Case Law Details

Case Name : ACIT Vs Davangere District Central Co-op Bank Limited (ITAT Bangalore)
Appeal Number : ITA No.1403/Bang/2019
Date of Judgement/Order : 17/06/2022
Related Assessment Year : 2011-12

ACIT Vs Davangere District Central Co-op Bank Limited (ITAT Bangalore)

At the outset, we find that the CIT(A) has proceeded on a wrong presumption that the sum claimed as a deduction was on account of write off of bad debts. This presumption of the CIT(A) is erroneous because factually it was a case of embezzlement by the employee of the assessee which resulted in a loss to the bank. In the course of the hearing, our attention was drawn to a circular of the CBDT which deals with the question as to when a deduction on account of loss on account of embezzlement can be allowed as a deduction and the said circular reads as follows:

SECTION 28(i) OF THE INCOME-TAX ACT, 1961 – BUSINESS LOSS/DEDUCTIONS ALLOWABLE AS – LOSS ARISING DUE TO EMBEZZLEMENT – WHETHER IT SHOULD BE TREATED AS INCIDENTAL TO BUSINESS AND SHOULD BE ALLOWED AS DEDUCTION IN THE YEAR IN WHICH IT IS DISCOVERED

CIRCULAR : NO. 35-D (XLVII-20) [F. NO. 10/48/65-1T(A-0],
DATED 24-11-1965

1. A reference is invited to the instructions on the above subject contained in the Board’s Circular No. 25 of 1939 and Circular No. 13 of 1944 [Clarification 2]. In these circulars it was clarified that losses arising due to embezzlement of employees or due to negligence of employees should be allowed if the loss took place in the normal course of business and the amount involved was necessarily kept for the purpose of the business in the place from which it was lost. Since the above circulars were issued, the Supreme Court has further considered the matter and laid down the law in this regard in the following two decisions in Badridas Naga v. CIT [1958] 34 ITR 10 and Associated Banking Corporation of India Ltd. v. CIT [1965] 56 ITR 1.

In the first case, the Supreme Court has affirmed the view that the loss resulting from embezzlement by an employee or agent of a business is admissible as a deduction under section 10(1) of the 1922 Act [corresponding to section 28 of the 1961 Act] if it arises out of the carrying on of the business and is incidental to it. In the second case, the decision is that loss must be deemed to have arisen only when the employer comes to know about it and realises that the amounts embezzled cannot be recovered.

2. In the light of the above decisions of the Supreme Court, the legal position now is that loss by embezzlement by employees should be treated as incidental a business and this loss should be allowed as deduction in the year which it is discovered.

On perusal of clause-1 of the aforesaid circular, it is clear that loss due to embezzlement by employees should be treated as a loss incidental to business. To this extent, in this case, there is no doubt that the assessee suffered a loss on account of embezzlement in the sense a fraud was carried out in one of its branches. With regard to the year in which the deduction is to be allowed,  the circular lays down that the loss should be allowed as a deduction in the  year in which the embezzlement was discovered. Factually, this aspect has neither been examined nor substantiated by the assessee either before the AO or the CIT(A). We are therefore of the view that the issue requires to be set aside to the AO for consideration afresh in the light of the CBDT’s circular referred to above only on the question as to in which year the loss has to be allowed as deduction.

FULL TEXT OF THE ORDER OF ITAT BANGALORE

This is an appeal by the Revenue against the order dated 27.03.2019 of CIT(A), Davangere, relating to Assessment Year 2011-12.

2. The grounds of appeal raised by the Revenue reads as follows:

1. The order of the Commissioner of Income Tax (Appeals), Davangere, is opposed to the law and not on the facts and circumstances of the case.

2. The CIT (Appeal) erred in granting relief to the assessee on the addition made on account of Interest accrued on Non-performing Assets (NPA).

3. The CIT (Appeal) erred in coming to the conclusion that the assessee can follow mixed system of accounting.

4. The CIT (Appeal) failed to appreciate the rationale of decision in the case of Hon’ble Supreme Court of India in Southern Technologies Ltd., Vs. JCIT (2010) 320 ITR 577. RBI Guidelines are only prudential norms and cannot overrule income recognition as per Income-tax Act.

