merged/renamed/closed thereafter and at Sl. No. 9 in the said point assessee having eight branches has been merged with Standard Chartered Bank w.e.f. 5/3/2008. Thus it was submitted by Ld. A.R that assessee is a Scheduled Bank.

14. Ld. D.R further submitted that assessee had credited the interest in its books of account and, therefore, AO as well as Ld. CIT(A), both are correct in rejecting the claim of the assessee.

15. We have carefully considered the rival submissions in the light of the material placed before us. The provisions of section 43D of the Act have already been reproduced above. For the year under consideration assessee is a Scheduled Bank. Section 43D of the Act is special provision in the case of income of public financial institutions. It is not even the case of AO that the policy adopted by the assessee with regard to categories of bad or doubtful debts is not in accordance with the guidelines prescribed and issued by Reserve Bank of India in relation to such debts. Therefore, the incidence of taxation of interest on such debts will be either when the same is credited to the P&L Account for that year or in the year in which it is actually received. Mere crediting of the interest to a reserve cannot be said to be an incidence by which the said interest could be charged to tax. Whatever has been recovered by the assessee has been shown as income. Therefore, we are of the opinion that the assessee is entitled to claim of such interest under the provisions of section 43D of the Act and the claim of the assessee cannot be rejected simply on the ground that interest has been credited on such type of debts in the reserve account. However, for the verification of the figures, we direct the AO to see that what has actually received by the assessee during the year has been offered to tax, we restore the matter to the file of AO for such verification. This ground of the assessee is allowed for statistical purposes in the manner aforesaid.

16. In the ITA No.5374/Mum/2001 is partly allowed for statistical purposes in the manner aforesaid.

INT.T.A. NO.97/MUM/2001:

17. The inclusion of aforesaid amount of interest of Rs. 5,87,37,862/- in the taxable interest was challenged by the assessee on the basis of proviso to section 5 of the Interest Tax Act r.w.s. 43D of the Income Tax Act, according to which interest on such non-performing assets was to be charged to interest tax only in the year in which the said interest is credited to the P&L Account or in the year of receipt, which is earlier. We have already recorded our finding that section 43D is applicable to the case of the assessee and interest can only be charged to the extent it is actually received during the year. The relevant figures have already been reproduced in earlier part of this order. Ld. A.R has submitted that this issue may be restored back to the file of AO for making re-computation of the assessable interest as there is some wrong calculations in the computation of the assessable interest.

18. It has already been mentioned that interest on non-performing assets as described in section 43D of the Act can be assessed only in a condition that either they are credited to P&L Account or it is actually received. In the present case of the assessee since interest is not credited on such assets to the P&L Account, therefore, whatever interest is actually received on such assets is taxable. The same principle will be applicable to interest tax also. Keeping in view this principle, after hearing both the parties we direct the AO to recompute the assessable interest after giving the assessee a reasonable opportunity of hearing and if there is incorrectness in the interest computed as assessable the same may also be removed. With these directions the appeal filed by the assessee is treated as allowed for statistical purposes in the manner aforesaid.

19. In the result, INT. TA. No. 97/Mum/2001 is treated as allowed for statistical purposes in the manner aforesaid.

Order pronounced in the open court on the 10th day of August, 2012

NF