5. The CIT(Appeals) erred in granting relief to the assessee on the addition made on account of claim of -provision for misappropriation amounting to Rs. 7,50,99,000/-as there is reasonable prospect of getting the misappropriate amount back, since the Bank has already attached the assets of the persons who indulged in fraud.

6. For these and other grounds that may be urged upon, the order of the CIT(A) may be reversed and that assessment order be restored.

7. The appellant craves leave to add, alter, amend or delete any other grounds on or before hearing of the appeal.

3. The assessee is a District Central Co-operative Bank carrying on banking business governed by Karnataka State Co-operative Societies Act, 1959, and the rules and regulations of NABARD and also RBI Guidelines for Banking activities. The assessee had debited an amount of Rs.7,50,99,000/- as provision for misappropriation in the P & L account and computed income from business after such deduction. The assessee had reduced this amount from loans and advances in the balance sheet. The assessee explained that the co-op department of Government of Karnataka conducted an enquiry on misappropriation in one of assessee’s branch at Honalli and submitted a report. The assessee submitted that a fraud occurred in the bank and was under enquiry by the Co-operative Societies Enquiry office under the Karnataka Co-operative Societies Act, 1959, under section 64. It is very difficult to recover the misappropriated amount [if the bank recovers as an affidavit is already filed the bank that it will admit the recovered amount as income] the recovery of the fraud amount depends upon the Sec.64 enquiry report under the Co-operative Spcoetoes Act. 1959.

4. The AO, after examining the claim of the assessee, held that there was a reasonable prospect of getting the misappropriated amount back since the bank has already attached the assets of the persons who indulged in fraud. The assessee bank did not prefer claim before the insurance company, though the bank is registered with insurance company for possible damage. Further, as per the audit report dated 13.01.2012 of M/s Bagrecha & Singhvi, Bellary at page No.8 had commented as under:

“C NON CLAIM OF INSURANCE IN RESPECT OF LOSS ARISING DUE TO MISAPPROPRIATION

A perusal of the Bankers Indemnity Policy taken by the banker with National Insurance Company Limited shows that the sad policy provides cover for the loss arising due to forgery or alteration due to dishonesty or criminal act of employee but it has been observed that no claim has been preferred by the banker in respect of employee fraud reported in Honalli Branch during the year.”

For the above reasons, the AO denied the claim of the assessee of the aforesaid sum.

5. Aggrieved by the order of the AO, the assessee preferred appeal before the CIT(A). The CIT(A) deleted the addition made by the AO on the basis that it was a write off bad debts and the assessee is entitled to claim deduction of bad debts purely on the basis of mere write off. Following were the observations of the CIT (A) in this regard:

“8a. I have carefully perused the order of the AO and the submissions made by the appellant. A conjointreading ofSection 36(2) and Section 36(i)(vii) makes it clear that the assessee would be entitled to a deduction of the amount of any bad debt which has been written offas irrecoverable in its Accounts for the previous year.

In order to eliminate the disputes in the matter of determining the year in which a bad debt can be allowed and also to rationalize the provisions, the Amending Act, 1987 to provide that the claim for bad debt will be allowed in the year in which such a bad debt has been written off as irrecoverable in the accounts of the assessed.

Any lingering doubt would vanish on a careful reading of Circular Number 551 dated 23.1.1990.

The assessee has relied on various case laws and there are many other case laws noted by me. The case law relied on by the AO was. relation to the old provisions of law as it stood before its amendment 1987.

The Delhi High Court in the case of Commissioner Of Income Tax vs Morgan Securities And Credits (P) as reported in 210 CTR Del 336 held as under:

“It is our view that the Circular Number 551 leaves no scope for debate since it specifically notices the previous practice of having to establish that a debt had become bad in the previous year, which had generated enormous litigation on the question of allowability of bad debt in a particular year. The Circular expressed the hope that this litigation would be eliminated by permitting a debt to be treated as a bad or recoverable no sooner it was . written off in the books of the assessed concerned.”

Therefore, respectfully following the decision of the Delhi High Court, I am of the opinion that the appellant is entitled to relief and the AO is ordered to delete the addition. Thus, the ground succeeds.”

6. Aggrieved by the order of the CIT(A), Revenue has referred the present appeal before the Tribunal.

7. We have heard the submissions of the learned DR and the learned Counsel for the assessee. At the outset, we find that the CIT(A) has proceeded on a wrong presumption that the sum claimed as a deduction was on account of write off of bad debts. This presumption of the CIT(A) is erroneous because factually it was a case of embezzlement by the employee of the assessee which resulted in a loss to the bank. In the course of the hearing, our attention was drawn to a circular of the CBDT which deals with the question as to when a deduction on account of loss on account of embezzlement can be allowed as a deduction and the said circular reads as follows:

SECTION 28(i) OF THE INCOME-TAX ACT, 1961 – BUSINESS LOSS/DEDUCTIONS ALLOWABLE AS – LOSS ARISING DUE TO EMBEZZLEMENT – WHETHER IT SHOULD BE TREATED AS INCIDENTAL TO BUSINESS AND SHOULD BE ALLOWED AS DEDUCTION IN THE YEAR IN WHICH IT IS DISCOVERED

CIRCULAR : NO. 35-D (XLVII-20) [F. NO. 10/48/65-1T(A-0],
DATED 24-11-1965

1. A reference is invited to the instructions on the above subject contained in the Board’s Circular No. 25 of 1939 and Circular No. 13 of 1944 [Clarification 2]. In these circulars it was clarified that losses arising due to embezzlement of employees or due to negligence of employees should be allowed if the loss took place in the normal course of business and the amount involved was necessarily kept for the purpose of the business in the place from which it was lost. Since the above circulars were issued, the Supreme Court has further considered the matter and laid down the law in this regard in the following two decisions in Badridas Naga v. CIT [1958] 34 ITR 10 and Associated Banking Corporation of India Ltd. v. CIT [1965] 56 ITR 1.

In the first case, the Supreme Court has affirmed the view that the loss resulting from embezzlement by an employee or agent of a business is admissible as a deduction under section 10(1) of the 1922 Act [corresponding to section 28 of the 1961 Act] if it arises out of the carrying on of the business and is incidental to it. In the second case, the decision is that loss must be deemed to have arisen only when the employer comes to know about it and realises that the amounts embezzled cannot be recovered.

2. In the light of the above decisions of the Supreme Court, the legal position now is that loss by embezzlement by employees should be treated as incidental a business and this loss should be allowed as deduction in the year which it is discovered.

Cash loss due to embezzlement by employees allowable in year of discovery

8. On perusal of clause-1 of the aforesaid circular, it is clear that loss due to embezzlement by employees should be treated as a loss incidental to business. To this extent, in this case, there is no doubt that the assessee suffered a loss on account of embezzlement in the sense a fraud was carried out in one of its branches. With regard to the year in which the deduction is to be allowed,  the circular lays down that the loss should be allowed as a deduction in the  year in which the embezzlement was discovered. Factually, this aspect has neither been examined nor substantiated by the assessee either before the AO or the CIT(A). We are therefore of the view that the issue requires to be set aside to the AO for consideration afresh in the light of the CBDT’s circular referred to above only on the question as to in which year the loss has to be allowed as deduction.

9. The learned Counsel for the assessee submitted that in the set aside proceedings, if it is found that the loss was not detected in the relevant previous year, direction should be given that it should be allowed in the year in which it was detected, as is laid down in the CBDT’s Circular referred to above. We are of the view that the submissions so made by the learned Counsel for the assessee is fair and reasonable and therefore the AO is directed to allow deduction in the year in which the embezzlement by the employee was discovered by the assessee. With these observations, we allow the appeal of the Revenue for statistical purposes.

10. In the result, the appeal of the Revenue is treated as allowed for statistical purpose.

Pronounced in the open court on the date mentioned on the caption page.

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